<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 10, 1996
REGISTRATION NO. 333-14327
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 2 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
NETSOURCE COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 4813 68-0386077
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
INCORPORATION OR
ORGANIZATION)
444 SPEAR STREET, SUITE 200
SAN FRANCISCO, CALIFORNIA 94105
(415) 243-8080
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
EDWARD A. BRINSKELE
CHIEF EXECUTIVE OFFICER
NETSOURCE COMMUNICATIONS, INC.
444 SPEAR STREET, SUITE 200
SAN FRANCISCO, CALIFORNIA 94105
(415) 243-8080
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
AARON J. ALTER CHRISTOPHER L. KAUFMAN
DAVID J. SEGRE ORA T. FRUEHAUF
CHRISTOPHER K. SADEGHIAN TAD J. FREESE
WILSON SONSINI GOODRICH & ROSATI LATHAM & WATKINS
PROFESSIONAL CORPORATION 505 MONTGOMERY STREET,
650 PAGE MILL ROAD SUITE 1900
PALO ALTO, CALIFORNIA 94304 SAN FRANCISCO, CA 94111
(415) 493-9300 (415) 391-0600
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH
SECTION 8(A), MAY DETERMINE.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANYSTATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED DECEMBER 10, 1996
[LOGO OF NETSOURCE]
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3,500,000 SHARES
COMMON STOCK
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All of the 3,500,000 shares of Common Stock offered hereby are being sold by
NetSource Communications, Inc. ("NetSource" or the "Company"). Prior to this
offering, there has been no public market for the Common Stock of the
Company. It is currently anticipated that the initial public offering price
will be between $13 and $15 per share. See "Underwriting" for a discussion of
the factors to be considered in determining the initial public offering
price.
Of the 3,500,000 shares of Common Stock offered hereby, 2,800,000 shares are
being offered for sale in the U.S. by the U.S. Underwriters, and 700,000
shares are being offered for sale in Europe and Canada by the International
Underwriters (together, the "offering"). See "Underwriting."
The Company has applied to have the Common Stock approved for quotation on
the Nasdaq National Market under the trading symbol "NSCE."
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" COMMENCING ON PAGE 8.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
Per Share $ $ $
Total (3) $ $ $
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other information.
(2) Before deducting expenses of the offering payable by the Company
estimated at $1,350,000.
(3) The Company has granted to the Underwriters a 30-day option to purchase
up to an additional 525,000 shares of Common Stock for the purpose of
covering over-allotments. If the Underwriters exercise such option in
full, the total Price to Public, Underwriting Discount and Proceeds to
Company will be $ , $ and $ , respectively. See "Underwriting."
The shares of Common Stock are offered by the Underwriters when, as and if
delivered to and accepted by them, subject to their right to withdraw, cancel
or reject orders in whole or in part and subject to certain other conditions.
It is expected that delivery of the shares of Common Stock will be made in
New York, New York, against payment therefor on or about , 1996.
The date of this Prospectus is , 1996
[LOGO OF DEUTSCHE MORGAN GRENFELL APPEARS HERE]
<PAGE>
Inside Cover
- ------------
Picture of man at notebook computer with the following overlay: Managed Business
Communications. Also lists the following services and products:
Telecommunications, Telemanagement, Network Design, Internet Access, Web
Hosting, Software Development, Web Architecture, Content Services, Web
Applications, Interactive Development and Marketing Communications.
IN CONNECTION WITH THIS OFFERING, THE U.S. UNDERWRITERS AND THE
INTERNATIONAL 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, IN THE OVER-THE-
COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
2
<PAGE>
[DESCRIPTION OF ARTWORK]
Gatefold
- --------
Photographs of man on telephone and a compact disk; world map with lines
illustrating existing and planned telecommunications frame relay network
connections and U.S. map with lines illustrating planned Internet backbone
connections and NetSource points of presence; a list of certain products and
services provided by the Company including Telecommunications, Interactive,
Marketing Communications, and Internet Access; the words "A Communications
Convergence"; and Web Sites developed by the Company including Tecmar
Technologies, SeniorNet, Fujitsu, ACC, The Yankee Group, Diamond Multimedia,
Union Camp, Cadence, Citibank, Ameritech, CCPA, and Cyber Cash.
<PAGE>
PROSPECTUS SUMMARY
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section entitled "Risk
Factors" and elsewhere in this Prospectus. The following summary is qualified
in its entirety by the more detailed information and Consolidated Financial
Statements, including notes thereto, appearing elsewhere in this Prospectus.
Except as otherwise specified, all information in this Prospectus (i) assumes
no exercise of the Underwriters' over-allotment option, (ii) reflects the
consummation of the Reorganization (as defined and described in "Business--
Reorganization") in June 1996, (iii) excludes the shares issued in connection
with the acquisitions of scruz-net, inc. and DNA New Media Group, Inc. in
November 1996 (as described in "Business--Recent Developments"), (iv) excludes
options, warrants and convertible notes exercisable for or convertible into an
aggregate of 5,889,598 shares of Common Stock outstanding as of September 30,
1996 (assuming an initial public offering price of $14 per share) and (v)
reflects a three-for-four reverse split of the Company's Common Stock as of
November 20, 1996. For the definition of certain terms used in this Prospectus,
see "Glossary."
THE COMPANY
NetSource Communications, Inc. ("NetSource" or the "Company") develops,
implements and manages a wide range of communications solutions for business
and end-user customers worldwide. The Company's products and services include
international and domestic long distance telecommunications, value-added
telecommunications and related telemanagement services, Internet access and
hosting, Internet and interactive electronic commerce products and services,
such as Web-based architecture development and maintenance, Web-based content
development and management, and marketing communications services. The
Company's strategy consists of integrating communications solutions, expanding
its telecommunications and Internet-related networks, broadening its
distribution channels, developing innovative technology and acquiring
complementary technologies and businesses.
The Company believes that the telecommunications, applications software
development and marketing communications services industries are becoming
increasingly complementary as a result of telecommunications deregulation, the
proliferation of personal computers, connectivity advances and rapidly
converging technologies. Traditional voice and data services, multimedia
applications and emerging Internet-based products are being delivered to
customers using the medium of telecommunications. At the same time, businesses
worldwide are being confronted with increasingly complex communications
requirements as interaction increases with customers, remote offices,
affiliates and computer networks in global markets. To manage increased traffic
from fax, voice, data and electronic/Internet related media, businesses must
currently utilize multiple vendors for a number of communications services
including long distance telecommunications, network design and engineering,
Internet access, design and implementation of Web architectures, and corporate
marketing communications. NetSource offers its customers a single source
solution for such services on both a bundled and discrete basis.
The Company currently offers telecommunications services in the U.S. and in
over 130 countries worldwide. NetSource offers international and domestic long
distance telephony services through its dedicated facilities and international
network of five digital switches that use advanced technologies such as packet
and SS7 signaling protocols and centralized computer control. The Company
believes that its proprietary Computer Controlled Switching Arrangement
provides it with a competitive advantage by enabling it to optimize the routing
of calls over the NetSource network or other carriers'
3
<PAGE>
networks, depending upon the lowest cost route available at any given time.
During the next 24 months, the Company expects to expand its telecommunications
network by deploying up to 14 additional switches in Europe, Asia and the
Americas. In addition to long distance services, NetSource offers value-added
telephony services including travel card, cellular reorigination, data
transmission, inbound toll free 800 and dedicated private line services. The
Company markets its telephony services via independent sales affiliates,
strategic partners, joint ventures, a direct sales force and M-net, the
Company's network marketing system. In the year ended December 31, 1995 and the
nine months ended September 30, 1996, the Company's revenues from its
telecommunications business were approximately $86.9 million and $67.9 million,
respectively.
NetSource also provides an array of Internet-based Web architecture
development and maintenance and content products and services for Internet and
Intranet-based electronic commerce solutions. The Company defines electronic
commerce as the delivery of information (both voice and data), products,
services, marketing, systems and support both within an organization or to the
external marketplace over any interactive, electronic or on-line medium. Many
of the Company's service and product offerings involve the implementation of
WebSense, the Company's Web architecture methodology, and Content Management
Services, the Company's software-based system that allows for the efficient
updating and management of content. The Company believes that its Internet and
Intranet solutions provide its customers with a cost-effective means of
storing, managing and transferring information via an interactive medium more
readily accessed by employees, clients, suppliers and other parties connected
to the customer. Since the inception of its Internet oriented business in mid-
1995, NetSource has created and deployed 20 electronic commerce Web sites for
its customers, including the American College of Cardiology, the American
College of Surgeons, Cadence Design Systems, Inc., Conner Peripherals, Inc.
(now a subsidiary of Seagate Technologies, Inc.), CyberCash, Inc., Fujitsu
Microelectronics, Inc. and The Yankee Group, and is in the process of creating
Web architectures for additional customers, including Boehringer Mannheim
Corporation, Boston Scientific Corporation, the California Society of Certified
Public Accountants and Union Camp Corporation. In the year ended December 31,
1995 and the nine months ended September 30, 1996, the Company's revenues from
its electronic commerce products and services business were approximately
$654,000 and $1.1 million, respectively.
Among its electronic commerce products and services, the Company offers a
variety of convergent product offerings that leverage the Company's
relationships and expertise in the telecommunications industry, including
Internet access and Web hosting services. The Company plans to use a portion of
the proceeds of this offering to deploy an Internet backbone. The Company also
has acquired scruz-net, inc., an Internet service provider located in Santa
Cruz, California with approximately 2,000 customers as of November 15, 1996.
The Company's business also includes a full-service advertising and marketing
communications component that specializes in leveraging both traditional and
electronic media into business solutions for a range of companies and other
organizations via today's range of print, broadcast and Internet
communications. The Company believes that its experience in and application of
more traditional content-related marketing communications services enhance the
Company's capabilities in delivering a comprehensive electronic commerce
solution to its customers. In the year ended December 31, 1995 and the nine
months ended September 30, 1996, the Company's revenues from its marketing
communications business were approximately $3.8 million and $1.9 million,
respectively.
REORGANIZATION
NetSource, which was incorporated in Delaware on November 20, 1995, succeeded
to the businesses of MTC Telemanagement Corporation, a California corporation
("MTC Telemanagement"),
4
<PAGE>
MTC International, Inc., a Nevada corporation ("MTC International"), and
Transphere Interactive, Inc. ("Transphere Interactive") and Transphere
International, Inc. ("Transphere International"), each California corporations
(collectively the "Transphere Entities") pursuant to a series of reorganization
transactions consummated on June 28, 1996 (collectively, the "Reorganization").
See "Business--Reorganization." MTC Telemanagement commenced operations in
October 1988 as a provider of long distance services in the U.S. MTC
International was formed in March 1993 as a provider of international
telecommunications services to countries outside the U.S. Pursuant to a series
of stock exchanges, MTC Telemanagement and MTC International became wholly-
owned subsidiaries of the Company. Transphere International, an advertising and
marketing communications company, was formed in 1985, while Transphere
Interactive, a provider of services related to the Internet, with a focus on
Web-site design and enabling Web-based electronic commerce on the Internet, was
formed in August 1995. The Transphere Entities merged to form NetSource
Interactive Services, Inc. ("NetSource Interactive") in June 1996. NetSource
Interactive thereafter merged into the Company in connection with the
Reorganization. Unless the context otherwise requires, references to NetSource
or the Company include NetSource Communications, Inc. and its subsidiaries,
including MTC Telemanagement and MTC International.
RECENT DEVELOPMENTS
In November 1996, the Company acquired scruz-net, inc., an Internet service
provider, for an aggregate of 230,190 shares of Common Stock. The business
competencies of scruz-net include Internet network design, implementation and
administration, and technology management for data networking and Intranet
applications. In November 1996, the Company also acquired DNA New Media Group,
Inc., an interactive development firm, for an aggregate of 230,190 shares of
Common Stock. The Company believes that DNA has substantial skill and
experience in the areas of multimedia, interactive and graphic design and
content creation for Web sites for a diverse group of clients. The shares
issued in both the acquisitions are restricted under federal securities laws
but have registration rights which permit, under certain circumstances, such
shares to be included in future public offerings of the Company.
In September 1996, the Company entered into a memorandum of understanding
with British Telecommunications plc ("BT") to provide electronic commerce
solutions to BT's finance sector customers. The memorandum contemplates the
training of BT sales personnel and includes revenue goals as well as specific
customers of BT that the parties hope to supply with the Company's electronic
commerce solutions. The Company expects to obtain additional customers referred
by BT. See "Business--Recent Developments."
The address of the Company's corporate headquarters is 444 Spear Street,
Suite 200, San Francisco, CA 94105. The Company's telephone number is (415)
243-8080, and its facsimile number is (415) 546-5252. The Company's Web site is
located at http://www.netsourcecom.com. Neither the information contained in
the Company's Web site nor those of its customers shall be deemed to be part of
this Prospectus.
5
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Common Stock offered hereby:
U.S. offering............................. 2,800,000 shares
International offering.................... 700,000 shares
Total offering............................ 3,500,000 shares
Common Stock to be outstanding after the
offering.................................. 19,478,074 shares
Use of Proceeds............................ For capital expenditures,
including telecommunications
network upgrade and expansion and
establishment of Internet
backbone, working capital and
other general corporate purposes.
See "Use of Proceeds."
Proposed Nasdaq National Market symbol..... NSCE
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OTHER OPERATING DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------- ------------------
1993 1994 1995 1995 1996
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPER-
ATIONS DATA
Revenues(1):
Telecommunications........... $23,510 $48,937 $86,871 $64,985 $67,907
Marketing communications..... 4,792 4,915 3,774 3,022 1,943
Electronic commerce products
and services................ -- -- 654 408 1,106
------- ------- ------- -------- --------
Total revenues............. 28,302 53,852 91,299 68,415 70,956
------- ------- ------- -------- --------
Cost of revenues:
Telecommunications........... 16,676 34,565 58,467 43,634 44,802
Marketing communications..... 2,164 1,497 1,194 986 544
Electronic commerce products
and services................ -- -- 281 154 402
------- ------- ------- -------- --------
Total cost of revenues..... 18,840 36,062 59,942 44,774 45,748
------- ------- ------- -------- --------
Gross profit................... 9,462 17,790 31,357 23,641 25,208
Sales and marketing expenses... 2,289 6,713 13,191 9,810 9,558
General and administrative ex-
penses........................ 7,708 12,837 18,495 13,131 17,825
------- ------- ------- -------- --------
Operating income (loss)........ $ (535) $(1,760) $ (329) $ 700 $ (2,175)
======= ======= ======= ======== ========
Net loss....................... $ (438) $(1,998) $(1,834) $ (124) $ (3,450)
======= ======= ======= ======== ========
Pro forma net loss per share... $ (0.10) $ (0.17)
Weighted average common shares
and common share equivalents
outstanding................... 16,952 17,507
OTHER FINANCIAL DATA
EBITDA(2)...................... $ (341) $(1,300) $ 711 $ 1,469 $ (1,044)
Net cash provided by operating
activities.................... 1,478 3,603 1,456 1,235 85
Net cash used in investing ac-
tivities...................... (1,659) (1,779) (3,276) (2,828) (6,802)
Net cash provided by (used in)
financing activities.......... (17) (832) 1,043 775 11,120
Capital expenditures........... 982 2,331 3,231 2,783 3,198
OTHER OPERATING DATA(3)
Number of switches(4).......... 4 4 5 5 5
Telecommunications customers... 7,000 36,400 60,000 56,300 75,300
Cumulative Web architectures
created and deployed.......... -- -- 8 2 16
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
--------------------
ACTUAL AS ADJUSTED
------- -----------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA
Cash, cash equivalents and short-term investments.......... $ 8,396 $52,816
Total working capital...................................... (2,282) 42,138
Total assets............................................... 37,042 81,462
Long-term debt and capital lease obligations............... 21,411 21,411
Total debt and capital lease obligations................... 22,689 22,689
Stockholders' equity (deficit)............................. (7,869) 36,551
</TABLE>
6
<PAGE>
- --------
(1) Telecommunications revenues represent revenues derived from sales of
telecommunications products and services; marketing communications revenues
represent revenues derived from sales of traditional advertising services;
and electronic commerce products and services revenues represent revenues
derived from sales of Internet and interactive products and services,
including Internet access and hosting.
(2) EBITDA consists of earnings before other income (expenses) net, income
taxes, depreciation, amortization and share of losses of joint ventures.
EBITDA is not a measure of financial performance under generally accepted
accounting principles and therefore should not be considered as an
alternative to net income as a measure of performance nor as an alternative
to cash flow as a measure of liquidity. EBITDA is a term commonly used in
the telecommunications industry. EBITDA differs from cash flow from
operating activities because changes in operating assets and liabilities,
provision for doubtful accounts, other income (expense) and current tax
expense are treated differently.
(3) Information derived from operating records of the Company.
(4) Total deployed switches at end of period indicated.
7
<PAGE>
RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 (the "Securities Act") and Section
21E of the Securities Exchange Act of 1934 (the "Exchange Act"). The Company's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors including those set
forth in the following risk factors and elsewhere in this Prospectus. In
evaluating the Company and its business, prospective investors should
carefully consider the following factors in addition to the other information
presented in this Prospectus before purchasing shares of Common Stock offered
hereby.
FINANCIAL MANAGEMENT AND INTERNAL CONTROLS. In connection with the audit of
the Company's financial statements for the nine months ended September 30,
1996 and the year ended December 31, 1995, the Company's independent auditors
identified a series of material weaknesses in the Company's internal
accounting control structure, including the lack of continuity of the
Company's financial management personnel, a shortage of staffing resources in
the finance and control functions, failure to maintain complete written
financial policies and procedures, inadequate maintenance and retention of
records and ineffective management reporting. In addition, in the course of
their audit, the auditors proposed a significant number of audit adjustments
relating to various account balances as of December 31, 1995 and 1994 to
conform with generally accepted accounting principles. The Company believes
that none of the identified material weaknesses in the Company's accounting
control structure has resulted in any material adverse effects on the
Company's business, financial condition or results of operations for the
periods examined.
In October 1996, the Company hired a Chief Financial Officer and a Corporate
Controller who are seeking to address the material weaknesses in the Company's
internal accounting and control structure cited by the auditors, including
hiring additional financial management personnel. There can be no assurance,
however, that the Company will be able to address the cited material
weaknesses and develop the requisite controls, resources, systems and
procedures effectively or on a timely basis, particularly in light of the
Company's plans for expansion, and the failure to do so would have a material
adverse effect on the Company's ability to manage its business, to have
visibility on its operating results and financial condition, and to accurately
report its financial position on a timely basis, and could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the Company has agreed to have its financial
statements for all quarterly periods beginning in 1997 audited by its
independent auditors prior to the public release of any financial information
related to such financial statements and until such time as it receives a
letter from such auditors to the effect that all identified material
weaknesses have been eliminated. The Company has also engaged a consulting
firm to review and make recommendations on the process of monitoring and
validating carrier charges. Additionally, the Company has engaged another
consulting firm to make recommendations to the Company on how to re-engineer
its financial processes to enable the Company to provide the reporting of
accurate financial data in a timely manner.
LIMITED OPERATING HISTORY; NO ASSURANCE OF FUTURE PROFITABILITY. The
Company's Reorganization, in which the businesses of MTC International, MTC
Telemanagement and NetSource Interactive were combined into the Company, was
consummated on June 28, 1996. See "Business--Reorganization." MTC
International and MTC Telemanagement have been operating in the
telecommunications market since March 1993 and October 1988, respectively.
NetSource Interactive entered the Internet and interactive products and
services business in the third quarter of 1995. Accordingly, the combined
Company and each operating entity has only a limited operating history on
which investors may evaluate the Company and an investment in the Common Stock
offered hereby. In fiscal 1994 and 1995 and for the nine months ended
September 30, 1996, the Company incurred operating losses of approximately
$1.8 million, $329,000 and $2.2 million, respectively. Such operating
8
<PAGE>
losses primarily related to the substantial increase in the Company's general
and administrative expense levels related to expenses incurred in connection
with the Reorganization, the retention of temporary and consulting personnel
in the financial and accounting area and an additional provision against
certain accounts receivable relating to a joint venture. The Company expects
to incur operating losses in fiscal 1996 and at least the first two quarters
of fiscal 1997 primarily due to increased expense levels associated with the
planned upgrade and expansion of the Company's switching network and continued
expansion of the Company's sales and marketing efforts and distribution
channels and hiring of additional management and other personnel to support
the Company's global operations. There can be no assurance that the Company
will be able to effectively grow its business or be profitable in any future
period. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RISKS OF GROWTH AND EXPANSION. The Company intends to deploy a global
telecommunications network of hardware, software and facilities while
introducing new telecommunications, Internet and interactive products and
services to allow the Company to expand its customer base and remain cost
effective. The Company's current network expansion plan requires substantial
capital expenditures and calls for the deployment over the next 24 months of
up to 14 additional telecommunications switches in Europe, Asia and the
Americas and additional hardware, software and switches to establish and
maintain the Company's Internet backbone. There can be no assurance, however,
that the Company will be able to deploy such a network or add Internet and
interactive products and services at the rate presently planned by the Company
or at all. The Company's telecommunications network and Internet backbone
expansion plan will substantially increase the Company's cost structure in
advance of a corresponding increase in revenues. At the same time, the Company
has experienced and expects to continue to experience competitive pricing
pressures in the telecommunications services market. As a result of these
planned increases in the Company's cost structure and competitive trends, the
Company's gross margins and other operating results would be adversely
affected if its revenues do not increase substantially in the future. In
addition, the expansion of NetSource's business will produce increased demands
on its network capabilities, its sales and marketing resources, its
engineering personnel as well as its management and accounting capabilities.
The inability to continue to upgrade its network and development hardware or
its switching and routing systems or to hire and retain necessary qualified
personnel or the occurrence of unexpected expansion difficulties could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In order to carry traffic on the Internet without payment of certain usage-
based fees, the Company may be required to obtain network "peering" in the
future. In the event that the Company is not able to obtain network peering
when needed, its ability to profitably act as an Internet service provider
("ISP") could be materially and adversely affected, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON OTHER CARRIERS; MINIMUM VOLUME REQUIREMENTS. NetSource is
dependent on local exchange carriers ("LECs"), typically the Regional Bell
Operating Companies ("RBOCs") and postal, telephone and telegraph companies
("PTTs") of foreign countries, in both the domestic and international
telecommunications markets for origination and termination of all calls. In
addition, the Company currently buys a large volume of long distance minutes
from a few long distance carriers. As such, the Company's ability to maintain
and expand its business depends, in part, on its ability to continue to obtain
these services on favorable terms from other facilities-based carriers such as
Sprint Communications Company, L.P. ("Sprint"), Worldcom, Inc., Frontier
Communications, Inc. ("Frontier') and others. The Company's agreements with
such carriers often provide that the carriers may terminate such agreements
with little notice. In the event of termination of any such agreements, there
can be no assurance that excess capacity would be available from alternate
carriers or that, if available, it would be available on acceptable terms. A
change in carriers could cause a delay in service and a possible loss of
sales, which would adversely affect the Company's operating results.
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Finally, certain of the Company's contract arrangements involve meeting
minimum volume commitments for leased capacity. Failure to do so may result in
significant cash penalties imposed by the applicable carriers. The Company has
from time to time failed to meet certain minimum volume requirements for
leased capacity from Frontier and Sprint. While these parties have in the past
waived the requirement of the Company to pay these penalties, there can be no
assurance that the carriers will waive penalties in the future if they become
due. The failure to obtain carrier services when needed would have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON THIRD PARTY SALES; DISTRIBUTION CONCENTRATION. The Company's
telecommunications sales efforts are primarily conducted by a network of
third-party sales affiliates and their sub-affiliates. There can be no
assurance that the Company will be able to recruit, retain and offer
incentives to these affiliates sufficient to support the Company's planned
expansion or that in the future these affiliates will be able to market the
Company's products and services effectively. In addition, other companies with
greater resources may be able to provide greater incentives to offer their
services, thereby reducing the Company's base of affiliates. Historically, a
significant portion of the Company's sales have been generated by fewer than
10% of the Company's sales affiliates. Although the Company bills to and
collects directly from the majority of its end-users rather than through its
sales affiliates, this concentration could adversely affect the Company's
ability to retain its end-users. A loss of any major sales affiliate could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business--Marketing and Sales."
GOVERNMENT REGULATION.
TELECOMMUNICATIONS
DOMESTIC. Federal and state regulations, regulatory actions and court
decisions have had, and may have in the future, an impact on the Company and
its ability to compete as well as on the number and types of competitors in
the market. The U.S. Federal Communications Commission (the "FCC") and various
state public service and utilities commissions typically impose obligations to
file tariffs containing the rates, terms and conditions of service. Neither
the FCC nor the state utility commissions currently regulate the Company's
profit levels, although they have the authority to do so. There can be no
assurance that regulators will not raise material issues with regard to the
Company's compliance with regulations or that existing or future regulations
will not have a material adverse effect on the Company's business, financial
condition and results of operations.
Federal. The Company has been granted authority by the FCC to provide
international telecommunication services through the resale of switched
services of U.S. facilities-based carriers. The FCC reserves the right to
condition, modify or revoke such international authority for violations of the
Communications Act of 1934, as amended and the rules promulgated thereunder.
The Telecommunications Act of 1996 (the "1996 Telecommunications Act")
substantially alters the regulatory framework for the telecommunications
industry for domestic and U.S. international telecommunications services. This
law allows telephone companies and cable television companies to compete in
each others' markets and permits the local exchange carriers ("LECs"),
including the RBOCs, to offer and sell long distance services (including
inter-LATA and interstate services within their service territories following
compliance with certain conditions), subject to any otherwise applicable state
and/or federal regulatory approvals, in exchange for permitting competition in
the local markets. Rulemaking proceedings implementing the 1996
Telecommunications Act are currently pending and there can be no assurances
that, when they are completed, the legislation and any rules will not have a
material adverse effect on the Company's business, financial condition or
results of operations. As of the date of this Prospectus, the FCC has not yet
issued a notice of proposed rulemaking contemplating changes in the rules
governing charges by LECs for access services,
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although such a notice is expected to be released before the end of 1996.
Because the FCC has not yet initiated the rulemaking proceeding considering
changes in the regulation of access charges, the Company cannot at this time
predict the likelihood that the rules will be changed in a way that would have
a material adverse effect on the Company's business. In addition, if the LECs
are no longer required to provide equal access for origination and termination
of calls by customers of long distance companies such as the Company, or if
the fees charged for such access services change, particularly if changed to
allow variable pricing of such fees based upon volume, such changes could have
a material adverse effect on the Company's business, financial condition and
results of operations.
The Company is classified by the FCC as a non-dominant carrier. Among
domestic carriers, only LECs are now classified as dominant carriers, with
charges and services subject to greater FCC regulation than those of the
Company. The FCC has reclassified AT&T Corporation as a non-dominant carrier,
eliminating certain pricing and tariffing restrictions that had applied to
AT&T Corporation, and making it easier for AT&T Corporation to compete with
the Company for low-volume long distance customers. The FCC retains the
jurisdiction to act upon complaints against any common carrier for failure to
comply with its statutory obligations. The FCC also has the authority to
impose more stringent regulatory requirements on the Company and change its
regulatory classification.
Both domestic and international non-dominant carriers must maintain
interstate tariffs on file with the FCC, except that during the next ten
months, domestic non-dominant carriers will be required to withdraw their
interstate tariffs but make information about rates and conditions of service
publicly available. Although the tariffs on non-dominant carriers, and the
rates and charges they specify, are subject to FCC review, they are presumed
to be lawful and are seldom contested. In reliance on the FCC's past practice
of allowing domestic non-dominant carriers to file tariffs with a "reasonable
range of rates" instead of the detailed schedules of individual charges
required of dominant carriers, the Company has not maintained detailed rate
schedules for domestic offerings in their tariffs. Until the two-year statute
of limitations expires, the Company could be held liable for damages for its
failure to do so, although it believes that such an outcome is highly unlikely
and would not have a material adverse effect on the Company.
State. The intrastate long distance telecommunications operations of the
Company are also subject to varying levels of regulation in those states in
which the Company provides intrastate telecommunications. The vast majority of
the states require the Company to apply for certifications to provide
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. 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. The Company is in the
process of seeking approvals from the applicable regulatory authorities in
each state in which such approval is required.
INTERNATIONAL. The Company's international telecommunications products and
services are subject to the jurisdiction of many regulators, including
individual foreign countries and international bodies, such as the World Trade
Organization. The FCC has imposed certain restrictions on international
callback and reorigination providers, including the requirement that licensees
provide service in a manner consistent with the laws of the countries in which
they operate. Local laws and regulations differ significantly among the
jurisdictions in which the Company operates, and the interpretation and
enforcement of such laws and regulations vary and are often based on the
informal views of the local ministries which, in some cases, are subject to
influence by PTTs. In addition, failure to interpret accurately the applicable
laws and regulations and the mode of their enforcement in particular
jurisdictions, could cause the Company to lose, or be unable to obtain,
regulatory approvals necessary for it to be able to provide certain services
it markets in such jurisdictions or could result in monetary penalties imposed
against it that could be significant. Furthermore, since the Company's
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callback and reorigination products and services effectively bypass the local
telephone system, regulators in certain countries have objected to callback
and reorigination services, and some countries have declared such services
illegal. Based on information made available by the FCC, the Company believes
that the following countries have prohibitions on callback services: Oman,
People's Republic of China, Colombia, Ecuador, Honduras, Hungary, India,
Indonesia, Netherlands Antilles, Peru, Philippines, Saudi Arabia, Tanzania,
Uruguay and Venezuela. In addition, other countries or their PTTs have
publicly indicated that at least some form of callback services was not
permitted in their respective countries. The Company does not derive material
revenues from callback and reorigination services to customers located in any
of such countries. In certain countries which have prohibited the provision of
services through the automatic callback access method utilized by the Company,
such as Thailand and Netherland Antilles, the Company has discontinued or
modified certain of its services. Existing or future regulations in other
countries could also have similar consequences. In addition, MCI
Communications Corporation has filed a petition with the FCC that challenges
the legality of reorigination. Such petition is currently pending. The Company
generates a significant portion of its monthly international revenue from
customers originating calls in Japan, Germany, Argentina, France, Hong Kong
and Taiwan. In 1994, approximately 45% of the Company's total revenues was
derived from customers located outside the U.S. That percentage increased to
69% in 1995, and to 72% in the first nine months of 1996. In the event that
any of these countries prohibited the Company's services or regulated the
pricing or profit levels of such services, the Company's business, results of
operations and financial condition could be materially adversely affected. At
this time, the Argentine government is attempting to provide sufficient
information to demonstrate to the FCC's satisfaction that call reorigination
is unlawful in Argentina. Although the Company believes that the probability
that the FCC would rescind the Company's grant of authority to provide
callback and reorigination services for failure to comply with non-U.S. law is
unlikely, such action by the FCC would have a material adverse effect on the
Company's business. The Company intends to expand its international service
offerings to continue to be competitive as new markets are opened and rates in
these countries are reduced. To facilitate this expansion, the Company may
deploy additional switching facilities located in a number of countries. As a
result, the Company will be directly subject to regulation in an increasing
number of countries, and there can be no assurance that foreign regulation
will not have a material adverse effect on the Company's business, results of
operations and financial condition.
The Council of the International Telecommunications Union ("ITU") also
recently approved a resolution which endorses suspension of callback methods
that seriously degrade network quality and performance and urges the ITU's
Standardization Sector to develop recommendations addressing "alternative
calling procedures," particularly those that seriously degrade network quality
and performance, and to give further study to other aspects of alternative
calling procedures. The Standardizing Sector is soliciting information to be
submitted by May 1997 to use in its further deliberations. In addition, while
the Japanese Ministry of Posts and Telecommunications (the "MPT") has
indicated that it will consider appropriate measures to comply with the ITU
resolution, it has not indicated that it is considering prohibiting other
forms of callback such as those employed by the Company. However, the Company
cannot predict the MPT's final response to the ITU resolution, the outcome of
the ongoing ITU study, whether the study will result in action prohibiting
callback or whether such action, if taken, would have a material adverse
effect on the Company's business, financial condition and results of
operations.
Finally there can be no assurance that the Company has accurately
interpreted or will accurately predict the interpretation of applicable laws
and regulations or regulatory and enforcement trends in a given jurisdiction
or that the Company will be found to be in compliance with all such laws and
regulations. Failure to interpret accurately the applicable laws and
regulations and the mode of their
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enforcement in particular jurisdictions, could cause the Company to lose, or
be unable to obtain, regulatory approvals necessary for it to be able to
provide certain services in such jurisdictions or to use certain of its
transmission methods. Such failure could result in significant monetary
penalties imposed against the Company.
INTERNET
Except for regulations governing the ability of the Company to disclose the
contents of communications by its customers and recent legislation that is the
subject of current constitutional challenge, there are currently no U.S.
government imposed limitations or guidelines pertaining to customer privacy or
the pricing, service characteristics or capabilities, geographic distribution
or quality control features of Internet access services. However, if a U.S.
governmental policy for the data network access industry were implemented, it
could have a material adverse effect on the Company. Also, a petition pending
before the FCC urges the FCC to regulate as telecommunications services voice
services utilizing the Internet. The Company cannot predict the impact, if
any, that future regulation or regulatory changes may have on its Internet
access business. The 1996 Telecommunications Act imposes criminal liability on
persons sending or displaying in a manner available to minors indecent
material on an interactive computer service such as the Internet and on an
entity knowingly permitting facilities under its control to be used for such
activities. The ultimate interpretation and enforcement of this law is
uncertain, but this legislation may decrease demand for Internet access, chill
the development of Internet content or have other adverse effects on Internet
access providers such as the Company. In addition, in light of the uncertainty
attached to interpretation and application of this law, there can be no
assurances that the Company would not have to modify its operations to comply
with the statute, including prohibiting users from maintaining home pages on
the Web. Certain foreign countries may also regulate Internet access or
electronic commerce, which could have a material adverse effect on the
Company. See "Business--Regulation."
COMPETITION. The markets in which the Company operates are extremely
competitive. There are no substantial barriers to entry in the Internet and
interactive products and services markets or in any of the telecommunications
markets in which the Company competes. The Company expects competition in
these markets to intensify in the future.
TELECOMMUNICATIONS
International. In the area of international telecommunications services, the
Company competes with large multinational corporations as well as PTTs in
foreign countries. The PTTs and many of these companies have significant
market share and greater resources than the Company. Certain PTTs may also
influence regulatory authorities to outlaw the provision of callback or
reorigination services or block access to the callback or reorigination
services the Company markets. In the past, the Company has benefited from the
fact that regulation of telecommunications services in foreign countries has
created a high differential between the rates charged by PTTs and the rates
charged by the Company. As deregulation continues in foreign markets, this
differential in rates is expected to decrease, which will place pricing
pressure on the Company, and may lead to additional competitors entering the
international telecommunications market. Some of the Company's competitors
offer cellular and other wireless products and services. While the Company
provides specialized long distance products for users of cellular devices,
there can be no assurance that the Company will be able to provide long
distance service to users of each new technology as it evolves. In addition,
certain global satellite-based telecommunication systems now under development
could eventually bypass the international long distance network of the PTTs
and major international carriers. Development of such technologies could
adversely affect the market for the Company's long distance telecommunication
services.
Domestic. In the U.S., the Company competes with long distance carriers and
second tier resellers. Domestically, the Company has a very small share of the
telecommunications services
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reseller market. In addition, this market is nearing maturity in terms of
aggregate revenue growth rates and consolidation. The Company and many other
smaller resellers anticipate adverse effects on their core customer base and
financial results by the entrance of the RBOCs into the long distance
industry. The RBOCs have significantly greater resources than the Company and,
as current providers of local service, substantial market intelligence and
end-user contact. As a result of this and continued international expansion,
the Company expects domestic revenues from its telecommunications business to
further decline as a percentage of its total telecommunications sales. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation" and "Business--Industry Overview."
INTERNET AND INTERACTIVE PRODUCTS AND SERVICES
Internet Access. The Company's current and prospective competitors in
Internet access include many large companies that have substantially greater
market presence and financial, technical, marketing and other resources than
the Company. In addition, the Company presently provides direct Internet
access services to a limited number of customers, and there can be no
assurance as to when or if the Company will be able to successfully provide
such services on a larger scale. The Company's Internet access business is
expected to compete directly or indirectly with national and regional
commercial ISPs, established on-line services companies that currently offer
or are expected to offer Internet access, national long distance
telecommunications carriers, RBOCs, media and cable operators, and nonprofit
or educational ISPs. In particular, the Company's ability to compete in the
Internet access market is substantially dependent upon the rates that it is
required to pay outside vendors for ISDN, T-1 and T-3 lines.
Electronic Commerce. In the area of electronic commerce, the Company
competes with or expects to compete with manufacturers of electronic commerce
server software tools and software companies as well as a range of Internet
development companies. Many of these companies have been in the electronic
commerce business longer than the Company and have substantially greater
market share and resources. The Company expects that many new competitors,
including large computer hardware and software, cable, media and
telecommunications companies, such as the RBOCs, will enter the electronic
commerce market.
The failure of the Company to adequately compete in its markets would have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Competition."
VARIABILITY OF QUARTERLY OPERATING RESULTS. The Company's quarterly
operating results are expected to fluctuate from quarter to quarter depending
on various factors, including the rate of deployment of new network hardware,
the timing of release of new products and services, competition, the evolving
and unpredictable nature of the markets in which the Company's products and
services are sold, the mix of distribution channels and products, pricing
actions by the Company or its competitors, the pace of telecommunications
deregulation in the markets in which the Company competes, seasonality, and
general economic conditions. A significant portion of the Company's expenses,
such as rent, headcount, depreciation, costs of telecommunications capacity
from local and interexchange carriers and capital lease expenses, are
relatively fixed in advance, based in large part on the Company's forecasts of
future sales. The forecasting of future sales by the Company is necessarily
imprecise and this imprecision is compounded and the timeliness of such
forecasting is adversely affected by the material weaknesses in the Company's
internal control structure and operations and by the early stage nature of the
Company's Internet and interactive products and services. If sales are below
expectations in any given period, the adverse effect of a shortfall in sales
on the Company's operating results may be magnified by the Company's inability
to adjust spending to compensate for such shortfall. The Company's markets,
characterized by short product life cycles and declining prices of existing
products and services, requires introduction of new products and
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services and enhancements to existing products and services to maintain gross
margins. Moreover, in response to competitive pressures or to pursue new
product or market opportunities, the Company may take certain pricing or
marketing actions that could materially and adversely affect the Company's
operating results. The Company's total revenues remained relatively flat in
the second half of 1995 through the quarter ended September 30, 1996,
primarily as a result of the lack of availability of sufficient capital
resources to support further expansion and upgrade of the Company's switching
network. This inability of the Company to expand and upgrade its network
during this period prevented the Company from offering its customers more
aggressively priced service rates, resulting in relatively flat
telecommunications revenues. In addition, the Company's telecommunications
revenues can be affected by seasonality, which varies by geographic region. As
a result of all of the foregoing, there can be no assurance that the Company
will be able to achieve or sustain profitability on a quarterly or annual
basis. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
FUTURE CAPITAL NEEDS. The Company intends to increase its telecommunications
network significantly, adding network hardware and dedicated leased lines in
numerous locations throughout the world. The Company believes that total
revenues remained relatively flat in the second half of 1995 through the third
quarter of 1996, primarily as a result of the lack of availability of
sufficient capital resources to support further expansion and upgrade of the
Company's switching network. This inability of the Company to expand and
upgrade its network during this period prevented the Company from offering its
customers more aggressively priced service rates, which resulted in slowed
revenue growth. In addition, the Company intends to utilize capital to invest
in research and development and strategic joint ventures and to make
acquisitions of complementary products, technologies and businesses. While the
Company believes that the proceeds of this offering combined with cash flow
from operations will be sufficient to meet its capital requirements for the 24
months following this offering, there can be no assurance that the Company
will not require additional financing before such time. The Company's funding
requirements may change at any time due to various factors including the
Company's operating results, the results and timing of the Company's launch of
new products and services, governmental or regulatory changes, the timing and
extent of its network expansion, the ability of the Company to meet product
and project demands, the nature and timing of the Company's acquisition of
complementary products, technologies or businesses, the success of the
Company's marketing efforts, technological advances and competition. There can
be no assurance that adequate funding will be available to the Company or, if
available, that funding will be on terms favorable to the Company. Any
shortfall in funding could result in the Company's having to curtail the
introduction of new products and services, its entry into new markets and the
deployment of network hardware, software and other facilities, which could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
UNCERTAINTIES RELATING TO INTEGRATION OF OPERATIONS. Achieving the
anticipated benefits of the Reorganization will depend in part upon whether
the integration of the constituent companies' businesses is achieved in an
efficient, effective and timely manner, and there can be no assurance that
this will occur. The combination of the constituent companies requires, among
other things, successful integration of MTC International and MTC
Telemanagement's telecommunications business with the Company's Internet and
interactive products and services offerings. The successful expansion of the
Company's business will require communication and cooperation in product
development and marketing among the senior executives and key technical
personnel of the constituent companies. Given the inherent difficulties
involved in major business combinations, there can be no assurance that such
cooperation will occur or that the integration of the respective businesses
will be successful and will not result in disruptions in one or more sectors
of the Company's business. The integration will require the dedication of
management's resources which may distract attention from the day-to-day
business of the Company. Failure to effectively accomplish the integration of
the constituent
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companies' operations could have a material adverse effect on NetSource's
business, financial condition and results of operations.
NEW AND UNCERTAIN MARKET. The Company's ability to derive increased revenues
from Internet and interactive products and services will depend in part upon
the development of the Internet as a viable commercial medium and on the
development of the public infrastructure for providing Internet access and
carrying Internet traffic. Because global commerce and online exchange of
information on the Internet and other similar open wide area networks are new
and evolving, it is difficult to predict with any assurance whether the
Internet will become and remain a viable commercial marketplace. Moreover,
critical issues concerning the commercial use of the Internet (including
security, reliability, cost, ease of use and access and quality of service)
remain unresolved and may impact the growth of Internet use. In particular,
inadequate development of the necessary infrastructure (e.g., reliable network
backbone), untimely development of complementary products (e.g., high speed
modems), or delays in the development or adoption of new standards and
protocols required to handle increased levels of Internet activity would make
it more difficult for the Company to market its Internet and Interactive
products. In addition, to the extent that the Internet continues to experience
significant growth in the number of users and the level of use, there can be
no assurance that the Internet infrastructure will continue to be able to
support the demands placed on it by such potential growth. The Company's
revenues derived from Internet and Interactive products and services for the
year ended December 31, 1995 and the nine months ended September 30, 1996 were
only approximately $654,000 and $1.1 million, respectively. The Company's
future growth depends, in part, upon increasing the amount of revenues it
derives from providing such products and services. To date, the Company has
only limited experience in providing Internet and interactive products and
services. If the Internet does not become a viable commercial marketplace, or
if the Company is unable to successfully expand its Internet and Interactive
products and services business, the Company's business, financial condition
and results of operations would be materially adversely affected.
DEPENDENCE ON ATTRACTION AND RETENTION OF KEY EMPLOYEES. The ability of the
Company to maintain its competitive and technological position depends, in
large part, on its ability to attract and retain highly qualified technical,
marketing, financial and management personnel. Competition for such personnel
is intense. The inability to retain certain key employees as well as to
attract and retain the significant numbers of additional personnel required to
effectively manage and expand its operations would have a significant adverse
impact on the Company's business. In particular, the loss of Edward Brinskele,
the Company's Chairman and Chief Executive Officer, or Charles Schoenhoeft,
the Company's Vice Chairman and President, could adversely affect the Company.
See "Business--Employees" and "Management."
RISK OF SYSTEM FAILURE; SECURITY RISKS. The success of the Company is
largely dependent upon its ability to deliver high quality, uninterrupted
telecommunications products and services and access to the Internet. From time
to time, the Company has experienced failures relating to its network
facilities, and the Company's customers have experienced difficulties in
accessing and utilizing the Company's telecommunications network. As the
Company attempts to expand its telecommunications network to include Internet
access services and data traffic grows, there will be increased stress on
network hardware and traffic management systems. The Company's operations also
are dependent on its ability to integrate new and emerging technologies and
equipment into its network, which are likely to increase the risk of system
failure and may cause unforeseen strains upon the network. There can be no
assurance that the Company will not experience failures relating to its
network facilities or the entire network. While the Company has not
experienced a significant interruption of its ability to provide service to
date, there can be no assurance that this type of failure will not occur in
the future. Significant or prolonged system failures or difficulties for
subscribers in accessing and maintaining connection with the Company's network
could damage the reputation of the Company and result in the loss of
customers. Such damage or losses could have a material adverse effect on the
Company's business, financial condition and results of operations.
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The Company's operations are dependent on its ability to protect its
software and hardware against damage from fire, earthquake, power loss,
telecommunications failure, natural disaster and similar events. A significant
portion of the Company's computer equipment is located at its facilities in
Petaluma and San Francisco, California. The Company does not currently carry
earthquake insurance. Accordingly, the destruction or damage of a significant
portion of the equipment located in such facilities would cause an
interruption in the Company's operations, which would have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company's planned Internet infrastructure will also be
vulnerable to computer viruses, break-ins and similar disruptive problems. See
"Business--Facilities."
UNCERTAINTIES RELATING TO ACQUISITIONS. The Company's growth strategy
includes the acquisition of complementary products, technologies and
businesses. In November 1996, the Company consummated the acquisitions of
scruz-net, inc., an ISP, and DNA New Media Group, Inc., an interactive
marketing firm. These acquisitions, and any future acquisitions by the
Company, will be subject to various risks and uncertainties, including the
inability to effectively assimilate the operations, products, technologies and
personnel of the acquired companies (which may be located in diverse
geographic regions), the potential disruption of the Company's existing
business, the inability to maintain uniform standards, controls, procedures
and policies and the potential impairment of relationships with customers. In
addition, there can be no assurance that the Company will be able to identify
appropriate acquisition candidates in the future. See "Business--Recent
Developments."
DEPENDENCE ON TECHNOLOGICAL DEVELOPMENT. The markets for telecommunications
and Internet and interactive products and services are characterized by rapid
technological developments, evolving industry standards and customer demands,
and frequent new product and service introductions and enhancements. These
market characteristics are exacerbated by the emerging nature of the Internet
and the fact that many companies are expected to introduce new Internet and
interactive products and services in the near future. The Company's future
success will depend in significant part on the Company correctly identifying
which technologies will achieve market acceptance and the Company's ability to
access and adapt to technological developments on a timely basis and to
respond to both evolving demands of the marketplace and competitive product
and service offerings. For example, Internet services are currently accessed
primarily by computers through telephone lines. The Company's planned Internet
access services are based on such method of access by end-users. However,
several companies have recently introduced, on an experimental basis, delivery
of Internet access services through cable television lines. If the Internet
becomes accessible by cable modem, screen-based telephones, television or
other consumer electronic devices, or customer requirements change the way
Internet access is provided, such developments could materially and adversely
affect the Company's business, and the Company could be required to develop
new technology or modify its existing technology to accommodate these
developments. There can be no assurance that the Company would be successful
in this regard.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. In fiscal 1994, 1995 and the
first nine months of 1996, international customers accounted for approximately
45%, 69% and 72%, respectively, of the Company's total revenues. International
customers accounted for a negligible amount of the Company's revenue in fiscal
1993. The Company anticipates that revenues from international customers will
continue to account for a significant percentage of its total revenues.
A significant portion of the Company's total revenues will therefore be
subject to risks associated with international sales, including unexpected
changes in legal and regulatory requirements, changes in tariffs, exchange
rates and other trade barriers, political and economic instability,
difficulties in staffing and managing international operations, difficulties
in protecting the Company's intellectual property overseas, potentially
adverse tax consequences and the regulation of telecommunications and Internet
access and commerce providers by foreign jurisdictions. In this regard, the
Company has not been issued any foreign counterparts for its U.S. patents.
There can be no assurance that the Company will be able to obtain the foreign
permits and operating licenses, if any, necessary for it to operate, hire and
train
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employees or market, sell and deliver its products and services. Although the
Company's sales to date to international customers have generally been
denominated in U.S. dollars, the value of the U.S. dollar in relation to
foreign currencies may also adversely affect the Company's sales to
international customers. The Company intends to expand its international
operations. To the extent the Company expands its international operations or
changes its pricing practices to denominate prices in foreign currencies, the
Company will be exposed to increased risks of currency fluctuation and would
need to develop a foreign exchange strategy to hedge currency fluctuations.
Failure to implement and successfully manage the Company's foreign currency
exchange program could subject the Company to the possibility of significant
losses. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business--Strategy."
DIFFERENCES IN FINANCIAL STATEMENTS CONTAINED IN PRIVATE PLACEMENT
MEMORANDUM. In June 1996, the Company sold $20 million principal amount Series
A Secured Subordinated Convertible Notes to 42 foreign investors (the
"Notes"), together with detachable Warrants to purchase Common Stock (the
"Warrants"). The Notes and the Warrants will be convertible into Common Stock
of the Company upon the earlier of December 31, 1996 or the closing of this
offering. The Notes are due and payable in June 1998. The Notes and Warrants
were sold pursuant to a private placement memorandum dated May 31, 1996 (the
"Private Placement Memorandum"). While the Reorganization had not yet been
completed at the time the Notes and Warrants were sold, the Private Placement
Memorandum contained unaudited selected financial data for the Company on a
pro forma basis giving effect to the Reorganization for the fiscal year ended
December 31, 1995 and for the fiscal quarter ended March 31, 1996. As a result
of adjustments recorded in connection with the Company's independent auditors'
audit of the Company's 1995 financial statements, the Company has determined
that the unaudited financial data included in the Private Placement Memorandum
differs in certain respects from the data contained in the audited financial
statements. In addition, the quarterly information for the first quarter of
1996 contained in the Private Placement Memorandum also differed from the
Company's revised quarterly information. For example, net income for fiscal
1995 and the first quarter of 1996 included in the Private Placement
Memorandum was $1,095,000 and $190,000, respectively, while the audited annual
financial statements contained in this Prospectus show a net loss of
$1,834,000 and the Company's revised quarterly information contained in this
Prospectus shows a net loss of $204,000 for the same period. The Company notes
that the purchasers of the Notes may convert their Notes and exercise their
Warrants at a 30% discount to the price to the public in this offering.
However, there can be no assurance that a claim based on the aforementioned
differences would not be made by any purchaser of the Notes and Warrants in
the future or that the Company would prevail in such an action. See "Risk
Factors--Financial Management and Internal Controls" and "Description of
Capital Stock--Notes and Warrants."
POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH COMPANY'S
NETWORK. ISPs, through their Internet access and Web hosting services, face
potential liability of uncertain scope for the actions of customers and others
using their systems, including liability for infringement of intellectual
property rights, rights of publicity, defamation, and libel and criminal
activity under the laws of the U.S. and foreign jurisdictions, which could
have a material adverse effect on the Company. In addition, recent legislative
enactments and pending legislative proposals aimed at limiting the use of the
Internet to transmit certain materials could potentially result in significant
potential liability to Internet access and service providers, including the
Company, as well as additional costs and technological challenges in complying
with any statutory or regulatory requirements imposed by such legislation. See
"Business--Regulation."
PROTECTION OF INTELLECTUAL PROPERTY. The Company's success is dependent in
part upon its ability to enhance its technology, although the Company believes
that its success is more dependent upon its technical expertise than its
proprietary rights. The Company relies on a combination of patent, copyright,
trademark and trade secret laws and contractual restrictions to establish and
protect its technology. The Company has been assigned two patents in the U.S.
relating to its least cost routing
18
<PAGE>
technology and has corresponding applications pending for patent protection of
such technology in 20 foreign countries. However, there can be no assurance
that the Company will be successful in obtaining foreign patent protection.
There can be no assurance that the Company's least cost routing patents or any
future patents will provide protection against competitive technology or will
be held valid and enforceable if challenged or that the Company's competitors
will not be able to design around the patents. In addition, there can be no
assurance that licenses for any intellectual property that might be required
by the Company will be available on reasonable terms, if at all. See
"Business--Technology and Intellectual Property."
CONTROL BY EXISTING STOCKHOLDERS. Following the completion of this offering,
Edward Brinskele, Charles Schoenhoeft and Roger Sheppard will collectively own
approximately 49.6% of the outstanding shares of the Common Stock on a fully
diluted basis, including shares issuable upon exercise or conversion of
outstanding options, warrants and convertible notes. Edward Brinskele,
together with either Roger Sheppard or Charles Schoenhoeft, may have the
ability to control the affairs and policies of the Company and may be able to
elect a sufficient number of directors to control the Board and to approve or
disapprove of any matter submitted to a vote of the stockholders. The voting
power of these stockholders could also have the effect of delaying or
preventing a change in control of the Company.
NO PRIOR PUBLIC MARKET; VOLATILITY OF STOCK PRICE. Prior to the date of this
Prospectus, there has been no public market for the Common Stock, and there
can be no assurance that a viable public market for the Common Stock will
develop or be sustained after completion of the offering contemplated hereby.
The initial public offering price of the Common Stock will be determined by
negotiation between the Company and the Underwriters and may bear no
relationship to the price at which the Common Stock will trade after
completion of the offering. For factors to be considered in determining the
initial public offering price, see "Underwriting." The Company believes that
factors such as announcements of developments related to the Company's
business, announcements by competitors, fluctuations in the Company's
financial results and general conditions in the telecommunications and
Internet and interactive products and services markets in which the Company
competes or the national economies in which the Company does business, could
cause the price of the Common Stock to fluctuate, perhaps substantially. In
addition, in recent years the stock market in general, and the market for
shares of small capitalization technology stocks in particular, have
experienced extreme price fluctuations, which have often been unrelated to the
operating performances of affected companies. Such fluctuations could have a
material adverse effect on the market price of the Common Stock.
RISKS ASSOCIATED WITH FEDERAL COURT LITIGATION. One of the Company's former
sales affiliates and current competitors has brought suit against the Company
in Federal District Court for the Northern District of California. The former
sales affiliate has made a number of claims, including breach of contract and
misappropriation of trade secrets and seeks compensatory and punitive damages.
In addition, in connection with such action, the former affiliate's foreign
sub-affiliate has brought suit against both the former sales affiliate and the
Company which suit is pending in Federal District Court for the District of
Iowa. The foreign sub-affiliate has claimed violation of RICO, intentional
interference with the prospective economic advantage of his customers (who are
end-users of the Company's services provided through the former sales
affiliate) and an open accounting for amounts allegedly owed to the foreign
sub-affiliate. The foreign sub-affiliate seeks compensatory damages in excess
of $1 million, as well as punitive damages and certain injunctive relief. The
Company has filed a motion to dismiss the RICO claim brought by the foreign
sub-affiliate against the former affiliate and the Company. The court has
granted the former affiliate's motion with respect to dismissing the RICO
claim and the Company expects a similar ruling from the court. The Company
believes these suits are without merit and intends to vigorously defend the
suits. While the Company believes it has valid defenses to these claims and
intends to contest them vigorously, an adverse determination of the
19
<PAGE>
claims and a judgment against the Company for a substantial amount of damages
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business--Legal Proceedings."
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS AND DELAWARE LAW. Certain
provisions of the Company's Certificate of Incorporation and Bylaws could
discourage potential acquisition proposals and could delay or prevent a change
in control of the Company. Such provisions could diminish the opportunities
for a stockholder to participate in tender offers, including tender offer at a
price above the then current market value of the Common Stock. Such provisions
may also inhibit fluctuations in the market price of the Common Stock that
could result from takeover attempts. The Company is also afforded the
protections of Section 203 of the Delaware General Corporation Law, which
could delay or prevent a change in control of the Company or could impede a
merger, consolidation, takeover or other business combination involving the
Company or discourage a potential acquiror from making a tender offer or
otherwise attempting to obtain control of the Company. In addition, the Board
of Directors has authority to issue up to 10,000,000 shares of Preferred Stock
and to fix the rights, preferences, privileges and restrictions, including
voting rights, of these shares without any further vote or action by the
stockholders. The rights of the holders of the Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding
voting stock of the Company, thereby delaying, deferring or preventing a
change in control of the Company. Furthermore, such Preferred Stock may have
other rights, including economic rights, senior to the Common Stock, and as a
result, the issuance of such Preferred Stock could have a material adverse
effect on the market value of the Common Stock. The Company has no present
plan to issue shares of Preferred Stock. Additionally, the Company's
Certificate of Incorporation provides for three classes of directors, to be
elected on a staggered basis, beginning after the first annual meeting of
stockholders of the Company after the date of the offering. One class is
elected each year with each class serving a three-year term, which also
enables existing management to exercise significant control over the Company's
affairs. See "Description of Capital Stock--Delaware Anti-Takeover Law and
Certain Charter Provisions."
IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of
the Common Stock in the public market after this offering could have a
material adverse effect on the market price of the Common Stock. In addition
to the 3,500,000 shares offered hereby, 15,978,074 additional shares
outstanding and 1,976,707 shares issuable upon exercise of vested options
outstanding as of the date of this Prospectus will be eligible for immediate
sale in the public market following expiration of 180 day lock-up agreements
with the Company and the Underwriters or release from such lock-up agreements
by the Company, with the consent of Deutsche Morgan Grenfell Inc., subject in
some cases to compliance with certain volume limitations and other
restrictions under Rule 144. The Company intends to file a Form S-8
Registration Statement with the Commission in order to register an aggregate
of 5,257,080 shares of Common Stock reserved for issuance upon exercise of
outstanding or future options and for sale under the Company's 1996 Employee
Stock Purchase Plan. In addition, after consummation of the offering, the
Notes and Warrants may be converted or exercised into an aggregate of
2,204,081 shares of Common Stock, assuming an initial public offering price of
$14 per share, and an additional Warrant issued to the placement agent for the
Note and Warrant financing may be exercised for 147,959 shares of Common
Stock. These shares will become eligible for sale in the public market
following expiration of 180 day lock-up agreements with the Company.
The Company also has outstanding vested options exercisable into an
aggregate of 225,000 shares of Common Stock which will become available for
sale in the public market two years after the exercise price is paid, subject
to compliance with Rule 144. The Company has granted certain rights to the
holders of these shares for the registration of such shares under the
Securities Act. See
20
<PAGE>
"Description of Capital Stock--Registration Rights." All such shares are
subject to 180 day lock-up agreements with the Company. See "Management--Stock
Option Plans and Arrangements," "Principal Stockholders," "Description of
Capital Stock--Notes and Warrants," "Shares Eligible for Future Sale" and
"Underwriting."
IMMEDIATE AND SUBSTANTIAL DILUTION TO NEW INVESTORS. The initial public
offering price is substantially higher than the book value per share of the
outstanding Common Stock. Investors purchasing Common Stock in this offering
will, therefore, incur immediate and substantial dilution of approximately
$12.12 in the net tangible book value per share of Common Stock from the
initial public offering price and may incur additional dilution upon the
exercise of outstanding stock options, warrants and convertible notes. See
"Dilution."
BENEFITS OF THE OFFERING TO CURRENT STOCKHOLDERS. Current stockholders will
receive the following benefits as a result of the offering: (a) the creation
of a market for the Company's Common Stock and (b) any unrealized gain in the
value of their equity based upon the difference between the cost of acquiring
the Company's Common Stock or securities that are convertible into such Common
Stock and the value of such Common Stock based upon the public offering price.
See "Dilution."
21
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,500,000 shares of
Common Stock offered by the Company hereby are estimated to be $44,420,000
($51,255,500 if the Underwriters' over-allotment option is exercised in full),
assuming an initial public offering price of $14 per share, after deducting
the underwriting discount and estimated offering expenses payable by the
Company.
Of such net proceeds, the Company expects to use approximately $10.0 million
to upgrade and maintain its telecommunications network, $15.0 million to
acquire additional switches and leased lines to expand its telecommunications
network, $11.5 million to establish and maintain the Company's Internet
backbone, although the Company may fund such capital expenditures through
lease financing arrangements, and the balance for working capital, product
development, expansion of sales and marketing efforts, and other general
corporate purposes. In addition, as part of its business strategy, the Company
intends to make strategic acquisitions of complementary businesses,
technologies or products. Although the Company evaluates such potential
acquisitions from time to time, the Company currently has no understanding,
commitment or agreement with respect to any such acquisitions.
Pending such uses, the Company intends to invest the net proceeds of this
offering in U.S. short-term, investment grade, interest-bearing securities.
While the Company believes that the proceeds of this offering combined with
cash flow from operations will be sufficient to meet its capital requirements
for the 24 months following this offering, there can be no assurance that the
Company will not require additional financing before such time. The foregoing
estimate of the period of time through which its financial resources will be
sufficient to meet its capital requirements is a forward-looking statement
that involves risks and uncertainties, and actual results could vary as a
result of a number of factors including the Company's operating results, the
results and timing of the Company's launch of new products and services, the
timing and extent of network expansion, governmental or regulatory changes,
the ability of the Company to meet product and project demands, the success of
the Company's marketing efforts, technological advances and competition,
working capital requirements, and acquisitions of complementary businesses,
technologies or products. There can be no assurance that adequate funding will
be available to the Company or, if available, that funding will be on terms
favorable to the Company, and could require the issuance of additional debt or
equity securities which could dilute the ownership of existing stockholders.
Any shortfall in funding could result in the Company's having to curtail the
introduction of new products and services, its entry into new markets and the
deployment of network hardware and other facilities, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Risk Factors--Future Capital Needs" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
The foregoing assumes conversion of the Notes into Common Stock. The Notes
bear interest at the rate of 10% per annum, payable semi-annually, and mature
in June 1998. The Notes are convertible into Common Stock subject to certain
events at a conversion price equal to 70% of the price to public set forth on
the cover of this Prospectus, subject to certain adjustments. The Notes are
also subject to prepayment at the election of the Company after the first
anniversary of their issuance (June 24, 1997). In the event that (i) the
Company elects to prepay the Notes and all of the Notes are not converted by
the holders prior to prepayment, or (ii) all of the Notes are not otherwise
converted prior to their maturity in June 1998, the Company will be required
to repay the principal amount of, plus any interest accrued on, such
unconverted Notes at such time. The Company expects that in the event any such
payment is required, the Company would be required to reduce its budget for
capital expenditures and, specifically, would be required to lease capital
equipment now planned to be purchased. There can be no assurance as to the
terms of such a lease financing. See Note 8 to Notes to Consolidated Financial
Statements.
22
<PAGE>
DIVIDEND POLICY
To date, the Company has neither declared nor paid any cash dividends on
shares of its Common Stock. The Company presently intends to retain all future
earnings for its business and does not anticipate paying cash dividends on its
Common Stock in the foreseeable future. In addition, so long as any of the
Company's Series A Convertible Secured Subordinated Notes remain outstanding,
and until the consummation of an initial public offering of the Common Stock,
the Company is prohibited from paying dividends with respect to any class of
the Company's capital stock.
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1996, and as adjusted to give effect to the sale of the shares
of Common Stock offered by the Company hereby at an assumed initial public
offering price of $14 per share, after deducting the underwriting discount and
estimated offering expenses.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
--------------------
ACTUAL AS ADJUSTED
------- -----------
<S> <C> <C>
Cash, cash equivalents and short-term investments......... $ 8,396 $52,816
======= =======
Secured Subordinated Convertible Notes.................... 19,691 19,691
Other long-term debt and capital lease obligations,
excluding current portion................................ 1,720 1,720
Stockholders' equity (deficit):
Common stock--$.001 par value; 44,000,000 shares
authorized, 15,978,074 shares issued and outstanding,
actual; 100,000,000 shares authorized, 19,478,074 shares
outstanding, as adjusted................................. 16 20
Additional paid-in capital................................ -- 44,416
Stock purchase warrants................................... 353 353
Accumulated deficit....................................... (8,238) (8,238)
------- -------
Total stockholders' equity (deficit).................... (7,869) 36,551
------- -------
Total capitalization.................................. $13,542 $57,962
======= =======
</TABLE>
The above computations assume that (i) no part of the Underwriters' over-
allotment option is exercised and (ii) no options or warrants are exercised
after September 30, 1996. As of September 30, 1996, there were (i) outstanding
options to purchase an aggregate of 3,537,558 shares of Common Stock at a
weighted average exercise price of $3.30 per share, (ii) outstanding warrants
to purchase 311,224 shares of Common Stock at an exercise price of $9.80 per
share (assuming an initial public offering price of $14 per share), and (iii)
Notes convertible into 2,040,816 shares of Common Stock at a conversion price
of $9.80 per share (assuming an initial public offering price of $14 per
share). See "Management--Stock Option Plans and Arrangements," "Description of
Capital Stock" and Notes 8, 11 and 14 of Notes to Consolidated Financial
Statements.
23
<PAGE>
DILUTION
The net tangible book value of the Company as of September 30, 1996, was
$(7,869,000), or $(0.49) per share of Common Stock. "Net tangible book value"
per share represents the amount of total tangible assets of the Company
reduced by the amount of its total liabilities and divided by the total number
of shares of Common Stock outstanding. Without taking into account any other
changes in such net tangible book value after September 30, 1996, other than
to give effect to the sale by the Company of the shares of Common Stock
offered hereby at an assumed initial public offering price of $14 per share
after deducting the underwriting discount and estimated offering expenses
payable by the Company, the pro forma net tangible book value of the Company
as of September 30, 1996, would have been $36,551,000, or $1.88 per share.
This amount represents an immediate increase in such net tangible book value
of $2.37 per share to existing stockholders and an immediate dilution of
$12.12 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................ $14.00
Net tangible book value per share as of September 30, 1996... $(0.49)
Increase per share attributable to new investors............. 2.37
------
Pro forma net tangible book value per share after the offer-
ing........................................................... 1.88
------
Dilution per share to new investors............................ $12.12
======
</TABLE>
The following table summarizes, on a pro forma basis as of September 30,
1996, the differences between the existing stockholders and the new investors
with respect to the number of shares of Common Stock purchased from the
Company, the total consideration paid to the Company and the average price
paid per share, based upon an assumed initial public offering price of $14 per
share (before deducting the underwriting discount and estimated offering
expenses payable by the Company) with respect to the 3,500,000 shares offered
by the Company hereby:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------ ------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......... 15,978,074 82.0% $ 412,600 0.8% $0.03
New investors.................. 3,500,000 18.0 49,000,000 99.2 14.00
---------- ----- ----------- -----
Total........................ 19,478,074 100.0% $49,412,600 100.0%
========== ===== =========== =====
</TABLE>
The above computations assume that (i) no part of the Underwriters' over-
allotment option is exercised and (ii) no options or warrants are exercised
after September 30, 1996. As of September 30, 1996, there were (i) outstanding
options to purchase an aggregate of 3,537,558 shares of Common Stock at a
weighted average exercise price of $3.30 per share, (ii) outstanding warrants
to purchase 311,224 shares of Common Stock at an exercise price of $9.80 per
share (assuming an initial public offering price of $14 per share), and (iii)
Notes convertible into 2,040,816 shares of Common Stock at a conversion price
of $9.80 per share (assuming an initial public offering price of $14 per
share). To the extent the above options and warrants are exercised and the
Notes are converted, there will be further dilution to new investors. See
"Management--Stock Option Plans and Arrangements," "Description of Capital
Stock" and Notes 8, 11 and 14 of Notes to Consolidated Financial Statements.
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Prospectus. The balance sheet information
as of December 31, 1994 and 1995 and September 30, 1996 and the income
statement data set forth below for the years ended December 31, 1993, 1994,
and 1995 and the nine months ended September 30, 1996 are derived from the
audited financial statements included elsewhere in this Prospectus. The
balance sheet information as of December 31, 1992 and 1993 and the income
statement data for the year ended December 31, 1992 are derived from unaudited
financial statements of the Company not included herein. The income statement
data for the nine months ended September 30, 1995 is derived from unaudited
financial statements included herein. In the opinion of management, such
unaudited financial statements have been prepared on the same basis as the
audited financial statements referred to above and include all adjustments,
consisting of normal recurring accruals, necessary for a fair presentation of
the Company results of operations for the indicated period. Operating results
for the nine months ended September 30, 1995 and 1996 are not necessarily
indicative of the results that may be expected for any future period.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------- ------------------
1992 1993 1994 1995 1995 1996
------- ------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT
OF OPERATIONS DATA:
Revenues:
Telecommunications..... $17,924 $23,510 $48,937 $86,871 $ 64,985 $ 67,907
Marketing communica-
tions................. 2,965 4,792 4,915 3,774 3,022 1,943
Electronic commerce
products and servic-
es.................... -- -- -- 654 408 1,106
------- ------- ------- ------- -------- --------
Total revenues....... 20,889 28,302 53,852 91,299 68,415 70,956
Cost of revenues:
Telecommunications..... 14,448 16,676 34,565 58,467 43,634 44,802
Marketing communica-
tions................. 1,564 2,164 1,497 1,194 986 544
Electronic commerce
products and servic-
es.................... -- -- -- 281 154 402
------- ------- ------- ------- -------- --------
Total cost of reve-
nues................ 16,012 18,840 36,062 59,942 44,774 45,748
------- ------- ------- ------- -------- --------
Gross profit......... 4,877 9,462 17,790 31,357 23,641 25,208
------- ------- ------- ------- -------- --------
Operating expenses:
Sales and marketing.... 1,067 2,289 6,713 13,191 9,810 9,558
General and adminis-
trative............... 4,637 7,708 12,837 18,495 13,131 17,825
------- ------- ------- ------- -------- --------
Total operating ex-
penses.............. 5,704 9,997 19,550 31,686 22,941 27,383
------- ------- ------- ------- -------- --------
Operating profit
(loss).............. (827) (535) (1,760) (329) 700 (2,175)
Share of losses of joint
ventures............... -- -- -- (489) (187) (541)
Other income (expense),
net.................... (149) 144 (233) (464) (225) (624)
------- ------- ------- ------- -------- --------
Income (Loss) before
income taxes.......... (976) (391) (1,993) (1,282) 288 (3,340)
Income tax expense...... (16) (47) (5) (552) (412) (110)
------- ------- ------- ------- -------- --------
Net loss............... $ (992) $ (438) $(1,998) $(1,834) $ (124) $ (3,450)
======= ======= ======= ======= ======== ========
Pro forma net loss per
share.................. $ (0.10) $ (0.17)
======= ========
Shares used in per share
computation............ 16,952 17,507
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------- SEPTEMBER 30,
1992 1993 1994 1995 1996
------- ------- ------- -------- -------------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA:
Cash, cash equivalents and
short-term investments... $ 424 $ 834 $ 1,274 $ 497 $ 8,396
Total working capital def-
icit..................... (1,114) (3,296) (8,309) (13,546) (2,282)
Total assets.............. 4,932 12,935 17,722 20,910 37,042
Long-term debt and capital
lease obligations........ 152 164 -- 1,146 21,411
Total debt and capital
lease obligations........ 157 173 24 6,252 22,689
Stockholders' deficit..... (752) (767) (2,768) (4,462) (7,869)
</TABLE>
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company for the nine months ended September 30, 1995 and
1996 and the years ended December 31, 1993, 1994 and 1995. The discussion
should be read in conjunction with the Company's Consolidated Financial
Statements, including the Notes thereto, and the other financial data included
elsewhere in this Prospectus.
OVERVIEW
NetSource develops, implements and manages a wide range of communications
solutions for business and end-user customers worldwide. The Company's
products and services include international and domestic long distance
telecommunications, value-added telecommunications and related telemanagement
services, Internet access and hosting, and Internet and interactive electronic
commerce products and services, such as Web-based architecture development and
maintenance, Web-based content development and management, and marketing
communications services. No customer represented greater than 10% of the
Company's revenues in any of the years ended December 31, 1993, 1994 and 1995
or in the nine months ended September 30, 1995 and 1996.
The Company's Reorganization, in which the businesses of MTC International,
MTC Telemanagement and NetSource Interactive were combined into the Company,
was consummated on June 28, 1996. MTC International and MTC Telemanagement,
the Company's subsidiaries, have been operating in the telecommunications
market since March 1993 and October 1988, respectively. NetSource Interactive
entered the interactive communications and Internet electronic commerce
services business in the third quarter of 1995. Accordingly, the combined
Company and each operating entity have only a limited operating history on
which investors may evaluate the Company. In addition, the Company has not had
material sales of its Internet product and service offerings to date. The
Company's current focus is on expanding its global network of hardware,
software and facilities and introducing new Internet and interactive products
and services to increase its customer base. The Company intends to continue to
hire additional personnel and to increase its expenses related to product
development, marketing, management, network infrastructure, technical
resources and customer support. There can be no assurance that revenue growth
will continue or that the Company will in the future achieve or sustain
profitability on either a quarterly or annual basis. See "Business--
Reorganization," "Risk Factors--Limited Operating History; No Assurance of
Future Profitability" and Note 1 of Notes to Consolidated Financial
Statements.
26
<PAGE>
RESULTS OF OPERATIONS
The following tables set forth certain financial data for the Company's
operations as a percentage of total revenues for the years ended December 31,
1993, 1994 and 1995, and for the nine months ended September 30, 1995 and
1996, except for cost of telecommunications revenues, cost of marketing
communications revenues and cost of electronic commerce revenues, which are
presented as a percentage of their respective associated revenues. The
operating results for any period are not necessarily indicative of results for
any future period. The Company anticipates that results will fluctuate
depending on a number of factors. See "Risk Factors--Variability of Quarterly
Operating Results."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------- ------------------
1993 1994 1995 1995 1996
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Telecommunications revenues..... 83.1% 90.9% 95.2% 95.0% 95.7%
Marketing communications reve-
nues........................... 16.9 9.1 4.1 4.4 2.7
Electronic commerce revenues.... -- -- 0.7 0.6 1.6
Total revenues................. 100.0 100.0 100.0 100.0 100.0
Cost of telecommunications reve-
nues........................... 70.9 70.6 67.3 67.1 66.0
Cost of marketing communications
revenues....................... 45.2 30.5 31.6 32.6 28.0
Cost of electronic commerce rev-
enues.......................... -- -- 43.0 37.7 36.3
Total cost of revenues......... 66.6 67.0 65.7 65.4 64.5
Gross margin.................... 33.4 33.0 34.3 34.6 35.5
Sales and marketing expenses.... 8.1 12.5 14.4 14.3 13.5
General and administrative ex-
penses......................... 27.2 23.8 20.3 19.2 25.1
Operating income (loss)......... (1.9) (3.3) (0.4) 1.0 (3.1)
Income (loss) before income tax-
es............................. (1.4) (3.7) (1.4) 0.4 (4.7)
Net loss........................ (1.5) (3.7) (2.0) (0.2) (4.9)
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1995
Revenues. Total revenues for the nine months ended September 30, 1996
increased 4% to $71.0 million from $68.4 million for the nine months ended
September 30, 1995. For the first nine months of 1996, revenues derived from
customers located outside the U.S. amounted to 72% of total revenues, as
compared to 68% in the first nine months of 1995. This increase reflects the
growth of the Company's telecommunications services business in international
markets due to increased recognition of the benefits of re-origination
services in these markets. This increase more than offset a decline in
domestic telecommunications revenue resulting from the Company's de-emphasis
in marketing its telecommunications services and the increased competition in
the domestic market. Domestic telecommunications revenues declined to $17.1
million in the first nine months of 1996 from $18.6 million in the first nine
months of 1995. Telecommunications revenues increased 4% to $67.9 million, or
96% of total revenues, in the first nine months of 1996, from $65.0 million,
or 95% of total revenues, in 1995. The Company experienced slowed growth in
telecommunications revenue in the first nine months of 1996, primarily as a
result of the lack of availability of sufficient capital resources to support
further expansion and upgrade of the Company's switching network. This
inability of the Company to expand and upgrade its network during this period
prevented the Company from offering its customers more aggressively priced
service rates, which resulted in slowed revenue growth. The Company currently
expects to spend a substantial portion of the proceeds of this offering on
capital expenditures over the next 24 months for switching and other equipment
for the upgrade and expansion of the Company's telecommunications network. See
"Use of Proceeds." Marketing communications revenues declined to $1.9 million,
or 3% of total revenues, in the first nine months of 1996 from $3.0 million,
or 4% of total revenues, in 1995. The decrease in marketing communications
27
<PAGE>
revenues primarily reflected the loss of a significant marketing
communications customer that was acquired by another company in the first half
of 1996. While the Company has obtained additional marketing communications
customers in 1996, the Company believes that significant growth of its
marketing communications revenues is substantially dependent upon the
Company's ability to expand its presence in the electronic commerce products
and services market. Electronic commerce products and services revenues
amounted to $1.1 million in the first nine months of 1996, as compared to
$408,000 in the first nine months of 1995. The Company commenced its
electronic commerce business in mid-1995. See Notes 1 and 2 of Notes to
Consolidated Financial Statements.
Cost of Telecommunications Revenues. The Company's cost of
telecommunications revenues consists primarily of the direct cost associated
with telecommunications capacity obtained from local and interexchange
carriers and costs related to the Company's telecommunications network such as
rent for switch housing and depreciation on switching equipment. Costs of
telecommunications revenues increased to $44.8 million in the first nine
months of 1996 from $43.6 million in the same period of 1995. As a percentage
of telecommunications revenues, such costs declined to 66% in the first nine
months of 1996 from 67% in the same period in 1995. This relative stability of
costs of telecommunications revenues as a percentage of telecommunications
revenues reflects the modest growth in such revenues in the first nine months
of 1996 as compared to 1995.
Cost of Marketing Communications Revenues. The Company's cost of marketing
communications revenues consists primarily of direct costs associated with
design and production of marketing communications materials. Cost of marketing
communications revenues decreased to $544,000 in the first nine months of 1996
from $986,000 in the first nine months of 1995 corresponding to related
revenue declines, while decreasing to 28% of marketing communications revenues
in the first nine months of 1996 from 33% in the first nine months of 1995.
This decrease in such costs as a percentage of marketing communications
revenues reflects a number of higher margin marketing communications projects
underway in the first nine months of 1996 as compared to 1995.
Cost of Electronic Commerce Revenues. The Company's cost of electronic
commerce products and services revenues consists primarily of direct costs
associated with the design, development and deployment of interactive media
products and services. Cost of such revenues amounted to $402,000 in the first
nine months of 1996, or 36% of such revenues, as compared to $154,000, or 38%
of such revenues, in the same period in 1995.
Gross Profit. The Company's gross profit (total revenues less total cost of
revenues) increased to $25.2 million in the first nine months of 1996, from
$23.6 million in the first nine months of 1995. The Company's gross margin
(total revenues less total cost of revenues as a percentage of revenues)
remained at approximately 35% in the first nine months of 1996 and 1995. The
Company's current telecommunications network and Internet backbone expansion
plan will substantially increase the Company's cost structure in advance of a
corresponding increase in revenues. At the same time, the Company has
experienced and expects to continue to experience competitive pricing
pressures in the telecommunications services market. As a result of these
planned increases in the Company's cost structure and competitive trends, the
Company's gross margins and other operating results would be adversely
affected if its revenues do not increase substantially in the future. The
number of telecommunications switches the Company expects to deploy over the
next 24 months and the Company's planned establishment and expansion of its
Internet backbone over this period are forward-looking statements that involve
risks and uncertainties, and actual results could differ materially as a
result of a number of factors, including those described in "Risk Factors--
Risks of Growth and Expansion."
28
<PAGE>
Sales and Marketing Expenses. The Company's sales and marketing expenses
consist primarily of sales commissions paid to independent master affiliates
and salaries and related support costs associated with the Company's affiliate
support and marketing group. Sales and marketing expenses decreased to $9.6
million in the first nine months of 1996 from $9.8 million in the year earlier
period. As a percentage of total revenues, these expenses decreased slightly
to approximately 13% in the first nine months of 1996, as compared to 14% in
the first nine months of 1995. Such decreases primarily reflected lower total
commission payments in respect of telecommunications sales due to lower
average commission rates on such sales and an increase in the proportion of
non-commissionable sales of such services. The Company expects sales and
marketing expenses to grow in dollar amount in future periods as it expands
its sales and marketing efforts and distribution channels in connection with
expansion of its telecommunications network and electronic commerce business.
General and Administrative Expenses. The Company's general and
administrative expenses increased 36% to $17.8 million in the first nine
months of 1996 from $13.1 million in the first nine months of 1995. As a
percentage of total revenues, general and administrative expenses increased to
25% of total revenues in the first nine months of 1996 from 19% in 1995. These
increases reflected legal fees and other administrative costs, as well as
severance payments, associated with the Reorganization effected in June 1996
and expansion of the Company's management team and administrative
infrastructure to support the Company's operations, an increase in expenses
associated with the retention of temporary and consulting personnel,
particularly in the financial and accounting area and an additional $493,000
provision against certain accounts receivable relating to the Company's Japan
joint venture. The Company expects that general and administrative expenses
will increase substantially in dollar amount in the future as the Company
continues to expand its global operations.
Share of Losses of Joint Ventures. In February 1995, the Company formed a
joint venture to market and distribute telecommunications services in Japan,
and in January 1996, the Company formed a joint venture to market and
distribute telecommunications services in the Netherlands. The Company's share
of losses generated by these joint ventures amounted to $541,000 and $187,000
in the nine months ended September 30, 1996 and 1995, respectively. These
losses resulted primarily from the early stages of development of the joint
ventures. The Company expects losses to continue from both joint ventures at
least through 1997. While the Company has no continuing contractual obligation
to fund such losses and reviews from time to time whether it should continue
to do so, the Company presently intends to continue recognizing its share of
the losses of the joint ventures. The foregoing statements concerning the
Company's expectation as to the duration of further losses from its joint
ventures constitute forward-looking statements that involve risks and
uncertainties and the actual results of operations of the joint ventures could
vary as a result of a number of factors, including, but not limited to, the
ability of such joint ventures to penetrate their target markets, the results
and timing of the Company's launch of new products and services, the timing
and extent of network expansion, governmental or regulatory changes, the
success of the Company's marketing efforts, technological advances and
competition. See Note 3 of Notes to Consolidated Financial Statements.
Other Income (Expense), Net. The increase in the net charge to other income
(expense), net to $624,000 in the nine months ended September 30, 1996
compared to $225,000 in the same period in 1995 primarily reflects increased
interest expense in the first nine months of 1996. The Company expects
interest expense to increase during the remainder of 1996 as the Company
incurs additional interest expense associated with the $20 million in
principal amount of secured subordinated convertible notes issued by the
Company in June 1996. See Note 8 of Notes to Consolidated Financial Statements
and "--Liquidity and Capital Resources."
Income Taxes. Prior to the Reorganization effected June 28, 1996, the
several entities that combined to form the Company did not file consolidated
tax returns. As a result, income recognized by a given entity could not be
offset for tax purposes by losses realized by another entity. In the nine
29
<PAGE>
months ended September 30, 1996 and 1995, certain of such entities recognized
pre-tax profits and as a result made related provisions for income taxes
aggregating $110,000 and $412,000, respectively. See Notes 2 and 10 of Notes
to Consolidated Financial Statements.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Revenues. Total revenues for the year ended December 31, 1995 increased 70%
to $91.3 million from $53.9 million for 1994. For 1995, revenues derived from
international customers amounted to 69% of total revenues, as compared to 45%
in 1994. This increase primarily reflects increased sales of the Company's
international telecommunications services due to the Company's expanded
international distribution channels and the increased recognition in the
international market of the benefits of re-origination services, which more
than offset a decline in domestic telecommunications revenues. Domestic
telecommunications revenues declined to $23.6 million in 1995 from $24.9
million in 1994. Telecommunications revenues increased 78% to $86.9 million,
or 95% of total revenues, in 1995, from $48.9 million, or 91% of total
revenues, in 1994. Marketing communications revenues declined to $3.8 million,
or 4% of total revenues, in 1995 from $4.9 million, or 9% of total revenues,
in 1994. The decrease in marketing communications revenues primarily reflected
the loss of a significant marketing communications customer that filed for
bankruptcy protection in mid-1994. Electronic commerce products and services
revenues amounted to $654,000 in 1995. The Company commenced, its electronic
commerce business in mid-1995. See Notes 1 and 2 of Notes to Consolidated
Financial Statements.
Cost of Telecommunications Revenues. Costs of telecommunications revenues
increased to $58.5 million in 1995, from $34.6 million in 1994, but declined
to 67% of telecommunications revenues in 1995 from 71% in 1994. This decrease
is primarily due to allocation of the Company's fixed costs over its larger
revenue base and the increased level of telecommunications revenues derived
from international markets in which the Company received favorable volume
pricing from a number of major interexchange carriers.
Cost of Marketing Communications Revenues. Cost of marketing communications
revenues decreased to $1.2 million in 1995 from $1.5 million in 1994 as
related revenue declined, but increased to 32% of marketing communications
revenues in 1995 from 30% in 1994. The increase in such costs as a percentage
of marketing communications revenues reflects the completion of a number of
higher margin marketing communications projects in 1994.
Cost of Electronic Commerce Revenues. The Company's cost of electronic
commerce products and services revenues amounted to $281,000 in 1995, or 43%
of such revenues.
Gross Profit. The Company's gross profit increased to $31.4 million in 1995,
from $17.8 million in 1994. The Company's gross margin increased to 34% in
1995 from 33% in 1994.
Sales and Marketing Expenses. Sales and marketing expenses increased 96% to
$13.2 million in 1995 from $6.7 million in 1994. These expenses increased as a
percentage of total revenues to 14% in 1995 from 12% in 1994. These increases
reflect higher average commissions paid on international products and services
than those paid on domestic products and services and an overall increase in
the support staff and marketing expenses of the Company associated with its
increased revenues.
General and Administrative Expenses. The Company's general and
administrative expenses increased 44% to $18.5 million in 1995 from $12.8
million for 1994. As a percentage of total revenues, general and
administrative expenses decreased to 20% of total revenues in 1995 from 24% in
1994, reflecting the Company's substantial increase in total revenues in 1995.
The increase in dollar amount of such spending primarily reflects expansion of
the Company's management team and administrative infrastructure to support the
Company's operations. In addition, general and administrative expense in
30
<PAGE>
1994 included a charge of approximately $1.2 million as a result of non-
payment by a customer for marketing communications services provided by the
Company.
Share of Losses of Joint Ventures. The Company's share of losses generated
by its telecommunications services joint venture in Japan amounted to $489,000
in 1995, its first year of operations. See Note 3 of Notes to Consolidated
Financial Statements.
Other Income (Expense), Net. The increase in the net charge to other income
(expense), net to $464,000 in 1995 compared to $233,000 in the same period in
1994 reflected several capital leases, notes payable and borrowing
transactions (including certain termination fees) that increased the Company's
interest expense to $312,000 during that year.
Income Taxes. In 1995, certain of the entities that combined to form the
Company pursuant to the Reorganization in June 1996 recognized pre-tax income
and, as a result, recorded related provisions for income taxes aggregating
$552,000. In 1994, the pre-tax income recognized by such entities was nominal
and accordingly only an immaterial tax provision was recorded. See Notes 2 and
10 of Notes to Consolidated Financial Statements.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
Revenues. Total revenues for the year ended December 31, 1994 increased 90%
to $53.9 million from $28.3 million for 1993. Telecommunications revenues
totaled $48.9 million, or 91% of total revenues, in 1994. In 1993,
international telecommunications revenues were nominal in amount. The Company
commenced its international telecommunication services business in mid-1993.
Marketing communications revenues totaled $4.9 million, or 9% of total
revenues, in 1994 as compared to $4.8 million, or 17% of total revenues, in
1993.
Cost of Telecommunications Revenues. Cost of telecommunications revenues
increased to $34.6 million in 1994 from $16.7 million in 1993. Such costs as a
percentage of telecommunications revenues remained at approximately 71% in
each of 1994 and 1993, however. During 1994, cost efficiencies associated with
the Company's higher level of telecommunications revenues were offset by
increased fixed costs attributable to deployment and expansion of the
Company's international telecommunications network.
Cost of Marketing Communications Revenues. The Company's costs of marketing
communications revenues declined to $1.5 million in 1994 from $2.2 million in
1993, and decreased substantially as a percentage of advertising revenues to
30% in 1994 from 45% in 1993. The significant decrease in such costs as a
percentage of marketing communications revenues primarily reflects the
commencement of a number of higher margin marketing communications projects
for customers in 1994.
Gross Profit. Gross profit increased to $17.8 million in 1994 from $9.5
million in 1993. The Company's gross margin remained at approximately 33% in
1994 and 1993.
Sales and Marketing Expenses. The Company's sales and marketing expenses
increased to $6.7 million in 1994 from $2.3 million in 1993. As a percentage
of total revenues, such expenditures increased to 12% of total revenues in
1994 from 8% of total revenues in 1993. These increases reflect higher average
commissions paid to international master affiliates and an overall increase in
support staff and marketing expenses associated with the Company's first full
year of international operations.
General and Administrative Expenses. The Company's general and
administrative expenses increased 67% to $12.8 million in 1994 from $7.7
million in 1993. As a percentage of total revenues, such expenses declined to
approximately 24% of total revenues in 1994 from 27% in 1993. The
31
<PAGE>
increase in dollar amount of such spending primarily reflects the substantial
expansion of the Company's management and administrative infrastructure to
support the Company's expansion into the international telecommunications
market beginning in mid-1993. In addition, general and administrative expense
in 1994 included a charge of approximately $1.2 million, on net receivables of
$2.7 million, as a result of non-payment by a customer for marketing
communications services provided by the Company.
Other Income (Expense), Net. During 1994, the Company recorded a net charge
of $233,000 in other income (expense), net primarily due to recognition of an
$83,000 loss related to a discontinued product line and an $82,500 loss on the
sale of certain fixed assets. This compared to the realization of $144,000 in
other income (expense), net in 1993, primarily due to the fact that interest
income was not offset by other expense.
Income Taxes. In each of 1994 and 1993, the Company recorded only nominal
provisions for income taxes.
QUARTERLY RESULTS
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1994 1995 1995 1995 1995 1996 1996 1996
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Telecommunications..... $17,749 $20,977 $22,066 $21,942 $21,886 $22,592 $22,737 $22,578
Marketing
communications........ 657 675 1,333 1,014 752 658 616 669
Electronic commerce
products and
services.............. -- -- 132 276 246 230 286 590
------- ------- ------- ------- ------- ------- ------- -------
Total revenues......... 18,406 21,652 23,531 23,232 22,884 23,480 23,639 23,837
Cost of revenues:
Telecommunications..... 12,816 13,966 14,859 14,809 14,833 14,852 14,693 15,257
Marketing
communications........ 248 222 424 340 208 146 188 210
Electronic commerce
products and
services.............. -- 1 52 101 127 164 106 132
------- ------- ------- ------- ------- ------- ------- -------
Total cost of
revenues.............. 13,064 14,189 15,335 15,250 15,168 15,162 14,987 15,599
------- ------- ------- ------- ------- ------- ------- -------
Gross profit........... 5,342 7,463 8,196 7,982 7,716 8,318 8,652 8,238
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
Sales and marketing.... 2,329 3,105 3,332 3,373 3,381 3,350 3,112 3,096
General and
administrative........ 3,367 3,965 4,410 4,756 5,364 4,836 5,435 7,554
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 5,696 7,070 7,742 8,129 8,745 8,186 8,547 10,650
------- ------- ------- ------- ------- ------- ------- -------
Operating profit
(loss)................ (354) 393 454 (147) (1,029) 132 105 (2,412)
Share of losses of joint
ventures............... 0 (2) (40) (145) (302) (35) (249) (257)
Other expense, net...... (211) (54) (77) (94) (239) (113) (155) (356)
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before
income taxes.......... (565) 337 337 (386) (1,570) (16) (299) (3,025)
Income tax benefit
(expense).............. 88 (80) (152) (180) (140) (188) (78) 156
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)...... $ (477) $ 257 $ 185 $ (566) $(1,710) $ (204) $ (377) $(2,869)
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
32
<PAGE>
The Company's quarterly operating results are expected to fluctuate from
quarter to quarter depending on various factors, including the rate of
deployment of new switching equipment, the timing of release of new products
and services, competition, the evolving and unpredictable nature of the
markets in which the Company's products and services are sold, the mix of
distribution channels and products, pricing actions by the Company or its
competitors, the pace of telecommunications deregulation in the markets in
which the Company competes, seasonality, and general economic conditions. A
significant portion of the Company's expenses, such as rent, headcount,
depreciation, costs of telecommunications capacity from local and
interexchange carriers and capital lease expenses, are relatively fixed in
advance, based in large part on the Company's forecasts of future sales. The
forecasting of future sales by the Company is necessarily imprecise and this
imprecision is compounded and the timeliness of such forecasting is adversely
affected by the material weaknesses in the Company's internal control
structure and operations and by the early stage of development of the
Company's Internet and interactive products and services. If sales are below
expectations in any given period, the adverse effect of a shortfall in sales
on the Company's operating results may be magnified by the Company's inability
to adjust spending to compensate for such a shortfall. The Company's markets,
characterized by short product life cycles and declining prices of existing
products and services, require introduction of new products and services and
enhancements to existing products and services to maintain gross margins.
Moreover, in response to competitive pressures or to pursue new product or
market opportunities, the Company may take certain pricing or marketing
actions that could materially and adversely affect the Company's operating
results. In addition, the Company's telecommunications revenues can be
affected by seasonality, which varies by geographic region. As a result of all
of the foregoing, there can be no assurance that the Company will be able to
achieve or sustain profitability on a quarterly or annual basis.
Total revenues increased on a quarter-to-quarter basis over the periods
presented through the quarter ended June 30, 1995, primarily reflecting growth
in demand for the Company's telecommunications services, especially in
international markets. The Company's total revenues remained relatively flat
in the second half of 1995 through the quarter ended September 30, 1996,
primarily as a result of the lack of availability of sufficient capital
resources to support further expansion and upgrade of the Company's switching
network. This inability of the Company to expand and upgrade its network
during this period prevented the Company from offering its customers more
aggressively priced service rates, resulting in relatively flat
telecommunications revenues. While the Company's results of operations over
the periods presented do not exhibit material seasonal trends, the Company
believes that such trends, in particular seasonal softness in Europe during
the late summer months, may affect its operating results in the future. Gross
margins (gross profit as a percentage of total revenues) increased to
approximately 34% to 36% in 1995 and 1996, respectively, from a gross margin
of approximately 29% in the quarter ended December 31, 1994, reflecting
increased competition in the telecommunications carrier market, which has
resulted in improved capacity pricing for the Company. Sales and marketing
expenses increased through the quarter ended December 31, 1995 but declined in
the three quarter period ended September 30, 1996, primarily due to lower
aggregate commission payments in respect of telecommunications sales due to an
increase in the proportion of non-commissionable sales of such services. While
general and administrative expenses generally increased on a quarter-to-
quarter basis over the periods presented, such expenditures increased
substantially in the quarter ended September 30, 1996, reflecting legal fees
and other administrative costs, as well as severance payments associated with
the Reorganization, expansion of the Company's management team and
administrative infrastructure to support the Company's operations, an increase
in expenses associated with the retention of temporary and consulting
personnel, particularly in the financial and accounting area, and an
additional provision against certain accounts receivable.
LIQUIDITY AND CAPITAL RESOURCES
The Company has experienced significant growth in its operations in recent
years, which has required substantial working capital to finance receivables
and capital expenditures. In addition, the
33
<PAGE>
Company has financed a substantial portion of its working capital needs by
taking advantage of the timing of its billing and collection cycle versus its
carrier payments. For the vast majority of the Company's international
telecommunications service revenue, the Company generally invoiced its
customers on a monthly basis, but collected funds on a weekly basis via an
automatic charge to its customers' credit card accounts. By collecting such
cash on a weekly basis while paying its carriers on a less frequent basis, the
Company has internally financed its activities, although occasionally
experiencing negative working capital balances. Such working capital deficits
have resulted in the Company's engaging in certain debt financing activities.
Net cash provided by operating activities was $1.5 million, $3.6 million,
$1.4 million and $85,000 in 1993, 1994, 1995 and the nine months ended
September 30, 1996, respectively. In 1994 and 1995, rapid international sales
growth and the accelerated collection process for international
telecommunications receivables relative to payment by the Company of its
carrier payables, resulted in significant cash flow from operations despite a
negative working capital position at year end.
Net cash used in investing activities was $1.7 million, $1.8 million, $3.3
million and $6.8 million in 1993, 1994, 1995 and the nine months ended
September 30, 1996, respectively. A substantial portion of investing activity
in 1993, 1994, 1995 and the first nine months of 1996 consisted of the
purchase and deployment of switching equipment, as well as costs incurred in
the development of the Company's management information systems and purchase
of office furniture as overall head count increased.
Net cash provided by (used in) financing activity was $(17,000), $(832,000),
$1.0 million and $11.1 million in 1993, 1994, 1995 and the nine months ended
September 30, 1996, respectively. The cash used in financing activity in 1994
primarily related to the repayment of $789,000 in bank overdrafts. During
1995, cash provided by financing activity primarily reflected drawdowns on a
domestic credit line that was in place in November and December 1995. The
substantial increase in net cash provided by financing activities in the nine
months ended September 30, 1996 reflected the proceeds from the Company's
issuance of the Notes. In June 1996 the Company issued $20 million in
principal amount of the Notes to certain foreign institutional investors. The
Notes bear interest at the rate of 10% per annum, payable semi-annually, and
mature in June 1998. The Notes are convertible into Common Stock subject to
certain events at a conversion price equal to 70% of the price to public set
forth on the cover of this Prospectus, subject to certain adjustments. The
Notes are also subject to prepayment at the election of the Company after the
first anniversary of their issuance (June 24, 1997). In the event that (i) the
Company elects to prepay the Notes and all of the Notes are not converted by
the holders prior to prepayment, or (ii) all of the Notes are not otherwise
converted prior to their maturity in June 1998, the Company will be required
to repay the principal amount of, plus any interest accrued on, such
unconverted Notes at such time. The Company expects that in the event any such
payment is required, the Company would be required to reduce its budget for
capital expenditures and, specifically, would be required to lease capital
equipment now planned to be purchased. There can be no assurance as to the
terms of such a lease financing. See Note 8 of Notes to Consolidated Financial
Statements.
At September 30, 1996, the Company's principal source of liquidity was $8.4
million in cash and cash equivalents, although the Company had a negative
working capital balance at such date of approximately $2.3 million. The
Company currently expects to spend approximately $36.5 million on capital
expenditures over the next 24 months for switching and other equipment for the
upgrade and expansion of the Company's telecommunications network, Internet
backbone, and for additional computer equipment in support of its interactive
businesses, although the Company may fund such capital expenditures through
lease financing arrangements.
The Company intends to increase its telecommunications network
significantly, adding network hardware and dedicated leased lines in numerous
locations throughout the world. In addition, the Company intends to utilize
capital to invest in research and development and strategic joint ventures
34
<PAGE>
and to make acquisitions of complementary products, technologies and
businesses. While the Company believes that the proceeds of this offering
combined with cash flow from operations will be sufficient to meet its capital
requirements for the 24 months following this offering, there can be no
assurance that the Company will not require additional financing before such
time. The Company's funding requirements may change at any time due to various
factors including the Company's operating results, the results and timing of
the Company's launch of new products and services, governmental or regulatory
changes, the timing and extent of its network expansion, the ability of the
Company to meet product and project demands, the nature and timing of the
Company's acquisition of complementary products, technologies or businesses,
the success of the Company's marketing efforts, technological advances and
competition. There can be no assurance that adequate funding will be available
to the Company or, if available, that funding will be on terms favorable to
the Company, and could require the issuance of additional debt or equity
securities which could dilute the ownership of existing stockholders. Any
shortfall in funding could result in the Company's having to curtail the
introduction of new products and services, its entry into new markets and the
deployment of network hardware and other facilities, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. See Note 1 of Notes to Consolidated Financial
Statements.
35
<PAGE>
BUSINESS
GENERAL
NetSource Communications, Inc. ("NetSource" or the "Company") develops,
implements and manages a wide range of communications solutions for business
and end-user customers worldwide. The Company's products and services include
international and domestic long distance telecommunications, value-added
telecommunications and related telemanagement services, Internet access and
hosting, Internet and interactive electronic commerce products and services,
such as Web-based architecture development and maintenance, content
development and management, and marketing communications services. The
Company's strategy consists of integrating communications solutions, expanding
its telecommunications and Internet-related networks, broadening its
distribution channels, developing innovative technology and acquiring
complementary technologies and businesses.
The Company believes that the telecommunications, applications software
development and marketing communications services industries are becoming
increasingly complementary as a result of telecommunications deregulation, the
proliferation of personal computers, connectivity advances and rapidly
converging technologies. Traditional voice and date services, multimedia
applications and emerging Internet-based products are being delivered to
customers using the medium of telecommunications. At the same time, businesses
worldwide are being confronted with increasingly complex communications
requirements as interaction increases with customers, remote offices,
affiliates and computer networks in global markets. To manage increased
traffic from fax, voice, data and electronic/Internet related media,
businesses must currently utilize multiple vendors for a number of
communications services including long distance telecommunications, network
design and engineering, Internet access, design and implementation of Web
architectures, and corporate marketing communications. NetSource offers its
customers a single source solution for such services on both a bundled and
discrete basis.
INDUSTRY OVERVIEW
DOMESTIC TELECOMMUNICATIONS
According to the U.S. Federal Communications Commission ("FCC"), in 1995 the
U.S. long distance telecommunications market was approximately $72.5 billion,
with AT&T Corporation, MCI Communications Corporation, Sprint Corporation and
Worldcom, Inc., generating approximately 81.9% of aggregate U.S. long distance
carrier revenues, with numerous other telecommunications carriers and
resellers accounting for the balance of the market.
Long distance companies that have their own transmission facilities and
switches are referred to as facilities-based carriers. Facilities-based
carriers are switch-based carriers, meaning that they have at least one switch
to direct their long distance traffic. Non-facilities-based carriers either
(i) depend upon facilities-based carriers for switching and transmission
facilities ("switchless resellers") or (ii) install and operate their own
switches but depend on facilities-based carriers for transmission facilities
("switch-based resellers"). Switch-based resellers are able to reduce service
costs with respect to those calls that originate and terminate in cities that
are served by such resellers' switches. Facilities-based carriers often engage
in the resale of other telecommunication carriers' services.
The relationship between resellers and the major long distance carriers is
predicated primarily upon the fact that the pricing strategies and cost
structures of the major long distance carriers have resulted historically in
their charging higher rates to the small to medium-sized business customer.
Small to medium-sized business customers typically are not able to make the
volume commitments necessary to negotiate reduced rates with long distance
carriers under individualized contracts. By
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committing to large volumes of traffic, the reseller guarantees traffic to the
major long distance carrier, but the major long distance carrier is relieved
of the administrative burden of qualifying and servicing large numbers of
small to medium-sized accounts. The successful reseller has lower overhead
costs and is able to efficiently market the long distance product, process
orders, verify credit and provide customer service to a large number of
accounts.
INTERNATIONAL TELECOMMUNICATIONS
International telecommunications consist of telephone-based (terrestrial,
wireless and satellite) transmissions that originate in one country and
terminate in a different country. The international long distance
telecommunications services market is divided into two major segments:
telecommunications that either originate or terminate in the U.S.; and
telecommunications between countries other than the U.S. The International
Telephone Union estimates that in 1994, the international long distance
telecommunications services market was approximately $50.6 billion, with AT&T
Corporation, Deutsche Telekom AG, MCI Communications Corporation, France
Telecom and British Telecommunications plc, generating approximately 39.8% of
aggregate global long distance carrier revenues, with numerous other
telecommunications carriers and resellers accounting for most of the balance
of the market.
Historically, national PTT monopolies provided the telephone services
required by their respective countries, leaving customers with no choice but
to use those services and pay the prices charged by PTTs. Additionally, much
of the intercountry traffic has been historically controlled by PTTs. Due to
this lack of competition, the historical cost of making international
telephone calls from points of origin outside of the U.S. has been
significantly higher than that of making international calls from inside the
U.S. In connection with increasing deregulation in international markets,
telecommunications providers such as the Company offered savings over the
rates charged by PTTs in countries with regulated telecommunications markets
through a process known as "callback." Callback technology allows
telecommunications providers to purchase telecommunications capacity from
service providers outside the regulated countries at lower rates and resell
the service to clients at a favorable rate relative to that offered by the
PTTs. Callback works by the caller making an initial telephone call and then
waiting for a "call back" from the network switch to complete the call.
Callback is a "non-transparent" service in that some action must be taken by
the caller other than dialing a phone number (i.e., hanging up and answering
the call back).
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More recently, technical innovations have allowed some companies to offer
customers a "transparent" callback service known as "reorigination" that
requires no additional actions by the caller. Using an "autodialer" which is
connected to the customer's telephone network, reorigination sends a signal to
an operations center which reroutes the call to the desired location without
the customer having to hang up and wait for a call back. The following diagram
illustrates the operation of callback and reorigination.
LOGO
The reduced costs afforded by callback and reorigination technology, coupled
with the introduction of value-added services such as voice mail, call
waiting, caller identification and call forwarding, have resulted in new
competitors to PTTs in providing international telecommunications services.
In the future, the Company believes that continuing deregulation of
international telecommunications markets coupled with technological advances
will lead to increased competition similar to that in the U.S. Specifically,
the Company believes that increased utilization of high speed
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fiber optic cable and technologically advanced switching software may increase
capacity, speed and quality and may offer value-added features while reducing
cost. The Company believes that these developments will result in decreased
demand for callback and reorigination services in deregulated markets, but
that these factors will lead to increased traffic volume for international
facilities-based carriers with an established customer base, carrier
relationships and switches.
THE INTERNET AND ELECTRONIC COMMERCE
The Internet is a global collection of computer networks cooperating to
enable commercial organizations, educational institutions, government agencies
and individuals to communicate electronically, access and share information
and conduct business. Unlike the public and private telecommunications
networks that are managed by businesses, government agencies or other
entities, the Internet is a cooperative interconnection of many such public
and private networks. The networks that comprise the Internet are connected in
a variety of ways, including the public switched telephone network and high
speed, dedicated leased lines.
A great deal of the growth in Internet use in the past several years has
been driven by the emergence of a specific network of servers and information
available on the Internet known as the World Wide Web (the "Web"). Based on a
client/server model and a set of standards for information access and
navigation, the Web allows non-technical users to exploit the capabilities of
the Internet thereby allowing them to retrieve, link and download information
on the Internet in a consistent manner and making the underlying complexities
of the Internet relatively seamless to the end-user. The growth of the
Internet and the Web has also been facilitated by the global proliferation of
personal computers, by connectivity advances, such as ISDN, xDSL and T-1
circuits, and by the development and distribution of easy-to-use graphical
interface software, such as NetScape Navigator and Microsoft Explorer.
The proliferation of the Web is a result in part of businesses recognizing
that the Web is an alternative for marketing communications and commerce due
to its interactive nature, which enables companies to customize their business
communications and access previously unused distribution channels. The
establishment of Web-based architectures for businesses represents an
efficient means of storing, managing and transferring documents and
interactive media in a way that can be more effectively used by employees,
customers, suppliers and other parties connected to a business. The use of the
Internet has also been expanded as a means for intra-enterprise
communications, or Intranets, as a cost effective way for businesses to link
their global internal networks.
The growth of the Web has led to an increase in the amount of electronic
commerce conducted over the Internet. The Company defines electronic commerce
as the delivery of information (both voice and data), products, services,
marketing, systems and support both within an organization or to the external
marketplace over any interactive, electronic or on-line medium. An electronic
commerce-based Web site may allow for the purchasing of products on-line or
the creation or changing of a visitor's bank or other account. The Forrester
Report for December 1995 estimated that typical budgets for a company to
launch and maintain a Web site for one year ranged, depending on the type of
site, from approximately $300,000 for a site with static content, to over $3
million for a site providing for consumer transactions. This report estimated
that these expenditures could rise up to 230% through 1997.
THE NETSOURCE STRATEGY
The Company believes that businesses worldwide are being confronted with
increasingly complex communications requirements as interaction increases with
customers, remote offices, affiliates and computer networks in global markets.
To manage increased traffic from fax, voice, data and
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electronic/Internet related media, businesses must currently utilize multiple
vendors for a number of communications services including long distance
telecommunications, network design and engineering, Internet access, design
and implementation of Web architectures, and corporate communications and
advertising. NetSource offers its customers a single source solution for such
services on both a bundled and discrete basis. The following are elements of
the Company's strategy in providing a complete communications solution.
Provide Integrated Solutions. The Company offers integrated communications
solutions which include telecommunications, network design, interactive
software systems, multimedia content creation and management and marketing
communications expertise. NetSource is able to exploit its technical
competence in telecommunications network design and computer telephony along
with its experience in the design and implementation of Web architectures and
marketing communications to provide its customers with a single source for
managed business communications products and services.
The foundation of the Company's solution is its global telecommunications
network and its experience in network design and computer telephony.
Telecommunications is the primary delivery medium for Internet access and
Internet hosting services. Internet access and hosting provides the platform
upon which the Company's Internet architectures, software and content
solutions are delivered. The Company's experience in marketing communications
enables the Company to create the "look and feel" of interactive media and
communications utilized in a client Internet presence. The ability to develop,
design and maintain content allows the Company to provide market-specific
applications.
Continue Development of Networks. The Company is currently engaged in a
large scale upgrade of its domestic and international telecommunications
network. During the next 24 months, the Company plans to deploy up to an
additional 14 digital switches throughout Europe, Asia and the Americas. The
Company's ownership of switches reduces its reliance on other carriers,
enables routing of traffic over multiple leased lines, aids in cost control
and permits the compilation of call record data and other customer
information, and will allow for the continued expansion of its switched based
network. In addition, the Company plans to expand its U.S. network control
center and establish a mirrored network control center in Europe. The Company
also continues to implement existing and emerging technologies, such as packet
and SS7 signalling protocols.
To complement its current telecommunications product offerings, the Company
plans to expand its Internet service capabilities to provide Internet access
and Web hosting. In order to do this, the Company plans to deploy a nationwide
network of data switches, routers and T-3 circuits to form the backbone of
such a network. The Company also acquired scruz-net, an ISP with approximately
2,000 customers as of November 15, 1996. See "--Recent Developments." In
addition, the Company plans to establish three Web farms in the U.S. and one
in Europe, to offer its Web hosting services.
Leverage and Expand Global Distribution Network. The Company is seeking to
leverage its international telecommunications distribution channels by selling
its telecommunications, Internet and interactive products and services through
such channels to new and existing customers. The Company intends to continue
to expand its distribution channels to obtain greater geographic and market
coverage. For example, the Company intends to increase its use of foreign
joint ventures to service markets in which the Company does not already have a
presence. See "--Marketing and Sales."
Maintain Leading Edge Technology. The Company believes that its core
technological capabilities enable it to offer differentiated services and
products to its customers. The Company believes it was a pioneer in the
development of least cost routing technology, computer-controlled switch-based
telecommunications networks and advanced Web architectures for electronic
commerce. NetSource's strategy of technology innovation and implementation is
based upon research and
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development efforts that the Company expects to continue to result in the
introduction of new products and services in a rapid time-to-market and cost-
effective manner. See "--Technology and Intellectual Property."
Acquire Complementary Technologies and Businesses. The Company intends to
pursue the acquisition of complementary technologies, products, services and
businesses. The Company's acquisition strategy is to pursue opportunistic
acquisitions which will allow the Company to obtain leading edge technology,
talented and experienced personnel, previously established customer
relationships and complementary product offerings. See "--Recent
Developments."
PRODUCTS AND SERVICES
TELECOMMUNICATIONS OFFERINGS
INTRODUCTION. NetSource currently provides its telecommunications services
to small and medium-sized businesses and end-users located in the U.S. and
over 130 countries worldwide. Through its dedicated facilities and network of
digital switches, NetSource is able to offer a wide variety of international
and domestic long distance telephony services. Principal telecommunications
service offerings consist of international long distance calls originating
outside the U.S., international long distance calls originating in the U.S.
and domestic long distance calls. NetSource also offers a wide array of value-
added services including travel card, cellular, data transmission, inbound
toll-free 800, conference calling and dedicated private line services. During
the nine months ended September 30, 1996 the top five foreign countries in
which the Company provided telecommunication services were Japan, Germany,
Argentina, France and the United Kingdom. See Note 1 to Notes to Consolidated
Financial Statements.
THE NETSOURCE NETWORK. The Company operates a facilities-based long distance
carrier network consisting of five digital switches, two of which are located
in San Francisco, California, and the remainder of which are located in
Newark, New Jersey, London, England and Tokyo, Japan. All of the switches are
connected to a control center located in Petaluma, California. The Company's
digital switches allow for the provision of a greater number of "on-net"
calls, that travel on the Company's fixed-cost facilities, thereby reducing
the number of calls handed off to other carriers. In addition, the Company's
ownership of switches reduces its reliance on other carriers, enables routing
of telecommunications traffic over multiple leased transmission lines, aids in
controlling costs and permits the compilation of call record data and other
customer information. The Company recently adopted SS7 and packet signaling
protocols that allow signalling for rapid call set up on the network. The
Company's SS7 upgrade provides increased performance and efficiencies network-
wide in the areas of call set up, call disconnect, look ahead routing, and
call progress identification messaging. SS7 is used by most major U.S.
carriers and provides increased performance and efficiencies within their
networks in these areas.
The Company's network is designed to allow all of the Company's switches to
be continually updated and controlled by a central computer at the Company's
control center. The Company believes that its Computer Controlled Switching
Arrangement ("CCSA") provides a competitive advantage by allowing the Company
to optimize the routing of calls over the NetSource network or by utilizing
other carriers, depending on the lowest cost route available at any given
time. This can result in savings over PTT rates. The Company has also
developed an Internet-based on-line capability that allows the Company's
authorized sales affiliates and direct sales force to create customer
profiles, conduct credit checks of potential customers and initiate
connectivity services through CCSA. The Company continually reviews the CCSA
system to determine whether additional suppliers should be added to the
Company's network to further reduce the cost of routing traffic to a specific
country and to maintain redundancy, diversity and quality within the network.
Substantially all of the Company's telecommunications products and services
utilize the Company's proprietary CCSA technology. The
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global least cost routing function of the Company's CCSA technology is based
on two U.S. patents; however, several of the Company's competitors utilize a
form of least cost routing technology, and there can be no assurance that the
Company's competitors will not develop or acquire least cost routing
technologies that are equal to or superior to the Company's CCSA technology.
See "Risk Factors--Dependence on Technological Development" and "--Technology
and Intellectual Property."
The Company plans to install 14 additional digital switches within the next
24 months in Germany, Sweden, France, the Netherlands, Australia, Belgium,
Hong Kong, Switzerland, Brazil, Argentina, Singapore, Italy, Spain and India.
In addition, during the fourth quarter of 1996, the Company expects to
commence on-net service in Frankfurt, Paris and Stockholm. The Company is also
in the process of testing for deployment additional open architecture digital
switching platforms which will provide it with the ability to deploy fully
functional nodes into key markets both on an expedited basis and at reduced
cost. These switches promote an open high speed bus architecture allowing
value added services like voice mail, fax mail, interactive voice response and
information services to be integrated into the network quickly and
efficiently. The foregoing statements regarding the timing of installation of
switches, commencement of services and deployment of new switching platforms
are forward-looking statements that involve risks and uncertainties and the
actual timing of these events could vary as a result of a number of factors
including the Company's operating results, governmental or regulatory changes,
the ability of the Company to meet product and project demands, the success of
the Company's marketing efforts, technological advances and competition,
working capital requirements and acquisitions of complementary businesses,
technologies or products. See "Risk Factors--Future Capital Needs."
The Company's telecommunications products and services are divided into five
types: (1) Non-Transparent Access Services; (2) Transparent Access Services;
(3) Wholesale Services; (4) Other Value-Added Services; and (5) Customer
Support Services.
NON-TRANSPARENT ACCESS SERVICES. The Company's Non-Transparent Access
Services require the caller to hang up after making the initial call and wait
for the "call back."
Passport. Passport is a long distance calling plan that offers competitive
international calling rates to and from over 130 countries outside the U.S.
The primary components of this product are country-specific rate plans based
on local competitive factors, typically offering savings to frequently called
destinations. This service is targeted at residential and small office/home
office ("SOHO") markets.
CellBacksm. CellBack is an international long distance product for cellular
phone users that offers international calling. Benefits of CellBack include
free air time on inbound calls in certain home service areas and the ability
to have CellBack billings consolidated with Passport billings. CellBack
typically offers discounts over services of PTTs and cellular service
providers. This service is primarily targeted to international business
customers.
MiliTelsm. MiliTel is an international long distance calling plan designed
for U.S. military personnel stationed overseas. MiliTel provides low cost long
distance calling to the most frequently called countries from military bases
located in Japan, Germany and other parts of the world.
TRANSPARENT ACCESS SERVICES. The Company's Transparent Access Services allow
the caller to utilize the Company's network to make long distance calls by
simply dialing the phone number.
GCMSsm. GCMS is a comprehensive direct dial call management system targeted
at business customers in regulated international markets. Through the use of
an "intelligent" autodialer and other telecommunication technology, GCMS
provides transparent access to the Company's global network utilizing call
routing decision capability that augments the Company's CCSA technology.
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Access Directsm. Access Direct allows customers to access dial-tone from a
Company-owned local digital switch, automatically connecting them to the
Company's global network. Access Direct is targeted at small to medium-sized
businesses in deregulating international markets. Currently, the Company
offers Access Direct in the United Kingdom.
Direct Connectsm. Direct Connect allows access via a dedicated line to the
Company's local digital switch for high volume, medium to large business users
to avoid PTT charges by paying a flat rate for the dedicated facility.
Competitive Edgesm. Competitive Edge is the Company's U.S. long distance
product that typically offers low rates on switched and dedicated services.
Calls made through Competitive Edge may be handled either by the Company's
network or on services of other carriers that are resold. Competitive Edge is
targeted at small to medium-sized businesses.
WHOLESALE SERVICES. The Company offers wholesale carrier services to both
facilities-based and non-facilities-based carriers and resellers worldwide.
Reselling wholesale services spreads the Company's fixed costs over a larger
volume of calls and increases the Company's purchasing power from long
distance carriers.
OTHER VALUE ADDED SERVICES.
One Cardsm. One Card is a long distance domestic and international calling
card that offers competitive international calling rates from 45 countries,
including the U.S., as well as other bundled value-added services such as
speed dial, conference calling and geographic call blocking. This product is
targeted at the business traveler.
Toll Free Services. The Company offers a variety of toll free inbound
calling services for both the U.S. and international markets. The Company's
U.S. toll free 800 and 888 services include a variety of time of day routing
and restricted access features and can be forwarded to other countries to
allow companies abroad to advertise and sell their products in the U.S.
market.
Conference-Calling. The Company resells a domestic and international
conference-calling service. The service allows the Company's customers to dial
a simple feature code that transfers the customer to an operator who can set
up a variety of types of conference calls and provides conference-related
features such as transcription, conference notification and set up for
multiple parties located throughout the world.
CUSTOMER SUPPORT SERVICES.
Consolidated Billing Services. The Company provides consolidated billing
which includes charges for most of the Company's various telecommunications
services and for multiple customer sites in a single bill. In addition, the
Company delivers its customers a monthly NetSource Intelligent Invoice. This
invoice consolidates the customer's calling patterns into easy-to-interpret
management reports, which the Company believes facilitates the management of
the customer's communications expenses.
Call Center. The Company's Call Center, located in Petaluma, California, is
staffed and operated seven days a week, 24 hours per day by support personnel
with English, French and Spanish language capabilities. The Company plans to
expand the number of operators and provide additional language capabilities,
including Italian, German, Chinese and Japanese. The Company is in the process
of establishing a Call Center in Ireland that will be operated on a
coordinated basis with the Company's Petaluma center.
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Telemanagement Services. Because the Company uses numerous carriers, the
Company manages the mix of different carriers to minimize a customer's
telecommunications costs. In addition, the Company offers customers management
reports that present billed minutes by calling type (i.e., domestic and
international long distance, toll free service and One Card), area code,
frequently called numbers, and call duration. The management reports can also
include multiple location businesses.
INTERNET AND INTERACTIVE PRODUCT AND SERVICE OFFERINGS
The Company provides an array of Internet-based Web architecture and content
products and services for Internet and Intranet-based electronic commerce
solutions. The Company's Internet products and service offerings are focused
on a number of complementary areas: (1) consulting services; (2) Web
architecture and development services, including Web maintenance services;
(3) content services; and (4) interactive applications. The Company believes
that its Internet solutions provide its customers with a cost effective means
of storing, managing and transferring information via an interactive medium
more easily accessed by employees, customers, suppliers and other parties
connected to the customer. The Company focuses on higher-margin offerings
through strategic consulting processes, advanced software tools and
architectures and advertising agency-level content and creative services that
enable a high level of functionality.
CONSULTING AND DESIGN SERVICES. The Company offers a range of consulting and
design services to its Internet and interactive customers that focus on
determining the appropriate architecture for the individual customer. These
consulting services also include marketing communications services, which
enhance the Company's ability to provide its customers with an easy-to-use
interface, a tailored "look and feel" and an effective delivery medium for
branded messages to a targeted constituency.
WebSense. The Company implements its "WebSense" methodology to assist
businesses in the implementation of Internet-based interactive software
architectures. WebSense is a comprehensive, in-depth, multi-stage consulting
process in which NetSource professionals analyze, structure, schedule and
budget each application of an electronic commerce solution. This allows the
customer to be more effective in the use of and interaction with all aspects
of electronic media. For example, companies often engage NetSource to assist
in establishing a basic Web architecture. NetSource believes that with the
benefit of WebSense, these companies are able to generate electronic commerce
Intranet and Internet systems, with informational databases, order processing
systems, billing systems, sales and marketing systems, Web-based training, and
on-line marketing and branding programs.
Marketing Communications Services. The Company believes that its experience
in and application of more traditional content-related marketing
communications services enhances the Company's capabilities in delivering a
comprehensive electronic commerce solution to its customers. The Company
maintains a marketing communications and advertising staff providing services
for companies in the areas of advertising, direct response, market research,
retail promotion, trade show and other marketing services. The Company's team
of experienced designers, art directors, copywriters, strategic planners and
account service staff is able to implement creative services and project
management. The Company believes that its client service and project
management systems, developed over 12 years of advertising agency experience,
allow it to effectively manage the competing demands of client needs and
production costs in the areas of marketing communications and creative
services. The Company has obtained a number of new marketing communications
services clients during 1996 to replace former customers and plans to continue
to develop this segment of its business by offering marketing communications
services as an integral part of certain of its Internet and interactive
products and services.
WEB ARCHITECTURE AND SOFTWARE DEVELOPMENT SERVICES. The Company's Web
architecture and development services include software development services,
the generation of the appropriate
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type of architecture for the customer and Web maintenance services. The
Company develops the software and related tools that underlie the Web sites
and related architectures designed by the Company for its customers, including
the user interface, layout and flow. The Company focuses on three types of Web
site architectures for its customers: (1) Promotional/Marketing, (2) Catalog
and (3) Transactional. The Company also delivers Web maintenance services
designed to provide an ongoing level of quality, functionality and performance
for a customer's Web site.
Software Development Services. The Company's software development group is
skilled in HTML, C/C++, Perl, CGI, Visual Basic and Java and uses these
programming languages and a variety of software development tools to engineer
the customers' Web sites, including software applications, customer database
integration and links to other sites or other areas within a site. The
software development group is also skilled in ISAPI, NSAPI, ODBC, JOBC,
Microsoft SQL server and Oracle and Sybase database methodologies. In
addition, the software development group includes professionals skilled in
creative design, graphic design, advertising and promotion which enables the
Company to offer its customers a range of services in development and
deployment of a Web site. The Company also designs and develops security
systems for the Web architectures it delivers to protect its customers'
confidential business information.
Promotional/Marketing Architectures. The Company designs and implements
interactive Web architectures for its customers that function as promotional
or marketing tools to illustrate their business or products. While this is the
Company's most basic consulting service, NetSource brings a range of services
to bear in designing and building these architectures, including creative
design, format conversion, content creation, staging of time dependent content
and quality control. Tools such as Adobe Photoshop, Adobe Exchange,
Debabelizer, NetScape Gold, Macromedia Shockwave and high resolution scanners
are used in developing promotional marketing architectures.
Case Study: Cadence Design Systems, Inc. In April 1995, Cadence retained
NetSource to create an interactive Web site to target design engineers, with
the goal of increasing exposure, furthering product knowledge and augmenting
customer service programs online. NetSource devised and implemented a strategy
that incorporated graphics, customized site search, links to strategic
business partners, trade show registration, worldwide training programs,
industry information and24-hour Web site administration. The Company recently
redesigned the Cadence Web site into an interactive magazine format designed
to deliver the latest industry information to electronic engineers.
Catalog Architectures. The Company's catalog architectures support an
extensive and comprehensive content driven platform to create a more
interactive format than the promotional/marketing architectures. This
architecture guides the visitor through different categories of information,
depending on choices that the visitor selects. Many of the Company-developed
catalog architectures are supported by its Content Management System
(discussed below). Catalog Architectures also contain content that is dynamic
in nature, such as site search results supported by the use of search engines
including Excite and WAIS.
Case Study: Fujitsu Microelectronics, Inc. Fujitsu Microelectronics, Inc.
("FMI") engaged the Company in February 1995 to create a Web site that would
describe FMI's comprehensive range of products while making detailed
information and specifications readily available to engineers developing
electronic systems in a consistent manner during key points in the development
process. NetSource developed a Web architecture site plan that was broad
enough to accommodate considerable amounts of data and highly specific product
information and was designed to allow such information to be managed,
accessed, downloaded and refreshed on a regular basis. Potential benefits to
FMI include faster time-to-market, ease of manipulation and dissemination of
data, and less need for hard copy documentation, printing and inventory. In
addition, the Company developed multi-Web site linkages to connect FMI's site
to various distributor and reseller sites, which were designed to broaden
FMI's customer base. As part of the Company's services to FMI, the Company
produces a CD-ROM for
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distribution to customers and sales personnel that is embedded with content
from, and can provide a link to, the FMI Web site.
Transactional Architectures. The Company's transactional architectures
contain the functionality to allow visitors to a Web site to engage in
transactions or make decisions via the Web site. For example, a transactional
Web site may allow for the purchase of products on-line or the creation or
changing of a visitor's bank or other account. Creating a transactional
architecture involves designing and building secure linkages between Web users
and existing corporate databases and business systems. Transactional
architectures provide interactive and dynamically generated user interfaces
with information tailored to individual users. NetSource employs its Object
Firewall in building transactional architectures. Transactional architectures
are complex systems built using a variety of technologies including Java,
Javascript, JDBC, C++, RDBMS and SSL capable servers such as the Netscape
Commerce Server and Microsoft IIS.
Case Study: WebDesk. The Company developed WebDesk as a transactional
Internet product for use by its own telecommunications sales affiliates and
direct sales force. Authorized users can use the WebDesk site to create a
customer profile, conduct a credit check of a potential customer, initiate
connectivity services and perform other general and administrative functions.
WebDesk allows such persons to access Company documents and information
without needing to deal with additional personnel, thereby reducing general
and administrative expenses.
Web Maintenance Services. Web sites need constant maintenance to provide an
ongoing level of quality, functionality and performance for the end-user. The
Company enters into maintenance contracts to provide regular services to its
customers such as ongoing software programming and changing the structure of
Web sites due to market factors.
CONTENT DEVELOPMENT AND MANAGEMENT SERVICES. The Company provides
development and management services to customers to create initial content for
their Web sites. As Web architectures grow larger, containing more and more
data, graphics and functionality, companies are searching for better ways to
manage, maintain and update the content and information contained within their
Web sites. Content management involves the tracking, coordination and
development of information that is distributed or otherwise made available on
the Internet or an Intranet. The Company provides the content development
services and software tools to build and update such content on an ongoing
basis. In addition, the Company provides more extensive content services, in
the form of online marketing and branding.
CMS. The Company's Content Management Services ("CMS") is a software-based
system that allows for the efficient updating and management of content for
each commerce architecture that the Company develops. This is essential for
larger sites which contain more graphics or data. Content management may
include the housing and maintaining of database libraries and multimedia
files. NetSource plans to support CMS on both the NT and Solaris platforms
using several relational databases including Microsoft SQL Server and Sybase.
NetSource also plans to support Netscape and Microsoft Web server software.
CMS defines a range of roles, assigns capabilities to each role and
orchestrates the flow of work in producing Web content. As a part of the CMS
system, the Company also builds and provides software tools and interfaces
that allow for the quick updating of Web-based content from a customer's
internal systems and resource libraries. CMS enables the Company to manage and
position company-specific content within a Web environment and allows the end-
user to select market-specific applications.
Online Marketing and Branding Services. The Company offers a range of on-
line marketing and electronic branding services for its clients worldwide
including on-line advertising, interface design on-line promotions and
electronic media planning. To date, the Company has prepared banner
advertising for several customers which were placed on publishing industry Web
sites, such as ZDNet, a division
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of Ziff-Davis publishing. The Company has also created consumer Web interfaces
for clients such as CyberCash in which the Company designed and prepared for
implementation the "look and feel" and usage structure for the consumer Web
site that CyberCash customers will use to buy services. In addition, the
Company intends to act as a development vendor to advertising agencies that
may not have the ability or knowledge necessary to develop their own
interactive service capability.
INTERACTIVE APPLICATIONS. The Company currently offers or intends to offer
certain interactive applications, that may be used by multiple customers.
PCINet. PCINet, initially created for an outpatient healthcare practice,
consists of a network system that combines Internet-based software, Internet
connectivity, industry-specific applications and interfaces, system
implementation and product support to facilitate communications and
information access. PCINet fulfills the specific connectivity needs of
outpatient healthcare practices which include access to clinical,
administrative and financial data and information. The system accomplishes
this task by using customizable browser and home page software, thereby
allowing each PCINet user to personalize a password-protected interface to
individual preferences and job duties. Due to the commonality of needs of
customers in the healthcare industry, the Company believes that this product
would be useful to a wide range of healthcare customers.
Sales Information System. In November 1996, the Company licensed a software
product from AOL Productions Inc. through which the Company will offer a sales
force automation solution to increase the productivity of a customer's sales
force. This extensive, business oriented product will enable sales personnel
to create proposals and sales presentations and customize marketing
communications more quickly and efficiently than with conventional methods by
providing these services and software programs in a CD-ROM format. Information
that can be stored and manipulated includes a customer's client profiles,
video and audio clips about the customer and data about a customer's
interaction with its clients, such as previous sales. The Company believes
that the CD-ROM format of this product is useful due to its portability and
the ability to store large amounts of data or video and audio that would not
otherwise be possible to store and use on the Internet.
CONVERGENCE OFFERINGS. The Company offers a number of Internet-related
services that leverage the Company's telecommunications products and services
base.
Internet Access Services. Internet access consists of services that allow
customers to access the Internet through dedicated lines or through local
telephone calls via modem to the nearest NetSource point of presence ("POP").
The Company currently intends to deploy its nationwide Internet backbone based
on leased T-3 lines and a network of switches and routers. Once connected, a
customer's traffic is routed through the Company's network infrastructure to
the desired Internet location. The Company believes that this network
infrastructure will provide the necessary bandwidth, increased throughput,
quality, reliability, capacity and geographic coverage desired by its
customers. In this regard, in November 1996 the Company acquired scruz-net, an
ISP with an established customer base of over 2,000 customers. The Company
also hopes to add its current telecommunications customers as Internet access
customers. See "--Recent Developments."
The Company currently offers Internet access through its NetSource
AnywhereSM and NetSource Superline services. NetSource Anywhere is the
Company's dial-up Internet access product. NetSource Anywhere delivers high
speed Internet access to the Company's North American customers with local or
toll free calls. The product includes an e-mail account, access to the Web,
FTP sites and Usenet news groups. NetSource Anywhere is targeted at
individuals and SOHO businesses. NetSource Superline is the Company's Internet
connectivity product that uses a T-1 line to provide dedicated, high speed
digital access to the Internet. This product includes domain name
registration, an IP address block, domain name service and news server access.
NetSource Superline targets medium to large business markets that require
dedicated access.
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The Company intends to offer an ISDN connectivity service called NetSource
On Demand during the first quarter of 1997 that is designed to provide
"transparent connectivity" in that connecting will be accomplished faster and
with less user interaction than conventional dial-up access. This product will
include a customer's domain name registration, an IP address block, domain
name service and installation coordination. NetSource On Demand will be
targeted at small to medium-sized businesses and regional offices of large
businesses.
Web Hosting Services. The Company offers Web hosting services to customers
worldwide. Web hosting consists of providing and/or managing the necessary
equipment to allow companies to operate Web architectures. The components of
the Web hosting service are the server, a workstation or PC which runs the Web
site; the facility to host the server; high-speed Internet access for hosted
servers on high speed circuits; server power and backup, designed to assure 24
hour per day functionality; and maintenance to ensure the on-going operations
of the server. Currently, the Company has 12 customers for which it provides
Web hosting.
The Company provides Web hosting services to multiple clients from
facilities called "Web farms." The Company does not currently operate any Web
farms and provides its Web hosting services primarily on a subcontract basis
with third parties. However, the Company intends to migrate its current Web
hosting customers to servers located in its own facilities. Web hosting
services are targeted at electronic commerce client companies that want the
performance and reliability of a NetSource server in a managed location on a
high-speed Internet connection.
CUSTOMERS
TELECOMMUNICATIONS
The Company sells its long distance telecommunications services to
businesses, SOHOs and individuals worldwide. Clients who utilize such services
include GE Japan, Limited and Hexcel Corporation. In addition, the Company
provides telecommunications wholesale services to facilities-based and non-
facilities-based customers, including British Telecommunications plc ("BT").
INTERNET AND INTERACTIVE
NetSource's customers for Internet and interactive products and services
include the American College of Cardiology, the American College of Surgeons,
Ameritech, Cadence Design Systems, Inc., Chicago Board of Trade, Citibank,
Conner Peripherals, Inc. (now a subsidiary of Seagate Technologies, Inc.),
CyberCash, Inc., Fujitsu Microelectronics, Inc., PepsiCo and The Yankee Group.
In addition, the Company is in the process of creating Web sites for
additional customers, including Boehringer Mannheim Corporation, Boston
Scientific Corporation, the California Society of Certified Public Accountants
and Union Camp Corporation.
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MARKETING AND SALES
The Company utilizes a three-tiered marketing and sales strategy to match
appropriate distribution channels to corresponding market segments. The
following table illustrates the Company's sales and marketing approach.
LOGO
Direct Sales Force. The Company's direct sales force consists of
approximately 10 employees located in San Francisco, Chicago, Stamford,
Connecticut and London, England who concentrate on selling the Company's
larger-scale interactive applications, Web architectures and tools, custom Web
content and design, Web hosting services, higher-end telecommunications
services and products and Internet access. The Company uses its direct sales
force to market to medium to large corporate customers, as well as small to
medium corporate customers.
Joint Ventures and Strategic Partners. The Company enters into joint
ventures in order to better sell its telecommunications products and services
in foreign markets. The Company entered into joint ventures in Japan (MTC
Japan, Ltd.) and the Netherlands (MTC Telecom Western Europe B.V.) in April
1995 and January 1996, respectively. The Company believes that the joint
ventures develop new local distribution sources and provide technical
telecommunications expertise to customers in the region. In addition, the
Company intends to use joint ventures to provide Internet expertise to such
customers. Under its agreements with its current joint venture partners, the
Company provides the joint ventures with carrier services while the joint
ventures are responsible for local marketing and distribution of NetSource
telecommunications services and products. The joint ventures sustained losses
in 1995 and 1996, primarily from the early stage of development of the joint
ventures. The
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Company expects losses to continue from both joint ventures at least through
1997, but does not expect such losses to have a material adverse effect on the
Company's business, financial condition or results of operations. While the
Company has no continuing contractual obligation to fund such losses and
reviews from time to time whether it should continue to do so, the Company
presently intends to continue funding the joint ventures. See "Management's
Discussion of Financial Condition and Results of Operations."
The Company sometimes uses strategic partnerships to increase penetration
into a particular market. For example, the Company has and expects to continue
to obtain customers referred by BT in the United Kingdom market. BT typically
refers clients to the Company for specialized services such as electronic
commerce products and services, digital private line, travel card and
reorigination services in international PTT-controlled markets. The Company
also works with its strategic partners to market its products to very large
corporations.
No joint venture partner currently competes with the Company in markets in
which the partners provide service. The Company's strategic partners do
compete with the Company and are expected to continue to compete with the
Company in the future.
Sales Affiliates. The Company has a network of approximately 100 independent
sales affiliate companies worldwide that market the Company's
telecommunications services and products to small to medium corporate
customers, SOHOs and individuals. In addition, the Company intends to use its
sales affiliates to market its Web hosting services, internet access and
custom Web content and design services in the future. The Company trains and
supplies its independent sales affiliates with necessary promotional materials
and product and service updates through printed material and access to the
WebDesk module. The affiliates are compensated on a commission basis relative
to monthly billings by their user accounts. Sales affiliates utilize
independent agents known as subaffiliates, to broaden their market coverage in
particular user segments. The Company's WebDesk system provides worldwide
access to the Company's order entry and product fulfillment services for its
sales affiliates and direct sales force. Specifically, WebDesk allows an
authorized user to check on the amounts of commission that such affiliate has
earned, to conduct a customer credit check, to create a customer profile, to
initiate connectivity services and to perform other general and administrative
functions. No sales affiliate was responsible for sales representing more than
10% of the Company's revenues.
M-net. M-net, the Company's network marketing system, currently consists of
approximately 2,500 active representatives, who are not employed by the
Company. This network marketing system has been selected by the Company for
SOHOs and individuals because the Company believes it reduces marketing costs,
subscriber acquisition costs and subscriber attrition. The Company encourages
M-net representatives to enroll subscribers with whom the M-net
representatives have an ongoing relationship because the Company believes that
subscribers will be more likely to remain with the Company because they have
been enrolled with the Company by someone with whom they have an ongoing
relationship. The Company also believes that its network marketing system will
continue to build a base of potential subscribers for additional services and
products. The Company believes that its network marketing system is
particularly attractive to prospective M-net representatives because of the
potential for supplemental income and because the M-net representatives are
not required to purchase any inventory, have no monthly sales quotas or
account collection issues, have minimal paperwork and have a flexible work
schedule.
All M-net representatives' compensation is paid directly by the Company and
is based on the acquisition of subscribers and their long distance usage. M-
net representatives receive subscriber acquisition commissions only after,
among other things, subscribers sign up for and utilize the Company's products
and services. In addition, while the Company does not pay a commission to M-
net representatives for introducing new M-net representatives to the Company,
M-net representatives may receive subscriber acquisition commissions as well
as long distance usage commissions for
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subscribers signed up by certain other M-net representatives they have
recruited directly themselves or indirectly.
An individual, partnership or corporation may become an M-net representative
by purchasing a training kit for approximately $50 that includes the basic
materials to begin a business and includes a detailed explanation of the
Company's products, services and compensation plan. M-net representatives are
not restricted to any geographic location, and the Company believes that many
M-net representatives acquire subscribers and recruit downline M-net
representatives who reside in different geographic locations than such M-net
representatives.
RECENT DEVELOPMENTS
In November 1996, the Company acquired scruz-net, an ISP, for an aggregate
of 230,190 shares of Common Stock. The business competencies of scruz-net
include Internet network design, implementation and administration, and
technology management for data networking and Intranet applications. NetSource
does not intend to actively pursue any new service accounts from individual
customers, rather the Company intends to concentrate on expanding corporate
Internet service accounts. In November 1996, the Company also acquired DNA, an
interactive development firm, for an aggregate of 230,190 shares of Common
Stock. The Company believes that DNA has substantial skill and experience in
the areas of multimedia, interactive and graphic design and content creation
for Web sites for a diverse group of clients. The shares issued in both the
acquisitions are restricted under federal securities laws but have
registration rights which permit, under certain circumstances, such shares to
be included in future public offerings of the Company. As of November 15,
1996, scruz-net had approximately 2,000 customers and an established ISP
backbone consisting of six POPs in Monterey, Santa Cruz, San Jose, Scotts
Valley, Mountain View and Palo Alto.
In September 1996, the Company entered into a memorandum of understanding
with British Telecommunications plc ("BT") to provide electronic commerce
solutions to BT's finance sector customers. The memorandum contemplates the
training of BT sales personnel and includes revenue goals as well as specific
customers of BT that the parties hope to supply with the Company's electronic
commerce solutions. The Company expects to obtain additional customers
referred by BT.
TECHNOLOGY AND INTELLECTUAL PROPERTY
The Company's success and ability to compete is dependent in part upon its
ability to enhance its technology, although the Company believes that its
success is more dependent upon its technical expertise than its proprietary
rights. The Company relies on a combination of patent, copyright, trademark
and trade secret laws and contractual restrictions to establish and protect
its technology.
The Company's CCSA technology is a telecommunications network architecture
that facilitates the routing of long distance calls over the least cost route
available. A long distance call travels along the local exchange network that
serves the customer to the Company's switch network. At that point, the
Company's CCSA technology analyzes the relative costs of the long distance
carriers available to the Company's network to carry the call. After making
such "least cost" choice, the Company's network routes the customer's call
along the chosen route to a terminating switch and from there along the
destination's local exchange network to the destination. This can result in
savings over PTT rates. The Company continually reviews the CCSA system to
determine whether additional suppliers should be added to the Company's
network to further reduce the cost of routing traffic to a specific country
and to maintain redundancy, diversity and quality within the network. The
global least cost routing function of the Company's CCSA technology is based
on two U.S. patents; however, several of the Company's competitors utilize a
form of CCSA technology, and there can be no assurance that the Company's
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competitors will not develop or acquire CCSA technologies that are equal to or
superior to the Company's CCSA technology.
The Company has been assigned two U.S. patents in connection with its least
cost routing technology, and has corresponding applications pending for
foreign patent protection of such technology in 20 foreign countries,
including Japan, Australia, Canada and 17 European countries. In addition, the
Company has applications pending in the U.S. and certain foreign countries
with respect to the registration of a number of trademarks and service marks,
including the name "NetSource." Several of the Company's competitors utilize a
form of least cost routing technology, and there can be no assurance that the
Company's competitors will not develop the ability to provide such services or
will not develop technologies that are superior to the Company's technology.
There can be no assurance that the Company's least cost routing patents will
provide protection against competitive technology or will be held valid and
enforceable if challenged or that the Company's competitors would not be able
to design around the patents. In addition, there can be no assurance that
licenses for any intellectual property that might be required by the Company
would be available on reasonable terms if at all. See "Risk Factors--
Dependence on Technological Development" and "Risk Factors--Protection of
Intellectual Property."
COMPETITION
The markets in which the Company operates are extremely competitive. There
are no substantial barriers to entry in either the Internet and interactive
products and services markets or in any of the telecommunications markets in
which the Company competes. The Company expects competition in these markets
to intensify in the future.
Telecommunications. In the international telecommunications markets in which
the Company competes, competition is based primarily on prices of services
offered and the ability of the supplier to "bundle" various telecommunications
products according to subscriber tastes.
International. While international operating agreements have in the past
deterred companies such as AT&T Corporation, BT, MCI Communications
Corporation, Sprint Corporation and Worldcom, Inc. from offering callback and
reorigination services in regulated markets, there can be no assurance that
these companies will not offer callback and reorigination services in the
future or that these companies will not reduce their rates significantly,
decreasing margins and profitability of the Company. In fact, AT&T Corporation
has recently announced its intention to offer callback services in certain
markets. In addition, the Company expects PTTs in foreign countries to price
their services more competitively in the future. International carriers, some
of which have larger customer bases and networks and higher capital resources,
may in the future develop and market their products more effectively than the
Company. Certain PTTs may also influence regulatory authorities to outlaw the
provision of call reorigination services or block access to the call
reorigination services the Company markets. Additionally, there are a large
number of competitors in the call reorigination market, several of which have
significant market share and greater resources than the Company. In the past,
the Company has benefited from the fact that regulation of telecommunications
services in foreign countries has created a high differential between the
rates charged by PTTs and the rates charged by the Company. As deregulation
continues in foreign markets this differential in rates is expected to
decrease, which will place pricing pressure on the Company. In addition,
deregulation may lead to additional competitors entering the international
telecommunications market. Some of the Company's competitors offer cellular
and other wireless products and services. While the Company provides
specialized long distance products for users of cellular devices, there can be
no assurance that the Company will be able to provide long distance service to
users of each new technology as it evolves. In addition, certain global
satellite-based telecommunications systems now under development could
eventually bypass the international long distance network of the PTTs and
major international carriers.
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Development of such technologies could adversely affect the market for the
Company's long distance telecommunication services.
Domestic. Domestically, the Company has a very small share of the
telecommunications services reseller market. In addition, this market is
nearing maturity in terms of aggregate revenue growth rates and consolidation.
In the U.S., the Company competes with long distance carriers such as AT&T
Corporation, MCI Communications Corporation, Sprint Corporation, and WorldCom,
Inc., as well as second tier resellers such as, LCI International and Frontier
Corporation. The Company anticipates adverse effects on its core customer base
and financial results by the entrance of the Regional Bell Operating Companies
("RBOCs") into the long distance industry. The RBOCs have significantly
greater resources than the Company and, as current providers of local service,
substantial market intelligence and end-user contact. As a result of this and
continued international expansion, the Company currently expects domestic
revenues from its telecommunications business to further decline as a
percentage of its total telecommunications sales. See "Business--
Telecommunications Offerings."
INTERNET AND INTERACTIVE PRODUCTS AND SERVICES.
Internet Access. In the Internet markets in which the Company competes,
competition is based primarily on price and range of services provided. The
Company's current and prospective competitors in Internet access include many
large companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. In addition, the
Company presently provides direct Internet access services to a limited number
of customers, and there can be no assurance as to when or if the Company will
be able to successfully provide such services on a larger scale. The Company's
Internet access business is expected to compete directly or indirectly with:
(i) national and regional commercial ISPs, such as BBN Planet, a subsidiary of
BBN Corporation, Netcom On-line Communication Services, Inc., PSINet, Inc. and
UUNET Technologies, Inc., a subsidiary of MFS Communications Company, Inc.,
(ii) established on-line services companies that currently offer or are
expected to offer Internet access, such as America OnLine, Inc., CompuServe
Incorporated, Delphi Internet Services, Inc. and Prodigy Services Company,
(iii) national long distance telecommunications, carriers, such as AT&T
Corporation, MCI Communications Corporation and Sprint Corporation that
currently offer electronic messaging services, (iv) RBOCs, such as Pacific
Bell, (v) media and cable operators, such as Comcast Corporation, Tele-
Communications, Inc. and Time Warner, Inc., which have recently begun, on an
experimental basis, to offer on-line services, and (vi) nonprofit or
educational ISPs. In particular, the Company's ability to compete in the
Internet access market is substantially dependent upon the rates that it is
required to pay outside vendors for ISDN, T-1 and T-3 lines.
Electronic Commerce. In the Internet and interactive products and services
markets in which the Company competes, competition primarily is based upon the
type and quality of services offered. The Company expects to compete with
companies such as Open Market and Connect Inc., manufacturers of electronic
commerce server software tools and software companies such as Microsoft and
NetScape, which have indicated an intention to enter the electronic commerce
products and services arena. In the area of Web site development and
electronic commerce, the Company competes with a range of Internet development
companies such as CKS Group, Inc., Eagle River Interactive, Inc., Modem Media,
Poppe Tyson and Organic Online, Inc. Many of these companies have been in the
Internet services business longer than the Company, and have substantially
greater market presence and resources. The Company believes that the
electronic commerce products and services market is at an early stage of
development and expects many new competitors, including large computer
hardware and software, cable, media and telecommunications companies, will
enter the electronic commerce products and services market. The ability of
these competitors or others to bundle connectivity services and products with
Internet connectivity services could place the Company at a significant
competitive disadvantage.
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REGULATION
TELECOMMUNICATIONS
DOMESTIC. The terms and conditions under which the Company provides
communications services are subject to government regulation. Federal laws and
FCC regulations apply to interstate telecommunications, while state regulatory
authorities have jurisdiction over telecommunications that originate and
terminate within the same state. Federal and state regulations, regulatory
actions and court decisions have had, and may have in the future, an impact on
the Company and its ability to compete as well as on the number and types of
competitors in the market. The FCC and various state public service and
utilities commissions typically impose obligations to file tariffs containing
the rate, terms and conditions of service. Neither the FCC nor the state
utility commissions currently regulate the Company's profit levels, although
they have the authority to do so. There can be no assurance that regulators
will not raise material issues with regard to the Company's compliance with
regulations or that existing or future regulations will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
Federal. The Company believes it has all necessary authority to provide
domestic interstate telecommunications services. The Company has been granted
authority by the FCC to provide international telecommunication services
through the resale of switched services of U.S. facilities-based carriers. The
FCC reserves the right to condition, modify or revoke such international
authority for violations of the Communications Act or its rules. The
Telecommunications Act of 1996 (the "1996 Telecommunications Act")
substantially alters the regulatory framework for the telecommunications
industry for domestic and U.S. international telecommunications services. This
law allows telephone companies and cable television companies to compete in
each others' markets and permits the local exchange carriers ("LECs"),
including the RBOCs, to offer and sell long distance services (including
inter-LATA and interstate services within their service territories following
compliance with certain conditions), subject to any otherwise applicable state
and/or federal regulatory approvals, in exchange for permitting competition in
the local markets. The RBOCs are already permitted to provide long distance
services outside of their service territories. As of the date of this
Prospectus, the FCC has not yet issued a notice of proposed rulemaking
contemplating changes in the rules governing charges by LECs for access
services, although such a notice is expected to be released before the end of
1996. Because the FCC has not yet initiated, the rulemaking proceeding
considering changes in the regulation of access charges, the Company cannot at
this time predict the likelihood that the rules will be changed in a way that
would have a material adverse effect on the Company's business. However, the
Company does not believe that the legislation imposes substantial regulatory
burdens on the Company's international call reorigination, Internet access or
domestic telecommunications operations.
The Company is classified by the FCC as a non-dominant carrier. Among
domestic carriers, only LECs are now classified as dominant carriers, with
charges and services subject to greater FCC regulation than those of the
Company. The FCC has reclassified AT&T as a non-dominant carrier, eliminating
certain pricing and tariffing restrictions that had applied to AT&T, and
making it easier for AT&T to compete with the Company for low-volume long
distance customers. The FCC retains the jurisdiction to act upon complaints
against any common carrier for failure to comply with its statutory
obligations. The FCC also has the authority to impose more stringent
regulatory requirements on the Company and change its regulatory
classification. The Company believes, however, that the FCC is unlikely to do
so.
Both domestic and international non-dominant carriers must maintain
interstate tariffs on file with the FCC. Although the tariffs on non-dominant
carriers, and the rates and charges they specify, are subject, except that
during the next ten months, domestic non-dominant carriers will be required to
withdraw their interstate tariffs but make information about rates and
conditions of service publicly available. Although the tariffs on non-dominant
carriers, and the rates and changes they specify, are subject to FCC review,
they are presumed to be lawful and are seldom contested. In reliance on the
FCC's past practice of allowing domestic non-dominant carriers to file tariffs
with a "reasonable range of rates" instead of the detailed schedules of
individual charges required of dominant carriers, the
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Company has not maintained detailed rate schedules for domestic offerings in
their tariffs. Until the two-year statute of limitations expires, the Company
could be held liable for damages for its failure to do so, although it
believes that such an outcome is highly unlikely and would not have a material
adverse effect on the Company. In order to recover damages, a competing
telecommunications service provider would have to show that the Company's
failure to file detailed rate schedules caused that other service provider to
lose customers and that the Company should be liable for the damages. The
possible amount of such damages, if any, cannot be determined by the Company.
The Company has always been required to include, and has included, detailed
rate schedules in its international tariffs. As a non-dominant carrier, the
Company is permitted to make tariff filings on a single day's notice and
without cost support to justify specific rates. Resale carriers are also
subject to a variety of miscellaneous regulations that, for instance, limit
the use of "800" numbers for pay-per-call services, require disclosure of
operator services and restrict interlocking directors and management.
State. The intrastate long distance telecommunications operations of the
Company are also subject to varying levels of regulation in the states in
which the Company provides intrastate telecommunications. The vast majority of
the states require the Company to apply for certifications to provide
telecommunications services, or at least to register or to be found exempt
from regulation, before commencing intrastate service. Currently, the Company
is certified and tariffed where required to provide intrastate service to
customers in approximately 35 states, and is in the process of obtaining
certification in all other states. The Company continuously monitors
regulatory developments and intends to continue to obtain licenses where
necessary for the conduct of its business. The Company is in the process of
seeking approvals from the applicable regulatory authorities in each state in
which such approval is required.
On January 24, 1995, the California Public Utilities Commission (the "PUC")
determined that the Company was operating as a reseller of long-distance
services in California without the requisite state authorization. The PUC
assessed a fine against the Company and required that the Company pay the fees
required to be collected by telecommunications providers for the services it
rendered during the period it operated without authorization. The total
amounts of such fines and fees were approximately $20,000 and $686,000,
respectively. The Company has since remitted all sums required and obtained
the requisite authorization to operate as a reseller in California.
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, assignments of carrier assets,
including customer 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.
INTERNATIONAL. The Company's international callback and reorigination
products and services are subject to the jurisdiction of many regulators. The
FCC has imposed certain restrictions on international callback and
reorigination providers, including the requirement that licensees provide
service in a manner consistent with the laws of the countries in which they
operate. Local laws and regulations differ significantly among the
jurisdictions in which the Company operates, and the interpretation and
enforcement of such laws and regulations vary and are often based on the
informal views of the local ministries which, in some cases, are subject to
influence by the local PTTs. In addition, since the Company's callback and
reorigination products and services effectively bypass the local telephone
system, regulators in certain countries have objected to callback and
reorigination services, and some countries have declared such services
illegal. Based on information made available by the FCC, the Company believes
that the following countries have prohibitions on callback services: Oman,
People's Republic of China, Colombia, Ecuador, Honduras, Hungary, India,
Indonesia, Netherlands Antilles,
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Peru, Philippines, Saudi Arabia, Tanzania, Uruguay, and Venezuela. In
addition, other countries or their PTTs have publicly indicated that at least
some form of callback service was not permitted in their respective
countries.The Company does not derive material revenues from callback and
reorigination services to customers located in any of such countries. In
certain countries which have prohibited the provision of services through the
automatic callback access method utilized by the Company, such as Thailand and
Netherland Antilles, the Company has discontinued or modified certain of its
services in such countries. Existing or future regulations in other countries
could also have similar consequences. In addition, MCI Communications
Corporation has filed a petition with the FCC that challenges the legality of
reorigination. Such petition is currently pending. The Company generates a
significant portion of its monthly international revenue from customers
originating calls in Japan, Germany, Argentina, France, Hong Kong and Taiwan.
In 1994, approximately 45% of the Company's total revenues was derived from
customers located outside the U.S. That percentage increased to 69% in 1995,
and to 72% in the first nine months of 1996. In the event that any of these
countries prohibited the Company's services or regulated the pricing or profit
levels of such services, the Company's business, results of operations and
financial condition could be materially adversely affected. At this time, the
Argentine government is attempting to provide sufficient information to
demonstrate to the FCC's satisfaction that call reorigination is unlawful in
Argentina. Although the Company believes that the probability that the FCC
would rescind the Company's grant of authority to provide callback and
reorigination services for failure to comply with non-U.S. law is unlikely,
such action by the FCC would have a material adverse effect on the Company's
business. The Company intends to expand its international service offerings to
continue to be competitive as new markets are opened and rates in these
countries are reduced. To facilitate this expansion, the Company may deploy
additional switching facilities located in a number of countries. As a result,
the Company will be directly subject to regulation in an increasing number of
countries, and there can be no assurance that such regulation will not have a
material adverse effect on the Company's business, results of operations and
financial condition.
The Council of the International Telecommunications Union ("ITU") also
recently approved a resolution which endorses suspension of callback methods
that seriously degrade network quality and performance and urges the ITU's
Standardization Sector to develop recommendations addressing "alternative
calling procedures," particularly those that seriously degrade network quality
and performance, and to give further study to other aspects of alternative
calling procedures. The Standardizing Sector is soliciting information to be
submitted by May 1997 to use in its further deliberations. In addition, while
the Japanese Ministry of Posts and Telecommunications (the "MPT") has
indicated that it will consider appropriate measures to comply with the ITU
resolution, it has not indicated that it is considering prohibiting other
forms of callback such as those employed by the Company. However, the Company
cannot predict the MPT's final response to the ITU resolution, the outcome of
the ongoing ITU study, whether the study will result in action prohibiting
callback or whether such action, if taken, would have a material adverse
effect on the Company's business, financial condition and results of
operations.
Finally, there can be no assurance that the Company has accurately
interpreted or will accurately predict the interpretation of applicable laws
and regulations or regulatory and enforcement trends in a given jurisdiction
or that the Company will be found to be in compliance with all such laws and
regulations. Failure to interpret accurately the applicable laws and
regulations and the mode of their enforcement in particular jurisdictions,
could cause the Company to lose, or be unable to obtain, regulatory approvals
necessary for it to be able to provide certain services in such jurisdictions
or to use certain of its transmission methods. Such failure could result in
significant monetary penalties imposed against the Company.
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<PAGE>
INTERNET
Internet access providers are generally not regulated under the laws and
regulations governing the U.S. telecommunications industry. Except for
regulations governing the ability of the Company to disclose the contents of
communications by its customers and a provision of the 1996 Telecommunications
Act that is the subject of current constitutional challenge and the
enforcement of which has been enjoined by the U.S. District Court for the
Eastern District of Pennsylvania, there are currently no U.S. government
imposed limitations or guidelines pertaining to customer privacy or the
pricing, service characteristics or capabilities, geographic distribution or
quality control features of Internet access services. However, proposed
regulations at the FCC would require discounted Internet connectivity rates
for schools and libraries. In addition, certain localities have imposed a tax
on companies that connect customers to the Internet, and other localities may
impose similar taxes. There also exists the risk that a U.S. governmental
policy for the data network access industry could be implemented by executive
order, legislation or administrative order. If such a policy is adopted, it
could have a material adverse effect on the Company. Also, a petition pending
before the FCC urges the FCC to regulate as telecommunications services voice
services utilizing the Internet. The Company cannot predict the impact, if
any, that future regulation or regulatory changes may have on its Internet
access business. The 1996 Telecommunications Act imposes criminal liability on
persons sending or displaying in a manner available to minors indecent
material on an interactive computer service such as the Internet and on an
entity knowingly permitting facilities under its control to be used for such
activities. The ultimate interpretation and enforcement of this law is
uncertain, but this legislation may decrease demand for Internet access, chill
the development of Internet content or have other adverse effects on Internet
access providers such as the Company. In addition, in light of the uncertainty
attached to interpretation and application of this law, there can be no
assurances that the Company would not have to modify its operations to comply
with the statute, including prohibiting users from maintaining home pages on
the Web. Certain foreign countries may in the future regulate Internet access
or electronic commerce in their respective countries. The Company cannot
predict the outcome of current or future FCC proceedings or of pending
amendments to international copyright conventions and U.S. copyright law that
would make the Company liable for the copyright violations of its customers
transmitting information over the Internet.
Depending on the outcome of FCC rulemakings required by the 1996
Telecommunications Act, the Company could be subjected to additional
regulatory requirements, including that it contribute some portion of its
telecommunications revenues to a universal service fund, and to increased
competition and interconnections costs. If the LECs are no longer required to
provide equal access for origination and termination of calls by customers of
long distance companies such as the Company, or if the fees charged for such
access services change, particularly if changed to allow variable pricing of
such fees based upon volume, such changes could have a material adverse effect
on the Company's business, financial condition and results of operations. In
the event that the Company is not able to provide the services it is presently
providing or intends to provide, or to use existing or contemplated
transmission methods due to the application of laws and regulations that
prohibit such services or transmission methods or due to its inability to
receive or retain formal or informal approvals for such services or
transmission methods, or for whatever other reason related to regulatory
compliance or the lack thereof, the Company's business could be materially
adversely affected. There can be no assurance that any number of the Company's
services or transmission methods will not be prohibited or become more costly
in its current and proposed markets. Depending upon the countries in which
such prohibition occurs, there could be a material adverse effect on the
Company's business, financial condition or results of operations. See "Risk
Factors--Governmental Regulation."
EMPLOYEES
As of October 15, 1996, the Company had 235 employees, including 56 in
research and development, 22 in marketing and sales and 157 in corporate,
administration. These employees are
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located in the Company's principal facilities as follows: 167 in the Company's
Petaluma, California offices, 61 in the Company's San Francisco, California
offices, four in the Company's Stamford, Connecticut offices, with three
additional home office employees in Chicago, Illinois. None of the Company's
employees are represented by unions, and the Company believes that its
employee relations are good.
FACILITIES
The Company's principal executive offices are located in San Francisco,
California, where the Company leases approximately 20,500 square feet under
two leases expiring in December 1997 and December 2001. The Company leases
approximately 41,750 square feet of office space in Petaluma, California under
a lease expiring in July 2001. In addition, the Company has entered into
leases to house switches in Frankfurt, Germany; London, England; Newark, New
Jersey; San Francisco, California; Stockholm, Sweden; and Paris, France. Most
of the Company's Internet-oriented functions are housed at the Company's San
Francisco location. The Company has also entered into a lease for
approximately 1,000 square feet in Stamford, Connecticut, expiring in January
1998. The Stamford facility houses certain of the Company's interactive
development sales channels. In addition, as a result of the acquisitions of
scruz-net, inc. and DNA New Media Group, Inc., the Company leases an aggregate
of approximately 5,600 square feet of office space in Santa Cruz, California
and Chicago, Illinois which house its Internet Service Provider business and
certain marketing communications functions.
LEGAL PROCEEDINGS
USA Global Link, one of the Company's former sales affiliates and a current
competitor has brought suit against the Company in Federal District Court for
the Northern District of California. USA Global Link has made a number of
claims, including breach of contract and misappropriation of trade secrets and
seeks compensatory and punitive damages. In addition, in connection with such
action, Hubert Haddad and Novavision, USA Global Link's foreign sub-affiliate,
has brought suit against both USA Global Link and the Company which suit is
pending in Federal District Court for the District of Iowa. Mr. Haddad and
Novavision have claimed violation of RICO, intentional interference with the
prospective economic advantage of their customers (who are end-users of the
Company's services provided through USA Global Link) and an open accounting
for amounts allegedly owed to Mr. Haddad and Novavision. Mr. Haddad and
Novavision seek compensatory damages in excess of $1 million, as well as
punitive damages and certain injunctive relief. The Company has filed a motion
to dismiss the RICO claim brought by Mr. Haddad and Novavision against USA
Global Link and the Company. The court has granted USA Global Link's motion
with respect to dismissing the RICO claim and the Company expects a similar
ruling from the court. The Company believes these suits are without merit and
intends to vigorously defend the suits. See "Risk Factors--Risks Associated
with Federal Court Litigation."
One World Communications, a former sales affiliate of the Company, filed an
informal complaint with the FCC in June 1995 alleging the Company engaged in
wrongful billing practices. The Company believes these claims are without
merit and is seeking to have such complaint dismissed by the FCC.
Thomas Bruner, a former consultant of MTC International, filed a complaint
against MTC International in the California Superior Court in August 1996. The
complaint for declaratory relief, breach of contract and fraud alleges that
MTC International failed to permit the former consultant to exercise certain
stock options granted to him by MTC International which represent the
equivalent of 450,000 shares of NetSource Common Stock. The Company believes
this action is without merit and intends to vigorously defend the suit.
In addition to the foregoing, from time to time individual customers file
complaints with various state and federal regulatory agencies, including the
California Public Utilities Commission, the Federal
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Trade Commission, the FCC and State Attorneys General relating to rate and
quality of service issues. There can be no assurance that the Company will
prevail in any such proceedings or in any of the above-described disputes.
REORGANIZATION
NetSource, which was incorporated in Delaware on November 20, 1995,
succeeded to the businesses of MTC Telemanagement Corporation, a California
corporation ("MTC Telemanagement"), MTC International, Inc., a Nevada
corporation ("MTC International"), and Transphere Interactive, Inc.
("Transphere Interactive") and Transphere International, Inc. ("Transphere
International"), each California corporations, pursuant to a series of
reorganization transactions consummated on June 28, 1996 and described below
(the "Reorganization"). MTC Telemanagement commenced operations in October
1988 as a switchless reseller of long-distance services in the U.S. MTC
International was formed in March 1993, as a provider of reorigination "call
back" telecommunications services in the international telecommunications
market. Transphere International, an advertising and marketing communications
Company, was formed in 1983, while Transphere Interactive was formed in August
1995, to provide services related to the Internet, with a focus on Web-site
design and enabling Web-based electronic commerce on the Internet. In June
1996, Transphere International and Transphere Interactive merged into
NetSource Interactive Services, Inc., a Delaware corporation ("NetSource
Interactive").
The Exchange. Pursuant to the Reorganization, the Company exchanged shares
of its Common Stock and options to purchase its Common Stock for the
outstanding shares of common stock and options to purchase common stock of MTC
Telemanagement and MTC International. The exchange described in the foregoing
sentence is referred to as the "Exchange." Upon the consummation of the
Exchange, MTC Telemanagement and MTC International each became wholly-owned
subsidiaries of the Company.
The Merger. Immediately after consummation of the Exchange, and pursuant to
an Agreement and Plan of Reorganization by and between NetSource Interactive
and the Company (the "Merger Agreement"), NetSource Interactive merged into
the Company (the "NetSource Merger"). The Company was the surviving
corporation in the NetSource Merger and issued shares of its Common Stock and
options to purchase its Common Stock in exchange for the outstanding shares of
and options to purchase common stock of NetSource Interactive.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding the executive
officers and directors of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Edward A. Brinskele..... 41 Chairman of the Board and Chief Executive Officer
Charles Schoenhoeft..... 39 Vice Chairman of the Board and President
Gary R. Anderson........ 49 Executive Vice President and Chief Financial Officer
Gregory A. Reznick...... 41 Executive Vice President and Chief Operating Officer
Evan A. Kraus........... 38 Executive Vice President, Secretary and General Counsel
Kevin J.F. Paul......... 36 Managing Director, Europe
Michael J. Brinskele.... 33 Executive Vice President, Global Network Services
Yoav Stern (1)(2)....... 43 Director
Joshua G. Cooperman
(1)(2)................. 47 Director
Alex S. Vieux(1)........ 39 Director
Yaron Eitan(2).......... 40 Director
</TABLE>
- --------
(1)Member of the Compensation Committee
(2)Member of the Audit Committee
OTHER KEY EMPLOYEES
The following table sets forth certain information regarding other key
employees of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
N. Scott Dickson................. 34 Vice President and Corporate Controller
Andrew G. Salisbury.............. 39 Vice President of Interactive Development
Ron Wolf......................... 45 Vice President of Software Technology
Jade Wong........................ 33 Vice President of Marketing Communications
</TABLE>
EDWARD A. BRINSKELE has served as the Chairman of the Board and Chief
Executive Officer of the Company since its formation in November 1995. In
1988, Mr. Brinskele founded MTC Telemanagement, and in 1993, he founded MTC
International. He has served as Chairman of the Board and Chief Executive
Officer of both companies since inception. Mr. Brinskele has been in the
telecommunications industry for over 20 years. In 1985, Mr. Brinskele was
involved with the start up of Centex Telemanagement, Inc., a
telecommunications company, as Director of Engineering, where he was
responsible for the design and engineering of all telecommunications
facilities used by Centex. From 1974 through 1983, he worked for Harris
Corporation, a manufacturer of telecommunications products and equipment, as a
System Engineer. Mr. Brinskele has designed telecommunications networks for
numerous domestic and international organizations, including MCI, American
Express and the U.S. Department of Energy.
CHARLES SCHOENHOEFT joined the Company in June 1996 as Vice Chairman of the
Board and President. From 1984 to June 1996, Mr. Schoenhoeft was Chief
Executive Officer and Chairman of the Board of Transphere International until
its merger with the Company in June 1996. In July 1995, he founded Transphere
Interactive which provided strategic planning and marketing commercial
services for fast growth, international high technology companies, including
Conner Peripherals, Fujitsu Microelectronics and Diamond Multimedia.
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<PAGE>
GARY R. ANDERSON joined the Company in September 1996 as Chief Financial
Officer and Executive Vice President. From April 1995 until April 1996, Mr.
Anderson was Vice President and Chief Financial Officer of Air Net
Communications, a manufacturer of base stations for wireless communications
services. From June 1989 until January 1995, Mr. Anderson served as Senior
Vice President and Chief Financial Officer of WYSE Technology, Inc., a
manufacturer of computer peripherals. Mr. Anderson is a Certified Public
Accountant.
GREGORY A. REZNICK has served as Executive Vice President and Chief
Operating Officer of the Company since June 1996. In February 1996, Mr.
Reznick joined Transphere Interactive as Executive Vice President and General
Manager--Interactive and served in that capacity until the merger of
Transphere Interactive into the Company in June 1996. From June 1995 until
February 1996, he was President of Orchid Technology, a computer peripherals
manufacturer, and from March 1993 until March 1995, he served as Vice
President--Marketing of Media Vision Technology, Inc., a multimedia
peripherals manufacturer. From 1990 until March 1993, he served as President
on a full-time basis of Pivotal Research, a software developer.
EVAN A. KRAUS has served as Executive Vice President, Secretary and General
Counsel of the Company since June 1996. Mr. Kraus served as Vice President and
Corporate Counsel of MTC Telemanagement since February 1996. Mr. Kraus has
also served as Secretary of MTC International since April 1996. From January
1992 until February 1996, Mr. Kraus served as Vice President, General Counsel
and Secretary for IASCO, a diversified international services company and as
corporate counsel from December 1989 until January 1992.
KEVIN J.F. PAUL has served as Managing Director, Europe since July 1996.
From November 1995 until July 1996, Mr. Paul served as President and Chief
Executive Officer of Applications of On-line Inc., an Internet based content
delivery company. Mr. Paul served as Chief Executive Officer of V. Corp Ltd.,
a company specializing in investing in start-up companies from September 1993
until November 1995. From May 1991 to September 1993, Mr. Paul served as Chief
Executive Officer of a division of Kent Technologies, a company engaged in the
development of factory automation software.
MICHAEL J. BRINSKELE has served as Executive Vice President--Global Network
Services of the Company since June 1996 and manages all of the Company's
global network operations including research, development and integration of
new technologies, applications engineering and product development. From May
1992 until the present, Mr. Brinskele has also served as Vice President of
Systems Engineering of MTC Telemanagement. From April 1991 until May 1992, he
served as Vice President of Corporate Services of MTC Telemanagement. Mr.
Brinskele joined MTC Telemanagement in March 1990 as Director of Customer
Service and in this position was responsible for field sales and
telecommunications consulting for major accounts until April 1991.
YOAV STERN has served as a director of the Company since April 1996. Mr.
Stern has been a Managing Partner of Helix Capital L.L.C., a merchant banking
firm involved in investments and mergers and acquisitions with technology-led-
businesses, since August 1995. Mr. Stern has served as Co-Chairman and Chief
Executive Officer of Kellstrom Industries, Inc., a commercial jet engine
reseller from its inception in December 1993 until June 1995 and has served as
Co-Chairman of the Board since then. Mr. Stern was the Co-Chief Executive
Officer, Co-President and a director of Bogen Communication International
("BCI") from March 1995 until August 1995, and since then he has served as a
director and member of the BCI Board's Executive Committee. BCI is a public
company involved in the business of voice processing and digital peripherals
for PABX. From January 1993 to September 1993, Mr. Stern was President and
from January 1992 until May 1995 a director of WordStar International, Inc.,
which was engaged in research and development and worldwide marketing and
distribution of software for business and consumer applications and which was
restructured and renamed Softkey International, Inc. From April 1989 to
December 1992, Mr. Stern was Vice President of Business Development of Elron
Electronic Industries Ltd., a multi-national
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publicly-traded holding company based in Israel that is engaged in operating
and investing in high technology companies.
JOSHUA G. COOPERMAN has served as a director of the Company since August
1996. Since October 1993 he has served as President and Chief Executive
Officer and Vice President of Transocean Funding, Inc., a company engaged in
municipal leasing and provision of financial advisory services. From December
1989 until October 1993, Mr. Cooperman was Vice President of Transocean
Funding, Inc. From December 1994 until October of 1996, Mr. Cooperman was a
Principal of Digital Wireless, a telecommunications marketing firm. From
September 1988 until July 1992, Mr. Cooperman served in an of counsel position
at the Boston law firm of Gaston & Snow.
ALEX S. VIEUX has served as a director of the Company since November 1996.
Mr. Vieux has served as Chairman and Chief Executive Officer of DASAR Inc., an
information technology consulting company since 1989. Mr. Vieux is a member of
the Board of Directors of Tandem Computer, Inc. Mr. Vieux has also served as a
special advisor to the French Minister of Industry, a business correspondent
for the French daily, Le Monde, and as an instructor in Economics at the
Universite de Paris-La Sorbonne.
YARON EITAN has served as a director of the Company since November 1996. Mr.
Eitan is currently Chief Executive Officer and a founder of Geotek
Communications, Inc., an international provider of wireless voice and data
communications for businesses, which positions he has held since 1989.
Mr. Eitan has also been the Chairman of the Board at Geotek since October
1996. Prior to 1989, he served as President and Chief Operating Officer of
Patlex Corporation, a manufacturer of electronic munitions fuses and
transformers from 1985 to 1987. Prior to that, Mr. Eitan served as Executive
Vice President of Reshef Technologies, Ltd., an electronic fuse manufacturer.
N. SCOTT DICKSON has served as Vice President and Corporate Controller since
October 1996. From June 1995 until April 1996, he served as Controller and
from May 1996 to October 1996 he served as Vice President and Chief Financial
Officer of Splash Studios, Inc., a company engaged in the development of
interactive children's entertainment for CD-ROM and Internet applications.
From November 1993 until June 1995 Mr. Dickson was a business consultant. He
was Controller at Ballard Computer, Inc., a regional retailer of computer
hardware, software and related accessories from December 1992 to October 1993.
From July 1991 to December 1992, Mr. Dickson served as Controller at Sight &
Sound Entertainment, Inc., a manufacturer and distributor of in-store
television programming. From September 1985 until September 1990, Mr. Dickson
served as a Senior Auditor at KPMG Peat Marwick LLP.
ANDREW G. SALISBURY has served as Vice President of Interactive Development
since April 1996. From July 1994 to March 1996, Mr. Salisbury was Vice
President of Strategic Technology at Walker Interactive, a software
applications company. From December 1993 to July 1994 he was the Chief
Technology Officer of Marathon Systems, a client-server systems integration
company. From November 1991 to December 1993, he was the Director of Systems
Integration at Oracle Corporation, a database software company. From March
1986 to November 1991 Mr. Salisbury was a Director of Price Waterhouse LLP.
RON WOLF has served as Vice President of Software Technology since June
1996. From February 1995 until June 1996 Mr. Wolf was Vice President,
Technology for Transphere Interactive. Mr. Wolf held various engineering and
executive positions at Gupta Corporation, a database software company, from
April 1989 to February 1995, including Senior Director of Connectivity.
JADE WONG has served as Vice President of Marketing Communications of the
Company since June 1996. From September 1993 until June 1996, Ms. Wong served
as General Manager of Transphere International and as Management Director of
Transphere International from July 1992 until September 1993. She joined
Transphere International as an Account Supervisor in March 1990.
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<PAGE>
There are no family relationships among any of the Company's directors or
executive officers, except that Edward A. Brinskele and Michael J. Brinskele
are brothers.
Currently, directors are elected for a term of one year or until their
successor is elected, appointed and qualified. The Company's Certificate of
Incorporation provides that, effective as of the date of the first regularly-
scheduled annual meeting of stockholders following the closing of this
offering, the Board of Directors will be divided into three classes of
directors serving staggered three-year terms. As a result, one-third of the
Company's Board of Directors will be elected each year. See "Delaware Anti-
Takeover Law and Certain Charter Provisions--Anti-Takeover Effect of Certain
Charter Provisions."
AUDIT COMMITTEE
The Audit Committee consists of Messrs. Stern, Cooperman and Eitan. The
Audit Committee makes recommendations to the Board regarding the selection of
independent auditors, reviews the results and scope of the audit and other
services provided by the Company's independent auditors and reviews and
evaluates the Company's internal audit and control functions.
COMPENSATION COMMITTEE; COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION
The Compensation Committee consists of Messrs. Stern, Cooperman and Vieux.
The Compensation Committee administers the Company's stock option plans and
makes recommendations to the Board concerning salaries and incentive
compensation for employees and consultants of the Company.
DIRECTOR COMPENSATION
The Company's non-employee directors currently receive $2,500 for attending
each board meeting. There is no additional compensation to directors for
attending the meetings of any committees on which they sit. In addition, board
members are reimbursed for their out-of-pocket expenses incurred in attending
committee meetings. The directors are eligible to receive stock option grants
under the Company's 1996 Stock Option Plan.
EXECUTIVE COMPENSATION
The following table sets forth, for the fiscal year ended December 31, 1995,
all compensation earned for services rendered to the Company's predecessor
corporations by the Company's Chief Executive Officer and the only other most
highly compensated executive officer of the Company whose total compensation
for 1995 exceeded $100,000 (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
IN 1995
------------------
NAME AND PRINCIPAL POSITION SALARY($) BONUS($)
- --------------------------- --------- --------
<S> <C> <C>
Edward A. Brinskele(1)....................................... $240,000 --
Chairman of the Board and Chief Executive Officer
Charles Schoenhoeft(2)....................................... 120,000 100,000
Vice Chairman of the Board and President
</TABLE>
- --------
(1) The amount shown does not include $239,664 paid to Mr. Brinskele in
consideration of the license of a patent by Mr. Brinskele to MTC
Telemanagement in 1995. See "Certain Transactions."
(2) Mr. Schoenhoeft was paid such compensation as an employee of Transphere
International.
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<PAGE>
EMPLOYMENT AGREEMENTS
The Company intends to enter into Employment Agreements with each of Edward
Brinskele, Charles Schoenhoeft, Gary Anderson, Kevin Paul, Gregory Reznick,
Evan Kraus and Michael Brinskele, for such persons to serve as Chief Executive
Officer, President, Executive Vice President and Chief Financial Officer,
Managing Director, Europe, Executive Vice President and Chief Operating
Officer, Executive Vice President and General Counsel and Executive Vice
President, Global Network Services, respectively, for terms and for salaries
to be agreed upon. The Company contemplates that such agreements will include
severance payments for terminations of employment during the terms of such
agreements.
STOCK OPTION PLANS AND ARRANGEMENTS
PREDECESSOR CORPORATION OPTIONS
In connection with the Reorganization, on June 28, 1996, the Company assumed
previously issued options to purchase shares of common stock of NetSource
Interactive (the "Assumed Options"). The Assumed Options were originally
granted by Transphere International, a predecessor corporation to NetSource
Interactive, to employees of Transphere International at an exercise price
equal to the fair market value of the shares on the respective dates of grant.
All of the Assumed Options are nonstatutory stock options. The Assumed Options
generally have terms of 10 years.
In the event of certain changes in control of the Company, the option
agreements for the Assumed Options require that such Assumed Options be
assumed or an equivalent option substituted by the successor corporation;
provided, however, if the Assumed Options are not so assumed or substituted,
the optionees of the Assumed Options shall have the right to exercise the
Assumed Options as to all or a portion of the stock subject thereto, including
shares which would not otherwise be exercisable. The Company may amend or
terminate the Assumed Options only with the written consent of the optionees.
As of the date of this Prospectus, there were outstanding Assumed Options to
purchase 356,745 shares of Common Stock.
In addition, on June 28, 1996, the Company issued nonstatutory options to
purchase 225,000 shares of Common Stock to certain holders of MTC
International in connection with the Reorganization in exchange for their
options to purchase shares of MTC International. These options were originally
granted by the Board of Directors of MTC International at an exercise price
equal to the fair market value on the date of grant, and have a term of 10
years. The options contain terms relating to changes in control of the Company
similar to those of the Assumed Options.
1996 OMNIBUS EQUITY INCENTIVE PLAN
In January 1996, the Company adopted its 1996 Omnibus Equity Incentive Plan
(the "Omnibus Plan"), pursuant to which an aggregate of 6,075,000 shares of
Common Stock were reserved for issuance to employees and consultants of the
Company and its subsidiaries. The Omnibus Plan provides for awards of both
nonstatutory stock options and incentive stock options within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"),
stock appreciation rights, restricted stock subject to forfeiture and
restrictions on transfer, and performance awards entitling the recipient to
receive cash or Common Stock in the future following the attainment of
performance goals determined by the Board of Directors.
The Omnibus Plan is administered by the Compensation Committee of the Board
of Directors, which has the authority to select the persons to whom future
awards will be made, to determine the nature and amounts of such awards and to
interpret, construe and implement the Omnibus Plan.
The exercise price of all incentive stock options granted under the Omnibus
Plan must be at least equal to the fair market value of the shares of Common
Stock on the date of grant. With respect to
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<PAGE>
any participant possessing more than 10% of the voting power of the Company's
outstanding capital stock, the exercise price of any option granted must be
equal to at least 110% of the fair market value on the grant date and the
maximum term of the option must not exceed five years. The terms of all
options granted under the Omnibus Plan may not exceed 10 years.
The Omnibus Plan provides that in the event of a merger, reorganization or
certain other events affecting the Common Stock, an adjustment shall be made
in the number and class of stock deliverable under the Omnibus Plan and the
shares subject to outstanding options, Stock Appreciation Rights and
Restricted Stock Awards granted under the Omnibus Plan as the plan
administrator, in its sole discretion, shall determine to be appropriate to
prevent the dilution or diminishment of awards outstanding under the Omnibus
Plan.
As of the date of this Prospectus, there were outstanding options to
purchase an aggregate of 2,200,335 shares of Common Stock under the Omnibus
Plan. The Omnibus Plan has been terminated as to future grants but remains in
place with respect to stock options already granted.
1996 STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the "1996 Plan") was adopted by the
Board of Directors in September 1996. A total of 1,950,000 shares of Common
Stock have been reserved for issuance under the 1996 Plan. The 1996 Plan
provides for the grant to employees of the Company (including officers and
directors) of incentive stock options within the meaning of Section 422 of the
Code, and for the grant of nonstatutory stock options to employees, directors
and consultants of the Company. The 1996 Plan is administered by the
Compensation Committee of the Board of Directors, which selects the optionees,
determines the number of shares to be subject to each option and determines
the exercise price of each option. The exercise price of all incentive stock
options granted under the 1996 Plan must be at least equal to the fair market
value of the Common Stock on the date of grant. The exercise price of all
nonstatutory stock options granted under the 1996 Plan must be at least equal
to 85% of the fair market value of the Common Stock on the date of grant. With
respect to any participant who owns stock possessing more than 10% of the
voting power of all classes of stock of the Company, the exercise price of any
stock option granted must equal at least 110% of the fair market value on the
grant date and the maximum term of the option must not exceed five years. The
term of all other options granted under the 1996 Plan may not exceed 10 years.
In the event of certain changes in control of the Company, the 1996 Plan
requires that each outstanding option be assumed or an equivalent option
substituted by the successor corporation; provided, however, if the options
are not so assumed or substituted, each optionee shall have the right to
exercise the option as to all or a portion of the stock subject thereto,
including shares which would not otherwise be exercisable. Unless terminated
sooner, the 1996 Plan will terminate ten years from its effective date. The
Board has authority to amend, suspend, or terminate the 1996 Plan, provided no
such action would impair the rights of the holder of any outstanding options
without the written consent of such holder.
As of the date of this Prospectus, there were outstanding options to
purchase an aggregate of 1,022,400 shares of Common Stock under the 1996 Plan.
1996 EMPLOYEE STOCK PURCHASE PLAN
The Company's Employee Stock Purchase Plan (the "Purchase Plan") was adopted
by the Board of Directors in October 1996. A total of 750,000 shares of Common
Stock have been reserved for issuance under the Purchase Plan. The Purchase
Plan, which is intended to qualify under Section 423 of the Code, will be
implemented by a series of offering periods of 24 months duration with new
offering periods (other than the first offering period) commencing on or about
May 14 and November 15 of each
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year. Each offering period will consist of four consecutive purchase periods
of six months duration, with the last day of each period being designated a
purchase date. The first such purchase period will commence on the effective
date of the Company's initial public offering and continue through May 14,
1997, with subsequent purchase dates to occur every six months thereafter. The
Purchase Plan is administered by the Board of Directors, or a committee named
by the Board of Directors. Employees (including officers and employee
directors) of the Company, or of any majority owned subsidiary designated by
the Board, are eligible to participate if they are employed by the Company or
any such subsidiary for at least 20 hours per week and more than five months
per year. The Purchase Plan permits eligible employees to purchase Common
Stock through payroll deductions, which may not exceed 10% of an employee's
compensation, at a price equal to the lower of 85% of the fair market value of
the Company's Common Stock at the beginning of the offering period or the
purchase date. If the fair market value of the Common Stock on a purchase date
is less than the fair market value at the beginning of the offering period, a
new 24 month offering period will automatically begin on the first business
day following the purchase date with a new fair market value. Employees may
end their participation in the Purchase Plan at any time during the offering
period, and once during each offering period may decrease the rate of payroll
deductions. Participation in the Purchase Plan ends automatically on
termination of employment with the Company.
The Purchase Plan provides that in the event of a merger of the Company with
or into another corporation or a sale of substantially all of the Company's
assets, each right to purchase stock under the Purchase Plan will be assumed
or an equivalent right substituted by the successor corporation unless the
Board of Directors shortens the offering period so that employees' rights to
purchase stock under the Purchase Plan are exercised prior to the merger or
sale of assets. The Board of Directors has the power to amend or terminate the
Purchase Plan as long as such action does not adversely affect any outstanding
rights to purchase stock thereunder. If not terminated earlier, the Purchase
Plan will have a term of 10 years.
SECTION 401(K) PLAN
In December 1995, MTC Telemanagement adopted a 401(k) Plan (the "401(k)
Plan"), subsequently assumed by the Company, covering the Company's full-time
employees located in the U.S. who have completed six months of service.
Pursuant to the 401(k) Plan, employees may elect to reduce their current
compensation by up to the statutorily prescribed limit ($9,500 in 1996) and to
have the amount of such reduction contributed to the 401(k) Plan. The Board
has approved an amendment to the 401(k) Plan to require an additional matching
contribution by the Company on behalf of all participants in an amount equal
to 10% of the employee's contribution, but only to the extent of the first 8%
of the employee's compensation. The 401(k) Plan is intended to qualify under
Section 401(k) of the Internal Revenue Code so that contributions to the
401(k) Plan by employees or by the Company, and the investment earnings
thereon, will not be taxable to employees until withdrawn from the 401(k) Plan
and so that contributions by the Company, if any, will be deductible by the
Company when made.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Certificate of Incorporation limits the liability of directors
to the maximum extent permitted by Delaware law. Delaware law provides that
directors of a corporation will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except liability for (i)
any breach of their duty of loyalty to the corporation or its stockholders,
(ii) acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) unlawful payments of dividends
or unlawful stock repurchase or redemptions or (iv) any transaction from which
the director derived an improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its directors
and executive officers and may indemnify its other officers and employees and
other agents to the fullest extent
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permitted by law. The Company believes that indemnification under its Bylaws
covers at least negligence and gross negligence on the part of indemnified
parties. The Company's Bylaws also permit it to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out
of his or her actions in such capacity, regardless of whether the Bylaws would
permit indemnification.
The Company has entered into agreements to indemnify its directors and
executive officers, in addition to indemnification provided for in the
Company's Bylaws. These agreements, among other things, indemnify the
Company's directors and executive offices for certain expenses (including
attorneys' fees), judgments, fines and settlement amounts incurred by any such
person in any action or proceeding, including any action by or in the right of
the Company, arising out of such person's services as a director or executive
officer of the Company, any subsidiary of the Company or any other company or
enterprise to which the person provides services at the request of the
Company. The Company believes that these provisions and agreements are
necessary to attract and retain qualified persons as directors and executive
officers.
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CERTAIN TRANSACTIONS
AGREEMENTS WITH MTC INFORMATION SYSTEMS, INC.
In January 1994, MTC Information Systems, Inc. ("Information Systems"), a
California corporation owned by Edward A. Brinskele, the Chairman of the
Board, Chief Executive Officer and currently a 42% stockholder of the Company,
and Roger Sheppard, currently an 18% stockholder of the Company, entered into
a sublease with the Company's wholly-owned subsidiary, MTC Telemanagement, for
the Company's offices in Petaluma, California. Information Systems charged MTC
Telemanagement the same rate that it was paying to the lessor. In October
1996, Information Systems and MTC Telemanagement terminated the sublease and
assigned the lease to the Company so that the Company currently leases the
property directly from the lessor. Additionally, Information Systems has
assigned to the Company certain leases for equipment space and an equipment
lease to which Information Systems was previously a party.
AGREEMENT WITH AIR TRAFFIC MANAGEMENT SERVICES, INC.
In July 1995, MTC Telemanagement entered into a five year
sales/distribution, license and services and facilities agreement with Air
Traffic Management Services, Inc. ("Air Traffic"), an overnight delivery and
shipping management services company, which at the time was owned equally by
Mr. Brinskele and Mr. Sheppard. Pursuant to the agreement, MTC Telemanagement
(i) sold and distributed a product and management service owned by Air
Traffic; (ii) performed services to run the day-to-day operations of Air
Traffic; (iii) provided Air Traffic facilities; and (iv) licensed to Air
Traffic certain billing software. Under the agreement, Air Traffic paid MTC
Telemanagement a monthly base charge and commission. Payments received from
Air Traffic for the years ended December 31, 1993, 1994, and 1995 and for the
nine months ended September 30, 1996, were $662,000, $1,516,000, $2,413,000
and $1,620,000, respectively. The Company had receivables from Air Traffic as
of December 31, 1993, 1994, and 1995, and September 30, 1996, in the amount of
$112,000, $687,000, $288,000 and $547,000, respectively. Mr. Brinskele has
disposed of his entire interest in Air Traffic.
In November, 1996, MTC Telemanagement, Air Traffic, Roger Sheppard and The
Dobson Acquisition Corp. entered into an Asset Purchase Agreement under which
Air Traffic sold all of its air courier service business assets and MTC
Telemanagement released its rights to certain assets that it used to operate
such service business. Concurrently with the execution of the aforementioned
Asset Purchase Agreement, MTC Telemanagement entered into a Settlement
Agreement with Air Traffic and Roger Sheppard pursuant to which the facilities
and services agreement was terminated, and MTC Telemanagement indemnified Air
Traffic and Roger Sheppard for certain Asset Purchase Agreement
representations. In connection with the agreements, MTC Telemanagement
received payment of $547,000 and expects to receive additional payments by
December 31, 1996. The Air Traffic arrangement was terminated as a result of
the fact that the arrangement generated minimal revenues, the services
provided were unrelated to the Company's primary telecommunications product
offerings and the sale of the Air Traffic product and management service owned
by Air Traffic utilized sales channels incompatible with the Company's
existing sales channels for its telecommunications products.
MERGER AND ACQUISITION ADVICE AGREEMENT
NetSource is a party to an agreement with Helix Capital L.L.C. dated April
15, 1996 ("Helix") pursuant to which Helix provides merger and acquisition,
financing and strategic advisory services to the Company and has a term of
eighteen months, which may be extended by mutual consent. The agreement
originally provided that Helix would receive a non-refundable retainer of
$7,500 per month for the first three months, and that the amount would
increase to $10,000 per month for one year following the completion of the
sale of the Notes in June 1996. In October 1996, recognizing additional
efforts in the financial integration of certain acquisitions not contemplated
in the original agreement, the
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retainer was increased to $17,500 per month. The agreement also provides that
the parties will agree upon fees for specific merger and acquisition
activities at a later stage. Yoav Stern, a director of the Company, is a
member of the managing partner of Helix and has a 33% equity ownership
interest in Helix. The Company believes that the terms of the Helix agreement
are comparable to those that the Company could have obtained in arms-length
bargaining with an unrelated third party.
PATENT ASSIGNMENT AGREEMENT
Pursuant to an agreement dated May 30, 1996, Edward A. Brinskele has
assigned to the Company all of his rights, title and interest in and to two
U.S. patents and corresponding patent applications pending in certain foreign
countries. The patents relate to the global least cost routing function of the
Company's CCSA technology. See "Business--Technology and Intellectual
Property." Mr. Brinskele has been paid an aggregate of approximately $409,000
between January 1994 and May 1996 in consideration of a prior license of the
patents. The patents expire in November 2012 and September 2013.
LOAN TO EDWARD A. BRINSKELE
During the period from January 1992 through November 1993, the Company made
payments to third parties on behalf of Edward A. Brinskele in the aggregate
amount of $249,000. The balance bears interest at the prime rate and is due no
later than June 1997.
CANCELLATION AND GRANT OF OPTIONS
Pursuant to a Settlement and Release Agreement, effective in June 1996,
Edward A. Brinskele and Roger Sheppard each consented to the rescission of
options held by them to purchase 112,500 shares each of Common Stock. Pursuant
to this agreement, the Company agreed to issue options for an aggregate of
225,000 shares of the Common Stock of the Company to certain other
stockholders of the Company.
ROGER SHEPPARD SETTLEMENT AGREEMENT
Pursuant to a Settlement and Release Agreement between the Company and Roger
Sheppard effective in June 1996, Mr. Sheppard was paid a severance payment of
$150,000 plus accrued salary and benefits arising out of his former employment
with the Company.
STOCK ISSUANCE TO EDWARD A. BRINSKELE
In March 1995, the Company issued Mr. Brinskele an aggregate of 88,410
shares of Common Stock in consideration of the transfer by Mr. Brinskele of an
aggregate of 25,260 shares to two employees of the Company in March 1992 and
the transfer of 56,835 shares to one employee in July 1993. Such transfers
were originally made by Mr. Brinskele on the Company's behalf because the
Company did not have sufficient authorized option shares to issue to such
employees at the times such grants were made.
See also "Business--Reorganization."
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding common stock as of September 30, 1996,
and as adjusted to reflect the sale of the securities offered by the Company
in the offering made hereby, (i) by each person (or group of affiliated
persons) who is known by the Company to own beneficially more than 5% of the
Company's Common Stock, (ii) each of the Company's directors and executive
officers who hold vested options within 60 days of September 30, 1996 and
(iii) all directors and executive officers as a group. Except as indicated in
the footnotes to this table and subject to applicable community property laws,
the persons named in the table, based on information provided by such persons,
have sole voting and investment power with respect to all shares of Common
Stock shown as beneficially owned by them.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED(1)
NUMBER OF SHARES ----------------------------
NAME AND ADDRESS OF BENEFICIAL BENEFICIALLY BEFORE AFTER
OWNER OWNED(1) THE OFFERING THE OFFERING(2)
------------------------------ ---------------- ------------ ---------------
<S> <C> <C> <C>
Edward A. Brinskele ............ 6,929,369(3) 42.47% 34.96%
444 Spear St., Suite 200
San Francisco, CA 94105
Charles Schoenhoeft ............ 3,082,035 19.28 15.82
444 Spear St., Suite 200
San Francisco, CA 94105
Roger Sheppard ................. 3,021,585(4) 18.51 15.24
14 Bracken Court
San Rafael, CA 94901
Michael J. Brinskele............ 102,630(5) * *
Gregory A. Reznick.............. 81,135(6) * *
Yoav Stern...................... 190,770(7) 1.19 *
Joshua G. Cooperman............. -- -- --
Yaron Eitan..................... -- -- --
Alex Vieux...................... -- -- --
All officers and directors as a
group (11 persons)............. 10,477,255(8) 63.20% 52.18%
</TABLE>
- --------
* Under 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that
person, shares of Common Stock subject to options or warrants held by that
person that are currently exercisable or will become exercisable within 60
days after September 30, 1996, are deemed outstanding, while such shares
are not deemed outstanding for purposes of computing percentage ownership
of any other person.
(2) Assumes no exercise of the Underwriters' over-allotment option to purchase
up to an aggregate of shares of Common Stock of the Company.
(3) Includes 337,500 shares issuable pursuant to stock options and exercisable
within 60 days of September 30, 1996 and 98,412 shares transferred to a
stockholder of the Company in October 1996.
(4) Includes 337,500 shares issuable pursuant to stock options and exercisable
within 60 days of September 30, 1996.
(5) Includes 90,000 shares issuable pursuant to stock options and exercisable
within 60 days of September 30, 1996.
(6) Constitutes shares issuable pursuant to stock options and exercisable
within 60 days of September 30, 1996.
(7) Constitutes shares held by Helix Capital L.L.C., of which Mr. Stern is a
managing partner and of which he holds a 33% equity ownership interest, as
to which shares he disclaims beneficial ownership.
(8) Includes 607,037 shares issuable pursuant to stock options and exercisable
within 60 days of September 30, 1996.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, par value $0.001 per share.
COMMON STOCK
As of September 30, 1996, there were 15,978,074 shares of Common Stock
issued and outstanding and held of record by 15 stockholders.
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders, except that
upon giving of a notice required by law, stockholders may cumulate the votes
in elections of directors. Upon the Company's having 800 stockholders,
stockholders shall no longer have such cumulative voting rights. The holders
of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor.
See "Dividend Policy." In the event of a liquidation, dissolution or winding
up of the Company, the holders of Common Stock are entitled to share ratably
in all assets remaining available for distribution to them after payment of
liabilities. The holders of Common Stock have no conversion, preemptive or
other subscription rights, and there are no redemption or sinking fund
provisions applicable to the Common Stock. All of the outstanding shares of
Common Stock are, and all shares of Common Stock to be outstanding upon
completion of this offering will be, fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has authority to issue up to 10,000,000 shares of
Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares without any further
vote or action by the stockholders. The rights of the holders of the Company's
Common Stock will be subject to, and may be adversely affected by, the rights
of the holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of the outstanding voting stock of the Company, thereby delaying, deferring or
preventing a change in control of the Company. Furthermore, such Preferred
Stock may have other rights, including economic rights, senior to the Common
Stock, and as a result, the issuance of such Preferred Stock could have a
material adverse effect on the market value of the Common Stock. As of the
date of this Prospectus, no shares of Preferred Stock are outstanding, and the
Company has no present plan to issue shares of Preferred Stock.
NOTES AND WARRANTS
In June 1996, the Company issued the Notes in the aggregate principal amount
of $20 million, together with the Warrants, to 42 foreign investors. The Notes
bear interest at the rate of 10% per annum, and interest is due semi-annually.
Principal and all accrued and unpaid interest under the Notes is due and
payable in full in June 1998. The Notes may be prepaid by the Company after
June 1997. The number of shares of Company Stock into which the Notes are
convertible and the conversion price are based on the per share initial public
offering price to the public of the Registrant's Common Stock. Assuming an
offering price of $14 per share in this offering, the Notes will be
convertible into an aggregate of 2,040,816 shares of Common Stock at a
conversion price of $9.80 per share or 70% of such offering price. The number
of shares into which the Warrants are exercisable and the exercise price are
based on the per share initial public offering price to the public of the
Registrant's Common Stock. Assuming an offering price of $14 per share in this
offering, the Warrants will be exercisable for an aggregate of 163,265 shares
of Common Stock at an exercise price of $9.80 per share, or 70% of such
offering price.
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TRANSFER AGENT AND REGISTRAR
The Company's transfer agent and registrar is ChaseMellon Shareholder
Services.
REGISTRATION RIGHTS
If the Company at any time proposes to register any of its securities under
the Securities Act (other than a registration effected solely to implement an
employee benefit plan, a transaction to which Rule 145 of the Commission is
applicable or any other form or type of registration in which "Registrable
Securities" (as defined below) cannot be included pursuant to Commission
regulation, rule or practice), then optionees whose stock options were assumed
or substituted in the Reorganization (who hold in the aggregate options to
purchase 2,213,700 shares of Common Stock) have been granted certain piggyback
registration rights with respect to the Common Stock issuable upon exercise of
their options (the "Registrable Securities"), subject to (i) termination at
such time that all shares of Registrable Securities held or entitled to be
held upon conversion by such holders may be publicly sold under Rule 144 or
any applicable exemption or registration statement during any three month
period and (ii) cutback if the underwriter managing such registration notifies
the holders of Registrable Securities in writing that market or economic
conditions limit the amount of securities which may reasonably be expected to
be sold or that inclusion of such Registrable Securities would jeopardize the
success of the offering. In addition, the Company has granted the shareholders
of scruz-net and DNA piggyback registration rights similar to those of the
optionees discussed above. See "Business--Recent Developments," "--
Reorganization" and "Shares Eligible for Future Sale."
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS. Certain provisions of
the Company's Certificate of Incorporation and Bylaws could discourage
potential acquisition proposals and could delay or prevent a change in control
of the Company. Such provisions could diminish the opportunities for a
stockholder to participate in tender offers, including tender offer at a price
above the then current market value of the Common Stock. Such provisions may
also inhibit fluctuations in the market price of the Common Stock that could
result from takeover attempts. The Company is also afforded the protections of
Section 203 of the Delaware General Corporation Law, which could delay or
prevent a change in control of the Company or could impede a merger,
consolidation, takeover or other business combination involving the Company or
discourage a potential acquiror from making a tender offer or otherwise
attempting to obtain control of the Company. In addition, the Board of
Directors has authority to issue up to 10,000,000 shares of Preferred Stock
and to fix the rights, preferences, privileges and restrictions, including
voting rights, of these shares without any further vote or action by the
stockholders. The rights of the holders of the Company's Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding
voting stock of the Company, thereby delaying, deferring or preventing a
change in control of the Company. Furthermore, such Preferred Stock may have
other rights, including economic rights, senior to the Common Stock, and as a
result, the issuance of such Preferred Stock could have a material adverse
effect on the market value of the Common Stock. No shares of Preferred Stock
are outstanding as of the date of this Prospectus. The Company has no present
plan to issue shares of Preferred Stock. The Company's Certificate of
Incorporation provides that, effective as of the date of the first regularly-
scheduled annual meeting of stockholders following the closing of the
offering, the Board of Directors will be divided into three classes of
directors serving staggered three-year terms. As a result, one-third of the
Company's Board of Directors will be elected each year.
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SHARES ELIGIBLE FOR FUTURE SALE
No prediction can be made as to the effect, if any, that market sales of the
Company's Common Stock or the availability of the Company's Common Stock for
sale will have on the market price prevailing from time to time. Nevertheless,
sales of substantial amounts of the Common Stock of the Company in the public
market after the restrictions described below lapse could adversely affect the
prevailing market price and the ability of the Company to raise equity capital
in the future.
Upon completion of this offering (assuming no exercise of the Underwriters'
over-allotment option), the Company will have outstanding 19,478,074 shares of
Common Stock (based on shares outstanding as of the date of this Prospectus).
Commencing 180 days after the date of the Prospectus, upon the expiration of
lock-up agreements with the Company and the Underwriters, approximately
15,978,074 of such shares of Common Stock will be eligible for immediate sale
in the public market pursuant to the exemption from registration contained in
Section 3(a)(10) of the Securities Act, subject in some cases to compliance
with certain volume limitations and other restrictions under Rule 144.
The Company currently has outstanding $20 million principal amount Notes,
together with the Warrants which were issued pursuant to Regulation S under
the Securities Act. The Notes are convertible into and the Warrants are
exercisable for Common Stock at the option of the holders thereof after the
earlier of December 31, 1996 or completion of the Company's initial public
offering. All of such shares are subject to 180 day lock-up agreements with
the Company. If the offering is completed prior to December 31, 1996, the
price per share into which the Notes are convertible and the exercise price of
the Warrants will each be 70% of the initial public offering price per share.
Assuming that the offering is completed on or before December 31, 1996 and the
initial public offering price is $14 per share, the maximum number of shares
that would be issuable upon conversion of the Notes and exercise of the
Warrants would be 2,204,081. In the event that the offering is not completed
prior to December 31, 1996, the conversion price would be $5.40 per share,
subject to adjustment, such that a maximum of 4,000,000 shares of Common Stock
would be issuable upon exercise or conversion. The shares issuable upon
conversion of the Notes and exercise of the Warrants will become eligible for
sale in the public market in June 1997 following expiration of the lock-up
agreements.
In connection with the issuance of the Notes and Warrants, a warrant
identical to the Warrants described above was issued for an aggregate of
147,959 shares of Common Stock to the placement agent for the financing
described above. Such warrant has the same exercise price as the warrants
described above. Such shares will become eligible for sale in the U.S.
following expiration of the lock-up agreements.
There are outstanding options for an aggregate of 3,579,480 shares of Common
Stock issued under the Company's Omnibus Plan and 1996 Plan or assumed as a
result of the Reorganization, all of which shall be subject to lock-up
agreements referenced above and 1,976,707 of which shall be vested and
exercisable after expiration of the lock-up agreements and eligible for sale
in the public market. Following the completion of this offering, the Company
intends to file a Form S-8 Registration Statement with the Commission in order
to register all of such shares and, in addition, the remaining shares reserved
for issuance under the 1996 Stock Plan and 1996 Employee Stock Purchase Plan.
Options to purchase an aggregate of an additional 225,000 shares of Common
Stock are currently outstanding, which were issued in connection with the
Reorganization and which will become eligible for sale in the U.S. only after
the exercise price is paid and the two-year holding period under Rule 144 has
elapsed.
In general, under Rule 144, a person (or persons whose shares are
aggregated) who has beneficially owned restricted shares for at least two
years, including the holding period of any securities which converted into the
Restricted Shares and including the holding period of any prior owner except
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an affiliate, will be 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 (194,780 shares immediately after this offering
assuming no exercise of the Underwriters' over-allotment option) or the
average weekly trading volume of the Common Stock during the four calendar
weeks preceding such sale. Sales under Rule 144 are also subject to certain
manner of sale provisions, notice requirements and the availability of current
public information about the Company. Any person (or persons whose shares are
aggregated) who is not deemed to have been an affiliate of the Company at the
time during the 90 days preceding a sale, and who has beneficially owned
shares for at least three years (including any period of ownership of
preceding non-affiliated holders), will be entitled to sell such shares under
Rule 144(k) without regard to the volume limitations, manner of sale
provisions, public information requirements or notice requirements.
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its
employees, directors, officers, consultants or advisers prior to the closing
of this offering, pursuant to written compensatory benefit plans or written
contracts relating to the compensation of such persons. In addition, the
Securities and Exchange Commission has indicated that Rule 701 will apply to
stock options granted by the Company before this offering, along with the
shares acquired upon exercise of such options. Securities issued in reliance
on Rule 701 are deemed to be restricted shares and, beginning 90 days after
the date of this Prospectus (unless subject to the contractual restrictions
described above), may be sold by persons other than affiliates subject only to
the manner of sale provisions of Rule 144 and by affiliates of the Company
under Rule 144 without compliance with its two-year minimum holding period
requirements.
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of Common Stock by a
person that, for U.S. federal income tax purposes, is a non-resident alien
individual, a foreign corporation, a foreign partnership or an estate or
trust, in each case not subject to U.S. federal income tax on a net income tax
basis in respect of income or gain from Common Stock (a "non-U.S. holder").
This discussion is based on the Internal Revenue Code of 1986, as amended,
Treasury regulations thereunder, and administrative and judicial
interpretations as of the date hereof, all of which may be changed. This
discussion does not address all the aspects of U.S. federal income and estate
taxation that may be relevant to non-U.S. holders in light of their particular
circumstances, or to certain types of holders subject to special treatment
under U.S. federal income tax laws (such as life insurance companies and
dealers in securities). Nor does it address tax consequences under the laws of
any state, municipality or other taxing jurisdiction or under the laws of any
country other than the U.S.
Prospective holders should consult their own tax advisors about the
particular tax consequences to them of holding and disposing of Common Stock.
DIVIDENDS
Generally, dividends paid to a non-U.S. holder of Common Stock will be
subject to U.S. federal withholding tax at a 30% rate or such lower rate as
may be specified by an applicable income tax treaty, unless the dividends are
effectively connected with the conduct of a trade or business within the U.S.
(or alternatively are attributable to a U.S. permanent establishment of such
holder, if an applicable income tax treaty so requires as a condition for the
non-U.S. holder to be subject to U.S. income tax on a net income basis in
respect of such dividends). Such "effectively connected" dividends, or
dividends attributable to a permanent establishment, are subject to tax at
rates applicable
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to U.S. citizens, resident aliens and domestic U.S. corporations, and are not
generally subject to withholding. Effectively connected dividends received by
a non-U.S. corporation may be subject to an additional "branch profits tax" at
a 30% rate (or a lower rate under an applicable income tax treaty) when such
dividends are deemed repatriated from the U.S.
Under current U.S. Treasury regulations, dividends paid to an address
outside the U.S. in a foreign country are presumed to be paid to a resident of
such country for purposes of the withholding tax. Under current interpretation
of U.S. Treasury regulations, the same presumption applies to determine the
applicability of a reduced rate of withholding under a tax treaty. Thus, non-
U.S. holders receiving dividends at addresses outside the U.S. are not
currently required to file tax forms to obtain the benefit of an applicable
treaty rate. Under U.S. Treasury regulations that are proposed to be effective
for distributions after 1997 (the "Proposed Regulations"), to claim the
benefits of a tax treaty a non-U.S. holder of Common Stock would be required
to satisfy applicable certification requirements. In addition, under the
Proposed Regulations, in the case of Common Stock held by a foreign
partnership, (x) the certification requirement would generally be applied to
the partners of the partnership and (y) the partnership would be required to
provide certain information. The Proposed Regulations also provide look-
through rules for tiered partnerships. It is not certain whether, or in what
form, the Proposed Regulations will be adopted as final regulations.
If there is excess withholding on a person eligible for a treaty benefit,
the person can file for a refund with the U.S. Internal Revenue Service.
GAIN ON DISPOSITION OF COMMON STOCK
A non-U.S. holder generally will not be subject to U.S. federal income tax
in respect of gain recognized on a disposition of Common Stock unless (i) the
gain is effectively connected with a trade or business of the non-U.S. holder
in the U.S., (ii) in the case of a non-U.S. holder who is an individual and
holds the Common Stock as a capital asset, such holder is present in the U.S.
for 183 or more days in the taxable year of the disposition and certain other
conditions are met, (iii) the non-U.S. holder is subject to tax pursuant to
the provisions of U.S. tax law applicable to certain U.S. expatriates, or
(iv) the Company is or has been a "U.S. real property holding corporation" for
federal income tax purposes and, if the Common Stock is regularly traded on an
established securities market, the non-U.S. holder held, directly or
indirectly, at any time during the 5-year period ending on the date of
disposition (or such shorter period that such shares were held) more than 5%
of the Common Stock. The Company has not been and does not anticipate becoming
a "U.S. real property holding corporation" for U.S. federal income tax
purposes.
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
Generally, the Company must report to the U.S. Internal Revenue Service the
amount of dividends paid, the name and address of the recipient and the
amount, if any, of tax withheld. A similar report is sent to the holder.
Pursuant to tax treaties or other agreements, the U.S. Internal Revenue
Service may make its reports available to tax authorities in the recipient's
country of residence. Dividends not subject to withholding tax may be subject
to backup withholding if the non-U.S. holder is not an "exempt recipient" and
fails to provide a tax identification number and other information to the
Company. Under the Proposed Regulations, dividend payments generally will be
subject to information reporting and backup withholding unless applicable
certification requirements are satisfied.
If the proceeds of a disposition of Common Stock are paid over by or through
a U.S. office of a broker, the payment is subject to information reporting and
possible backup withholding at a 31% rate unless the disposing holder
certifies under penalties of perjury as to his name, address, and non-U.S.
holder status or otherwise establishes an exemption. Generally, U.S.
information reporting and backup withholding requirement will not apply to a
payment of disposition proceeds if the payment is made
75
<PAGE>
outside the U.S. through a non-U.S. office of a broker. However, U.S.
information reporting requirements (but not backup withholding) will apply to
a payment of disposition proceeds outside the U.S. if (A) the payment is made
through an office outside the U.S. of a broker that either (i) is a U.S.
person, (ii) derives 50% or more of its gross income for certain periods from
the conduct of a trade or business in the U.S. or (iii) is a "controlled
foreign corporation" for U.S. federal income tax purposes and (B) the broker
fails to maintain documentary evidence that the holder is a non-U.S. holder or
that the holder otherwise is entitled to an exemption.
Backup withholding is not an additional tax. Rather, the tax liability of
persons subject to backup withholding will be reduced by the amount of tax
withheld. If withholding results in an overpayment of taxes, a refund may be
obtained.
FEDERAL ESTATE TAXES
Common Stock held by a non-U.S. holder at the time of death will be included
in such holder's gross estate for U.S. federal estate tax purposes unless an
applicable estate tax treaty provides otherwise.
76
<PAGE>
UNDERWRITING
The U.S. Underwriters named below, for whom Deutsche Morgan Grenfell Inc. is
acting as the representative, and the International Underwriters named below,
for whom Morgan Grenfell & Co. Limited is acting as the representative, have
severally agreed, subject to the terms and conditions contained in the
Underwriting Agreement to purchase from the Company the respective number of
shares of Common Stock indicated below opposite their respective names. The
Underwriters are committed to purchase all of the shares, if they purchase
any.
<TABLE>
<CAPTION>
NUMBER OF
U.S. UNDERWRITERS SHARES
----------------- ---------
<S> <C>
Deutsche Morgan Grenfell Inc........................................
---------
Subtotal..........................................................
=========
<CAPTION>
INTERNATIONAL UNDERWRITERS
--------------------------
<S> <C>
Morgan Grenfell & Co. Limited.......................................
---------
Subtotal..........................................................
=========
Total........................................................... 3,500,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.
The U.S. Underwriters and the International Underwriters have entered into
an Agreement between U.S. and International Underwriters (the "Intersyndicate
Agreement") that provides for the coordination of their activities. Pursuant
to the Intersyndicate Agreement, sales may be made between the U.S.
Underwriters and the International Underwriters of such number of shares of
Common Stock as may be mutually agreed. The price of any shares of Common
Stock so sold shall be the initial public offering price, less an amount not
greater than the selling concession.
Under the terms of the Intersyndicate Agreement, the International
Underwriters and any dealer to whom they sell shares of Common Stock will not
offer to sell or sell shares of Common Stock to persons who are U.S. persons,
and the U.S. Underwriters and any dealer to whom they sell shares of Common
Stock will not offer to sell or sell shares of Common Stock to any non-U.S.
persons except, in each case, for transactions pursuant to the Intersyndicate
Agreement. As used herein, "U.S. person" means any national or resident of the
U.S., or any corporation, pension, profit-sharing or other trust or other
entity organized under the laws of the U.S. or of any political subdivision
thereof (other than a branch located outside of the U.S. of any U.S. Person)
and shall include any U.S. branch of a person who is otherwise not a U.S.
person.
The Underwriters propose to offer the Common Stock to the public on the
terms set forth on the cover page of this Prospectus. The Price to Public and
Underwriting Discount will be identical in the U.S. and international
offerings. The Underwriters may allow to selected dealers (who may include the
Underwriters) a concession of not more than $ per share. The selected
dealers may reallow a concession of not more than $ to certain other
dealers. After the initial public offering, the price and concessions and re-
allowances to dealers and other selling terms may be changed by the
Underwriters. The Common Stock is offered subject to receipt and acceptance by
the Underwriters, and to certain other conditions, including the right to
reject orders in whole or in part. The Underwriters do not intend to sell any
of the shares of Common Stock offered hereby to accounts for which they
exercise discretionary authority.
77
<PAGE>
The Company has granted an option to the Underwriters to purchase up to a
maximum of 525,000 additional shares of Common Stock to cover over-allotments,
if any, at the public offering price, less the underwriting discount set forth
on the cover page of this Prospectus. Such option may be exercised at any time
until 30 days after the date of the Underwriting Agreement. To the extent the
Underwriters exercise this option, each of the Underwriters will be committed,
subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with the offering.
Each International Underwriter has represented and agreed that (i) it has
not offered or sold and will not offer or sell any shares of Common Stock
offered hereby to persons in the United Kingdom except to persons whose
ordinary activities involve them in acquiring, holding, managing or disposing
of investments (as principal or agent) for the purpose of their business or
otherwise in circumstances which 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 all applicable provisions of the Financial Services Act 1986 with respect
to anything done by it in relation to the shares of Common Stock offered
hereby in, from or otherwise involving the United Kingdom, and (iii) it has
only issued or passed on and will only issue or pass on to any person in the
United Kingdom any document received by it in connection with the issue of the
shares of Common Stock offered hereby if that person 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.
Pursuant to the Intersyndicate Agreement, each International Underwriter has
represented that it has not offered or sold, and has agreed not to offer or
sell, any shares of Common Stock offered hereby, directly or indirectly, in
Canada in contravention of the securities laws of Canada or any province or
territory thereof and has represented that any offer of such shares of Common
Stock in Canada will be made only pursuant to an exemption from the
requirement to file a prospectus in the province or territory of Canada in
which such offer is made. Each International Underwriter has further agreed to
send to any dealer who purchases from it any shares of Common Stock offered
hereby a notice stating in substance that, by purchasing such shares, such
dealer represents and agrees that it has not offered or sold, and will not
offer or sell, directly or indirectly, any of such shares in Canada or to, or
for the benefit of, any resident of Canada in contravention of the securities
laws of Canada or any province or territory thereof and that any offer of
shares of Common Stock in Canada will be made only pursuant to an exemption
from the requirement to file a prospectus in the province or territory of
Canada in which such offer is made, and that such dealer will deliver to any
other dealer to whom it sells any of such shares of Common Stock a notice to
the foregoing effect.
The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act or will contribute to payments the Underwriters may
be required to make in respect thereof.
The Company has entered into an additional agreement with the Underwriters
pursuant to which, in the event the offering contemplated by this Prospectus
is consummated, the Company will pay reasonable, itemized out-of-pocket
expenses (including reasonable fees and expenses of counsel) of the
Underwriters in the offering, of up to $200,000.
In connection with the offering, the Company and the directors and executive
officers of the Company and all other holders of the Company's securities have
agreed not to offer, sell or otherwise dispose of any shares of Common Stock
for a period of 180 days after the date of this Prospectus without the prior
written consent of Deutsche Morgan Grenfell Inc.
78
<PAGE>
Deutsche Bank Aktiengesellschaft, an affiliate of Deutsche Morgan Grenfell
Inc. and Morgan Grenfell & Co. Limited, holds $100,000 in principal amount of
the Company's Notes and related Warrants convertible into 816 shares of Common
Stock, assuming an initial public offering price of $14 per share.
Prior to this offering, there has been no public market for the Common
Stock. Consequently, the initial public offering price for the Common Stock
will be determined by negotiations among the Company and the Underwriters.
Among the factors to be considered in such negotiations are prevailing market
conditions, the market prices of securities of publicly traded companies
engaged in activities somewhat similar to those of the Company, the Company's
financial and operating history and condition, estimates of the business
potential of the Company and the present state of the Company's development.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo
Alto, California. Certain matters will be passed upon for the Company by
Pezzola & Reinke, A Professional Corporation, Oakland, California, and for the
Underwriters by Latham & Watkins, San Francisco, California.
EXPERTS
The consolidated financial statements and schedule of NetSource
Communications, Inc. and subsidiaries as of December 31, 1994 and 1995 and
September 30, 1996 for each of the years in the three-year period ended
December 31, 1995 and nine months ended September 30, 1996 have been included
in this Prospectus and in the registration statement in reliance upon the
report of KPMG Peat Marwick LLP, independent auditors, appearing elsewhere
herein and upon the authority of said firm as experts in accounting and
auditing.
79
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission a
Registration Statement on Form S-1, including amendments thereto, under the
Securities Act with respect to the Common Stock offered hereby. This
Prospectus, which constitutes a part of the Registration Statement, does not
contain all of the information set forth in the Registration Statement and the
exhibits and schedules filed therewith. For further information with respect
to the Company and the Common Stock offered hereby, reference is hereby made
to such Registration Statement and to the exhibits and schedules filed
therewith. Statements contained in this Prospectus regarding the contents of
any contract or other document referred to 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 such reference. The Registration
Statement, including the exhibits and schedules thereto, may be inspected
without charge at the principal office of the Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all
or any part thereof may be obtained from such office upon the payment of the
prescribed fees. Such materials may also be obtained from the Commission's Web
site at http://www.sec.gov.
The Company intends to furnish its stockholders with annual reports
containing consolidated financial statements audited by its independent
auditors and quarterly reports containing consolidated financial information.
80
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES ----
<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of December 31, 1994, 1995, and September
30, 1996 ................................................................ F-3
Consolidated Statements of Operations for the Years Ended December 31,
1993, 1994, and 1995, and the Nine Months Ended September 30, 1995 (unau-
dited) and 1996.......................................................... F-4
Consolidated Statements of Stockholders' Deficit for the Years Ended De-
cember 31, 1993, 1994, and 1995, and the Nine Months Ended September 30,
1996..................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
1993, 1994, and 1995, and the Nine Months Ended September 30, 1995 (unau-
dited) and 1996.......................................................... F-6
Notes to Consolidated Financial Statements................................ F-7
MTC JAPAN LTD.
Independent Auditors' Report.............................................. F-26
Balance Sheet as of December 31, 1995..................................... F-27
Statement of Operations for the Period from Inception (March 22, 1995) to
December 31, 1995........................................................ F-28
Statement of Stockholders' Deficit for the Period from Inception (March
22, 1995) to December 31, 1995........................................... F-29
Statement of Cash Flows for the Period from Inception (March 22, 1995) to
December 31, 1995........................................................ F-30
Notes to Financial Statements............................................. F-31
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NetSource Communications, Inc. and subsidiaries:
We have audited the accompanying consolidated balance sheets of NetSource
Communications, Inc. and subsidiaries ("the Company") as of December 31, 1994
and 1995 and September 30, 1996, and the related consolidated statements of
operations, stockholders' deficit, and cash flows for each of the years in the
three-year period ended December 31, 1995 and for the nine months ended
September 30, 1996. 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NetSource
Communications, Inc. and subsidiaries as of December 31, 1994 and 1995 and
September 30, 1996, and the results of their operations and their cash flows
for each of the years in the three-year period ended December 31, 1995 and for
the nine months ended September 30, 1996, in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
San Francisco, California
November 13, 1996,
except as to Note
14(b) which is as of
November 20, 1996.
F-2
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------- SEPTEMBER 30,
ASSETS 1994 1995 1996
------ ------- ------ -------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents...................... $ 1,274 497 4,900
Short-term investments......................... -- -- 3,496
Trade receivables, less allowances of $1,319,
$1,496, and $1,500, respectively.............. 9,291 7,062 7,501
Due from joint ventures, less allowances of
$ -- , $ -- , and $493, respectively.......... -- 688 2,981
Due from officer............................... -- -- 249
Other receivables, less allowances of $607,
$950, and $457, respectively.................. 840 485 617
Costs in excess of billings on uncompleted pro-
jects......................................... 94 162 153
Prepaid expenses and other current assets...... 330 892 286
------- ------ ------
Total current assets......................... 11,829 9,786 20,183
Property and equipment, net..................... 3,323 7,954 11,505
Deposits with carriers.......................... 2,008 2,501 1,981
Debt issuance costs, net of accumulated amorti-
zation of $243................................. -- -- 1,702
Other assets and deposits....................... 313 420 1,671
Due from officer................................ 249 249 --
------- ------ ------
Total assets................................. $17,722 20,910 37,042
======= ====== ======
<CAPTION>
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
<S> <C> <C> <C>
Current liabilities:
Trade accounts payable and accrued expenses.... $17,642 14,483 16,728
Notes payable.................................. -- 3,495 304
Line of credit................................. -- 1,087 --
Current portion of capital lease obligations... 24 524 974
Billings in excess of costs on uncompleted pro-
jects......................................... 212 195 121
Other current liabilities...................... 2,260 3,548 4,338
------- ------ ------
Total current liabilities.................... 20,138 23,332 22,465
Series A secured subordinated convertible prom-
issory notes................................... -- -- 19,691
Capital lease obligations, less current por-
tion........................................... -- 1,146 1,720
Deferred rent................................... 212 333 312
Investments in joint ventures, net of advances.. -- 290 723
Deferred taxes.................................. -- 271 --
Payable to stockholder.......................... 140 -- --
------- ------ ------
Total liabilities............................ 20,490 25,372 44,911
Commitments and contingencies
Stockholders' deficit
Common stock: $.001 par value, 44,000,000
shares authorized; 13,746,719, 14,786,384, and
15,978,074 shares issued and outstanding,
respectively.................................. 14 15 16
Additional paid-in capital...................... 83 222 --
Stock purchase warrants......................... -- -- 353
S corporation retained earnings (deficit)....... 1,063 (2,361) --
Accumulated deficit............................. (3,928) (2,338) (8,238)
------- ------ ------
Total stockholders' deficit.................. (2,768) (4,462) (7,869)
------- ------ ------
Total liabilities and stockholders' deficit.. $17,722 20,910 37,042
======= ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER NINE MONTHS ENDED
31, SEPTEMBER 30,
------------------------ ------------------
1993 1994 1995 1995 1996
------- ------ ------- ----------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Telecommunications.............. $23,510 48,937 86,871 64,985 67,907
Marketing communications........ 4,792 4,915 3,774 3,022 1,943
Electronic commerce products and
services........................ -- -- 654 408 1,106
------- ------ ------- ------ ------
Total revenues................. 28,302 53,852 91,299 68,415 70,956
Cost of revenues:
Telecommunications.............. 16,676 34,565 58,467 43,634 44,802
Marketing communications........ 2,164 1,497 1,194 986 544
Electronic commerce products and
services........................ -- 281 154 402
------- ------ ------- ------ ------
Total cost of revenues......... 18,840 36,062 59,942 44,774 45,748
------- ------ ------- ------ ------
Gross profit................... 9,462 17,790 31,357 23,641 25,208
------- ------ ------- ------ ------
Operating expenses:
Sales and marketing............. 2,289 6,713 13,191 9,810 9,558
General and administrative...... 7,708 12,837 18,495 13,131 17,825
------- ------ ------- ------ ------
Total operating expenses....... 9,997 19,550 31,686 22,941 27,383
------- ------ ------- ------ ------
Operating income (loss)........ (535) (1,760) (329) 700 (2,175)
Share of losses of joint
ventures........................ -- -- (489) (187) (541)
Other income (expense), net...... 144 (233) (464) (225) (624)
------- ------ ------- ------ ------
Income (loss) before income
taxes.......................... (391) (1,993) (1,282) 288 (3,340)
Income tax expense............... (47) (5) (552) (412) (110)
------- ------ ------- ------ ------
Net loss....................... $(438) (1,998) (1,834) (124) (3,450)
======= ====== ======= ====== ======
Pro Forma:
Net loss before income taxes.... (1,282) (3,340)
Pro forma income tax benefit
(expense)...................... (347) 378
------- ------
Pro forma net loss.............. $(1,629) (2,962)
======= ======
Pro forma net loss per share.... $ (0.10) (0.17)
======= ======
Shares used in pro forma per
share computation............... 16,952 17,507
======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
S CORPORATION
COMMON STOCK ADDITIONAL STOCK RETAINED TOTAL
----------------- PAID-IN PURCHASE EARNINGS ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL WARRANTS (DEFICIT) DEFICIT DEFICIT
---------- ------ ---------- -------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances as of December
31, 1992............... 13,656,720 $ 14 63 -- (391) (38) (352)
Net earnings (loss)..... -- -- -- -- 911 (1,349) (438)
---------- ---- ---- --- ------ ------ ------
Balances as of December
31, 1993............... 13,656,720 14 63 -- 520 (1,387) (790)
Issuance of common
stock................... 90,000 -- 20 -- -- -- 20
Net earnings (loss)..... -- -- -- -- 543 (2,541) (1,998)
---------- ---- ---- --- ------ ------ ------
Balances as of December
31, 1994............... 13,746,720 14 83 -- 1,063 (3,928) (2,768)
Issuance of common
stock................... 1,039,664 1 139 -- -- -- 140
Net earnings (loss)..... -- -- -- -- (3,424) 1,590 (1,834)
---------- ---- ---- --- ------ ------ ------
Balances as of December
31, 1995............... 14,786,384 15 222 -- (2,361) (2,338) (4,462)
Issuance of common
stock.................. 1,191,690 1 11 -- -- -- 12
Issuance of warrants in
conjunction with con-
vertible promissory
notes.................. -- -- -- 353 -- -- 353
Distributions to
shareholders........... -- -- (233) -- (89) -- (322)
Merger with MTC and
Transphere............. -- -- -- -- 3,315 (3,315) --
Net loss................ -- -- -- -- (865) (2,585) (3,450)
---------- ---- ---- --- ------ ------ ------
Balances as of September
30, 1996............... 15,978,074 $ 16 -- 353 -- (8,238) (7,869)
========== ==== ==== === ====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
----------------------- -------------------
1993 1994 1995 1995 1996
------- ------ ------ ----------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net loss........................ $ (438) (1,998) (1,834) (124) (3,450)
Adjustments to reconcile net
loss to net cash provided by
operating activities:
Depreciation and amortization.. 194 460 1,040 769 1,131
Amortization of debt issuance
costs......................... -- -- -- -- 243
Provision for doubtful accounts
trade receivables............. 487 2,495 1,213 735 1,263
Provision for doubtful accounts
on other receivables.......... 218 389 343 257 (493)
Loss on disposition of fixed
assets........................ -- 50 -- -- --
Share of losses of joint
ventures...................... -- -- 489 231 541
Noncash service expense........ -- 20 -- -- --
Deferred taxes................. 20 (20) 271 237 110
Changes in operating assets and
liabilities:
Trade receivables.............. (4,877) (4,937) 925 (211) (1,209)
Due from joint venture......... -- -- (688) (217) (2,293)
Other receivables.............. (340) (1,107) 103 (369) (132)
Costs in excess of billings on
uncompleted projects.......... (540) 498 (68) 16 9
Prepaid expenses and other
current assets................ (118) (195) (716) 227 606
Deposits with carriers......... (1,013) (995) (493) (391) 520
Deposits and other assets...... (107) (104) (107) (180) (1,207)
Trade accounts payable and
accrued expenses.............. 5,978 7,918 (92) (532) 3,745
Billings in excess of costs on
uncompleted projects.......... 299 (87) (17) (27) (74)
Other current liabilities...... 1,715 1,004 966 702 796
Deferred rent.................. -- 212 121 112 (21)
------- ------ ------ ------ -------
Net cash provided by operating
activities................... 1,478 3,603 1,456 1,235 85
------- ------ ------ ------ -------
Cash flows from investing
activities:
Purchases of property and
equipment...................... (982) (2,331) (3,231) (2,783) (3,198)
Investment in joint ventures.... -- -- (45) (45) (108)
Purchases of short-term
investments.................... (1,029) -- -- -- (5,481)
Proceeds from sale of short-term
investments.................... 477 552 -- -- 1,985
Loans to stockholders........... (125) -- -- -- --
------- ------ ------ ------ -------
Net cash used in investing
activities.................... (1,659) (1,779) (3,276) (2,828) (6,802)
------- ------ ------ ------ -------
Cash flows from financing
activities:
Cash overdraft.................. -- (789) 322 1,051 (387)
Proceeds from line of credit.... -- -- 3,881 -- 9,478
Proceeds from note payable...... -- -- -- 103 --
Repayment of line of credit..... -- -- (2,794) -- (10,565)
Repayment of note payable....... -- -- -- -- (4,579)
Principal payments under capital
lease obligations.............. (17) (43) (366) (379) (572)
Payment of debt issuance costs.. -- -- -- -- (1,945)
Issuance of convertible
promissory notes............... -- -- -- -- 20,000
Distributions to shareholders... -- -- -- -- (322)
Issuance of common stock........ -- -- -- -- 12
------- ------ ------ ------ -------
Net cash provided by (used in)
financing activities.......... (17) (832) 1,043 775 11,120
------- ------ ------ ------ -------
Increase (decrease) in cash and
cash equivalents................ (198) 992 (777) (818) 4,403
Cash and cash equivalents at
beginning of period............. 480 282 1,274 1,274 497
------- ------ ------ ------ -------
Cash and cash equivalents at end
of period....................... $ 282 1,274 497 456 4,900
======= ====== ====== ====== =======
Supplemental disclosures of cash
paid during the period:
Interest........................ $ 16 37 120 34 709
======= ====== ====== ====== =======
Taxes........................... $ 91 2 14 12 370
======= ====== ====== ====== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30,1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(1) ORGANIZATION
NetSource Communications, Inc. (the "Company"), incorporated in Delaware on
November 20, 1995, was formed to succeed the businesses of MTC Telemanagement
Corporation, a California corporation, MTC International, Inc., a Nevada
corporation (collectively, "MTC"), and Transphere International, Inc. and
Transphere Interactive, Inc., each California corporations (collectively,
"Transphere").
On June 28, 1996, the Company issued 11,704,364 shares of its common stock
in a merger with MTC. In conjunction with this merger, the Company granted
2,186,985 options to replace stock options outstanding in the MTC entities.
The entities comprising MTC had substantial common ownership and accordingly
this transaction was accounted for as a combination of entities under common
control in a manner similar to a pooling of interests.
Concurrently, the Company merged with Transphere in exchange for 4,273,710
shares of the Company's common stock. In conjunction with this merger, the
Company granted 356,745 options to replace stock options outstanding in the
Transphere entities. This merger was accounted for as a pooling of interests.
The accompanying consolidated financial statements have been restated to
include the accounts and operations of MTC and Transphere for all periods
presented. Net sales for MTC are reflected as telecommunication revenues,
while net sales for Transphere are reflected as marketing communications and
electronic commerce product and services revenues in the consolidated
financial statements. Net income of the merged entities, prior to the merger,
are presented in the following table.
<TABLE>
<CAPTION>
SIX
MONTHS
YEARS ENDED ENDED
DECEMBER 31, JUNE 30,
--------------------- ---------
1993 1994 1995 1995 1996
----- ------ ------ ---- ----
<S> <C> <C> <C> <C> <C>
Net income (loss):
MTC....................................... $ (73) (2,008) (2,288) 204 (88)
Transphere................................ (365) 10 454 238 (493)
----- ------ ------ --- ----
$(438) (1,998) (1,834) 442 (581)
===== ====== ====== === ====
</TABLE>
No significant nonrecurring costs and expenses were incurred in 1996 in
conjunction with this series of transactions.
Nature of Operations
The Company develops, implements and manages a wide range of communications
solutions for business and end-user customers worldwide. The Company's
products and services include international and domestic long distance
telecommunications, value-added telecommunications and related telemanagement
services, Internet access and hosting, Internet and interactive electronic
commerce products and services, such as Web-based architecture development and
maintenance, Web-based content development and management, and marketing
communications services.
F-7
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Sales by geographic area were as follows:
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------- -----------------
1994 1995 1995 1996
------- ------ -------- --------
<S> <C> <C> <C> <C>
USA........................................ $29,801 27,998 22,049 20,171
Europe..................................... 8,850 24,630 18,792 23,541
Other Asia................................. 5,238 14,578 11,729 6,717
Japan...................................... 3,624 10,086 6,790 9,214
South America.............................. 3,510 9,770 5,273 9,394
Other...................................... 2,829 4,237 3,782 1,919
------- ------ -------- --------
$53,852 91,299 68,415 70,956
======= ====== ======== ========
</TABLE>
Export sales were not significant in 1993. No customer exceeded 10% of total
net revenues in 1993, 1994, or 1995, or in the nine months ended September 30,
1995 or 1996. Since marketing communications revenues were not significant in
1994 and 1995 and are not expected to exceed 10% of total revenues in the near
future, segment information by operating activity is not presented even though
marketing communications revenues for 1993 exceeded 10% of total revenues.
Liquidity
The Company has incurred recurring losses from operations over the past
several years and as of September 30, 1996, has negative working capital of
approximately $2,300. The Company secured financing for $20,000 in June 1996,
in the form of secured subordinated convertible promissory notes (see Note 8).
Management believes that such debt financing, combined with a number of cost
and growth control measures, will be sufficient to fund operations through
December 31, 1997. Management further believes, however, that achievement of
the Company's growth will require additional financing.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries, MTC. All significant
intercompany balances and transactions have been eliminated in consolidation.
Cash Equivalents and Short-Term Investments
Cash equivalents consist of instruments with maturities of 90 days or less
when such instruments were purchased.
In 1995, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. The cumulative effect of adopting SFAS No. 115 was not material to
the Company's consolidated financial position and results of
F-8
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
operations. The Company's investments, which consist of corporate debt
securities, are classified as "available-for-sale" under the provisions of
SFAS No. 115. The securities are carried at fair value which approximates cost
and mature within one year.
Premiums and discounts on available-for-sale debt securities are amortized
to income using the effective interest method. Such amortization is included
in other income, net. Realized gains and losses, and declines in value judged
to be other than temporary on available-for-sale securities are included in
other income, net. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in other income, net.
Revenue Recognition
The Company recognizes revenue on telecommunication and electronic commerce
products and services in the month the related service is provided.
Marketing communications revenues consist of commissions for placement of
advertisements in printed media and from fees for production of materials.
Commission revenue is recognized when the advertisements are published. Trade
receivables include both the commission income recognized as well as the
actual media and production costs which are paid for by the Company and
rebilled to clients at the Company's cost. Fee revenues derived from fixed fee
arrangements are recognized on the percentage-of-completion method based on
the ratio of costs incurred to total estimated costs.
Costs in excess of billings on uncompleted projects represent the costs
incurred and anticipated profits earned on projects in progress in excess of
amounts billed, and are recorded as an asset. Billings in excess of costs on
uncompleted projects represent amounts billed in excess of costs incurred and
estimated profit earned, and are recorded as a liability. Such billings are
generally in accordance with contract provisions. To the extent incurred and
anticipated costs to complete projects in progress exceed anticipated
billings, a loss is accrued for the excess.
The Company incurred a loss of approximately $1,200 in 1994 as the result of
nonpayment by a customer for marketing communication services provided by the
Company. In connection with this transaction, the Company conveyed the rights
to certain trade receivables from this customer to certain vendors in
settlement of accounts payable to the vendors of $1,463.
Debt Issuance Costs
The costs related to the issuance of debt are capitalized and amortized to
interest expense using the effective interest method over the period in which
the related debt is outstanding.
Due from Officer
Due from officer consists of expenses paid by MTC on behalf of the Company's
Chief Executive Officer. The balance bears interest at the prime rate (8.25%
as of September 30, 1996) and is due in June 1997.
Property and Equipment
Property and equipment are recorded at cost. Equipment under capital lease
is recorded at the lower of the present value of the minimum payments or the
fair value of the leased property. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets, ranging
from 5 to 15 years. Leasehold improvements are stated at cost and are
amortized using the
F-9
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
straight-line method over the shorter of the estimated useful life of the
improvements or the related lease term. Equipment under capital leases is
amortized on a straight-line basis, generally 3 to 5 years.
Deposits with Carriers
Deposits with carriers consist of funds held by interexchange carriers
generally based upon a percentage of anticipated volume, and accrued interest
under the terms of the respective carrier contracts.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to concentrations
of credit risk principally consist of cash, cash equivalents, short-term
investments and trade receivables. The Company's cash investment policies
limit investments to short-term, low risk instruments. Concentrations of
credit risk with respect to trade receivables are limited due to the
dispersion of the Company's customer base among different industries and
geographic areas.
The Company receives a significant portion of its payments for
telecommunication services from customer's credit card charges. The Company
receives payments for the credit card charges through the use of a third-party
intermediary. The Company's exposure to credit loss in the event of
nonperformance by the third party consists of charges for payment presented to
the third party for payment for which the Company has not yet received
reimbursement. Amounts due from the third-party intermediary in the normal
course of business were $1,958, $1,007, and $5 as of December 31, 1994 and
1995, and September 30, 1996, respectively.
Foreign Currency
The functional currency for substantially all of the Company's activities is
the U.S. Dollar. Substantially all of the Company's revenues and costs are
denominated in U.S. Dollars.
The functional currency for MTC Japan is the Japanese Yen. Translation gains
or losses of the joint ventures are included in a separate component of
stockholders' deficit. Translation gains or losses were not significant in any
period.
Income Taxes
The Company accounts for income taxes under the asset and liability method
of accounting. Under the asset and liability method, deferred tax assets and
liabilities are recognized based on the future tax consequences attributable
to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
changes in tax rates is recognized in income in the period that includes the
enactment date.
Prior to the mergers discussed in Note 1, the Company consisted of three
entities treated as C corporations and one entity treated as an S corporation
for federal and state income tax purposes. The income of the S corporation was
taxed at the individual stockholder level. Accordingly, tax
F-10
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
expense in the accompanying consolidated statements of operations for the
years ended December 31, 1993, 1994, and 1995, reflect a different effective
rate of tax than would be expected if all the entities were taxed as C
corporations and filed as a consolidated group. The accompanying pro forma
loss for the year ended December 31, 1995, and for the nine months ended
September 30, 1996, reflect provisions for taxes on a pro forma basis, using
the asset and liability method, as if all entities had been taxed as
C corporations and filed as a consolidated group since the beginning of those
respective periods.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
consolidated financial statements and the recorded amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Trade accounts payable to telecommunication service providers are subject to
negotiation as to the ultimate payment to be made by the Company. Amounts
recovered by the Company from telecommunication service providers will be
recognized in the period in which such amounts are realized. Additional
amounts owed by the Company to telecommunication service providers will be
recognized in the period in which it becomes probable that such amounts will
be paid.
Stock Splits
On August 1, 1996, the Company effected a ten-for-one stock split on
outstanding shares. Additionally, on September 16, 1996, the Company effected
an additional two-for-one stock split on outstanding shares. Accordingly, all
share amounts have been adjusted to reflect the stock splits.
Pro Forma Net Loss Per Share
Pro forma net loss per share is based on the weighted average number of
shares of common stock and dilutive common equivalent shares from options and
warrants outstanding during the period using the treasury stock method and
from convertible securities outstanding during the period using the as if
converted method.
Pursuant to certain Securities and Exchange Commission (SEC) Staff
Accounting Bulletins, common stock issued for consideration below the assumed
initial public offering (IPO) price and stock options and warrants granted
with exercise prices below the assumed IPO price during the 12-month period
prior to the date of the initial filing of the Registration Statement, even
when antidilutive, have been included in the calculation of pro forma net
income per share, using the treasury stock method based on the assumed IPO
price, as if they were outstanding for all periods presented prior to their
issuance or grant.
Interim Financial Information
The accompanying unaudited consolidated financial statements for the nine
months ended September 30, 1995, have been prepared on substantially the same
basis as the audited consolidated financial statements, and include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the consolidated financial information set forth therein.
F-11
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(3) JOINT VENTURES
The Company has investments in the following joint ventures which are
accounted for by the equity method of accounting:
MTC Japan
In February 1995, the Company formed MTC Japan, Ltd., a joint venture. The
Company has a 45% interest in the joint venture. The joint venture distributes
telecommunication equipment and telemanagement product and services in Japan.
The Company's share of losses incurred by the joint venture during 1995 and
for the nine months ended September 30, 1995 and 1996, were $489, $187, and
$380, respectively. The recorded loss in excess of the Company's investment as
of December 31, 1995, is due to the Company's intention to provide continued
financial support to the joint venture over the near term. Investments in
joint ventures, net of advances is comprised of the losses incurred to date
net of the Company's original investment of $45 and advances of
telecommunication equipment of $154.
Summary financial information for the joint venture is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------
DECEMBER 31,
1995 1995 1996
------------ ------ -------
<S> <C> <C> <C>
Assets:
Current assets............................... $ 719 239 1,095
Noncurrent assets............................ 456 468 743
------- ------ -------
1,175 707 1,838
Total liabilities............................. 1,911 1,102 3,643
------- ------ -------
Deficit....................................... $ (736) (395) (1,805)
======= ====== =======
Revenues...................................... $ 1,169 413 3,463
======= ====== =======
Operating loss................................ $(1,086) (416) (843)
======= ====== =======
Net loss...................................... $(1,086) (416) (843)
======= ====== =======
</TABLE>
During 1995 and for the nine months ended September 30, 1995 and 1996, the
Company recorded sales to the joint venture totaling $688 and $234, and
$2,399, respectively.
F-12
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
MTC Telecom Western Europe
In January 1996, the Company formed MTC Telecom Western Europe B.V., a joint
venture. The joint venture provides telecommunication services in Western
Europe. The Company has a 50% interest in the joint venture. The Company's
share of losses incurred by the joint venture during the nine months ended
September 30, 1996 were $160. The recorded loss in excess of the Company's
investment as of September 30, 1996 is due to the Company's intention to
provide continued financial support to the joint venture over the near term.
Investments in joint ventures, net of advances, is comprised of the losses
incurred to date net of the Company's original investment of $25 and advances
of $82.
Summary financial information for the joint venture is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
<S> <C>
Assets:
Current assets................................................ $ 774
Noncurrent assets............................................. 301
-----
1,075
Total liabilities.............................................. 1,334
-----
Deficit........................................................ $(259)
=====
Revenues....................................................... $ 670
=====
Operating losses............................................... $(311)
=====
Net loss....................................................... $(321)
=====
</TABLE>
During the nine months ended September 30, 1996, the Company recorded sales
to the joint venture totalling $329.
(4) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------- SEPTEMBER 30,
1994 1995 1996
------ ------ -------------
<S> <C> <C> <C>
Switching and installation equipment.......... $1,325 4,179 6,401
Computer equipment............................ 1,499 3,196 5,823
Furniture and fixtures........................ 742 912 1,063
Leasehold improvements........................ 281 798 900
Access equipment.............................. 354 377 377
Construction in progress...................... 18 428 --
------ ------ ------
4,219 9,890 14,564
Accumulated depreciation and amortization..... (896) (1,936) (3,059)
------ ------ ------
$3,323 7,954 11,505
====== ====== ======
</TABLE>
F-13
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
Property and equipment as of December 31, 1994 and 1995, and September 30,
1996, included equipment under capital leases of approximately $56, $2,103 and
$3,637 respectively; and related accumulated amortization of approximately $7,
$119 and $557, respectively.
(5) OTHER CURRENT LIABILITIES
A summary of other current liabilities is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------ SEPTEMBER 30,
1994 1995 1996
------ ----- -------------
<S> <C> <C> <C>
Accrued commissions.............................. $ 928 1,152 1,005
Taxes payable.................................... 414 593 567
Accrued payroll and related items................ 125 319 708
Accrued interest................................. -- -- 537
Cash overdraft................................... 65 387 --
Other liabilities................................ 728 1,097 1,521
------ ----- -----
$2,260 3,548 4,338
====== ===== =====
</TABLE>
(6) NOTES PAYABLE
Notes payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER
31, SEPTEMBER 30,
---------- -------------
1994 1995 1996
---- ----- -------------
<S> <C> <C> <C>
Note payable to vendor, unsecured, interest rate
14%; monthly payments from January to October
1996............................................. $-- 3,067 304
Note payable for equipment financing; interest
rate 9%; due July 1996........................... -- 428 --
---- ----- ---
$-- 3,495 304
==== ===== ===
</TABLE>
The note payable to vendor represents trade payables converted to short-term
notes payable during 1995.
(7) LINE OF CREDIT
In November 1995, a subsidiary entered into a $3,000 revolving line of
credit agreement which bore interest at the bank's prime rate plus 2.5%. Under
the terms of the agreement, advances under the line were limited to 80% of
billed trade receivables and 45% of unbilled trade receivables. The agreement
contained certain financial covenants restricting the subsidiary from entering
into major debt agreements. The creditor was granted a security interest in
certain of the subsidiary's tangible and intangible assets. As of December 31,
1995, the outstanding balance was $1,087. As of December 31, 1995, the
subsidiary was not in technical compliance with the debt covenants, and in
June, 1996, the
F-14
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
creditor recalled the line of credit based on non-compliance. In conjunction
with the called line, the subsidiary paid $175 in termination fees which were
accrued as of December 31, 1995.
(8) SERIES A SECURED SUBORDINATED CONVERTIBLE PROMISSORY NOTES
In June 1996, the Company issued $20,000 in Series A Secured Subordinated
Convertible Promissory Notes ("Notes") and detachable warrants ("Detachable
Warrants") to purchase a number of shares of the Company's common stock equal
to 8% of the number of shares into which the Notes are convertible. The Notes
bear interest at a rate of 10% per annum, interest is payable semiannually,
and they are due and payable in June 1998. The holders of the Notes have been
granted a security interest in all of the assets of the Company, subordinated
to any other secured institutional debt incurred by the Company in an
aggregate amount not to exceed $10,000, plus any existing or future capital
leases. The Notes contain certain restrictive covenants with respect to the
Company's payments of bonuses or dividends.
The holders of the Notes have the right to convert the Notes into shares of
the Company's common stock at any time after the earlier to occur of (i) the
consummation of an IPO, or (ii) January 1, 1997. In the event an IPO is
consummated on or before December 31, 1996, the per share conversion price for
the Notes shall be equal to 70% of the per share price to the public of the
common stock in the IPO. In the event an IPO is not consummated by December
31, 1996, the conversion price for the Notes shall be $5.40.
The Detachable Warrants may be exercised at any time after the earlier to
occur of (i) an IPO, or (ii) January 1, 1997, and the Detachable Warrants
expire on June 30, 1999.
The per share exercise price for the Detachable Warrants shall be equal to
the conversion price established under the Notes. However, if an IPO is not
consummated prior to June 30, 1998, the Detachable Warrant exercise prices
will be adjusted to equal 50% of the per share price of any unaffiliated
third-party equity financing in excess of $2,000 consummated on or after June
30, 1998, and prior to the expiration of the Detachable Warrants.
The Company also granted warrants to a placement agent, to purchase shares
of the Company's common stock. Warrants issued shall entitle the warrant
holder to purchase an aggregate number of shares equal to approximately 8% of
the number of shares into which the Notes are convertible.
The Company has recorded the fair value of the warrants amounting to $353 as
a discount on the related debt with an offsetting credit to stockholders'
deficit. The fair value of the warrants was determined using a Black-Sholes
valuation methodology using the following assumptions: risk free interest rate
of 6.06%; 3 year life of the warrant; .60 expected volatility and no
dividends. The debt discount is being amortized to interest expense over the
period in which the debt is outstanding using the effective interest method.
F-15
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(9) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its principal offices under noncancelable operating lease
agreements which expire in various years through 2001 and provide for renewal
options. In addition, the lease agreements require the payment of a pro rata
share of certain annual operating expenses of the property. The Company leases
certain equipment under capital leases. Property and equipment acquired under
capital leases for the years ended December 31, 1993, 1994, and 1995, and for
the nine months ended September 30, 1995 and 1996, were $-0-, $56, $2,103,
$1,313, and $3,637, respectively. As of December 31, 1995, future minimum
lease payments under all noncancelable lease agreements are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEARS ENDING DECEMBER 31, LEASES LEASES
------------------------- ------- ---------
<S> <C> <C>
Three months ending December 31, 1996...................... $ 338 368
1997....................................................... 1,279 1,231
1998....................................................... 1,070 982
1999....................................................... 471 891
2000....................................................... 90 805
2001 and thereafter........................................ -- 319
------ ------
Total minimum lease payments............................... 3,248 $4,596
======
Less amount representing interest.......................... 554
------
Present value of minimum lease payments.................... 2,694
Less current portion....................................... 974
------
Long-term capital lease obligations........................ $1,720
======
</TABLE>
Net rental expenses for operating leases during the years ended December 31,
1993, 1994, and 1995, and the nine months ended September 30, 1995 and 1996,
were $420, $815, $1,043, $620, and $1,075, respectively.
Litigation
The Company is party to various legal proceedings arising in the ordinary
course of its business. In the opinion of management, the results of these
proceedings will not have a material adverse effect on the Company's financial
position or results of operations.
Telecommunications Service Contracts
The Company has entered into short-term telecommunications service contracts
with various carriers in the normal course of business that provide the
Company with long distance capacity at specified rates. The telecommunications
service contracts contain minimum usage or purchase requirements, which
contain a provision whereby if in any month the Company's customers use less
F-16
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
than the minimum commitment, the difference is nevertheless due and payable to
the carrier in the following month. In the opinion of management, the
Company's sales to its current customer base is sufficient to meet these
minimum commitments as they come due.
The Company has three carriers that represented 53%, 86%, 69%, 72%, and 44%
of the total cost of revenues in 1993, 1994, and 1995 and in the nine months
ended September 30, 1995 and 1996, respectively. Management believes that
other carriers could provide the volume required upon similar terms and
conditions. A change in carriers, however, could cause a delay in service and
a possible loss of sales, which could adversely affect operating results.
(10) INCOME TAXES
Income tax expense consisted of:
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
--------------- -------------------
1993 1994 1995 1995 1996
---- ---- ---- -------- ---------
<S> <C> <C> <C> <C> <C>
Current:
Federal.................................. $18 -- 188 158 194
State.................................... 9 25 93 49 187
--- --- --- -------- ---------
27 25 281 207 381
--- --- --- -------- ---------
Deferred:
Federal.................................. 17 (23) 217 164 (217)
State.................................... 3 3 54 41 (54)
--- --- --- -------- ---------
20 (20) 271 205 (271)
--- --- --- -------- ---------
Income taxes............................ $47 5 552 412 110
=== === === ======== =========
</TABLE>
Income tax expense differs from the amounts computed by applying the U.S.
federal income tax rate of 34% to pretax income as a result of the following:
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30,
----------------- -------------------
1993 1994 1995 1996
----- ---- ---- ----
<S> <C> <C> <C> <C>
Expected tax benefit................ $(133) (678) (436) (1,136)
Other............................... (25) 93 50 (72)
Reserve on deferred tax asset....... 587 753 180 891
State taxes, net of federal
benefit............................. 8 26 64 122
S corporation (earnings) losses not
subject to corporate taxation....... (390) (189) 694 305
----- ---- ---- ------
Income tax expense............... $ 47 5 552 110
===== ==== ==== ======
</TABLE>
F-17
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are presented below:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
-------------- -------------
1994 1995 1996
------ ------ -------------
<S> <C> <C> <C>
Deferred tax assets:
Reserves on receivables....................... $ 396 918 2,542
Investment in affiliate....................... -- 196 444
Accrued expenses.............................. -- 89 298
Other......................................... 40 95 129
Net operating loss carryforwards.............. 1,223 512 1,086
------ ------ ------
Total gross deferred tax assets.............. 1,659 1,810 4,499
Less valuation allowance....................... (1,540) (1,720) (3,801)
------ ------ ------
Net deferred tax assets...................... 119 90 698
Deferred tax liability:
Fixed assets.................................. (119) (361) (698)
------ ------ ------
Deferred tax liability........................ $ -- (271) --
====== ====== ======
</TABLE>
The Company has the following net operating loss carryforwards as of
December 31, 1995, and September 30, 1996, as follows:
<TABLE>
<CAPTION>
1995 1996
----- -----
<S> <C> <C>
Federal.......................................................... 1,487 2,942
State............................................................ 93 1,471
</TABLE>
The Company's federal net operating loss carryforwards expire between 2008
and 2011. The Company's state net operating loss carryforwards expire between
1998 and 2001. Additionally, the Company's net operating loss carryforwards as
of December 31, 1995, and September 30, 1996 are also subject to the "Separate
Return Limitation Year" rules. These rules provide that the net operating
losses of one corporation cannot offset the taxable income of another
corporation in the consolidated group.
F-18
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
The pro forma provisions for income taxes reflect the tax expense that would
have been reported if all the entities had been taxed as C corporations and
filed as a consolidated group. The components of pro forma income taxes are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
<S> <C> <C>
Pro forma income taxes:
Current:
Federal.................. $ 31 --
State.................... 53 4
---- ----
84 4
---- ----
Deferred:
Federal.................. 210 (304)
State.................... 53 (78)
---- ----
263 (382)
---- ----
Total pro forma income
tax expense (benefit).. $347 (378)
==== ====
</TABLE>
The following tabulation reconciles the statutory corporate federal income
tax benefit (computed by multiplying the Company's loss before income taxes by
34%) to the Company's pro forma income tax expense:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
<S> <C> <C>
Pro forma expected federal income tax benefit... $(436) (1,136)
State taxes, net of federal effect.............. 70 (49)
Change to reserve on deferred tax asset......... 656 736
Permanent differences........................... 66 71
Other differences............................... (9) --
----- ------
Total pro forma income tax expense (benefit).... $ 347 (378)
===== ======
</TABLE>
F-19
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
The tax effects of temporary differences that give rise to significant
portions of the pro forma deferred tax assets are presented below:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30
-------------- ------------
1994 1995 1996
------ ------ ------------
<S> <C> <C> <C>
Pro forma deferred tax assets:
Reserves on receivables...................... $1,120 1,952 2,539
Investment in affiliate...................... -- 196 444
Accrued expenses............................. 200 474 298
Other........................................ 63 71 69
Net operating loss carryforwards............. 634 126 917
------ ------ ------
Total gross pro forma deferred tax assets.. 2,017 2,819 4,267
Less valuation allowance...................... (2,017) (2,819) (3,569)
------ ------ ------
Net pro forma deferred tax assets.......... -- -- 698
Pro forma deferred tax liability--fixed
assets....................................... (119) (382) (698)
------ ------ ------
Net pro forma deferred tax liability........ $ (119) (382) 0
====== ====== ======
</TABLE>
(11) STOCKHOLDERS' DEFICIT
1996 Omnibus Equity Incentive Plan
As of September 30, 1996, the Company had reserved 6,075,000 shares of
common stock for issuance under its 1996 Omnibus Equity Incentive Plan (the
"Omnibus Plan"). Under the Omnibus Plan, options may be granted to employees
and consultants to purchase shares of the Company's common stock at not less
than the fair market value of the Company's common stock at the grant date
(for incentive stock options) or not less than 85% of the fair market value of
such common stock (for nonqualified stock options). Options become exercisable
as determined by the Company's Board of Directors, and generally expire no
more than 10 years from the date of grant.
1996 Stock Option Plan
In September 1996, the Company adopted the Stock Option Plan (the "1996
Plan"), which is in addition to the Omnibus Plan discussed above. Under the
1996 Plan, the Company has reserved 1,950,000 shares of common stock. Options
may be granted under the 1996 Plan at the discretion of the Company's Board of
Directors. Under the 1996 Plan, options may be granted to employees,
directors, and consultants to purchase shares of the Company's common stock at
not less than the fair market value of the Company's common stock at the grant
date (for incentive stock options) or not less 85% of the fair market value of
such common stock (for nonqualified stock options) at the grant date. Options
under the 1996 Plan become exercisable as determined by the Company's Board of
Directors, generally over four years. Options generally expire no more than 10
years from the grant date.
F-20
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
A summary of the Omnibus Plan and 1996 Plan transactions follows:
<TABLE>
<CAPTION>
STOCK OPTIONS
OUTSTANDING
------------------------
PRICE PER
SHARES SHARE
--------- -------------
<S> <C> <C>
Balances as of December 31, 1992................... -- $ --
Stock options authorized.......................... -- --
Stock options granted............................. 30,780 .23 - 1.59
--------- -------------
Balances as of December 31, 1993................... 30,780 .23 - 1.59
Stock options granted............................. 1,440,000 .23 - 1.59
--------- -------------
Balances as of December 31, 1994................... 1,470,780 .23 - 1.59
Stock options granted............................. 1,745,805 .23 - 1.59
Stock options canceled............................ (750,795) .23 - 1.59
--------- -------------
Balances as of December 31, 1995................... 2,465,790 .23 - 1.59
Stock options granted............................. 1,413,858 .23 - 10.40
Stock options canceled............................ (923,835) .23 - 1.59
--------- -------------
Balances as of September 30, 1996.................. 2,955,813 $ .23 - 10.40
========= =============
</TABLE>
As of September 30, 1996 the Company had an additional 581,745 options to
purchase shares of the Company's common stock outstanding which are not
pursuant to any stock option plan. The options are subject to terms and
conditions as determined by the Board of Directors on the date of grant.
As of September 30, 1996, 1,844,610 options were exercisable.
1996 Employee Stock Purchase Plan
In September 1996, the Company adopted the 1996 Stock Purchase Plan (the
"1996 Plan") and reserved 750,000 shares of common stock for issuance under
the Purchase Plan.
Accounting for Stock-Based Compensation
The Company has elected to continue to use the intrinsic value-based method
to account for all of its employee stock-based compensation plans. Under APB
Opinion No. 25, Accounting for Stock Issued to Employees, the Company has
recorded no compensation costs related to its stock option plans for the years
ended December 31, 1993, 1994, and 1995 and for the nine months ended
September 30, 1996 because the exercise price of each option equals or exceeds
the fair value of the underlying common stock as of the grant date for each
stock option.
Pursuant to SFAS No. 123, Accounting for Stock-Based Compensation, the
Company is required to disclose the pro forma effects on net loss and net loss
per share data as if the Company had elected to use the fair value approach to
account for all its employee stock-based compensation plans. Had compensation
cost for the Company's plans been determined consistent with the fair value
approach enumerated in SFAS No. 123, the Company's pro forma net loss and pro
forma net loss per
F-21
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
share for the year ended December 31, 1995 and the nine months ended September
30, 1996 would have been increased as indicated below:
NINE
YEAR MONTHS
ENDED ENDED
DECEMBER SEPTEMBER
31, 1995 30, 1996
-------- ---------
Pro forma net loss As reported $1,629 $2,962
Adjusted pro forma 1,659 3,135
Pro forma net loss per share As reported (0.10) (0.17)
Adjusted pro forma (0.10) (0.18)
The fair value of options granted was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995 and 1996: risk-free interest rate of
6.25%; expected life ranging from 1.25 years to 3.25 years; zero expected
volatility; and no dividends.
A summary of the status of the Company's fixed option plans as of December
31, 1995 and September 30, 1996 and changes during the periods ended on those
dates is presented below:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 SEPTEMBER 30, 1996
------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
Fixed Options
Outstanding at beginning of
year.............................. 1,695,780 0.29 2,752,215 0.37
Granted.......................... 1,807,230 0.44 1,709,178 6.49
Forfeited........................ (750,795) 0.37 (923,835) 0.48
--------- --------- ---
Outstanding at end of period..... 2,752,215 0.37 3,537,558 3.30
========= ========= ===
Options exercisable at period-end.. 1,538,928 1,844,610
Weighted-average fair value of
options granted during the period
at exercise price equal to market
price at grant date............... $ 0.07 $ 1.05
</TABLE>
The following table summarizes information about fixed stock options
outstanding at September 30, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- --------------------------
RANGE OF NUMBER OF WEIGHTED AVERAGE
EXERCISE OUTSTANDING AT REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
PRICES SEPTEMBER 30, 1996 CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
-------- ------------------ ---------------- ---------------- --------- ----------------
<S> <C> <C> <C> <C> <C>
$.004 to 0.47 2,115,793 8.3 years $0.26 1,679,943 $0.25
$1.59 to 3.33 302,462 9.4 2.77 58,051 1.94
$6.67 to 10.40 1,119,303 9.9 9.19 106,616 6.69
</TABLE>
F-22
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(12) PROFIT SHARING PLANS
(a) Transphere Plan
Transphere had a qualified noncontributory profit sharing plan that covered
all employees on the later of the date upon which they attained 18 years of
age or complete one year of service. The plan provided for annual
discretionary contributions by Transphere which were proportionately allocated
to eligible employees based upon each participant's proportionate compensation
for the plan year (July 1 through June 30). Such discretionary company profit
sharing contributions were subject to a gradual "step" vesting schedule,
becoming 100% vested after completing six years of service. The charge to
operations for contributions to the plan were $91 in 1993. There were no
contributions to the plan in 1995 or 1994. The plan was terminated in 1996.
(b) Retirement and Savings Plan
The Company maintains a salary deferral defined contribution benefit plan
under which participating employees employed as of January 1, 1996, or who
have completed six months of service, may elect to defer a portion of their
pretax earnings, up to 15% of their qualified compensation. Effective October
1, 1996, the Company matches 10% of each employee's contributions, up to a
maximum of 8% of the employee's annual earnings. Prior to October 1, 1996, the
Company matched 10% of each employee's contributions, up to 6% of the
employee's annual earnings to a maximum of $250. In addition, the Company will
make a discretionary profit sharing contribution to the plan which will be
proportionately allocated to eligible employees who have completed at least
1,000 hours of service in the plan year and are employed on the last day of
the plan year.
(13) RELATED PARTY TRANSACTIONS
MTC Information Systems, Inc.
In January 1994, the Company entered into a sublease agreement with MTC
Information Systems, Inc. ("Information Systems"), a California corporation,
wholly owned by the holders of a majority of the Company's common stock, for
certain office space. The Company lease payments are paid directly to the
ultimate landlord. No fees or commissions are paid to Information Systems.
Lease payments for the years ended December 31, 1993, 1994, and 1995 and the
nine months ended September 30, 1995 and 1996 were $84, $451, $564, $401, and
$531, respectively.
Additionally, Information Systems held certain telecommunication service
contracts on behalf of the Company. The Company makes all payments on the
telecommunication service contracts directly to the carriers. No fees or
commissions are made payable to Information Systems.
Air Traffic Management Services, Inc.
The Company had a sales and distribution, license and services, and
facilities agreement dated July 27, 1995, with Air Traffic Management
Services, Inc. ("Air Traffic"), a California corporation, owned by the holders
of a majority of the Company's common stock. Pursuant to the agreement, the
Company sells and distributes Air Traffic products and services; provided
accounting, billing and administrative functions; shares facilities with; and
licensed certain software to Air Traffic. Payments made by the Company on
behalf of Air Traffic for the years ended December 31, 1993, 1994, and 1995
and the nine months ended September 30, 1995 and 1996, were $773, $1,701,
$2,192, $1,638 and $1,264, respectively. Payments received from Air Traffic
for the years ended December 31, 1993, 1994, and 1995 and the nine months
ended September 30, 1995 and 1996, were $662, $1,516, $2,413, $1,516, and
$1,620, respectively. These amounts are included in the Company's balance
sheet as other receivables.
F-23
<PAGE>
NETSOURCE COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1993, 1994, AND 1995 AND SEPTEMBER 30, 1996
(INFORMATION AS OF SEPTEMBER 30, 1995 AND FOR THE NINE MONTHS THEN ENDED IS
UNAUDITED.)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
The Company had receivables from Air Traffic as of December 31, 1993, 1994,
and 1995, and September 30, 1996, in the amount of $112, $687, $288, and $547,
respectively.
In November 1996 the Company and Air Traffic terminated the sales and
distribution, license and services, and facilities agreement and the Company
received a payment from Air Traffic as partial settlement of amounts due from
Air Traffic. This settlement consisted of cash proceeds of $547. The Company
included the cash proceeds in other income (expense), net for the nine months
ended September 30, 1996 because the Company previously had established an
allowance against the receivables. Due to the uncertainty regarding the
collectability of the Company's remaining amounts due from Air Traffic, the
Company will recognize income as payments are received from Air Traffic.
Patent Agreement
For the years ended December 31, 1994 and 1995 and the nine months ended
September 30, 1995 and 1996, the Company paid $139, $240, $180, and $30,
respectively, to an officer for the right to use certain patents. The patents
were assigned to the Company in May 1996 for no additional consideration.
Merger and Acquisition Advice Agreement
In fiscal 1996, the Company entered into an agreement with Helix Capital
L.L.C. ("Helix") to provide merger and acquisition, financing and strategic
advisory services to the Company. The managing partner of Helix is a Director
of the Company. Total payments made to Helix for services rendered in the nine
month period ended September 30, 1996 were approximately $39.
(14) SUBSEQUENT EVENTS
(a) Acquisition of scruz-net, inc. and DNA New Media Group, Inc. (unaudited)
On November 14, 1996, the Company completed the acquisition of scruz-net.
Under the terms of the acquisition, the Company exchanged 230,190 shares of
common stock in exchange for all the outstanding shares of scruz-net, inc. The
acquisition of scruz-net is expected to be accounted for as a pooling of
interests. On November 18, 1996, the Company completed the acquisition of DNA
New Media Group, Inc. ("DNA"). Under the terms of the acquisition, the Company
exchanged 230,190 shares of common stock in exchange for all the outstanding
shares of DNA. The acquisition of DNA is expected to be accounted for as a
pooling of interests. Since the impact of these acquisitions on prior period
financial statements is not expected to be material, the acquisitions will be
accounted for on a prospective basis.
(b) Reverse Stock Split
On November 20, 1996, the Company effected a three-for-four reverse stock
split in outstanding shares. Accordingly, all share amounts have been adjusted
to reflect the reverse stock split.
F-24
<PAGE>
MTC JAPAN LTD.
FINANCIAL STATEMENTS
DECEMBER 31, 1995
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
F-25
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
MTC Japan Ltd.
We have audited the accompanying balance sheet of MTC Japan Ltd. as of
December 31, 1995, and the related statements of operations, stockholders'
deficit, and cash flows for the period from inception (March 22, 1995) to
December 31, 1995. Those financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards in the United States. 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 MTC Japan Ltd. at December
31, 1995, and the results of its operations for the period from inception
(March 22, 1995) to December 31, 1995 in conformity with financial accounting
standards of Japan.
Accounting principles generally accepted in Japan vary in certain significant
respects from accounting principles generally accepted in the United States.
Application of accounting principles generally accepted in the United States
would have affected results of operations for the period from inception (March
22, 1995) to December 31, 1995 and stockholders' deficit as of December 31,
1995, to the extent summarized in Note 6 to the financial statements.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 8 to the
financial statements, the Company has suffered substantial loss from
operations and has a net capital deficiency that raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also described in Note 8. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
KPMG PEAT MARWICK
Tokyo, Japan
October 31, 1996
F-26
<PAGE>
MTC JAPAN LTD.
BALANCE SHEET
DECEMBER 31, 1995
ASSETS 1995 1995
------ ---- ----
((Yen)) (US$)
Current assets:
Cash............................................... 2,403,792 24,038
Trade accounts receivable (note 4)................. 33,631,107 336,311
Other receivable................................... 14,329,008 143,290
Bad debts reserve.................................. (333,802) (3,338)
Prepaid expenses................................... 1,239,354 12,394
Refundable consumption tax......................... 4,006,183 40,062
Other current assets............................... 220,721 2,207
------------ ----------
Total current assets............................. 55,496,363 554,964
------------ ----------
Fixed assets:
Telecommunications equipment....................... 35,524,668 355,247
Less accumulated depreciation...................... (9,958,257) (99,583)
------------ ----------
Net.............................................. 25,566,411 255,664
Telephone rights................................... 432,000 4,320
Rental deposit..................................... 900,000 9,000
Long-term prepaid expenses......................... 483,334 4,833
------------ ----------
Total fixed assets............................... 27,381,745 273,817
------------ ----------
Deferred assets:
Organization costs (note 6)........................ 15,083,649 150,837
------------ ----------
Total assets..................................... 97,961,757 979,618
============ ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
Current liabilities:
Trade accounts payable (notes 3 and 4)............. 70,829,600 708,296
Other accounts payable (note 3).................... 8,560,345 85,604
Short-term borrowing (note 3)...................... 110,391,753 1,103,918
Accrued expenses (note 3).......................... 18,413,437 184,134
Accrued corporate taxes (note 2)................... 52,500 525
Other current liabilities.......................... 498,830 4,988
------------ ----------
Total current liabilities........................ 208,746,465 2,087,465
------------ ----------
Stockholders' deficit:
Common stock, (Yen)50,000 par value. Authorized 800
shares, issued and outstanding 200 shares......... 10,000,000 100,000
Accumulated deficit................................ (120,784,708) (1,207,847)
------------ ----------
Total stockholders' deficit...................... (110,784,708) (1,107,847)
------------ ----------
Commitments (note 5):
Total liabilities and stockholders' deficit...... 97,961,757 979,618
============ ==========
See accompanying notes to financial statements.
F-27
<PAGE>
MTC JAPAN LTD.
STATEMENT OF OPERATIONS
PERIOD FROM INCEPTION (MARCH 22, 1995) TO DECEMBER 31, 1995
<TABLE>
<CAPTION>
1995 1995
---- ----
(Yen) (US$)
<S> <C> <C>
Revenue........................................... 116,850,751 1,168,508
Cost of revenue (notes 3 and 5)................... 64,740,300 647,403
----------- ---------
Gross profit.................................... 52,110,451 521,105
----------- ---------
Selling, general and administrative expenses
(note 3)......................................... 172,913,867 1,729,139
----------- ---------
Operating loss.................................. 120,803,416 1,208,034
----------- ---------
Other income (note 3):
Equipment received free of charge................ 15,389,316 153,893
Other............................................ 546,429 5,464
----------- ---------
15,935,745 159,357
----------- ---------
Other expense (note 3):
Foreign exchange loss............................ 6,111,310 61,113
Disposal loss of equipment....................... 8,575,000 85,750
Interest expense................................. 1,178,227 11,782
----------- ---------
15,864,537 158,645
----------- ---------
Loss before income taxes........................ 120,732,208 1,207,322
Income taxes (note 2)............................. 52,500 525
----------- ---------
Net loss (note 7)............................... 120,784,708 1,207,847
=========== =========
</TABLE>
See accompanying notes to financial statements.
F-28
<PAGE>
MTC JAPAN LTD.
STATEMENT OF STOCKHOLDERS' DEFICIT
PERIOD FROM INCEPTION (MARCH 22, 1995) TO DECEMBER 31, 1995
<TABLE>
<CAPTION>
TOTAL
COMMON ACCUMULATED STOCKHOLDERS'
STOCK DEFICIT DEFICIT
--------------- ------------ -------------
<S> <C> <C> <C>
Balance as of March 22, 1995....... -- --
Issuance of common stock.......... (Yen)10,000,000 -- 10,000,000
Net loss for the period from in-
ception (March 22, 1995) to De-
cember 31, 1995.................. -- (120,784,708) (120,784,708)
--------------- ------------ ------------
Balance as of December 31, 1995.... (Yen)10,000,000 (120,784,708) (110,784,708)
=============== ============ ============
</TABLE>
See accompanying notes to financial statements.
F-29
<PAGE>
MTC JAPAN LTD.
STATEMENT OF CASH FLOWS
PERIOD FROM INCEPTION (MARCH 22, 1995) TO DECEMBER 31, 1995
<TABLE>
<CAPTION>
<S> <C> <C>
Cash flows from operating activities:
Net loss................................... (Yen)(120,784,708)
Adjustments to reconcile net earnings to
net cash used in operating activities:
Depreciation of telecommunication equip-
ment...................................... (Yen)9,958,257
Amortization of organization costs......... 3,033,394
Bad debt expense........................... 333,802
Disposal loss of equipment................. 8,575,000
Equipment received free of charge.......... (15,389,316)
Increase in trade accounts receivable...... (33,631,107)
Increase in prepaid expenses............... (1,239,354)
Increase in refundable consumption tax..... (4,006,183)
Increase in other current assets........... (220,721)
Increase in long-term prepaid expenses..... (483,334)
Increase in trade accounts payable......... 70,829,600
Increase in other accounts payable......... 8,560,345
Increase in accrued expenses............... 18,413,437
Increase in accrued corporate taxes........ 52,500
Increase in other current liabilities...... 498,830 65,285,150
-----------------
Net cash used in operating activities... (55,499,558)
-----------------
Cash flows from investing activities
Purchase of telecommunication equipment.... (28,710,352)
Purchase of telephone rights............... (432,000)
Increase in other receivable............... (14,329,008)
Increase in rental deposit................. (900,000)
Increase in organization costs............. (18,117,043)
-----------------
Net cash used in investing activities... (62,488,403)
-----------------
Cash flows from financing activities
Issuance of common stock................... 10,000,000
Increase in short-term borrowing........... 110,391,753
-----------------
Net cash provided by financing activi-
ties................................... 120,391,753
-----------------
Net increase in cash.................... 2,403,792
Cash at beginning of period............... --
-----------------
Cash at end of period..................... (Yen) 2,403,792
=================
</TABLE>
See accompanying notes to financial statements.
F-30
<PAGE>
MTC JAPAN LTD.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Financial Statement Preparation
The accompanying financial statements have been prepared from the accounts
of the Company, which are maintained in accordance with financial accounting
standards of Japan with certain modifications considered necessary in order to
present them in a form more familiar to readers outside Japan.
The notes to the financial statements include additional information, not
required under generally accepted accounting principles and practices in
Japan, in order to present them in a form more familiar to readers outside
Japan.
(b) Allowance for Doubtful Accounts
An allowance for doubtful accounts has been set up as a general provision
for uncollectible accounts. This allowance approximates the allowable limit
for Japanese income tax purposes.
(c) Fixed Assets
Telecommunication equipment is stated at cost less accumulated depreciation.
Depreciation of telecommunication equipment is computed on the straight line
method based on the estimated useful lives. Depreciation for the period from
inception (March 22, 1995) to December 31, 1995 amounted to (Yen)9,958,257.
The cost of minor additions, less than (Yen)200,000, is charged to
operations when incurred. In case of retirement and other dispositions, the
asset and accumulated depreciation accounts are relieved and any resulting
gain or loss is credited or charged to operations.
(d) Income Taxes
The Company does not recognize deferred income taxes which would arise from
certain timing differences between taxable income and income for financial
statement purposes. Recognition of deferred taxes is not required in Japan.
(e) Employee Retirement and Severance Benefits
The Company has an employee retirement plan under which employees who sever
their connection with the Company for reasons other than dismissal for cause,
are entitled to lump sum payments based on rate of pay and length of service.
Payments with respect to voluntary severance are half of the payments for
involuntary severence.
Employees do not vest for 5 years and the service period of all MTC Japan
employees is less than one year. Accordingly no accrual is required in Japan
at December 31, 1995.
Directors are not covered by the plan described above and benefits provided
to directors are charged to operations as paid.
(f) Organization Costs
Organization costs have been capitalized and are amortized over five years
on a straight line basis according to the Japanese Commercial Code.
F-31
<PAGE>
MTC JAPAN LTD.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(g) Consumption Tax
Transactions subject to consumption tax are recorded under the net tax
method.
(h) Translation of Foreign Currency Transactions
The Company maintains its records and prepares its financial statements in
Japanese yen. Transactions denominated in currencies other than Japanese yen
are translated into Japanese yen at rates in effect at the time they occur,
and the gains or losses arising on settlement of the related receivables or
payables are included in operations and reflected in non-operating income
(expenses). Receivables and payables denominated in foreign currencies at the
balance sheet date are translated into Japanese yen at the rates in effect as
of the balance sheet date.
(i) Financial Statement Translation
The financial statements presented herein are expressed in yen and, solely
for the convenience of the reader, have been translated into United States
dollars at the rate of (Yen)102.95 or (Yen)100=U.S.$1, the approximate
exchange rate prevailing on the Tokyo Foreign Exchange Market on December 31,
1995. This translation should not be construed as a representation that the
amounts shown could be converted into United States dollars at such rate.
(2) INCOME TAXES
The Company is subject to a number of taxes based on profit, which in the
aggregate resulted in a normal tax rate of approximately 51%.
The Company incurred a loss during the period and accordingly no taxes,
except per capita inhabitants taxes were paid. At December 31, 1995, the
Company had a tax loss carryforward of (Yen)106 million which expires December
31, 2000.
The Company's corporate tax returns have not been examined by the Japanese
tax authorities since inception of the Company.
(3) INTERCOMPANY BALANCES AND TRANSACTIONS
The Company is a joint venture among NetSource Communications Inc. (45%),
General Tsushin Japan K.K. (45%) and a partnership (10%). The Company was
established March 22, 1995 to provide callback service in the Japan market.
Major intercompany balances at December 31, 1995 and transactions for the
period from inception (March 22, 1995) to December 31, 1995 are summarized as
follows:
<TABLE>
<CAPTION>
BALANCES 1995
-------- ----
<S> <C>
General Tsushin Kogyo K.K.:
Other accounts payable................................ (Yen) 8,560,345
Short-term borrowing.................................. 110,391,753
Accrued expenses...................................... 4,786,167
NetSource Communications Inc.:
Trade accounts payable................................ 70,829,600
</TABLE>
F-32
<PAGE>
MTC JAPAN LTD.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
<TABLE>
<S> <C>
TRANSACTIONS 1995
------------ ----
General Tsushin Kogyo K.K.:
Selling, general and administrative expenses........... (Yen)42,975,236
Other expense.......................................... 1,178,227
NetSource Communications Inc.:
Telecommunication charge (cost of revenue)............. 64,740,300
Other income (equipment received free of charge)....... 15,389,316
</TABLE>
(4) ASSETS AND LIABILITIES DENOMINATED IN FOREIGN CURRENCY
At December 31, 1995, the Company had the following assets and liabilities
denominated in foreign currency:
<TABLE>
<S> <C> <C>
Trade accounts receivable.............. (Yen) 2,487,051 (U.S. $ 24,158)
Trade accounts payable................. (Yen)70,829,600 (U.S. $688,000)
</TABLE>
At December 31, 1995, the U.S. dollar denominated receivable and payable
were translated into yen at (Yen)102.95, the year end rate.
(5) COMMITMENTS
The Company occupies office and other facilities under certain lease
agreements. Rental expense and lease expense for the period from inception
(March 22, 1995) to December 31, 1995 amounted to (Yen)3,193,894 and
(Yen)2,382,800, respectively.
(6) RECONCILIATION OF JAPANESE AND U.S. ACCOUNTING PRINCIPLES
The Company prepares its accounts in accordance with Japanese GAAP, which
differ in certain material respects from U.S. GAAP. The significant
differences relate to the following items.
Income Taxes -- In accordance with Japanese GAAP, income taxes are provided
only for amounts currently payable for each year. U.S. GAAP requires that
deferred income taxes be recognized for temporary differences between the tax
basis of assets and liabilities and the reported amounts in the financial
statements. The Company would have a gross deferred tax asset under US GAAP.
However, it would be fully reserved.
Pension Cost -- Under Japanese GAAP, liabilities for retirement and
severance benefits are not recorded until the employees vest. The Company is a
startup and no employees will vest until they have 5 years of service. U.S.
GAAP requires the liability and periodic pension expense to be measured on an
actuarial basis. Management believes that the liability would be immaterial.
Organization Costs -- According to Japanese GAAP, organization costs broadly
defined are capitalized and amortized over 5 years. U.S. GAAP permits only
limited organization costs to be capitalized.
F-33
<PAGE>
MTC JAPAN LTD.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
The following table summarizes the effect on net loss of the differences
between Japanese GAAP and U.S. GAAP for the period from inception (March 22,
1995) to December 31, 1995 (in thousands of yen):
<TABLE>
<CAPTION>
1995
------------
<S> <C>
Net loss as shown in the Japanese GAAP fi-
nancial statements......................... (Yen)120,784
Adjustments for:
Other income (equipment received free of
charge).................................. 15,389
Organization costs........................ 8,244
Others (vacation pay accrual)............. 2,407
------------
Net loss according to U.S. GAAP............. (Yen)146,824
============
</TABLE>
(7) NET LOSS PER SHARE
Net loss per share for the period from inception (March 22, 1995) to
December 31, 1995 amounted to (Yen)603,924 which is based on the number of
issued shares as of the end of the year.
(8) LIQUIDITY
The Company had an excess of current liabilities over current assets of
(Yen)153,250,102 and a stockholders' deficiency of (Yen)110,784,708 as of
December 31, 1995, and had a net loss of (Yen)120,784,708 for the period from
inception (March 22, 1995) to December 31, 1995. To continue to meet its
current obligations, the Company must achieve future profitable operations,
obtain suspension of repayment of debt, arrange for additional financing or
capital or a combination thereof.
Management believes it will be able to successfully accomplish one or more
of the aforementioned actions.
F-34
<PAGE>
GLOSSARY OF TERMS
CALLBACK--a form of dial up access that allows an end-user to access a
telecommunications company's network by placing a telephone call and waiting
for a call back.
CAPACITY--the amount of circuit volume to which a telecommunications services
provider has access.
CCSA--Computer Controlled Switching Arrangement.
DEDICATED OR DIRECT ACCESS--a means of accessing a network through the use of
a permanent circuit.
DOMAIN NAME--the location of a specific computer or group of network computers
that is on the Internet.
ELECTRONIC COMMERCE--the delivery of information, including voice and data,
products, services, marketing, systems and support within an organization or
to the external marketplace over any interactive, electronic or on-line
medium.
FACILITIES-BASED CARRIER--a carrier that owns transmission facilities both in
terms of capacity and digital switches.
FIREWALL--A security architecture that uses multiple machines and carefully
designed interfaces to wall off corporate information.
FTP--File Transfer Protocol. A standard transfer protocol used on the
Internet.
HOSTING--the provision of the necessary hardware, software, equipment,
facilities and services that allows end-users to operate Web architectures.
INTERNET--a global collection of computer networks that use a common
communications protocol, TCP/IP.
INTERNET BACKBONE--a high speed digital data network usually consisting of T-3
dedicated circuits connected to smaller regional digital networks.
IP--Internet Protocol.
ISDN--Integrated Services Digital Network. A hybrid digital network capable of
providing transmission speeds of up to 128 kilobits per second for both voice
and data.
ISP--Internet Service Provider. A company that provides access services to the
Internet via modem, ISDN, xDSL and dedicated circuits.
MODEM--communications equipment that allows computers to connect to a
transmission line.
PACKET SIGNALING PROTOCOL--allows for packet signaling on the Company's
network (i.e. X.25 is a standard switching protocol for data that enables data
to be broken down into packets).
PEERING--The exchange of traffic and routing information between two networks,
so that traffic may be sent directly between the two networks without using
the services of any other Internet service provider.
POP--Point of Presence. An interconnected group of routers and servers located
in particular regional areas that allows end-users to access the Internet
through a local telephone call or dedicated circuit.
PTT--Postal, Telephone and Telegraph Companies. Incumbent national
telecommunications carriers which usually have dominant home market positions
due to monopolistic practices.
RELATIONAL DATABASE PRODUCTS--a database product that is based on relational
theory and that is accessed via standard interfaces and languages such as ODBC
and SQL. Examples of relational database products include Microsoft SQL
Server, Sybase, and Oracle.
REORIGINATION--a transparent call back service which, through the use of an
autodialer, allows end-users to seamlessly access an alternative
telecommunications network.
RESALE--the leasing and reselling of network capacity from a
telecommunications carrier.
G-1
<PAGE>
ROUTER--a device which receives and transmits data packets within a network.
SERVER--a high powered computer combined with software that allows computers
to offer service to another computer.
SS7--a standard signaling protocol of Signaling System 7.
SWITCH--a device which originates and terminates circuits or selects the
necessary path or circuits to be used for the transmission of voice, data and
video.
T-1--a high speed communications line capable of providing transmission speeds
of up to 1.5 megabits per second.
T-3--a high speed communications line capable of providing transmission speeds
of up to 45 megabits per second. Also known as DS3.
TCP/IP--Transmission Control Protocol/Internet Protocol. A collection of
computer protocols that allows computers with different architectures and
operating systems to communicate in an open system.
WEB ARCHITECTURE--the design and specification of a web site including the
range of content, interelationship of content, navigation, system design,
security, access characteristics, and phasing of implementation.
WORLD WIDE WEB--a client/server model using a set of standards to link servers
and that allows end- users to access information, data, graphics, video and
sound.
X.25--a standard packet protocol for data which enables data to be broken down
into small, manageable packets.
XDSL--Digital Subscriber Line. A high speed communications protocol utilizing
a standard copper wire with varying transmission speeds of between 769
kilobits per second and 1.5 megabits per second. Also known as ADSL, CAP ADSL,
DSL and HDSL.
G-2
<PAGE>
[DESCRIPTION OF ARTWORK]
Back Cover
- ----------
World map with lines illustrating existing and planned telecommunications frame
relay network connections and U.S. map with lines illustrating planned Internet
backbone connections and NetSource points of presence.
<PAGE>
-------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS, AND,
IF GIVEN OR MADE, INFORMATION OR SUCH REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PRO-
SPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER
TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PER-
SON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. EXCEPT WHERE
OTHERWISE INDICATED, THIS PROSPECTUS SPEAKS AS OF THE EFFECTIVE DATE OF THE
REGISTRATION STATEMENT. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
-------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary...................................................... 3
Risk Factors............................................................ 8
Use of Proceeds......................................................... 22
Dividend Policy......................................................... 23
Capitalization.......................................................... 23
Dilution................................................................ 24
Selected Consolidated Financial Data.................................... 25
Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... 26
Business................................................................ 36
Management.............................................................. 60
Certain Transactions.................................................... 68
Principal Stockholders.................................................. 70
Description of Capital Stock............................................ 71
Shares Eligible for Future Sale......................................... 73
Certain United States Federal Tax Considerations for Non-U.S. Holders of
Common Stock........................................................... 74
Underwriting............................................................ 77
Legal Matters........................................................... 79
Experts................................................................. 79
Additional Information.................................................. 80
Index to Consolidated Financial Statements.............................. F-1
Glossary of Terms....................................................... G-1
</TABLE>
UNTIL , 1997 (25 DAYS FROM THE DATE OF THIS PROSPECTUS) ALL DEALERS EF-
FECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS
IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
-------------------------------------------------------------------------------
LOGO
3,500,000 SHARES
COMMON STOCK
PROSPECTUS
, 1996
LOGO
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated costs and expenses payable by
the Registrant in connection with the sale of the Common Stock being
registered hereby.
<TABLE>
<CAPTION>
ITEM AMOUNT
---- ----------
<S> <C>
SEC Registration Fee............................................. $ 18,296
NASD Filing Fee.................................................. 6,538
Nasdaq National Market Listing Fee............................... 50,000
Blue Sky Fees and Expenses....................................... 10,000
Printing and Engraving Expenses.................................. 100,000
Legal Fees and Expenses.......................................... 400,000
Accounting Fees and Expenses..................................... 550,000
Out-of-pocket expenses of Underwriters........................... 200,000
Transfer Agent and Registrar Fees................................ 1,500
Miscellaneous.................................................... 13,666
----------
Total.......................................................... $1,350,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145(a) of the Delaware General Corporation Law (the "DGCL") provides
in relevant part that "a corporation may indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative
or investigative (other than an action by or in the right of the corporation),
by reason of the fact that he is or was a director, officer, employee or agent
of another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorney's fees), judgments, fines and amounts
paid in settlement actually and reasonable incurred by him in connection with
such action, suitor proceeding if he acted in good faith and in a manner he
reasonable believed to be in or not opposed to the best interest of the
corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful." With respect to
derivative actions, Section 145(b) of the DGCL provides in relevant part that
"[a] corporation may indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action
or suit by or in the right of the corporation to procure a judgment in its
favor. .....[by reason of his service in one of the capacities specified in the
preceding sentence] against expenses (including attorneys' fees) actually and
reasonable incurred by him in connection with the defense or settlement of
such action or suit is he acted in good faith and in a manner he reasonable
believed to be in or not opposed to the best interest of the corporation and
except that no indemnification shall be made in respect of any claim, issue or
matter as to which such person shall have been adjudged to be liable to the
corporation unless and only to the extend that the Court of Chancery or the
court in which such action or suit was brought shall determine upon
application that, despite the adjudication of liability but in view of all the
circumstances of the case, such person is fairly and reasonable entitled to
indemnify for such expenses which the Court of Chancery or such other court
shall deem proper."
The Registrant's Certificate of Incorporation provides that each person who
is or was or who had agreed to become a director or officer of the Registrant
or who had agreed at the request of the Registrant's Board of Directors or an
officer of the Registrant to serve as an employee or agent of the Registrant
or as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, shall be indemnified by
the Registrant to the full extent permitted by the DGCL or any other
applicable laws. Such Certificate of Incorporation also provides that the
Registrant may enter into one or more agreements with any person which
provides for indemnification greater or
II-1
<PAGE>
different than that provided in such Certificate, and that no amendment or
repeal of such Certificate shall apply to or have any effect on the right to
indemnification permitted or authorized thereunder for or with respect to
claims asserted before or after such amendment or repeal arising from acts or
omissions occurring in whole or in part before the effective date of such
amendment or repeal.
The Registrant's Bylaws provide that the Registrant shall indemnify to the
full extent authorized by law any person made or threatened to be made a party
to an action or a proceeding, whether criminal, civil, administrative or
investigative, by reason of the fact that he, his testator or intestate was or
is a director, officer or employee of the Registrant or any predecessor of the
Registrant or serves or served any other enterprise as a director, officer or
employee at the request of the Registrant or any predecessor of the
Registrant.
The Registrant has entered into indemnification agreements with its
directors and certain of its officers.
The Registrant has purchased and maintains insurance on behalf of any person
who is or was a director or officer against any loss arising from any claim
asserted against him and incurred by him in any such capacity, subject to
certain exclusions.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
On May 28, 1996, the Company issued 15 shares of Common Stock to Edward
Brinskele for a purchase price of $0.067 in cash. The sale of the shares was
deemed to be exempt from registration under the Securities Act pursuant to
Section 4(2) thereof.
In connection with the Reorganization, on June 28, 1996, the Registrant
issued an aggregate of 15,978,059 shares of Common Stock to the shareholders
of MTC Telemanagement, MTC International, and NetSource Interactive. The
shares were issued after the Registrant obtained the determination of the
California Department of Corporations of the fairness of the terms and
conditions of the Reorganization following a hearing. As a result of such
approval, the issuance of the shares was exempt from registration under the
Securities Act pursuant to Section 3(a)(10) thereof.
In connection with the Reorganization, on June 28, 1996, the Registrant
issued options to purchase an aggregate of 2,213,700 shares of Common Stock to
the former option holders of MTC Telemanagement, MTC International and
NetSource Interactive at exercise prices ranging from $0.004 to $1.583 per
share. The issuance of such options was exempt from registration under the
Securities Act pursuant to Section 3(a)(10) thereof.
On June 24, 1996, the Registrant issued 10% Series A Secured Subordinated
Convertible Notes (the "Notes") in the aggregate principal amount of $20
million, together with detachable Warrants (the "Warrants"), to 42 foreign
investors. The Notes bear interest at the rate of 10% per annum, and interest
is due semi-annually in arrears. Principal and all accrued and unpaid interest
under the Notes is due and payable in full on June 24, 1998. The number of
shares into which the Notes are convertible and the conversion price are based
on the per share initial public offering price to the public of the
Registrant's Common Stock. Assuming an offering price of $14 per share in this
offering, the Notes will be convertible into an aggregate of 2,040,816 shares
of Common Stock at a conversion price of $9.80 per share or 70% of such
offering price. The number of shares into which the Warrants are exercisable
and the exercise price are based on the per share initial public offering
price to the public of the Registrant's Common Stock. Assuming an offering
price of $14 per share in this offering, the Warrants will be exercisable for
an aggregate of 163,265 shares of Common Stock at an exercise price of $9.80
per share, or 70% of such offering price. The Registrant received $18,200,000
in cash for the Notes and the Warrants, after paying $1,800,000 in commissions
to a placement agent in connection with services performed by such person in
connection with the sale of the Notes and Warrants. The
II-2
<PAGE>
sale of the Notes and Warrants to the foreign investors was deemed to be
exempt from registration under the Securities Act in reliance on Regulation S
promulgated under the Securities Act.
On June 24, 1996, the Registrant issued a warrant to a placement agent in
consideration of services performed by the placement agent in the offering of
the Notes and Warrants. Assuming an offering price of $14 per share in this
offering, this warrant will be exercisable for an aggregate of 147,959 shares
of Common Stock at an exercise price of $9.80 per share, or 70% of such
offering price. The sale of the warrant to the placement agent was deemed to
be exempt from registration under the Securities Act in reliance on Regulation
S promulgated under the Securities Act.
At various times between July 1996 and October 1996, the Company granted
options under the Company's 1996 Omnibus Equity Incentive Plan and 1996 Stock
Option Plan to employees, directors and consultants to purchase an aggregate
of 1,590,780 shares of Common Stock. Such options had exercise prices ranging
from $3.33 to $11.05 per share. Such issuances were exempt from the
requirement of registration pursuant to Rule 701 promulgated under the
Securities Act or Section 4(2) of the Securities Act.
In November 1996, the Company issued an aggregate of 230,190 shares of
Common Stock to the three former shareholders of scruz-net inc. in exchange
for all of the outstanding stock of scruz-net. Such issuance was made in
reliance of the exemption contained in Section 4(2) of the Securities Act.
In November 1996, the Company issued an aggregate of 230,190 shares of
Common Stock to the two former shareholders of DNA New Media Group, Inc. in
exchange of all of the outstanding stock of DNA. Such issuance was made in
reliance of the exemption contained in Section 4(2) of the Securities Act.
II-3
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
A. EXHIBITS.
<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement.
2.1* Agreement and Plan of Reorganization dated as of May 31, 1996 between
NetSource Interactive and NetSource International Telecommunications,
Inc.
2.2* Form of Common Stock and Option Exchange Agreement dated as of May 31,
1996 between NetSource International Telecommunications, Inc. and
shareholders and holders of options to purchase shares of MTC
International, Inc.
2.3* Form of Common Stock and Option Exchange Agreement dated as of May 31,
1996 between NetSource International Telecommunications, Inc. and
shareholders and holders of options to purchase shares of MTC
Telemanagement Corporation.
2.4* Agreement and Plan of Reorganization dated October 15, 1996 by and
between the Registrant, DNA Acquisition Corporation, DNA New Media
Group, Inc., Andrew Hayman and David Wallinga.
2.5* Agreement and Plan of Reorganization dated October 16, 1996 by and
between the Registrant, scruz-net, inc., Qarin Van Brink, Matthew
Kaufman, Timothy Garlick and scruz-net Acquisition Corporation.
2.6* Form of Exchange Agreement dated as of June 4, 1996 between NetSource
Interactive and the holders of common stock and holders of options to
purchase common stock of Transphere Interactive, Inc.
2.7* Exchange Agreement dated June 4, 1996 between NetSource Interactive and
the holder of common stock of Transphere International, Inc.
2.8* Agreement and Plan of Reorganization dated June 4, 1996 by and between
NetSource Interactive and Transphere Interactive, Inc.
2.9* Agreement and Plan of Reorganization dated June 4, 1996 by and between
NetSource Interactive and Transphere International, Inc.
3.1 Amended and Restated Certificate of Incorporation of the Registrant
dated November 20, 1996.
3.2* Bylaws of the Registrant.
4.1* Specimen Common Stock certificate of the Registrant.
4.2* Form of 10% Series A Secured Subordinated Convertible Note.
4.3* Form of Series A Warrant to purchase Common Stock.
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, P.C.
10.1* Form of Indemnification Agreement for directors and executive officers.
10.2* 1996 Omnibus Equity Incentive Plan.
10.3* 1996 Stock Option Plan.
10.4* 1996 Employee Stock Purchase Plan.
10.5* Severance Agreement between the Registrant and Evan Kraus dated March
15, 1996.
10.6* Patent Assignment Agreement dated as of May 30, 1996 between the
Registrant and Edward Brinskele.
10.7* Letter Agreement dated April 12, 1996 among NetSource Inc., Transphere
International and Helix Capital LLC.
10.8* Lease Agreement between Charles R. Stevens and MTC Information Systems
dated December 20, 1993 for the Registrant's facility located in
Petaluma.
10.9* Sublease Agreement dated January 1, 1994 between MTC Information Systems
and MTC Telemanagement for the Registrant's facility located in
Petaluma.
</TABLE>
II-4
<PAGE>
<TABLE>
<C> <S>
10.10* Lease Agreement between 470 Spear Associates and Offices Unlimited of
California, Inc. dated September 29, 1987 for the Registrant's
facility located in San Francisco.
10.11* Amendment, dated August 15, 1994, to Lease Agreement between 470 Spear
Associates and Offices Unlimited of California, Inc. for the
Registrant's facility located in San Francisco.
10.12* Lease Agreement dated May 17, 1996 between 470 Spear Associates and
Transphere International, Inc. for Registrant's facility located in
San Francisco.
10.13** Joint Venture Agreement dated February 1995 among MTC Telemanagement
Corporation, Tsushin-Kogyo KK and Associated Strategic Alliance
Partners.
10.14** Joint Venture Agreement dated January 1996 by and among MTC
Telemanagement Corporation, Henk J. Keilman and Jan-Peter Kastelein.
10.15* Form of Subscription Agreement for sale of Series A Secured
Subordinated Convertible Note and Series A Warrants.
10.16* Sublease Agreement between Lee Pierce and Transphere International
Inc. and assignment to the Registrant.
10.17* Office Lease dated November 4, 1996 between the Registrant and 470
Spear Associates, a California Limited Partnership.
11.1* Statement regarding calculation of earnings per share.
21.1* Subsidiaries of the Registrant.
23.1 Consent of KPMG Peat Marwick LLP, independent auditors.
23.2 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (See Exhibit 5.1).
23.3 Consent of KPMG Peat Marwick, independent auditors.
23.4* Consent of Pezzola & Reinke, A Professional Corporation.
24.1* Power of Attorney.
27.1* Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
** Documents for which confidential treatment has been requested.
B. FINANCIAL STATEMENT SCHEDULES.
Schedule IX--Valuation and Qualifying Accounts
All other schedules are omitted because they are inapplicable or the
requested information is shown in the Consolidated Financial Statements of the
Registrant or Notes thereto.
II-5
<PAGE>
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
of 1993 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Securities Act, the information omitted
from the form of prospectus filed as part of this registration statement in
reliance upon Rule 430A and contained in the form of prospectus filed by the
registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this registration statement as of the time
it was declared effective; (2) for the purpose of determining any liability
under the Securities Act, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes that, for the purposes of
determining any liability under the Securities Act, each filing of the
Registrant's annual report pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriter to
permit prompt delivery to each purchaser.
II-6
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT NO. 2 TO THE REGISTRATION STATEMENT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
PETALUMA, STATE OF CALIFORNIA, ON THE 10TH DAY OF DECEMBER, 1996.
NetSource Communications, Inc.
/s/ Edward A. Brinskele
By: __________________________________
EDWARD A. BRINSKELE,
CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed by the following persons in
the capacities and on the dates indicated:
SIGNATURE TITLE DATE
/s/ Edward A. Brinskele Chief Executive
- ------------------------------------ Officer, Chairman December 10, 1996
EDWARD A. BRINSKELE of the Board
(Principal
Executive Officer)
/s/ Gary Anderson* Chief Financial
- ------------------------------------ Officer (Principal December 10, 1996
GARY ANDERSON Financial and
Accounting
Officer)
/s/ Charles Schoenhoeft* President and Vice
- ------------------------------------ Chairman of the December 10, 1996
CHARLES SCHOENHOEFT Board
/s/ Yoav Stern* Director
- ------------------------------------ December 10, 1996
YOAV STERN
/s/ Joshua G. Cooperman* Director
- ------------------------------------ December 10, 1996
JOSHUA G. COOPERMAN
Director , 1996
- ------------------------------------
ALEX VIEUX
Director , 1996
- ------------------------------------
YARON EITAN
- --------
* By attorney-in-fact.
II-7
<PAGE>
SCHEDULE IX
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND NINE MONTHS ENDED
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD
----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR TRADE
RECEIVABLES
Year ended December 31,
1993........................ -- 487 -- 487
Year ended December 31,
1994........................ 487 2,495 1,663 1,319
Year ended December 31,
1995........................ 1,319 1,213 1,036 1,496
Nine months ended September
30, 1996.................... 1,496 1,263 1,259 1,500
ALLOWANCE FOR OTHER
RECEIVABLES AND DUE FROM
JOINT VENTURES
Year ended December 31,
1993........................ -- 218 -- 218
Year ended December 31,
1994........................ 218 389 -- 607
Year ended December 31,
1995........................ 607 343 -- 950
Nine months ended September
30, 1996.................... 950 -- -- 950
VALUATION ALLOWANCE FOR
DEFERRED TAX ASSET
Year ended December 31,
1993........................ 200 587 -- 787
Year ended December 31,
1994........................ 787 753 -- 1,540
Year ended December 31,
1995........................ 1,540 180 -- 1,720
Nine months ended September
30, 1996.................... 1,720 2,081(1) -- 3,801
</TABLE>
- --------
(1) Includes an increase to the valuation allowance of $1,100 relating to the
initial recognition of deferred tax assets in connection with the
conversion of MTC Telemanagement from an S corporation to a C corporation.
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
1.1* Form of Underwriting Agreement.
2.1* Agreement and Plan of Reorganization dated as of May 31, 1996 between
NetSource Interactive and NetSource International Telecommunications,
Inc.
2.2* Form of Common Stock and Option Exchange Agreement dated as of May 31,
1996 between NetSource International Telecommunications, Inc. and
shareholders and holders of options to purchase shares of MTC
International, Inc.
2.3* Form of Common Stock and Option Exchange Agreement dated as of May 31,
1996 between NetSource International Telecommunications, Inc. and
shareholders and holders of options to purchase shares of MTC
Telemanagement Corporation.
2.4* Agreement and Plan of Reorganization dated October 15, 1996 by and
between the Registrant, DNA Acquisition Corporation, DNA New Media
Group, Inc., Andrew Hayman and David Wallinga.
2.5* Agreement and Plan of Reorganization dated October 16, 1996 by and
between the Registrant, scruz-net, inc., Qarin Van Brink, Matthew
Kaufman, Timothy Garlick and scruz-net Acquisition Corporation.
2.6* Form of Exchange Agreement dated as of June 4, 1996 between NetSource
Interactive and the holders of common stock and holders of options to
purchase common stock of Transphere Interactive, Inc.
2.7* Exchange Agreement dated June 4, 1996 between NetSource Interactive
and the holder of common stock of Transphere International, Inc.
2.8* Agreement and Plan of Reorganization dated June 4, 1996 by and between
NetSource Interactive and Transphere Interactive, Inc.
2.9* Agreement and Plan of Reorganization dated June 4, 1996 by and between
NetSource Interactive and Transphere International, Inc.
3.1 Amended and Restated Certificate of Incorporation of the Registrant
dated November 20, 1996.
3.2* Bylaws of the Registrant.
4.1* Specimen Common Stock certificate of the Registrant.
4.2* Form of 10% Series A Secured Subordinated Convertible Note.
4.3* Form of Series A Warrant to purchase Common Stock.
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, P.C.
10.1* Form of Indemnification Agreement for directors and executive
officers.
10.2* 1996 Omnibus Equity Incentive Plan.
10.3* 1996 Stock Option Plan.
10.4* 1996 Employee Stock Purchase Plan.
10.5* Severance Agreement between the Registrant and Evan Kraus dated March
15, 1996.
10.6* Patent Assignment Agreement dated as of May 30, 1996 between the
Registrant and Edward Brinskele.
10.7* Letter Agreement dated April 12, 1996 among NetSource Inc., Transphere
International and Helix Capital LLC.
10.8* Lease Agreement between Charles R. Stevens and MTC Information Systems
dated December 20, 1993 for the Registrant's facility located in
Petaluma.
10.9* Sublease Agreement dated January 1, 1994 between MTC Information
Systems and MTC Telemanagement for the Registrant's facility located
in Petaluma.
10.10* Lease Agreement between 470 Spear Associates and Offices Unlimited of
California, Inc. dated September 29, 1987 for the Registrant's
facility located in San Francisco.
10.11* Amendment, dated August 15, 1994, to Lease Agreement between 470 Spear
Associates and Offices Unlimited of California, Inc. for the
Registrant's facility located in San Francisco.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
10.12* Lease Agreement dated May 17, 1996 between 470 Spear Associates and
Transphere International, Inc. for Registrant's facility located in
San Francisco.
10.13** Joint Venture Agreement dated February 1995 among MTC Telemanagement
Corporation, Tsushin-Kogyo KK and Associated Strategic Alliance
Partners.
10.14** Joint Venture Agreement dated January 1996 by and among MTC
Telemanagement Corporation, Henk J. Keilman and Jan-Peter Kastelein.
10.15* Form of Subscription Agreement for sale of Series A Secured
Subordinated Convertible Note and Series A Warrants.
10.16* Sublease Agreement between Lee Pierce and Transphere International
Inc. and assignment to the Registrant.
10.17* Office Lease dated November 4, 1996 between the Registrant and 470
Spear Associates, a California Limited Partnership.
11.1* Statement regarding calculation of earnings per share.
21.1* Subsidiaries of the Registrant.
23.1 Consent of KPMG Peat Marwick LLP, independent auditors.
23.2 Consent of Wilson Sonsini Goodrich & Rosati, P.C. (See Exhibit 5.1).
23.3 Consent of KPMG Peat Marwick, independent auditors.
23.4* Consent of Pezzola & Reinke, A Professional Corporation.
24.1* Power of Attorney.
27.1* Financial Data Schedule.
</TABLE>
- --------
* Documents previously filed.
** Documents for which confidential treatment has been requested.
2
<PAGE>
EXHIBIT 3.1
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
NETSOURCE COMMUNICATIONS, INC.
NetSource Communications, Inc., a corporation organized and existing under
the laws of the State of Delaware, does hereby certify:
1. The name of the corporation is NetSource Communications, Inc. The
original Certificate of Incorporation was filed with the Secretary of State of
the State of Delaware on November 20, 1995 (formerly MTC Telecommunications,
Inc.).
2. This Amended and Restated Certificate of Incorporation restates and
integrates and further amends the provisions of the corporation's Certificate of
Incorporation as heretofore amended. The amendments and restatement herein set
forth have been duly approved by the Board of Directors in accordance with
Sections 242 and 245 of the General Corporation Law of Delaware and by the
written consent of a majority of the stockholders of the corporation and a
majority of the holders of each class entitled to a class vote thereon in
accordance with the provisions of Sections 228 and 242 of the General
Corporation Law of Delaware.
3. The text of the Certificate of Incorporation is hereby restated and
further amended to read in its entirety as follows:
FIRST. The name of the corporation is NetSource Communications, Inc.
SECOND. The address of the corporation's registered office in the State
of Delaware is 1209 Orange Street, Wilmington, County of New Castle, Delaware
19801. The name of its registered agent at such address is Corporation Trust
Company.
THIRD. The purpose of the corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of Delaware.
FOURTH. The corporation is authorized to issue two classes of stock to
be designated, respectively, "Common Stock" and "Preferred Stock". The total
number of shares that the corporation is authorized to issue is One Hundred and
Ten Million (110,000,000) shares, consisting of One Hundred
<PAGE>
Million (100,000,000) shares of Common Stock, par value $0.001 per share, and
Ten Million (10,000,000) shares of Preferred Stock, par value $0.001 per share.
The Preferred Stock may be issued from time to time in one or more series.
The Board of Directors is hereby authorized to fix or alter from time to time
the designation, powers, preferences and rights of the shares of each such
series and the qualifications, limitations or restrictions thereof, including
without limitation the dividend rights, dividend rate, conversion rights, voting
rights, rights and terms of redemption (including sinking fund provisions),
redemption price or prices, and the liquidation preferences of any wholly
unissued series of Preferred Stock, and to establish from time to time the
number of shares constituting any such series and the designation thereof, or
any of them; and to increase or decrease the number of shares of any series
subsequent to the issuance of shares of that series, but not below the number of
shares of such series then outstanding. In case the number of shares of any
series shall be decreased in accordance with the foregoing sentence, the shares
constituting such decrease shall resume the status that they had prior to the
adoption of the resolution originally fixing the number of shares of such
series.
FIFTH. The number of directors which constitute the entire Board of
Directors of the corporation shall be as specified in the bylaws of the
corporation. At each annual meeting of stockholders, directors of the
corporation shall be elected to hold office until the expiration of the term of
which they are elected and until their successors have been dully elected and
qualified; except that if any such election shall not be so held, such election
shall take place at a stockholders' meeting called and held in accordance with
the General Corporation Law of Delaware.
Effective as of the date of the first regularly-scheduled annual meeting of
the stockholders following the closing of this corporation's initial public
offering (the "Closing Date"), the directors of the corporation shall be divided
into three classes as nearly equal in size as is practicable, hereby designated
Class I, Class II and Class III. The term of office of the initial Class I
directors shall expire at the second annual meeting of the stockholders
following the Closing Date, the term of office of the initial Class II directors
shall expire at the third annual meeting of the stockholders following the
Closing Date and the term of office of the initial Class III directors shall
expire at the fourth annual meeting of the stockholders following the Closing
Date. At each annual meeting of stockholders, commencing with the second
regularly-scheduled annual meeting of stockholders following the Closing Date,
each of the successors elected to replace the directors of a Class whose term
shall have expired at such annual meeting shall be elected to hold office until
the third annual meeting next succeeding his or her election and until his or
her respective successor shall have been duly elected and qualified .
If the number of directors is hereafter changed, any newly created
directorships or decrease in directorships shall be so apportioned among the
classes as to make all classes as nearly equal in number as is practicable,
provided that no decrease in the number of directors constituting the Board of
Directors shall shorten the term of any incumbent director.
Any director may be removed from office by the stockholders of the
corporation only for cause.
-2-
<PAGE>
Vacancies occurring on the Board of Directors for any reason and newly
created directorships resulting from an increase in the authorized number of
directors may be filled only by vote of a majority of the remaining members of
the Board of Directors, although less than a quorum, at any meeting of the
Board of Directors. A person so elected by the Board of Directors to fill a
vacancy or newly created directorship shall hold office until the next election
of the Class for which such director shall have been chosen and until his or her
successor shall have been duly elected and qualified.
SIXTH. The Board of Directors of the corporation is expressly authorized
to adopt, amend or repeal the bylaws of the corporation (except as may be
otherwise provided in the bylaws), but the stockholders may make additional
bylaws and may alter or repeal any bylaw whether adopted by them or otherwise.
SEVENTH. Elections of directors need not be by written ballot except and
to the extent provided in the bylaws of the corporation.
EIGHTH. A director of the corporation shall not be liable to the
corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except to the extent such exemption from liability or
limitation thereof is not permitted under the General Corporation Law of
Delaware as the same exists or may hereafter be amended. Any repeal or
modification of this Article EIGHTH shall not adversely affect any right or
protection of a director of the corporation existing hereunder with respect to
any act or omission occurring prior to such repeal or modification.
NINTH. Stockholders of the corporation may not take action by written
consent in lieu of a meeting but must take any actions at a duly called annual
or special meeting.
TENTH. Notwithstanding any other provisions of this Amended and Restated
Certificate of Incorporation or any provision of law which might otherwise
permit a lesser vote or no vote, but in addition to any affirmative vote of the
holders of the capital stock required by law or this Amended and Restated
Certificate of Incorporation, the affirmative vote of the holders of at least
two-thirds (2/3) of the combined voting power of all of the then-outstanding
shares of the corporation entitled to vote shall be required to alter, amend or
repeal Articles FIFTH, SIXTH, SEVENTH, EIGHTH, NINTH and TENTH.
ELEVENTH. The corporation reserves the right to amend, alter, change or
repeal any provision contained in this Amended and Restated Certificate of
Incorporation, in the manner now or hereafter prescribed by statute, and all
rights conferred upon stockholders herein are granted subject to this
reservation.
-3-
<PAGE>
THE UNDERSIGNED, being the President and Chief Executive Officer of the
corporation, does make this certificate, hereby declaring and certifying that
this is his act and deed and the facts herein stated are true, and accordingly,
has hereunto set his hand this 19th day of November, 1996.
NetSource Communications, Inc.
/s/ EDWARD A. BRINSKELE
----------------------------------------
Edward A. Brinskele,
Chief Executive Officer
Attest:
/s/ EVAN A. KRAUS
- -------------------------
Evan A. Kraus
Secretary
<PAGE>
EXHIBIT 5.1
[LETTERHEAD OF WILSON, SONSINI, GOODRICH & ROSATI]
December 9, 1996
NetSource Communications, Inc.
444 Spear Street, Suite 200
San Francisco, CA 94105
Re: Registration Statement on Form S-1
----------------------------------
Ladies and Gentlemen:
We have examined (1) the Registration Statement on Form S-1 (file no.
333-14237) filed by you with the Securities and Exchange Commission on October
16, 1996, in connection with the registration under the Securities Act of 1933,
as amended, of 3,500,000 shares of your Common Stock, $0.001 par value (the
"Shares"), all of which are authorized but heretofore unissued, including an
over-allotment option for 525,000 shares held by the Underwriters, (2) Pre-
effective Amendment No. 1 to the Registration Statement proposed to be filed
with the Commission on November 25, 1996, and (3) Pre-effective Amendment No. 2
to the Registration Statement proposed to be filed with the commission on or
about December 10, 1996. The Shares are to be sold to the Underwriters for
resale to the public as described in the Registration Statement pursuant to the
Underwriting Agreement filed as an exhibit thereto. As your counsel in
connection with this transaction, we have examined the proceedings proposed to
be taken in connection with said sale and issuance of the Shares.
It is our opinion that, upon completion of the proceedings being taken
or contemplated by us, as your counsel, to be taken prior to the issuance of the
Shares, the Shares when issued and sold in the manner referred to in the
Registration Statement will be legally and validly issued, fully paid and
non-assessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement, including the prospectus constituting a part thereof, and any
amendment thereto and consent to the use of our name under the heading "Legal
Matters" contained in the Prospectus.
Very truly yours,
WILSON, SONSINI, GOODRICH & ROSATI
Professional Corporation
/s/ Wilson, Sonsini, Goodrich & Rosati
<PAGE>
EXHIBIT 10.13
JOINT VENTURE AGREEMENT
THIS JOINT VENTURE AGREEMENT, together with all appendices and exhibits
hereto ("Agreement") is made the __th day of February, 1995, by and among
GENERAL TSUSHIN KOGYO KABUSHIKI KAISHA, a Japanese corporation having its
principal place of business at S&S Building, 6-36 Shin Ogawa-machi, Shinjuku-ku,
Tokyo 162 Japan (hereinafter referred to as "GTC"), MTC TELEMANAGEMENT
CORPORATION, an American corporation having its principal place of business at
1304 Southpoint Boulevard, Petaluma, CA 94954 U.S.A. (hereinafter referred to
as "MTC") and ASSOCIATED STRATEGIC ALLIANCE PARTNERS, an American corporation
having its principal address at 242 Pinehurst Avenue, Los Gatos, CA 95032
U.S.A. (hereinafter referred to as "ASAP").
W I T N E S S E T H:
WHEREAS, GTC has been engaged in the sales and installation of
telecommunications products and services;
WHEREAS, MTC has been engaged in the business of developing, producing and
distributing unique, technology-based telecommunication products and services;
WHEREAS, ASAP has been engaged in the business of facilitating new market
development by coordinating relations between American and Japanese business
partners;
WHEREAS, GTC, MTC and ASAP wish to establish the Joint Venture Company
(hereinafter referred to as "NEWCO") under the laws of Japan in order to
actively expand the business of telemanagement products and services in the
country of Japan.
NOW, THEREFORE, the parties hereto agree as follows:
Article 1. Organization of the New Company
1. Promptly after the effective date hereof, GTC, MTC and ASAP shall cause
a new company to be organized as a Kabushiki Kaisha under the Commercial Code of
Japan. NEWCO shall be known in the Japanese language as "MTC Japan Kabushiki
Kaisha and in English as "MTC Japan, Ltd."
2. The Articles of Incorporation for NEWCO shall be in both the Japanese
and English languages, attached herewith as Exhibit A.
- 1 -
<PAGE>
3. The authorized capital of NEWCO shall be forty million yen
((Yen)40,000,000). The initial paid-in capital of NEWCO shall be ten million
((Yen) 10,000,000). All shares to be issued by NEWCO shall be non-bearer common
shares having a par value of fifty thousand yen ((Yen)50,000). As the
contribution to the initial capital of NEWCO, (i) GTC shall subscribe to ninety
(90) shares, which shall represent forty five percent (45%) of the shares to be
issued upon incorporation, by paying four million, five hundred thousand yen
((Yen) 4,500,000), (ii) MTC shall subscribe to (ninety) (90) shares, which shall
represent (forty five) percent (45%) of the shares to be issued upon
incorporation, by paying four million, five hundred thousand yen ((Yen)
4,500,000), and (iii) ASAP shall subscribe to twenty (20) shares, which shall
represent ten percent (10 %) of the shares to be issued upon incorporation by
paying one million yen ((Yen) 1,000,000). GTC, MTC and ASAP shall make payment
in full for their respective shares in conformity with GTC's instructions on the
bank or banks to which such payment shall be made and on the time limit for such
payment.
4. The parties hereby agree to notify NEWCO of their intention not to
receive and hold their respective share certificates of NEWCO in accordance with
the Commercial Code of Japan.
5. GTC shall prepare any and all such documents as shall be required for
the incorporation of NEWCO, and MTC and ASAP shall, in conformity with GTC's
instructions promptly execute of cause to execute any such document as shall
require execution by MTC and ASAP and/or their nominees, respectively.
Article 2. Object and Purposes of NEWCO
The business activities of NEWCO shall be to:
(1) Manufacture and distribute telecommunication equipment and
telemanagement products and services;
(2) Distribute telemanagement products and services in Japan and the other
countries of Asia;
(3) Manufacture telemanagement products for distribution in Japan and the
other countries of Asia;
(4) Act as an MTC sales distributor in Japan and the other countries of
Asia; and
(5) Act as an MTC hardware manufacturer and distributor in Japan.
- 2 -
<PAGE>
Article 3. Certain Restrictions upon the Activities of GTC, MTC and ASAP
During the term of this Agreement, and for a period of two years after the
termination of this Agreement, the parties, and their respective employees,
shall not directly or indirectly, engage in, invest in or perform any business
competitive with the business performed by NEWCO, without the prior written
approval of MTC.
Article 4. Directors and Auditor(s) of NEWCO
1. The total number of directors of NEWCO shall consist of five (5)
persons. GTC shall nominate two (2) persons, MTC shall nominate two (2)
directors and ASAP shall nominate one (1) director.
The parties hereto agree to exercise their voting rights to elect the
directors so nominated.
2. The statutory auditor(s) of NEWCO shall be as many as two (2)
person(s), one to be nominated by GTC, and one to be nominated by MTC. The
parties agree to exercise their respective voting rights to elect the person(s)
so nominated as statutory auditor(s).
3. Should the position of any director or statutory auditor become vacant,
however occasioned, the parties hereto agree to cause their respective voting
rights exercised to elect a director or statutory auditor nominated by the party
who nominated the preceding director or statutory auditor.
4. If and when any of the parties hereto intends to exercise its voting
right by proxy at any general meeting of shareholders of NEWCO, it shall appoint
any shareholder of NEWCO as its proxy.
Article 5. Staff of NEWCO
1. By the joint appointment of GTC and MTC, NEWCO's Board of Directors
shall appoint, Mr. Steve Weiner as ("President and Representative Director) and
Mr. Ikuo Kimura as a representative director.
2. During the initial period, staff support in Japan shall be provided by
GTC and dedicated product support shall be provided from the USA by MTC and its
affiliated companies in accordance with the terms of this Agreement.
3. Any and all such matters relating to the staffing of NEWCO as are not
provided for herein shall be separately agreed upon in writing by the Board of
Directors at a Board Meeting of NEWCO.
- 3 -
<PAGE>
Article 6. Financing of NEWCO
1. The parties hereto shall make all reasonable efforts to cause NEWCO to
operate on a self-supporting basis.
2. If and when NEWCO requires additional funds for its operation, the
Board of Directors of NEWCO shall direct the representative directors to arrange
commercial lines of credit sufficient to finance NEWCO's on-going operations.
In addition, GTC and MTC shall negotiate in good faith the terms and conditions
upon which GTC and MTC will provide an initial credit facility to NEWCO as set
forth in Exhibit B attached hereto. If such credit facility or other financing
arranged by NEWCO shall be insufficient then each of the parties hereto may
provide additional financing to NEWCO on terms and conditions to be agreed.
3. Unless otherwise agreed upon in advance by the parties hereto in
writing, the parties shall consult with each other to determine the initial
annual budget of NEWCO and sales planning therefor. Subsequent annual budgets
and sales planning will be determined and agreed upon prior to the commencement
of each of NEWCO's fiscal years.
Article 7. Certain Actions by NEWCO
1. The unanimous written consent of GTC, MTC and ASAP shall be required
for any of the actions set forth below of NEWCO:
(1) Changes in the Articles of Incorporation of NEWCO;
(2) The amount of remuneration of directors and statutory auditors;
(3) Payment of dividends;
(4) Approval of any financial statement for each fiscal year period;
and
(5) Acquisition, transfer (including the imposition of liens thereon)
or disposition of any patents, design patents, trademarks or
other intellectual property.
2. As for any of the actions referred to in the preceding paragraph
for which the unanimous written consent of GTC, MTC and ASAP has been given and
for which a resolution of either the general meeting of shareholders or the
Board of Directors is required, the parties hereto shall exercise their voting
rights as the shareholders or, as the case may be, shall cause their respective
nominee directors to exercise their voting rights to adopt the resolution
concerned in conformity with the action for which the unanimous consent of GTC,
MTC and ASAP was given.
3. Any other actions by NEWCO shall be made after the resolution of
a Board Meeting or a Shareholder's Meeting, as appropriate, adopted pursuant to
the Commercial Code and the Articles of Incorporation.
- 4 -
<PAGE>
Article 8. Management of NEWCO
1. The President and Representative Director of NEWCO, as jointly
appointed by GTC and MTC, shall have principal responsibility for the management
and business affairs except for all the actions set forth in Paragraph 1 of
Article 7.
2. The Board of Directors of NEWCO shall have authority to decide
the matters set forth in Paragraph 1 of Article 245 of the Commercial Code
except for all the actions set forth in Paragraph 1 of Article 7 and the
President and Representative Director shall have authority to perform such
matters in accordance with the resolution of the Board of Directors, provided,
however, that the President and Representative Director shall have authority to
decide and perform any other business and management activities other than
Paragraph 1 of Article 245 of the Commercial Code.
3. If any director nominated by the parties hereto performs any
business activity without authorization, the party hereto who nominated such a
director shall indemnify, defend and hold NEWCO, its agents, employees and
clients harmless from any loss damage, liability, claim, cost or expense
(including reasonable attorney's fees) incurred as a result of such unauthorized
act.
Article 9. Board of Directors
1. Except for all the actions set forth in Paragraph 1 of Article 7
hereof and in the Commercial Code and Articles of Incorporation, resolution of
the Board of Directors shall be adopted by a vote of four-fifths (4/5) of all
directors. The President and Representative Director shall be the Chairman of
the Board of Directors.
2. If the Board of Directors has reached a deadlock concerning a
proposed resolution, the Chairman shall make his best efforts to reach unanimous
approval to either adopt or reject the resolution concerned.
3. Notice of the convening of a meeting of the Board of Directors
shall be dispatched to each director not less than forty-five (45) days prior to
the date of such meeting. The period of notice may be shortened or the notice
may be dispensed with for a particular meeting by the unanimous consent of all
of the directors.
- 5 -
<PAGE>
Article 10. Records and Books of NEWCO
1. NEWCO shall prepare records and books of accounts in accordance
with the laws, regulations and accounting rules of Japan and shall preserve
these at the office of NEWCO.
2. The parties hereto shall have the right, at their sole expense,
to designate a certified public accountant to audit NEWCO's records and books
once a year.
3. The fiscal year period of NEWCO shall commence on the 1st of
January of each year and end on the 31st day of December of the same year,
provided however, that the first fiscal year period of NEWCO shall commence on
the day of its incorporation until the 31st day of December, 1995.
Article 11. Transfer of Shares of NEWCO
1. Without the prior written consent of MTC and GTC, the parties
shall not transfer, pledge or otherwise encumber of dispose of any of its shares
of NEWCO.
Article 12. Prohibition of Assignment of Rights and Duties
This Agreement or any of the rights or duties hereunder may not be
assigned by the parties hereto without the prior written consent of MTC and GTC.
Article 13. Use of Trade Mark
MTC has given permission to NEWCO to use and modify, subject to prior
approval, the "MTC" marks for business promotion during the term of this
Agreement.
Article 14. Notices
1. Any notice or other communication required or permitted to be
given or made under this Agreement, shall be in writing and may be given by
electronic mail, facsimile or registered airmail addressed to the party
concerned at the address of such party or by delivery to the addressee at such
address as shown on Page 1 of this Agreement. Any notice given by registered
mail shall be deemed to have been served seven (7) days after the date of
postmark, and any notice given by other manners shall be deemed to have been
serviced twenty-four (24) hours after date of transmission.
2. If and when the parties hereto respectively shall hereafter
change address as shown on Page 1, written notice shall be promptly given to
that effect to the other parties.
- 6 -
<PAGE>
Article 15. Modification
Any of the provisions of this Agreement may be modified by an
instrument duly executed by the authorized representatives of the parties
hereto.
Article 16. Effective Date, Duration and Termination of this Agreement
1. This Agreement shall become effective upon the date of the last
of all approvals of this Agreement by the Board of Directors of any of the
parties hereto and by the appropriate Japanese authorities in order to implement
their respective rights and duties under this Agreement.
2. Unless terminated earlier in accordance with the provisions of
Paragraph 3 or 4 below of this Article, this Agreement shall continue to be in
full force and effect so long as NEWCO is in existence.
3. This Agreement shall terminate if:
a) any party hereto commences relevant procedures for bankruptcy,
insolvency, receivership, liquidation, or winding up of its
affairs or such procedures are instituted by any third party
against any of the parties hereto;
b) any party shall be merged or consolidated or shall sell all or
substantially all of its assets to a third party; or
c) any party hereto materially violates any provision of this
Agreement and fails to cure or remedy the same within forty-five
(45) days after notice of such breach is provided to such party
by any other party hereto; AND
MTC and GTC hereto agree to the termination of this Agreement and send a notice
of such termination to the party which is subject of any of the acts set forth
in clauses a) - c) of this Paragraph 3. The effective date of termination shall
be the date upon which such notice of termination is dispatched.
4. NEWCO's "Total Quarterly Revenue Due MTC" is NEWCO's invoiced
-------------------------------
usage amount, as calculated quarterly, due MTC from NEWCO for services under
-----------------------
this Agreement plus any amount due to MTC from end user customers signed by
NEWCO and being invoiced directly by MTC. Usage is defined as the amount due to
MTC for services generated by call record activity processed through the MTC
switching network.
MTC reserves the right to terminate this Agreement after one (1) year
if customers signed by NEWCO have not achieved Total Quarterly Revenue Due MTC
-------------------------------
in the twelfth (12) calendar month after the incorporation of NEWCO of $250,000.
-------------
- 7 -
<PAGE>
5. This Agreement shall also terminate if and when the parties
hereto agree to dissolve NEWCO.
Article 17. Effect of Termination
1. If and when this Agreement has been terminated under Paragraph 3 of
Article 16, the parties hereto shall decide either to dissolve NEWCO or to
receive the outstanding shares of NEWCO owned by the other parties hereto.
2. If and when this Agreement has been terminated under Article 16, the
parties hereto shall cause NEWCO to cease any use of the marks "MTC" upon the
termination of this Agreement.
3. If and when this Agreement has been terminated for any reason, the
following shall occur:
a. MTC shall have the right of first refusal to purchase 100% of the
outstanding shares of NEWCO, "Purchase". Such Purchase shall take place within
ninety (90) days of termination of this Agreement. Purchase price shall be
NEWCO's book price, as determined by an independent auditing firm, with such
firm agreed upon by MTC and GTC. If no agreement can be reached, MTC shall
select a firm.
Article 18. Ancillary Agreements
1. GTC and MTC shall provide an unsecured credit facility to NEWCO in
accordance with the basic terms set forth in Exhibit B and Such additional terms
as may be agreed based on good faith negotiations between GTC and MTC.
2. GTC shall, provide certain facilities and staff which GTC currently
has available to assist NEWCO to start its business operations as set forth in
Exhibit D.
3. MTC shall, upon incorporation of NEWCO, provide products and technical
support to NEWCO in accordance with the terms set forth in Exhibit C.
4. MTC shall, upon incorporation of NEWCO, appoint NEWCO as an MTC sales
distributor and hardware manufacturer in Japan.
5. MTC agrees to appoint NEWCO as MTC's exclusive sales distributor and
hardware manufacturer in Japan providing NEWCO meets the criteria set forth in
Exhibit E.
6. GTC shall, as soon as practicable after incorporation of NEWCO , enter
into an agreement with NEWCO to become a master affiliate (major distributor) of
NEWCO's products and services, upon terms and conditions agreeable to both GTC
and NEWCO.
- 8 -
<PAGE>
7. MTC shall, upon incorporation of NEWCO, provide technical, engineering
and other assistance to enable NEWCO to have MTC Matrix manufactured by third
parties for use and sale by NEWCO in Japan and the other countries of Asia.
Article 19. Other Provisions
1. MTC and ASAP hereby represents and warrants that any of the provisions
of this Agreement or any implementation thereof will not violate any of the
United States laws.
2. GTC hereby represents and warrants that any of the provisions of this
Agreement or any implementation thereof will not violate any of the Japanese
laws.
3. GTC hereby appoints Mr. Shigeru Miki, Esq. as GTC's attorney-in-fact
for the sole purpose of notification given on behalf of GTC, MTC and ASAP,
pursuant to the Japanese Foreign Exchange and Foreign Trade Control Act.
4. GTC, MTC and ASAP shall cause NEWCO to submit to the Japanese Fair
Trade Commission ("FTC") the report on its holding shares of NEWCO within three
(3) months from the end of each and every fiscal year period of NEWCO under the
Act concerning prohibition of private monopoly and maintenance of fair trade in
Japan.
5. NEWCO shall file the required reports with the Ministry of Posts and
Telecommunications, pursuant with the requirements of foreign investment in
Japan.
Article 20. No Waiver of Rights
All waivers hereunder must be made in writing, and failure at any time to
require the other party's performance of any obligation under this Agreement
shall not affect the right subsequently to require performance of that
obligation. No waiver of any breach of any provision of this Agreement shall be
construed as a waiver of any continuing or succeeding breach of such provision
or a waiver or modification of the provision.
Article 21. Attorney's Fees
If any action or arbitration proceeding shall be commenced to enforce this
Agreement or any right arising in connection with this Agreement, the prevailing
party in such action or proceeding shall be entitled to recover from the other
party the reasonable attorney's fees, costs and expenses incurred by such
prevailing party in connection with such action or proceeding and in enforcing
any judgment or award obtained.
Article 22. Severability
Whenever possible, each provision of this Agreement shall be interpreted in
such manner as to be effective and valid under applicable law, but if any
provision of this Agreement should be prohibited or applicable law, such
provision or invalidity without invalidating the remainder of such provision or
the remaining provisions of this Agreement.
- 9 -
<PAGE>
Article 23. Subject Headings
The subject headings of the Articles of this Agreement are included for the
purposes of convenience only, and shall not affect the construction or
interpretation of any of its provisions.
Article 24. Further Assurances
The parties hereto shall each perform such acts, execute and deliver such
instruments and documents, and do all such other things as may be reasonably
necessary to accomplish the transactions contemplated in this Agreement.
The parties agree that this Agreement may be modified from time to time as
agreed by NEWCO's Board of Directors.
Article 25. Entire Agreement
1. This Agreement constitutes the entire agreement between the parties
hereto and supersedes all previous negotiations, agreement, commitments in
respect thereto.
2. Any and all documents attached as Exhibits A through E hereto shall
constitute part of this Agreement, provided, however, that if there are any
discrepancies between any provisions of Exhibit A through E and the provisions
of the main body of this Agreement, the provisions of the main body of this
Agreement shall prevail and provisions of such Exhibits shall be ineffective to
the extent of such discrepancy(ies).
3. The parties agree to finalize and execute a side agreement(s) as
deemed necessary, "Side Agreement" provided by MTC to the other parties within
sixty (60) days of the execution of this Agreement.
Article 26. Arbitration
All disputes arising among the parties to this Agreement shall be resolved
exclusively by arbitration in the country of the principal office of the party
against which the claim is entered, in accordance with the arbitration rules of
the arbitration associated in that location. Arbitration in Japan shall be
conducted in Tokyo at and in accordance with the rules of the Japan Commercial
Arbitration Association and arbitration in the United States shall be conducted
in San Francisco, California at the International Committee of the American
Arbitration Association in accordance with the rules of the American Arbitration
Association.
Judgment upon the award entered by the arbitrator(s) may be entered in any
court having jurisdiction thereof.
- 10 -
<PAGE>
Article 27. Governing Law and Languages
This Agreement shall be governed by the laws of Japan. This Agreement
shall be executed in English and Japanese languages and the text hereof in both
languages shall be equally valid as among the parties hereof.
IN WITNESS WHEREOF, the parties hereto having caused this Agreement to be
executed by their duly authorized representatives as of the date first written
above.
General Tsushin Kogyo Kabushiki Kaisha
By: Ikuo Kimura /s/
---------------
Name: Ikuo Kimura
-----------
Title: President, CEO
--------------
MTC Telemanagement Corporation
By: Edward A. Brinskele /s/
-----------------------
Name: Edward A. Brinskele
-------------------
Title: President, CEO
--------------
Associated Strategic Alliance Partners
By: Steve E. Weiner /s/
-------------------
Name: Steve E. Weiner
---------------
Title: President, CEO
--------------
- 11-
<PAGE>
EXHIBIT A
ARTICLES OF INCORPORATION
-------------------------
- 12 -
<PAGE>
ARTICLES OF INCORPORATION
OF
MTC JAPAN Ltd.
--------------
Duly Notarized on ___________________, 1994
in accordance with the approval of the
---
Meeting of Promoters as of _____________, 1994
- 13 -
<PAGE>
ARTICLES OF INCORPORATION
OF
MTC JAPAN, Ltd.
CHAPTER I. GENERAL PROVISIONS
------------------------------
Article 1. Corporate Name
The name of the Company shall be EMU TI-SHI- JAPAN KABUSHIKIKAISHA (in
--
"Katakana"). In English language it shall be known as MTC Japan Ltd.
Article 2. Purposes
The purposes of the Company shall be to:
(1) Manufacture and distribute telecommunication equipment and
telemanagement products and provide services in relation to the
products;
(2) Export and distribute telemanagement products and services in Japan and
the other countries of Asia;
(3) Manufacture telemanagement products for distribution in Japan and the
other countries of Asia;
(4) Act as MTC's exclusive service provider and hardware manufacturer and
distributor in Japan and other countries of Asia; and
(5) Undertake any and all businesses incidental to the foregoing activities
(The purpose of the Company will be subject to further negotiation with
the Legal Affairs Bureau.)
Article 3. Location of Head Office
The company shall have its head office in Shinjuku-ku, Tokyo.
Article 4. Method of Public Notice
Public notices of the Company shall be published in the Official Gazette.
CHAPTER II. SHARES
- 14 -
<PAGE>
Article 5. Number of Shares to be Issued
The total number of shares authorized to be issued by the Company shall be
eight thousand (800).
Article 6. Amount of Each Share Having Par Value
All shares to be issued by the Company shall have a par value of fifty
thousand yet ((Yen)50,000).
Article 7. Types of Share Certificates
All share certificates to be issued by the Company shall be in registered
and non-bearer form and in four (4) denominations of one (1) share certificate,
ten (10) share certificate, fifty (50) share certificate and one hundred (100)
share certificate.
Article 8. Restriction on Transfer of Shares
1. Transfers of shares of the Company shall require the approval of
the board of directors.
2. If the board of directors does not approve an application for a
particular share transfer, the board of directors shall designate another
transferee for such share transfer.
Article 9. Share Handling
The procedure for registration of transfer of shares, registration of
pledge of shares, indication of trust estate, re-issue of share certificates and
any other proceedings concerning share handling and relevant fees therefor shall
be governed by Share Handling Regulations adopted by resolution of the board of
directors.
- 15 -
<PAGE>
Article 10. Suspense of Alteration of Entries in the
Register of Shareholders
1. The Company shall suspend alterating any entry in the register of
shareholders from the date following the end of each fiscal year to the date on
which the ordinary general meeting of shareholders shall be completed.
2. In addition to the preceding paragraph, whenever necessary, the
Company may, by giving prior public notice, temporarily suspend alterating any
entry in the register of shareholders or fix the record in accordance with a
resolution of the board of directors.
CHAPTER III. GENERAL MEETINGS OF SHAREHOLDERS
Article 11. Procedures to Convene
1. An ordinary general meeting of shareholders shall be convened
within three (3) months following the end of each fiscal year period, and an
extraordinary general meeting of shareholders shall be convened from time to
time whenever necessary.
2. The president shall convene a general meeting of shareholders
pursuant to a resolution of the board of directors except as otherwise provided
for in the laws and government laws and regulations.
Article 12. Chairman of General Meetings
The president shall act as the chairman at a general meeting of
shareholders. When the president is unable to act as a chairman, one of other
directors, in accordance with the order previously determined by a resolution of
the board of directors, shall act as the chairman.
Article 13. Matters to be Resolved at General Meeting
The resolution of the following matters shall be made by unanimous
agreement of all the shareholders present at general meeting of shareholders,
including any vote by proxy:
- 16 -
<PAGE>
(1) Any changes in the Articles of Incorporation;
(2) The amount of the remuneration of directors and auditor;
(3) Payment of dividends;
(4) Approval of financial statements and other accounting documents for
fiscal year period;
(5) Acquisition, transfer (including the imposition of liens thereon), or
disposition of any patents design patents, trademarks or other
intellectual property.
Article 14. Method of Resolution
Except for the matters provided for in the preceding Article 13 and except
as otherwise provided for in the laws or government laws and regulations, any
resolutions of a general meeting of shareholders shall be adopted by a majority
vote at a meeting at which shareholders holding shares representing of more than
one half of the total number of the issued shares are present.
Article 15. Exercise of Voting Rights by a Proxy
A shareholder may exercise his vote by proxy. In such a case, the person
holding the proxy shall submit to the Company a document evidencing power of
representation at each general meeting of shareholders.
Article 16. Minutes
The substance of proceedings at a general meeting or shareholders and the
results thereof shall be recorded in the minutes of the meetings, which shall be
kept at the office of the Company after the chairman and the directors present
have signed their names or affixed their names and seals thereto.
2. A shareholder may have access to any minutes or other company records
at any time during business hours of the Company and may make copies hereof.
- 17 -
<PAGE>
CHAPTER 4, Directors and Auditors
Article 17. Number of Directors and Auditors
The Company shall have up to five (5) directors and one auditor.
Article 18. Election of Directors and Auditors
1. The directors and auditor of the Company shall be elected at a general
meeting of shareholders.
2. The election of directors shall not be based on cumulative voting.
Article 19. Term of Office
1. The terms of office or directors shall expire at the close of the
ordinary general meeting of shareholders held with respect to the settlement of
accounts for the last fiscal year period ending within one (1) year after their
assumption of office.
2. The term of office of a director elected to fill a vacancy shall
expire at the time when the term of office of the other directors then in office
shall expire.
3. The term of office of an auditor shall expire at the close of the
ordinary general meeting of shareholders held with respect to the settlement of
accounts for the last fiscal year period ending within three (3) years after
their assumption of office.
Article 20. Representative Director and Director with
Managing Position
1. The board of directors shall elect a President, one or more Senior
Managing directors and Managing directors, among the directors.
2. The President and Senior Managing Director shall represent the
Company, respectively.
- 18 -
<PAGE>
Article 21. Procedures of Convening a Meeting of the
Board of Directors
1. The President shall convene a meeting of the board of directors, and
act as a chairman of such meeting. When the President is unable to convene or
act as a chairman, one of the other directors, in accordance with the order
previously determined by a resolution of the board of directors shall convene a
meeting of the board of directors and may act as a chairman.
2. A notice of a meeting of the board of directors shall be dispatched to
each director at least forty-five (45) days prior to the date of such meeting,
provided, however, that the period of notice may be shortened or the notice may
be dispensed with by the unanimous consent of all the directors.
Article 22. Method of Adopting Resolution
Resolutions of the meeting of the board of directors shall require the
presence of not less than four fifth of all the directors and shall be adopted
by a majority of the directors present at the meeting.
Article 23. Remuneration for Directors and Auditors
Remuneration of the directors and auditor shall be determined by the
resolution of a general meeting of shareholders, respectively.
CHAPTER 4, Accounts
Article 24. Fiscal Year Period and the Settlement of
Accounts
The fiscal year period of the Company shall commence on January 1 of each
year and end on December 31 of the same year.
- 19 -
<PAGE>
Article 25. Disposition of Profit
Except as otherwise provided for in the laws and government laws and
regulatory, the profit for each fiscal year period shall be disposed of upon
approval of a general meeting of shareholders.
Article 26. Distribution of Dividends
Dividends on shares shall be paid to shareholders or registered pledges
appearing on the Register of shareholders as of the last day of each fiscal year
period.
Supplementary Provision
Article 27. Shares to be Issued upon Incorporation
The total amount of shares to be issued at the time of incorporation of the
Company shall be two hundred (200) shares having par value and the issue price
of fifty thousand (50,000) yen per share.
Article 28. Initial Fiscal Year Period
The initial fiscal year period of the Company shall commence on the day of
its incorporation and end on December 31, 1995.
Article 29. The Initial Term of Office of Directors and
Auditor
The initial term of office of directors and auditor shall expire at the
close of the ordinary general meeting of shareholders held with respect to the
settlement of accounts for the last fiscal year period ending within one year
after their assumption of office.
- 20 -
<PAGE>
Article 30. Promoters
The names and addresses of the promoters and the number of shares
subscribed to by such promoters upon incorporation are as follows:
Promoters Number of Shares
--------- ----------------
(Name) one (1) share
(Address)
(Name) one (1) share
(Address)
For the purpose of incorporation of said MTC Japan K.K., these Articles of
Incorporation have been prepared and the promoters have hereinbelow set forth
their names and addresses and affixed their seals:
Promoters
---------
(Name)
(Address)
(Name)
(Address)
- 21 -
<PAGE>
EXHIBIT B
UNSECURED CREDIT FACILITY TO BE PROVIDED BY GTC AND MTC
-------------------------------------------------------
Set forth below are the basic terms and conditions upon which GTC and MTC
shall provide an initial unsecured credit facility to NEWCO in the total
aggregate amount of (Yen) 100,000,000. Additional terms and conditions shall be
agreed to by GTC, MTC and NEWCO in good faith, as soon as possible after the
establishment of NEWCO.
1. TOTAL AGGREGATE AMOUNT OF CREDIT FACILITY:
(Yen) 100,000,000
2. ADVANCES: Advances shall be made in increments of (Yen) 10,000,000, to be
funded equally by MTC and GTC. Each advance shall be evidenced by a
promissory note duly executed by NEWCO.
3. TERM: The term of the credit facility shall be ten years.
4. LOAN FEES: None.
5. REPAYMENT AND INTEREST:
(a) Interest on the unpaid principal amount of each advance shall accrue
from the date of the advance until repaid in full at the fixed rate of three
percent per annum, for the actual number of days elapsed.
(b) No interest or principal shall be due and payable until a period of
five years, calculated from the first day of the month following the month in
which the advance is made, has elapsed ("Grace Period").
(c) The principal amount of each advance shall be repaid in twenty equal
quarterly installments in arrears, commencing on the last day of the first three
calendar months after the end of the Grace Period.
(d) Accrued interest during the Grace Period shall be repaid in 20
equal installments, together with the interest on the outstanding principal
amount of each advance, on the same date as the repayment of the principal
amount of the advance.
6. Optional Prepayments:
NEWCO may, upon at least one business day's prior written notice to GTC and
MTC, prepay the outstanding principal amount of any advance in whole, provided
that any such prepayment must be accompanied by payment of all accrued interest
to the date of such prepayment on the amount prepaid.
- 22 -
<PAGE>
EXHIBIT C
PRODUCTS SUPPLY AGREEMENT (Products and Services)
AND TECHNICAL SUPPORT
Upon incorporation of NEWCO, MTC shall provide products and services to
NEWCO, as requested by NEWCO, at the prices set forth below.
1. Products MTC shall initially provide to NEWCO shall include:
(a) Matrix Boxes (both single and multi line).
(b) As determined by MTC, Passport and related platform products at a cost
equal to MTC's loaded carrier cost plus ten percent.
2. MTC shall also provide NEWCO, promptly upon request, with complete
technical support, including:
(a) ESA Computer and software to provide communication facility to/from MTC
make NEWCO operational in terms of order entry and customer service in Japan;
(b) Sample data and specifications of MTC's billing software to allow third
party customization of the billing/invoicing system for the Japanese market.
(c) MTC shall use its best efforts, based upon production capacities, to
provide NEWCO with up to 50 Matrix Boxes per month for a period of up to four
(4) months.
- 23 -
<PAGE>
EXHIBIT D
OFFICE FACILITY AND STAFFING PROVIDED BY GTC
GTC shall provide the following office facility for NEWCO at the time of
establishment of NEWCO.
1. Dedicated office space at the S&S Building, co-located with GTC.
2. Furniture and office equipment to fully create an operational facility
for NEWCO.
3. On an as needed basis, staff support by assigning employees of GTC to
assist NEWCO staff with daily operations.
The above described facility shall be provided according to the following
conditions:
1. During the start-up period, defined as NEWCO able to perform at a better
than break-even level (revenue exceeds expenses) for three successive months, at
no cost.
2. When NEWCO's business performance demonstrates the capability to pay
"rent", a fee shall be negotiated in good faith between the management of GTC
and NEWCO.
3. When NEWCO's business performance demonstrates the capability to sustain
dedicated office facilities in location outside the S&S Building, and it is
determined beneficial to increasing marketshare, the management of NEWCO shall
coordinate with the management of GTC a move to another building.
- 24 -
<PAGE>
EXHIBIT E
EXCLUSIVITY AGREEMENT
1. MTC shall, upon the incorporation of NEWCO, appoint NEWCO as its
exclusive ("Exclusive") sales distributor in Japan provided that NEWCO meet the
following criteria:
a. For NEWCO to quality for and maintain Exclusive status, NEWCO must
meet the Total Quarterly Revenue Due MTC as provided herein and as shown in
===============================
Table 1. If NEWCO does not meet and maintain the Total Quarterly Revenue
=======================
Due MTC in Table 1, MTC, at its sole discretion, reserves the right to
=======
modify NEWCO's Exclusive status.
b. NEWCO agrees to use its best efforts to grow and expand its master
affiliate or sales distribution base in Japan. NEWCO further agrees that
after one year, master affiliate representation shall be distributed such
that no single master affiliate organization shall represent more than 40%
as measured by three successive months of NEWCO's monthly net revenue
sales.
c. NEWCO agrees to use its best efforts to promote the sale of NEWCO
products and services throughout the major geographical markets in Japan.
For the purposes of this Section, Exclusive shall mean that during the term
of this Agreement, that NEWCO meets the criteria as stated in Section 1(a) (b)
and (c) above, MTC agrees not to establish a Joint Venture Agreement with any
other entity in Japan for the purpose of selling and marketing the same MTC
products and services being marketed and sold by NEWCO.
2. MTC shall, upon the incorporation of NEWCO, appoint NEWCO as its
exclusive ("Exclusive") hardware manufacturer for the Matrix Box, any equipment
which provides similar functions and any similar equipment which provides new or
additional features or is designed as successor equipment for the Matrix Box to
NEWCO and shall not sell, supply, license or otherwise make available Matrix
Boxes or the technology embodied therein to any other entity in Japan provided
that NEWCO meet the following criteria:
a. NEWCO agrees to meet and maintain the criteria as set forth under
Section 1 as specified hereunder in this Exhibit E.
b. NEWCO agrees to meet and maintain manufacturing standards
consistent with ISO 9000 (International Standards of Operations) and MTC.
- 25 -
<PAGE>
For the purposes of this Section, Exclusive shall mean that during the
term of this Agreement that NEWCO meets the criteria as stated in Section 2 (a)
and (b) above. MTC agrees not to contract with any other entity in Japan for the
purposes of manufacturing the Matrix Box.
MTC agrees that during the term of this Agreement that NEWCO maintains
its status as Exclusive, MTC will forward requests for Matrix Box orders,
intended for installation at the end user customer premise in Japan, to NEWCO.
3. NEWCO understands that (i) MTC currently distributes its products and
services through a network of independent master affiliates ("MTC MAs") located
in the USA and around the world, and (ii) MTC MAs further contract with
independent contractor organizations and individuals known as Sub-Affiliates
("Subs") to distribute MTC products and services, and (iii) both MTC MAs and
Subs currently market and sell MTC products and services, including the Matrix
Box, in Japan, and (iv) current MTC MAs and current and future Subs, will
continue to be authorized to sell and market MTC products and services in Japan.
Furthermore, MTC agrees to promote to MTC MAs (i) that for the purposes
of marketing continuity and to promote the best interests of MTC and NEWCO, MTC
MAs and Subs seek a contact with NEWCO. NEWCO agrees that such reference shall
not entitle NEWCO to any association, claim or contractual relationship with
such MTC MAs or Subs and understands that MTC has no control over the decision
of the MTC MAs and Subs as to whether they elect to abide by the promotions of
MTC.
- 26 -
<PAGE>
MTC JAPAN
February, 1995
TABLE 1
QUARTER - YEAR 1 1 2 3 4
TOTAL QUARTERLY REVENUE DUE MTC $50,000 $543,600 $1,468,883 $3,831,741
QUARTER - YEAR 2 1 2 3 4
TOTAL QUARTERLY REVENUE DUE MTC $5,838,297 $7,863,297 $9,955,797 $12,318,297
<PAGE>
EXHIBIT 10.14
JOINT VENTURE AGREEMENT
THIS JOINT VENTURE AGREEMENT (as modified or amended from time to time, this
"Agreement") is made this ____ day of January, 1996, by and between Henk J.
Keilman and Jan Peter Kastelein (each individually a "JV Partner" and
collectively the "JV Partners"), and MTC Telemanagement Corporation, a
California corporation with offices in Petaluma, California, USA ("MTC") (the JV
Partners and MTC collectively referred to hereinafter as the "Parties"), with
reference to the following facts:
A. MTC is in the business of developing, producing, and
distributing unique, technology-based telecommunications products and services;
B. The JV Partners are principals in Atlantic Telecom B.V., a Dutch
corporation ("ATC"), which is engaged in the marketing, sales and installation
of telecommunications products and services; and
C. The Parties, desiring to establish a joint venture company under
the laws of the Netherlands in order to actively market and sell such products
and services in the Territory (defined below), entered into a Memorandum of
Understanding, dated as of November 22, 1995, which set forth the general
agreements of the Parties with respect to the joint venture.
D. The Parties now have agreed to establish such joint venture
company under the terms and conditions set forth below.
NOW, THEREFORE, in consideration of the foregoing and other good and
valuable consideration, the receipt and sufficiency of which is hereby
acknowledged, MTC and the JV Partners hereby agree as follows:
I. DEFINITIONS
A. Defined Terms. The following definitions shall apply to this
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Agreement:
"Affiliate Support Services" shall mean those services provided by the
Corporation to any Master Affiliate Licensee or Sub-Affiliate, including,
without limitation, services in connection with customer support, promotion,
public relations, advertising, ESA support services, and billing services.
"Agent" shall mean any person who is or was a director, officer,
employee or agent of the Corporation, or is or was serving at the request of the
Corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise.
"Authorized Signatory" shall have the meaning set forth in Section V.D.1
hereof.
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"Business Plan" shall mean the comprehensive business plan for the
Corporation covering a period of at least three (3) years, a copy of which is
attached hereto as Exhibit C.
"Commercial Code" shall mean the laws of the Netherlands but only
insofar as they relate to the organization and internal management of a
corporation in the Netherlands.
"Common Stock" shall have the meaning set forth in Section II.B. hereof.
"Corporation" shall have the meaning set forth in Section II.A. hereof.
"Disclosing Party" shall mean the Party furnishing Proprietary
Information to any other Party.
"Effective Date" shall mean the later of (i) the date first written
above or (ii) the date on which this Agreement is executed by each Joint Venture
Partner, the Chief Executive Officer of MTC and a Senior Vice President of MTC.
"ESA" shall mean MTC's Extended System Access computer system.
"Events of Default" shall have the meaning set forth in Section X.C.
hereof.
"Existing Affiliate" shall mean any Master Affiliate Licensee or Sub-
Affiliate existing as of the date of this Agreement.
"Existing Sales" shall have the meaning set forth in Section III.F.2.
hereof.
"JV Partner" shall have the meaning set forth in the preamble hereof.
"Letters of Credit" shall mean the letters of credit issued for the
benefit of MTC pursuant to Section II.E. hereof.
"Majority Shareholders" shall mean, with respect to each class of Stock,
the Shareholders holding more than fifty percent (50%) of such class of Stock.
"Master Affiliate Licensees" shall mean the network of independent
contractors located in the United States of America and around the world which
enter into agreements with MTC and/or the Corporation to promote and market MTC
Services.
"MTC Customers" shall mean any customer of MTC, but shall specifically
exclude any Subscribers.
"MTC Services" shall mean MTC's Communication Management Services offered by MTC
to the Corporation from time to time, including, but not limited TO, incoming
and outgoing international long distance telephone service, client services such
as, but not limited to, billing sorts, formats,
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master billing arrangements, and carrier services provided by MTC through OCCs,
as the foregoing may be modified from time to time, and related Products.
"New Affiliates" shall mean those entities which first become Master
Affiliate Licensees or any Sub-Affiliate thereof following the Effective Date of
this Agreement.
"New Affiliate License Agreement" shall have the meaning set forth in
Section III.C. hereof.
"OCC" shall mean other common carriers.
"Party" shall mean either MTC or any JV Partner.
"Products" shall mean communication products offered by MTC to the MTC
Customers and/or Subscribers.
"Proprietary Information" shall mean: (i) this Agreement and any
amendment hereto; (ii) any and all technical information of the Disclosing Party
including, without limitation, product data, methods of manufacture, technical
processes, designs and design systems, inventions and research programs, trade
"know-how", software, algorithms, computer processing systems, object and source
codes, user manuals, systems documentation, secret processes, know-how,
receipts, formulas, training material and technical data, any other similar
information; (iii) any and all business information of or relating to the
Disclosing Party that is not known to the general public including, without
limitation, personnel information, employment records and policies, rates and
rate tables, compensation schedules, pricing policies, credit and collections
policies, operational methods, marketing plans and strategies, product
development techniques or plans, new personnel acquisition plans, contract terms
and conditions, affiliate lists and customer lists; (iv) any information
disclosed to the Disclosing Party by a third party and designated as
confidential; and (v) any other information designated as confidential by the
Disclosing Party. Notwithstanding the foregoing, Proprietary Information shall
not include information which: (a) has been published or otherwise come into the
public domain through no fault of the Parties; (b) prior to disclosure is
properly within the legitimate possession of the Receiving Party without
obligation of confidentiality; (c) subsequent to disclosure is lawfully received
from a third party having rights therein without restriction of the third
party's right to disseminate such information and without notice of any
restriction against its farther disclosure; (d) is independently developed
without breach of any obligation of confidentiality through parties who have not
had direct or indirect access to or knowledge of such Proprietary Information;
or (e) is transmitted to the Receiving Party after the Disclosing Party has
received written notice from the Receiving Party that it does not desire to
receive further Proprietary Information.
"Receiving Party" shall mean any Party receiving Proprietary Information
from the Disclosing Party.
"Sales Revenue" shall mean MTC billed revenue that is eligible for
commission as determined by MTC.
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"Secondary Joint Venture" shall have the meaning set forth in Section
III.C. hereof.
"Secondary Joint Venture Agreement" shall mean, with respect to any
Secondary Joint Venture established pursuant to the terms hereof, the joint
venture agreement between MTC, the Corporation, and the Third Party.
"Shareholders" shall mean each JV Partner and MTC and their permitted
successors and assigns.
"Stock" shall mean any capital stock issued by the Corporation as
contemplated herein.
"Sub-Affiliates" shall mean those independent contractor organizations
which contract with Master Affiliate Licensees to promote and market MTC
Services.
"Subscribers" shall mean customers who are billed directly by the
Corporation.
"Territory" shall mean Belgium, the Netherlands, Luxembourg, France and
Germany.
"Third Party" shall mean any entity within the Territory that (a)
occupies strategic positions and has substantial market share in the
telecommunication industry in the Territory, (b) has significant abilities to
market, sell and distribute the Services, (c) whose business is compatible with
MTC's business and global strategy, and (d) is willing to make substantial
investments, including a minimum of initial capital contribution of no less than
U.S.$l,000,000.
B. Section References. As used in this Agreement, the words
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"hereof," "herein" and "hereunder," and words of similar import shall refer to
this Agreement as a whole, and not to any particular provision of this
Agreement, and the words "Article", "Section", "Exhibit" and "Addendum" are to
this Agreement unless otherwise specified.
II. ORGANIZATION OF THE CORPORATION
A. General. Prior to the Effective Date, the JV Partners
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established a new company organized as a public limited liability company under
the Commercial Code of the Netherlands. The new company currently is known as
MTC Telecom Western Europe B.V.I.O. and upon proper qualification under the laws
of the Netherlands shall be known as MTC Telecom Western Europe B.V.
(hereinafter, the "Corporation"). The charter documents required for the
formation of the Corporation shall be printed in both the Dutch and English
languages (copies of which are attached hereto as Exhibit A.) The JV Partners
shall prepare any and all documents as shall be required for the incorporation
of the Corporation, and MTC and the JV Partners shall, in conformity with the JV
Partners' instructions, promptly execute or cause to be executed any such
document as may be required in connection therewith.
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Furthermore the Parties recognize that due to legal or tax
considerations, or considerations related to Dutch Company law, some aspects of
the Joint Venture Agreement may have to be amended after the Agreement has been
executed. Such amendments will be agreed upon by the Parties on a case by case
basis, and will be guided by the legal and tax requirements as advised by an
external, qualified consultant.
B. Authorized Capital. The Corporation shall have the authority to
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issue ___________________ (_______) shares of non-bearer common stock issuable
by the Corporation ("Common Stock"). The Common Stock shall have a par value of
one Dutch guilder per share. The Corporation's stock may be held by the Parties
directly or indirectly through an affiliated legal entity controlled by such
Party.
C. Contributions by the Parties. The Parties shall make capital
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contributions or loans to the Corporation in the following amounts:
1. MTC will contribute a total amount in cash of U.S.
$[ * ], of which U.S. $[ * ], will be contributed in the form of share
capital, and U.S. $[ * ] will be contributed in the form of [ * ]. The
total amount of U.S. $[ * ] will be paid in twelve equal monthly
installments of U.S. $[ * ] each, of which the first installment was
made on or around _________________ , 1996. In addition MTC will provide
to the Corporation the use of assets deemed worth U.S. $[ * ] in the
form of know how, contacts, the MTC name and support structure. The use
of these assets will be provided to the Corporation free of charge for
the duration of this Agreement.
2. The JV Partners collectively will contribute a total
amount in cash of U.S. $[ * ], of which U.S. $[ * ] will be contributed
in the form of share capital, and U.S. $[ * ] will be contributed in the
form of [ * ]. This amount will be paid within the first two weeks of
December 1995. In addition the JV Partners will provide to the
Corporation the use of assets deemed worth U.S. $[ * ]. These assets
comprise the assets of ATC, including its know how, trained staff, the
base of customers which are billed directly by ATC or one of its
affiliates, office equipment, contacts, distribution agreement with
Salland Corporation, billing and customer service software. A balance
sheet of ATC, in which these assets are stated, has been attached to
this Agreement as Exhibit A. The use of these assets will be provided to
the Corporation free of charge for the duration of this Agreement.
3. The Shareholders agree, that in the case the above
funding arrangements will not be adequate, the Shareholders will discuss
additional funding to the Corporation on a case by case basis.
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* Confidential treatment requested; omitted portion filed separately with the
Commission.
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D. Issuance of Shares.
1. MTC, directly or indirectly, shall receive ____________
shares of the Common Stock, representing fifty percent (50%) of the
total issued and outstanding shares Common Stock.
2. The JV Partners, directly or indirectly, collectively
shall receive _________________ shares of the Common Stock, representing
fifty percent (50%) of the total issued and outstanding shares of Common
Stock.
3. MTC and each JV Partner each shall notify the
Corporation of its intention not to receive and hold its respective
share certificates of the Common Stock in accordance with the laws of
the Netherlands.
E. Assignment of Credit Insurance. The JV Partners shall cause ATC
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to assign to the Corporation all credit insurance policies with respect to
Subscribers, and the Corporation immediately shall assign such policies to MTC.
Furthermore, the Corporation shall require credit insurance policies in
connection with sales to each Subscriber and shall assign all such policies to
MTC. Bach such credit insurance policy shall insure no less than eighty percent
(80%) of the retail amount of MTC Services billed to such Subscribers.
In the event that contractual or legal requirements prevent the JV Partners from
assigning such credit insurance policies, the JV Partners shall cause such
credit insurance policies to be pledged to MTC.
F. Financing. The Parties shall make all reasonable efforts to
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cause the Corporation to operate on a self-supporting basis. If and when the
Corporation requires additional fluids for its operation, the board of
supervisory directors of the Corporation shall direct the managing directors to
arrange commercial lines of credit sufficient to finance the Corporation's on-
going operations.
G. Security for Obligations to MTC. The Corporation shall take
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appropriate actions to limit any credit exposure of MTC with respect to all
wholesale sales of MTC Services to the Corporation for sale by the Corporation
to Subscribers. Notwithstanding the foregoing, the Corporation shall provide to
MTC such guaranties as shall deemed necessary by the Shareholders upon
consultation with the board of supervisory directors.
H. Proprietary Information. Notwithstanding any other provision
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contained herein, all product designs and design projects, technical, secret
process, product development techniques or plans, invention and research
projects, trade "know-how", methods of operation, formulae, software,
algorithms, computer processing systems, object and source codes, user manuals,
system documentation, training and marketing materials, technical data, and
other similar material and information are and shall remain the sole and
exclusive property of MTC; provided, that all such proprietary information owned
or developed by ATC or in which ATC claimed an interest prior to the Effective
Date, and all such proprietary information owned or developed by
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the Corporation or in which the Corporation claims an interest, is and shall
remain the sole and exclusive property of the Corporation. MTC shall license the
Corporation to market and distribute MTC Services in connection therewith during
the term of this Agreement.
I. Subscribers. Once MTC has completed the implementation of its
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new billing platform, it is the intent of the parties to migrate Subscribers to
a direct billing arrangement by MTC and treated as MTC Customers.
III. OBJECTS AND PURPOSES OF THE CORPORATION
A. Actions. All actions with respect to the Corporation shall be
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made pursuant to a resolution approved by the board of supervisory directors or
the Shareholders, as appropriate.
B. Authorized Activities. The authorized business activities of the
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Corporation shall be:
1. To distribute MTC Services in the Territory;
2. To provide customer support to MTC Customers and
Subscribers;
3. To find and appoint New Affiliates within the Territory;
4. To establish Secondary Joint Ventures within the
Territory pursuant to Section III.C. below;
5. To make all Affiliate Support Services available to any
Master Affiliate Licensee, M-net representative, or Secondary Joint
Venture;
6. To make direct sales to MTC Customers or Subscribers;
and
7. Any other activities consistent with the terms of this
Agreement and otherwise as authorized from time to time by the
Shareholders.
C. New Affiliates. New Affiliates appointed by the Corporation
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shall enter into written marketing and license agreements with the Corporation,
in form and substance acceptable to MTC (each, a "New Affiliate License
Agreement"). Without limiting the generality of the foregoing, each New
Affiliate License Agreement shall provide that such agreement is assignable to
MTC, and the Corporation shall assign such agreement to MTC immediately after
its execution by the parties thereto.
D. Secondary Joint Ventures. In the event that the Corporation or
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MTC identifies a Third Party in the Territory then MTC, in its sole discretion,
may offer any such Third Party a joint venture arrangement with MTC (a
"Secondary Joint Venture") under the following terms
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and conditions and other such terms and conditions as shall be agreed upon by
MTC, the Corporation, and the Third Party in the respective Secondary Joint
Venture Agreement:
1. The division of shares between the Third Party, MTC and
the Corporation will be decided on a case by case basis.
2. Each Secondary Joint Venture Agreement will set forth
sales and revenue criteria, and the failure of the Secondary Joint
Venture to meet such criteria shall constitute an event of default
thereunder that shall give MTC the right, but not the obligation, to
purchase at fair market value the shares of such Secondary Joint Venture
held by either the Third Party or the Corporation.
3. The day-to-day management of any Secondary Joint Venture
shall be conducted by the Third Party. The Corporation shall provide
executive management and support services to the Secondary Joint Venture
as set forth in the Business Plan.
4. MTC, at its sole discretion, may agree with the JV
Partners and/or the Corporation to establish other joint ventures
outside of the Territory, but within Europe.
E. Restricted Activities.
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1. During the term of this Agreement and for a period of
two YEARS following the termination thereof, no JV Partner shall
directly or indirectly engage in, invest in, or perform any business
competitive with the business activities of the Corporation except as
described in Section III.F. below without the prior written consent of
MTC.
2. The Corporation may only contact existing MTC Customers
(other than those MTC Customers which became MTC Customers through ATC
or one of its Sub-Affiliates) with the written approval of the
appropriate Existing Affiliate and MTC.
F. Affiliate Relations. The JV Partners acknowledge that,
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notwithstanding any provision to the contrary contained herein, MTC and/or any
of its Existing Affiliates currently may market and sell MTC Services in the
Territory and that Existing Affiliates and New Affiliates will continue to be
authorized to sell and market MTC Services in the Territory. MTC will use its
best efforts to encourage the cooperation of Existing Affiliates with the
Corporation with respect to such sales and distribution activities, particularly
in the areas of certain support services that will be offered by the Corporation
including: (a) Affiliate Support Services; (b) promotion, public relations and
advertising; and (c) contract administration and MTC Customer database services.
Notwithstanding the foregoing, the JV Partners acknowledge that Existing
Affiliates are parties to binding contracts with MTC that do not contain such
provisions and that modification of such contracts will be time-consuming and,
in some cases, may not be possible without the consent of the Existing
Affiliates. Further details regarding the development of relations between the
Corporation, Existing Affiliates, M-Net representatives and MTC Customers will
be described in the Business Plan.
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G. Revenues of the Corporation. The Corporation shall earn revenues
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as follows:
1. Sales by New Affiliates. With respect to sales of MTC
Services by each New Affiliate within the Territory, during the term of
this Agreement the Corporation will receive from MTC a commission equal
to the greater of (a) [ * ] percent ([ * ]%) of such Sales Revenue, or
(b) the difference between (i) [ * ] percent ([ * ]%) of such Sales
Revenue and (ii) the commission paid to such New Affiliate; provided,
that any agreements which provide for commissions of greater than [ * ]
percent ([ * ]%) to any New Affiliate must be approved in advance by MTC
in writing.
2. Sales by Existing Affiliates. MTC will use its best
efforts to propose that Existing Affiliates modify their respective
agreements with MTC to provide that, with respect to sales of MTC
Services by each Existing Affiliate within the Territory who agrees to
use the Affiliate Support Services provided by the Corporation, the
Corporation will receive from the commissions currently paid to such
Existing Affiliate during the term of this Agreement a commission equal
to (a) [ * ] percent ([ * ]%) of such Sales Revenue up to the level of
Sales Revenue of such Existing Affiliate as of the date such Existing
Affiliate agreed to use the support services provided by the Corporation
(the "Existing Sales"), (b) [ * ] percent ([ * ]%) of the Sales Revenue
by such Existing Affiliate in excess of the Existing Sales, and (c)
[ * ] percent ([ * ]%) of the Sales Revenue of any Sub-Affiliate
appointed by the Existing Affiliate following the effective date of such
agreement. The Corporation will earn no commission with respect to the
Sales Revenue of an Existing Affiliate unless such Existing Affiliate
enters into a written modification of its existing agreements with MTC
pursuant to which such Existing Affiliate agrees to (y) use the
Affiliate Support Services provided by the Corporation, and (z) modify
its commission schedule with MTC.
3. Sales by Secondary Joint Ventures. With respect to sales
of MTC Services by any Secondary Joint Venture within the Territory,
during the term of this Agreement the Corporation will receive from MTC
a commission of between [ * ] percent ([ * ]%) to [ * ] percent ([ * ]%)
of such Sales Revenue, as agreed upon by the Parties from time to time.
4. Sales by M-net Representatives. With respect to sales of
Services by M-net representatives within the Territory, during the term
of this Agreement the Corporation will receive from MTC a commission
equal to [ * ] percent ([ * ]%) of eligible M-net Sales Revenue and as
defined in the Business Plan.
5. Equity in Secondary Joint Ventures. The Corporation will
receive no less than [ * ] percent ([ * ]%) of the initial equity
distribution in any Secondary Joint Venture, subject to (a) agreement
with the Third Party, (b) compliance by the JV Partners with the terms
of this Agreement and during the term hereof and (c) repurchase of such
equity interest by MTC as provided in the Secondary Joint Venture
Agreement between MTC, the Corporation, and the Third Party.
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* Confidential treatment requested; omitted portion filed separately with the
Commission.
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IV. SHAREHOLDERS
A. Time and Place of Meetings. Meetings of the Shareholders for any
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purpose or purposes, unless otherwise prescribed by statute or by the
certificate of incorporation, (i) may be called by any Shareholder, and (ii)
shall be called at the request in writing of a majority of the board of
supervisory directors. Such request shall state the purpose or purposes of the
proposed meeting. Written notice of a Shareholder meeting stating the place,
date and hour of the meeting, and the purpose or purposes for which the meeting
is called, shall be given not less than ten (10) nor more than sixty (60) days
before the date of the meeting to each Shareholder. The period of notice may be
shortened or the notice may be dispensed with for a particular meeting by the
unanimous consent of all of the Shareholders. Shareholder meetings may be held
by telephone.
B. Quorum. At all meetings of the Shareholders, Shareholders owning
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or otherwise representing eighty percent (80%) of all shares of Stock shall
constitute a quorum for the transaction of business.
C. Voting. Whenever Shareholders vote in connection with any action
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contemplated under the terms of this Agreement, each Shareholder shall be
entitled to cast votes equal in number to the number of shares held by such
Shareholder. Except as otherwise provide herein, any resolution of the
Shareholders shall be adopted by vote of the Majority Shareholders. Shareholders
will act reasonably and in good faith to avoid deadlocks.
D. Vote by Proxy. If and when any of the Shareholders intends to
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exercise its voting right by proxy at any general meeting of the Shareholders of
the Corporation, such Shareholder may appoint any Shareholder of the Corporation
as its proxy.
E. Consent Required for Certain Actions. The unanimous written
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consent of all Shareholders shall be required for any of the following actions
of the Corporation:
1. Any addition to or modification of the articles of
association;
2. The amount of compensation of statutory auditors;
3. Approval of any annual budgets, financial statement, or
business plan for each fiscal year;
4. Acquisition, transfer (including the granting or
imposition of liens thereon or the license or sub-license thereof), or
disposition of any patents, design patents, trademarks, copyrights, or
any other intellectual property, including any license of any of the
foregoing;
5. Sale of all or substantially all of the assets of the
Corporation, or the merger or consolidation of the Corporation with
another entity;
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6. Any modification of the capitalization of the
Corporation, whether such modification pertains to an increase in the
number of shares of Common Stock or the establishment of any other class
of capital stock;
7. The sale of any additional shares of Stock of the
Corporation; or
8. Other similar actions as agreed from time to time by a
unanimous written consent of the Shareholders.
As for any of the actions referred to in this Section IV.E. for which all
Shareholders have given written consent and for which a resolution of either the
general meeting of Shareholders or the board of supervisory directors is
required, the Shareholders shall exercise their respective voting rights as
Shareholders or, as the case may be, shall cause their respective nominee
supervisory directors to exercise their voting rights to adopt the related
resolution in conformity with the action for which such unanimous consent of the
Shareholders was given.
F. Written Consent. Unless otherwise provided in the certificate of
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incorporation, any action required to be taken at any meeting of the
Shareholders, or any action which may be taken at any meeting of the
Shareholders, may be taken without a meeting, without prior notice and without a
vote, if a consent in writing, setting forth the action so taken, shall be
signed by all Shareholders.
G. Business Plans, Annual Budgets and Sales Planning. Prior to the
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formation of the Corporation, the JV Partners will provide the lead role in the
development of the Business Plan. Each year thereafter, the Corporation shall
prepare a revised business plan for approval by the Shareholders. Unless
otherwise agreed upon in advance by the Shareholders in writing, the
Shareholders shall consult with each other to determine the initial annual
budget of the Corporation and sales planning therefore. Subsequent annual
budgets and sales planning will be determined and agreed upon by the
Shareholders prior to the commencement of each of the Corporation's fiscal
years, along with the updated Business Plan.
H. Transfer of Shares. MTC may assign, pledge or otherwise transfer
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its shares in the Corporation without the consent of the JV Partners. The JV
Partners may not assign, pledge or otherwise transfer any of their shares in the
Corporation without the prior written consent of MTC.
I. Auditors. Any Shareholder may, at its sole expense, designate a
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certified public accountant to audit the books and records of the Corporation
once each fiscal year.
J. Audit and Inspection Rights. Upon the request of any
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Shareholder, the board of managing directors shall provide to such Shareholder
copies of Corporation's corporate, financial, and operating records in such
detail as requested by such Shareholder. Any Shareholder or its representatives
may visit the properties of the Corporation at any time during normal business
hours to review such records, make copies thereof or abstracts therefrom, and to
discuss the
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matters related to the Corporation with the managing directors, other officers
or agents, and independent accountants, all at the expense of the Corporation.
V. GENERAL PROVISIONS
A. Dividends. Dividends upon the Stock, if any, and subject to the
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provisions of the certificate of incorporation, may be declared by the board of
supervisory directors at any regular or special meeting, pursuant to applicable
law. Dividends may be paid in cash, in property, or in shares of the Stock,
subject to the provisions of the certificate of Incorporation.
B. Reserves. Before payment of any dividend, there may be set aside
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out of any funds of the Corporation available for dividends such sum or sums as
the supervisory directors from time to time, in their absolute discretion, think
proper as a reserve or reserves to meet contingencies, or for equalizing
dividends, or for repairing or maintaining any property of the Corporation, or
for such other purpose as the supervisory directors shall think conducive to the
interest of the Corporation, and the supervisory directors may modify or abolish
any such reserve in the manner in which it was created.
C. Corporate Condition. Upon the request of the Majority
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Shareholders, the board of managing directors shall present at a meeting of the
Shareholders a full and clear statement of the business and condition of the
Corporation.
D. Fiscal Year. The fiscal year of the Corporation shall commence
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on the first (1st) day of January of each calendar year and shall end on the
thirty-first (31st) day of December of the same year; provided, that the initial
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fiscal year of the Corporation shall commence on the day of its incorporation
and shall end on the thirty-first (31st) day of December, 199_.
E. Indemnification. The Corporation shall, to the maximum extent
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permitted by law, have the power to indemnify each of its supervisory directors,
managing directors, officers and agents against expenses, judgments, fines,
settlements, and other amounts actually and reasonably incurred in connection
with any proceeding arising by reason of the fact that any such person is or was
a director, officer, or agent of the Corporation, and shall have the power to
advance to each such agent expenses incurred in defending any such proceeding to
the maximum extent permitted by law.
F. Staff and Product Support. The Shareholders shall provide
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ongoing staff and product support to the Corporation as set FORTH in the
Business Plan. Any and all such matters relating to the staffing of the
Corporation not specifically provided for in the Business Plan shall be
separately agreed upon in writing by the board of supervisory directors.
VI. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE JV PARTNERS
A. Representations and Warranties. Each JV Partner represents and
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warrants to
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MTC, as the Effective Date, that:
1. ATC is a corporation duly organized, validly existing
and in good standing under the laws of the Netherlands;
2. ATC has the power and authority and all governmental
licenses, authorizations, consents and approvals to own its assets,
carry on its business, and to execute, deliver and perform its
obligations under each agreement to which it is a party;
3. the execution, delivery and performance by the JV
Partners of this Agreement and each other agreement in connection
herewith to which any JV Partner or ATC is a party have been duly
authorized by all necessary corporate action, and do not and will not
(a) contravene the terms of any of ATC's organization documents, (b)
conflict with or result in the contravention of any order, injunction,
writ or decree of any governmental authority to which ATC is subject,
and (c) violate any requirement of any applicable law;
4. no approval, consent, exemption, authorization, or other
action by, or notice to, or filing with, any governmental authority is
necessary or required in connection with the execution, delivery or
performance by, or enforcement against, any JV Partner of this Agreement
except as expressly provided herein;
5. this Agreement constitutes a legal, valid and binding
obligation of each JV Partner, enforceable against each JV Partner in
accordance with its terms, except as enforceability may be limited by
applicable insolvency or similar laws or by equitable principles
relating to enforceability;
6. no JV Partner has entered into this Agreement for any
purpose other than to sell and market MTC Services, and that any use of
the Proprietary Information of MTC for purposes other than the
performance of its obligations hereunder, including any direct or
indirect competition with MTC. would cause MTC irreparable harm;
7. neither any JV Partner, ATC, nor any affiliate thereof
has entered into any agreement or understanding, oral or written, with
any MTC Customer which is inconsistent with the terms of this Agreement
or which shall result in, or with the passage of time reasonably may
result in, the breach or violation of this Agreement;
8. except as set forth in Exhibit D hereto, neither ATC nor
any JV Partner is a party to any actual or threatened claims,
litigation, suits, or proceedings;
9. except as set forth on Exhibit E hereto, no JV Partner
is a partner or joint venturer in any partnership or joint venture
related to the provision of telecommunications products and services or
in any manner or which might be construed as competitive in nature to
MTC and MTC Services; and
13
<PAGE>
10. All information provided to MTC by any JV Partner,
including the information set forth on the Exhibits attached hereto, is
true and correct as of the Effective Date.
B. Affirmative Covenants. Each JV Partner covenants to MTC that
---------------------
until the performance of all of its obligations hereunder and until the
termination of this Agreement, each JV Partner shall cause the Corporation to
comply with the following covenants:
1. Books and Records. The Corporation shall maintain
-----------------
adequate books and records and accounts in accordance with generally
accepted accounting principles consistently applied, and shall permit
any Shareholder, at any reasonable time during normal business hours, to
inspect, audit, and examine such books and records and inspect any of
its properties, and shall furnish each Shareholder with all information
regarding the business or finances of the Corporation promptly upon
request;
2. Quarterly Financial Reports. The Corporation shall
---------------------------
provide to each Shareholder, within sixty (60) days after the close of
each quarterly accounting period in each fiscal year the following
financial statements, each in form and substance satisfactory to MTC:
(a) a statement of Shareholders' equity and statement of changes in
financial position for such quarterly period; (b) an income statement;
and (c) a balance sheet as of the end of such quarterly period in all
reasonable detail, subject to year-end audit adjustments and certified
by the Corporation's principal financial officer to have been prepared
in accordance with generally accepted accounting principles consistently
applied;
3. Annual Financial Reports. The Corporation shall provide
------------------------
to MTC, within ninety (90) days after the close of each fiscal year, a
copy of the annual audit report for such year for the Corporation in
form and substance satisfactory to MTC, including therein: (a) a
statement of Shareholders' equity and statement of changes in financial
position for such quarterly period; (b) an income statement; and (c) a
balance sheet as of the end of such quarterly period in all reasonable
detail, certified by the Corporation's principal financial officer to
have been prepared in accordance with generally accepted accounting
principles consistently applied;
4. Compliance with Law. The Corporation shall comply with
-------------------
the requirements of all applicable laws, rules, regulations, orders of
any governmental agency and all material agreements to which it is a
party;
5. Notice of Litigation. The Corporation shall provide to
--------------------
each Shareholder prompt, written notice of any actual or threatened
claims, litigation, suits, proceedings or disputes which, if adversely
determined, would have a material adverse effect on the operations,
business, properties or condition (financial or otherwise) of the
Corporation or its ability to perform its obligations hereunder; and
6. Other Information. The Corporation shall provide to each
-----------------
Shareholder any other reports or information as any Shareholder may
reasonably request from time to time.
14
<PAGE>
C. Negative Covenants. Each JV Partner covenants to MTC that until
------------------
the performance of all of its respective obligations hereunder and until the
termination of this Agreement (unless another time period is specified), each JV
Partner shall comply with the following covenants:
1. Non-Competition. Without the prior written approval of
---------------
MTC, no JV Partner shall enter into a similar enterprise with any long
distance company, long distance reseller, long distance service
provider, switchless reseller, rebiller, aggregator, OCC, local exchange
carrier, post-telephone and telegraph administration, call-back service
provider, re-originator service provider, telemanagement company, agent,
or any other originating and/or terminating long distance, local access
or transport area, or local telephone service that sells, remarkets or
otherwise represents an organization that might be construed as
competitive in nature to MTC and MTC Services;
2. Non-Solicitation. Prior to that date which is two (2)
----------------
years following the termination of this Agreement, neither any JV
Partner, the Corporation nor any of its officers or employees shall (a)
solicit for business, directly or indirectly, verbally or otherwise, any
MTC Customer, (b) directly or indirectly sell, market, consult,
recommend, or offer opinions or referrals related to products and/or
services on behalf of any organization that may be construed, in the
sole but reasonable judgment of MTC, as providing and/or representing
products and/or services competitive in nature to MTC Services, (c)
derive direct or indirect financial benefit from the sale of any product
and/or service to any customer of MTC that may be construed, in the sole
but reasonable judgment of MTC, as competitive in nature to MTC
Services, (d) provide information regarding MTC Customers to any third
party for any purpose, (e) solicit MTC employees for employment
elsewhere, or (f) solicit any other sales entity of MTC, including,
without limitation any Master Affiliate Licensee or Sub-Affiliate, for
the purpose of representing the Corporation or any JV Partner;
3. Confidential Information. Except as set forth herein,
------------------------
neither the Corporation nor any JV Partner shall provide any third
party, directly or indirectly, with any Proprietary Information of MTC;
4. Other Agreements. Neither the Corporation nor any JV
----------------
Partner shall enter into any agreement or understanding, oral or
written, with any MTC Customer which attempts or purports to alter or
vary, or is inconsistent with, the terms of this Agreement or which
results in, or with the passage of time reasonably may result in, the
breach or violation of this Agreement;
5. Misrepresentations. Neither the Corporation nor any JV
------------------
Partner shall furnish MTC with any certificate or other document that
will contain any untrue statement
15
<PAGE>
of material fact or that will omit to state a material fact necessary to
make it not misleading in light of the circumstances under which it was
furnished; and
6. Partnerships. Except as set forth on Exhibit E hereto,
------------
without prior written notice to MTC no JV Partner shall be a partner or
joint venturer in any partnership or joint venture related to the
provision of telecommunications products and services or in any manner
or which might be construed as competitive in nature to MTC and MTC
Services.
VII. COVENANTS OF MTC
MTC covenants to the JV Partners that until the performance of all of
its obligations hereunder and until the termination of this Agreement, MTC shall
comply with the following covenants:
A. Confidential Information. Except as set forth herein, MTC shall
------------------------
not provide any third party, directly or indirectly, with any Proprietary
Information of any JV Partner except as permitted herein.
B. Misrepresentations. MTC shall not furnish any JV Partner or the
------------------
Corporation with any certificate or other document that will contain any untrue
statement of material fact or that will omit to state a material fact necessary
to make it not misleading in light of the circumstances under which it was
furnished.
VIII. CONFIDENTIALITY
A. Use of Proprietary Information. In performing its respective
------------------------------
obligations hereunder, the Parties may disclose to each other certain
Proprietary Information. Each Party agrees that Proprietary Information is, and
shall remain, the sole and exclusive property of the Disclosing Party. Each
Party shall treat the Proprietary Information in a confidential manner and shall
not divulge, communicate or use to the detriment of the Disclosing Party or for
the benefit of the Receiving Party or any other person or persons, or misuse in
any way, any Proprietary Information of the other Party except (i) with the
prior written consent of the Disclosing Party, (ii) if the Receiving Party is
required to do so pursuant to a final order of a court of competent
jurisdiction, or (iii) as the Receiving Party is otherwise required by
applicable law following notice of not less than thirty (30) days to the
Disclosing Party.
B. Dissemination of Proprietary Information. No Party shall reveal
----------------------------------------
the Proprietary Information of any other Party to any employee or agent of such
Party other than those employees or agents who (i) have a need to know such
Proprietary Information and (ii) agree to be bound by the provisions of this
Section VIII. Each Party shall inform each such employee or agent of the
confidential nature of the Proprietary Information and shall take all reasonable
and appropriate measures to ensure that no such employee or agent shall use or
disclose any Proprietary Information of any other Party, other than in
accordance with the terms
16
<PAGE>
of this Agreement. Such appropriate measures may include a written agreement
signed by each such employee or agent.
C. Return of Proprietary Information and Other Materials. Upon the
-----------------------------------------------------
earlier of (i) thirty (30) days following the termination or expiration of this
Agreement or (ii) the written request of the Disclosing Party at any time, the
Receiving Party shall return to the Disclosing Party all originals and any
copies of Proprietary Information of the Disclosing Party.
D. Relief Available Upon Disclosure or Dissemination. Each Party
-------------------------------------------------
acknowledges that the breach or threatened breach of this Section VIII may cause
the Disclosing Party irreparable harm which would not be adequately compensated
by monetary damages. Accordingly, in the event of any such breach or threatened
breach, the Receiving Party agrees that equitable relief, including temporary
restraining orders or preliminary or permanent injunctions, shall be an
available remedy in addition to any other legal remedies to which the Disclosing
Party may be entitled.
IX. CONDITIONS PRECEDENT
A. The obligation of MTC to provide any services or products to the
Corporation or its customers is subject to the fulfillment to MTC's satisfaction
of each of the following conditions on the Effective Date:
1. MTC shall have received written assurance from the JV
Partners that within one month from the date of this Agreement, the JV
Partners shall deliver an assignment of each credit insurance policy in
effect with respect to any Subscriber.
2. MTC shall have received executed copies of any ancillary
agreements as appropriate with respect to services to be provided to the
Corporation during the term of this Agreement;
3. MTC shall have received, in form and of substance
satisfactory to MTC, a written opinion, dated as of the Effective Date,
from a firm of international reputation licensed or otherwise authorized
to practice law in the Netherlands with respect to any matters required
by MTC;
4. MTC shall have received and approved the Business Plan;
5. MTC shall have received (a) ATC's most recent balance
sheet and profit and loss statement, and (b) a commitment to forward
ATC's year end 1995 financial statements upon their completion.
6. MTC shall have received evidence that ATC is organized
and is in good standing under the laws of the Netherlands;
17
<PAGE>
7. Within thirty (30) days of the Effective Date, MTC shall
have received evidence that the Corporation is organized and is in good
standing under the laws of the Netherlands; and
8. Within thirty (30) days of the Effective Date, MTC shall
have received evidence of insurance with respect to the operations of
the Corporation.
X. TERM OF AGREEMENT; TERMINATION
A. Term of Agreement. This Agreement shall remain in effect until
-----------------
terminated as set forth below.
B. Termination. Upon the occurrence of an Event of Default, the
-----------
non-breaching Party may terminate this Agreement and, except as provided in
Section X.D.1. below, all rights of the Parties hereunder upon forty-five (45)
days notice to the other Parties; provided, that the breaching Party shall have
--------
thirty (30) days from the occurrence of any Event of Default to cure such Event
of Default to the sole satisfaction of the non-breaching Party.
C. Events of Default. Each of the following events shall constitute
-----------------
a default hereunder (each, an "Event of Default"):
1. The breach by any JV Partner of any representation,
warranty, covenant or agreement contained herein;
2. The Corporation fails to meet projected sales, revenues
or other financial criteria as set forth in the Business Plan;
3. The liquidation or insolvency of any Shareholder; the
appointment of a receiver or similar officer for any Shareholder; an
assignment by any Shareholder for the benefit of all or substantially
all of its creditors; entry by any Shareholder into an agreement for the
composition, extension, or readjustment of all or substantially all of
its obligations; or the filing of a meritorious petition in bankruptcy
or similar procedure by or against any Shareholder under any bankruptcy
or debtors' law for its relief or reorganization;
4. Henk J. Keilman either (a) becomes deceased, (b) in good
faith becomes unable to effectively perform his duties as an employee or
director of the Corporation for any reason, (c) ceases to be employed by
the Corporation for any reason other than his resignation, or (d)
resigns from his position(s) with the Corporation;
5. Jan Peter Kastelein ceases to be employed by the
Corporation for any reason including, without limitation, his
resignation;
18
<PAGE>
6. Any assignment or attempted assignment by any JV Partner
of this Agreement or any interest of any JV Partner herein except as
permitted pursuant to Section XI.C. hereof; or
7. Any JV Partner performs any act, or omits to act, in a
situation which is considered by MTC to be detrimental to the business
of MTC or its relationship with any Subscriber or MTC Customer,
including, but not limited to, any material misrepresentation by any JV
Partner, any criminal act by any JV Partner, dissemination of
Proprietary Information pursuant to Section VIII hereof, or any W
Partner's interference with present or potential contractual rights of
MTC with any third party, including any Subscriber or MTC Customer.
D. Effect of Termination.
---------------------
1. Remedies Following Termination. Termination of this
------------------------------
Agreement shall not limit any Party from pursuing other remedies
available to it. The Parties' rights and obligations under Sections
VI.B. (Affirmative Covenants), VI.C. (Negative Covenants), VII
(Covenants of MTC), VIII (Confidentiality), and XI (Miscellaneous)
hereof shall survive the termination of this Agreement.
2. Purchase of JV Partners' Stock in the Corporation.
-------------------------------------------------
a. In the event that MTC exercises its right to
terminate this Agreement based solely on the occurrence of an
Event of Default set forth in Sections XII.C.2., XII.C.4.a.,
XII.C.4.b., XII.C.4.c., or any combination thereof, MTC shall
have the obligation to purchase the Stock of the Corporation
held by each JV Partner pursuant to Article XII.D.3. below.
b. In the event that any Shareholder terminates this
Agreement as a result of the occurrence of any Event of Default
other than those set forth in Sections XII.C.2., XIJ.C.4.a,
XII.C.4.b., or XII.C.4.c., MTC will have the option, but not the
obligation, to purchase the Stock of the Corporation from each
JV Partner.
3. Valuation of Stock in the Corporation. Any purchase of
-------------------------------------
the Stock of the Corporation pursuant to Section X.D.2. above shall be
for fair market value as determined according to generally accepted
accounting and valuation principles by an independent consulting firm
agreed upon by the Shareholders. Such valuation shall take into
consideration the goodwill associated with the income stream to the
Corporation as it relates to Sections III.G.l., III.G.2., III.G.3., and
III.G.4., and also the equity participation of the Corporation as
provided in Section III.G.5. In case the Shareholders cannot agree on a
consulting firm, MTC shall select a consulting firm to conduct such
appraisal, provided such consulting firm has no direct link with MTC,
and provided such consulting firm is a generally recognized and
reputable firm.
19
<PAGE>
XI. MISCELLANEOUS
A. Modification of MTC Services. MTC reserves the right at any time
----------------------------
to modify, alter, improve, change, add to or discontinue any or all of the MTC
Services or any carrier or feature thereof. MTC reserves the right to alter its
rates charged for the MTC Services as it deems appropriate in its sole
discretion. IATC shall use its best efforts to provide the Corporation with
advance notification of discontinued MTC Services and rate changes.
B. Use of Trademarks. The Corporation may use the trademarks and
-----------------
trade names of MTC in such form as provided to the Corporation. The Corporation
shall not use trademarks or service marks for services or products of other
companies except in strict compliance with the requirements of the holder of
such trademarks or service marks. Authorized logos will be provided by MTC.
C. Binding Agreement; Assignment. This Agreement shall be binding
-----------------------------
on the parties and their permitted successors and assigns; provided, however,
-------- -------
that MTC may assign, pledge or otherwise transfer this Agreement, all of its
rights thereunder, and transfer its Stock in the Corporation without the consent
of the JV Partners; and provided, further, that the JV Partners may not assign,
-------- -------
pledge or otherwise transfer any of their right, title and interest in this
Agreement or any of their Stock in the Corporation without the prior written
consent of MTC.
D. Arbitration. Any disputes arising under this Agreement shall be
-----------
submitted to neutral, binding arbitration in either the county of Sonoma,
California, U.S.A. or the county of San Francisco, California, U.S.A. (at the
sole discretion of MTC) in accordance with the California Arbitration Act
(C.C.P. (S)(S) 1280 et seq.) and not by court action except as provided by
California law for the judicial review of arbitration proceedings. The parties
shall be entitled to discovery as provided in Sections 1283.05 and 1283.1 of the
California Code of Civil Procedure, whether or not the California Arbitration
Act is deemed to apply to said arbitration. Any decision or award entered as a
result of such arbitration shall be final and binding upon both parties. The
filing of a judicial action to enable the recording of a notice of a pending
action, or for orders of attachment, receivership, injunction, or other
provisional remedies, shall not constitute a waiver of the right to arbitrate
under this provision. The Parties agree to the exclusive personal jurisdiction
of courts of general jurisdiction in Sonoma County, California, U.S.A. for
enforcement of such arbitration awards, agree to accept any service of process
by personal service, facsimile, express or overnight mail, or regular mail,
return receipt requested, at the address listed in Section XI.E. below as being
binding on such Party and agree to accept such arbitrators and court as being
the sole and exclusive forum and venue for hearing such claims, disputes,
controversies, breaches or similar events. The Parties agree to waive any
defense of forum non conveniens or improper venue respecting such courts.
----- --- ----------
E. Notices. Wherever one Party is required or permitted to give
-------
notice to any other Party pursuant to this Agreement, such notice shall be
deemed given when delivered in hand or by facsimile, or five days following
mailing when mailed by registered or certified mail, return receipt requested,
postage prepaid, and addressed as follows:
20
<PAGE>
In the case of MTC: MTC Telemanagement Corporation
1304 Southpoint Blvd.
Petaluma, CA 94954
U.S.A.
Attn: Roger J. Sheppard
Fax: (707) 769-6190
In the case of c/o Holland Trust
the JV Partners: Haaksbergweg 55
1101 BR Amsterdam Z.O.
The Netherlands
Attn: Henk J. Keilman
Fax: 31(0)206911728
Any Party may from time to time change its address for notification purposes by
giving the other Parties written notice of the new address and the date upon
which it will become effective.
F. Severability. If, but only to the extent that, any provision of
------------
this Agreement is declared or found to be illegal, unenforceable or void, then
both parties shall be relieved of all obligations arising under such provision,
it being the intent an agreement of the parties that this Agreement shall be
deemed amended by modifying such provision, to the extent necessary to make it
legal and enforceable while preserving its intent.
G. Waiver. A waiver by either of the parties of any covenants,
------
conditions or agreements to be performed by the other or any breach thereof
shall not be construed to be a waiver of any succeeding breach thereof or of any
other covenant, condition or agreement herein contained.
H. Remedies. Except as otherwise provided herein, all remedies set
--------
forth in this Agreement shall be cumulative and in addition to and not in lieu
of any other remedies available to the other Parties at law, in equity or
otherwise, including injunctive relief, and may be enforced concurrently or from
time to time.
I. Expenses. Each Party shall pay its own costs and expenses in the
--------
performance of its obligations hereunder; provided, however, that in the event
--------- -------
of an arbitration proceeding, the prevailing party shall be awarded its costs
and expenses (including, without limitation, legal expenses).
J. Entire Agreement. This Agreement, including any Exhibits and
----------------
documents referred to in this Agreement or attached thereto, constitutes the
entire and exclusive statement of agreement between the parties with respect to
its subject matter and supersedes any written or oral representations,
understandings or agreements which are not fully expressed herein.
K. Amendments. This Agreement may be amended or modified by a
----------
written instrument which specifically references this Agreement and which is
signed by a duly authorized
21
<PAGE>
representative of each party.
L. Governing Law. This Agreement shall be governed by and construed
-------------
in accordance with the laws of the State of California, U.S.A., applicable to
contracts made and performed in that state, excluding conflicts of laws
principles, and, to the extent applicable, the laws of the United States;
provided, however, that matters of internal corporate governance shall be
- -------- -------
governed by the laws of the Netherlands to the extent required by such laws.
M. Headings. The section headings used in this Agreement are for
--------
reference and convenience only and shall not enter into the interpretation
hereof.
N. Initials. This Agreement shall not become effective unless and
--------
until all pages are initialed by the Chief Executive Officer or a Senior Vice
President of MTC.
IN WITNESS WHEREOF, the Parties have each caused this Agreement to be
signed and delivered by its duly authorized officer or representative as of the
date first written above.
MTC TELEMANAGEMENT CORPORATION
/s/ Henk J. Keilman
-------------------------------
By: /s/ MTC Telemanagement Corporation Henk J. Keilman,
---------------------------------- as an individual
Title:
------------------------------- /s/ Jan Peter Kastelein,
-------------------------------
By: Jan Peter Kastelein,
---------------------------------- as an individual
Title:
-------------------------------
22
<PAGE>
EXHIBIT A
ARTICLES OF ASSOCIATION AND BYLAWS OF THE CORPORATION
-----------------------------------------------------
XII. SUPERVISORY DIRECTORS AND AUDITORS
A. Supervisory Directors. Supervisory directors shall serve on a
---------------------
part-time basis without compensation. The number of supervisory directors which
shall constitute the whole board of supervisory directors of the Corporation
shall be five (5) persons. MTC shall nominate three (3) persons and the JV
Partners together shall nominate two (2) persons. The Shareholders agree to
exercise their respective voting rights to elect the supervisory directors so
nominated.
B. Statutory Auditors. The statutory auditor(s) of the Corporation
------------------
shall be as many as two (2) persons. The JV Partners collectively may nominate
one (1) statutory auditor, and MTC may nominate one (1) statutory auditor. The
Shareholders agree to exercise their respective voting rights to elect the
auditor(s) so nominated.
C. Vacancies. Should the position of any supervisory director or
---------
statutory auditor become vacant, however occasioned, the Shareholders shall
agree to exercise their respective voting rights to elect a supervisory director
or statutory auditor nominated by the Shareholder who nominated the preceding
supervisory director or statutory auditor.
D. Management. The business of the Corporation shall be managed by
----------
or under the direction of its board of supervisory directors which may exercise
all such powers of the Corporation and do all such lawful acts and things that
as are not by statute or by the certificate of incorporation or by this
Agreement directed or required to be exercised or done by the Shareholders.
Without in any way limiting the generality of the foregoing, the board of
supervisory directors is specifically granted the authority to approve the
hiring of all salaried employees of the Corporation. No such salaried employees
may be hired without such prior approval.
E. Regular Meetings. Regular meetings of the board of supervisory
----------------
directors may be held without notice at such time and at such place as shall
from time to time be determined by such board.
F. Special Meetings. Special meetings of the board of supervisory
----------------
directors may be called by any managing director on ten (10) days notice to each
supervisory director, either personally (by telephone or otherwise) or by
facsimile or telegram. Special meetings of the board of supervisory directors
shall be called by a managing director or the secretary of the Corporation in
like manner and on like notice on the written request of any two (2) supervisory
directors. The period of notice may be shortened or the notice may be dispensed
with for a particular meeting by the unanimous consent of all of the supervisory
directors.
23
<PAGE>
G. Quorum and Voting. At all meetings of the board of supervisory
-----------------
directors, a majority of the entire board shall constitute a quorum for the
transaction of business. Any resolution of the board of supervisory directors
shall be adopted by a vote of a majority of those supervisory directors present
at such meeting, except (i) as otherwise provided in the Commercial Code or the
articles of association, or (ii) those actions listed below, which shall also
require the unanimous written consent of all Shareholders:
1. Any addition to or modification of the articles of
association;
2. The amount of compensation of statutory auditors;
3. Approval of any annual budgets, financial statement, or
business plan for each fiscal year;
4. Acquisition, transfer (including the granting or
imposition of liens thereon or the license or sub-license thereof), or
disposition of any patents, design patents, trademarks, copyrights, or
any other intellectual property, including any license of any of the
foregoing;
5. Sale of all or substantially all of the assets of the
Corporation, or the merger or consolidation of the Corporation with
another entity;
6. Any modification of the capitalization of the
Corporation, whether such modification pertains to an increase in the
number of shares of Common Stock or the establishment of any other class
of capital stock;
7. The sale of any additional shares of Stock of the
Corporation; or
8. Other similar actions as agreed from time to time by a
unanimous written consent of the Shareholders.
H. Vote by Proxy. If and when any supervisory director intends to
-------------
exercise his or her voting right by proxy at any general meeting of the board of
supervisory directors, such supervisory director may appoint any other
supervisory director of the Corporation as his or her proxy.
I. Compensation. The board of supervisory directors shall not fix
------------
or modify the compensation to be received by supervisory directors or statutory
auditors without the written consent of all Shareholders. The supervisory
directors may be paid their reasonable expenses, if any, for the attendance at
each meeting of the board of supervisory directors. No such payment shall
preclude any supervisory director from serving the Corporation in any other
capacity and receiving compensation therefor.
24
<PAGE>
J. Removal. A supervisory director may be removed only by the vote
-------
of the Shareholder(s) who nominated such supervisory director.
XIII. MANAGING DIRECTORS
A. Managing Directors. The managing directors of the Corporation
------------------
shall be chosen by the Shareholders or, if the Shareholders so desire, by the
board of supervisory directors AND shall be a ________________________. The
Shareholders or the board of supervisory directors, as the case may be, may also
choose additional managing directors. Any number of offices may be held by the
same person, unless the articles of association otherwise provide.
B. Other Officers. The board of directors may appoint managing
--------------
directors and agents as it may deem necessary who shall hold their offices for
such terms and shall exercise such powers and perform such duties as shall be
determined from time to time by the board of supervisory directors.
C. Compensation. The managing directors shall serve without
------------
compensation.
D. Tenure. The managing directors of the Corporation shall hold
------
office until their successors are chosen and qualify. Any officer elected or
appointed by the board of supervisory directors may be removed at any time by
the affirmative vote of a majority of the supervisory directors. Any vacancy in
any office of the Corporation shall be filled by the board of supervisory
directors.
E. Execution of Contracts. The managing directors shall sign and
----------------------
execute bonds, mortgages and other contracts, except where the signing and
execution thereof shall be expressly reserved by the board of supervisory
directors or delegated by the board of supervisory directors to some other
officer or agent of the Corporation.
[THE FOLLOWING SECTIONS WILL BE REVISED AS REQUIRED BY NETHERLANDS LAW]
F. PRESIDENT. THE PRESIDENT SHALL BE THE CHIEF EXECUTIVE AND CHIEF
---------
OPERATING OFFICER OF THE CORPORATION, SHALL PRESIDE AT ALL MEETINGS OF THE BOARD
OF DIRECTORS, SHALL HAVE GENERAL AND ACTIVE MANAGEMENT OF THE BUSINESS OF THE
CORPORATION AND SHALL EXECUTE ALL ORDERS AND RESOLUTIONS OF THE BOARD OF
DIRECTORS, SUBJECT, HOWEVER, TO THE RIGHT OF THE DIRECTORS TO DELEGATE ANY
SPECIFIC POWER, EXCEPT SUCH AS MAY BY STATUTE EXCLUSIVELY BE CONFERRED TO ANY
OTHER OFFICER OR OFFICERS OF THE CORPORATION. THE PRESIDENT SHALL DIRECT THE
ACTIVITIES OF THE OTHER OFFICERS IN THE EXECUTION OF THOSE DUTIES NOT
SPECIFICALLY ASSOCIATED
25
<PAGE>
WITH THEIR OFFICE.
G. VICE PRESIDENT. IN THE ABSENCE OF THE PRESIDENT OR IN THE EVENT
--------------
OF HIS OR HER INABILITY OR REFUSAL TO ACT, THE VICE PRESIDENTS IN THE ORDER
DESIGNATED BY THE DIRECTORS, OR IN THE ABSENCE OF ANY DESIGNATION, THEN IN THE
ORDER OF THEIR ELECTION, SHALL PERFORM THE DUTIES OF THE PRESIDENT, AND WHEN SO
ACTING, SHALL HAVE ALL THE POWERS OF AND BE SUBJECT TO ALL THE RESTRICTIONS UPON
THE PRESIDENT. THE VICE PRESIDENTS SHALL PERFORM SUCH OTHER DUTIES AND HAVE SUCH
OTHER POWERS AS THE BOARD OF DIRECTORS MAY FROM TIME TO TIME PRESCRIBE.
H. SECRETARY. THE SECRETARY SHALL ATTEND ALL MEETINGS OF THE BOARD
---------
OF DIRECTORS AND RECORD ALL THE PROCEEDINGS OF THE MEETINGS OF THE CORPORATION
AND OF THE BOARD OF DIRECTORS IN A BOOK TO BE KEPT FOR THAT PURPOSE. HE OR SHE
SHALL GIVE, OR CAUSE TO BE GIVEN, NOTICE OF ALL SPECIAL MEETINGS OF THE BOARD OF
DIRECTORS, AND SHALL PERFORM SUCH OTHER DUTIES AS MAY BE PRESCRIBED BY THE BOARD
OF DIRECTORS OR PRESIDENT, UNDER WHOSE SUPERVISION HE OR SHE SHALL BE. HE OR SHE
SHALL HAVE CUSTODY OF THE CORPORATE SEAL OF THE CORPORATION AND HE OR SHE, OR AN
ASSISTANT SECRETARY, SHALL HAVE AUTHORITY TO AFFIX THE SAME TO ANY INSTRUMENT
REQUIRING IT AND WHEN SO AFFIXED, IT MAY BE ATTESTED BY HIS OR HER SIGNATURE OR
BY THE SIGNATURE OF SUCH ASSISTANT SECRETARY. THE BOARD OF DIRECTORS MAY GIVE
GENERAL AUTHORITY TO ANY OTHER OFFICER TO AFFIX THE SEAL OF THE CORPORATION AND
TO ATTEST THE AFFIXING BY HIS OR HER SIGNATURE.
I. ASSISTANT SECRETARY. THE ASSISTANT SECRETARY, OR IF THERE BE
-------------------
MORE THAN ONE, THE ASSISTANT SECRETARIES IN THE ORDER DETERMINED BY THE BOARD OF
DIRECTORS (OR IF THERE BE NO SUCH DETERMINATION, THEN IN THE ORDER OF THEIR
ELECTION), SHALL, IN THE ABSENCE OF THE SECRETARY OR IN THE EVENT OF HIS OR HER
INABILITY OR REFUSAL TO ACT, PERFORM THE DUTIES AND EXERCISE THE POWERS OF THE
SECRETARY AND SHALL PERFORM SUCH OTHER DUTIES AND HAVE SUCH OTHER POWERS AS THE
BOARD OF DIRECTORS MAY FROM TIME TO TIME PRESCRIBE.
J. TREASURER. THE TREASURER SHALL HAVE THE CUSTODY OF THE CORPORATE
---------
FUNDS AND SECURITIES AND SHALL KEEP FULL AND ACCURATE ACCOUNTS OF RECEIPTS AND
DISBURSEMENTS IN BOOKS BELONGING TO THE CORPORATION AND SHALL DEPOSIT ALL MONEYS
AND OTHER VALUABLES IN THE NAME AND TO THE CREDIT OF THE CORPORATION IN SUCH
DEPOSITORIES AS MAY BE DESIGNATED BY THE BOARD OF DIRECTORS. THE TREASURER SHALL
HAVE EXCLUSIVE AUTHORITY TO OPEN BANK ACCOUNTS OR OTHERWISE TRANSACT THE
FINANCIAL BUSINESS OF THE CORPORATION; PROVIDED, HOWEVER, THAT THE PRESIDENT AND
-------- -------
EACH SHAREHOLDER SHALL HAVE COMPLETE ACCESS TO THE FINANCIAL RECORDS OF THE
CORPORATION AND SHALL BE PROVIDED UNAUDITED QUARTERLY FINANCIAL STATEMENTS,
AUDITED ANNUAL FINANCIAL STATEMENTS, OF THE CORPORATION, AND SUCH OTHER REPORTS
OR INFORMATION AS THE PRESIDENT OR ANY SHAREHOLDER MAY REQUEST FROM TIME TO
TIME.
K. TREASURER DUTIES. THE TREASURER SHALL DISBURSE THE FUNDS OF THE
----------------
CORPORATION AS MAY BE ORDERED BY THE BOARD OF DIRECTORS, TAKING PROPER VOUCHERS
FOR SUCH DISBURSEMENTS AND SHALL RENDER TO THE PRESIDENT AND THE BOARD OF
DIRECTORS AT ITS REGULAR MEETINGS, OR WHEN THE BOARD OF DIRECTORS SO REQUIRES,
AN ACCOUNT OF ALL HIS OR HER TRANSACTIONS AS TREASURER AND OF THE FINANCIAL
CONDITION OF THE CORPORATION.
26
<PAGE>
L. TREASURER BOND. IF REQUIRED BY THE BOARD OF DIRECTORS, THE
--------------
TREASURER SHALL GIVE THE CORPORATION A BOND IN SUCH SUM AND WITH SUCH SURETY OR
SURETIES AS SHALL BE SATISFACTORY TO THE BOARD OF DIRECTORS FOR THE FAITHFUL
PERFORMANCE OF THE DUTIES OF HIS OR HER OFFICE AND FOR THE RESTORATION TO THE
CORPORATION, IN CASE OF HIS OR HER DEATH, RESIGNATION, RETIREMENT OR REMOVAL
FROM OFFICE, OF ALL BOOKS, PAPERS, VOUCHERS, MONEY AND OTHER PROPERTY OF
WHATEVER KIND IN HIS OR HER POSSESSION OR UNDER HIS OR HER CONTROL BELONGING TO
THE CORPORATION.
M. ASSISTANT TREASURER. THE ASSISTANT TREASURER, OR IF THERE SHALL
-------------------
BE MORE THAN ONE, THE ASSISTANT TREASURERS IN THE ORDER DETERMINED BY THE BOARD
OF DIRECTORS (OR IF THERE BE NO SUCH DETERMINATION, THEN IN THE ORDER OF THEIR
ELECTION), SHALL, IN THE ABSENCE OF THE TREASURER OR IN THE EVENT OF HIS OR HER
INABILITY OR REFUSAL TO ACT, PERFORM THE DUTIES AND EXERCISE THE POWERS OF THE
TREASURER AND SHALL PERFORM SUCH OTHER DUTIES AND HAVE SUCH OTHER POWERS AS THE
BOARD OF DIRECTORS MAY FROM TIME TO TIME PRESCRIBE.]
27
<PAGE>
EXHIBIT B
BALANCE SHEET OF ATLANTIC TELECOM BV
---------------- -------------------
<PAGE>
ATLANTIC TELECOM B.V. PAGE: -1-
DATE: 25-JAN-96
<TABLE>
<CAPTION>
<S> <C>
BALANCE SHEET AS AT 1 NOVEMBER 1995
(after appropriation of results )
01 November
.......1995
-----------
NLG
FIXED ASSETS
- ------------
Software/Inventory 148,917
Goodwill 178,560
Development casts 235,000
--------
TOTAL FLIED ASSETS 562,477
CURRENT ASSETS
- --------------
Debtors 16,815
Taxes receivable 8,958
Other receivables 7,326
Cash at Banks & Deposits 3,323
TOTAL CURRENT ASSETS 36,422
TOTAL ASSETS 598,899
CURRENT LIABILITIES
- -------------------
Creditors 59,411
Clients deposits 18,975
Wage tax & Social charges 9,002
Other payables 13,669
TOTAL CURRENT LIABILITIES 101,056
TOTAL LIABILITIES 101,056
TOTAL ASSETS LESS LIABILITIES 497,843
--------
CAPITAL AND RESERVES
- --------------------
Share capital 40,000
Subordinated loan RIG Holding N.V 572,032
Revaluation reserve 178,550
Retained earnings/(acc. deficits) (292,749)
--------
TOTAL SHAREHOLDERS' EQUITY 497,843
</TABLE>
<PAGE>
ATLAI'ITIC TELECOM B.V. PAGE: -2-
DATE: 25-JAN-96
<TABLE>
<CAPTION>
PROFIT & LOSS ACCOUNT
FOR THE PERIOD ENDED 1 NOVEMBER 1995
01 November
1995
-----------
NLG
<S> <C>
Sales Commissions 128,308
Cost 0' sales 98,685
GROSS MARGIN 29,623
GENERAL EXPENSES
- ----------------
Personal expenses 81,695
Office expenses 80,699
Communication 40,393
Travel expenses 23,293
Other general expenses 85,725
311,805
FINANCIAL EXPENSES
- ------------------
Bankcharges 1,884
Interest bankers 278
Exchange results 1,385
-------
3,546
Total expenses 315,351
-------
OPERATING PROFITI(LOSS) BEFORE TAX (285,728)
Extraordinary item. (7,022)
NET PROFIT/(LOSS) FOR THE YEAR (292,749)
</TABLE>
<PAGE>
FAX TRANSMISSION
----------------
To: MTC Telemanagement Corporation
Att: Mr. Roger Sheppard
Fax: 707 7696190
From: Henk J. Keilman 25/01/96
MTC Western Europe BV
Haaksberweg 55
I 101 BR Amsterdam Z.O.
The Netherlands
Tel: 31(0)20691 1780
Fax: 31(0)20691 1728 Time: 23:52
Number of pages Incl. this page....................3........................
RE: BALANCE SHEET OF ATLANTIC TELECOM I ATTACHMENT TO JOINT-VENTURE AGREEMENT
<PAGE>
EXHIBIT C
BUSINESS PLAN
-------------
<PAGE>
MTC WESTERN EUROPE
------------------
BUSINESS PLAN
-------------
by Henk J. Keilman
November, 1995
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
<S> <C> <C>
I Background 3
II: Objectives 4
III: The Market 5
IV. The Competition 5
V. Marketing arid Sales Strategy 6
VI. Strengths and Opportunities 9
VII. Weaknesses and Threats 10
VIII. Organisation and Operations 10
IX. Staff 11
X. Sales Forecast and Budget 12
XI. Conclusion 13
</TABLE>
<PAGE>
MTC Western Europe - Business Plan
November 1995
I - BACKGROUND
In September 1995 Atlantic Telecom BV and MTC Telemanagement Corporation decided
to enter into a Joint Venture for the purpose of marketing and selling MTC's
sophisticated telecommunication services to the Western European Market,
including the following countries: Benelux, France and Germany. Switzerland and
Austria will also be serviced from the headquarters of the Venture, based in
Amsterdam, The Netherlands, however not on the bases the exclusive arrangement
that exists within the Joint Venture territory. The Joint-Venture will be called
MTC Telecom Western Europe (hereinafter "MTC WE").
MTC, as provider of telecommunication technology and services, referred to as
Telemanagement Services, contributes its Telemanagement capacity to the Joint
Venture, which includes the following services:
. Call Back services
. Conference Calling
. Travel Card
. Itemised billing
. Direct dial for certain parts of the territory, to be extended within
two years to all parts of the territory
These Services include two key features:
1. Rates are competitive in comparison to local European PTT's, with
discounts varying from 20% to 65% depending on the countries from where
calls originate and where they terminate. It is the strategic objective
of MTC to be able to provide, at all times, a discount of 25% in
comparison to local European PTT's.
2. The quality of the lines must be comparable to those provided by the
local European PTT's:
Atlantic Telecom, primarily a marketing and sales organisation with strong roots
in the countries of the Venture, has contributed its organisational, marketing
and sales skills to the Venture. In addition it has developed customised
software to enable billing in local currencies, greater flexibility in terms of
pricing policy in the territory, and to provide an powerful customer database.
Furthermore, Atlantic Telecom has assisted in the development of a dialler, to
be used in conjunction with the call back services.
The joining of the capabilities, skills, assets and strengths of the two Venture
partners, will lead to a greater synergy, and will provide clear benefits to
both partners in the Venture.
<PAGE>
MTC Western Europe - Business Plan
November 1995
II - OBJECTIVES
MTC Western Europe has been formed by the parties to achieve the following
strategic objective:
"TO OCCUPY WITHIN THREE YEARS FROM NOW A STRONG, DISTINCT AND RECOGNISED
POSITION WITHIN THE EUROPEAN MARKET FOR TELECOMMUNICATION SERVICES -
PARTICULARLY WITHIN THE MARKET FOR SMALL AND MEDIUM SIZE BUSINESSES, AND IN THE
HIGHER SEGMENT OF THE PRIVATE MARKET, BY SUPPLYING MTC SERVICES AND FACILITIES,
POSSIBLY SUPPLEMENTED WITH COMPLEMENTARY PRODUCTS AND SERVICES FROM THIRD
PARTIES."
While the above stated strategic objective is clear, it is also general and
unspecified. Within the context of MTC's global strategy it is important to
elaborate on, and further specify the strategic objective. Before doing so, it
is important to understand MTC's global strategy. MTC is committed to develop
its global organisation on the bases of a decentralised model. Such a
decentralised model is to be accomplished by setting up partnerships with local
organisations, in key territories around the world. The definition of a
territory within this strategy, may vary from country to country, or region to
region. Yet, in general terms a territory has been defined as a homogenous area,
from cultural, social, political and economic perspectives. In some instances a
territory may be defined as a country, in other instances it may be a group of
countries.
The Joint Ventures are extensions of MTC, and enable MTC to operate in foreign
markets by providing a real presence, without on the one hand alienating this
market and on the other hand loosing control.
The Joint-Ventures will locally manage the selling, marketing and distribution
of MTC's services in the territory, thereby providing local support to already
existing sales organisations, while simultaneously further developing and
expanding the channels of distribution.
MOST IMPORTANTLY, MARKETING STRATEGY WILL BE CO-ORDINATED CENTRALLY, YET
LOCALLY, THROUGHOUT EACH JOINT VENTURE TERRITORY, TAKING LOCAL MARKET CONDITIONS
INTO CONSIDERATION, WHILE PRESERVING THE PROFESSIONAL IMAGE MTC IS TRYING TO
BUILD WORLD WIDE.
Over the past two years MTC has already developed a significant presence in the
Western European market, totalling sales of approximately 16 million US$ per
annum at present. These sales have been achieved by sub-affiliates, originally
appointed by and therefore acting through MTC's US based master affiliates.
However, no effective support structure exists to adequately service these sub-
affiliates and their customer base. The Joint Venture will fill this gap by
providing a local support and service infrastructure.
<PAGE>
MTC Western Europe - Business Plan
November 1995
III - THE MARKET
In The Netherlands the sales of the Dutch PTT constitutes approximately Nlg 11
billion per annum. Approximately one quarter of that volume is generated
through international telecommunication, the target market for MTC. The total
amount of calling minutes per annum for all outward international calls for the
Western European territory, not including the UK, is approximately 13.99
billion. Considering that on average each minute represents approximately Nlg
2,- in revenue, the international calling volume in Dutch Guilders would
therefore be approximately 28 billion per annum (or US$ 17,5 billion). This
volume is enormous indeed, and provides the relevant background to MTC WE
marketing efforts. Projected sales by MTC WE over 1996 of US$ 5.2 million
(approximately Nlg 8 million) would constitute a market share of 0,029%, which
is marginal in relative terms.
The world-wide market for Call-Hack services was estimated US$ 80 million in
1993, US$ 330 million in 1994, and is expected to grow to approximately US$ one
billion within five years. The Call-Back market has been growing, and will
continue to grow at an explosive rate.
IV - COMPETITION
Presently a detailed market study is being conducted in which the important
competitors of MTC are being analysed in terms of respective market share,
rates, quality of service, and market positioning. However, based on past
studies a great deal of information on the competition has already been
obtained. From this information, it appears that within the segment of call back
providers, MTC occupies a unique position in the market. The direct competitor
in this area is Telegroup Inc., an American company that started its services
approximately 5 years ago. Telegroup is rivalling MTC in size and sales volume.
However, it is evident that the medium and longer term strategy of MTC is
stronger and better developed, with clear competitive advantages. Regarding the
present situation, MTC has a clear advantage over Telegroup in terms of :
. rates,
. quality of lines,
. reliability of connections,
. capacity
. time needed to connect a new client to the system,
. response time of the call back system.
. availability of reliable dialler systems
In all of these areas MTC has distinct and quantifiable advantages. The main
disadvantage of MTC so far, has been the unavailability of discounts on the
intra-European calls. These discounts have been available to Telegroup for
nearly a year. However, as of August 1995, MTC has introduced competitive
discounts on intra-European calls, a service called EuroCall, thereby
eliminating this disadvantage. Beside call back services there have been
developments in other areas with regard to providing competitive
telecommunication rates. These consist of various organisations providing direct
dial services, at rates that are significantly lower in comparison to the
European national telecommunication providers. Direct dial providers are trying
to eliminate the one main disadvantage of the call back system, namely the user-
unfriendly additional action of calling, putting down the phone, waiting for the
call back, only after which
<PAGE>
MTC Western Europe - Business Plan
November 1995
time the real call can be initiated. However, the rates of direct dial providers
are not as competitive as the rates provided by call back providers. In
addition, the direct dial organisations are still dependant on a box, a dialler
or rerouter, in order to gain access to the local switch. In addition, depending
on the location, a client of such providers may still have to pay local tariffs
for calls made from his location to the switch:
However, call back services that take advantage of a computerised dialler, are
not at a disadvantage in comparison to the direct dial providers. A computerised
dialler, or "Dialler System" handles the entire call back procedure, so that the
end user, without virtually any delay, will immediately get access to the MTC
external line. In other words, the call back procedure has been made invisible
by the Dialler. Without a disadvantage from the viewpoint of user friendliness,
the better rates provided by call back providers, constitute a distinct
competitive advantage in comparison to direct dial providers. MTC, due to the
excellent quality of its services, has been highly successful in implementing
dialler systems in various countries.
Direct dial providers are also subject to our market research, and their
activities, marketing strategies, market shares, and sales volumes are being
analysed. Direct dial providers do pose some threat to MTC, in that they are
usually backed by powerful, professional organisations, that may have various
and different motivations to gain a market share in the telecommunication
market. On the other hand, the size of the market is such, that MTC with its
leading technology, and competitive edge in many areas, has every reason to be
optimistic.
V - MARKETING AND SALES STRATEGY
Considering the enormous size of the telecommunication market in Europe, whereby
market share is expressed in fractions of percentages, the objectives of MTC WE
are to be accomplished by precision marketing. Precision marketing requires a
clear identification of target groups. This can be achieved by hyper-
segmentation of the market, and a subsequent identification of the core of each
hyper segment. After the core has been identified, marketing efforts must be
directed to and focused on this core.
Furthermore, the American product formula and market approach will be translated
to a European market approach, on a country by country bases. Among other things
this requires translating product documentation into a format understandable to
the local market, and billing clients in their local currencies.
Due to the size of the market, several marketing and sales strategies will be
used simultaneously, such as direct marketing, dealer marketing and strategic
partnerships. In addition, the MLM channels will be utilised, although operating
under a different name (M-Net). Due to the massive size of the market, these
various channels will not conflict, but rather reinforce each other. Key
objective is to expand sales and increase market share as quickly as possible.
The above are general guidelines for the development of the marketing and sales
strategy for MTC Western Europe.
More specifically, on the operational side, marketing and sales strategy will
Consist of the following five items:
1) to engage in direct sales and marketing to end-users throughout the
territory,
2) finding and training new and qualified master and/or sub-affiliates
(dealers) in each country
<PAGE>
MTC Western Europe - Business Plan
November 1995
3) providing support to existing master and sub-affiliates, as well as the
M-Net organisation, the Multi Level Marketing branch of MTC world-wide.
4) to enter into strategic partnerships and JOINT-VENTURES, whenever
warranted
5) to develop, co-ordinate and implement a European strategy for
advertisement, promotion and PR
1) TO ENGAGE IN DIRECT SALES TO BOTH PRIVATE AND CORPORATE END-USERS
-----------------------------------------------------------------
In view of existing sales operations as developed by Atlantic Telecom,
direct sales to end users should be continued and vastly expanded under
the name of MTC Telecom. Direct sales is most important, since recent
investigations in marketing and sales strategies have indicated that MTC
Services and Products are ideally suited for direct sales, for two
reasons:
a. Because of its digital nature, most of the Services can be
delivered directly and instantaneously to the end-user, across
any boundaries
b. The Services :can easily be communicated to end-users by the
mass media
Direct sales and marketing will offer five major advantages:
1. Direct and substantial recruitment of new customers
2. Simultaneous creation of brand awareness
3. Inclusion of affiliates in the sales process by providing
referrals
4. Cost effective method of distribution
5. a direct relationship with end users will result in direct
contact with and better control and feed back from the market.
2) FINDING AND TRAINING NEW AND QUALIFIED MASTER AND/OR SUB-AFFILIATES IN
----------------------------------------------------------------------
EACH COUNTRY
------------
MTC WE will spend a great deal of effort in identifying master
affiliates for each country. The profile of a master affiliate can be
described as follows:
a. professional organisation, already active in the
telecommunications business with a good track record and
reputation
b. in possession of a significant customer base
c. ability to sell services, as well as telecommunication hardware;
in other words an organisation with a culture compatible to
MTC's services
d. willing to invest in training, promotion and advertisement
e. financially sound
All of the support services as described under point 1.2 Will also be
extended to the newly appointed affiliates.
3) PROVIDING SUPPORT TO EXISTING MASTER AND SUB-AFFILIATES, AS WELL AS
-------------------------------------------------------------------
THE M-NET ORGANISATION
----------------------
3.1 It is not the intention of MTC WE to compete with existing distribution
channels. To the contrary, one of the key functions of the Venture is to
provide support to existing channels, and to be SEEN to be providing
support. In other words, existing affiliates must be made aware of MTC
WE as an organisation that has been created to serve their interest, and
to assist them in doing a better job of selling and marketing MTC
products and services in Western Europe.
<PAGE>
MTC Western Europe - Business Plan
November 1995
In view of this consideration, MTC WE must be introduced carefully to
existing affiliates, taking into consideration sensitivities. The
introduction will effectively take place in two stages, namely
1. the introduction and presentation of the Joint Venture, followed
by a transitional period, and
2. consolidation, whereby clear operational guidelines are
established and agreed upon between MTC WE and the European
affiliates
The second phase will be achieved by a careful management of the first
phase, m which it is emphasised that MTC WE is there to serve, and not
to compete. Affiliates must be convinced on the bases of practical
experience, that the relationship with MTC WE is a win-win relationship.
The development of the two phases must be a natural evolution.
Phase one should start immediately after the formal incorporation of the
Joint Venture, phase two should take place within three to six months
thereafter.
3.2 Support to existing affiliates will consist of :
a. A European multilingual Call Centre, based in Amsterdam, to
provide customer support throughout the territory
b. National support centres for training and supporting master
affiliates and their sub-affiliates, on a country by COUNTRY
bases
c. National support centres for training and supporting the M-Net
organisation and its representatives
d. Customised and variable billing in local currencies
e. ESA support for connecting customers and processing applications
for MTC services
f. Providing additional marketing tools based on information
generated by the customer data base, such as selective mailings,
telemarketing etc.
g. Co-ordination and development of promotion, advertisement and PR
on a country by country bases, throughout the territory
4. TO ENTER INTO STRATEGIC PARTNERSHIPS AND JOINT-VENTURES, WHENEVER
-----------------------------------------------------------------
WARRANTED
---------
While MTC WE is the primary Joint-Venture in the Territory, in case it
or MTC identifies a third party in the Territory that:
a. occupies strategic positions and has substantial market share
in the telecommunication industry in the Territory
b. is interested, and is capable in a significant way to market,
sell and distribute the Services
c. whose businesses is compatible with MTC's business and global
strategy
d. is willing to make substantial investments, with a minimum of
US$ 1.000.000 in marketing and sales efforts in parts of the
Territory
MTC WE and MTC USA together may enter into a secondary Joint-Venture
agreement with such a Party. The objective is that such a secondary
Joint-Venture will accelerate market penetration in a significant way.
5. TO DEVELOP, CO-ORDINATE AND IMPLEMENT A EUROPEAN STRATEGY FOR
-------------------------------------------------------------
ADVERTISEMENT, PROMOTION AND PR
-------------------------------
In order to promote MTC as a professional and sophisticated provider of
telecommunications services, an advertisement and promotional campaign
will be launched throughout the territory of the
<PAGE>
MTC Western Europe - Business Plan
November 1995
Venture. Such a campaign will have a European ring to it, but will be
adjusted to local and national cultures, habits and customs.
VI - STRENGTHS AND OPPORTUNITIES
The strength of MTC lies within its advanced technology and competitive
pricing. The opportunity within the European market place is evident due
to the present high pricing structures set by the national
telecommunication monopolies. Their ability to reduce prices,
considering the fact that international telecommunications are their
main source of profit, is severely restricted by inflexible social and
political structures, and the undesirable prospect of having to lay off
people. The longer term opportunity consist of building upon the
customer base, and then upgrade this customer base and expand the range
of Value Added Services.
VII - WEAKNESSES AND THREATS
Ultimately the greatest threat will come from the major European carriers, who
will eventually lower their prices in order to become more competitive. This
will happen ahead of the official deadline for deregulation, which is January 1,
1998. MTC will have to retain a competitive pricing edge of approximately 20% to
25% in comparison to the local PTT's, which percentage is seen by industry
specialists as a critical margin. Furthermore MTC will have to be able to
upgrade its services to its customers, and move them over to more advanced
services, featuring direct dial, as well as other Value Added Services.
An immediate threat is the possibility of technological problems, such as
inferior quality of lines, unavailability of lines, incorrect billing. Although
intercontinental calls are relatively trouble free, till today EuroCall is still
problematic.
VIII - ORGANISATION AND OPERATIONS
MTC WE will have three main departments within its organisational structure,
which reflect the key functions and objectives of the organisation:
1. MARKETING & SALES
This department will provide the following functions:
a. recruitment of master and/or sub-affiliates
b. affiliate support and training
c. customer support
d. direct sales
e. maintenance of a customer database
f. Billing
g. Advertisement and promotion
Most of the functions of this department will be decentralised. i.e.
they will be implemented locally within the relevant country or area.
However, part of the support functions, billing and direct sales
<PAGE>
MTC Western Europe - Business Plan
November 1995
will be conducted centrally. For customer support a "Call Centre" will
be set up centrally in Amsterdam, with a multilingual staff. The Call
Centre can be accessed through toll free numbers in each country.
2. OPERATIONS
The department of Operations will be responsible for the "delivery" of
the products and services to the customers, and will include the
following functions:
a. technical support,
b. close liaison with suppliers (primarily MTC in California), or
future capacity suppliers with whom MTC has entered into strategic
alliances
c. input into customer and affiliate support functions
d. connecting customers to MTC services via ESA input
f. input into customer administration and data base
3. FINANCE AND ADMINISTRATION
The Finance and Administration department will be responsible for all
accounting and basic administrative functions of the Venture, including:
a. Preparing periodical reports, such as P&L accounts, balance sheets
and relevant management information
b. Management of Accounts receivables
c. Banking and management of cash flows
The Accounting and Operations departments will be predominantly centralised
departments, operating out of the Amsterdam head office, whereas the Sales and
Marketing department will be largely decentralised. In view of the core business
of the Venture, the Sales and Marketing department will play an eminently
important role within the entire organisational structure.
IX - STAFF
The executive board of MTC WE will consist of three executive directors (see
attached diagram), namely a Managing Director, a Director Operations, and a
Director Marketing arid Sales. The Managing Director will be directly
responsible for Finance and Administration. At a later stage the executive board
can be expanded to include a Director of Finance and Administration.
As such the following positions will be occupied:
1. Managing Director: Mr. Henk J. Keilman
(Including Finance and Administration)
2. Director Operations: Mr. Jan Peter Kastelein
(Including Training and Human resources)
3. Director Marketing and Sales: Vacant
4. Manager Marketing and Sales: Mr. Pieter Strijder
5. Accounting: Mr. Patrick Voorman
6. Personal Assistant to Henk J. Keilman
and sales support: Ms. Maltie Ramlal
7. Automation and Software Development: Mr. Rob Geleyn
8. System Support (internal automation): Mr. Stephan Olivier
9. Office Manager including Affiliate Support: Mrs. Ine van Daalen
<PAGE>
MTC Western Europe - Business Plan
November 1995
10 Administration: Ms. Cynthia Talen
11 Affiliate Support: Mrs. Dini van Guldener
12 Direct Sales: Mr. Simon Heijkoop
13 Benelux Marketing & Sales: Mr. Henk J. Keilman
Mr. Jan Peter Kastelein
14 Germany Marketing & Sales: Mr. Frans Verhoeven
Mr. Hans Lodewichs
15 France Marketing & Sales: Mr. Joe Claessens
. Accounting will include Cash Management and Receivables Management at
first
. Technical Support, Network Management, Co-ordination Network Suppliers
and Co ordination hardware suppliers will be combined at first. This
position is vacant, to be filled within a month.
. Marketing and Sales Director: Vacancy, to be filled immediately, will be
co-managed by Jan Peter Kastelein and Henk J. Keilman in the interim,
with assistance of Mr. Pieter Strijder. Marketing and Sales Director
will also manage directly PR' Advertisement and Promotion.
. Management of Affiliate Support and After Sales & Customer support will
be combined at first. This position is vacant, to be filled immediately.
. Total staff requirements at start: 17 employees, of which 9 will be on
the payroll of the Joint venture, and 8 will be working on either a
commission bases, or on contract bases. In view of labour laws in Europe
and Holland, it is advisable to employ a portion of staff on a contract
and/or commission bases.
. presently available 13 staff members, four vacancies need to be filled
almost immediately
<PAGE>
MTC Western Europe - Business Plan
November 1995
X - SALES FORECASTS AND BUDGET
The present objective of achieving US$ 38 million sales in 1996, and US$
76 million sales in 1997 is ambitious yet realistic, in view of market
opportunities. Results that have been achieved up until the present, as
well as the data obtained from our market research, justify the above
objectives, and their subsequent organisational and financial commitments.
However, these projected results are subject to the fact that the
potential weaknesses and threats, as outlined above, are largely
contained. A detailed analyses of sales and cash flow projections is
presented in separate documents. A summary of these projections, expressed
in US$ are shown below.
<TABLE>
<CAPTION>
ALL AMOUNTS IN US$ 1995 1996 1997 1998
<S> <C> <C> <C> <C>
Existing Sales 16,000,000 16,000,000 16,000,000 16,000,000
Increase existing Sales 1,600,000 17,680,641 47,113,723 94,449,015
New Sales 279,000 5,075,000 13,513,184 35,981,504
TOTAL SALES 17,879,000 38,755,641 76,626,906 146,430,518
Gross Margin 43,780 1,116,500 2,972,900 7,915,931
Commission Dealers 15,130 502,500 1,351,318 4,317,780
Net Margin 28,650 614,000 1,621,582 3,598,150
Net Margin from existing sales 28,800 690,419 1,858,123 4,922,451
TOTAL NET MARGIN 57,450 1,304,419 3,479,705 8,520,601
Expenses 219,219 790,275 1,418,015 1,943,064
Result before tax (161,769) 514,144 2,061,690 6,577,537
Taxes 309,253 986,631
NET RESULT (161,769) 514,144 1,752,436 5,590,906
</TABLE>
AS MENTIONED BEFORE, THE ABOVE PROJECTIONS WILL HAVE TO BE ADJUSTED ON A REGULAR
BASES.
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MTC Western Europe - Business Plan
November 1995
XI - CONCLUSION
In view of the strong technological position of MTC in the market, and the
enormous market opportunities in Europe, we are most confident that MTC WE will
be successful in realising its strategic objectives, and to create a strong
presence within the European telecommunication market. Present level of sales
within Europe demonstrate the potential, and the added support, sales and
marketing infrastructure should greatly enhance this potential. Other markets in
which MTC has expanded its services, such as the Japanese market are a
significant case in point, and show the vitality and attractiveness of its
products and services, and their high potential for success.
<PAGE>
EXHIBIT D
LITIGATION
----------
<PAGE>
The undersigned, Mr. ABRAHAM ZEEGERS, born in Amsterdam on March 15, 1949,
residing and practicing civil law in Amsterdam, herewith declares:
HENDRIK JOHANNES KEILMAN, born in Hoofddorp, The Netherlands, on October 7, 1953
and holder of a passport of The Kingdom of the Netherlands, number E 447360
and:
JAN-PETER KASTELEIN, born in Wissenkerke, The Netherlands, on April 12, 1969 and
holder of a passport of The Kingdom of the Netherlands, number N 04018263.
are known to him as his clients, are gentlemen of good reputation and financial
standing, have never been involved in bankruptcy and are not subject to any
litigation or financial claims.
Amsterdam, December 29, 1995
Mr. A. Zeegers (esq.)
<PAGE>
EXHIBIT E
PARTNERSHIPS AND JOINT VENTURES
-------------------------------
<PAGE>
EXHIBIT E
---------
Henk J. Keilman is owner of Holland Trust and Holland Trust related subsidiaries
and Holding Companies. In addition, in his capacity as trustee, he is also
involved in other partnerships and positions of directorship, the nature of
which he can not disclose for confidentiality reasons in relation to clients of
the trust company.
<PAGE>
EXHIBIT 23.1
REPORT ON SCHEDULE AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
NetSource Communications, Inc. and subsidiaries:
The audits referred to in our report dated November 13, 1996, except as to
Note 14(b) which is as of November 20, 1996, included the related financial
statement schedule as of December 31, 1994 and 1995 and September 30, 1996 and
for each of the years in the three-year period ended December 31, 1995 and for
the nine months ended September 30, 1996, included in the Registration
Statement. This financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits. In our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
We consent to the use of our reports included herein and to the reference to
our firm under the heading "Experts" in the Prospectus.
/s/ KPMG Peat Marwick LLP
San Francisco, California
December 9, 1996
<PAGE>
EXHIBIT 23.3
The Board of Directors
MTC Japan Ltd.
We consent to the inclusion of our report dated October 31, 1996, with
respect to the balance sheet of MTC Japan Ltd. (Company) as of December 31,
1995, and the related statements of operations, stockholders' deficit, and
cash flows for the period from inception (March 22, 1995) to December 31,
1995, which report appears in Amendment No. 2 to Form S-1 of NetSource
Communications, Inc.
Our report dated October 31, 1996, contains an explanatory paragraph that
states that the Company has suffered substantial loss from operations and has
a net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of that uncertainty.
/s/ KPMG Peat Marwick
Tokyo, Japan
December 9, 1996
