FILED PURSUANT TO RULE 424B3
REGISTRATION NO. 333-32753
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2,850,000 SHARES
STARTEC GLOBAL COMMUNICATIONS CORPORATION
[GRAPHIC OMITTED]
COMMON STOCK
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All of the shares of common stock, par value $0.01 per share (the "Common
Stock") offered hereby are being sold by Startec Global Communications
Corporation ("STARTEC" or the "Company"). Prior to this offering (the
"Offering"), there has been no public market for the Common Stock of the
Company. For a discussion of the factors considered in determining the initial
public offering price, see "Underwriting."
The shares of Common Stock have been approved for quotation on the Nasdaq
National Market under the symbol "STGC," subject to official notice of issuance.
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SEE "RISK FACTORS" BEGINNING ON PAGE 6 OF THIS PROSPECTUS FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
SHARES OF COMMON STOCK OFFERED HEREBY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURI-
TIES 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 PROSPEC-
TUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS AND TO
PUBLIC COMMISSIONS(1) COMPANY(2)
------------- ---------------- ------------
<S> <C> <C> <C>
Per Share ........ $ 12.00 $ 0.84 $ 11.16
Total(3) ........ $34,200,000 $2,394,000 $31,806,000
</TABLE>
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(1) Excludes a non-accountable expense allowance payable to the Representatives
of the Underwriters equal to 1% of the gross proceeds of the Offering. The
Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $1,142,000.
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to 427,500 additional shares of Common Stock solely to cover
over-allotments, if any. If the Underwriters exercise this option in full,
the Price to Public, Underwriting Discounts and Commissions and Proceeds to
Company will be $39,330,000, $2,753,100 and $36,576,900, respectively. See
"Underwriting."
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The shares of Common Stock are offered by the Underwriters named herein,
subject to prior sale, when, as and if delivered to and accepted by the
Underwriters, and subject to their right to reject any order in whole or in
part. It is expected that delivery of certificates representing the shares of
Common Stock will be made against payment therefor at the offices of Ferris,
Baker Watts, Incorporated, 1720 Eye Street, N.W., Washington, D.C., or through
the Depositary Trust Company, on or about October 15, 1997.
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FERRIS, BAKER WATTS BOENNING & SCATTERGOOD, INC.
Incorporated
The date of this Prospectus is October 9, 1997
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING ENTERING INTO STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
<PAGE>
EXPLANATORY NOTE
This Registration Statement, filed pursuant to Rule 462(b) under the
Securities Act of 1993, as amended, incorporates by reference the information
contained in the Registration Statement on Form S-1 filed by Startec Global
Communications Corporation with the Securities and Exchange Commission (File No.
333-32753) and declared effective on October 8, 1997.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information, including risk factors and
financial statements and notes thereto, appearing elsewhere in this Prospectus.
Unless otherwise indicated, the information in this Prospectus assumes no
exercise of the Underwriters' over-allotment option. See "Underwriting." For
definitions of certain technical and other terms used in this Prospectus, see
"Glossary of Terms."
THE COMPANY
STARTEC is a rapidly growing, facilities-based international long distance
carrier which markets its services to select ethnic U.S. residential communities
that have significant international long distance usage. Additionally, to
maximize the efficiency of its network capacity, the Company sells its
international long distance services to some of the world's leading carriers.
The Company provides its services through a flexible network of owned and leased
transmission facilities, resale arrangements and a variety of operating
agreements and termination arrangements, all of which allow the Company to
terminate traffic in every country which has telecommunications capabilities.
The Company currently owns and operates a switch in Washington, D.C. and leases
switching facilities from other telecommunications carriers. The Company is
currently in the final stages of negotiating the purchase of new switching
equipment, which is expected to be installed and placed in service at a new
facility in New York City by the end of 1997.
The Company's mission is to dominate select international telecom markets
by strategically building network facilities that allow it to manage both sides
of a telephone call. The Company intends to own multiple switches and other
network facilities which will allow it to originate and terminate a substantial
portion of its own traffic. Further, the Company intends to implement a network
hubbing strategy, linking foreign-based switches and other telecommunications
equipment together with the Company's marketing base in the United States. To
implement this hubbing strategy, the Company intends to: (i) build transmission
capacity, including its ability to originate and transport traffic; (ii) acquire
additional termination options to increase routing flexibility; and (iii) expand
its customer base through focused marketing efforts.
STARTEC's residential customers access its network by dialing a carrier
identification code ("CIC Code") prior to dialing the number they are calling.
Using a CIC Code to access the Company's network is known as "dial-around" or
"casual calling," because customers can use the Company's services at any time
without changing their existing long distance carrier. Additionally, the
customer's monthly bill from the local exchange carrier ("LEC") reflects the
charges for the international carrier services rendered by the Company. As part
of the Company's marketing strategy, it maintains a comprehensive database of
customer information which is used for the development of marketing programs,
planning, and other strategic purposes.
Increased deregulation and the globalization of the telecommunications
industry have resulted in accelerated growth in the use of international long
distance services. The international switched telecommunications market was
approximately $56 billion in aggregate carrier revenues for 1995, of which $14
billion was U.S.-originated international traffic. According to the Company's
market research, during the period from 1990 to 1995, the U.S.-originated
international telecommunications market grew at an annual compound rate of
11.7%, from $8 billion to $14 billion, compared with an annual compound growth
rate of 7.25% in the U.S. domestic long distance market. The Company believes
that the international telecommunications market will continue to experience
growth for the foreseeable future as a result of numerous factors, including:
(i) global economic development with corresponding increases in the number of
telephones, particularly in developing countries; (ii) continuing deregulation
of foreign telecommunications markets; (iii) reductions in rates stimulating
higher traffic volumes; (iv) increases in the availability of transmission
capacity; and (v) increases in investment in telephone infrastructure and
consequent increases in access to telecommunications services.
3
<PAGE>
The Company currently markets its services to ethnic residential
communities throughout the United States through a variety of media including
print advertising, direct marketing, radio and television. These marketing
efforts have resulted in significant growth in the Company's residential billed
customer base from approximately 5,000 as of June 30, 1994 to over 43,700 as of
June 30, 1997.
To achieve the economies of scale necessary to maintain cost effective
operations, the Company in late 1995 began reselling its international carrier
capacity to other carriers. As a result, STARTEC has experienced significant
growth in revenues and in the number of its carrier customers. As of June 30,
1997, the Company had 32 carrier customers who were active users of the
Company's international long distance services. Carrier revenues were $20.2
million for the fiscal year ended December 31, 1996 and reached approximately
$18.3 million for the six months ended June 30, 1997. The Company will continue
to market its international long distance services to existing and new carrier
customers.
RECENT DEVELOPMENTS
On July 1, 1997, the Company entered into a Secured Revolving Line of
Credit Facility Agreement with Signet Bank (the "Signet Agreement"), which
provides for maximum borrowings of up to $10 million through the end of 1997,
and the lesser of $15 million or 85% of eligible accounts receivable thereafter
until maturity on December 31, 1999. The Company has used some amounts available
under the Signet Agreement to begin implementing its strategic plan to build its
transmission capacity, acquire additional termination options, and expand its
customer base. Proceeds received under the Signet Agreement have also been
allocated to the Company's marketing programs, the anticipated acquisition of
rights in transatlantic digital undersea fiber optic cable, and the addition of
monitoring equipment and software upgrades to help support the expanded network
and the anticipated increase in traffic. See "Description of Capital Stock -
Signet Agreement."
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The Company was incorporated in Maryland in 1989. The principal executive
offices of the Company are located at 10411 Motor City Drive, Bethesda, Maryland
20817, and its telephone number is (301) 365-8959. The Company recently changed
its name from STARTEC, Inc. to Startec Global Communications Corporation.
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered by the Company ...... 2,850,000 shares
Common Stock to be Outstanding After the
Offering .............................. 8,247,999 shares(1)
Use of Proceeds ........................ The Company intends to use the net
proceeds of the Offering as
follows: (i) to acquire cable
facilities, switching, compression
and other related telecommu-
nications equipment; (ii) for
marketing; (iii) to pay down
amounts due under the Signet
Agreement; and (iv) for working
capital and other general
corporate purposes, including
possible future acquisitions and
strategic alliances. See "Use of
Proceeds."
Nasdaq National Market symbol ............. STGC
</TABLE>
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(1) Includes 17,175 non-voting common shares which were converted to voting
common shares, and excludes 5,351 non-voting common shares which were
purchased and retired, subsequent to June 30, 1997. Excludes (i) 269,766
shares of Common Stock issuable upon the exercise of options under the
Company's Amended and Restated Stock Option Plan; (ii) 750,000 (254,250 of
which were granted as of the date of this Prospectus) shares of Common
Stock reserved for issuance under the Company's 1997 Performance Incentive
Plan; and (iii) 716,800 shares of Common Stock issuable pursuant to the
exercise of certain warrants and upon conversion of a note. See "Management
- Stock Option Plans," "Description of Capital Stock - Warrants and
Registration Rights," and "Underwriting."
4
<PAGE>
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE DATA)
The following table presents summary financial data of the Company for the
years ended December 31, 1992, 1993, 1994, 1995 and 1996 and the six months
ended June 30, 1996 and 1997. The historical financial data for the years ended
December 31, 1994, 1995 and 1996 has been derived from the financial statements
of the Company which have been audited by Arthur Andersen LLP, independent
public accountants, as set forth in the financial statements and notes thereto
presented elsewhere herein. The financial data for the years ended December 31,
1992 and 1993, for the six months ended June 30, 1996 and 1997, and as of June
30, 1997 has been derived from the Company's unaudited financial statements in a
manner consistent with the audited financial statements. In the opinion of the
Company's management, these unaudited financial statements include all
adjustments necessary for a fair presentation of such information. Operating
results for interim periods are not necessarily indicative of the results that
might be expected for the entire fiscal year. The following information should
be read in conjunction with the Company's financial statements and notes thereto
presented elsewhere herein. See "Financial Statements" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
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1992 1993 1994 1995 1996 1996 1997
-------- ----------- ----------- ------------ ------------ --------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues ..................... $2,394 $ 3,288 $ 5,108 $ 10,508 $ 32,215 $13,206 $28,836
Gross margin ..................... 809 198 407 1,379 2,334 818 3,586
Income (loss) from operations ... 254 (1,610) (933) (1,112) (2,509) (853) 605
Net income (loss) ............... $ 208 $ (1,668) $ (979) $ (1,206) $ (2,830) $ (962) $ 351
PER SHARE DATA:
Net income (loss) per common and
equivalent share ............... $ 0.04 $ (0.33) $ (0.20) $ (0.21) $ (0.49) $(0.17) $ 0.06
Weighted average common and equiva-
lent shares outstanding 4,969 4,989 4,989 5,710 5,796 5,796 5,796
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
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ACTUAL AS ADJUSTED(1)
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(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents ........................... $ 2,106 $30,270
Working capital .................................... (7,293) 20,871
Total assets ....................................... 14,265 42,429
Long-term obligations, net of current portion ...... 759 1,801
Stockholders' (deficit) equity ..................... $ (5,714) $25,728
</TABLE>
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(1) Adjusted to give effect to (i) the sale of the 2,850,000 shares of Common
Stock offered hereby (at an initial public offering price of $12.00 per
share) and the application of the estimated net proceeds therefrom; (ii)
the fair value of 150,000 warrants issued to the Underwriters and the fair
value of the Signet Bank warrants, which are not redeemable upon completion
of the Offering; and (iii) the acceleration of unearned compensation
expense related to stock options which vest upon completion of the
Offering.
5
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully by prospective investors
prior to making an investment in the Common Stock offered hereby. Information
contained in this Prospectus contains "forward-looking statements" which can be
identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology or as discussions of
strategy. No assurance can be given that the future results covered by the
forward-looking statements will be achieved or that the events contemplated
thereby will occur or have the effects anticipated. The following matters
constitute cautionary statements identifying important factors with respect to
such forward-looking statements, including certain risks and uncertainties that
could cause actual results to vary materially from the anticipated results
covered in such forward-looking statements. Other factors could also cause
actual results to vary materially from the anticipated results covered in such
forward-looking statements.
HISTORY OF LOSSES; UNCERTAINTY OF FUTURE OPERATING RESULTS
Although the Company has experienced significant revenue growth in recent
years, the Company had an accumulated deficit of approximately $6.7 million as
of June 30, 1997 and its operations have generated a net loss and negative
operating cash flows in each of the last three fiscal years. There can be no
assurance that the Company's revenue will continue to grow or be sustained in
future periods or that the Company will be able to achieve or maintain
profitability in any future period. See "Selected Financial Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company's quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future as a result of a variety of factors
which can affect revenues, cost of services and other expenses. These factors
include costs relating to entry into new markets, variations in carrier revenues
from return traffic under operating agreements, variations in user demand, the
mix of residential and carrier services sold, the introduction of new services
by the Company or its competitors, pricing pressures from increased competition,
prices charged by the Company's providers of leased facilities, and capital
expenditures and other costs relating to the expansion of operations. In
addition, general economic conditions, specific economic conditions affecting
the telecommunications industry, and the effects of governmental regulation or
regulatory changes on the telecommunications industry may also cause
fluctuations in the Company's quarterly operating results. Certain of these
factors are outside of the Company's control. In the event that one or more of
such factors cause fluctuations in the Company's quarterly operating results,
the price of the Common Stock could be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
CAPITAL REQUIREMENTS; NEED FOR ADDITIONAL FINANCING
The Company believes that the net proceeds from this Offering, together
with amounts available under the Signet Agreement, will be sufficient to fund
the Company's capital needs for the next 18 months. The Company expects,
however, that it will need to raise additional capital from public or private
equity or debt sources in order to finance its future growth, including
financing construction or acquisition of additional transmission capacity,
expanding service within its existing markets and into new markets, and the
introduction of additional or enhanced services, all of which can be capital
intensive. In addition, the Company may need to raise additional capital to fund
unanticipated working capital needs and capital expenditure requirements and to
take advantage of unanticipated business opportunities, including accelerated
expansion, acquisitions, investments or strategic alliances. There can be no
assurance that additional financing will be available to the Company on
satisfactory terms or at all. Moreover, the Signet Agreement significantly
limits the Company's ability to obtain additional financing. In the event that
the Signet Agreement is extinguished or otherwise refinanced with a new credit
facility, the Company intends to expense, as an extraordinary item (if
material), the then-existing unamortized debt discount and deferred financing
cost related to the Signet Agreement, which was
6
<PAGE>
approximately $1.2 million as of July 1, 1997. If additional financing is
obtained through the issuance of equity securities, the percentage ownership of
the Company's then-current stockholders would be reduced and, if such equity
securities take the form of preferred stock, the holders of such preferred stock
may have rights, preferences or privileges senior to those of holders of Common
Stock. If the Company is unable to obtain additional financing in a timely
manner or on satisfactory terms, it may be required to postpone or reduce the
scope of its expansion, which could adversely affect the Company's ability to
compete, as well as its business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" and "Description of Capital
Stock."
MANAGEMENT OF GROWTH
The Company's recent growth and its strategy to continue such growth has
placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources and increased demands
on its systems and controls. In order to manage its growth effectively, the
Company must continue to implement and improve its operational and financial
systems and controls, accurately forecast customer demand and its need for
transmission facilities, attract additional managerial, technical and customer
service personnel, and train and manage its personnel base. There can be no
assurance that the Company will be successful in these activities. Failure of
the Company to satisfy these requirements or the emergence of unexpected
difficulties in managing its expansion could materially adversely affect the
Company's business, financial condition and results of operations.
COMPETITION
The long distance telecommunications industry is intensely competitive. In
many of the markets targeted by the Company there are numerous entities which
are currently competing with each other and the Company for the same residential
and carrier customers and others which have announced their intention to enter
those markets. International and interstate telecommunications providers compete
on the basis of price, customer service, transmission quality, breadth of
service offerings and value-added services. Residential customers frequently
change long distance providers in response to competitors' offerings of lower
rates or promotional incentives, and, in general, because the Company is a
dial-around provider, the Company's customers can switch carriers at any time.
In addition, the availability of dial-around long distance services has made it
possible for residential customers to use the services of a variety of competing
long distance providers without the necessity of switching carriers. The
Company's carrier customers generally also use the services of a number of
international long distance telecommunications providers. The Company believes
that competition in its international and interstate long distance markets is
likely to increase as these markets continue to experience decreased regulation
and as new technologies are applied to the telecommunications industry. Prices
for long distance calls in several of the markets in which the Company competes
have declined in recent years and are likely to continue to decrease.
The U.S. based international telecommunications services market is
dominated by AT&T, MCI and Sprint. The Company also competes with numerous other
carriers in certain markets, some of which focus their efforts on the same
customers targeted by the Company. Recent and pending deregulation initiatives
in the U.S. and other countries may encourage additional new entrants. The
Telecommunications Act of 1996 (the "Telecommunications Act" or the "1996 Act"),
permits, and is designed to promote, additional competition in the intrastate,
interstate and international telecommunications markets by both U.S. based and
foreign companies, including the RBOCs. In addition, pursuant to the terms of
the WTO Agreement on basic telecommunications, countries who are signatories
have committed, to varying degrees, to allow access to their domestic and
international markets to competing telecommunications providers, to allow
foreign ownership interests in existing telecommunications providers and to
establish regulatory schemes and policies designed to accommodate
telecommunications competition. The Company also is likely to be subject to
additional competition as a result of mergers or the formation of alliances
among some of the largest telecommunications carriers. Many of the Company's
competitors are significantly larger, have substantially greater financial,
technical and marketing resources than the Company, own or control larger
networks, transmission and termination facilities, offer a
7
<PAGE>
broader variety of services than the Company, and have strong name recognition,
brand loyalty, and long-standing relationships with many of the Company's target
customers. In addition, many of the Company's competitors enjoy economies of
scale that can result in a lower cost structure for transmission and other costs
of providing services, which could cause significant pricing pressures within
the long distance telecommunications industry. If the Company's competitors were
to devote significant additional resources to the provision of international
long distance services to the Company's target customer base, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "Business - Government Regulation" and "Business -
Competition."
DEPENDENCE ON AVAILABILITY OF TRANSMISSION FACILITIES
Substantially all of the telephone calls made by the Company's customers to
date have been connected through transmission lines of facilities-based long
distance carriers which provide the Company transmission capacity through a
variety of lease and resale arrangements. The Company's ability to maintain and
expand its business is dependent, in part, upon whether the Company continues to
maintain satisfactory relationships with these carriers, many of which are, or
may in the future become, competitors of the Company. The Company's lease
arrangements generally do not have long terms and its resale agreements
generally permit price adjustments on short notice, which makes the Company
vulnerable to adverse price and service changes or terminations. Although the
Company believes that its relationships with these carriers generally are
satisfactory, the failure to continue to maintain satisfactory relationships
with one or more of the carriers could have a material adverse effect upon the
Company's cost structure, service quality, network diversity, results of
operations and financial condition. During the fiscal year ended December 31,
1996, VSNL, Cherry Communications, Inc., and WorldCom accounted for
approximately 25%, 13% and 13%, respectively, of the Company's acquired
transmission capacity (on a cost of services basis). During the six month period
ending June 30, 1997, VSNL and WorldCom accounted for approximately 13% and 15%,
respectively, of the Company's acquired transmission capacity (on a cost of
services basis). No other supplier accounted for 10% or more of the Company's
acquired transmission capacity during either 1996 or the first six months of
1997. See "Business - The STARTEC Network."
The future profitability of the Company will depend in part on its ability
to obtain transmission facilities on a cost effective basis. Presently, the
terms of the Company's agreements for transmission lines subject the Company to
the possibility of unanticipated price increases and service cancellations.
Although the rates the Company is charged generally are less than the rates the
Company charges its customers for connecting calls through these lines, to the
extent these costs increase, the Company may experience reduced or, in certain
circumstances, negative margins for some services. As its traffic volume
increases in particular international markets, however, the Company may reduce
its use of variable usage arrangements and enter into fixed leasing arrangements
on a longer-term basis and/or construct or acquire additional transmission
facilities of its own. To the extent the Company enters into such fixed
arrangements and/or increases its owned transmission facilities and incorrectly
projects traffic volume in particular markets, it would experience higher fixed
costs without any concomitant increase in revenue.
Acquisition of ownership positions in, and other access rights to, digital
undersea fiber optic cable transmission lines is a key element of the Company's
business strategy. Because digital undersea fiber optic lines typically take
several years to plan and construct, international long distance service
providers generally make investments based on anticipated traffic. The Company
does not control the planning or construction of digital undersea fiber optic
cable transmission lines, and must seek access to such facilities through
partial ownership positions or through lease and other access arrangements on
negotiated terms that may vary with industry and market conditions. There can be
no assurance that digital undersea fiber optic cable transmission lines will be
available to the Company to meet its current and/or projected international
traffic volume, or that such lines will be available on satisfactory terms. See
"Business - The STARTEC Network."
DEPENDENCE ON FOREIGN CALL TERMINATION ARRANGEMENTS
The Company currently offers U.S.-originated international long distance
service globally through a network of operating agreements, resale arrangements,
transit and refile agreements, and various other foreign termination
arrangements. The Company's ability to terminate traffic in its targeted foreign
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<PAGE>
markets is an essential component of its service, and, therefore, the Company is
dependent upon its operating agreements and other termination arrangements.
While to date the Company has negotiated and maintained operating agreements and
termination arrangements sufficient for its current business and traffic levels,
there can be no assurance that the Company will be able to negotiate additional
operating agreements or termination arrangements or maintain agreements or
arrangements with its current foreign partners in the future. Cancellation of
certain operating agreements or other termination arrangements could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, the failure to enter into additional operating
agreements and termination arrangements could limit the Company's ability to
increase its services to its current target markets, gain entry into new
markets, or otherwise increase its revenues.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
In the normal course of its business, the Company must record and process
significant amounts of data quickly and accurately in order to bill for the
services it has provided to customers and to ensure that it is properly charged
by vendors for services it has used. While the Company believes that its current
management information systems are sufficient to meet its current demands, these
systems have not grown at the same rate as the Company's business and it is
anticipated that additional investment in these systems will be needed. The
successful implementation and integration of any additional or new management
information systems resources is important to the Company's ability to monitor
costs, bill customers, achieve operating efficiencies, and otherwise support its
growth. There can be no assurance, however, that the Company will not encounter
difficulties in the acquisition, implementation, integration and ongoing use of
any additional management information systems resources, including possible
delays, cost-overruns, or incompatibility with the Company's current information
systems resources or its business needs. See "Business - Management Information
and Billing Systems."
CUSTOMER CONCENTRATION
During the fiscal year ended December 31, 1996, the Company's five largest
carrier customers, including one related party, accounted for approximately 40%
of the Company's net revenues, with one of the carrier customers, WorldCom,
accounting for approximately 23% of net revenues during that year. In addition,
during the six month period ending June 30, 1997, the Company's five largest
carrier customers, including one related party, accounted for approximately 41%
of the Company's net revenues, with one of the carrier customers, WorldCom,
accounting for approximately 27% of net revenues during that period. WorldCom
recently announced its intention to acquire MCI. Management of the Company is
unable to predict what effect, if any, this transaction may have on the
Company's business, financial condition and results of operations. The Company's
agreements and arrangements with its carrier customers generally may be
terminated on short notice without penalty, and do not require the carriers to
maintain their current levels of use of the Company's services. Carriers may
terminate their relationship with the Company or substantially reduce their use
of the Company's services for a variety of reasons, including the entry of
significant new competitors offering lower rates than the Company, problems with
transmission quality and customer service, changes in the regulatory
environment, increased use of the carriers' own transmission facilities, and
other factors. A loss of a significant amount of carrier business could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In addition, this concentration of carrier customers increases the risk of
non-payment or difficulties in collecting the full amounts due from customers.
The Company's four largest carrier customers represented 35% and 22% of gross
accounts receivable as of December 31, 1996 and June 30, 1997, respectively. The
Company performs initial and ongoing credit evaluations of its carrier customers
in an effort to reduce the risk of non-payment. There can be no assurance that
the Company will not experience collection difficulties or that its allowances
for non-payment will be adequate in the future. If the Company experiences
difficulties in collecting accounts receivable from its significant carrier
customers, its business financial condition and results of operations could be
materially adversely affected. See "Business - Customers."
RESPONSE RATES; RESIDENTIAL CUSTOMER ATTRITION
The Company is significantly affected by the residential customer response
rates to its marketing campaigns and residential customer attrition rates.
Decreases in residential customer response rates or
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<PAGE>
increases in the Company's residential customer attrition rates, could have a
material adverse impact on the Company's business, financial condition and
results of operations.
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
The Company has to date generated substantially all of its revenues by
providing international long distance telecommunications services and expects
that this will continue in the future. There are certain risks inherent in doing
business on an international level, such as unexpected changes in regulatory
requirements, tariffs, customs, duties and other trade barriers, political
risks, and other factors which could materially adversely impact the Company's
current and planned operations. The international telecommunications industry is
changing rapidly due to deregulation, privatization of Post Telephone and
Telegraphs (the "PTTs"), technological improvements, expansion of
telecommunications infrastructure and the globalization of the world's
economies. There can be no assurance that one or more of these factors will not
vary in a manner that could have a material adverse effect on the Company.
A key component of the Company's business strategy is its planned expansion
into additional international markets. The Company intends to pursue
arrangements with foreign correspondents to gain access to and terminate its
traffic in those markets. In many of these markets, the government may control
access to the local networks and otherwise exert substantial influence over the
telecommunications market, either directly or through ownership or control of
the PTT. In addition, incumbent U.S. carriers serving international markets may
have better brand recognition and customer loyalty, and significant operational
advantages over the Company. Further, the existing carrier may take many months
to allow competitors such as the Company to interconnect to its switches within
the market. The Company has limited recourse if its foreign partners fail to
perform under their arrangements with the Company, or if foreign governments,
PTTs or other carriers take actions that adversely affect the Company's ability
to gain entry into those markets.
The Company is also subject to the Foreign Corrupt Practices Act ("FCPA"),
which generally prohibits U.S. companies and their intermediaries from bribing
foreign officials for the purpose of obtaining or maintaining business. While
Company policy prohibits such actions, the Company may be exposed to liability
under the FCPA as a result of past or future actions taken without the Company's
knowledge by agents, strategic partners, and other intermediaries.
GOVERNMENT REGULATION
The Company's business is subject to varying degrees of federal and state
regulation. Federal laws and the regulations of the Federal Communications
Commission (the "FCC") apply to the Company's international and interstate
facilities-based and resale telecommunications services, while applicable state
regulatory authorities ("PSCs") have jurisdiction over telecommunications
services originating and terminating within the same state. At the federal level
the Company is subject to common carriage requirements under the Communications
Act of 1934, as amended (the "Communications Act"). Comprehensive amendments to
the Communications Act were made by the Telecommunications Act, which was signed
into law on February 8, 1996. In addition, although the laws of other countries
only directly apply to carriers doing business in those countries, the Company
may be affected indirectly by such laws insofar as they affect foreign carriers
with which the Company does business.
International telecommunications carriers are required to obtain authority
from the FCC under Section 214 of the Communications Act in order to provide
international service that originates or terminates in the United States. U.S.
international common carriers also are required to file and maintain tariffs
with the FCC specifying the rates, terms, and conditions of their services. In
1996, the FCC established new rules that streamlined its Section 214
authorization and tariff regulation processes to provide for shorter notice and
review periods for certain U.S. international carriers including the Company. On
August 27, 1997, the Company was granted global facilities-based Section 214
authority under the FCC's new streamlined processing rules. Facilities-based
global Section 214 authority permits the Company to provide international basic
switched, private line, data, television and business services
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using previously authorized U.S. facilities to virtually every country in the
world. The Company also holds a Section 214 authorization granted in 1989
covering the provision of facilities-based satellite and resold international
services.
The FCC's streamlined rules also provide for global Section 214
authorization to resell switched and private line services of other carriers by
non-dominant international carriers. The FCC decides on a case-by-case basis
however whether to grant Section 214 authority to U.S. carriers to resell the
switched private lines of affiliated foreign carriers to countries where a
foreign carrier is dominant, based on a showing that there are equivalent resale
opportunities for U.S. carriers in the foreign carrier's market. To date, the
FCC has found that Canada, the U.K., Sweden and New Zealand provide equivalent
resale opportunities. The FCC has also found that equivalent resale
opportunities do not exist in Germany, Hong Kong and France. The FCC also is
considering applications for equivalency determinations with respect to
Australia, Chile, Denmark, Finland and Mexico. It is possible that
interconnected private line resale to additional countries may be allowed in the
future. Pursuant to FCC rules and policies, the Company's authorization to
provide service via the resale of interconnected international private lines
will be expanded to include countries subsequently determined by the FCC to
afford equivalent resale opportunities to those available under United States
law, if any. As a result of the recent signing of the WTO Agreement, the FCC has
proposed to replace the equivalency test with a rebuttable presumption in favor
of resale of interconnected private lines to WTO member countries. See "Business
- - Government Regulation."
The FCC is currently considering whether to limit or prohibit the practice
whereby a carrier routes, through its facilities in a third country, traffic
originating from one country and destined for another country. The FCC has
permitted third country calling where all countries involved consent to this
type of routing arrangements, referred to as "transiting." Under certain
arrangements referred to as "refiling," the carrier in the destination country
does not consent to receiving traffic from the originating country and does not
realize the traffic it receives from the third country is actually originating
from a different country. The FCC to date has made no pronouncement as to
whether refile arrangements comport either with U.S. or ITU regulations. It is
possible that the FCC may determine that refiling, as defined, violates U.S.
and/or international law. To the extent that the Company's traffic is routed
through a third country to reach a destination country, such an FCC
determination with respect to transiting and refiling could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company must also conduct its international business in compliance with
the FCC's international settlements policy ("ISP"). The ISP establishes the
parameters by which U.S.-based carriers and their foreign correspondents settle
the cost of terminating each other's traffic over their respective networks. The
precise terms of settlement are established in a correspondent agreement (also
referred to as an "operating agreement"), which also sets forth the term of the
agreement, the types of service covered by the agreement, the division of
revenues between the carrier that bills for the call and the carrier that
terminates the call, the frequency of settlements, the currency in which
payments will be made, the formula for calculating traffic flows between
countries, technical standards, and procedures for the settlement of disputes.
The Company's provision of domestic long distance service in the United
States is subject to regulation by the FCC and certain PSCs, who regulate, to
varying degrees, interstate and intrastate rates, respectively, ownership of
transmission facilities, and the terms and conditions under which the Company's
domestic services are provided. In general, neither the FCC nor the PSCs
exercise direct oversight over cost justification for domestic carriers' rates,
services or profit levels, but either or both may do so in the future. Domestic
carriers such as the Company, however, are required by federal law and
regulations to file tariffs listing the rates, terms and conditions applicable
to their interstate services.
The FCC adopted an order on October 29, 1996, requiring that non-dominant
interstate carriers, such as the Company, eliminate FCC tariffs for domestic
interstate long distance service. This order was to take effect as of December
1997. However, on February 13, 1997, the U.S. Court of Appeals for the District
of Columbia Circuit ruled that the FCC's order be stayed pending judicial review
of appeals challenging the order. Should the appeals fail and the FCC's order
become effective, the Company may
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benefit from the elimination of FCC tariffs by gaining more flexibility and
speed in dealing with marketplace changes. The absence of tariffs, however, will
also require that the Company secure contractual agreements with its customers
regarding many of the terms of its existing tariffs or face possible claims
arising because the rights of the parties are no longer clearly defined. To the
extent that the Company's customer base involves "casual calling" customers, the
potential absence of tariffs would require the Company to establish contractual
methods to limit potential liability to such customers. On August 20, 1997, the
FCC partially reconsidered its order by allowing dial-around carriers such as
the Company the option of maintaining tariffs on file with the FCC.
In addition, the Company generally is also required to obtain certification
from the relevant state PSC prior to the initiation of intrastate service and to
file tariffs with each such state. The Company currently has the certifications
required to provide service in 21 states, and has filed or is in the process of
filing requests for certification in 13 additional states. Although the Company
intends and expects to obtain operating authority in each jurisdiction in which
operating authority is required, there can be no assurance that one or more of
these jurisdictions will not deny the Company's request for operating authority.
Any failure to maintain proper federal and state certification or tariffs, or
any difficulties or delays in obtaining required certifications, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The FCC and certain PSCs also impose prior approval requirements on
transfers or changes of control, including pro forma transfers of control and
corporate reorganizations, and assignments of regulatory authorizations. Such
requirements may have the effect of delaying, deterring or preventing a change
in control of the Company. The Company also is required to obtain state approval
for the issuance of securities. Seven of the states in which the Company is
certificated provide for prior approval or notification of the issuance of
securities by the Company. Although the necessary approvals are being sought and
notification made prior to the Offering, because of time constraints, the
Company may not have obtained approval from two of the states prior to
consummation of the Offering. Although these state filing requirements may have
been preempted by the National Securities Market Improvement Act of 1996, there
is no case law on this point. The Company believes the remaining approvals will
be granted and that obtaining such approvals subsequent to the Offering should
not result in any material adverse consequences to the Company, although there
can be no assurance that such consequence will not result.
The 1996 Act is designed to promote local telephone competition through
federal and state deregulation. As part of its pro-competitive policies, the
1996 Act frees the RBOCs from the judicial orders that prohibited their
provision of long distance services outside of their operating territories
(which are called, Local Access and Transport Areas ("LATAs"). The 1996 Act
provides specific guidelines that allow the RBOCs to provide long distance
interLATA service to customers inside the RBOC's region but not before the RBOC
has demonstrated to the FCC and state regulators that it has opened up its local
network to competition and met a "competitive checklist" of requirements
designed to provide competing network providers with nondiscriminatory access to
the RBOC's local network. To date, the FCC has denied applications for in-region
long distance authority filed by Ameritech Corporation in Michigan and
Southwestern Bell Corporation ("SBC") in Oklahoma. Bell South recently filed a
similar application for Mississippi. If granted, such authority would permit
RBOCs to compete with the Company in the provision of domestic and international
long distance services. See "- Competition."
To originate and terminate calls in connection with providing their
services, long distance carriers such as the Company must purchase "access
services" from LECs or CLECs. Access charges represent a significant portion of
the Company's cost of U.S. domestic long distance services and, generally, such
access charges are regulated by the FCC for interstate services and by PSCs for
intrastate services. The FCC has undertaken a comprehensive review of its
regulation of LEC access charges to better account for increasing levels of
local competition. Under alternative access charge rate structures being
considered by the FCC, LECs would be permitted to allow volume discounts in the
pricing of access charges. While the outcome of these proceedings is uncertain,
if these rate structures are adopted, many long distance carriers, including the
Company, could be placed at a significant cost disadvantage to larger
competitors.
In February 1997, the World Trade Organization ("WTO") announced that 69
countries, including the United States, Japan, and all of the member states of
the European Union ("EU"), reached an agreement (the "WTO Agreement"), within
the framework of the General Agreement of Trade Ser-
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vices ("GATS") to facilitate trade in basic telecommunication services. The WTO
Agreement becomes effective January 1, 1998. Pursuant to the terms of the WTO
Agreement, signatories have committed to varying degrees to allow access to
their domestic and international markets by competing telecommunications
providers, allow foreign ownership interests in domestic telecommunications
providers and establish regulatory schemes to develop and implement policies to
accommodate telecommunications competition. At this time, the Company is unable
to predict the effect the WTO Agreement and related developments might have on
its business, financial condition and results of operations.
There can be no assurance that future regulatory, judicial and legislative
changes will not have a material adverse effect on the Company, that U.S. or
foreign regulators or third parties will not raise material issues with regard
to the Company's compliance or noncompliance with applicable laws and
regulations, or that regulatory activities will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Moreover, the FCC and the PSCs generally have the authority to condition,
modify, cancel, terminate or revoke the Company's operating authority for
failure to comply with federal and state laws and applicable rules, regulations
and policies. Fines or other penalties also may be imposed for such violations.
Any such action by the FCC and/or the PSCs could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Business - Government Regulation."
EFFECT OF RAPID TECHNOLOGICAL CHANGES
The telecommunications industry is characterized by rapid and significant
technological advancements and introductions of new products and services
employing new technologies. Improvements in transmission equipment, the
development of switching technology allowing the simultaneous transmission of
voice, data and video, and the commercial availability of Internet-based
domestic and international switched voice, data and video services at prices
lower than comparable services offered by the Company are all possible
developments that could adversely affect the Company. The Company's
profitability will depend on its ability to anticipate and adapt to rapid
technological changes, acquire or otherwise access new technology, and offer, on
a timely and cost-effective basis, services that meet evolving industry
standards. There can be no assurance that the Company will be able to adapt to
such technological changes, maintain competitive services and prices or obtain
new technologies on a timely basis, on satisfactory terms or at all. Failure to
adapt to rapid technological changes could have a material adverse effect on the
Company's business, financial condition and results of operations.
RISK OF NETWORK FAILURE
The success of the Company is largely dependent upon its ability to deliver
high quality, uninterrupted telecommunications services. Any failure of the
Company's network or other systems or hardware that causes interruptions in the
Company's operations could have a material adverse effect on the Company.
Increases in the Company's traffic and the build-out of its network will place
additional strains on its systems, and there can be no assurance that the
Company will not experience system failures. Frequent, significant or prolonged
system failures, or difficulties experienced by customers in accessing or
maintaining connection with the Company's network could substantially damage the
Company's reputation and could have a material adverse effect on the Company's
business, financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continued
contributions of its management team and technical, marketing and customer
service personnel. The Company's success also depends on its ability to attract
and retain additional qualified management, technical, marketing and customer
service personnel. Competition for qualified employees in the telecommunications
industry is intense and, from time to time, there are a limited number of
persons with knowledge of and experience in particular sectors of the industry.
The process of locating personnel with the combination of skills and attributes
required to implement the Company's strategies is often lengthy, and there can
be no assurance that the Company will be successful in attracting and retaining
such personnel. The loss
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of the services of key personnel, or the inability to attract additional
qualified personnel, could have a material adverse effect on the Company's
operations, its ability to implement its business strategies, and its efforts to
expand. Any such event could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management."
RISKS RELATED TO USE OF STARTEC NAME
Certain other telecommunications companies and related businesses use names
or hold registered trademarks that include the word "star." In addition, several
other companies in businesses that the Company believes are not
telecommunications-related use variations of the "star-technology" word
combination (e.g., Startek and Startech). Although the Company holds a
registered trademark for "STARTEC," there can be no assurance that its continued
use of the STARTEC name will not result in litigation brought by companies using
similar names or, in the event the Company should change its name, that it would
not suffer a loss of goodwill. In addition, the Company is filing for federal
registration of the trademark of "Startec Global Communications Corporation."
While no guarantee can be made that this application will be successful and
mature into a federal trademark registration, the established rights in and
registration of STARTEC provides the basis for expanding the trademark rights to
include the supplemental terms "Global Communications Group."
RISKS ASSOCIATED WITH STRATEGIC ALLIANCES, ACQUISITIONS AND INVESTMENTS
The Company intends to pursue strategic alliances with, and to acquire
assets and businesses or make strategic investments in, businesses that it
believes are complementary to the Company's current and planned operations. The
Company, however, has no present commitments, agreements or understandings with
respect to any strategic alliance, acquisition or investment. Any future
strategic alliances, investments or acquisitions would be accompanied by the
risks commonly encountered in strategic alliances with, or acquisitions of, or
investments in, other companies. Such risks include those associated with
assimilating the operations and personnel of the companies, potential disruption
of the Company's ongoing business, inability of management to maximize the
financial and strategic position of the Company by the successful incorporation
of the acquired technology, know-how, and rights into the Company's business,
maintenance of uniform standards, controls, procedures and policies, and
impairment of relationships with employees and customers as a result of changes
in management. There can be no assurance that the Company would be successful in
overcoming these risks or any other problems encountered with such strategic
alliances, investments or acquisitions.
Further, if the Company were to proceed with one or more significant
strategic alliances, acquisitions or investments in which the consideration
given by the Company consists of cash, a substantial portion of the Company's
available cash could be used to consummate such strategic alliances,
acquisitions or investments. If the Company were to consummate one or more
significant strategic alliances, acquisitions or investments in which the
consideration given by the Company consists of stock, stockholders of the
Company could suffer a significant dilution of their interests in the Company.
Many of the businesses that might become attractive acquisition candidates for
the Company may have significant goodwill and intangible assets, and
acquisitions of these businesses, if accounted for as a purchase, would
typically result in substantial amortization charges to the Company. The
financial impact of acquisitions, investments and strategic alliances could have
a material adverse effect on the Company's business, financial condition and
results of operations and could cause substantial fluctuations in the Company's
future quarterly and yearly operating results. See "- Potential Fluctuations in
Quarterly Operating Results."
CONTROL OF COMPANY BY CURRENT STOCKHOLDERS
After completion of this Offering, the executive officers and directors of
the Company will continue to beneficially own 4,008,491 shares of Common Stock,
representing 45.5% of the Common Stock, including options to purchase 117,616
shares of Common Stock exercisable over time following the completion of this
Offering. Of these amounts, Ram Mukunda, President of the Company will
beneficially own 3,579,675 shares of Common Stock. Mr. Mukunda, Vijay Srinivas
and Usha Srinivas have
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entered into a voting agreement dated as of July 31, 1997 (the "Voting
Agreement"), pursuant to which Mr. Mukunda has the power to vote all of the
shares held by Mr. and Mrs. Srinivas. The Voting Agreement will terminate
December 31, 1997, or at such other time as the parties may otherwise agree. The
Company's executive officers and directors as a group, or Mr. Mukunda, acting
individually, will exercise significant influence over such matters as the
election of the directors of the Company, amendments to the Company's charter,
and other fundamental corporate transactions such as mergers, asset sales, and
the sale of the Company. See "Principal Stockholders" and "Description of
Capital Stock."
RESTRICTIONS IMPOSED BY SIGNET AGREEMENT
The Signet Agreement contains a number of affirmative and negative
covenants, including covenants restricting the Company and its subsidiaries with
respect to the conduct of business and maintenance of corporate existence, the
incurrence of additional indebtedness, the creation of liens, transactions with
Company affiliates, the consummation of certain merger or consolidating
transactions or the sale of substantial amounts of the Company's assets, the
sale of capital stock of any subsidiary, the making of investments or
acquisition of assets, and the making of dividend and similar payments or
distributions. In addition, the Signet Agreement includes a number of financial
covenants, including covenants requiring the Company to maintain certain
financial ratios and thresholds. A material breach of any of these obligations
or covenants could result in an event of default pursuant to which Signet Bank
could declare all amounts outstanding due and payable immediately. There can be
no assurance that one or more of such breaches will not occur or that the assets
or cash flows of the Company, or other sources of financing, would be sufficient
to repay in full all borrowings outstanding under the Signet Agreement in the
event of such breach. Beginning on January 1, 1998 (and extending to July 1,
1998 upon the occurrence of defined events), should Signet Bank determine and
assert based on its reasonable assessment that a material adverse change to the
Company has occurred, it could declare all amounts outstanding to be immediately
due and payable. The warrants issued to Signet Bank in connection with the
Signet Agreement also contain provisions which may adversely affect the
Company's ability to raise additional capital through the sale or issuance of
its Common Stock, options, warrants or other rights to purchase Common Stock, or
securities convertible into Common Stock without providing Signet Bank with the
right to maintain its percentage ownership in the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" and "Description of Capital Stock - Warrants
and Registration Rights."
In addition, the Company's repayment and other obligations under the Signet
Agreement are secured by (i) a first priority security interest in all of the
Company's tangible and intangible assets, including all customer lists and other
intellectual property of all direct and indirect subsidiaries; (ii) a pledge of
all of the capital stock of the Company owned by Ram Mukunda, the Company's
President, director and principal shareholder, and Vijay Srinivas, a Company
director and his wife, Usha Srinivas; and (iii) all leased or owned real estate
and all fixtures and equipment. A breach of any of the Company's obligations or
covenants under the Signet Agreement could result in an event of default
pursuant to which Signet Bank could also seek to foreclose on the security
provided by the Company, Mr. Mukunda and Mr. and Mrs. Srinivas. If Signet Bank
were to take possession of and control over the shares subject to the pledge, it
would acquire voting control of a significant percentage of the issued and
outstanding shares of Common Stock. See "Description of Capital Stock - Signet
Agreement."
CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES OF INCORPORATION, BYLAWS AND
MARYLAND LAW
The Company's Amended and Restated Articles of Incorporation (the
"Charter") and Bylaws (the "Bylaws") include certain provisions which may have
the effect of delaying, deterring or preventing a future takeover or change in
control of the Company such as notice requirements for stockholders, staggered
terms for its Board of Directors, limitations on the stockholders' ability to
remove directors, call meetings, or to present proposals to the stockholders for
a vote, and "super-majority" voting requirements for amendments to certain key
provisions of the Charter, unless such takeover or change in control is approved
by the Company's Board of Directors. Such provisions may also render the removal
of directors and management more difficult. In addition, the Company's Board of
Directors has the authority to issue up to 100,000 shares of preferred stock
(the "Preferred Stock") and to determine the
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price, rights, preferences and privileges of those shares without any further
vote or action by the stockholders. The rights of the holders of 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 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. The Company has no present plan to issue any shares of
Preferred Stock.
The Company is also subject to the anti-takeover provisions of the Maryland
General Corporation Law, which prohibit the Company from engaging in a "business
combination" with an Interested Stockholder (as defined) for a period of five
years after the date of the transaction in which the person first becomes an
Interested Stockholder, unless the business combination is approved in a
prescribed manner. The Company is also subject to the control share acquisition
provisions of the Maryland General Corporation Law, which provide that shares
acquired by a person with certain levels of voting power have no voting rights
unless the share acquisition is approved by the vote of two-thirds of the votes
entitled to be cast, excluding shares owned by the acquiror and by the Company's
officers and employee-directors, and in certain circumstances, such shares may
be redeemed by the Company. The application of these statutes and certain other
provisions of the Company's Charter could have the effect of discouraging,
delaying or preventing a change of control of the Company not approved by the
Board of Directors, which could adversely affect the market price of the
Company's Common Stock. Additionally, certain Federal regulations require prior
approval of certain transfers of control which could also have the effect of
delaying, deferring or preventing a change of control. See "Business -
Government Regulation" and "Description of Capital Stock Certain Provisions of
the Company's Articles of Incorporation, Bylaws and Maryland Law."
ABSENCE OF PRIOR PUBLIC MARKET; ARBITRARY OFFERING PRICE; POSSIBLE VOLATILITY OF
STOCK PRICE
Prior to this Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market for the Common
Stock will develop after the Offering or that, if a public market develops, the
market price for the Common Stock will equal or exceed the initial public
offering price set forth on the cover page of this Prospectus. The initial
public offering price of the Common Stock offered hereby was determined by
negotiations between the Company and the Representatives of the Underwriters and
may bear no relationship to the price at which the Common Stock will trade after
completion of this Offering. The initial public offering price of the Common
Stock offered hereby does not necessarily bear any relationship to the Company's
earnings, assets, book value, or any other recognized measure of value. For
factors considered in determining the initial public offering price, see
"Underwriting."
Historically, the market prices for securities of emerging companies in the
telecommunications industry have been highly volatile. Future announcements
concerning the Company or its competitors, including results of operations,
technological innovations, government regulations, proprietary rights or
significant litigation, may have a significant impact on the market price of the
Common Stock. In addition, the stock markets recently have experienced
significant price and volume fluctuations that particularly have affected
telecommunications companies and have resulted in changes in the market prices
of the stocks of many companies which have not been directly related to the
operating performance of those companies. Such market fluctuations may
materially adversely affect the market price of the Common Stock.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock and has no
plans to do so in the foreseeable future. The declaration and payment of any
dividends in the future will be determined by the Board of Directors, in its
discretion, and will depend on a number of factors, including the Company's
earnings, capital requirements and overall financial condition. In addition, the
Company's ability to declare and pay dividends is substantially restricted under
the terms of the Signet Agreement. See "Dividend Policy," "Management's
Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources" and "- Restrictions Imposed by Signet
Agreement."
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DILUTION TO PURCHASERS OF COMMON STOCK
Purchasers of Common Stock in this Offering will experience immediate and
substantial dilution. To the extent outstanding options and warrants to purchase
shares of Common Stock are exercised in the future, there will be further
dilution. See "Dilution."
BENEFITS OF THE OFFERING TO CURRENT STOCKHOLDERS
Current stockholders of the Company will benefit from the creation of a
public market for the Common Stock as a result of the Offering. Such
stockholders also will have an unrealized gain, represented by the difference
between the aggregate cost of the Common Stock which they currently own
($1,003,259) and the aggregate value of the Common Stock upon completion of the
Offering ($64,775,988, at an Offering price per share of $12.00). In addition,
Ram Mukunda, the Company's President and a director, Vijay Srinivas, a director,
and Usha Srinivas may be viewed as receiving a benefit from the completion of
the Offering, as part of the proceeds of the Offering are intended to be used to
partially repay amounts due under the Signet Agreement, which is secured, in
part, by all of the Common Stock owned by Mr. Mukunda and Mr. and Mrs. Srinivas.
See "Dilution" and "Description of Capital Stock Signet Agreement."
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of Common Stock in the public market following this Offering
by the current stockholders of the Company, or the perception that such sales
could occur, could adversely affect the market price for the Common Stock. The
Company's principal stockholders hold a significant portion of the Company's
outstanding Common Stock and a decision by one or more of these stockholders to
sell shares pursuant to Rule 144 under the Securities Act or otherwise could
materially adversely affect the market price of the Common Stock.
On the date of this Prospectus, the 2,850,000 shares of Common Stock to be
sold in this Offering (together with shares sold upon exercise of the
Underwriters' over allotment option, if any) will be eligible immediately for
sale in the public market. An additional 2,073,790 shares will become eligible
for public sale beginning 180 days after the effective date of the Registration
Statement of which this Prospectus forms a part, subject to the provisions of
Rule 144 under the Securities Act. Certain of the stockholders, and certain
holders of warrants to purchase shares of Common Stock, also have the right to
request that the Company register their shares for public sale. If a large
number of shares is registered and sold in the public market pursuant to the
exercise of such registration rights, such sales could have an adverse effect on
the market price of the Common Stock. See "Shares Eligible For Future Sale" and
"Description of Capital Stock - Signet Agreement."
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
in this Offering are estimated to be $30.7 million ($35.4 million if the
Underwriters' over-allotment option is exercised in full), after deducting
underwriting discounts and commissions and estimated offering expenses payable
by the Company.
The Company intends to use the net proceeds of the Offering as follows:
approximately $14.2 million to acquire cable facilities, switching, compression
and other related telecommunications equipment; approximately $4.7 million for
marketing; approximately $2.5 million to pay down amounts due under the Signet
Agreement, which matures on December 31, 1999 and bears interest, as of October
1, 1997, at a rate of 9.77%; and the balance for working capital and other
general corporate purposes, including possible future acquisitions and strategic
alliances. While the Company continually reviews possible acquisitions and
strategic alliances, it has not entered into any understanding or agreement with
respect to any future acquisition or strategic alliance. Pending application of
the net proceeds, the Company may invest such net proceeds in short-term,
interest-bearing investment grade securities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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<PAGE>
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock, nor does it expect to do so in the foreseeable future. It is anticipated
that all future earnings, if any, generated from operations will be retained by
the Company to develop and expand its business. Any future determination with
respect to the payment of dividends will be at the discretion of the Board of
Directors and will depend upon, among other things, the Company's operating
results, financial condition and capital requirements, the terms of
then-existing indebtedness, general business conditions and such other factors
as the Board of Directors deems relevant. In addition, the terms of the Signet
Agreement prohibit the payment of cash dividends without the lender's consent.
See "Risk Factors - Dividend Policy" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources."
DILUTION
The deficit in net tangible book value of the Company as of June 30, 1997
was $6.1 million or $1.14 per share of Common Stock. The deficit in net tangible
book value per share represents the amount of total tangible assets of the
Company less the amount of its total liabilities and divided by the total number
of shares of Common Stock outstanding. After giving effect to the sale by the
Company of the 2,850,000 shares of Common Stock offered hereby at an initial
public offering price of $12.00 per share, net of underwriting discounts and
commissions, and receipt of the net proceeds therefrom, the pro forma net
tangible book value of the Company as of June 30, 1997 would have been $24.5
million, or $2.97 per share. This represents an immediate increase in net
tangible book value of $4.11 per share to existing stockholders and an immediate
dilution of $9.03 per share to investors purchasing shares of Common Stock in
the Offering. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share .................................... $12.00
Net tangible book deficit per share as of June 30, 1997 before
Offering ......................................................... $ (1.14)
Increase in net tangible book value per share attributable to
this Offering ................................................... 4.11
-------
Pro forma net tangible book value per share as adjusted for this
Offering ............................................................ 2.97
------
Dilution in net tangible book value per share to new investors ...... $ 9.03
======
</TABLE>
The following table sets forth, on a pro forma basis as of June 30, 1997,
the differences between the existing stockholders and the new investors
purchasing Common Stock in the Offering with respect to the number of shares of
Common Stock to be purchased from the Company, the total consideration paid to
the Company in connection with the Offering and the average price per share paid
or to be paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
----------------------- ------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- --------- ------------- --------- ----------
<S> <C> <C> <C> <C> <C>
Existing stockholders ...... 5,397,999 65% $ 1,003,259 3% $ 0.19
New investors ............... 2,850,000 35% 34,200,000 97% 12.00
--------- ---- ------------ ---- -------
Total ..................... 8,247,999 100% $35,203,259 100% $ 4.27
========= ==== ============ ==== =======
</TABLE>
The foregoing table assumes no exercise of the Underwriters' over allotment
option and no conversion or exercise of convertible securities, options or
warrants to purchase additional shares of Common Stock. As of the date of this
Prospectus, there were options outstanding to purchase a total of 524,016 shares
of Common Stock at a weighted average exercise price of $5.59 per share, and
warrants and other rights outstanding to purchase a total of 566,800 shares. To
the extent outstanding options and warrants are exercised, there will be further
dilution to new investors. See "Management - Stock Option Plans," "Principal
Stockholders," "Description of Capital Stock - Warrants and Registration
Rights," and "Underwriting."
18
<PAGE>
CAPITALIZATION
(IN THOUSANDS, EXCEPT SHARE DATA)
The following table sets forth the capitalization of the Company (i) as of
June 30, 1997, (ii) on a pro forma basis to reflect the repayment of debt with
proceeds under the Signet Agreement and the conversion and retirement of
non-voting common stock as if such events had occurred as of June 30, 1997; and
(iii) as adjusted to reflect the sale and issuance of 2,850,000 shares of Common
Stock by the Company in the Offering (at an initial public offering price of
$12.00 per share, and assuming no exercise of the Underwriters' over allotment
option), and the application of the estimated net proceeds therefrom as
described under "Use of Proceeds." This table should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and related notes thereto appearing
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
---------------------------------------
ACTUAL PRO FORMA(1) AS ADJUSTED
----------- -------------- ------------
<S> <C> <C> <C>
Cash and cash equivalents ................................................ $ 2,106 $ 2,106 $ 30,270
======== ======== ========
Current maturities of long-term obligations:
Receivables based credit facility ....................................... $ 2,919 $ - $ -
Notes payable to related parties ....................................... 103 - -
Notes payable to individuals and other ................................. 1,300 - -
Capital lease obligations ................................................ 356 313 313
-------- -------- --------
4,678 313 313
Long-term obligations, net of current portion:
Signet credit facility ................................................... - 3,669 1,169
Redeemable Signet warrants(2) .......................................... - 823 -
Capital lease obligations ................................................ 665 588 588
Notes payable to related parties ....................................... 50 - -
Notes payable to individuals and others ................................. 44 44 44
-------- -------- --------
759 5,124 1,801
-------- -------- --------
Total current and long-term obligations ................................. 5,437 5,437 2,114
-------- -------- --------
Stockholders' (deficit) equity
Common Stock; $0.01 par value; 10,000,000 shares authorized on an actual and
pro forma basis, 20,000,000 shares authorized as adjusted; 5,380,824 shares
issued and outstanding, 5,397,999 pro forma and 8,247,999 as ad-
justed(3) 54 54 83
Non voting common stock; $1.00 par value; 25,000 shares authorized; 22,526
shares issued and outstanding, no shares outstanding pro forma and as
adjusted ............................................................... 23 - -
Preferred stock, $1.00 par value; no shares authorized on an actual and pro
forma basis, 100,000 shares authorized as adjusted; no shares issued and
outstanding ............................................................ - - -
Additional paid-in capital ............................................. 1,063 1,041 30,806
Unearned compensation(2) ............................................. (108) (108) -
Warrants(2) ............................................................ - - 1,693
Accumulated deficit(2) ................................................ (6,746) (6,746) (6,854)
-------- -------- --------
Total stockholders' (deficit) equity ................................. (5,714) (5,759) 25,728
-------- -------- --------
Total capitalization ................................................ $ (277) $ (322) $ 27,842
======== ======== ========
</TABLE>
- ----------
(1) Gives pro forma effect to (i) proceeds under the Signet Agreement used to
retire amounts due under a receivables-based credit facility, notes payable
to related parties, notes payable to individuals and other and certain
capital lease obligations; (ii) the fair value of 269,900 warrants granted
to Signet Bank, which contain a repurchase feature, recorded as the Signet
Agreement; (iii) the conversion of 17,175 shares of non voting common stock
into an equal number of shares of Common Stock; and (iv) the purchase and
retirement of 5,351 shares of non voting common stock.
(2) Reflects (i) the fair value of 150,000 warrants issued to the Underwriters
and the fair value of the Signet Warrants, which are not redeemable upon
completion of the Offering; and (ii) the acceleration of unearned
compensation expense related to stock options which vest upon completion of
the Offering.
(3) Excludes (i) 269,766 shares of Common Stock issuable upon the exercise of
options under the Amended and Restated Stock Option Plan; (ii) 750,000
(254,250 of which were granted in September 1997) shares of Common Stock
reserved for issuance under the Company's 1997 Performance Incentive Plan;
and (iii) 716,800 shares of Common Stock issuable pursuant to the exercise
of certain warrants and upon conversion of a note. See "Management - Stock
Option Plans," "Description of Capital Stock - Warrants and Registration
Right," and "Underwriting."
19
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE DATA)
The following table presents selected financial data of the Company for the
years ended December 31, 1992, 1993, 1994, 1995, 1996 and the six months ended
June 30, 1996 and 1997. The historical financial data as of December 31, 1994,
1995, 1996 and for each of the three years in the period ended December 31, 1996
have been derived from the financial statements of the Company which have been
audited by Arthur Andersen LLP, independent public accountants, as set forth in
the financial statements and notes thereto presented elsewhere herein. The
financial data as of December 31, 1992 and 1993, and for the years then ended
and for the six months ended June 30, 1996 and 1997 have been derived from the
Company's unaudited financial statements in a manner consistent with the audited
financial statements. In the opinion of the Company's management, these
unaudited financial statements include all adjustments necessary for a fair
presentation of such information. Operating results for interim periods are not
necessarily indicative of the results that might be expected for the entire
fiscal years. The following information should be read in conjunction with the
Company's selected financial statements and notes thereto presented elsewhere
herein. See "Financial Statements" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------------- ------------------
1992 1993 1994 1995 1996 1996 1997
-------- ----------- ----------- ------------ ------------ --------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues ........................... $2,394 $ 3,288 $ 5,108 $ 10,508 $ 32,215 $13,206 $28,836
Cost of services ........................ 1,585 3,090 4,701 9,129 29,881 12,388 25,250
------ -------- ------- -------- -------- ------- --------
Gross margin ........................... 809 198 407 1,379 2,334 818 3,586
General and administrative expenses ...... 464 1,491 1,159 2,170 3,996 1,373 2,461
Selling and marketing expenses ......... 30 232 91 184 514 154 306
Depreciation and amortization ............ 61 85 90 137 333 144 214
------ -------- ------- -------- -------- ------- --------
Income (loss) from operations ............ 254 (1,610) (933) (1,112) (2,509) (853) 605
Interest expense ........................ 47 71 70 116 337 118 252
Interest income ........................... 1 13 24 22 16 9 5
------ -------- ------- -------- -------- ------- --------
Income (loss) before income tax
provision .............................. 208 (1,668) (979) (1,206) (2,830) (962) 358
Income tax provision ..................... - - - - - - 7
------ -------- ------- -------- -------- ------- --------
Net income (loss) ........................ $ 208 $ (1,668) $ (979) $ (1,206) $ (2,830) $ (962) $ 351
====== ======== ======= ======== ======== ======= ========
PER SHARE DATA:
Net income (loss) per common and
equivalent share ..................... $ 0.04 $ (0.33) $ (0.20) $ (0.21) $ (0.49) $(0.17) $ 0.06
====== ======== ======= ======== ======== ======= ========
Weighted average common and equiva-
lent shares outstanding 4,969 4,989 4,989 5,710 5,796 5,796 5,796
</TABLE>
<TABLE>
<CAPTION>
AS OF
AS OF DECEMBER 31, JUNE 30,
--------------------------------------------------------- ------------
1992 1993 1994 1995 1996 1997
--------- ----------- ----------- ----------- ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents .................. $ 230 $ 194 $ 257 $ 528 $ 148 $ 2,106
Working capital deficit ..................... (364) (2,097) (3,295) (3,744) (7,000) (7,293)
Total assets ................................. 1,606 1,176 1,954 4,044 7,328 14,265
Long-term obligations, net of current portion 165 248 6 361 646 759
Stockholders' deficit ........................ $ (207) $ (1,824) $ (2,803) $ (3,259) $ (6,089) $ (5,714)
</TABLE>
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and
results of operations should be read in conjunction with the financial
statements, related notes, and other detailed information included elsewhere in
this Prospectus. This discussion, including the Company's plans and strategy for
its business, contains forward-looking statements that involve certain risks and
uncertainties. The Company's actual results could differ materially from those
anticipated by the forward-looking statements as a result of certain factors,
including, but not limited to those discussed under "Risk Factors" and elsewhere
in this Prospectus.
OVERVIEW
The Company is a rapidly growing, facilities-based international long
distance carrier that has implemented a marketing strategy to serve ethnic
residential markets in the U.S. and some of the leading international long
distance carriers. The Company's quarterly revenues have increased fifteen fold
over the last three years from approximately $1.1 million in the quarter ended
June 30, 1994 to approximately $16.5 million in the quarter ended June 30, 1997.
The Company's residential billing customers increased to over 43,700 for June
1997 compared to approximately 5,000 for June 1994, as measured over a 30 day
period. Since its inception in 1989, the Company has focused its marketing
efforts on the residential consumer marketplace in ethnic communities in which
management believes there is a high demand for international long distance
services. To achieve the economies of scale necessary to maintain cost effective
operations, the Company began reselling its capacity to other carriers in late
1995. The Company currently offers U.S.-originated long distance service
worldwide through a flexible network of owned and leased transmission facilities
and resale arrangements, as well as a variety of operating agreements and
termination arrangements.
Until 1995, the Company's business was concentrated in the New York to
Washington, D.C. corridor and focused on the delivery of dial-around access
calling services to India. At the end of 1995, the Company expanded its customer
base to include the West Coast, and began targeting other ethnic groups in the
U.S., such as the Middle Eastern, Philippine and Russian communities. This
expansion was facilitated by utilizing a portion of the proceeds of the sale of
stock to Blue Carol Enterprises Ltd., an affiliate of Portugal Telecom
International. The Company supported this expansion by leasing network capacity
from other domestic telecommunications companies, thereby experiencing higher
per-minute costs. In late 1995, the Company began to market its international
long distance services to other telecommunications carriers. While providing
greater utilization of its own network facilities, the carrier group allowed the
Company to build relationships with other carriers, which in turn, led to
additional termination options for its residential traffic. See "Business -
Strategy."
The Company's strategy is to serve its customers by building its own global
network, which will allow the Company to originate, transmit, and terminate
calls utilizing network capacity the Company manages. The Company anticipates
that this network expansion will allow it to achieve a per-minute cost advantage
over current arrangements. As the Company transitions from leasing to owning or
managing its facilities, the Company's management believes economies in the
per-minute cost of a call will be realized, while fixed costs will increase.
Presently, the facilities owned by the Company are domestically based and
provide a cost advantage only with respect to origination costs. The Company
realizes a per-minute cost savings when it is able to originate calls on network
facilities it owns and manages ("on net") versus calls which must be originated
through the utilization of facilities the Company does not own ("off net"). For
the six months ended June 30, 1997 and for the year ended December 31, 1996,
approximately 58.1% and 44.9% of the Company's residential revenues were
originated on net, resulting in gross margins of approximately 4.4% and 3.7% as
compared to gross margins of approximately 2.2% and 3.1% on residential revenues
originated off net during the respective periods on other carrier facilities
during the respective periods. As a higher percentage of calls are originated,
transmitted, and terminated on the Company's own facilities, per-minute costs
are expected to decline, predicated on call traffic volumes.
21
<PAGE>
Revenues for telecommunication services are recognized as such services are
rendered, net of an allowance for revenue that the Company estimates will
ultimately not be realized. Revenues for return traffic received according to
the terms of the Company's operating agreements with foreign PTT's, as described
below, are recognized as revenue as the return traffic is received and
processed. There can be no assurance that traffic will be delivered back to the
United States or what impact changes in future settlement rates, allocations
among carriers or levels of traffic will have on net payments made and revenues
received and recorded by the Company.
The Company's cost of services consists of origination, transmission and
termination expenses. Origination costs include the amounts paid to LECs and
other domestic telecommunication network providers in areas where the Company
does not have its own network facilities. Transmission expenses are fixed
month-to-month payments associated with capacity on satellites, undersea
fiber-optic cables, and other domestic and international leased lines. Leasing
this capacity subjects the Company to price changes that are beyond the
Company's control and to transmission costs that are higher than transmission
costs on the Company's owned network. As the Company builds its own transmission
capacity, the risk associated with price fluctuations and the relative costs of
transmission are expected to decrease, however, fixed costs will increase. See
"Risk Factors - Potential Fluctuations in Quarterly Operating Results."
Among its various foreign termination arrangements, the Company has entered
into operating agreements with a number of foreign PTTs, under which
international long distance traffic is both delivered and received. Under these
agreements, the foreign carriers are contractually obligated to adhere to the
policy of the FCC, whereby traffic from the foreign country is routed through
U.S. international carriers, such as the Company, in the same proportion as
traffic carried into the country ("return traffic"). Mutually exchanged traffic
between the Company and foreign carriers is reconciled through a formal
settlement arrangement at agreed upon rates. The Company records the amount due
to the foreign PTT as an expense in the period the traffic is terminated. When
the Company receives return traffic in a future period, the Company generally
realizes a higher gross margin on the return traffic as compared to the lower
margin on the outbound traffic. Return traffic accounted for approximately 3.4%
and 3.5% of revenues in the six months ended June 30, 1997 and the year ended
December 31, 1996, respectively.
In addition to the operating agreements, the Company utilizes alternative
termination arrangements offered by third party vendors. The Company seeks to
maintain strong vendor diversity for countries where traffic volume is high.
These vendor arrangements provide service on a variable cost basis subject to
volume. These prices are subject to changes, generally upon seven-days notice.
As the international telecommunications marketplace has been deregulated,
per-minute prices have fallen and, as a consequence, related per-minute costs
for these services have also fallen. As a result, the Company has not been
adversely affected by the price reductions, although there can be no assurance
that this will continue. Although the Company generated positive net income for
the six months ended June 30, 1997, the Company expects selling, general and
administrative costs to increase as it develops its infrastructure to manage
higher business volume. Thus, continued profitability is dependent upon
management's ability to successfully manage growth and operations. See "Risk
Factors - Management of Growth."
22
<PAGE>
Results of Operations
The following table sets forth for the periods indicated certain financial
data as a percentage of net revenues.
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------ -------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
Net revenues ........................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of services ........................ 92.0 86.9 92.8 93.8 87.6
--------- --------- --------- --------- ------
Gross margin ........................... 8.0 13.1 7.2 6.2 12.4
General and administrative expenses . 22.7 20.7 12.4 10.4 8.5
Selling and marketing expenses ......... 1.8 1.8 1.6 1.2 1.1
Depreciation and amortization ............ 1.8 1.3 1.0 1.1 0.7
--------- --------- --------- --------- ------
Income (loss) from operations ......... (18.3) (10.7) (7.8) (6.5) 2.1
Interest expense ........................ (1.4) (1.1) (1.1) (0.9) (0.9)
Interest income ........................ 0.5 0.2 0.1 0.1 -
--------- --------- --------- --------- ------
Income (loss) before income tax
provision ........................... (19.2) (11.6) (8.8) (7.3) 1.2
Income tax provision ..................... - - - - -
--------- --------- --------- --------- ------
Net income (loss) ..................... (19.2)% (11.6)% (8.8)% (7.3)% 1.2%
========= ========= ========= ========= ======
</TABLE>
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
Net Revenues. Net revenues increased approximately $15.6 million or 118.2%,
to $28.8 million in the six months ended June 30, 1997 from $13.2 million for
the six months ended June 30, 1996. Residential revenue increased in comparative
periods by approximately $5.5 million or 110.0%, to $10.5 million in the first
six months of 1997 from approximately $5.0 million for the first six months of
1996. The increase in residential revenue is due to an increase in residential
customers to over 43,700 for June 1997 from approximately 19,800 for June 1996.
Carrier revenue increased approximately $10.1 million or 123.2%, to $18.3
million in the first six months of 1997 from $8.2 million in the first six
months of 1996. The increase in carrier revenue is due to the execution of the
Company's strategy to optimize its capacity on its facilities, which has
resulted in sales to additional customers and increased sales to existing
customers. Carrier revenue also improved due to an increase in return traffic to
approximately $994,000 for the six months ended June 30, 1997 from approximately
$490,000 for the six months ended June 30, 1996.
Gross Margin. Total gross margin increased approximately $2.8 million to
$3.6 million for the six months ended June 30, 1997 from $818,000 for the six
months ended June 30, 1996. Gross margin improved as a percentage of net revenue
to approximately 12.4% for the first six months of 1997 from 6.2% for the first
six months of 1996. The gross margin on residential revenue increased to
approximately 12.4% for the six months ended June 30, 1997 from 9.2% for the six
months ended June 30, 1996, due to an increase in the percentage of residential
traffic originated on net and improved termination costs. In the six months
ended June 30, 1997, approximately 58.1% of residential revenue originated on
net, as compared to approximately 41.6% in the six months ended June 30, 1996.
The gross margin on carrier revenue increased to approximately 12.5% in the
first six months of 1997 from 4.4% for the first six months of 1996. Excluding
the impact of return traffic, which is included in carrier revenue, the gross
margin on carrier revenue would have been approximately 7.4% for the six months
ended June 30, 1997, and negative 1.6% for the six months ended June 30, 1996.
The improvement in margin on carrier revenue is due to reduced termination costs
pursuant to the Company's strategy of diversifying its termination options.
The reported gross margin for the six months ended June 30, 1997 and June
30, 1996 includes the effect of accrued disputed charges of approximately
$67,000 and $487,000, respectively, which represents less than 1.0% and 4.0% of
reported net revenues.
23
<PAGE>
General and Administrative. General and administrative expenses increased
approximately $1.1 million or 78.6%, to $2.5 million for the six months ended
June 30, 1997 from $1.4 million for the six months ended June 30, 1996. As a
percentage of net revenue, general and administrative expenses declined to
approximately 8.5% from 10.4% for the respective periods. The increase in dollar
amounts was primarily due to an increase in personnel to 72 from 54 in the
respective periods and, to a lesser extent, an increase in billing processing
fees.
Selling and Marketing. Selling and marketing expenses decreased as a
percentage of net revenue to approximately 1.1% in the six months ended June 30,
1997 from 1.2% in the six months ended June 30, 1996. In dollar amounts, selling
and marketing expenses increased to approximately $306,000 in the first six
months of 1997, from approximately $154,000 in the first six months of 1996, as
a result of the Company's efforts to market to new customer groups.
Depreciation and Amortization. Depreciation and amortization expenses
increased to approximately $214,000 in the six months ended June 30, 1997 from
$144,000 in the six months ended June 30, 1996, primarily due to increases in
capital expenditures for the expansion of the network infrastructure.
Interest. Interest expense increased to approximately $252,000 for the six
months ended June 30, 1997 from $118,000 for the six months ended June 30, 1996,
as a result of additional debt incurred by the Company to fund working capital
needs.
Net Income. Net income was approximately $351,000 for the six months ended
June 30, 1997 as compared to a loss of $962,000 for the six months ended June
30, 1996. The improvement in net income is largely attributable to the increase
in gross margin dollar amounts as described above.
1996 COMPARED TO 1995
Net Revenues. Net revenues increased approximately $21.7 million or 206.7%,
to $32.2 million for the year ended 1996 from $10.5 million in the year ended
1995. Residential revenue increased in comparative periods by approximately $6.6
million or 122.2%, to $12.0 million in 1996 from $5.4 million in 1995. The
increase in residential revenue is due to a concerted effort to expand marketing
to the West Coast and to target additional ethnic communities such as the Middle
Eastern, Philippine, and Russian communities. The Company's residential customer
base grew to approximately 27,800 customers as of December 31, 1996 from 10,700
customers as of December 31, 1995. Carrier revenue increased approximately $15.1
million or 296.1%, to $20.2 million in 1996 from $5.1 million in 1995. This
growth is a result of the Company's strategy to optimize network utilization by
offering its services to other carriers. In this regard, the Company was
successful in expanding its marketing and increased sales to first and
second-tier carriers. Return traffic decreased to approximately $1.1 million in
1996 from $2.0 million in 1995. Net revenues in 1995 reflect the receipt of
previously undelivered return traffic revenues to the Company.
Gross Margin. Total gross margin increased approximately $900,000 to $2.3
million in 1996 from $1.4 million for 1995. Gross margin decreased as a
percentage of net revenue to approximately 7.2% for 1996 from 13.1% for 1995.
The gross margin on residential revenue decreased to approximately 10.1% in 1996
from 10.4% in 1995 due to initial expenses associated with the entry into new
markets. As a result of the expansion into additional ethnic markets and new
geographic areas, on net origination declined to approximately 44.9% in 1996, as
compared to 62.9% in 1995. The relative decrease in on net originated traffic
was due to customer base growth prior to the expansion of owned or managed
facilities. The gross margin on carrier revenue, excluding return traffic,
increased to approximately negative 0.02% in 1996 from negative 36.9% in 1995.
General and Administrative. General and administrative expenses increased
approximately $1.8 million or 81.8%, to $4.0 million for 1996 from $2.2 million
for 1995. However, as a percentage of net revenue, general and administrative
expenses declined to approximately 12.4% from 20.7% in the respective periods.
The increase in dollar amounts in general and administrative expenses primarily
resulted from increased third party billing and collection fees of approximately
$349,000 to support higher calling volume; increased personnel expenses to $1.5
million in 1996 from $1.1 million in 1995 as a result of new hires; and bad debt
losses of approximately $529,000 attributable to the bankruptcy of one former
customer.
24
<PAGE>
Selling and Marketing. Selling and marketing expenses decreased as a
percentage of net revenue to approximately 1.6% in 1996 from 1.8% in 1995. In
dollar amounts, selling and marketing expenses increased to approximately
$514,000 in 1996 from $184,000 in 1995. The increase is attributable to the
Company's efforts to enter additional ethnic markets and new geographic areas.
Depreciation and Amortization. Depreciation and amortization expenses grew
to approximately $333,000 in 1996 from $137,000 in 1995, primarily due to
increased capital expenditures.
Interest. Interest expense increased to approximately $337,000 for 1996
from $116,000 in 1995, primarily due to increased borrowings under a credit
facility to support growth in accounts receivable, and to a lesser extent,
increased borrowings from related and other parties.
Net Loss. The Company experienced a net loss of approximately $2.8 million
in 1996 as compared to a net loss of $1.2 million in 1995.
1995 COMPARED TO 1994
Net Revenues. Net revenues increased approximately $5.4 million or 105.9%,
to $10.5 million for the year ended 1995 from $5.1 million in the year ended
1994. Residential revenue increased in comparative periods by approximately $2.0
million or 58.8%, to $5.4 million in 1995 from $3.4 million in 1994. The
increase in residential revenue was due to an increase in the number of
customers to approximately 10,700 by the end of 1995 from approximately 6,300 at
the end of 1994. Carrier revenue increased approximately $3.4 million or 200.0%,
to $5.1 million in 1995 from $1.7 million in 1994. The increase in carrier
revenue was primarily the result of both increased sales to existing customers
and an increase in return traffic to approximately $2.0 million in 1995 from
$174,000 in 1994.
Gross Margin. Total gross margin increased approximately $972,000 to $1.4
million in 1995 from $407,000 for 1994. Gross margin increased as a percentage
of net revenue to approximately 13.1% for 1995 from 8.0% for 1994. The gross
margin on residential revenue decreased to approximately 10.4% in 1995 from
21.1% in 1994 due to an expansion from the Company's Mid-Atlantic customer base.
The Company elected to expand its business base in advance of acquiring
facilities, thereby reducing the percentage of on net originating traffic. In
1995, approximately 62.9% of residential revenue originated on net, as compared
to 75.8% in 1994. The gross margin on carrier revenue, excluding the impact of
return traffic, decreased to approximately negative 36.9% in 1995 from negative
33.2% in 1994.
General and Administrative. General and administrative expenses increased
approximately $1.0 million or 83.3%, to $2.2 million for 1995 from $1.2 million
for 1994. As a percentage of revenue, general and administrative expenses
declined to approximately 20.7% from 22.7% in the respective periods. The
increase in dollar amounts was primarily due to increased personnel and
commission expenses incurred to develop new markets.
Selling and Marketing. Selling and marketing expenses remained
approximately the same as a percentage of net revenue in 1995 and 1994 at 1.8%.
In dollar amounts, selling and marketing expenses increased to approximately
$184,000 in 1995 from $91,000 in 1994. The increase in dollar amounts is
attributable to the Company's efforts to enter additional ethnic markets.
Depreciation and Amortization. Depreciation and amortization expenses
increased to approximately $137,000 in 1995 from $90,000 in 1994, primarily due
to an increase in capital expenditures for the expansion of the network
infrastructure.
Interest. Interest expense increased to approximately $116,000 for 1995
from $70,000 in 1994, primarily as a result of increased borrowings under a
credit facility to support growth in accounts receivable.
Net Income. The Company experienced a net loss of approximately $1.2
million in 1995 as compared to a net loss of $979,000 in 1994.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly financial data
for each of the quarters in the year ended December 31, 1995, the year ended
December 31, 1996, the three months ended March 31, 1997, and the three months
ended June 30, 1997. This quarterly information has been derived from
25
<PAGE>
and should be read in conjunction with the Company's financial statements and
the notes thereto included elsewhere in this Prospectus, and, in management's
opinion, reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information. Operating
results for any quarter are not necessarily indicative of results for any future
period.
<TABLE>
<CAPTION>
QUARTERS ENDED
-------------------------------------------------------------------------------------
1995 1996
----------------------------------------- -------------------------------------------
MAR. 31, JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31
---------- --------- ---------- --------- --------- --------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues ..................... $1,462 $1,860 $2,762 $4,424 $4,722 $8,485 $7,652 $ 11,356
Cost of services .................. 1,137 1,533 2,363 4,096 4,467 7,922 6,763 10,729
------ ------ ------ ------ ------ ------ ------ --------
Gross margin(1) .................. 325 327 399 328 255 563 889 627
General and administrative
expenses ........................ 449 460 484 777 595 778 1,370 1,253
Selling and marketing expenses ... 30 30 39 85 52 101 166 195
Depreciation and amortization ...... 29 31 32 45 52 93 93 95
------ ------ ------ ------ ------ ------ ------ --------
Income (loss) from operations . (183) (194) (156) (579) (444) (409) (740) (916)
Interest expense .................. 22 23 25 46 58 60 80 139
Interest income .................. 5 5 6 6 5 4 5 2
------ ------ ------ ------ ------ ------ ------ --------
Income (loss) before income tax
provision ........................ (200) (212) (175) (619) (497) (465) (815) (1,053)
Income tax provision ............... - - - - - - - -
------ ------ ------ ------ ------ ------ ------ --------
Net income (loss) ............... $ (200) $ (212) $ (175) $ (619) $ (497) $ (465) $ (815) $ (1,053)
====== ====== ====== ====== ====== ====== ====== ========
<CAPTION>
1997
------------------
MAR. 31 JUNE 30
--------- --------
<S> <C> <C>
Net revenues ..................... $12,372 $16,464
Cost of services .................. 10,765 14,485
------- -------
Gross margin(1) .................. 1,607 1,979
General and administrative
expenses ........................ 1,151 1,310
Selling and marketing expenses ... 104 202
Depreciation and amortization ...... 96 118
------- -------
Income (loss) from operations . 256 349
Interest expense .................. 117 135
Interest income .................. 1 4
------- -------
Income (loss) before income tax
provision ........................ 140 218
Income tax provision ............... 3 4
------- -------
Net income (loss) ............... $ 137 $ 214
======= =======
</TABLE>
- ----------
(1) During the first quarter of 1997, the Company's gross margin improved by
approximately $1.0 million over the fourth quarter 1996. The improvement
was due to (i) approximately $500,000 in costs accrued in the fourth
quarter 1996 for disputed vendor obligations as compared to approximately
$8,000 in costs accrued during the first quarter of 1997; (ii)
approximately $400,000 of cost reductions in 1997 resulting from an
increase in the utilization of alternative termination options; and (iii) a
lesser extent, an increase in the percentage of retail traffic originated
on net.
LIQUIDITY AND CAPITAL RESOURCES
Although founded in 1989, the Company's rapid growth commenced in 1995 as
the Company began actively marketing international services to additional ethnic
communities in major metropolitan areas in the U.S. and to other
telecommunication carriers. This growth required an investment in working
capital to finance the net loss that was incurred through 1996 and the increase
in accounts receivable. Until the first quarter of 1997, however, operating
activities were a net use of cash. Net cash used in operating activities was
$76,000 in 1994, $768,000 in 1995 and $1.4 million in 1996. In the first six
months of 1997, operating activities generated net cash of approximately
$514,000. To facilitate this growth, the Company made investments in property
and equipment of approximately $44,000 in 1994, $200,000 in 1995, $520,000 in
1996 and $184,000 in the first six months of 1997. Through 1996, the Company
funded its growth primarily through borrowings under its receivable credit
facility, notes payable to individuals and the issuance of voting common stock.
Net cash provided by financing activities was approximately $183,000 in 1994,
$1.2 million in 1995 and $1.5 million in 1996, and approximately $1.6 million in
the first six months of 1997.
On July 1, 1997, the Company entered into the Signet Agreement, which
provides for maximum borrowings of up to $10 million through December 31, 1997,
and the lesser of $15 million or 85% of eligible accounts receivable, as
defined, thereafter until maturity on December 31, 1999. The Company may elect
to pay quarterly interest payments at the prime rate, plus 2%, or the adjusted
LIBOR, plus 4%. The Signet Agreement required a $150,000 commitment fee to be
paid at closing, and a quarterly commitment fee of 0.25% of the unborrowed
portion. The Signet Agreement is secured by substantially all of the Company's
assets. It contains certain financial and non-financial covenants, including,
but not limited to, ratios of monthly net revenue to loan balance, interest
coverage, and cash flow leverage, minimum subscribers, limitations on capital
expenditures, additional indebtedness, acquisition or transfer of assets,
payment of dividends, new ventures or mergers, and issuance of additional
equity. The Company is currently in compliance with all financial ratios and
covenants of the Signet Agreement. Beginning on January 1, 1998 (and extending
to July 1, 1998 upon the occurrence of defined events),
26
<PAGE>
should Signet Bank determine and assert based on its reasonable assessment that
a material adverse change to the Company has occurred, it could declare all
amounts outstanding to be immediately due and payable.
The Signet Agreement provides that Signet Bank (the "Lender" or "Signet
Bank") receive warrants to purchase up to 539,800 shares of the Common Stock,
which represents 10% of the issued and outstanding shares of Common Stock as of
July 1, 1997. Warrants representing 5% of the issued and outstanding shares are
currently exercisable. The exercise price of these warrants is $8.46. Further,
beginning in the first calendar quarter of 1998, and continuing until the
Company completes an initial public offering, an additional 1% each calendar
quarter will vest in the Lender. The exercise price of these warrants will be
set at a price which values the Company at 10 times revenue for the immediately
preceding month. So long as the Offering is completed by December 31, 1997, the
Lender will only receive warrants to purchase 269,900 shares of Common Stock,
representing 5% of the issued and outstanding shares of Common Stock as of July
1, 1997. Until the Offering has been completed, the Company is obligated to
repurchase the shares underlying the warrant in certain circumstances at the
then fair value of the Company as determined by an independent appraisal. The
Lender has certain registration rights with respect to the shares underlying the
warrant. See "Description of Capital Stock - Signet Agreement."
The Company will be reporting the warrants to purchase 269,900 shares of
the Common Stock, which are currently exercisable, as a discount to the loan,
which will be amortized to interest expense over the term of the loan. In the
event that the Signet Agreement is extinguished or otherwise refinanced with a
new credit facility, the Company intends to expense, as an extraordinary item
(if material), the then-existing unamortized debt discount and deferred
financing cost related to the Signet Agreement, which was approximately $1.2
million as of July 1, 1997. Until the Offering has been completed, amounts
ascribed to the warrants will be reflected as a liability and will be adjusted
based upon their redemption value. Additional warrants which may become
exercisable in the event that the Company does not complete the Offering in 1997
will be valued at their fair value when and if exercisable and will be charged
to interest expense over the balance of the term of the Signet Bank loan.
Prior to the execution of the Signet Agreement, the Company had a credit
and billing arrangement with a third party. This facility allowed the Company to
receive advances of 70% of all records submitted for billing. These advances
were secured by receivables involved. The credit limit under the agreement was
$3 million and bore an interest rate of prime plus 4%.
The Company is continuing to pursue a flexible approach to expand its
markets and enhance its network facilities by investing in marketing, and in
switching and transmission facilities, where anticipated traffic volumes justify
such investments. Historically, the Company has achieved market penetration with
only modest investments in marketing. There can be no assurance that the
Company's prior marketing achievements can be replicated with increased
marketing investments. A number of factors, including market share, competitor
rates and quality of service determine the effectiveness of the market entry
strategy. See "Business - Strategy."
The Company has planned capital expenditures through 1998 of $8.5 million.
Additionally, marketing expenditures for 1997 and 1998 are expected to reach
$4.5 million in the aggregate. These expenditure needs are expected to be met by
cash from operations, amounts available under the line of credit and the
proceeds of the Offering. See "Use of Proceeds." These capital needs will
continue to expand as the Company executes its business strategy. See "Risk
Factors - Capital Requirements; Need for Additional Financing."
The Company has accrued approximately $2.1 million as of June 30, 1997, for
disputed vendor obligations asserted by one of the Company's foreign carriers
for minutes processed in excess of the minutes reflected on the Company's
records. If the Company prevails in its dispute, these amounts or portions
thereof would be credited to operations in the period of resolution. Conversely,
if the Company does not prevail in its dispute, these amounts or portions
thereof would be paid in cash.
27
<PAGE>
NEW ACCOUNTING STANDARDS
In 1997 the Financial Accounting Standards Board Released Statement No.
128, "Earnings Per Share" ("Statement 128"). Statement 128 requires dual
presentation of basic and diluted earnings per share on the face of the income
statement for all periods presented. Basic earnings per share excludes dilution
and is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. Diluted earnings per share is computed similarly
to fully diluted earnings per share pursuant to Accounting Principles Bulletin
No. 15. Statement 128 is effective for fiscal periods ending after December 15,
1997, and when adopted, will require restatement of prior periods' earnings per
share.
The requirements of the Securities and Exchange Commission require the
dilutive effects of common stock and stock rights issued within 12 months of an
initial public offering be included in the computation of both basic and
dilutive earnings per share. Accordingly, management anticipates that Statement
128 will not have a material impact upon reported earnings per share.
EFFECTS OF INFLATION
Inflation is not a material factor affecting the Company's business and has
not had a significant effect on the Company's operations to date.
28
<PAGE>
BUSINESS
GENERAL
STARTEC is a rapidly growing, facilities-based international long distance
carrier which markets its services to select ethnic U.S. residential communities
that have significant international long distance usage. Additionally, to
maximize the efficiency of its network capacity, the Company sells its
international long distance services to some of the world's leading carriers.
The Company provides its services through a flexible network of owned and leased
transmission facilities, resale arrangements and a variety of operating
agreements and termination arrangements. The Company currently operates a switch
in Washington, D.C. and leases switching facilities from other
telecommunications carriers. The Company is in the process of constructing an
international gateway facility in New York City.
The Company's mission is to dominate select international telecom markets
by strategically building network facilities that allow it to manage both sides
of a telephone call. The Company intends to own multiple switches and other
network facilities which allow it to originate and terminate a substantial
portion of its own traffic. The Company believes that building network
facilities, acquiring additional termination options and expanding its proven
marketing strategy should lead to continued growth and improved profitability.
INDUSTRY BACKGROUND
The international telecommunications industry consists of transmissions of
voice and data that originate in one country and terminate in another. This
industry is experiencing a period of rapid change which has resulted in
substantial growth in international telecommunications traffic. For domestic
carriers, the international market can be divided into two major segments: the
U.S.-originated market, which consists of all international calls which either
originate or are billed in the United States, and the overseas market, which
consists of all calls billed outside the United States. According to the
Company's market research, the international telecommunications services market
was approximately $56 billion in aggregate carrier revenues for 1995, and the
volume of international traffic on the public telephone network is expected to
grow at a compound annual growth rate of 10% or more from 1997 through the year
2000. The U.S.-originated international market has experienced substantial
growth in recent years, with revenues rising from approximately $8 billion in
1990 to approximately $14 billion in 1995.
The Company believes that the international telecommunications market will
continue to experience strong growth for the foreseeable future as a result of
the following developments and trends:
o Global Economic Development and Increased Access to Telecommunications
Services. The dramatic increase in the number of telephone lines around the
world, stimulated by economic growth and development, government mandates
and technological advancements, is expected to lead to increased demand for
international telecommunications services in those markets.
o Deregulation of Telecommunications Markets. The continuing deregulation and
privatization of telecommunications markets has provided, and continues to
provide, opportunities for carriers who desire to penetrate those markets.
o Reduced Rates Stimulating Higher Traffic Volumes. The reduction of outbound
international long distance rates, resulting from increased competition and
technological advancements, has made, and continues to make, international
calling available to a much larger customer base thereby stimulating
increased traffic volumes.
o Increased Capacity. The increased availability of higher-quality digital
undersea fiber optic cable has enabled international long distance carriers
to improve service quality while reducing costs.
o Popularity and Acceptance of Technology. The proliferation of
communications devices, including cellular telephones, facsimile machines
and communications equipment has led to a general increase in the use of
telecommunications services.
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<PAGE>
o Bandwidth Needs. The demand for bandwidth-intensive data transmission
services, including Internet-based demand, has increased rapidly and is
expected to continue to increase in the future.
Development of U.S. and Foreign Telecommunications Markets
The 1984 court-ordered dissolution of AT&Ts monopoly over local and long
distance telecommunications fostered the emergence of new U.S. long distance
companies. Today there are over 500 U.S. long distance companies, most of which
are small- or medium-sized companies, serving residential and business customers
and other carriers. In order to be successful, these small- and medium-sized
companies must offer customers a full range of services, including international
long distance. However, management believes most of these carriers do not have
the critical mass of traffic to receive volume discounts on international
transmission from the larger facilities-based carriers such as AT&T, MCI and
Sprint, or the financial ability to invest in international facilities.
Alternative international carriers, such as the Company, have capitalized on the
demand created by these small- and medium-sized companies for less expensive
international transmission facilities. These carriers are able to take advantage
of larger traffic volumes to obtain discounts on international routes (through
resale) and/or invest in facilities when volume on particular routes justifies
such investments. As these emerging international carriers have become
established, they have also begun to carry overflow traffic from larger long
distance providers which own international transmission facilities.
Liberalization and privatization have also allowed new long distance
providers to emerge in foreign markets. Liberalization began in the U.K. in 1981
when Mercury, a subsidiary of Cable & Wireless plc, was granted a license to
operate a facilities-based network and compete with British Telecom. The 1990
adoption of the "Directive on Competition in the Market for Telecommunications
Services" marked the beginning of deregulation in Europe, and a series of
subsequent EU directives, reports and actions are expected to result in
substantial deregulation of the telecommunications industries in most EU member
states by 1998. Liberalization is also occurring on a global basis as many
governments in Eastern Europe, Asia and Latin America privatize government-owned
monopolies and open their markets to competition. Also, signatories to the WTO
Agreement have committed, to varying degrees, to allow access to their domestic
and international markets to competing telecommunications providers, allow
foreign ownership interests in existing telecommunications providers and
establish regulatory schemes to develop and implement policies to accommodate
telecommunications competition.
As liberalization erodes the traditional monopolies held by single national
providers, many of which are wholly or partially government-owned PTT's, U.S.
long distance providers have the opportunity to negotiate more favorable
agreements with both the traditional and newly-emerging foreign providers.
Further, deregulation in certain countries is enabling U.S.-based providers to
establish local switching and transmission facilities in those countries,
allowing them to terminate their own traffic and begin to carry international
long distance traffic originating in those countries.
International Switched Long Distance Services
International switched long distance services are provided through
switching and transmission facilities that automatically route calls to circuits
based upon a predetermined set of routing criteria. In the U.S., an
international long distance call typically originates on a LEC's network and is
transported to the caller's domestic long distance carrier. The domestic long
distance provider picks up the call and carries the call to its own or another
carrier's international gateway switch, where an international long distance
provider picks it up and sends it directly or through one or more other long
distance providers to a corresponding gateway switch in the destination country.
Once the traffic reaches the destination country, it is routed to the party
being called through that country's domestic telephone network.
International long distance carriers are often categorized according to
ownership and use of transmission facilities and switches. No carrier utilizes
exclusively-owned facilities for transmission of all of its long distance
traffic. Carriers vary from being primarily facilities-based, meaning that they
own and operate their own land-based and/or undersea cable and switches, to
those that are purely resellers of another carrier's transmission network. The
largest U.S. carriers, such as AT&T, MCI, Sprint and
30
<PAGE>
WorldCom primarily use owned transmission facilities and switches and may
transmit some of their overflow traffic through other long distance providers,
such as the Company. Only very large carriers have the transmission facilities
and operating agreements necessary to cover the over 200 countries to which
major long distance providers generally offer service. A significantly larger
group of long distance providers own and operate their own switches but use a
combination of resale agreements with other long distance providers and leased
and owned facilities to transmit and terminate traffic, or rely solely on resale
agreements with other long distance providers. For a discussion of the Company's
analysis of the mix of providers in the long distance market see "STARTEC's
Industry Paradigm."
Operating Agreements. Traditional operating agreements provide for the
termination of traffic in, and return traffic to, the international long
distance carriers' respective countries for mutual compensation at an
"accounting rate" negotiated by each country's dominant carrier. Under such
traditional operating agreements, the international long distance provider that
originates more traffic compensates the long distance provider in the other
country by paying an amount determined by multiplying the net traffic imbalance
by half of the accounting rate.
Under a typical operating agreement, each carrier owns or leases its
portion of the transmission facilities between two countries. A carrier gains
ownership rights in digital undersea digital fiber optic cable by: (i)
purchasing direct ownership in a particular cable (usually prior to the time the
cable is placed into service); (ii) acquiring an IRU in a previously installed
cable; or (iii) by leasing or otherwise obtaining capacity from another long
distance provider that has either direct ownership or IRU rights in a cable. In
situations in which a long distance provider has sufficiently high traffic
volume, routing calls across cable that is directly owned by a carrier or in
which a carrier has an IRU is generally more cost-effective than the use of
short-term variable capacity arrangements with other long distance providers or
leased cable. Direct ownership and IRU rights, however, require a carrier to
make an initial capital commitment based on anticipated usage.
Transit Arrangements. In addition to using traditional operating
agreements, an international long distance provider may use transit
arrangements, pursuant to which a long distance provider in an intermediate
country carries the traffic to the destination country. Transit arrangements
require agreement among all of the carriers of the countries involved in the
transmission and termination of the traffic, and are generally used for overflow
traffic or in cases in which a direct circuit is unavailable or not volume
justified.
Switched Resale Arrangements. Switched resale arrangements typically
involve the carrier purchase and sale of termination services between two long
distance providers on a variable, per minute basis. The resale of capacity was
first permitted as a result of the deregulation of the U.S. telecommunications
market, and has fostered the emergence of alternative international long
distance providers which rely, at least in part, on transmission services
acquired on a carrier basis from other long distance providers. A single
international call may pass through the facilities of multiple resellers before
it reaches the foreign facilities-based carrier which ultimately terminates the
call. Resale arrangements set per minute prices for different routes, which may
be guaranteed for a set period of time or may be subject to fluctuation
following notice. The resale market for international transmission capacity is
continually changing, as new long distance resellers emerge and existing
providers respond to changing costs and competitive pressures. In order to be
able to effectively manage costs when using resale arrangements, long distance
providers must have timely access to changing market prices and be able to react
to changes in costs through pricing adjustments and routing decisions.
Alternative Transit/Termination Arrangements. As the international long
distance market began to be more competitive, long distance providers developed
alternative transit/termination arrangements in an effort to decrease their
costs of terminating international traffic. Some of the more significant of
these arrangements include refiling, international simple resale ("ISR"), and
ownership of switching facilities in foreign countries. Refiling of traffic,
which takes advantage of disparities in settlement rates between different
countries, allows traffic to a destination country to be treated as if it
originated in another country which enjoys lower settlement rates with the
destination country, thereby resulting in a lower overall termination cost.
Refiling is similar to transit, except that with respect to transit, the
facilities-
31
<PAGE>
based long distance provider in the destination country has a direct
relationship with the originating long distance provider and is aware of the
transit arrangement, while with refiling, it is likely that the long distance
provider in the destination country is not aware that the received traffic
originated in another country with another carrier. To date, the FCC has made no
pronouncement as to whether refiling complies with U.S. or ITU regulations,
although it is considering such issues in an existing proceeding.
With ISR, a long distance provider completely bypasses the accounting rates
system by connecting an international leased private line to the public switched
telephone network of a foreign country or directly to the premises of a customer
or foreign partner. Although ISR is currently sanctioned by applicable
regulatory authorities only on a limited number of routes (including U.S.-U.K.,
U.S.-Canada, U.S.-Sweden, U.S.-New Zealand, U.K.-worldwide and Canada-U.K.), its
use is increasing and is expected to expand significantly as deregulation
continues in the international telecommunications market. In addition,
deregulation has made it possible for U.S.-based long distance providers to
establish their own switching facilities in certain foreign countries, allowing
them to directly terminate traffic. See "- Government Regulation."
STARTEC'S INDUSTRY PARADIGM
It is common in the industry to classify and identify different
telecommunications companies as "first-tier," "second-tier" or "third-tier"
carriers based primarily on their revenue size. The Company analyzes its
competitive market position and its strategy based on a more comprehensive set
of criteria, focusing on technology, network infrastructure and margins.
Broadly, the Company's Industry Paradigm is comprised of four identifiable
segments: Switchless Reseller, Switch-Based Reseller, Single-Sided
Facilities-Based Carrier and Dual-Sided Facilities-Based Carrier.
STARTEC'S INDUSTRY PARADIGM
CHARACTERISTICS
DUAL SIDED Sophisticated technology
FACILITIES BASED Highly competent network operations
CARRIER Highest margin
SINGLED SIDED Higher technology
FACILITIES BASED Competent network management
CARRIER Higher margin
SWITCH BASED Limited technology
RESELLER Limited network
SWITCHLESS RESELLER No technology
No network
Low margin
At the bottom of the Industry Paradigm are the Switchless Resellers, which
do not own switching facilities and rely solely on resale agreements with other
long distance carriers to transport and terminate their traffic. Although these
companies generally are able to keep overhead costs down, since they are not
burdened with the costs associated with ownership of facilities, their
dependence on other companies for capacity and service substantially reduces
their ability to control variable costs associated with origination, transport
and termination of telephone calls.
Switch-Based Resellers occupy the next level of the Industry Paradigm.
Companies at this level usually own a switch, which may or may not embody the
most current technology, and may even do their own billing and collection of
customer accounts. While the margins at this level generally are better than for
Switchless Resellers, these companies are also substantially dependent upon
resale agreements with facilities-based long distance carriers to transport and
terminate their traffic.
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<PAGE>
At the level above the Switch-Based Resellers are the Single-Sided
Facilities-Based Carriers. The move up from the reseller levels to the
facilities-based carrier levels is a significant one in terms of costs, required
technology, and available margins. Single-Sided Facilities-Based Carriers
generally operate multiple switches, have the ability to originate at least some
of their own calls, and maintain network management facilities.
The top level of the Industry Paradigm consists of Dual-Sided
Facilities-Based Carriers. The domestic carriers at this level generally own
multiple switches, and other facilities which allow them to originate and
terminate a substantial portion of their own traffic. In addition, the
international carriers at this level also have ownership rights, IRUs or other
arrangements to use undersea fiber optic cable lines and satellite facilities,
operating agreements and other termination arrangements with foreign
telecommunications providers, and may even have switches in foreign countries
which allow them to terminate their own traffic. The domestic and the
international Dual-Sided Facilities-Based Carriers use the latest technology,
have sophisticated network operations, and are best able to control the quality
of their services. The margins are potentially the highest at this level, as the
carriers have the greatest control over costs of service.
STRATEGY
The Company began, and has historically operated, as a Switch-Based
Reseller. The Company currently is investing in network infrastructure which
will allow it to operate as a single-sided facilities-based carrier. Utilizing a
portion of the net proceeds from this Offering, the Company intends to invest in
additional network infrastructure with the objective of becoming an
international dual-sided facilities-based carrier.
The Company intends to implement a network hubbing strategy, linking
foreign-based switches and other telecommunications equipment together with the
Company's marketing base in the United States. To implement this hubbing
strategy, the Company intends to: (i) build transmission capacity, including its
ability to originate and transport traffic; (ii) acquire additional termination
options to increase routing flexibility; and (iii) expand its customer base
through focused marketing efforts.
A "hub" will consist of a switch and/or other telecommunications equipment,
including cables and compression equipment. Hub locations will be selected based
on their similarity to the established U.S. model, in which identifiable
international ethnic communities are accessible, and where it is possible to
connect with some of the leading international carriers. Once established, these
hubs will be connected to the Company's marketing base in the United States.
Management believes the hubbing strategy will allow the Company to move up the
Industry Paradigm, from a single-sided facilities-based carrier to a dual-sided
facilities-based carrier serving ethnic communities and telecommunication
carriers in select markets worldwide.
To implement this hubbing strategy, the Company intends to:
Build Transmission Capacity. The Company originates and transports customer
traffic through a network of Company-owned and managed facilities and facilities
leased or acquired through resale arrangements from other facilities-based long
distance carriers. The additional traffic generated by the Company's expanded
customer base and increased usage of its long distance services will necessitate
the acquisition of additional switching and transmission capacity. To meet these
needs, the Company has begun to implement a strategic build-out of its network,
including installation of improved switching facilities, planned acquisition of
ownership interests in and/or rights to use digital undersea fiber optic cables,
and installation of compression equipment to increase capacity on those cables.
The Company has also taken steps to improve its systems supporting the network
and further enhance the quality of its services by adding equipment upgrades in
its network monitoring and customer service centers, and plans to install
enhanced software which will allow it to monitor call traffic routing, capacity,
and quality. Building additional switching and transmission capacity will
decrease the Company's reliance on leased facilities and exposure to price
fluctuations. The Company's goal in taking these actions is to improve its gross
margin and provide greater assurance of the quality and reliability of its
services.
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Acquire Additional Termination Options. Customer traffic is terminated in
the destination country through a variety of arrangements, including
international operating agreements. The anticipated expansion of the Company's
customer base in existing and new target markets, and the resulting increase in
traffic, will require the Company to provide additional methods to terminate
that traffic. As part of its hubbing strategy, the Company plans to explore a
number of options including additional operating agreements, strategic
alliances, transit and refile arrangements, and the acquisition of switching
facilities in foreign countries. The increase in termination options is expected
to provide greater routing flexibility and reliability, as well as permitting
greater management and control over the cost of transmitting customers' calls.
Expand Customer Base. The Company will continue to target additional ethnic
U.S. residential communities with significant international long distance usage.
In addition, the Company plans to extend its marketing efforts outside the U.S.
into countries which have ethnic communities which the Company believes are
potential customers, and to begin marketing its long distance services to
U.S.-based small businesses which have an international focus. The Company will
also consider opportunities to increase its residential customer base through
strategic alliances and acquisitions. By increasing its residential customer
base, the Company's goal is to capture operating efficiencies associated with
high traffic volumes and to increase its margins.
The Company's marketing strategy, which targets selected ethnic communities
is attractive to foreign carriers who enter into agreements with STARTEC in
order to capture outgoing international U.S. traffic from customers located in
their corresponding U.S. ethnic communities. As a result of the relationships
established by these agreements, STARTEC expects that its global
telecommunications network will become more cost effective and will make the
Company an attractive supplier to the world's leading carriers. The Company also
anticipates that its hubbing strategy will allow it to serve carrier customers
over a wider geographical area.
CUSTOMERS
The number of the Company's residential customers has grown significantly
over the past three years, from approximately 5,000 as of June 30, 1994 to more
than 43,700 as of June 30, 1997 (as measured over a 30 day period). These
customers generally are members of ethnic groups that tend to be concentrated in
major U.S. metropolitan areas, including Middle Eastern, Indian, Russian,
African and Southeast Asian communities. Net revenues from residential customers
accounted for approximately 37% and 36% of the Company's net revenues in the
year ended December 31, 1996 and the six month period ended June 30, 1997,
respectively. No single residential customer accounted for more than one percent
of the Company's revenues during those periods.
The number of the Company's carrier customers also has grown significantly
since the Company first began marketing its services to this segment in late
1995. As of June 30, 1997, the Company had 32 active carrier customers, with
revenues from carrier customers accounting for 63% and 64% of the Company's net
revenues in the year ended December 31, 1996 and the six month period ended June
30, 1997, respectively. One of these carrier customers, WorldCom, accounted for
approximately 23% of total revenues in the year ended December 31, 1996, and
approximately 27% of total revenues for the six months ended June 30, 1997. In
addition, certain carrier customers also accounted for more than 10% of the
Company's net revenues during the fiscal years ended December 31, 1994 and 1995.
In 1994, CST and WorldCom accounted for approximately 12% and 11%, respectively,
of net revenues and in 1995, VSNL accounted for approximately 19% of net
revenues. No other customer accounted for 10% or more of the Company's net
revenues during 1994, 1995, 1996 or the first six months of 1997. In a number of
cases, the Company provides services to carriers which are also suppliers to the
Company.
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Substantially all of the Company's revenues for the past three fiscal years
and the six months ended June 30, 1997 have been derived from calls terminated
outside the United States. The percentages of net revenues attributable on a
region-by-region basis are set forth in the table below.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Asia/Pacific Rim ............... 81.9% 66.4% 43.0% 54.1% 41.9%
Middle East/North Africa ...... 2.7 6.6 25.7 19.8 28.1
Sub-Saharan Africa ............ 0.4 0.3 3.5 2.1 8.2
Eastern Europe ............... 0.5 3.0 8.2 6.9 9.9
Western Europe ............... 12.1 15.7 5.5 4.7 3.1
North America .................. 2.2 4.7 11.5 10.9 5.4
Other ........................ 0.2 3.3 2.6 1.5 3.4
------ ------ ------ ------ ------
Total ..................... 100.0 100.0 100.0 100.0 100.0
====== ====== ====== ====== ======
</TABLE>
The Company has entered into operating agreements with telecommunication
carriers in foreign countries under which international long-distance traffic is
both delivered and received. Under these agreements, the foreign carriers are
contractually obligated to adhere to the policy of the FCC, which requires that
traffic from the foreign country is routed to international carriers, such as
the Company, in the same proportion as traffic carried into the country.
Mutually exchanged traffic between the Company and foreign carriers is settled
through a formal settlement policy at agreed upon rates per minute. The Company
records the amount due to the foreign partner as an expense in the period the
traffic is terminated. When the return traffic is received in the future period,
the Company generally realizes a higher gross margin on the return traffic
compared to the lower margin (or sometimes negative margin) on the outbound
traffic. Revenue recognized from return traffic was approximately $174,000,
$1,959,000, and $1,121,000 or 3%, 19% and 3% of net revenues in 1994, 1995, and
1996, and $490,000 and $994,000 or 4% and 3% of net revenues in the six-month
periods ended June 30, 1996 and 1997, respectively. There can be no assurance
that traffic will be delivered back to the United States or what impact changes
in future settlement rates, allocations among carriers or levels of traffic will
have on net payments made and revenues received.
SERVICES AND MARKETING
STARTEC focuses primarily on the provision of international long distance
services to targeted residential customers in major U.S. metropolitan areas.
STARTEC also offers international long distance services to other
telecommunications carriers and interstate long distance services in the U.S.
Using part of the proceeds obtained under the Signet Agreement, the Company
recently expanded its residential marketing program, targeting additional ethnic
communities with significant international long distance usage and increasing
its efforts within its current target markets. The Company intends to use a
portion of the proceeds of the Offering to expand significantly its residential
marketing programs in the U.S., and to implement its marketing strategy abroad.
See "Use of Proceeds" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations Liquidity and Capital Resources."
Residential Customers
The Company generally provides international and interstate residential
long distance customers with dial-around long distance service. Residential
customers access STARTEC's network by dialing its CIC code before dialing the
number they are calling. Using a CIC Code to access the Company allows customers
to use the Company's services at any time without changing their existing long
distance carrier. It is also possible for a customer to select STARTEC as its
default long distance carrier. In this instance, the LEC would automatically
route all of that customer's long distance calls through STARTEC's network. As
part of its marketing strategy, the Company maintains a comprehensive database
of customer information which is used for the development of marketing programs,
strategic planning, and other purposes.
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<PAGE>
The Company invests substantial resources in identifying and evaluating
potential markets for its services. In particular, the Company looks for ethnic
groups having qualities and characteristics which indicate a large potential for
high-volume international telecommunications usage. Once a market has been
identified, the Company evaluates the opportunity presented by that market based
upon factors that include the credit characteristics of the target group,
switching requirements, network access and vendor diversity. Assuming that the
target market meets the Company's criteria, the Company implements marketing
programs targeted specifically at that ethnic group, with the goal of generating
region-specific international long distance traffic. The Company markets its
residential services under the "STARTEC" name through a variety of media,
including low-cost print advertising, radio and television advertising on ethnic
programs and direct mail, all in the customers' native language. The Company
also sponsors and attends community events and trade shows.
Potential customers call a toll free number and are connected to a
multilingual customer service representative. The Company uses this opportunity
to obtain detailed information regarding, among other things, customers'
anticipated calling patterns. The customer service representative then sends out
a welcome pack explaining how to use the services. Once the customer begins to
use the services, the Company monitors usage and periodically communicates with
the customer to gauge service satisfaction. STARTEC also uses proprietary
software to assist it in tracking customer satisfaction and a variety of
customer behaviors, including turnover ("churn"), retention and frequency of
usage.
The Company currently markets its services to the Middle Eastern, Indian,
Russian, African and Southeast Asian communities in the U.S. In addition, the
Company is considering marketing its services in countries such as Canada and
the United Kingdom, which also have ethnic communities that may meet the
Company's criteria for potential target markets.
In addition to its current long distance services, the Company continually
evaluates potential new service offerings in order to increase traffic and
customer retention and loyalty. New services the Company expects to introduce
include Home Country Direct Services which provides customers with access to
STARTEC's network from any country and allows them to place either collect or
credit/debit card calls, and Prepaid Domestic and International Calling Cards
which can be used from any touch tone telephone in the United States, Canada or
the United Kingdom.
Carrier Customers
To maximize the efficiency of its network capacity, the Company sells its
international long distance services to other telecommunication carriers.
STARTEC has been actively marketing its services to carrier customers since late
1995 and believes that it has established a high degree of credibility and
valuable relationships with the leading carriers. The Company participates in
international carrier membership organizations, trade shows, seminars and other
events that provide its marketing staff with opportunities to establish and
maintain relationships with other carriers that are potential customers. The
Company generally avoids providing services to lower-tiered carriers because of
potential difficulties in collecting accounts receivable.
THE STARTEC NETWORK
The Company provides its services through a flexible network of owned and
leased transmission facilities, resale arrangements, and a variety of operating
agreements and termination arrangements, all of which allow the Company to
terminate traffic in every county which has telecommunication capabilities. The
Company has been expanding its network to match increases in its long distance
traffic volume, and has recently begun to implement plans for a significant
strategic build-out of the STARTEC network. The purpose of the build-out is to
increase profitability by controlling costs, while maintaining a high degree of
network quality and reliability. The network employs advanced switching
technologies and is supported by monitoring facilities and the Company's
technical support personnel.
Switching and Transmission Facilities
The Company currently owns and operates a switch in Washington, D.C. and
leases a line to New York City where major telephone cables are terminated. The
Company is currently in the final stages of negotiating the purchase of new
switching equipment which is expected to be installed and placed in
36
<PAGE>
service at a new facility in New York City by the end of 1997. At that time, the
Company intends that its switching functions will be transferred to the New York
City facility and the Washington, D.C. location will become a point-of-presence.
Relocating the switch to New York City is expected to reduce leased line charges
and increase the Company's ability to originate traffic on its own network. In
addition, the New York City facility is larger than the Company's Washington,
D.C. facility, thereby allowing the Company to install a larger and more cost
effective switch. Over the next 12 to 18 months, the Company intends to add
facilities in key locations, such as the United Kingdom and California, which is
a gateway to the Asia/Pacific market.
International long distance traffic is transmitted through an international
gateway switch, across undersea digital fiber optic cable lines or via
satellite, to the destination country. STARTEC currently has access to digital
undersea fiber optic cable and satellite facilities through arrangements with
other carriers. The Company is currently negotiating for the acquisition of
three other trans-Atlantic cables such as Columbus II, Cantat and Americas-, and
is also exploring the possibility of acquiring IRUs in trans-Pacific cables. The
Company believes that it may achieve substantial savings by acquiring additional
IRUs, which would reduce its dependence on leased cable access. Having an
ownership interest rather than a lease interest in undersea cable enables the
Company to increase its capacity without a significant increase in cost, by
utilizing digital compression equipment, which it cannot do under leasing or
similar access arrangements. Digital compression equipment enhances the traffic
capacity of the undersea cable, which permits the Company to maximize cable
utilization while reducing the Company's need to acquire additional capacity.
The Company is currently in negotiations to acquire digital compression
equipment.
The Company enters into lease arrangements and resale agreements with other
telecommunications carriers when cost effective. The Company purchases switched
minute capacity from various carriers and depends on such agreements for
termination of its traffic. The Company currently purchases capacity from
approximately 30 carriers. Purchases from the five largest suppliers of capacity
represented 67% and 47% of the Company's total cost of services for the fiscal
year ended December 31, 1996 and the six months ended June 30, 1997,
respectively. During the fiscal year ended December 31, 1996, VSNL, Cherry
Communications, Inc., and WorldCom accounted for 25%, 13% and 13% of total cost
of services, respectively. During the six months ended June 30, 1997, VSNL and
WorldCom accounted for 13%, and 15% of total costs of services, respectively.
Further, the Company utilizes the services of several alternate, cost
effective carriers in order to transport and terminate its traffic. These
alternative carriers provide the Company with substantial flexibility and cost
efficiency, as well as diversity, in the event one carrier's charges increase or
such carrier is not capable of providing the services STARTEC needs in order to
transport and terminate its traffic.
The Company's efforts to build additional switching and transmission
capacity are intended to decrease the Company's reliance on leased facilities
and resale agreements. The strength of the Company's international operations is
based upon the diversity of its cost effective routes to terminal points. The
primary benefits of owning and operating additional network facilities instead
of leasing or reselling another carrier's capacity arise from reduced
transmission costs and greater control over service quality and reliability. The
transmission cost for a call that is not routed on net through the Company's
owned facilities is dependent upon the cost per minute paid to the underlying
carrier. In contrast, the cost of a call routed on net through the Company's
owned facilities is dependent upon the total fixed costs associated with owning
and operating those facilities. As traffic across the owned facilities
increases, management believes the Company can capture operating efficiencies
and improve its margins.
Termination Arrangements
STARTEC attempts to retain flexibility and maximize its termination options
by using a mix of operating agreements, transit and refile arrangements, resale
agreements and other arrangements to terminate its traffic in the destination
country. The Company's approach is designed to enable it to take advantage of
the rapidly evolving international telecommunications market in order to provide
low cost international long distance services to its customers.
37
<PAGE>
The Company currently has effective operating agreements with the national
telecommunications administrations of India, Uganda, Syria and Monaco under
which it exchanges traffic. The Company pursues additional operating agreements
with other foreign governments and administrations on an ongoing basis. In
addition, the Company uses resale agreements and transit and refile arrangements
to terminate its traffic in countries with which it does not have operating
agreements. These agreements and arrangements provide the Company with multiple
options for routing traffic to each destination country.
The Company is also exploring the possibility of acquiring facilities in
certain foreign countries, including the United Kingdom. This option is becoming
increasingly available as deregulation continues in the international
telecommunications market, and would provide the Company with opportunities to
terminate its own traffic and better control customer calls.
Network Operations, Technical Support and Customer Service
The Company uses proprietary routing software to maximize routing
efficiency. Network operations personnel continually monitor pricing changes by
the Company's carrier-suppliers and adjust call routing to make cost efficient
use of available capacity. In addition, the Company provides 24-hour network
monitoring, trouble reporting and response procedures, service implementation
coordination and problem resolution. The Company has developed and uses
proprietary software which allows it to monitor, on a minute by minute basis,
all key aspects of its services. Recent software upgrades and additional network
monitoring equipment have been installed to enhance the Company's ability to
handle increased traffic and monitor network operations. The Company's customer
service center, which services the residential customer base, is staffed by
trained, multilingual customer service representatives, and operates 16 hours
per day during the week and 12 hours per day on the weekends. The customer
service center uses advanced ACD software to distribute incoming calls to its
customer service representatives. Over time, the Company plans to increase its
customer service coverage and eventually operate 24-hours per day, 7 days per
week.
The Company generally utilizes redundant, highly automated state-of-the-art
telecommunications equipment in its network and has diverse alternate routes
available in cases of component or facility failure, or in the event that cable
transmission wires are inadvertently cut. Back-up power systems and automatic
traffic re-routing enable the Company to provide a high level of reliability for
its customers. Computerized automatic network monitoring equipment allows fast
and accurate analysis and resolution of network problems. In general, the
Company relies upon other carriers' networks to provide redundancy in the event
of technical difficulties in the network. The Company believes that this is a
more cost effective strategy than purchasing or leasing its own redundant
capacity.
MANAGEMENT INFORMATION AND BILLING SYSTEMS
The Company's operations use advanced information systems including call
data collection and call data storage linked to a proprietary reporting system.
The Company also maintains redundant billing systems for rapid and accurate
customer billing. The Company's systems enable it, on a real time basis, to
determine cost effective termination alternatives, monitor customer usage and
manage profit margins. The Company's systems also enable it to ensure accurate
and timely billing and reduce routing errors.
The Company's proprietary reporting software compiles call, price and cost
data into a variety of reports which the Company can use to re-program its
routes on a real time basis. The Company's reporting software can generate
additional reports, as needed, including customer usage, country usage, vendor
rates, vendor usage by minute, dollarized vendor usage, and loss reports.
The Company has built multiple redundancies into its billing and call data
collection systems. Two call collector computers receive redundant call
information simultaneously, one of which produces a file every 24 hours for
filing purposes while the other immediately forwards the called data to
corporate headquarters for use in customer service and traffic analysis. The
Company maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drive and redundant storage devices.
38
<PAGE>
Residential customers are billed for the Company's services through the
LEC, with the Company's charges appearing directly on the bill each residential
customer receives from its LEC. The Company utilizes a third party billing
company to facilitate collections of amounts due to the Company from the LECs.
The third party billing company receives collections from the LEC and transfers
the sums to the Company, after withholding processing fees, applicable taxes,
and provisions for credits and uncollectible accounts. As part of its strategy,
the Company also plans to enter into billing and collection agreements directly
with certain LECs, which will provide the Company with opportunities to reduce
some of the costs currently associated with billing and collection.
COMPETITION
The long distance telecommunications industry is intensely competitive. In
many of the markets targeted by the Company there are numerous entities which
are currently competing for the same residential and carrier customers and
others which have announced their intention to enter those markets.
International and interstate telecommunications providers compete on the basis
of price, customer service, transmission quality, breadth of service offerings
and value-added services. Residential customers frequently change long distance
providers in response to competitors' offerings of lower rates or promotional
incentives, and, in general, the Company's customers can switch carriers at any
time. In addition, the availability of dial-around long distance services has
made it possible for residential customers to use the services of a variety of
competing long distance providers without the necessity of switching carriers.
The Company's carrier customers generally also use the services of a number of
other international long distance telecommunications providers. The Company
believes that competition in its international and interstate long distance
markets is likely to increase as these markets continue to experience decreased
regulation and as new technologies are applied to telecommunications. Prices for
long distance calls in several of the markets in which the Company competes have
declined in recent years and are likely to continue to decrease. While the
Company competes generally with the domestic and international carriers
discussed herein, it believes that STARTEC is a leader in its chosen business
niche - the provision of international long distance services to residential
customers in targeted ethnic markets.
The U.S.-based international telecommunication services market is dominated
by AT&T, MCI and Sprint. The Company also competes with numerous other carriers
in certain markets, including WorldCom, Inc., TresCom International, Inc., and
STAR Telecommunications, Inc. Some of these competitors focus their efforts on
the same customers targeted by the Company. In addition, many of the Company's
current competitors are also Company customers. The Company's business could be
materially adversely affected if a significant number of those customers reduce
or cease doing business with the Company for competitive reasons. See "Risk
Factors - Competition."
Recent and pending deregulation initiatives in the U.S. and other countries
may encourage additional new industry entrants. The Telecommunications Act
permits and is designed to promote additional competition in the intrastate,
interstate and international telecommunications markets by both U.S.-based and
foreign companies, including the RBOCs. In addition, pursuant to the terms of
the WTO Agreement, countries who are signatories to the agreement are expected
to allow access to their domestic and international markets to competing
telecommunications providers, allow foreign ownership interests in existing
telecommunications providers and establish regulatory schemes and policies
designed to accommodate telecommunications competition. The Company also is
likely to be subject to additional competition as a result of mergers or the
formation of alliances among some of the largest telecommunications carriers.
Recent examples of mergers and alliances include the planned merger of British
Telecom and MCI and the "Global One" alliance among Sprint, Deutsche Telekom and
France Telecom.
Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources than the
Company, own or control larger networks, transmission and termination
facilities, and offer a broader variety of services than the Company, and have
strong name recognition, brand loyalty, and long-standing relationships with the
many of the Company's target customers. In addition, many of the Company's
competitors enjoy economies of scale that can result in a lower cost structure
for transmission and other costs of providing services, which could cause
significant
39
<PAGE>
pricing pressures within the long distance telecommunications industry. If the
Company's competitors were to devote significant additional resources to the
provision of international long distance services to the Company's target
customer base, the Company's business, results of operations and financial
condition could be materially adversely affected. See "Risk Factors --
Competition."
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing satellite and undersea cable transmission capacity for services
similar to those provided by the Company. Such technologies include satellite
and ground based systems, utilization of the Internet for voice, data and video
communications, and digital wireless communication systems such as personal
communications services ("PCS"). The Company is unable to predict which of many
future product and service offerings will be important to maintain its
competitive position or the expenditures that may be required to acquire,
develop or otherwise provide such products and services.
GOVERNMENT REGULATION
Overview
The Company's business is subject to varying degrees of federal and state
regulation. Federal laws and the regulations of the FCC apply to the Company's
international and interstate facilities-based and resale telecommunications
services, while applicable PSCs have jurisdiction over telecommunications
services originating and terminating within the same state. At the federal level
the Company is subject to common carriage requirements under the Communications
Act. Comprehensive amendments to the Communications Act were made by the
Telecommunications Act. The purpose of the 1996 Act is to promote competition in
all areas of telecommunications by reducing unnecessary regulation at both the
federal and state levels to the greatest extent possible. The FCC and PSCs are
in the process of implementing the 1996 Act's regulatory reforms.
In addition, although the laws of other countries only directly apply to
carriers doing business in those countries, the Company may be affected
indirectly by such laws insofar as they affect foreign carriers with which the
Company does business. There can be no assurance that future regulatory,
judicial and legislative changes will not have a material adverse effect on the
Company, that U.S. or foreign regulators or third parties will not raise
material issues with regard to the Company's compliance or noncompliance with
applicable laws and regulations, or that regulatory activities will not have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, the FCC and the PSCs generally have the
authority to condition, modify, cancel, terminate or revoke the Company's
operating authority for failure to comply with federal and state laws and
applicable rules, regulations and policies. Fines or other penalties also may be
imposed for such violations. Any such action by the FCC and/or the PSCs could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Risk Factors - Government Regulation."
Federal and State Transactional Approvals
The FCC and certain PSCs also impose prior approval requirements on
transfers or changes of control, including pro forma transfers of control and
corporate reorganizations, and assignments of regulatory authorizations. Such
requirements may have the effect of delaying, deterring or preventing a change
in control of the Company. The Company also is required to obtain state approval
for the issuance of securities. Seven of the states in which the Company is
certificated provide for prior approval or notification of the issuance of
securities by the Company. Although the necessary approvals will be sought and
notifications made prior to the offering, because of time constraints, the
Company may not have obtained such approval from two of the states prior to
consummation of the Offering. The Company's intrastate revenues for the first
half of 1997 for each of the two states was less than $100 for each such state.
Although these state filing requirements may have been preempted by the National
Securities Market Improvement Act of 1996, there is no case law on this point.
After consultation with counsel, the Company believes the approvals will be
granted and that obtaining such approvals subsequent to the Offering should not
result in any material adverse consequences to the Company, although there can
be no assurance that such consequences will not result.
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International Services
International telecommunications carriers are required to obtain authority
from the FCC under Section 214 of the Communications Act in order to provide
international service that originates or terminates in the United States. U.S.
international common carriers also are required to file and maintain tariffs
with the FCC specifying the rates, terms, and conditions of their services. In
1989, the Company received Section 214 authority from the FCC to acquire and
operate satellite facilities for the provision of direct international service
to Italy, Israel, Kenya, India, Iran, Saudi Arabia, Pakistan, Sri Lanka, South
Korea and the United Arab Emirates ("UAE"). The Company also is authorized to
resell services of other common carriers for the provision of switched voice,
telex, facsimile and other data services, and for the provision of INTELSAT
Business Services ("IBS") and international television services to various
overseas points.
In 1996, the FCC established new rules that streamlined its Section 214
authorization and tariff regulation processes to provide for shorter notice and
review periods for certain U.S. international carriers including the Company.
The FCC established streamlined regulation for "non-dominant" carriers service
providers found to lack market power on the routes served. The Company is
classified by the FCC as a non-dominant carrier on its international and
domestic routes. On August 27, 1997, the Company was granted global
facilities-based Section 214 authority under the FCC's new streamlined
processing rules. A facilities-based global Section 214 authorization enables
the Company to provide international basic switched, private line, data,
television and business services using authorized facilities to virtually all
countries in the world.
The FCC's streamlined rules also provide for global Section 214 authority
to resell switched and private line services of other carriers by non-dominant
international carriers. The FCC decides on a case-by-case basis, however,
whether to grant Section 214 authority to U.S. carriers to resell the switched
private lines of affiliated foreign carriers to countries where a foreign
carrier is dominant based on a showing that there are equivalent resale
opportunities for U.S. carriers in the foreign carrier's market. To date, the
FCC has found that Canada, the U.K., Sweden and New Zealand do provide
equivalent resale opportunities. The FCC has found that equivalent resale
opportunities do not exist in Germany, Hong Kong and France. The FCC also is
considering applications for equivalency determinations with respect to
Australia, Chile, Denmark, Finland and Mexico. It is possible that
interconnected private line resale to additional countries may be allowed in the
future. Pursuant to FCC rules and policies, the Company's authorization to
provide service via the resale of interconnected international private lines
will be expanded to include countries subsequently determined by the FCC to
afford equivalent resale opportunities to those available under United States
law, if any. As a result of the recent signing of the WTO Agreement, the FCC has
proposed to replace the "equivalency" test with a rebuttable presumption in
favor of resale of interconnected private lines to WTO member countries.
The Company must also conduct its international business in compliance with
the ISP. The ISP establishes the parameters by which U.S.-based carriers and
their foreign correspondents settle the cost of terminating each other's traffic
over their respective networks. The precise terms of settlement are established
in a correspondent agreement (also referred to as an "operating agreement"),
which also sets forth the term of the agreement, the types of service covered by
the agreement, the division of revenues between the carrier that bills for the
call and the carrier that terminates the call at the other end, the frequency of
settlements, the currency in which payments will be made, the formula for
calculating traffic flows between countries, technical standards, and procedures
for the settlement of disputes. The amount of payments (the "settlement rate")
is determined by the negotiated accounting rate specified in the operating
agreement. Under the ISP, the settlement rate generally must be one-half of the
accounting rate. Carriers must obtain waivers of the FCC's rules if they wish to
use an accounting rate that differs from the prevailing rate or vary the
settlement rate from one-half of the accounting rate.
The ISP is designed to eliminate foreign carriers' incentives and
opportunities to discriminate in their operating agreements among different
U.S.-based carriers through a practice referred to as "whipsawing." Whipsawing
involves a foreign carrier varying the accounting and/or settlement rate offered
to different U.S.-based carriers for the benefit of the foreign carrier, which
could secure various incentives
41
<PAGE>
by favoring one U.S.-based carrier over another. Under the uniform settlements
policy, U.S.-based carriers can only enter into operating agreements that
contain the same accounting rate and settlement terms offered to all U.S.-based
carriers in that country and provide for proportionate return traffic. When a
U.S.-based carrier negotiates an accounting rate with a foreign carrier that is
lower than the accounting rate offered to another U.S.-based carrier for the
same service, the U.S.-based carrier with the lower rate must file a
notification letter with the FCC. If a U.S.-based carrier does not already have
an operating agreement in effect, it must file a request with the FCC to modify
the accounting rate for that country to introduce service with the foreign
correspondent in that country. A U.S.-based carrier also must request
modification authority from the FCC for any proposal that is not prospective,
that is not a simple reduction in the accounting rate, or that changes the terms
and conditions of an existing operating agreement. The notification and
modification procedures are intended to provide all U.S.-based carriers with an
opportunity to compete in foreign markets on a nondiscriminatory basis. Among
other efforts to counter the practice of whipsawing and inequitable treatment of
similarly situated U.S.-based carriers, the FCC adopted the principle of
proportionate return - which requires that the U.S. carrier terminate
U.S.-inbound traffic in the same proportion as the U.S-outbound traffic that it
sends to the foreign correspondent - to assure that competing U.S.-based
carriers have roughly equitable opportunities to receive the return traffic that
reduces the marginal cost of providing international service.
Consistent with its pro-competition policies, the FCC also prohibits
U.S.-based carriers from agreeing to accept special concessions from any foreign
carrier or administration. A special concession is any arrangement that affects
traffic flow to or from the U.S. that is offered exclusively by a foreign
carrier or administration to a particular U.S. carrier that is not offered to
similarly situated U.S. carriers authorized to serve a particular route. With
the adoption of the WTO Agreement this year, the FCC is considering modifying
its no-special concessions rule to prohibit only those exclusive arrangements
granted by a foreign correspondent with market power.
In 1996, the FCC amended the ISP to provide carriers with flexibility to
introduce alternative payment arrangements that deviate from the ISP with
foreign correspondents in any foreign country where the FCC has previously
determined that effective competitive opportunities ("ECO") exist. Alternative
arrangements that deviate from the ISP also may be established for international
switched traffic between the U.S. and countries that have not previously been
found to satisfy the ECO test where the U.S. carrier can demonstrate that
deviation from the ISP will promote market-oriented pricing and competition,
while precluding abuse of market power by the foreign correspondent. As a result
of the WTO Agreement, the FCC has proposed to replace the ECO test with a
rebuttable presumption in favor of alternative payment arrangements with WTO
member countries. While these rule changes may provide more flexibility to the
Company to respond more rapidly to changes in the global telecommunications
market, it will also provide similar flexibility to the Company's competitors.
The Company intends, where possible, to take advantage of lowered accounting
rates and more flexible settlement arrangements. On August 7, 1997, the FCC
adopted revisions to reduce the level and increase enforcement of its
international accounting "benchmark" rates, which are the FCC's target ceilings
for prices that U.S. carriers should pay to foreign carriers for terminating
U.S. calls overseas. Certain foreign carriers have challenged the FCC decision
in court appeals as well as petitions for reconsideration filed with the FCC. If
the FCC mandate of benchmark reductions achieves its stated goal of establishing
competitive international settlement rates, the Company may benefit from such
rate reductions.
Pursuant to FCC regulations, U.S. international telecommunications carriers
are required to file copies of their contracts with foreign correspondents,
including operating agreements, with the FCC within 30 days of execution. The
Company has filed each of its operating agreements with the FCC. The FCC's rules
also require the Company to file periodically a variety of reports regarding its
international traffic flows and use of international facilities. The FCC is
engaged in a rulemaking proceeding in which it has proposed to reduce certain
reporting requirements of common carriers. The Company is unable to predict the
outcome of this proceeding or its effect on the Company. The Company currently
has on file with the FCC operating agreements and accounting rate modifications
for India, Syria, Uganda and Monaco. In addition, the Company has on file and
maintains with the FCC annual circuit status reports and traffic data reports.
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The FCC is currently considering whether to limit or prohibit the practice
whereby a carrier routes, through its facilities in a third country, traffic
originating from one country and destined for another country. The FCC has
permitted third country calling where all countries involved consent to this
type of routing arrangements, referred to as "transiting." Under certain
arrangements referred to as "refiling," the carrier in the destination country
does not consent to receiving traffic from the originating country and does not
realize the traffic it receives from the third country is actually originating
from a different country. The FCC to date has made no pronouncement as to
whether refile arrangements comport either with U.S. or ITU regulations. It is
possible that the FCC may determine that refiling, as defined, violates U.S.
and/or international law. To the extent that the Company's traffic is routed
through a third country to reach a destination country, such an FCC
determination with respect to transiting and refiling could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The FCC also regulates the ability of U.S.-based international carriers
affiliated with foreign carriers to serve markets where the foreign affiliate is
dominant. U.S.-based carriers must report to the FCC a 10% ownership affiliation
with a foreign carrier. A U.S. international carrier is required to notify the
FCC prior to entering into an agreement that would provide a foreign carrier
with a 10% or greater interest in the U.S. carrier. This notification is subject
to a public notice and comment period and FCC review to determine whether a U.S.
carrier should be regulated as dominant on routes where the foreign affiliate is
dominant. The Company has provided notification to the FCC of the 15% investment
in the Company by an affiliate of Portugal Telecom, a foreign carrier from a WTO
member country and signatory to the WTO Agreement. Currently, the FCC considers
a U.S. international carrier to be dominant, and will limit its entry, on routes
where a foreign carrier has a 25% or greater or a controlling interest in the
U.S. carrier or where the U.S. carrier has a 25% or greater or controlling
interest in the foreign carrier. In order for a U.S. carrier that has a 25% or
greater affiliation with or controls or is controlled by a foreign carrier to
receive authority from the FCC to enter markets where the foreign carrier is
dominant, the U.S. carrier is required to show to the FCC that it meets the ECO
test, i.e. that effective opportunities exist for other U.S. carriers to compete
in the foreign market. As a result of WTO Agreement, the FCC has proposed to
replace the ECO test with a rebuttable presumption in favor of foreign market
entry by U.S. carriers with foreign affiliates in WTO member countries. If
adopted, the FCC's liberalized foreign market entry policies may have a two-fold
effect on the Company: (i) increased opportunities for foreign investment in and
by the Company and entry by the Company into WTO member countries; and (ii)
increased competition for the Company from other U.S. international carriers
serving or seeking to serve WTO member countries.
The FCC may condition, modify or revoke any of the Section 214
authorizations granted to the Company for violations of the Communications Act,
the FCC's rules and policies or the conditions of those authorizations or may
impose monetary forfeitures for such violations. Any such action on the part of
the FCC may have a material adverse effect on the Company's business, financial
condition and results of operations.
Interstate and Intrastate Services
The Company's provision of domestic long distance service in the United
States is subject to regulation by the FCC and certain state PSCs, who regulate
to varying degrees interstate and intrastate rates, respectively, ownership of
transmission facilities, and the terms and conditions under which the Company's
domestic services are provided. In general, neither the FCC nor the PSCs
exercise direct oversight over cost justification for domestic carriers' rates,
services or profit levels, but either or both may do so in the future. Domestic
carriers such as the Company, however, are required by federal law and
regulations to file tariffs listing the rates, terms and conditions applicable
to their interstate services. The Company has filed domestic long distance
tariffs with the FCC. The FCC adopted an order on October 29, 1996 requiring
that non-dominant interstate carriers, such as the Company, eliminate FCC
tariffs for domestic interstate long distance service. This order was to take
effect as of December 1997. On February 13, 1997, however, the U.S. Court of
Appeals for the District of Columbia Circuit ruled that the FCC's order be
stayed pending judicial review of appeals challenging the order. Should the
appeals fail and the FCC's order become effective, the Company may benefit from
the elimination of FCC tariffs by
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gaining more flexibility and speed in dealing with marketplace changes. The
absence of tariffs, however, will also require that the Company secure
contractual agreements with its customers regarding many of the terms of its
existing tariffs or face possible claims arising because the rights of the
parties are no longer clearly defined. To the extent that the Company's customer
base involves "casual calling" customers, the potential absence of tariffs would
require the Company to establish contractual methods to limit potential
liability. On August 20, 1997, the FCC partially reconsidered its order by
allowing dial-around carriers such as the Company to maintain tariffs on file
with the FCC.
In addition, the Company generally is also required to obtain certification
from the relevant state PSC prior to the initiation of intrastate service and to
file tariffs with such states. The Company currently has the certifications
required to provide service in 21 states, and has filed or is in the process of
filing requests for certification in 13 additional states. Although the Company
intends and expects to obtain operating authority in each jurisdiction in which
operating authority is required, there can be no assurance that one or more of
these jurisdictions will not deny the Company's request for operating authority.
Any failure to maintain proper federal and state certification or tariffs, or
any difficulties or delays in obtaining required certifications could have a
material adverse effect on the Company's business, financial condition and
results of operations. Many states also impose various reporting requirements
and/or require prior approval for transfers of control of certified carriers,
corporate reorganizations, acquisitions of telecommunications operations,
assignments of carrier assets, 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 PSCs. Fines and other penalties also may be
imposed for such violations. Any such action by the PSCs could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company monitors regulatory developments in all 50 states to
ensure regulatory compliance.
Casual Calling Issues
The FCC is currently engaged in a rulemaking proceeding to expand the
number of codes available for casual calling services. An increase in the number
of codes available for casual calling will allow for increased competition in
the casual calling industry. In addition, the FCC is considering rules to
require dominant local exchange carriers and competitive local exchange carriers
to make billing arrangements available on a nondiscriminatory basis to casual
calling service providers. The Company already has LEC billing arrangements in
place but may wish to take advantage of rules the FCC may adopt to develop new
billing arrangements with competing LECs. Competing casual calling providers
without billing arrangements also would benefit from such a nondiscriminatory
billing obligation.
Other Legislative and Regulatory Initiatives
The 1996 Act is designed to promote local competition through state and
federal deregulation. As part of its pro-competitive policies, the 1996 Act
frees the RBOCs from the judicial orders that prohibited their provision of long
distance services outside of their operating territories (LATAs). The 1996 Act
provides specific guidelines that allow the RBOCs to provide long distance
inter-LATA service to customers inside the RBOC's region but not before the RBOC
has demonstrated to the FCC and state regulators that it has opened up its local
network to competition and met a "competitive checklist" of requirements
designed to provide competing network providers with nondiscriminatory access to
the RBOC's local network. To date, the FCC has denied applications for in-region
long distance authority filed by Ameritech Corporation in Michigan and SBC in
Oklahoma. Denial of the SBC Application is pending judicial review. The grant of
such authority could permit RBOCs to compete with the Company in the provision
of domestic and international long distance services. The FCC also has proposed
rules to govern the RBOCs's provision of affiliated out-of-region interstate,
interexchange services. Among other things, the FCC has proposed to allow
affiliates of RBOCs that provide out-of-region interstate, interexchange service
to be regulated as non-dominant carriers, under certain circumstances.
The 1996 Act also contains provisions that will permit the FCC to forbear
from any provision of the Communications Act or FCC regulation upon a finding
that forbearance will promote competition and
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that the carrier seeking forbearance does not possess market power. FCC
forbearance could reduce some of the Company's regulatory requirements, such as
filing specific rates for its domestic interstate interexchange services.
To originate and terminate calls in connection with providing their
services, long distance carriers such as the Company must purchase "access
services" from LECs or CLECs. Access charges represent a significant portion of
the Company's cost of U.S. domestic long distance services and, generally, such
access charges are regulated by the FCC for interstate services and by PSCs for
intrastate services. The FCC has undertaken a comprehensive review of its
regulation of LEC access charges to better account for increasing levels of
local competition. Under alternative access charge rate structures being
considered by the FCC, LECs would be permitted to allow volume discounts in the
pricing of access charges. While the outcome of these proceedings is uncertain,
if these rate structures are adopted, many long distance carriers, including the
Company, could be placed at a significant cost disadvantage to larger
competitors.
Certain additional provisions of the 1996 Act, and the rules that have been
proposed to be adopted pursuant thereto, could materially affect the growth and
operation of the telecommunications industry and the services provided by the
Company. Further, certain of the 1996 Act's provisions have been, and likely
will continue to be, judicially challenged. The Company is unable to predict the
outcome of such rulemakings or litigation or the substantive effect of the new
legislation and the rulemakings on the Company's business, financial condition
and results of operations.
WTO Agreement on Basic Telecommunications
In February 1997, the WTO announced that 69 countries, including the United
States, Japan, and all of the member states of the EU, agreed on the WTO
Agreement to facilitate competition in basic telecommunications services. The
WTO Agreement becomes effective January 1, 1998. Pursuant to the terms of the
WTO Agreement, signatories to the WTO Agreement have committed to varying
degrees to allow access to their domestic and international markets to competing
telecommunications providers, allow foreign ownership interests in existing
telecommunications providers and establish regulatory schemes to develop and
implement policies to accommodate telecommunications competition.
The FCC has initiated certain proceedings which must be completed by the
end of the year to review, and modify if necessary, its current international
telecommunications policies in light of U.S. obligations under the WTO
Agreement. These proceedings address, among other issues, the viability of
equivalency and other reciprocity principles currently applicable to
international facilities-based and resale services, foreign ownership
limitations, foreign carrier entry into the U.S. market, and accounting rate
benchmarks. At the same time, telecommunications markets in many foreign
countries are expected to be significantly liberalized, creating additional
competitive market opportunities for U.S. telecommunications businesses such as
the Company. Although many countries have agreed to make certain changes to
increase competition in their respective markets, there can be no assurance that
countries will enact or implement the legislation required to effect the changes
to which they have committed in a timely manner or at all. Failure by a country
to meet commitments made under the WTO Agreement may give rise to a cause of
action for the injured foreign countries to lodge a trade dispute with the WTO.
At this time, the Company is unable to predict the effect the WTO Agreement and
related developments might have on its business, financial condition and results
of operations.
EMPLOYEES
As of September 1, 1997, the Company had 50 full time employees and 40 part
time employees. None of the Company's employees are currently represented by a
collective bargaining agreement. The Company believes that its relations with
its employees are good.
PROPERTIES
The Company's headquarters are located in approximately 13,300 square feet
of space in Bethesda, Maryland. The Company leases this space under an agreement
under which it pays approximately $18,200 per month, which expires on October
31, 1999. The Company also is a party to a co-location agreement
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pursuant to which it has the right to occupy certain space in Washington, D.C.
as a site for its switching facilities, under which it pays $250 per month and
has recently entered into a co-location agreement with another party pursuant to
which it has the right to occupy approximately 2,000 square feet in New York
City, New York as a site for its switching facilities and under which it pays
approximately $8,000 per month. The Washington, D.C. co-location agreement is
currently renewable on a year-to-year basis, and the New York City co-location
agreement has a term of five years, with a five-year renewal option. The Company
anticipates that it will incur additional lease and co-location expenses as it
adds additional switching capacity.
LEGAL PROCEEDINGS
The Company is from time to time involved in litigation incidental to the
conduct of its business. The Company is not currently a party to any lawsuit or
proceeding which, in the opinion of management, is likely to have a material
adverse effect on the Company's business, financial condition or result of
operations.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, as of September 1, 1997, certain
information regarding the Company's directors and executive officers.
<TABLE>
<CAPTION>
YEAR OF EXPIRATION
NAME AGE POSITION OF TERM AS DIRECTOR
- -------------------------- ----- ---------------------------------------- --------------------
<S> <C> <C> <C>
Ram Mukunda ............ 39 President, Chief Executive Officer, 2000
Treasurer and Director
Prabhav V. Maniyar ...... 38 Senior Vice President, Chief Financial 1999
Officer, Secretary and Director
Nazir G. Dossani ......... 55 Director 1998
Richard K. Prins ......... 40 Director 1998
Vijay Srinivas ......... 44 Director 1999
</TABLE>
RAM MUKUNDA is the founder and majority owner of STARTEC. Prior to founding
STARTEC in 1989, Mr. Mukunda was Advisor, Strategic Planning with INTELSAT, an
international consortium responsible for global satellite services. While at
INTELSAT, he was responsible for issues relating to corporate, business,
financial planning and strategic development. Mr. Mukunda earned a M.S. in
Electrical Engineering from the University of Maryland. Mr. Mukunda and Mr.
Srinivas are brothers-in-law.
PRABHAV V. MANIYAR joined STARTEC as Chief Financial Officer in January
1997. From June 1993 until he joined the Company, Mr. Maniyar was the Chief
Financial Officer of Eldyne, Inc., Unidyne Corporation and Diversified Control
Systems, LLC, collectively know as the Witt Group of Companies. The Witt Group
of Companies was acquired by the Titan Corporation in May 1996. From June 1985
to May 1993, he held progressively more responsible positions with NationsBank.
Mr. Maniyar earned a B.S. in Economics from Virginia Commonwealth University and
an M.A. in Economics from Old Dominion University.
NAZIR G. DOSSANI will join STARTEC as a director immediately upon
completion of the Offering. Mr. Dossani has been Vice President for
Asset/Liability Management at Freddie Mac since January 1993. Prior to this
position, Mr. Dossani was Vice President - Pricing and Portfolio Analysis at
Fannie Mae. Mr. Dossani received a Ph.D. in Regional Science from the University
of Pennsylvania and an M.B.A. from the Wharton School of the University of
Pennsylvania.
RICHARD K. PRINS will join STARTEC as a director immediately upon
completion of the Offering. Mr. Prins is currently Senior Vice President with
Ferris, Baker Watts, Incorporated. From July 1988 through March 1996, he served
as Managing Director of Investment Banking with Crestar Securities Corporation.
Mr. Prins received an M.B.A. from Oral Roberts University and a B.A. from
Colgate University. He currently serves on the Board of Directors for Path Net,
Inc., a domestic telecommunications company, and The Association for Corporate
Growth, National Capital Chapter.
VIJAY SRINIVAS is the brother-in-law of Ram Mukunda and is a founding
director of the Company. He has a Ph.D. in Organic Chemistry from the University
of North Dakota and is a senior research scientist at ELF Atochem, North
America, a diversified chemical company.
CERTAIN KEY EMPLOYEES
ANTHONY DAS joined STARTEC as Vice President of Corporate and International
Affairs in February 1997. Prior to joining the Company, Mr. Das was a Senior
Consultant at Armitage Associates from April 1996 to January 1997. Prior to
joining Armitage Associates, he served as a Senior Career Executive in the
Office of the Secretary, Department of Commerce from 1993 to 1995. From 1990 to
1993, Mr. Das was the Director of Public Communication at the State Department.
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GUSTAVO PEREIRA joined STARTEC in August 1995 and is Vice President for
Engineering. From 1989 until he joined the Company in 1995, Mr. Pereira served
as Director of Switching Systems for Marconi in Portugal. In this capacity he
supervised more than 100 engineers and was responsible for Portugal's
international telecommunications network.
SUBHASH PAI joined STARTEC in January 1992 and is Controller and Assistant
Secretary. Mr. Pai is a CA/CPA. Prior to joining STARTEC, he held various
positions with a multinational shipping company in India.
DHRUVA KUMAR joined STARTEC in April 1993 and is Director of Global Carrier
Services. Prior to managing the Carrier Services group, Mr. Kumar held a series
of progressively more responsible positions within the Company.
T.J. MASTER joined STARTEC in May 1993 and is Manager of Switched Services.
Mr. Master is responsible for the Company's residential marketing efforts.
Previously he was Marketing Executive at the Times of India publication group in
New Delhi.
TEFERI DEJENE joined STARTEC in October 1992 and is Manager of Network
Switching. Since 1992, Mr. Dejene has held a series of progressively more
responsible positions in network operations within the Company.
SOSSINA TAFARI joined STARTEC in May 1993 and is Manager of Network
Operations. Ms. Tafari manages Network Operations for the Company. Previously
she worked in network maintenance for MCI.
CLASSIFIED BOARD OF DIRECTORS
Pursuant to its Charter, the Company's Board of Directors is divided into
three classes of directors each containing, as nearly as possible, an equal
number of directors. Directors within each class are elected to serve three-year
terms, and approximately one-third of the directors stand for election at each
annual meeting of the Company's stockholders. A classified Board of Directors
may have the effect of deterring or delaying an attempt by a person or group to
obtain control of the Company by a proxy contest since such third party would be
required to have its nominees elected at two annual meetings of stockholders in
order to elect a majority of the members of the Board. See "Risk Factors -
Control of Company by Current Stockholders" and "Certain Provisions of the
Company's Articles of Incorporation, Bylaws and Maryland Law."
COMMITTEES OF THE BOARD
Following completion of the Offering, the Board of Directors intends to
establish two standing committees: the Audit Committee and the Compensation
Committee.
The Audit Committee will be charged with recommending the engagement of
independent accountants to audit the Company's financial statements, discussing
the scope and results of the audit with the independent accountants, reviewing
the functions of the Company's management and independent accountants pertaining
to the Company's financial statements, reviewing management's procedures and
policies regarding internal accounting controls, and performing such other
related duties and functions as are deemed appropriate by the Audit Committee
and the Board of Directors. Upon completion of the Offering, it is expected that
Messrs. Dossani and Prins will serve as the members of the Audit Committee.
The Compensation Committee will be responsible for reviewing and approving
salaries, bonuses and benefits paid or given to all executive officers of the
Company and making recommendations to the Board of Directors with regard to
employee compensation and benefit plans. The Compensation Committee will also
administer the Restated Option Plan and 1997 Performance Incentive Plan. Upon
completion of the Offering, it is expected that Messrs. Dossani and Prins will
serve as the members of the Compensation Committee.
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COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Board of Directors will not have a Compensation Committee until
completion of the Offering. Accordingly, the entire Board of Directors,
including directors who are executive officers of the Company, to date has made
all determinations concerning compensation of executive officers. Following the
completion of the Offering, the Board of Directors intends to establish a
Compensation Committee which will consist entirely of directors who are not
employees of the Company. See "- Committees of the Board."
COMPENSATION OF DIRECTORS
Currently, the Company's directors do not receive cash compensation for
their service on the Board of Directors. Following completion of the Offering,
directors who are not executive officers or employees of the Company may receive
meeting fees, committee fees and other compensation. Each member of the Board
who is not an officer of the Company will receive a grant of options to purchase
5,000 shares of the Common Stock upon joining the Board and additional options
to purchase 2,000 shares per year thereafter. All directors will be reimbursed
for reasonable out-of-pocket expenses incurred in connection with attendance at
Board and committee meetings.
COMPENSATION OF EXECUTIVE OFFICERS
The following Summary Compensation Table sets forth the compensation earned
by the Company's President and Chief Executive Officer and the Vice President
for Engineering (the "Named Officers") during the three years ended December 31,
1994, 1995 and 1996. No other executive officer earned in excess of $100,000 for
services rendered in all capacities to the Company during the three years ended
December 31, 1994, 1995 and 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------------------------------------
NAME AND OTHER ANNUAL
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
- -------------------------------------- ------ ------------- ------- ----------------
<S> <C> <C> <C> <C>
Ram Mukunda ........................ 1996 $165,875 N/A $18,000(1)
President and Chief Executive Officer 1995 150,000 N/A N/A
1994 127,000 N/A N/A
Gustavo Pereira(2) .................. 1996 110,000 N/A N/A
Vice President, Engineering 1995 32,000 N/A N/A
1994 N/A N/A N/A
</TABLE>
- ----------
(1) This amount represents the value of an automobile allowance.
(2) Mr. Pereira joined the Company in August 1995.
STOCK OPTION GRANTS
During the year ended December 31, 1996, the Named Officers were not
awarded any options to purchase any securities of the Company, nor were the
Named Officers granted any stock appreciation rights during fiscal 1996.
OPTION EXERCISES AND HOLDINGS
There were no options exercised by the Named Officers for the fiscal year
ended December 31, 1996 or outstanding at the end of that year, nor were any
stock appreciation rights exercised during such year or outstanding at the end
of that year.
EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement with Ram Mukunda on July
1, 1997 (the "Mukunda Employment Agreement"), pursuant to which Mr. Mukunda
holds the positions of President, Chief Executive Officer and Treasurer of the
Company, is paid an annual base salary of $250,000
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<PAGE>
per year, is entitled to participate in the Company's 1997 Performance Incentive
Plan, is eligible to receive a bonus of up to 40% of his base salary, as
determined by the Compensation Committee of Board of Directors of the Company
based upon the financial and operating performance of the Company, and is
entitled to receive an automobile allowance of $1,500 per month. In addition,
the Mukunda Employment Agreement provides that if there is a "Change of Control"
(as defined below), Mr. Mukunda will receive, for the longer of 12 months or the
balance of the term under his employment agreement (which initially could be for
a period of up to three years), the following benefits: (1) a severance payment
equal to $20,830 per month; (2) a pro rata portion of the bonus applicable to
the calendar year in which such termination occurs; (3) all accrued but unpaid
base salary and other benefits as of the date of termination; and (4) such other
benefits as he was eligible to participate in at and as of the date of
termination.
The Company also entered into an employment agreement with Prabhav Maniyar
on July 1, 1997 (the "Maniyar Employment Agreement"), pursuant to which Mr.
Maniyar holds the positions of Senior Vice President, Chief Financial Officer
and Secretary of the Company, is paid an annual base salary of $175,000 per
year, is entitled to participate in the Company's 1997 Performance Incentive
Plan, is eligible to receive a bonus of up to 40% of his base salary, as
determined by the Compensation Committee of Board of Directors of the Company
based upon the financial and operating performance of the Company, and is
entitled to receive an automobile allowance of $750 per month. In addition, the
Maniyar Employment Agreement provides that if there is a "Change of Control" (as
defined below), Mr. Maniyar will receive, for the longer of 12 months or the
balance of the term under his employment agreement (which initially could be for
a period of up to three years), the following benefits: (1) a severance payment
equal to $14,580 per month; (2) a pro rata portion of the bonus applicable to
the calendar year in which such termination occurs; (3) all accrued but unpaid
base salary and other benefits; and (4) such other benefits as he was eligible
to participate in at and as of the date of termination.
The Mukunda Employment Agreement and the Maniyar Employment Agreement each
has an initial term of three years and is renewable for successive one year
terms. In addition, the agreements also contain provisions which restrict the
ability of Messrs. Mukunda and Maniyar to compete with the Company for a period
of one year following termination.
A "Change of Control" shall be deemed to have occurred, with respect to the
terms and conditions set forth in each of the Mukunda Employment Agreement and
the Maniyar Employment Agreement, if (A) any person becomes a beneficial owner,
directly or indirectly, of securities of the Company representing 30% or more of
the combined voting power of all classes of the Company's then outstanding
voting securities; or (B) during any period of two consecutive calendar years
individuals who at the beginning of such period constitute the Board of
Directors, cease for any reason to constitute at least a majority thereof,
unless the election or nomination for the election by the Company's stockholders
of each new director was approved by a vote of at least two-thirds (2/3) of the
directors then still in office who either were directors at the beginning of the
two-year period or whose election or nomination for election was previously so
approved; or (C) the stockholders of the Company approve a merger or
consolidation of the Company with any other company or entity, other than a
merger or consolidation that would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent more than
50% of the combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation
(exclusive of the situation where the merger or consolidation is effected in
order to implement a recapitalization of the Company in which no person acquires
more than 30% of the combined voting power of the Company's then outstanding
securities); or (D) the stockholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets.
STOCK OPTION PLANS
Amended and Restated Stock Option Plan
The Company adopted the STARTEC, Inc. Stock Option Plan (the "Option Plan")
in 1993 to encourage stock ownership by key management employees of the Company,
to provide an incentive for such employees to expand and improve the profits and
prosperity of the Company and to assist the
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Company in attracting and retaining key personnel through the grant of options
to purchase shares of Common Stock. The Board of Directors amended and restated
the Option Plan in January 1997 (the "Restated Option Plan") to establish a
determinable date for the exercisability of options granted under the Option
Plan and to make other changes and updates.
The Restated Option Plan provided for the grant of options to purchase up
to an aggregate of 270,000 shares of Common Stock to selected full-time
employees of the Company. Options granted may be exercised only upon the
occurrence of a sale of more than fifty percent of the Common Stock in one
transaction, a dissolution or liquidation of the Company, a merger or
consolidation of the Company in which it is not the surviving corporation, a
filing by the Company of an effective registration statement under the
Securities Act, or the seventh anniversary of the date the participant is first
hired as a full-time employee of the Company. All such options terminate and
expire under the Restated Option Plan on the earlier of ten years from the date
of grant or the date the participant is no longer employed by the Company as a
full-time employee and such participant's employment was not terminated as a
result of death or permanent disability of the participant, or the Company's
termination of the participant's full-time employment without cause.
As of June 30, 1997, options to purchase an aggregate of 269,766 shares of
Common Stock have been granted under the Restated Option Plan to 32 persons with
exercise prices ranging from $0.30 to $1.85 per share. Pursuant to resolution of
the Board of Directors, no further awards may be made under the Restated Option
Plan.
1997 Performance Incentive Plan
On August 18, 1997, the stockholders of the Company approved the Company's
1997 Performance Incentive Plan (the "Performance Plan"). The purpose of the
Performance Plan is to support the Company's ongoing efforts to develop and
retain qualified directors, employees and consultants and to provide the Company
with the ability to provide incentives more directly linked to the profitability
of the Company's business and increases in stockholder value.
The Performance Plan provides for the award to eligible employees of the
Company and others of stock options, stock appreciation rights, restricted
stock, and other stock-based awards, as well as cash-based annual and long-term
incentive awards. The Performance Plan reserves 750,000 shares of Common Stock
for issuance, representing 9.1% of the shares of Common Stock outstanding
including the shares offered hereby. The Company may grant options to acquire up
to 480,000 shares of Common Stock without triggering the antidilution provisions
of the warrants issued to Signet Bank. As of the date of this Prospectus,
254,250 options have been granted under the Performance Plan, at an exercise
price of $10 per share. The Performance Plan will be administered by the
Compensation Committee of the Board of Directors. This committee will select the
persons to whom awards will be granted and will set the terms and conditions of
such awards. The shares of Common Stock subject to any award that terminates,
expires or is cashed out without payment being made in the form of Common Stock
will again be available for distribution under the Performance Plan, as will
shares that are used by an employee to pay withholding taxes or as payment for
the exercise price of an award. See "Description of Capital Stock - Signet
Agreement."
Awards under the Performance Plan are not transferable except in the event
of the person's death or unless otherwise required by law. Other terms and
conditions of each award will be set forth in award agreements. The Performance
Plan constitutes an unfunded plan for incentive compensation purposes.
INDEMNIFICATION AND LIMITATION OF LIABILITY
The Company's Charter provides that the Company shall indemnify its current
and former officers and directors against any and all liabilities and expenses
incurred in connection with their services in such capacities to the maximum
extent permitted by Maryland law, as from time to time amended. The Charter
further provides that the right to indemnification shall also include the right
to be paid by the Company for expenses incurred in connection with any
proceeding arising out of such service in advance of its final disposition. The
Charter further provides that the Company may, by action of its Board of
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Directors, provide indemnification to such of the employees and agents of the
Company and such other persons serving at the request of the Company as a
director, officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust, or other enterprise to such extent and to
such effect as is permitted by Maryland law and as the Board of Directors may
determine. The Company expects to purchase and maintain insurance on behalf of
any person who is or was a director, officer, employee, or agent of the Company,
or is or was serving at the request of the Company as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust, or
other enterprise against any expense, liability, or loss incurred by such person
in any such capacity or arising out of his status as such, whether or not the
Company would have the power to indemnify him against such liability under
Maryland law. The Charter provides that (i) the foregoing rights of
indemnification and advancement of expenses shall not be deemed exclusive of any
other rights to which any officer, director, employee or agent of the Company
may be entitled; and (ii) neither the amendment nor repeal of the Charter, nor
the adoption of any additional or amendment provision of the Charter or the
By-laws shall apply to or affect in any respect the applicability of the
Charter's provisions with respect to indemnification for any act or failure to
act which occurred prior to such amendment, repeal or adoption.
Under Maryland law, the Company is permitted to limit by provision in its
Charter the liability of its directors and officers, so that no director or
officer shall be liable to the Company or to any stockholder for money damages
except to the extent that (i) the director or officer actually received an
improper benefit in money, property, or services, for the amount of the benefit
or profit in money, property or services actually received; or (ii) a judgment
or other final adjudication adverse to the director or officer is entered in a
proceeding based on a finding in the proceeding that the director's or officer's
action, or failure to act, was the result or active and deliberate dishonesty
and was material to the cause of action adjudicated in the proceeding. In
Article VII of its amended Charter, the Company has included a provision which
limits the liability of its directors and officers for money damages in
accordance with the Maryland law. Article VII does not eliminate or otherwise
limit the fiduciary duties or obligations of the Company's directors and
officers, does not limit non-monetary forms of recourse against such directors
and officers, and, in the opinion of the Securities and Exchange Commission,
does not eliminate the liability of a director or officer under the federal
securities laws.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information as of October 1, 1997 and as
adjusted to reflect the sale of the Common Stock offered hereby concerning: (i)
each person or group known to the Company to be the beneficial owner of more
than 5% of the Common Stock; (ii) each current director and director designate
of the Company; (iii) each of the Named Officers; and (iv) all directors and
executive officers of the Company as a group. All information with respect to
beneficial ownership has been furnished to the Company by the respective
stockholders.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
----------------------------------------------------
PERCENT OF CLASS
NUMBER OF --------------------------------------
BENEFICIAL OWNER(1) SHARES(2) BEFORE OFFERING AFTER OFFERING(3)
- ----------------------------------------------- ----------- ----------------- ------------------
<S> <C> <C> <C>
Ram Mukunda(4) .............................. 3,579,675 60.0% 40.6%
Blue Carol Enterprises Ltd(5) ............... 807,124 13.5% 9.2%
Vijay Srinivas(6) ........................... 311,200 5.2% 3.5%
Prabhav V. Maniyar ........................... 107,616 1.8% 1.2%
Signet Bank(7) .............................. 269,900 4.5% 3.1%
Nazir G. Dossani(8) ........................... 5,000 * *
Richard K. Prins(9) ........................... 5,000 * *
All Directors and Executive Officers as a Group
(5 persons) ................................. 4,008,491 67.2% 45.5%
--------- ------ -----
</TABLE>
- ----------
* Represents beneficial ownership of less than 1% of the outstanding shares
of Common Stock.
(1) Unless otherwise noted, the address of all persons listed is c/o Startec
Global Communications Corporation, 10411 Motor City Drive, Bethesda, MD
20817.
(2) Beneficial ownership is determined in accordance with the rules of the
Commission. Shares of Common Stock subject to options, warrants or other
rights to purchase which are currently exercisable or are exercisable
within 60 days of September 1, 1997 are deemed outstanding for computing
the percentage ownership of the persons holding such options, warrants or
rights, but are not deemed outstanding for computing the percentage
ownership of any other person. Unless otherwise indicated, each person
possesses sole voting and investment power with respect to the shares
identified as beneficially owned.
(3) Assumes no exercise of the Underwriters' over-allotment option.
(4) Mr. Mukunda has pledged all of his shares of Common Stock as security for
the Company's obligations under the Signet Agreement. In addition, Mr.
Mukunda and Mr. and Mrs. Srinivas have entered into a Voting Agreement
dated as of July 31, 1997 pursuant to which Mr. Mukunda has the power to
vote all of the shares held by Mr. and Mrs. Srinivas. See "Description of
Capital Stock - Signet Agreement."
(5) The address of Blue Carol Enterprises Ltd. is 930 Ocean Center Harbour
City, Kowloon, Hong Kong. Blue Carol Enterprises Ltd. is a subsidiary of
Portugal Telcom International.
(6) Such shares are held by Mr. Srinivas and his wife as joint tenants. Mr. and
Mrs. Srinivas have pledged all of their shares of Common Stock as security
for the Company's obligations under the Signet Agreement. See "Description
of Capital Stock - Signet Agreement." In addition, Mr. Mukunda and Mr. and
Mrs. Srinivas has entered into a Voting Agreement dated as of July 31, 1997
pursuant to which Mr. Mukunda has the power to vote all of the shares held
by Mr. and Mrs. Srinivas.
(7) In connection with the Signet Agreement, the Company issued to Signet Bank
warrants to purchase 539,800 shares of Common Stock. Warrants with respect
to 269,900 shares are currently vested. The remaining 269,900 shares will
not vest if the Company completes the Offering prior to December 31, 1997.
See "Description of Capital Stock - Signet Agreement" and "Risk Factors
Restrictions Imposed by Signet Agreement." The address for Signet Bank is
7799 Leesburg Pike, Suite 500, Falls Church, VA 22043.
(8) Upon joining the Company's Board of Directors, Mr. Dossani will receive
options to purchase 5,000 shares of the Common Stock.
(9) Upon joining the Company's Board of Directors, Mr. Prins will receive
options to purchase 5,000 shares of the Common Stock. In addition, Mr.
Prins is a Senior Vice President of Ferris, Baker Watts, Incorporated, one
of the Representatives of the Underwriters. The Representatives of the
Underwriters will receive warrants to purchase up to 150,000 shares of the
Company's Common Stock upon the completion of the Offering. These warrants
are not currently exercisable. See "Underwriting."
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CERTAIN TRANSACTIONS
The Company has an agreement with Companhia Santomensed De
Telecommunicacoes ("CST"), an affiliate of Blue Carol Enterprises Ltd. ("Blue
Carol"), which currently holds 15% of the outstanding shares of Common Stock,
for the purchase and sale of long distance services. Revenues generated from
this affiliate amounted to approximately $625,000, $1,035,000 and $1,501,000, or
12%, 10% and 5% of the Company's total revenues for the years ended December 31,
1994, 1995 and 1996, respectively. Services provided to the Company by this
affiliate amounted to approximately $134,000 and $663,000 of the Company's costs
of services for the years ended December 31, 1995 and 1996, respectively. No
services were purchased from this affiliate in fiscal 1994. The Company also has
a lease agreement with another Blue Carol affiliate, Marconi, for rights to use
undersea fiber optic cable under which the Company is obligated to pay Marconi
$38,330 semi-annually for five years on a resale basis.
Pursuant to the terms of a Subscription Agreement and an Agreement for
Management Participation by and among Blue Carol, the Company and Ram Mukunda
dated as of February 8, 1995, the Company and Mr. Mukunda granted Blue Carol
certain management rights in the Company. The agreement was subsequently amended
in June 1997 to remove certain restrictions applicable to the Company. This
agreement terminates, and all of Blue Carol's management rights expire, upon the
completion of this Offering.
The Company provided long distance services to EAA, Inc. ("EAA"), an
affiliate owned by Ram Mukunda, the Company's President and Chief Executive
Officer. Payments received by the Company from EAA amounted to approximately
$396,000 and $262,000 for the years ended December 31, 1995 and 1996,
respectively. Accounts receivable from EAA were $167,000 and $64,000 for the
years ended December 31, 1995 and 1996, respectively. There were no transactions
with EAA in 1994. The Company believes that the services provided were on
standard commercial terms, which are no less favorable than those available on
an arms-length basis with an unaffiliated third party.
The Company was indebted to Vijay and Usha Srinivas and Mrs. B.V. Mukunda
under certain notes payable in the amounts of $46,000 and $100,000, respectively
as of June 30, 1997. Mr. and Mrs. Srinivas are the brother-in-law and sister,
and Mrs. B.V. Mukunda is the mother, of Ram Mukunda, the Company's President and
Chief Executive Officer. The interest rates on these notes ranged from 15% to
25%. These amounts were repaid in July 1997.
In July 1997, the Company offered to exchange shares of its voting common
stock for all of the issued and outstanding shares of its non voting common
stock, or alternatively, to repurchase such shares of non voting common stock
for cash. In connection therewith, Mr. Mukunda exchanged 17,175 shares of non
voting stock for an equal number of shares of voting common stock.
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DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon the completion of this Offering, the Company will be authorized to
issue 20,000,000 shares of Common Stock, par value $.01 per share, and 100,000
shares of Preferred Stock, par value $1.00 per share.
COMMON STOCK
As of October 1, 1997, there were 5,397,999 shares of Common Stock
outstanding held of record by 15 stockholders. As of October 1, 1997, options to
purchase an aggregate of 524,016 shares of Common Stock were outstanding, of
which none were exercisable. Warrants and other rights to purchase an aggregate
of 566,800 shares of Common Stock were also outstanding, of which options and
warrants to purchase 272,900 shares were then exercisable. After giving effect
to the sale of 2,850,000 shares of Common Stock by the Company in this Offering,
there will be 8,247,999 shares of Common Stock outstanding (8,675,499 shares if
the Underwriters' over-allotment option is exercised in full).
The holders of Common Stock are entitled to one vote per share on all
matters to be voted on by stockholders, including the election of directors.
There are no cumulative voting rights in the election of directors. Subject to
the prior rights of holders of Preferred Stock, if any, the holders of Common
Stock are entitled to receive such dividends, if any, as may be declared from
time to time by the Board of Directors in its discretion from funds legally
available therefor. Upon liquidation or dissolution of the Company, the
remainder of the assets of the Company will be distributed ratably among the
holders of Common Stock after payment of liabilities and the liquidation
preferences of any outstanding shares of Preferred Stock. The Common Stock has
no preemptive or other subscription rights and there are no conversion rights or
redemption or sinking fund provisions with respect to such shares. All of the
outstanding shares of Common Stock are, and the shares to be sold in this
Offering will be, fully paid and nonassessable.
Prior to the Offering, the Company's capital structure consisted of two
classes of common stock, one class with voting rights and one class without
voting rights. In July 1997, the Company offered to exchange shares of voting
common stock for all of its issued and outstanding shares of non voting common
stock, or, alternatively to repurchase such shares of non voting common stock
for cash. All of the shares of non voting common stock were exchanged or
repurchased pursuant to the offer and the class of non voting common stock has
been eliminated.
PREFERRED STOCK
The Board of Directors has the authority to issue up to 100,000 shares of
Preferred Stock in one or more series and to fix the price, rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting a series or the
designation of such series, without any further vote or action by the Company's
stockholders. The issuance of Preferred Stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of delaying, deferring or preventing a change in
control of the Company without further action by the stockholders and may
adversely affect the market price of, and the voting and other rights of, the
holders of Common Stock. There are no shares of Preferred Stock outstanding, and
the Company has no current plans to issue any shares of Preferred Stock. See
"Risk Factors - Capital Requirements; Need for Additional Financing."
SIGNET AGREEMENT
In connection with the Signet Agreement, the Company issued to Signet Bank
warrants (the "Signet Warrants") to purchase 539,800 shares of Common Stock,
representing 10% of the outstanding Common Stock on the date of issuance.
Warrants with respect to 269,900 of such shares, or 5% of the outstanding Common
Stock at the time the Signet Warrants were issued, vested fully on the date of
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issuance. The terms of the Signet Agreement provide that additional Signet
Warrants will become fully vested in the event that the Company's initial public
offering is not consummated by certain target dates. Such additional vesting, if
any, will begin in the first calendar quarter of 1998, and an additional one
percent each calendar quarter will vest, up to an aggregate of 10% of the
outstanding Common Stock, continuing until the Company completes its initial
public offering. No additional Signet Warrants will vest if the Company
consummates an initial public offering prior to December 31, 1997. The exercise
price of the Signet Warrants is $8.46 per share, and they expire July 1, 2002.
The holders of the Signet Warrants will have no voting or other stockholder
rights unless and until the Signet Warrants are exercised. The number of shares
of Common Stock issuable and the exercise price of the Signet Warrants are
subject to antidilution adjustments in the event the Company issues additional
shares of Common Stock or options to purchase shares of Common Stock (except
pursuant to certain outstanding warrants, existing employee options, and up to
750,000 shares that may be issued in connection with issuances of options under
employee incentive plans). The intent of the antidilution provisions is to
permit Signet Bank to maintain its percentage ownership after the Offering,
which will be 3.4%, regardless of future sales or issuance by the Company of its
Common Stock, options, warrants or other rights to purchase Common Stock, or
securities convertible into Common Stock (subject to the exceptions outlined
above), and to give Signet Bank price protection such that the $8.46 purchase
price will be adjusted downward in the event of future sales or issuances by the
Company at an effective price which is below that exercise price. The
antidilution provisions will survive the Offering and may affect the Company's
ability to raise additional capital through the sale or issuance of its Common
Stock, options, warrants or other rights to purchase Common Stock or securities
convertible into Common Stock.
In addition, in connection with the Signet Agreement and the issuance of
the Signet Warrants, the Company agreed to provide the holders of the Signet
Warrants with certain rights to request the Company to register the shares of
Common Stock underlying the Signet Warrants under the Securities Act. At any
time after 90 days following the date of this Prospectus, the holders of the
Signet Warrants may twice demand that the Company register, at the Company's
expense, at least 50% of the shares of Common Stock underlying the Signet
Warrants. Signet Bank has agreed to refrain from selling or otherwise
transferring any shares underlying the Signet Warrants for a period of 180 days
following the date of this Prospectus. In addition to the demand registration
rights, the Signet Warrant holders also have "piggy-back" registration rights
with respect to any offering by the Company following this Offering.
The Company's repayment and other obligations under the Signet Agreement
are secured by, among other things, a pledge of all of the capital stock of the
Company owned by Ram Mukunda, the Company's President, Chief Executive Officer,
director and principal stockholder, and Vijay Srinivas, a Company director and
his wife, Usha Srinivas. Beginning on January 1, 1998 (and extending to July 1,
1998 upon the occurrence of defined events), should Signet Bank determine and
assert based on its reasonable assessment that a material adverse change to the
Company has occurred, all amounts outstanding would be immediately due and
payable. Under certain circumstances, if an event a default occurs under the
Signet Agreement which would permit Signet Bank to take possession and control
over the shares subject to the pledge, Signet Bank would acquire voting control
of a significant percentage of the issued and outstanding shares of Common
Stock.
WARRANTS AND REGISTRATION RIGHTS
The Company has agreed to issue to the Representatives of the Underwriters,
for consideration of $.01 per warrant, warrants (the "Representatives'
Warrants") to purchase up to 150,000 shares of Common Stock at an exercise price
per share equal to 110% of the initial public offering price. The
Representatives' Warrants are exercisable for a period of five years beginning
one year from the date of this Prospectus. The holders of the Representatives'
Warrants will have no voting or other stockholder rights unless and until the
Representatives' Warrants are exercised. See "Underwriting."
In connection with the issuance of the Representatives' Warrants, the
Company will agree to provide the holders of the Representatives' Warrants with
certain rights to request the Company to register the shares of Common Stock
underlying the Representatives' Warrants under the Securities Act, in
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addition to "piggy-back" registration rights with respect to certain offerings
by the Company following this Offering. See "Underwriting."
Further, the Company has granted to Atlantic-ACM the option to acquire
3,000 shares of Common Stock in lieu of payment in the amount of $30,000 owed by
the Company to Atlantic-ACM for certain consulting services.
CERTAIN PROVISIONS OF THE COMPANY'S ARTICLES OF INCORPORATION, BYLAWS AND
MARYLAND LAW
Amended and Restated Articles of Incorporation and Bylaws
The Company's Charter and Bylaws include certain provisions which may have
the effect of delaying, deterring or preventing a future takeover or change in
control of the Company, by proxy contest, tender offer, open-market purchases or
otherwise, unless such takeover or change in control is approved by the
Company's Board of Directors. Such provisions may also make the removal of
directors and management more difficult.
In this regard, the Charter and Bylaws provide that the number of directors
shall be five but may not be fewer than three nor more than twenty-five members.
The Charter divides the Board of Directors into three classes, with one class
having a term of one year, one class having a term of two years, and one class
having a term of three years. Each class is to be as nearly equal in number as
possible. At each annual meeting of stockholders, directors will be elected to
succeed those directors whose terms have expired, and each newly elected
director will serve for a three-year term. In addition, the Charter and Bylaws
provide that any director or the entire Board may be removed by stockholders
only for cause and with the approval of the holders of 80% of the total voting
power of all outstanding securities of the Company then entitled to vote
generally in the election of directors, voting together as a single class. The
Charter and Bylaws also provide that all vacancies on the Board of Directors,
including those resulting from an increase in the number of directors, may be
filled solely by a majority of the remaining directors; provided, however, that
if the vacancy occurs as a result of the removal of a director, the stockholders
may elect a successor at the meeting at which such removal occurs.
The classification of directors and the provisions in the Charter that
limit the ability of stockholders to remove directors and that permit the
remaining directors to fill any vacancies on the Board, will have the effect of
making it more difficult for stockholders to change the composition of the Board
of Directors. As a result, at least two annual meetings of stockholders will be
required, in most cases, for the stockholders to change a majority of the
directors, whether or not a change in the Board of Directors would be beneficial
to the Company and its stockholders and whether or not a majority of the
Company's stockholders believes that such a change would be desirable.
The Bylaws also contain provisions relating to the stockholders' ability to
call meetings of stockholders, present stockholder proposals, and nominate
candidates for the election of directors. The Bylaws provide that special
meetings of stockholders can be called only by the Chairman of the Board of
Directors, the President, the Board of Directors, or by the Secretary at the
request of holders of at least 25% of all votes entitled to be cast. These
provisions may have the effect of delaying consideration of a stockholder
proposal until the next annual meeting unless a special meeting is called. In
addition, the Charter and Bylaws establish procedures requiring advanced notice
with regard to stockholder proposals and the nomination of candidates for
election as directors (other than by or at the direction of the Board of
Directors or a committee of the Board of Directors). Pursuant to these
procedures, stockholders desiring to introduce proposals or make nominations for
the election of directors must provide written notice, containing certain
specified information, to the Secretary of the Company not less than 60 nor more
than 90 days prior to the meeting. If less than 30 days notice or prior public
disclosure of the date of the meeting is given, the required notice regarding
stockholder proposals or director nominations must be in writing and received by
the Secretary of the Company no later than the tenth day following the day on
which notice of the meeting was mailed. The Company may reject a stockholder
proposal or nomination that is not made in accordance with such procedures.
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The Charter also includes certain "super-majority" voting requirements,
which provide that the affirmative vote of the holders of at least 80% of the
aggregate combined voting power of all classes of capital stock entitled to vote
thereon, voting as one class, is required to amend certain provisions of the
Charter, including those provisions relating to the number, election, term of
and removal of directors; the amendment of the Bylaws; and the provision
governing applicability of the Maryland Control Share Act (summarized below).
The effect of these provisions will be to make it more difficult to amend
provisions of the Charter, even if such amendments are favored by a majority of
stockholders. In addition, the Charter includes provisions which require the
vote of a simple majority of the Company's issued and outstanding Common Stock
to approve certain significant corporate transactions, including the sale of all
or substantially all of the Company's assets, rather than the vote of two-thirds
of the issued and outstanding Common Stock.
The description of the Charter and Bylaw provisions set forth above are
intended to be summaries only. The forms of Charter and Bylaws, as amended and
restated, are filed as exhibits to the Registration Statement filed with the
Commission of which this Prospectus forms a part. This summary is qualified in
its entirety by reference to such documents. See "Risk Factors - Control of
Company by Current Stockholders" and "- Certain Provisions of the Company's
Articles of Incorporation, Bylaws and Maryland Law."
Maryland Law
Section 3-601, et seq. of the Maryland General Corporation Law (the
"Business Combination Statute"), and Section 3-701 et seq. of the Maryland
General Corporation Law with respect to acquisitions of "control shares" may
also have the effect of delaying, deterring or preventing a future takeover or
change in control of the Company, by proxy contest, tender offer, open-market
purchases or otherwise.
Under the Business Combination Statute, certain "business combinations"
(including mergers or similar transactions subject to a statutory stockholder
vote and additional transactions involving transfers of assets or securities in
specified amounts) between a Maryland corporation subject to the Business
Combination Statute and an Interested Stockholder, or an affiliate thereof are
prohibited for five years after the most recent date on which the Interested
Stockholder became an Interested Stockholder unless an exemption is available.
Thereafter, any such business combination must be recommended by the board of
directors of the corporation and approved by the affirmative vote of at least:
(i) 80% of the votes entitled to be cast by all holders of outstanding shares of
voting stock of the corporation; and (ii) two-thirds of the votes entitled to be
cast by holders of voting stock of the corporation other than voting stock held
by the Interested Stockholder who will or whose affiliate will be a party to the
business combination voting together as a single voting group, unless the
corporation's stockholders receive a minimum price (as described in the Business
Combination Statute) for their stock and the consideration is received in cash
or in the same form as previously paid by the Interested Stockholder for its
shares. The Business Combination Statute defines an "Interested Stockholder" as
any person who is the beneficial owner, directly or indirectly, of 10% or more
of the outstanding voting stock of the corporation after the date on which the
corporation had 100 or more beneficial owners of its stock; or any affiliate or
associate of the corporation who, at any time within the two-year period
immediately prior to the date in question was the beneficial owner of 10% or
more of the voting power of the then-outstanding stock of the corporation.
These provisions of the Business Combination Statute do not apply, unless
the corporation's charter or Bylaws provide otherwise, to a corporation that on
July 1, 1983 had an existing Interested Stockholder, unless, at any time
thereafter, the Board of Directors elects to be subject to the law. These
provisions of the Business Combination Statute also would not apply to business
combinations that are approved or exempted by the Board of Directors of the
corporation prior to the time that any other Interested Stockholder becomes an
Interested Stockholder. A Maryland corporation may adopt an amendment to its
charter electing not to be subject to the special voting requirements of the
Business Combination Statute. Any such amendment would have to be approved by
the affirmative vote of at least 80% of the votes entitled to be cast by all
holders of outstanding shares of voting stock of the corporation voting together
as a single voting group, and 66 2/3% of the votes entitled to be cast by
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persons (if any) who are not Interested Stockholders of the corporation or
affiliates or associates of Interested Stockholders voting together as a single
voting group. The Company has not adopted such an amendment to its Charter.
In addition to the Business Combination Statute, Section 3-701 et seq. of
the Maryland General Corporation Law provides that "control shares" of a
Maryland corporation acquired in a "control share acquisition" have no voting
rights except to the extent approved by the stockholders at a special meeting by
the affirmative vote of two-thirds of all the votes entitled to be cast on the
matter, excluding all interested shares. "Control shares" are voting shares of
stock which, if aggregated with all other such shares previously acquired by the
acquiror, or in respect of which the acquiror is able to exercise or direct the
exercise of voting power, would entitle the acquiror, directly or indirectly, to
exercise or direct the exercise of the voting power in electing directors within
any one of the following ranges of voting power: (i) 20% or more but less than
33 1/3%; (ii) 33 1/3% or more but less than a majority or (iii) a majority or
more of all voting power. Control shares do not include shares the acquiror is
then entitled to vote as a result of having previously obtained stockholder
approval. A "control share acquisition" means the acquisition, directly or
indirectly, by any person, of ownership of, or the power to direct the exercise
of voting power with respect to, issued and outstanding control shares.
A person who has made or proposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses and
delivery of an "acquiring person statement"), may compel a corporation's board
of directors to call a special meeting of stockholders to be held within 50 days
of a demand to consider the voting rights to be accorded the shares acquired or
to be acquired in the control share acquisition. If no request for a meeting is
made, the corporation may itself present the question at any stockholders'
meeting. Unless the charter or bylaws provide otherwise, if the acquiring person
does not deliver an acquiring person statement within 10 days following a
control share acquisition then, subject to certain conditions and limitations,
the corporation may redeem any or all of the control shares (except those for
which voting rights have previously been approved) for fair value determined,
without regard to the absence of voting rights for the control shares, at any
time during a period commencing on the 11th day after the control share
acquisition and ending 60 days after a statement has been delivered. Moreover,
unless the charter or bylaws provide otherwise, if voting rights for control
shares are approved at a stockholders' meeting and the acquiror becomes entitled
to exercise or direct the exercise of a majority or more of all voting power,
other stockholders may exercise appraisal rights. The fair value of the shares
as determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition.
The control share acquisition statute does not apply to shares acquired in a
merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by the charter or bylaws of
the corporation. The shares of Common Stock held by Ram Mukunda and his family
are not subject to the restrictions imposed by the Maryland Control Share Act.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is Continental Stock
Transfer & Trust Company.
LISTING
The shares of Common Stock have been approved for quotation on the Nasdaq
National Market under the symbol "STGC" subject to official notice of issuance.
59
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 8,247,999
outstanding shares of Common Stock, and options, warrants and other rights to
purchase up to an additional 1,240,816 shares of Common Stock (of which 566,666
currently are exercisable) at prices ranging from $0.30 to $13.20 per share.
Of the Common Stock outstanding upon completion of the Offering, the
2,850,000 shares of Common Stock (excluding the shares subject to the
Underwriters' over allotment option) sold in the Offering will be freely
tradeable without restriction or further registration under the Securities Act,
except for any shares held by "affiliates" of the Company, as that term is
defined in Rule 144 under the Securities Act, and the regulations promulgated
thereunder (an "Affiliate"), or persons who have been Affiliates within the
preceding three months. The remaining 5,397,999 outstanding shares of Common
Stock will be "restricted securities" as that term is defined in Rule 144 and
may be sold in the public market only if registered or if they qualify for an
exemption from registration, including under Rule 144, as described below.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an Affiliate, who has beneficially owned
restricted securities for a period of at least one year from the later of the
date such restricted securities were acquired from the Company or from an
Affiliate, is entitled to sell, within any three-month period, a number of
shares that does not exceed the greater of 1% of the then outstanding shares of
Common Stock or the average weekly trading volume in the Common Stock during the
four calendar weeks preceding such sale. Such sales under Rule 144 are also
subject to certain provisions relating to the manner and notice of sale and the
availability of current public information about the Company. Further, under
Rule 144(k), if a period of at least two years has elapsed from the later of the
date restricted securities were acquired from the Company or from an Affiliate,
a holder of such restricted securities who is not an Affiliate at the time of
the sale and has not been an Affiliate for at least three months prior to the
sale would be entitled to sell the shares immediately without regard to the
volume, manner of sale or current information requirements described above. In
addition, Rule 701 under the Securities Act also permits resales of shares
acquired pursuant to certain compensation plans and arrangements.
The Company and its executive officers, directors and all stockholders,
have agreed that for a period of 180 days following the Offering, without the
prior written consent of the Representatives, they will not, directly or
indirectly, offer or agree to sell, hypothecate, pledge or otherwise dispose of
any shares of Common Stock (or securities convertible into, exchangeable, or
exercisable for or evidencing the right to purchase shares of Common Stock). In
addition, Signet Bank has agreed to refrain from selling or otherwise
transferring any shares underlying the Signet Warrants for a period of 180 days
following the Offering. As a result of these contractual restrictions,
notwithstanding possible earlier eligibility for sale under the provisions of
Rule 144 under the Securities Act, the terms of the Signet Warrants or
otherwise, shares subject to lock-up agreements will not be saleable until such
agreements expire.
In addition, the Company intends to register on Form S-8 under the
Securities Act 270,000 of Common Stock issuable under Restated Option Plan and
750,000 shares under its 1997 Performance Incentive Plan. Shares issued under
these plans (other than shares issued to Affiliates) generally may be sold
immediately in the public market, subject to vesting requirements and lock-up
agreements. The Company has also agreed to provide certain holders of warrants
to purchase its Common Stock with rights to request the registration of the
shares underlying the warrants under the Securities Act. See "Description of
Capital Stock - Warrants and Registration Rights."
Future sales of Common Stock in the public market following this Offering
by the current stockholders of the Company, or the perception that such sales
could occur, could adversely affect the market price for the Common Stock. The
Company's principal stockholders hold a significant portion of the outstanding
shares of Common Stock and a decision by one or more of these stockholders to
sell shares pursuant to Rule 144 under the Securities Act or otherwise could
materially adversely affect the market price of the Common Stock. See "Risk
Factors - Shares Eligible for Future Sale."
60
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting
Agreement, the Company has agreed to sell to each of the underwriters named
below (the "Underwriters"), for whom Ferris, Baker Watts, Incorporated and
Boenning & Scattergood, Inc. are acting as representatives (the
"Representatives"), and each of the Underwriters has severally agreed to
purchase from the Company, the respective number of shares of Common Stock set
forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ----------
<S> <C>
Ferris, Baker Watts, Incorporated ...... 2,020,000
Boenning & Scattergood, Inc. ............ 830,000
----------
Total .............................. 2,850,000
==========
</TABLE>
The nature of the respective obligations of the Underwriters is such that
all of the shares of Common Stock must be purchased if any are purchased. The
Underwriting Agreement provides that the obligations of the Underwriters to pay
for and accept delivery of the shares of Common Stock are subject to certain
conditions, including the approval of certain legal matters by counsel.
The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock initially at the public offering
price set forth on the cover page of this Prospectus and to certain selected
dealers at such price less a concession not to exceed $0.50 per share; that the
Underwriters may allow, and such selected dealers may reallow, a concession to
certain other dealers not to exceed $0.10 per share; and that after the
commencement of the Offering, the public offering price and the concessions may
be changed.
The Company has granted the Underwriters an option to purchase in the
aggregate up to 427,500 additional shares of Common Stock solely to cover
over-allotments, if any. The option may be exercised in whole or in part at any
time within 30 days after the date of this Prospectus. To the extent the option
is exercised, the Underwriters will be severally committed, subject to certain
conditions, to purchase the additional shares of Common Stock in proportion to
their respective purchase commitments as indicated in the preceding table.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, and, where such
indemnification is unavailable, to contribute to payments that the Underwriters
may be required to make in respect of such liabilities.
The executive officers, directors and stockholders of the Company have
agreed that they will not offer, sell, contract to sell or grant an option to
purchase or otherwise dispose of any shares of the Company's Common Stock,
options to acquire shares of Common Stock or any securities exercisable for, or
convertible into Common Stock owned by them, for a period of 180 days from the
date of this Prospectus, without the prior written consent of the
Representatives. The Company also has agreed not to offer, sell, or issue any
shares of Common Stock, options to acquire Common Stock or any securities
exercisable for, or convertible into Common Stock, for a period of 180 days from
the date of this Prospectus, without the prior written consent of the
Representatives, except that the Company may issue securities pursuant to the
Company's stock option and incentive plans and upon the exercise of any
outstanding options and warrants. In addition, Signet Bank has agreed to refrain
from selling or otherwise transferring any shares of Common Stock underlying the
Signet Warrants for a period of 180 days following the Offering.
Prior to the Offering, there has been no public market for the Common
Stock. The initial public offering price for the shares of Common Stock included
in this Offering has been determined by negotiation among the Company and the
Representatives. Among the factors considered in determining such price were the
history of and prospects for the Company's business and the industry in which it
operates, an assessment of the Company's management, past and present revenues
and earnings of the Company, the prospects for growth of the Company's revenues
and earnings and currently prevailing conditions in the securities markets,
including current market valuations of publicly traded companies which are
61
<PAGE>
comparable to the Company. There can be no assurance, however, that the prices
at which the shares of Common Stock will sell in the public market after this
Offering will not be lower than the price at which it is sold by the
Underwriters.
The Representatives have advised the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
Certain persons participating in the Offering may over allot or engage in
transactions that stabilize, maintain or otherwise affect the market price of
the Common Stock, including entering stabilizing bids, effecting syndicate
covering transactions or imposing penalty bids. A stabilizing bid means the
placing of any bid or effecting any purchase for the purpose of pegging, fixing
or maintaining the price of the Common Stock. A syndicate covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
the Offering. A penalty bid means an arrangement that permits the Underwriters
to reclaim a selling concession from a syndicate member in connection with the
Offering when the Common Stock sold by the syndicate member is purchased in
syndicate covering transactions. Any of the transactions described in this
paragraph may result in the maintenance of the price of the Common Stock at a
level above that which might otherwise prevail in the open market. Such
stabilizing activities, if commenced, may be discontinued at any time.
The Company has agreed to issue to the Representatives, for consideration
of $.01 per warrant, warrants (the "Representatives' Warrants") to purchase up
to 150,000 shares of the Common Stock at an exercise price per share equal to
110% of the initial public offering price. The Representatives' Warrants are
exercisable for a period of five years beginning one year from the effective
date of the Company's registration statement, of which this Prospectus is a
part. The holders of the Representatives' Warrants will have no voting or other
stockholder rights unless and until the Representatives' Warrants are exercised.
The Representatives' Warrants may not be sold, transferred, assigned, pledged or
hypothecated by any person, other than among the Underwriters and bona fide
officers or partners of the Underwriters, for a period of one year following the
effective date of the Company's registration statement, of which this Prospectus
is a part. Pursuant to an arrangement between Ferris, Baker Watts, Incorporated
and Richard K. Prins, a Senior Vice President of Ferris, Baker Watts,
Incorporated and who will be named a director of the Company upon completion of
the Offering, Mr. Prins will receive a portion of the Representatives' Warrants
for the purchase of up to 25,000 shares of the Common Stock. In addition, the
Company has granted the holders of the Representatives' Warrants certain rights
to register the shares of Common Stock underlying the Representatives' Warrants
under the Securities Act.
The Company has also agreed to pay the Representative a non-accountable
expense allowance equal to 1.0% of the gross proceeds of the Offering for
expenses incurred in connection therewith.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby has been passed
upon for the Company by Shulman, Rogers, Gandal, Pordy & Ecker, P.A., Rockville,
Maryland. Certain legal matters in connection with the Offering will be passed
upon for the Underwriters by Venable, Baetjer & Howard LLP, McLean, Virginia.
EXPERTS
The audited financial statements of the Company included in this Prospectus
and the audited financial statement schedule included in the Registration
Statement of which this Prospectus forms a part have been audited by Arthur
Andersen LLP, independent public accountants, as indicated in their reports with
respect thereto, and are included herein in reliance upon the authority of said
firm as experts in giving said reports.
62
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 under the Securities Act with
respect to the Common Stock offered hereby. This Prospectus does not contain all
of the information set forth in the Registration Statement and the exhibits and
schedules to the Registration Statement. For further information with respect to
the Company and such Common Stock offered hereby, reference is made to the
Registration Statement and the exhibits and schedules filed as a part of the
Registration Statement. Statements contained in this Prospectus concerning the
contents of any contract or any other document referred to are not necessarily
complete and in each instance reference is made to the copy of such contract or
document filed as an exhibit to the Registration Statement. Each such statement
is qualified in all respects by such reference to such exhibit. The Registration
Statement, including exhibits and schedules thereto, as well as the reports and
other information filed by the Company with the Commission, may be inspected
without charge at the Public Reference Room of the Commission's principal office
at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices at Seven World Trade Center, 13th Floor, New York,
New York 10048, and 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. Copies of such material can also be obtained at prescribed rates from the
Public Reference Section of the Commission at Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549. Electronic filings made through the Electronic
Data Gathering Analysis and Retrieval System are also publicly available through
the Commission's Web Site (http://www.sec.gov).
The Company is not currently subject to the periodic reporting and
informational requirements of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). As a result of the Offering, the Company will be required
to file reports and other information with the Commission pursuant to the
requirements of the Exchange Act. Such reports and other information may be
obtained from the Commission's Public Reference Section and copied at the public
reference facilities and regional offices of the Commission referred to above.
The Company intends to furnish holders of the Common Stock with annual reports
containing financial statements audited by an independent public accounting firm
and with quarterly reports containing unaudited summary financial statements for
each of the first three quarters of each fiscal year.
63
<PAGE>
GLOSSARY OF TERMS
Access Charges: The fees paid by long distance carriers to LECs for
originating and terminating long distance calls on their local networks.
Accounting or Settlement Rate: The per minute rate negotiated between
carriers in different countries for termination of international long distance
traffic in, and return traffic to, the carriers' respective countries.
Call reorigination: a form of dial up access that allows a user to access a
telecommunications company's network by placing a telephone call and waiting for
an automated callback. The callback then provides the user with dial tone which
enables the user to place a call.
CLEC: Competitive Local Exchange Carrier.
Correspondent agreement: Agreement between international long distance
carriers that provides for the termination of traffic in, and return traffic to,
the carriers' respective countries at a negotiated per minute rate and provides
for a method by which revenues are distributed between the two carriers (also
known as an "operating agreement").
CST: Companhia Santomensed De Telecommunicacoes.
Dedicated access: A means of accessing a network through the use of a
permanent point-to-point circuit typically leased from a facilities-based
carrier. The advantage of dedicated access is simplified premises-to-anywhere
calling, faster call set-up times and potentially lower access costs (provided
there is sufficient traffic over the circuit to generate economies of scale).
Dial up access: A form of service whereby access to a network is obtained
by dialing a toll-free number or a paid local access number.
Direct access: A method of accessing a network through the use of private
lines.
EU (European Union): Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden,
and the United Kingdom.
Facilities-based carrier: A carrier which transmits a significant portion
of its traffic over owned or leased transmission facilities.
FCC: Federal Communications Commission.
Fiber optic: A transmission medium consisting of high-grade glass fiber
through which light beams are transmitted carrying a high volume of
telecommunications traffic.
International gateway: A switching facility that provides connectivity
between international carriers and performs any necessary signaling conversions
between countries.
IRU (Indefeasible Rights of Use): The rights to use a telecommunications
system, usually an undersea cable, with most of the rights and duties of
ownership, but without the right to control or manage the facility and,
depending upon the particular agreement, without any right to salvage or duty to
dispose of the cable at the end of its useful life.
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.
ISR (International Simple Resale): The use of international leased lines
for the resale of switched telephony to the public, bypassing the current system
of accounting rates.
ITO (Incumbent Telecommunications Operator): The dominant carrier in each
country, often government-owned or protected; commonly referred to as the
Postal, Telephone and Telegraph Company, or PTT.
ITU: The International Telecommunications Union.
G-1
<PAGE>
LEC (Local Exchange Carrier): Companies from which the Company and other
long distance providers must purchase "access services" to originate and
terminate calls in the U.S.
Local connectivity: Physical circuits connecting the switching facilities
of a telecommunications services provider to the interexchange and transmission
facilities of a facilities-based carrier.
Local exchange: A geographic area determined by the appropriate regulatory
authority in which calls generally are transmitted without toll charges to the
calling or called party.
Long distance carriers: Long distance carriers provide services between
local exchanges on an interstate or intrastate basis. A long distance carrier
may offer services over its own or another carriers facilities.
Marconi: Companhia Portuguesa Radio Marconi, S.A.
PBX (Public Branch Exchange): Switching equipment that allows connection of
private extension telephones to the PSTN or to a private line.
PSTN (Public Switched Telephone Network): A telephone network which is
accessible by the public at large through private lines, wireless systems and
pay phones.
PTT: A foreign telecommunication carrier that has been dominant in its home
market and which may be wholly or partially government-owned, often referred to
as Post Telephone and Telegraph or "PTT".
Private line: A dedicated telecommunications connection between end-user
locations.
Proportional return traffic: Under the terms of the operating agreements,
the foreign partners are required to deliver to the U.S. carriers the traffic
flowing to the U.S. in the same proportion as the U.S. carriers delivered
U.S.-originated traffic to the foreign carriers.
RBOC (Regional Bell Operating Company): The seven local telephone companies
established by the 1982 agreement between AT&T and the Department of Justice.
Resale: Resale by a provider of telecommunications services of services
sold to it by other providers or carriers on a wholesale basis.
Securities Act: The Securities Act of 1933, as amended.
Switch: Equipment that accepts instructions from a caller in the form of a
telephone number. Like an address on an envelope, the numbers tell the switch
where to route the call. The switch opens or closes circuits or selects the
paths or circuits to be used for transmission of information. Switching is a
process of interconnecting circuits to form a transmission path between users.
Switches allow telecommunications service providers to connect calls directly to
their destination, while providing advanced features and recording connection
information for future billing.
Switched minutes: The number of minutes of telephone traffic carried on a
network using switched access.
Voice telephony: A term used by the EU, defined as the commercial provision
for the public of the direct transport and switching of speech in real-time
between public switched network termination points, enabling any user to use
equipment connected to such a network termination point in order to communicate
with another termination point.
WTO: World Trade Organization.
G-2
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Public Accountants ............................................. F-2
Balance Sheets as of December 31, 1995 and 1996 and June 30, 1997 .................. F-3
Statements of Operations for the years ended December 31, 1994, 1995 and 1996 and
the Six Months ended June 30, 1996 and 1997 ....................................... F-4
Statements of Changes in Stockholders' Deficit for the years ended December 31, 1994,
1995 and 1996 and the Six Months ended June 30, 1997 .............................. F-5
Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 and
the Six Months ended June 30, 1996 and 1997 ....................................... F-6
Notes to Financial Statements ...................................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Startec Global Communications Corporation (formerly Startec, Inc.):
We have audited the accompanying balance sheets of Startec Global
Communications Corporation (a Maryland corporation, formerly Startec, Inc.) as
of December 31, 1995 and 1996, and the related statements of operations, changes
in stockholders' deficit, and cash flows for each of the three years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Startec Global
Communications Corporation, as of December 31, 1995 and 1996, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Washington, D.C.
September 11, 1997
F-2
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
BALANCE SHEETS
AS OF DECEMBER 31, 1995 AND 1996 AND JUNE 30, 1997
<TABLE>
<CAPTION>
JUNE 30,
1995 1996 1997
-------------- --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ....................................... $ 528,198 $ 148,469 $ 2,105,521
Accounts receivable, net of allowance for doubtful accounts
of approximately $457,000, $1,079,000 and $1,576,000 ............ 2,220,755 5,334,183 9,244,023
Accounts receivable, related party .............................. 319,040 78,347 347,809
Other current assets ............................................. 130,449 210,522 230,258
----------- ------------ ------------
Total current assets .......................................... 3,198,442 5,771,521 11,927,611
----------- ------------ ------------
PROPERTY AND EQUIPMENT:
Long distance communications equipment ........................... 906,568 1,773,137 2,225,087
Computer and office equipment .................................... 215,685 392,238 502,251
Less - Accumulated depreciation and amortization .................. (456,527) (789,053) (1,002,778)
----------- ------------ ------------
Total property and equipment, net .............................. 665,726 1,376,322 1,724,560
----------- ------------ ------------
Deferred debt financing and offering costs ........................ - - 433,000
Restricted cash ................................................... 180,000 180,000 180,000
----------- ------------ ------------
Total assets ................................................... $ 4,044,168 $ 7,327,843 $ 14,265,171
=========== ============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable ................................................ $ 4,655,119 $ 7,170,904 $ 11,203,392
Accrued expenses ................................................ 1,279,506 2,858,090 3,338,941
Receivables-based credit facility ................................. 570,446 1,812,437 2,918,888
Capital lease obligations ....................................... 79,100 226,464 356,103
Notes payable to related parties ................................. 58,160 53,160 103,160
Notes payable to individuals and other ........................... 300,000 650,000 1,300,000
----------- ------------ ------------
Total current liabilities ....................................... 6,942,331 12,771,055 19,220,484
----------- ------------ ------------
Capital lease obligations, net of current portion .................. 260,861 545,643 664,878
Notes payable to related parties, net of current portion ......... 100,000 100,000 50,000
Notes payable to individuals and other, net of current portion . - - 44,400
----------- ------------ ------------
Total liabilities ............................................. 7,303,192 13,416,698 19,979,762
----------- ------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT (NOTES 5 AND 12):
Voting common stock, $.01 par value; 10,000,000 shares au-
thorized; 5,380,824 shares issued and outstanding 53,808 53,808 53,808
Nonvoting common stock, $1.00 par value; 25,000 shares au-
thorized; 22,526 shares issued and outstanding 22,526 22,526 22,526
Additional paid-in capital ....................................... 932,276 932,276 1,063,283
Unearned compensation ............................................. - - (108,167)
Accumulated deficit ............................................. (4,267,634) (7,097,465) (6,746,041)
----------- ------------ ------------
Total stockholders' deficit .................................... (3,259,024) (6,088,855) (5,714,591)
----------- ------------ ------------
Total liabilities and stockholders' deficit ..................... $ 4,044,168 $ 7,327,843 $ 14,265,171
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
AND THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------------
1994 1995 1996 1996 1997
------------ ---------------- ---------------- ------------- ---------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues .............................. $5,108,709 $ 10,507,450 $ 32,214,506 $13,206,583 $ 28,836,145
Cost of services ........................ 4,701,262 9,128,609 29,880,629 12,388,348 25,250,492
---------- ------------ ------------ ----------- ------------
Gross margin ........................... 407,447 1,378,841 2,333,877 818,235 3,585,653
General and administrative expenses ...... 1,159,382 2,169,946 3,995,966 1,372,624 2,461,406
Selling and marketing expenses ............ 91,062 183,927 514,298 153,650 305,537
Depreciation and amortization ............ 90,069 137,019 332,526 144,442 213,725
---------- ------------ ------------ ----------- ------------
Income (loss) from operations ............ (933,066) (1,112,051) (2,508,913) (852,481) 604,985
Interest expense ........................ 70,015 115,713 336,887 118,395 251,743
Interest income ........................... 24,244 21,750 15,969 8,649 5,405
---------- ------------ ------------ ----------- ------------
Income (loss) before
income tax provision .................. (978,837) (1,206,014) (2,829,831) (962,227) 358,647
Income tax provision ..................... - - - - (7,223)
---------- ------------ ------------ ----------- ------------
Net (loss) income ........................ $ (978,837) $ (1,206,014) $ (2,829,831) $ (962,227) $ 351,424
========== ============ ============ =========== ============
Net (loss) income per common and equiv-
alent share .............................. $ (0.20) $ (0.21) $ (0.49) $ (0.17) $ 0.06
========== ============ ============ =========== ============
Weighted average common and equivalent
shares outstanding ........................ 4,988,837 5,709,720 5,795,961 5,795,961 5,795,961
========== ============ ============ =========== ============
Pro forma net (loss) income per common
and equivalent share (unaudited) ......... $ (0.43) $ (0.14) $ 0.08
============ =========== ============
Pro forma weighted average common
and equivalent shares outstanding
(unaudited) .............................. 6,028,903 6,028,903 6,028,903
============ ========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND THE SIX MONTHS ENDED
JUNE 30, 1997
<TABLE>
<CAPTION>
VOTING NONVOTING
COMMON STOCK COMMON STOCK
--------------------- ------------------
SHARES AMOUNT SHARES AMOUNT
----------- --------- -------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1993 .............................. 4,573,700 $45,737 22,526 $22,526
Net loss ............................................. - - - -
--------- ------- ------ -------
Balance, December 31, 1994 .............................. 4,573,700 45,737 22,526 22,526
Net loss ............................................. - - - -
Issuance of common stock .............................. 807,124 8,071 - -
--------- ------- ------ -------
Balance, December 31, 1995 .............................. 5,380,824 53,808 22,526 22,526
Net loss ............................................. - - - -
--------- ------- ------ -------
Balance, December 31, 1996 .............................. 5,380,824 53,808 22,526 22,526
Net income (unaudited) ................................. - - - -
Unearned compensation pursuant to issuance of stock
options (unaudited) .................................... - - - -
Amortization of unearned compensation (unaudited) ...... - - - -
--------- ------- ------ -------
Balance, June 30, 1997 (unaudited) ..................... 5,380,824 $53,808 22,526 $22,526
========= ======= ====== =======
<CAPTION>
ADDITIONAL
PAID-IN UNEARNED ACCUMULATED
CAPITAL COMPENSATION DEFICIT TOTAL
------------ -------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Balance, December 31, 1993 .............................. $ 190,347 $ - $ (2,082,783) $ (1,824,173)
Net loss ............................................. - - (978,837) (978,837)
---------- ---------- ------------ ------------
Balance, December 31, 1994 .............................. 190,347 - (3,061,620) (2,803,010)
Net loss ............................................. - - (1,206,014) (1,206,014)
Issuance of common stock .............................. 741,929 - - 750,000
---------- ---------- ------------ ------------
Balance, December 31, 1995 .............................. 932,276 - (4,267,634) (3,259,024)
Net loss ............................................. - - (2,829,831) (2,829,831)
---------- ---------- ------------ ------------
Balance, December 31, 1996 .............................. 932,276 - (7,097,465) (6,088,855)
Net income (unaudited) ................................. - - 351,424 351,424
Unearned compensation pursuant to issuance of stock
options (unaudited) .................................... 131,007 (131,007) - -
Amortization of unearned compensation (unaudited) ...... - 22,840 - 22,840
---------- ---------- ------------ ------------
Balance, June 30, 1997 (unaudited) ..................... $1,063,283 $ (108,167) $ (6,746,041) $ (5,714,591)
========== ========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
AND THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997
<TABLE>
<CAPTION>
1994 1995
--------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) .............................. $ (978,837) $ (1,206,014)
Adjustments to net loss-
Depreciation and amortization ............... 90,069 137,019
Compensation pursuant to stock options ...... - -
Changes in operating assets and liabilities:
Accounts receivable ........................ (417,055) (1,342,047)
Accounts receivable, related party ......... (273,145) (45,895)
Other current assets ........................ (16,678) (83,532)
Accounts payable ........................... 1,421,249 1,135,137
Accrued expenses ........................... 98,624 637,084
----------- ------------
Net cash (used in) provided by operating
activities .............................. (75,773) (768,248)
----------- ------------
INVESTING ACTIVITIES:
Purchases of property and equipment ............ (44,258) (199,526)
----------- ------------
FINANCING ACTIVITIES:
Net borrowings under receivables-based credit
facility .................................... - 570,446
Repayments under capital lease obligations ... (102,158) (96,680)
Borrowings under notes payable to related par-
ties 49,999 -
Repayments under notes payable to related par-
ties - -
Borrowings under notes payable to individuals
and other .................................... 235,000 50,000
Repayments under notes payable to individuals
and other .................................... - (35,000)
Proceeds from issuance of voting common stock - 750,000
----------- ------------
Net cash provided by financing activities 182,841 1,238,766
----------- ------------
Net increase (decrease) in cash and cash
equivalents .............................. 62,810 270,992
Cash and cash equivalents at the begin-
ning of the period 194,396 257,206
----------- ------------
Cash and cash equivalents at the end of
the period .............................. $ 257,206 $ 528,198
=========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ................................. $ 62,526 $ 87,046
=========== ============
Income taxes paid .............................. $ - $ -
=========== ============
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Equipment acquired under capital lease ......... $ 53,944 $ 285,230
=========== ============
Deferred debt financing and offering costs not
paid .......................................... $ - $ -
=========== ============
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------------------
1996 1996 1997
---------------- --------------- ---------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) .............................. $ (2,829,831) $ (962,227) $ 351,424
Adjustments to net loss-
Depreciation and amortization ............... 332,526 144,442 213,725
Compensation pursuant to stock options ...... - - 22,840
Changes in operating assets and liabilities:
Accounts receivable ........................ (3,113,428) (3,545,778) (3,909,840)
Accounts receivable, related party ......... 240,693 (326,212) (269,462)
Other current assets ........................ (80,073) (59,179) (19,736)
Accounts payable ........................... 2,515,785 4,236,681 4,032,488
Accrued expenses ........................... 1,578,584 373,424 92,251
------------ ------------ ------------
Net cash (used in) provided by operating
activities .............................. (1,355,744) (138,849) 513,690
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment ............ (519,519) (258,089) (184,061)
------------ ------------ ------------
FINANCING ACTIVITIES:
Net borrowings under receivables-based credit
facility .................................... 1,241,991 342,370 1,106,451
Repayments under capital lease obligations ... (91,457) (65,883) (129,028)
Borrowings under notes payable to related par-
ties - - -
Repayments under notes payable to related par-
ties (5,000) (5,000) -
Borrowings under notes payable to individuals
and other .................................... 475,000 - 650,000
Repayments under notes payable to individuals
and other .................................... (125,000) - -
Proceeds from issuance of voting common stock - - -
------------ ------------ ------------
Net cash provided by financing activities 1,495,534 271,487 1,627,423
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents .............................. (379,729) (125,451) 1,957,052
Cash and cash equivalents at the begin-
ning of the period 528,198 528,198 148,469
------------ ------------ ------------
Cash and cash equivalents at the end of
the period .............................. $ 148,469 $ 402,747 $ 2,105,521
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ................................. $ 296,926 $ 115,668 $ 269,933
============ ============ ============
Income taxes paid .............................. $ - $ - $ -
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Equipment acquired under capital lease ......... $ 523,603 $ 425,368 $ 377,902
============ ============ ============
Deferred debt financing and offering costs not
paid .......................................... $ - $ - $ 433,000
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1997 AND FOR THE
SIX MONTHS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
1. BUSINESS DESCRIPTION:
ORGANIZATION
Startec Global Communications Corporation (the "Company", formerly Startec,
Inc.), is a Maryland corporation founded in 1989 to provide long-distance
telephone services. The Company currently offers U.S.-originated long-distance
service to residential and carrier customers through foreign termination
arrangements. The Company's marketing targets specific ethnic residential market
segments in the United States that are most likely to seek low-cost
international long-distance service to specific and identifiable country
markets. The Company is headquartered in Bethesda, Maryland.
RISKS AND OTHER IMPORTANT FACTORS
For each of the three years in the period ending December 31, 1996, the
Company's operations have generated a net loss and negative operating cash
flows. As of June 30, 1997, the Company had a deficit in working capital of
approximately $7,293,000, and total liabilities exceeded total assets by
approximately $5,715,000. As more fully described in Note 12, on July 1, 1997,
the Company entered into a credit facility with a bank. The credit facility
provides for maximum borrowings of up to $10 million through December 31, 1997,
and the lesser of $15 million or 85 percent of eligible accounts receivable, as
defined, thereafter until maturity in December 1999. The Company will require
significant additional capital to finance its expansion plans. There can be no
assurance that the Company will be successful in raising additional capital.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, dependence on
operating agreements with foreign partners, significant foreign and U.S.-based
customers and suppliers, availability of transmission facilities, U.S. and
foreign regulations, international economic and political instability,
dependence on effective billing and information systems, customer attrition, and
rapid technological change. Many of the Company's competitors are significantly
larger and have substantially greater financial, technical, and marketing
resources than the Company; employ larger networks and control transmission
lines; offer a broader portfolio of services; have stronger name recognition and
loyalty; and have long-standing relationships with the Company's target
customers. In addition, many of the Company's competitors enjoy economies of
scale that can result in a lower cost structure for transmission and related
costs, which could cause significant pricing pressures within the long-distance
telecommunications industry. If the Company's competitors were to devote
significant additional resources to the provision of international long-distance
services to the Company's target customer base, the Company's business,
financial condition, and results of operations could be materially adversely
affected.
In the United States, the Federal Communications Commission ("FCC") and
relevant state Public Service Commissions have the authority to regulate
interstate and intrastate telephone service rates, respectively, ownership of
transmission facilities, and the terms and conditions under which the Company's
services are provided. Legislation that substantially revised the U.S.
Communications Act of 1934 was signed into law on February 8, 1996. This
legislation has specific guidelines under which the Regional Bell Operating
Companies ("RBOCs") can provide long-distance services, which will permit the
RBOCs to compete with the Company in providing domestic and international
long-distance services. Further, the legislation, among other things, opens
local service markets to competition from any entity (including long-distance
carriers, such as AT&T, cable television companies and utilities).
F-7
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Because the legislation opens the Company's markets to additional
competition, particularly from the RBOCs, the Company's ability to compete may
be adversely affected. Moreover, certain Federal and other governmental
regulations may be amended or modified, and any such amendment or modification
could have material adverse effects on the Company's business, results of
operations, and financial condition.
2. SIGNIFICANT ACCOUNTING PRINCIPLES:
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The interim financial data as of June 30, 1997 and for the six-month
periods ended June 30, 1996 and 1997 has been prepared by the Company, without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC") and include, in the opinion of management, all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
interim periods results. The results of operations for the six months ended June
30, 1997 are not necessarily indicative of the results to be expected for the
full year.
REVENUE RECOGNITION
Revenues for telecommunication services provided to customers are
recognized as services are rendered, net of an allowance for revenue that the
Company estimates will ultimately not be realized. Revenues for return traffic
received according to the terms of the Company's operating agreements with its
foreign partners are recognized as revenue as the return traffic is received and
processed.
The Company has entered into operating agreements with telecommunications
carriers in foreign countries under which international long-distance traffic is
both delivered and received. Under these agreements, the foreign carriers are
contractually obligated to adhere to the policy of the FCC, whereby traffic from
the foreign country is routed to international carriers, such as the Company, in
the same proportion as traffic carried into the country. Mutually exchanged
traffic between the Company and foreign carriers is settled through a formal
settlement policy at agreed upon rates per-minute. The Company records the
amount due to the foreign partner as an expense in the period the traffic is
terminated. When the return traffic is received in the future period, the
Company generally realizes a higher gross margin on the return traffic compared
to the lower margin (or sometimes negative margin) on the outbound traffic.
Revenue recognized from return traffic was approximately $174,000, $1,959,000,
and $1,121,000 or 3 percent, 19 percent, and 3 percent of net revenues in 1994,
1995, and 1996, and $490,000 and $994,000 or 4 and 3 percent of net revenues in
the six-month periods ended June 30, 1996 and 1997, respectively. There can be
no assurance that traffic will be delivered back to the United States or what
impact changes in future settlement rates, allocations among carriers or levels
of traffic will have on net payments made and revenues received and recorded by
the Company.
COST OF SERVICES
Cost of services represents direct charges from vendors that the Company
incurs to deliver service to its customers. These include costs of leasing
capacity and rate-per-minute charges from carriers that originate, transmit, and
terminate traffic on behalf of the Company. See Note 4 for further discussion.
F-8
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers all short-term investments with original maturities
of 90 days or less to be cash equivalents. Cash equivalents consist primarily of
money market accounts that are available on demand. The carrying amount reported
in the accompanying balance sheets approximates fair value.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for current assets and current liabilities, other than
the current portion of notes payable to related parties and individuals and
other, approximate their fair value due to their short maturity. The carrying
value of the receivables based credit facility approximates fair value, since it
bears interest at a variable rate which reprices frequently. The carrying value
of restricted cash approximates fair value plus accrued interest. The fair value
of notes payable to individuals and other and notes payable to related parties
cannot be reasonably and practicably estimated due to the unique nature of the
related underlying transactions and terms (Note 7). However, given the terms and
conditions of these instruments, if these financial instruments were with
unrelated parties, interest rates and payment terms could be substantially
different than the currently stated rates and terms. These notes were paid in
full subsequent to June 30, 1997 (Note 12).
LONG-LIVED ASSETS
Long-lived assets and identifiable assets to be held and used are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount should be addressed. Impairment is measured by comparing the
carrying value to the estimated undiscounted future cash flows expected to
result from the use of the assets and their eventual dispositions. The Company
considers expected cash flows and estimated future operating results, trends,
and other available information in assessing whether the carrying value of the
assets is impaired.
The Company's estimates of anticipated gross revenues, the remaining
estimated lives of tangible and intangible assets, or both, could be reduced
significantly in the future due to changes in technology, regulation, available
financing, or competitive pressures (see Note 1). As a result, the carrying
amount of long-lived assets could be reduced materially in the future.
PROPERTY AND EQUIPMENT
Property and equipment are stated at historical cost. Depreciation is
provided for financial reporting purposes using the straight line method over
the following estimated useful lives:
<TABLE>
<S> <C>
Long-distance communications equipment ...... 7 years
Computer and office equipment ............... 3 to 5 years
</TABLE>
Long-distance communications equipment includes assets financed under
capital lease obligations of approximately $763,000, $1,287,000, and $1,665,000
at December 31, 1995 and 1996, and June 30, 1997, respectively. Accumulated
depreciation on these assets as of December 31, 1995 and 1996, and June 30,
1997, was approximately $403,000, $587,000, and $667,000, respectively.
Maintenance and repairs are expensed as incurred. Replacements and
betterments are capitalized. The cost and related accumulated depreciation of
assets sold or retired are removed from the balance sheet, and any resulting
gain or loss is reflected in the statement of operations.
CONCENTRATIONS OF RISK
Financial instruments that potentially subject the Company to a
concentration of credit risk are accounts receivable. Residential accounts
receivable consist of individually small amounts due from geographically
dispersed customers. Carrier accounts receivable represent amounts due from
second-tier
F-9
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
long-distance carriers. The Company's allowance for doubtful accounts is based
on current market conditions. The Company's four largest carrier customers
represented 35 and 22 percent of gross accounts receivable as of December 31,
1996, and June 30, 1997, respectively. Revenues from several customers
represented more than 10 percent of net revenues for the periods presented (see
Note 10). Including charges in dispute (see Note 4), purchases from the five
largest suppliers represented 67 and 47 percent of cost of services in the year
ended December 31, 1996, and the six month period ended June 30, 1997,
respectively. Services purchased from several suppliers represented more than 10
percent of cost of services in the periods presented (see Note 10). One of these
suppliers, representing 25 and 13 percent of cost of services in the year ended
December 31, 1996, and the six-month period ended June 30, 1997, respectively,
is based in a foreign country.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes."
SFAS No. 109 requires that deferred income taxes reflect the expected tax
consequences on future years of differences between the tax bases of assets and
liabilities and their bases for financial reporting purposes. Valuation
allowances are established when necessary to reduce deferred tax assets to the
estimated amount to be realized.
NET (LOSS) INCOME PER COMMON AND EQUIVALENT SHARE
Net loss per common share for the years ended December 31, 1994, 1995 and
1996, and for the six-month period ended June 30, 1996, is based upon the
weighted-average number of common shares outstanding during the period. The
effect of outstanding options on net loss per common share is not included for
these periods because such options would be antidilutive. Net income per common
share for the six-month period ended June 30, 1997 is based upon the
weighted-average number of common and common equivalent shares outstanding
during the period, using the treasury stock method. Fully diluted net (loss)
income per share is not presented as it would not materially differ from the
amounts stated.
Pursuant to the requirements of the Securities and Exchange Commission
under Staff Accounting Bulletin ("SAB") No. 83 , common stock and stock rights
issued by the Company during the 12 months immediately preceding an anticipated
initial public offering (the "Offering") have been included in the calculation
of the shares used in computing net (loss) income per common share as if such
shares had been outstanding the entire period for periods prior to the Offering.
Pro forma net income (loss) per share gives effect to the anticipated
repayment of $2,500,000 in debt with proceeds from the Offering and has been
computed by dividing pro forma net income (loss), after adjustment for
applicable interest expense, by the pro forma weighted average common shares
outstanding. The pro forma weighted average common shares outstanding has been
adjusted for the estimated number of shares that the Company would need to issue
to repay debt.
In 1997, the Financial Accounting Standards Board released Statement No.
128, "Earnings Per Share." Statement 128 requires dual presentation of basic and
diluted earnings per share on the face of the income statement for all periods
presented. Basic earnings per share excludes dilution and is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
Diluted earnings per share is computed similarly to fully diluted earnings per
share pursuant to Accounting Principles Bulletin No. 15. Statement 128 is
effective for fiscal periods ending after December 15, 1997, and when adopted,
it will require restatement of prior periods' earnings per share.
F-10
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
As discussed above, SAB 83 requires an entity involved in an initial public
offering to treat those potentially dilutive common shares as outstanding common
shares in the computation of both basic and diluted net (loss) income per share
for all reported periods. Accordingly, management anticipates that Statement 128
will not have a material impact upon reported net (loss) income per share.
3. ACCOUNTS RECEIVABLE:
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------ ---------------
1995 1996 1997
------------ --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
Residential ........................... $2,605,958 $ 3,840,707 $ 5,906,036
Carrier .............................. 71,826 2,572,954 4,913,833
---------- ------------ ------------
2,677,784 6,413,661 10,819,869
Allowance for doubtful accounts ...... (457,029) (1,079,478) (1,575,846)
---------- ------------ ------------
$2,220,755 $ 5,334,183 $ 9,244,023
========== ============ ============
</TABLE>
The Company has certain service providers that are also customers. The
Company carries and settles amounts receivable and payable from and to certain
of these parties on a net basis.
Approximately $1,195,000, $3,428,000, and $5,502,000 of retail receivables
as of December 31, 1995 and 1996, and June 30, 1997, respectively, were pledged
as security under the receivable credit facility agreement discussed in Note 6.
4. ACCRUED EXPENSES:
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
--------------------------- ------------
1995 1996 1997
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
Disputed vendor obligations .................. $ 642,515 $2,056,957 $2,124,228
Accrued payroll and related taxes ............ 348,545 368,266 365,978
Accrued debt financing and offering costs ...... - - 433,000
Accrued excise taxes and related charges ...... 197,993 182,286 182,439
Accrued interest .............................. 47,960 87,921 69,731
Other .......................................... 42,493 162,660 163,565
----------- ----------- -----------
$1,279,506 $2,858,090 $3,338,941
=========== =========== ===========
</TABLE>
Disputed vendor obligations represent an assertion from one of the
Company's foreign carriers for minutes processed that are in excess of the
Company's records. The Company has accrued approximately $643,000, $1,414,000,
and $67,000 in the years ended December 31, 1995 and 1996, and the six-month
period ended June 30, 1997, respectively, related to disputed minutes for which
the Company has not recognized any corresponding revenue. If the Company
prevails in its dispute, these amounts or portions thereof would be credited to
operations in the period of resolution. Conversely, if the Company does not
prevail in its dispute, these amounts or portions thereof would be paid in cash.
F-11
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
5. STOCK AND STOCK RIGHTS:
As of June 30, 1997, the Company had 5,380,824 shares of voting common
stock issued and outstanding and 22,526 shares of nonvoting common stock issued
and outstanding. For 17,175 shares of outstanding nonvoting common stock, the
Company has agreed to exchange one share of its authorized voting common stock
for each presently outstanding share of nonvoting common stock. As of July 29,
1997, the Company has agreed to purchase 5,351 shares of outstanding nonvoting
common stock from a former officer and director of the Company for $45,269.
STOCK OPTION PLAN
The Company has elected to account for stock and stock rights in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25") and its related interpretations. In October 1995, the
Financial Accounting Standards Board issued SFAS No. 123, "Accounting for
Stock-Based Compensation," which established an alternative method of expense
recognition for stock-based compensation awards to employees based on fair
values. The Company has elected not to adopt SFAS No. 123 for expense
recognition purposes.
The Company maintains a stock option plan, reserving 270,000 shares of
voting common stock to be issued to officers and key employees under terms and
conditions to be set by the Company's Board of Directors. Options granted under
this plan may be exercised only upon the occurrence of any of the following
events: (i) a sale of more than 50 percent of the issued and outstanding shares
of stock in one transaction, (ii) a dissolution or liquidation of the Company,
(iii) a merger or consolidation in which the Company is not the surviving
corporation, (iv) a filing by the Company of an effective registration statement
under the Securities Act of 1933, as amended, or (v) the seventh anniversary of
the date of full-time employment.
Pursuant to APB No. 25, compensation expense is recognized for financial
reporting purposes when it becomes probable that the options will be
exercisable. The amount of compensation expense that will be recognized is
determined by the excess of the fair value of the common stock over the exercise
price of the related option at the measurement date.
Pro forma information regarding net income is required by SFAS No. 123 and
has been determined as if the Company had accounted for its employee stock
options under the fair value method prescribed by SFAS No. 123. The fair value
of options granted in the year ended December 31, 1995, and the six-month period
ended June 30, 1997, was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions: risk-free
interest rates of 5.4 percent and 6.17 percent; no dividend yield;
weighted-average expected lives of the options of five years, and expected
volatility of 50 percent. There were no options granted in 1996.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
characteristics that are significantly different from those of traded options.
Because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
The weighted-average fair value of options granted during the year ended
December 31, 1995, and the six-month period ended June 30, 1997, was $0.34 and
$1.04, respectively. For purposes of pro forma disclosures, the estimated fair
value of the options is amortized to expense over the estimated service period.
If the Company had used the fair value accounting provisions of SFAS No. 123,
the pro forma net loss for 1995 and 1996 would have been $1,208,714 and
$2,832,531, respectively, or $0.21 and $0.49 per share, respectively, and net
income for the six months ended June 30, 1997 would have been $323,283, or $0.06
per share.
F-12
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
A summary of the Company's stock option activity and related information,
is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------- SIX MONTHS ENDED
1994 1995 1996 JUNE 30, 1997
---------------------- --------------------- ---------------------- ------------------------
(UNAUDITED)
WEIGHTED- WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ----------- --------- ----------- ---------- ----------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of period ...... 75,000 $ 0.30 103,200 $ 0.30 143,200 $ 0.38 138,300 $ 0.38
Granted .................. 32,700 0.30 40,000 0.60 - - 269,966 1.44
Exercised .................. - - - - - - -
Forfeited .................. (4,500) 0.30 - - (4,900) 0.36 (138,500) 0.38
------- ------- -------- ------- ------- ------- --------- -------
Options outstanding at end
of period ............... 103,200 $ 0.30 143,200 $ 0.38 138,300 $ 0.38 269,766 $ 1.44
======= ======= ======== ======= ======= ======= ========= =======
Options exercisable at end
of period ............... - - - -
======= ======== ======= =========
</TABLE>
Exercise prices for options outstanding as of June 30, 1997, are as
follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------------------------
WEIGHTED-AVERAGE
REMAINING WEIGHTED-
RANGE OF NUMBER OUTSTANDING CONTRACTUAL LIFE AVERAGE
EXERCISE PRICES AS OF JUNE 30, 1997 IN YEARS EXERCISE PRICE
- ------------------------- --------------------- ------------------ ---------------
<S> <C> <C> <C>
$0.30 -- 0.30 39,300 9.56 $ 0.30
0.60 -- 0.60 39,000 9.56 0.60
1.85 -- 1.85 191,466 9.56 1.85
------------------------ -------- ---- -------
$0.30 -- 1.85 269,766 9.56 $ 1.44
======================== ======== ==== =======
</TABLE>
The Company amended its stock option plan as of January 20, 1997 to provide
that options may be exercised on or after the seventh anniversary of the date of
full time employment, in addition to other events discussed above. In
conjunction with this amendment, all options outstanding were cancelled, and
certain options were reissued at their original exercise prices. Pursuant to APB
No. 25, the Company recognizes compensation expense for the excess of the fair
market value of the common stock over the exercise price of the related option
at the date of grant. The Company recognized $22,840 in compensation expense for
the six-month period ended June 30, 1997, and expects to recognize approximately
$108,167 over the remaining term of the options, subject to accelerated vesting
in the event of a public offering or a change in control.
SHAREHOLDER AND MANAGEMENT AGREEMENTS
In 1995, the Company issued 807,124 shares of voting common stock for
$750,000. In connection with this transaction, the Company executed a
Subscription Agreement ("Shareholder Agreement") and a Management Participation
Agreement ("Management Agreement"). Among other provisions, the Shareholder
Agreement provides the investor certain antidilution provisions and a right of
first refusal as to any shares offered for sale, at the offering price. Further,
with certain exceptions, the Company's primary shareholder may not sell,
transfer, or assign any shares unless they are first offered to the investor;
and under certain circumstances, if the investor declines to purchase the shares
offered, such shares may not be sold to any third party unless such third party
also offers to purchase all of the investor's shares at the same price.
F-13
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The Management Agreement contains several covenants that provide the
investor protection with respect to dilution, nonroutine changes in the Articles
of Incorporation or Bylaws, and the declaration of dividends.
The provisions of the Shareholder Agreement and the Management Agreement
expire upon the earlier of a public offering under the Securities Act of 1933,
as amended, or the sale or other transfer of 50 percent or more of the shares
owned by the investor.
6. BILLING ARRANGEMENT AND RECEIVABLES BASED CREDIT FACILITY:
The Company has a billing and information management services agreement
with a third party, which provides for its residential customers to be billed
directly by their local exchange carrier. The third party receives collections
from the local exchange carrier and submits these funds to the Company, after
withholding processing fees, applicable taxes, and provisions for credits and
uncollectible accounts.
The Company has an advanced payment agreement with this third party, which
allows the Company to take advances against 70 percent of all records submitted
for billing. Advances are secured by the receivables involved. The credit limit
under the advanced payment agreement was $3,000,000 as of June 30, 1997. The
agreement provides for interest at the prime rate (8.5 percent at June 30, 1997)
plus 4 percent.
7. NOTES PAYABLE TO RELATED PARTIES AND NOTES PAYABLE TO INDIVIDUAL AND OTHER:
NOTES PAYABLE TO RELATED PARTIES
Notes payable to related parties consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------- ------------
1995 1996 1997
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Notes payable to parties related to the primary shareholder and
president of the Company, bearing interest at rates ranging from
15 to 25 percent ............................................. $158,160 $153,160 $ 153,160
Less - Current portion ....................................... (58,160) (53,160) (103,160)
--------- --------- ----------
$100,000 $100,000 $ 50,000
========= ========= ==========
</TABLE>
NOTES PAYABLE TO INDIVIDUALS AND OTHER
Notes payable to individuals and other consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
--------------------------- ---------------
1995 1996 1997
------------- ------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
Notes payable to various parties, bearing interest at rates ranging from
15 to 33.3 percent at December 31, 1995, and from 15 to 25 percent
at December 31, 1996 and June 30, 1997, all due within one year ...... $ 300,000 $ 650,000 $ 800,000
Note payable to an individual, non-interest bearing, convertible into
24,000 shares of voting common stock upon the earlier of the com-
pletion of a public offering or maturity in 1999........................ - - 44,400
Note payable to a bank, bearing interest at the prime rate plus 2 per-
cent. Subsequent to period-end, this note was refinanced with the
credit facility described in Note 12. ................................. - - 500,000
---------- ---------- ------------
300,000 650,000 1,344,400
Less-current portion ................................................... (300,000) (650,000) (1,300,000)
---------- ---------- ------------
$ - $ - $ 44,400
========== ========== ============
</TABLE>
F-14
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The aggregate maturities of notes payable to related parties and notes
payable to individuals and other are as follows as of December 31, 1996:
<TABLE>
<CAPTION>
YEAR ENDING RELATED INDIVIDUALS
DECEMBER 31, PARTIES AND OTHER
- ------------------------- ---------- ------------
<S> <C> <C>
1997 $ 53,160 $650,000
1998 50,000 -
1999 50,000 -
--------- ---------
$153,160 $650,000
========= =========
</TABLE>
8. COMMITMENTS AND CONTINGENCIES:
LEASES
The Company leases office space and equipment under noncancelable operating
leases. Rent expense was approximately $63,000, $94,000, and $97,000 for the
years ended December 31, 1994, 1995, and 1996, and $47,000 and $65,000 for the
six-month periods ended June 30, 1996 and 1997, respectively. The terms of the
office lease require the Company to pay a proportionate share of real estate
taxes and operating expenses. As discussed in Note 2, the Company also leases
equipment under capital lease obligations. The future minimum commitments under
lease obligations are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR ENDING DECEMBER 31, LEASES LEASES
- -------------------------------------------------- ------------- ----------
<S> <C> <C>
1997 ....................................... $ 318,913 $154,219
1998 ....................................... 305,443 165,025
1999 ....................................... 283,376 140,710
2000 ....................................... 59,225 -
2001 ....................................... 12,586 -
---------- ---------
979,543 $459,954
=========
Less -- Amounts representing interest ...... (207,436)
Less -- Current portion ..................... (226,464)
----------
$ 545,643
==========
</TABLE>
LEASE WITH RELATED PARTY
The Company has entered into an agreement with an affiliate of a
shareholder to lease capacity in certain undersea fiber optic cable. The
agreement grants a perpetual right to use the cable and requires ten semiannual
payments of $38,330 beginning on June 30, 1996. The Company has recorded $76,660
in accounts payable as of June 30, 1997, related to this agreement. Unpaid
amounts bear interest at the 180-day LIBOR rate, plus one quarter percent.
The Company is required to pay a proportional share of the cost of
operating and maintaining the cable. The Company can cancel this agreement
without further obligation, except for amounts related to past usage, at any
time.
F-15
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
RESTRICTED CASH
The Company was required to provide a bank guarantee of $180,000 in
connection with one of its foreign operating agreements. This guarantee is in
the form of a certificate of deposit and is shown as restricted cash in the
accompanying balance sheets.
PROFESSIONAL SERVICES AND CONSULTING AGREEMENTS
The Company has arrangements with its legal counsel and investment bankers
to represent the Company in a proposed public offering of the Company's common
stock. These arrangements for professional services and other expenses commit
the Company to costs of up to $300,000 in the event that such an offering is not
successful.
The Company has agreed to issue warrants to acquire 150,000 shares of
common stock to its investment bankers at the close of the Offering. The
warrants will have a five-year term, will vest after one year, and will have an
exercise price of 110 percent of the Offering price. The warrants will include
certain anti-dilution provisions.
The Company has a consulting agreement with an individual who will serve as
an agent for the Company in a foreign country. Under the agreement, the Company
will pay a total of $90,000 over a three-year period, commencing March 1, 1997.
In addition, the Company will pay other office facilities and general expenses
approximating $12,000 per year.
LITIGATION
Certain claims and suits have been filed or are pending against the
Company. In management's opinion, resolution of these matters will not have a
material impact on the Company's financial position or results of operations and
adequate provision for any potential losses has been made in the accompanying
financial statements.
9. RELATED-PARTY TRANSACTIONS:
The Company has an agreement with an affiliate of a shareholder of the
Company that calls for the purchase and sale of long distance services. Revenues
generated from this affiliate amounted to approximately $625,000, $1,035,000,
and $1,501,000, or 12 percent, 10 percent, and 5 percent of total revenues for
the years ended December 31, 1994, 1995, and 1996, and $717,000 and $1,159,000,
or 5 and 4 percent of total revenues for the six-month periods ended June 30,
1996 and 1997, respectively. The Company was in a net account receivable
position with this affiliate of approximately $152,000, $14,000, and $336,000 as
of December 31, 1995 and 1996, and June 30, 1997, respectively. Services
provided by this affiliate and recognized in cost of services amounted to
approximately $134,000 and $663,000 for the years ended December 31, 1995 and
1996, and $122,000 and $495,000 for the six-month periods ended June 30, 1996
and 1997, respectively. There were no services purchased from this affiliate in
1994.
The Company provided long-distance services to an affiliated entity owned
by the primary shareholder and president of the Company. In the opinion of
management, these services were provided on standard commercial terms. The
affiliate provided long-distance services to customers in certain foreign
countries. Payments received by the Company from this affiliate amounted to
approximately $396,000 and $262,000 for the years ended December 31, 1995 and
1996, respectively, and $52,000 for the six month period ended June 30, 1997.
The affiliate was unable to collect approximately $150,000 and $95,000 from its
residential customers in the years ended December 31, 1995 and 1996,
respectively. Accounts receivable from this affiliated entity were approximately
$167,000 as of December 31, 1995, $64,000 as of December 31, 1996, and $12,000
as of June 30, 1997, respectively. There was no activity related to this entity
for the year ended December 31, 1994.
F-16
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The Company has notes payable from parties related to the primary
shareholder and president of the Company (see Note 7) and a lease with an
affiliate of a shareholder of the Company (see Note 8).
10. SEGMENT DATA AND SIGNIFICANT CUSTOMERS AND SUPPLIERS:
SEGMENT DATA
The Company classifies its operations into one industry segment,
telecommunications services. Substantially all of the Company's revenues for
each period presented were derived from calls terminated outside the United
States.
Net revenues terminated by geographic area were as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------- ----------------------------
1994 1995 1996 1996 1997
------------ ------------- ------------- ------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Asia/Pacific Rim ............... $4,187,799 $ 6,970,140 $13,823,875 $ 7,152,989 $12,083,360
Middle East/North Africa ...... 136,419 693,948 8,276,205 2,613,998 8,090,191
Sub-Saharan Africa ............ 18,521 34,400 1,135,695 279,728 2,370,960
Eastern Europe ............... 25,562 316,470 2,649,759 913,099 2,848,335
Western Europe .................. 617,255 1,647,446 1,782,435 615,951 903,826
North America .................. 110,643 493,811 3,718,172 1,433,128 1,558,848
Other ........................... 12,510 351,235 828,365 197,690 980,625
----------- ------------ ------------ ------------ ------------
$5,108,709 $10,507,450 $32,214,506 $13,206,583 $28,836,145
=========== ============ ============ ============ ============
</TABLE>
SIGNIFICANT CUSTOMERS
A significant portion of the Company's revenues is derived from a limited
number of customers. During 1996, the Company's five largest carrier customers
accounted for approximately 40% of the Company's net revenues, with one carrier
customer accounting for approximately 23% of net revenues during that year. In
addition, during the six-month period ended June 30, 1997, the Company's five
largest carrier customers accounted for approximately 41% of net revenues, with
one carrier customer accounting for approximately 27% during the period. The
Company's agreements and arrangements with its carrier customers generally may
be terminated on short notice without penalty. The following customers provided
10 percent or more of the Company's net revenues:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------- ----------------------------
1994 1995 1996 1996 1997
---------- ------------ ------------ ------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Videsh Sanchar Nigam Limited
(foreign) ............... $ * $1,958,827 $ * $ * $ *
Companhia Sao Tomense (relat-
ed party) ................ 624,613 * * * *
WorldCom, Inc. ............ 564,345 * 7,383,218 2,921,150 7,694,384
</TABLE>
- ----------
* Revenue provided was less than 10 percent of total revenues for the period.
F-17
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
SIGNIFICANT SUPPLIERS
A significant portion of the Company's cost of services is purchased from a
limited number of suppliers. The following suppliers provided 10 percent or more
of the Company's cost of services:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------ ----------------------------
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Videsh Sanchar Nigam Limited ("VSNL")
(foreign) ........................ $3,733,464 $7,154,552 $7,524,983 $2,898,939 $3,404,664
Cherry Communications ............... * * 3,896,555 3,327,605 *
WorldCom, Inc. ..................... * * 3,971,654 1,351,906 3,774,134
Teleglobe, Inc. ..................... * * * 1,255,757 *
</TABLE>
- ----------
* Cost of services provided was less than 10 percent of total cost of sales
for the period.
The cost of services attributable to VSNL include charges that are in
dispute, as discussed in Note 4. VSNL is a government-owned, foreign carrier
that has a monopoly on telephone service in that country.
11. INCOME TAXES:
The Company has net operating loss ("NOLS") carryforwards for Federal
income tax purposes of approximately $2,564,000 and $2,248,000, as of December
31, 1996 and June 30, 1997, respectively, which may be applied against future
taxable income and expire in years 2005 through 2011. The Company utilized a
portion of these NOLs to partially offset its taxable income for the six months
ended June 30, 1997. The use of the NOLs is subject to statutory and regulatory
limitations regarding changes in ownership. SFAS No. 109 requires that the tax
benefit of NOLs for financial reporting purposes be recorded as an asset to the
extent that management assesses the realization of such deferred tax assets is
"more likely than not." A valuation reserve is established for any deferred tax
assets that are not expected to be realized.
As a result of historical operating losses and the fact that the Company
has a limited operating history, a valuation allowance equal to the deferred tax
asset was recorded for all periods presented, which resulted in no tax benefit
being realized during any period.
The tax effect of significant temporary differences, which comprise the
deferred tax assets and liabilities, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------- JUNE 30,
1995 1996 1997
--------------- --------------- ---------------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards ...... $ 418,934 $ 1,014,072 $ 888,982
Allowance for doubtful accounts ...... 149,273 336,127 532,506
Contested liabilities .................. 254,115 813,526 840,132
Cash to accrual adjustment ............ 1,043,264 777,917 648,265
Other ................................. - 18,086 22,516
------------ ------------ ------------
Total deferred tax assets ............ 1,865,586 2,959,728 2,932,401
------------ ------------ ------------
Deferred tax liabilities:
Depreciation ........................... 34,794 66,434 82,254
Other ................................. 2,628 - -
------------ ------------ ------------
Total deferred tax liabilities ...... 37,422 66,434 82,254
------------ ------------ ------------
Net deferred tax assets ............ 1,828,164 2,893,294 2,850,147
Valuation allowance ..................... (1,828,164) (2,893,294) (2,850,147)
------------ ------------ ------------
$ - $ - $ -
============ ============ ============
</TABLE>
F-18
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
Pursuant to Section 448 of the Internal Revenue Code, the Company is
required to change from the cash to the accrual method of accounting. The effect
of this change will be amortized over four years for tax purposes.
The Company recorded no benefit or provision for income taxes for each of
the three years in the period ended December 31, 1996 or for the six-month
period ended June 30, 1996. A current provision for Federal alternative minimum
tax was recorded for the six-month period ended June 30, 1997. The components of
income tax expense for the six-month period ended June 30, 1997 are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1997
-----------------
(UNAUDITED)
<S> <C>
Current provision
Federal .......................................... $ 187,523
Federal alternative minimum tax .................. 7,223
State ............................................. 40,328
Deferred benefit
Federal .......................................... (35,511)
State ............................................. (7,636)
Benefit of net operating loss carryforwards ...... (199,150)
----------
$ 7,223
==========
</TABLE>
The provision for income taxes results in an effective rate which differs
from the Federal statutory rate as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1997
-----------------
(UNAUDITED)
<S> <C>
Statutory Federal income tax rate .................. 35.0%
Impact of graduated rate ........................... (1.0)
State income taxes, net of Federal tax benefit ...... 4.6
Federal alternative minimum tax ..................... 2.0
Benefit of net operating loss carryforwards ......... (38.6)
------
Effective rate ....................................... 2.0%
======
</TABLE>
12. SUBSEQUENT EVENTS:
CREDIT FACILITY
On July 1, 1997, the Company entered into a credit facility ("Loan") with a
bank ("Lender"). The Loan provides for maximum borrowings of up to $10 million
through December 31, 1997, and the lesser of $15 million or 85 percent of
eligible accounts receivable, as defined, thereafter until maturity in December
1999. The Company may elect to pay quarterly interest payments at the prime
rate, plus 2 percent, or the adjusted LIBOR, plus 4 percent. The Loan required a
$150,000 commitment fee to be paid at closing, and a quarterly commitment fee of
one quarter percent of the unborrowed portion. The Loan is secured by
substantially all of the Company's assets and the common stock owned by the
majority stockholder and another stockholder. The Loan contains certain
financial and non-financial covenants, as defined, including, but not limited
to, ratios of monthly net revenue to Loan balance, interest coverage, and cash
flow leverage, minimum subscribers, and limitations on capital expenditures,
additional indebtedness, acquisition or transfer of assets, payment of
dividends, new ventures or mergers, and issuance of additional equity (excluding
shares issuable in connection with the Offering). Beginning on January 1, 1998
(and extending to July 1, 1998 upon the occurrence of defined events), should
the Lender determine and assert based on its reasonable assessment that a
material adverse change has occurred, all amounts outstanding would be due and
payable.
F-19
<PAGE>
STARTEC GLOBAL COMMUNICATIONS CORPORATION
(FORMERLY STARTEC, INC.)
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
The Loan provides that the Lender receive warrants to purchase up to
539,800 shares of the Company's voting common stock representing 10 percent of
the issued and outstanding shares of the Company. Warrants representing 5
percent of the issued and outstanding shares are immediately exercisable. The
exercise price of these warrants is $8.46. Further, beginning in the first
calendar quarter of 1998, and continuing until the Company completes an initial
public offering, the Lender will vest in an additional 1 percent for each
calendar quarter. The exercise price of these warrants will be set at a price
which values the Company at 10 times revenue for the immediately preceding
month. Until the Company is a public registrant, the Company is obligated to
repurchase the shares under warrant in certain circumstances at the then fair
value of the Company as determined by an independent appraisal. The Lender has
certain registration rights with respect to the shares under warrant.
Prior to closing the above described credit facility, the Company obtained
a $500,000 credit facility from the Lender at prime plus 2 percent. Amounts
outstanding under this facility were refinanced under the Loan.
Proceeds from the loan were used to pay down the receivables based credit
facility (Note 6), to retire the notes payable to related parties and
individuals and other (Note 7), to retire certain capital lease obligations, to
purchase long-distance communications equipment, and for general working capital
purposes.
1997 PERFORMANCE PLAN
In August 1997, the Board of Directors and the stockholders approved the
Company's 1997 Performance Incentive Plan (the "Performance Plan"). The
Performance Plan provides for the award of stock options, stock appreciation
rights, restricted stock and other stock-based awards to eligible employees of
the Company, as well as cash-based annual and long-term incentive awards. The
Performance Plan provides for the issuance of options to acquire up to 750,000
shares of common stock. The Company may grant options to acquire up to 480,000
shares of common stock without triggering the antidilution privileges granted
under the warrants issued in connection with the Loan.
GRANT OF OPTIONS AND WARRANTS
In September 1997, the Company granted options and warrants to employees,
directors, and other parties to acquire 257,250 shares of common stock at an
exercise price of $10.00 per share.
CHANGE IN AUTHORIZED SHARES
In August 1997, the Company increased its authorized shares of common stock
to 20,000,000 and created a preferred class of stock with 100,000 shares of
$1.00 par value preferred stock authorized for issuance.
OTHER
In July 1997, the Company paid off approximately $3,990,000 of its existing
debt as of June 30, 1997, using proceeds from the Loan.
In August 1997, the Company entered into a co-location and facilities
management services agreement. This agreement requires the Company to make
monthly payments of approximately $7,500 for five years, and to pay buildout
fees of approximately $500,000 by the end of October 1997.
F-20
<PAGE>
======================================== =====================================
NO DEALER, SALES REPRESENTATIVE OR
ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST 2,850,000 SHARES
NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ANY OF THE
UNDERWRITERS. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THE SHARES OF
COMMON STOCK TO WHICH IT RELATES OR AN
OFFER TO, OR A SOLICITATION OF, ANY
PERSON IN ANY JURISDICTION WHERE SUCH AN
OFFER OR SOLICITATION WOULD BE UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS
NOR ANY SALE MADE HEREUNDER SHALL, UNDER [LOGO]
ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT
AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
COMMON STOCK
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Prospectus Summary ........... 3
Risk Factors .................... 6 -------------------------------
Use of Proceeds ................. 17
Dividend Policy ................. 18 PROSPECTUS
Dilution ....................... 18
Capitalization ................. 19 -------------------------------
Selected Financial Data ........ 20
Management's Discussion and
Analysis of Financial
Condition and Results of
Operations.................... 21
Business ....................... 29
Management .................... 47 FERRIS, BAKER WATTS
Principal Stockholders ........ 53 Incorporated
Certain Transactions ........... 54
Description of Capital Stock .. 55
Shares Eligible for Future Sale 60
Underwriting .................... 61
Legal Matters ................. 62
Experts ....................... 62
Available Information ........... 63 BOENNING & SCATTERGOOD, INC.
Glossary of Terms .............. G-1
Index to Financial Statements .. F-1
</TABLE>
UNTIL NOVEMBER 2, 1997 (25 DAYS
AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE
COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY
BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION October 9, 1997
TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
======================================== =====================================
