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Filed Pursuant to Rule 424(b)(1)
Registration Statement No. 333-86503
PROSPECTUS
6,000,000 SHARES
[LOGO]
Common Stock
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This is our initial public offering of shares of common stock. We are offering
6,000,000 shares.
No public market currently exists for our shares.
Our shares have been approved for quotation on the Nasdaq National Market
under the symbol "DDDC".
INVESTING IN THE SHARES INVOLVES RISKS. RISK FACTORS BEGIN ON PAGE 5.
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Per Share Total
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Public Offering Price ........................................................... $ 15.00 $90,000,000
Underwriting Discount ........................................................... $ 1.05 $ 6,300,000
Proceeds to deltathree.com ...................................................... $ 13.95 $83,700,000
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We have granted the underwriters the right to purchase up to 900,000 additional
shares within 30 days to cover any over-allotments.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
Lehman Brothers, on behalf of the underwriters, expects to deliver the shares on
or about November 29, 1999.
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LEHMAN BROTHERS
MERRILL LYNCH & CO.
U.S. BANCORP PIPER JAFFRAY
LAZARD FRERES & CO. LLC
FIDELITY CAPITAL MARKETS
a division of National
Financial Services Corporation
November 22, 1999
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[DESCRIPTION OF INSIDE FRONT AND BACK COVER GRAPHIC:
GRAPHIC DEPICTS WORLD MAP SHOWING THE COMPANY'S PRIVATELY-MANAGED, GLOBAL IP
NETWORK, SCREEN SHOTS OF THE COMPANY'S COMMUNICATIONS PORTAL AND SCREEN SHOTS OF
CO-BRANDED COMMUNICATIONS CENTERS]
[THE COMPANY DISTRIBUTED WITH PRELIMINARY PROSPECTUSES CDS CONTAINING THE
COMPANY'S PC-TO-PHONE SOFTWARE.]
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TABLE OF CONTENTS
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Prospectus Summary............................. 1
Risk Factors................................... 5
Forward-Looking Statements..................... 16
Use of Proceeds................................ 17
Dividend Policy................................ 17
Capitalization................................. 18
Dilution....................................... 20
Selected Consolidated Financial Data........... 21
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 22
Business....................................... 34
Management..................................... 52
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Principal Stockholders......................... 62
Related Party Transactions..................... 64
Description of Capital Stock................... 68
Shares Eligible for Future Sale................ 71
Important United States Federal Tax
Consequences of Our Common Stock to Non-U.S.
Holders...................................... 72
Underwriting................................... 75
Legal Matters.................................. 78
Experts........................................ 78
Where You Can Find Additional
Information.................................. 78
Index to Consolidated Financial Statements..... F-1
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Investors may rely only on the information contained in this prospectus. We
and the underwriters have not authorized anyone to provide any different or
additional information. This prospectus is not an offer to sell or a
solicitation of an offer to buy common stock in any jurisdiction where it is
unlawful. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of common stock.
Until December 17, 1999, all dealers that buy, sell or trade our common
stock, whether or not participating in this offering, may be required to deliver
a prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
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PROSPECTUS SUMMARY
This summary highlights the information contained elsewhere in this
prospectus. You should read the entire prospectus, including the section
entitled "Risk Factors" and our consolidated financial statements and related
notes, before deciding to invest in our common stock.
DELTATHREE.COM
We are a global provider of Internet Protocol (IP) telephony services,
which include the transmission of voice and data traffic for communications
carriers and the provision of enhanced Web-based and other communications
services to individuals and businesses. IP telephony is the real time
transmission of voice communications in the form of digitized "packets" of
information over the public Internet or a private network, similar to the way in
which e-mail and other data is transmitted. We were founded in 1996 to
capitalize on the growth of the Internet as a communications tool by
commercially offering IP telephony services. We have built a privately-managed,
global network using IP technology, and we have primarily been using this
network to transmit traffic for communications carriers, including RSL
Communications, Ltd., our parent company. This service is referred to as carrier
transmission services.
We are now using our expertise in IP telephony to provide our users with a
package of enhanced IP communications services. Our on-line interactive
communications portal, www.deltathree.com, enables users to make calls and send
e-mail, as well as retrieve and forward voice mail, e-mail and faxes using one
unified mailbox from anywhere in the world at any time. Our package of enhanced
IP communications services includes the following:
o PC-to-phone: a service allowing a user to place a call through a personal
computer and speak to a party who uses a standard telephone
o D3 Box: a unified messaging service permitting convenient single-source
retrieval of voice mail, e-mail and faxes through the Web or by phone
o Click IT: a Web-based e-commerce service allowing a party to
simultaneously view the Web site of a business and talk directly with
that business while continuing to view the Web site
o Phone-to-phone: a voice and fax service allowing a user to place a call
or send a fax over our privately-managed, global IP network from a
standard telephone or fax machine
o Global roaming: a service enabling businesses and individuals to use a
single account number to place phone-to-phone calls over our IP network
from locations throughout the world using country-specific, toll-free
access numbers
We provide our services at a cost to users that is generally lower than
that charged by traditional carriers because we minimize our network costs by
using efficient packet-switched technology and we generally avoid local access
charges and by-pass international settlement charges by routing international
long distance calls over our privately managed network.
We intend to introduce additional enhanced IP communications services that
meet the communications needs of individuals and businesses. These services are
expected to include D3 Fax, a Web-based, PC-to-fax service allowing users to
conveniently send faxes directly from their computer to a standard fax machine
anywhere in the world, and white boarding, a service allowing multiple users to
simultaneously edit a document while speaking with each other over their
computers.
We market our enhanced IP communications services through our own Web site.
In addition, we market these services through "communications centers" on the
Web sites of other Internet companies. Communications centers enable viewers of
those Web sites to directly access our services without leaving those Web sites.
We have sought to establish marketing relationships with Internet companies that
have strong brand names and high traffic volumes. To date, we have marketing
relationships with CBS.com, CNET, Sony.com, Xoom.com and Yahoo! and we are
continuing to pursue marketing relationships with other companies. We also have
entered into distribution and marketing arrangements with communications
equipment and software companies.
Carrier transmission services accounted for 74.7% of our total revenues in
1998 and 79.2% of our total revenues for the nine months ended September 30,
1999. As we expand our marketing and promotional efforts for our enhanced IP
communications services, we expect revenue from these services, over time, to
represent a majority of our total revenues.
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Our privately-managed, IP telephony network consists of:
o 45 points of presence (POPs) in 29 countries
o gateways, gatekeepers and routers at each POP
o hubs in New York, Los Angeles, London,
Frankfurt and Hong Kong
o dedicated leased bandwidth
o interconnections with the RSL COM network
o peering arrangements with Internet backbone providers
o a network operations center
OUR STRATEGY
Our goal is to be the leading provider of IP telephony services and to make
our interactive communications portal the leading one-stop solution for
communications needs. To achieve our goal, we intend to:
o build strong recognition of the deltathree.com brand through marketing
and promotional programs
o expand and enhance our service offerings
o ensure a positive user experience
o establish additional sources of revenue
o pursue strategic acquisitions and alliances
OUR HISTORY AND PARENT COMPANY
We were founded in 1996. In July 1997, RSL COM, a global facilities-based
telecommunications company, acquired a controlling 51% interest in us. By April
1998, RSL COM had acquired the remaining 49% interest in us from existing
shareholders, and we became a wholly-owned subsidiary of RSL COM. After this
offering, RSL COM's shares of our Class B common stock will represent
approximately 96.1% of the combined voting power of all classes of our capital
stock and approximately 70.9% of the economic interest in our company. We
provide carrier transmission services to RSL COM. Such services accounted for
69.1% of our total revenues in 1998 and 63.4% of our total revenues for the nine
months ended September 30, 1999. For more information about our relationship
with RSL COM and certain services they provide to us, and we provide to them,
see the section of this prospectus entitled "Related Party Transactions--RSL
COM."
Our executive offices are located at 430 Park Avenue, Suite 500, New York,
New York 10022, where our telephone number is (212) 588-3670. Our Web site is
www.deltathree.com. The information contained on our Web site does not
constitute a part of this prospectus.
RISK FACTORS
You should read the section of this prospectus entitled "Risk Factors."
This section indicates among other things that:
o we have a history of losses; we reported a net loss of approximately
$17.5 million for the nine months ended September 30, 1999 and of
approximately $7.1 million in 1998
o we anticipate recording substantial losses for the foreseeable future
o we have a limited operating history
o we operate in a highly competitive market
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THE OFFERING
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Common stock offered ......................... 6,000,000 shares
Capital stock to be outstanding after
this offering:
Common stock................................ 8,018,132 shares
Class B common stock........................ 19,569,459 shares
Total capital stock...................... 27,587,591 shares
Over-allotment option......................... 900,000 shares of common stock
Use of proceeds............................... We estimate that the net proceeds from this offering will be
approximately $82.2 million. We expect to use the net proceeds
from the offering to fund marketing and promotional activities,
for capital expenditures and for general corporate purposes.
Voting rights:
Common stock................................ One vote per share.
Class B common stock........................ Ten votes per share. Upon completion of this offering, RSL COM
will be the only holder of our Class B common stock.
Conversion of Class B common stock............ Each share of Class B common stock is convertible into one share
of common stock at any time and automatically converts into common
stock upon transfer, other than to permitted transferees.
Other capital stock provisions................ The holders of common stock and Class B common stock have
identical rights except with respect to voting and transfer.
Nasdaq National Market symbol................. "DDDC"
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ABOUT THIS PROSPECTUS
Unless otherwise indicated, the information in this prospectus:
o reflects a 2.48-for-1 stock split which was effected prior to this
offering
o assumes no exercise of the underwriters' over-allotment option
o assumes no exercise of outstanding options or options to be granted to
directors who are not our employees to purchase our common stock
o assumes the exchange of 748,288 RSL COM restricted units that have vested
for 748,288 shares of our common stock and the exchange of 372,976 RSL
COM restricted units that have not vested for options to purchase 372,976
shares of our common stock
We have a registered trademark in the United States for "Delta
Three(Registered)". We have submitted United States trademark applications for
the names "deltathree.com(Trademark)," "V-Greetings(Trademark)," "D3
Box(Trademark)," "Click IT(Trademark)," "D3 Fax(Trademark)" and
"deltathree.com(Trademark) the Communications Portal(Trademark)." All other
trademarks and trade names appearing in this prospectus are the property of
their respective holders.
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SUMMARY CONSOLIDATED FINANCIAL DATA
The following tables present summary consolidated financial data derived
from our consolidated financial statements. You should read this along with the
sections of this prospectus entitled "Selected Consolidated Financial Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes.
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PERIOD FROM
JUNE 1996 YEAR ENDED NINE MONTHS ENDED
(INCEPTION) TO DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, ------------------ -------------------------
1996 1997 1998 1998
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
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STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 1 $ 1,246 $ 5,638 $ 3,669
Costs and operating expenses.............. 179 3,576 12,796 8,111
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Loss from operations...................... (178) (2,330) (7,158) (4,442)
Interest expense, net..................... -- (38) (186) (146)
Minority interests........................ -- -- 223 --
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Net loss.................................. $ (178) $(2,368) $(7,121) $(4,588)
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Net loss per share--basic and
diluted................................. $ (0.03) $ (0.19) $ (0.37) $ (0.24)
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Weighted average shares outstanding--
basic and diluted....................... 6,420 12,390 19,254 19,149
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NINE MONTHS ENDED
SEPTEMBER 30,
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1999
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STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 6,432
Costs and operating expenses.............. 22,975
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Loss from operations...................... (16,543)
Interest expense, net..................... (915)
Minority interests........................ --
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Net loss.................................. $ (17,458)
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Net loss per share--basic and
diluted................................. $ (0.89)
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Weighted average shares outstanding--
basic and diluted....................... 19,569
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The pro forma balance sheet data gives effect to:
o the issuance of 183,901 shares of common stock to Yahoo! (including
58,626 shares issued upon the exercise of a warrant at an exercise
price of $7.98 per share, assuming a cashless exercise) in exchange
for the offset of an account payable to Yahoo! in the amount of
$1 million
o the issuance of 1,085,943 shares of common stock to CNET for
approximately $11 million (excluding a warrant to purchase 466,028
shares of common stock)
o an increase in deferred compensation attributable to RSL COM
restricted units, representing the difference between the exercise
price of the restricted units and the deemed fair value of our
common stock
The pro forma as adjusted balance sheet data gives effect to the foregoing
and to:
o the sale of 6,000,000 shares of common stock offered by us in this
offering
o the issuance of 748,288 shares in exchange for RSL COM restricted
units that have vested at a weighted average exercise price of $0.31
per share
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AS OF
SEPTEMBER 30, 1999
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PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
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(IN THOUSANDS)
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BALANCE SHEET DATA:
Cash and cash equivalents.................................................. $ 1,293 $12,293 $ 94,725
Working capital (deficiency)............................................... (3,890) 7,110 89,542
Total assets............................................................... 24,587 35,587 118,019
Long-term debt due to affiliates........................................... 12,307 12,307 12,307
Total stockholders' equity................................................. 3,838 14,838 97,270
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RISK FACTORS
You should carefully consider the risks described below before deciding
whether to invest in shares of our common stock.
If we do not successfully address any of the risks described below, there
could be a material adverse effect on our business, financial condition or
results of operations, and the trading price of our common stock may decline and
you may lose all or part of your investment. We cannot assure you that we will
successfully address these risks.
RISKS RELATED TO OUR COMPANY
WE HAVE A HISTORY OF LOSSES AND WE ANTICIPATE OUR LOSSES WILL CONTINUE
We have incurred significant losses since inception, and we expect to
continue to incur significant losses for the foreseeable future. We reported a
net loss of approximately $17.5 million for the nine months ended September 30,
1999 and a net loss of approximately $7.1 million in 1998. As of September 30,
1999, our accumulated deficit was approximately $27.1 million. As a percentage
of revenues, our net loss for the nine months ended September 30, 1999 was
271.4% and 126.3% in 1998. Our revenues may not continue to grow or even
continue at their current level. In addition, we expect our operating expenses
to increase significantly as we develop and expand our business. For example, we
intend to spend approximately $20 million on marketing and promotional programs
in 2000 compared to $3.1 million for the nine months ended September 30, 1999
and $2.4 million in 1998. As a result, we will need to increase our revenues
significantly to become profitable. In order to increase our revenues, we need
to attract users to increase the fees we collect for our services. If our
revenues do not increase as much as we expect or if our expenses increase at a
greater pace than revenues, we may never be profitable or, if we become
profitable, we may not be able to sustain or increase profitability on a
quarterly or annual basis.
WE HAVE A LIMITED OPERATING HISTORY UPON WHICH YOU CAN EVALUATE US
We have only a limited operating history upon which you can evaluate our
business and prospects. We commenced operations in June 1996. You should
consider our prospects in light of the risks, expenses and difficulties we may
encounter as an early stage company in the new and rapidly evolving market for
IP communications services. These risks include our ability:
o to increase awareness of our brand, increase the number of users of our
IP telephony services and build user loyalty
o to increase revenues to cover the increased marketing expenditures we
have planned
o to compete effectively
o to develop new products and keep pace with developing technology
In addition, because we expect an increasing percentage of our revenues to
be derived from our enhanced IP communications services, our past operating
results may not be indicative of our future results.
WE MAY NOT BE ABLE TO EXPAND OUR REVENUE AND ACHIEVE PROFITABILITY
Our business strategy is to expand our revenue sources to enhanced IP
communications services and advertising on the Internet. We can neither assure
you that we will be able to do this or that this strategy will be profitable.
Currently our revenues are primarily generated from carrier transmission
services for RSL COM and other communications carriers. Carrier transmission
services generated 79.2% of our total revenues for the nine months ended
September 30, 1999 and 74.7% in 1998. Enhanced IP communications services
generated 18.7% of our total revenues for the nine months ended September 30,
1999 and 20.5% in 1998. The provision of carrier transmission services and
enhanced IP communications services have not been profitable to date.
In the future, we intend to generate increased revenues from multiple
sources, many of which are unproven, including the commercial sale of enhanced
IP communications services and advertising on the Internet. To date, we have
recorded no revenue from advertising. We expect that our revenues for the
foreseeable future will be dependent on, among other factors:
o sale of enhanced IP communications services
o acceptance and use of Internet communications
o continued rapid growth of the Internet consumer market
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o expansion of service offerings
o user traffic levels
o the effect of competition, regulatory environment, international long
distance rates and access and transmission costs on our prices
o sale of carrier transmission services
o continued improvement of our global network quality
o sale of Internet advertising
We may not be able to sustain our current revenues or successfully generate
additional revenues from the sale of carrier transmission services, enhanced IP
communications services and advertising on the Internet in the future.
WE CANNOT ASSURE YOU THAT A MARKET FOR OUR SERVICES WILL DEVELOP
We are uncertain whether a market will develop for our enhanced IP
communications services. Our market is new and rapidly evolving. Our ability to
sell our services to end users may be inhibited by, among other factors, the
reluctance of some end users to switch from traditional communications carriers
to IP communications carriers and by concerns with the quality of Internet and
IP telephony and adequacy of security in the exchange of information over the
Internet. End users in markets serviced by recently deregulated
telecommunications providers are not familiar with obtaining services from
competitors of these providers and may be reluctant to use new providers, such
as our company. Our ability to increase revenues from enhanced IP communications
services depends on the migration of traditional telephone network traffic to
our IP network. We will need to devote substantial resources to educate end
users about the benefits of IP communications solutions in general and our
services in particular, and as a result, we intend to spend approximately $20
million in 2000 for marketing and promotional activities. If end users do not
accept our enhanced IP communications services as a means of sending and
receiving communications we will not be able to increase our number of paid
users or successfully generate revenues in the future.
OUR FUTURE SUCCESS DEPENDS ON THE GROWTH IN THE USE OF THE INTERNET AS A MEANS
OF COMMUNICATIONS
If the market for IP communications, in general, and our services in
particular, does not grow at the rate we anticipate, we will not be able to
increase our number of users or generate revenues from our enhanced IP
communications services or from advertising on the Internet at the rate we
anticipate. We currently rely on revenues generated primarily from the sale of
carrier transmission services but expect in the future to increasingly rely on
revenues generated from enhanced IP communications services and from advertising
on the Internet. To be successful, IP communications requires validation as an
effective, quality means of communication and as a viable alternative to
traditional telephone service. As is typical in the case of a new and rapidly
evolving industry, demand and market acceptance for recently introduced services
are subject to a high level of uncertainty. The Internet may not prove to be a
viable alternative to traditional telephone service for reasons including:
o inconsistent quality or speed of service
o traffic congestion on the Internet
o potentially inadequate development of the necessary infrastructure
o lack of acceptable security technologies
o lack of timely development and commercialization of performance
improvements
o unavailability of cost-effective, high-speed access to the Internet
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, or its performance or
reliability may decline. In addition, Web sites may from time to time experience
interruptions in their service as a result of outages and other delays occurring
throughout the Internet network infrastructure. If these outages or delays
frequently occur in the future, Internet usage, as well as usage of our
communications portal and our services, could be adversely affected.
IF WE DO NOT DEVELOP THE DELTATHREE.COM BRAND, WE MAY NOT BE ABLE TO MAINTAIN A
LEADING POSITION IN OUR INDUSTRY
We may not be able to become the leader in our industry. To become the
leader, we must strengthen the brand awareness of the deltathree.com brand. If
we fail to create and maintain brand awareness, it could
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adversely affect our ability to attract sufficient Web traffic and reduce our
attractiveness to advertisers. Brand recognition may become more important in
the future with the growing number of Internet sites and IP communications
providers.
IF WE FAIL TO ESTABLISH MARKETING RELATIONSHIPS THAT PROVIDE US VISIBILITY, WE
MAY NOT BE ABLE TO SUFFICIENTLY INCREASE OUR SALES
We believe that our success depends, in part, on our ability to develop and
maintain marketing and promotional relationships with Internet companies and
communications equipment and software companies that themselves have strong
brand names or high traffic volumes. If we are unable to establish and maintain
these relationships, we may not be able to increase sales of our services, and
we may lose users.
WE WILL NEED ADDITIONAL CAPITAL TO FINANCE OUR OPERATIONS IN THE FUTURE AND MAY
HAVE TO REQUEST IT FROM RSL COM WHO HAS NO OBLIGATION TO PROVIDE IT
We intend to continue to enhance and expand our network in order to
maintain our competitive position and meet the increasing demands for service
quality, capacity and competitive pricing. Also, the introduction of our new
enhanced IP communications services will require significant marketing and
promotional expenses that we often incur before we begin to receive the related
revenue. If our cash flow from operations is not sufficient to meet our capital
expenditure and working capital requirements, we will need to raise additional
capital from other sources. Although we are neither the debtor nor the guarantor
under any of the indentures that govern a substantial amount of RSL COM's debt,
we are a "restricted subsidiary" under these indentures and will continue to be
one after the completion of the offering. The limitations under RSL COM's
restrictive indenture covenants prohibit RSL COM and its restricted
subsidiaries, including us, from incurring any significant amount of additional
debt. We have agreed with RSL COM not to take any action which would cause RSL
COM to default under its indentures and not to incur any debt, other than inter-
company debt, without its written consent so long as we are a restricted
subsidiary of RSL COM. These limitations may require us to resort to other
sources of funding, such as the issuance of equity. If we issue additional
equity, investors could experience dilution. If we are unable to raise
additional capital through the issuance of equity, we may need to rely upon RSL
COM to provide any additional capital to meet our working capital and capital
expenditure requirements and we cannot assure you that RSL COM or any other
third party will be willing or able to provide additional capital on favorable
terms. If we are unable to obtain additional capital, we may be required to
reduce the scope of our business or our anticipated growth, which would reduce
our revenues.
WE MAY BE UNABLE TO MANAGE OUR EXPANSION AND ANTICIPATED GROWTH EFFECTIVELY
We have grown and expect to continue to grow rapidly. This growth has
placed, and is likely to continue to place, a significant strain on our
managerial, operational and financial resources. To manage our growth, we must
continue to implement and improve our operational and financial systems, as well
as our managerial controls and procedures. We cannot assure you that we have
made adequate allowances for the costs and risks associated with this expansion,
that our systems, procedures or controls will be adequate to support our
operations or that our management will be able to successfully offer and expand
our services. If we are unable to effectively manage our expanding operations,
our revenues may not increase, our cost of operations may rise and we may not be
profitable.
POTENTIAL FLUCTUATIONS IN OUR QUARTERLY FINANCIAL RESULTS MAKE IT DIFFICULT FOR
INVESTORS TO PREDICT OUR FUTURE PERFORMANCE
Our quarterly operating results may fluctuate significantly in the future
as a result of a variety of factors, many of which are outside our control. The
factors generally within our control include:
o the rate at which we are able to attract users to purchase our enhanced
IP communications services
o the amount and timing of expenses to enhance marketing and promotion
efforts and to expand our infrastructure
o the timing of announcements or introductions of new or enhanced services
by us
The factors outside our control include:
o the timing of announcements or introductions of new or enhanced services
by our competitors
o technical difficulties or network interruptions in the Internet or our
privately managed network
o general economic and competitive conditions specific to our industry
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The foregoing factors also may create other risks affecting our long-term
success, as discussed in the other risk factors.
We believe that quarter-to-quarter comparisons of our historical operating
results may not be a good indication of our future performance, nor would our
operating results for any particular quarter be indicative of our future
operating results.
OUR NETWORK MAY NOT BE ABLE TO ACCOMMODATE OUR CAPACITY NEEDS
We expect the volume of traffic we carry over our network to increase
significantly as we expand our operations and service offerings. Our network may
not be able to accommodate this additional volume. In order to ensure that we
are able to handle additional traffic, we may have to enter into long-term
agreements for leased capacity. To the extent that we overestimate our capacity
needs, we may be obligated to pay for more transmission capacity than we
actually use, resulting in costs without corresponding revenues. Conversely, if
we underestimate our capacity needs, we may be required to obtain additional
transmission capacity from more expensive sources. If we are unable to maintain
sufficient capacity to meet the needs of our users, our reputation could be
damaged and we could lose users.
WE FACE A RISK OF FAILURE OF COMPUTER AND COMMUNICATIONS SYSTEMS USED IN OUR
BUSINESS
Our business depends on the efficient and uninterrupted operation of our
computer and communications systems as well as those that connect to our
network. We maintain communications systems in five facilities in New York, Los
Angeles, London, Frankfurt and Jerusalem. Our systems and those that connect to
our network are subject to disruption from natural disasters or other sources of
power loss, communications failure, hardware or software malfunction, network
failures and other events both within and beyond our control. In December 1998,
we experienced a system disruption while we were installing a new billing system
and users were unable to access our Web site for six hours. In July 1999, we
experienced a system disruption with respect to our unified messaging service,
D3 Box, while the product was being market tested. For a period of three days
the system was down and users were unable to send or retrieve new messages. Any
system interruptions that cause our services to be unavailable, including
significant or lengthy telephone network failures or difficulties for users in
communicating through our network or portal, could damage our reputation and
result in a loss of users.
OUR COMPUTER SYSTEMS AND OPERATIONS MAY BE VULNERABLE TO SECURITY BREACHES
Our computer infrastructure is potentially vulnerable to physical or
electronic computer viruses, break-ins and similar disruptive problems and
security breaches which could cause interruptions, delays or loss of services to
our users. We believe that the secure transmission of confidential information
over the Internet, such as credit card numbers, is essential in maintaining user
confidence in our services. We rely on licensed encryption and authentication
technology to effect secure transmission of confidential information, including
credit card numbers. It is possible that advances in computer capabilities, new
technologies or other developments could result in a compromise or breach of the
technology we use to protect user transaction data. A party that is able to
circumvent our security systems could misappropriate proprietary information or
cause interruptions in our operations. Security breaches also could damage our
reputation and expose us to a risk of loss or litigation and possible liability.
Although we have experienced no security breaches to date of which we are aware,
we cannot guarantee you that our security measures will prevent security
breaches.
YEAR 2000 COMPLICATIONS MAY HARM OUR BUSINESS
The "Year 2000 issue" is the result of computer systems and programs using
two digits (rather than four) to identify a given year. Computer systems that
have time sensitive software may interpret the date code "00" as the year 1900
rather than the year 2000. This could result in a major system failure or
miscalculations or other computer errors causing disruptions of operations. The
potential for system failures encompasses all aspects of our business, including
our computer systems and IP network, and could cause, among other things,
disruptions in the operation of the Internet and our Web site and a temporary
inability to engage in normal business activities.
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We completed testing of our systems in October 1999. This testing did not
identify any material non-compliant systems operated by us or our vendors,
suppliers and service providers. Therefore, the most reasonably likely worst
case Year 2000 scenario is a systemic failure beyond our control, such as a
prolonged disruption or failure of the Internet or the telecommunications
infrastructure. Any failures or disruptions could prevent us from operating our
network or prevent users from accessing our Web site and services, which could
result in loss of users, lost revenues, increased operating costs and material
disruptions in the operation of our business. We have not developed our own
contingency plan to deal with problems that result from Year 2000 issues and are
dependent on a contingency plan developed by RSL COM to deal with such problems.
THIRD PARTIES MIGHT INFRINGE UPON OUR PROPRIETARY TECHNOLOGY
We cannot assure you that the steps we have taken to protect our
intellectual property rights will prevent misappropriation of our proprietary
technology. To protect our rights to our intellectual property, we rely on a
combination of trademark and patent law, trade secret protection,
confidentiality agreements and other contractual arrangements with our
employees, affiliates, strategic partners and others. Although we do not
currently own any issued patents, we have pending applications for patents in
the United States and Israel. We may be unable to detect the unauthorized use
of, or take appropriate steps to enforce, our intellectual property rights.
Effective copyright and trade secret protection may not be available in every
country in which we offer or intend to offer our services. Failure to adequately
protect our intellectual property could harm our brand, devalue our proprietary
content and affect our ability to compete effectively. Further, defending our
intellectual property rights could result in the expenditure of significant
financial and managerial resources.
OUR SERVICES MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS
Third parties may assert claims that we have violated a patent or infringed
a copyright, trademark or other proprietary right belonging to them. We
incorporate licensed third-party technology in some of our services. In these
license agreements, the licensors have agreed to indemnify us with respect to
any claim by a third party that the licensed software infringes any patent or
other proprietary right so long as we have not made changes to the licensed
software. We cannot assure you that these provisions will be adequate to protect
us from infringement claims. Any infringement claims, even if not meritorious,
could result in the expenditure of significant financial and managerial
resources.
On October 8, 1999, we were named as a defendant in a lawsuit alleging that
we are infringing on a patent by making, using, selling and offering for sale
prepaid telephone card products in the United States. The plaintiffs are seeking
an injunction to stop us from using the technology covered by this patent,
monetary damages in an unspecified amount and reimbursement of attorneys' fees.
The litigation was only recently filed and we are presently evaluating these
claims. We believe that we have meritorious defenses to the claim and we intend
to defend the lawsuit vigorously. However, the outcome of the litigation is
inherently unpredictable and an unfavorable result may have a material adverse
effect on our business, financial condition and results of operations.
Regardless of the ultimate outcome, the litigation could result in substantial
expenses to us and significant diversion of efforts by our managerial and other
personnel.
OPERATING INTERNATIONALLY EXPOSES US TO ADDITIONAL AND UNPREDICTABLE RISKS
We intend to continue to enter additional markets in Eastern Europe, Africa
and Asia and to expand our existing operations outside the United States.
International operations are subject to inherent risks, including:
o potentially weaker protection of intellectual property rights
o political instability
o unexpected changes in regulations and tariffs
o fluctuations in exchange rates
o varying tax consequences
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o uncertain market acceptance and difficulties in marketing efforts due to
language and cultural differences
WE HAVE EXPERIENCED LOSSES AS A RESULT OF FRAUD
We have experienced losses due to fraud. In 1998, we experienced losses
from fraud of approximately $240,000. Callers have obtained our services without
rendering payment by unlawfully using our access numbers and personal
identification numbers. Although we have implemented anti-fraud measures in
order to control losses relating to these practices, these measures may not be
sufficient to effectively limit all of our exposure in the future from fraud and
we continue to experience losses from fraud. Such losses in 1999 were $2,000 a
month on average. While we have established reserves for bad debts in accordance
with historical levels of uncollectible receivables resulting primarily from
these fraudulent practices, our losses may exceed our reserves and could rise
significantly above anticipated levels.
INTENSE COMPETITION COULD REDUCE OUR MARKET SHARE AND HARM OUR FINANCIAL
PERFORMANCE
Competition in the market for each of enhanced IP communications services
and carrier transmission services is becoming increasingly intense and is
expected to increase significantly in the future. The market for enhanced
internet and IP communications is new and rapidly evolving. We expect that
competition from companies both in the Internet and telecommunications
industries will increase in the future. Our competitors include both start-up IP
telephony service providers and established traditional communications
providers. Many of our existing competitors and potential competitors have
broader portfolios of services, greater financial, management and operational
resources, greater brand-name recognition, larger subscriber bases and more
experience than we have. In addition, many of our IP telephony competitors use
the Internet instead of a private network to transmit traffic. Operating and
capital costs of these providers may be less than ours, potentially giving them
a competitive advantage over us in terms of pricing.
We also compete in the growing market of discount telecommunications
services including calling cards, prepaid cards, call-back services, dial-around
or 10-10 calling and collect calling services. In addition, some Internet
service providers have begun to aggressively enhance their real time interactive
communications, focusing initially on instant messaging, although we expect them
to begin to provide PC-to-phone services.
For the carrier transmission services business, we compete with
telecommunications providers, long distance carriers and other long distance
resellers and providers of carrier services. Competition for carrier traffic is
primarily based on price. Decreasing telecommunications rates have resulted in
intense price competition and we expect that competition will continue to
increase significantly as telecommunications rates decrease. Increased
competition could force us to further reduce our prices and profit margins, and
may reduce our market share.
If we are unable to provide competitive service offerings, we may lose
existing users and be unable to attract additional users. In addition, many of
our competitors, especially traditional carriers, enjoy economies of scale that
result in a lower cost structure for transmission and related costs, which cause
significant pricing pressures within the industry. Although the minutes of use
we sell are increasing, revenues are not increasing at the same rate due
primarily to a decrease in revenue per minute for our carrier transmission
services. In order to remain competitive we intend to increase our efforts to
promote our services, and we cannot be sure that we will be successful in doing
this.
In addition to these competitive factors, recent and pending deregulation
in some of our markets may encourage new entrants. We cannot assure you that
additional competitors will not enter markets that we plan to serve or that we
will be able to compete effectively.
DECREASING TELECOMMUNICATIONS RATES MAY DIMINISH OR ELIMINATE OUR COMPETITIVE
PRICING ADVANTAGE
Decreasing telecommunications rates may diminish or eliminate the
competitive pricing advantage of our enhanced IP communications services and
carrier transmission services. International and domestic telecommunications
rates have decreased significantly over the last few years in most of the
markets in which we operate, and we anticipate that rates will continue to be
reduced in all of the markets in which we do business or expect to do business.
Users who select our enhanced IP communications services to take
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advantage of the current pricing differential between traditional
telecommunications rates and our rates may switch to traditional
telecommunications carriers as such pricing differentials diminish or disappear,
and we will be unable to use such pricing differentials to attract new customers
in the future. In addition, our ability to market our carrier transmission
services to telecommunications carriers depends upon the existence of spreads
between the rates offered by us and the rates offered by traditional
telecommunications carriers, as well as a spread between the retail and
wholesale rates charged by the carriers from which we obtain wholesale service.
Continued rate decreases will require us to lower our rates to remain
competitive and will reduce or possibly eliminate our gross profit from our
carrier transmission services. If telecommunications rates continue to decline,
we may lose users for our enhanced IP communications services and carrier
transmission services.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES RELATING TO IP TELEPHONY COULD
HARM OUR BUSINESS
Traditionally, voice communications services have been provided by
regulated telecommunications common carriers. We offer voice communications to
the public for international and domestic calls using IP telephony, and we do
not operate as a licensed telecommunications common carrier in any jurisdiction.
Based on specific regulatory classifications and recent regulatory decisions, we
believe we qualify for certain exemptions from telecommunications common carrier
regulation in many of our markets. However, the growth of IP telephony has led
to close examination of its regulatory treatment in many jurisdictions making
the legal status of our services uncertain and subject to change as a result of
future regulatory action, judicial decisions or legislation in any of the
jurisdictions in which we operate.
Established regulated telecommunications carriers have sought and may
continue to seek regulatory actions to restrict the ability of companies such as
ours to provide services or to increase the cost of providing such services. In
addition, our services may be subject to regulation if regulators distinguish
phone-to-phone telephony service using IP technologies over privately-managed
networks such as our services from integrated PC-to-PC and PC-originated voice
services over the Internet. Some regulators may decide to treat the former as
regulated common carrier services and the latter as unregulated enhanced or
information services.
Application of new regulatory restrictions or requirements to us could
increase our costs of doing business and prevent us from delivering our services
by our current arrangements. In such event, we would consider a variety of
alternative arrangements for providing our services, including obtaining
appropriate regulatory authorizations for our local network partners or
ourselves, changing our service arrangements with RSL COM for a particular
country or limiting our service offerings. Such regulations could limit our
service offerings, raise our costs and restrict our pricing flexibility, and
potentially limit our ability to compete effectively. Further, regulations and
laws which affect the growth of the Internet could hinder our ability to provide
our services over the Internet. For a more detailed discussion of the regulation
of IP telephony, see "Business--Regulation of IP Telephony."
WE MAY NOT BE ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN THE
COMMUNICATIONS INDUSTRY
Our industry is subject to rapid technological change. We cannot predict
the effect of technological changes on our business. In addition, widely
accepted standards have not yet developed for the technologies we use. We expect
that new services and technologies will emerge in the market in which we
compete. These new services and technologies may be superior to the services and
technologies that we use, or these new services may render our services and
technologies obsolete.
To be successful, we must adapt to our rapidly changing market by
continually improving and expanding the scope of services we offer and by
developing new services and technologies to meet customer needs. Our success
will depend, in part, on our ability to license leading technologies and respond
to technological advances and emerging industry standards on a cost-effective
and timely basis. We will need to spend significant amounts of capital to
enhance and expand our services to keep pace with changing technologies.
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RISKS RELATED TO OUR RELATIONSHIP WITH RSL COM
WE DEPEND ON SALES TO RSL COM
We currently depend on sales to RSL COM, our controlling stockholder, for a
substantial majority of our revenues. RSL COM accounted for 37.6%, 69.1% and
63.4% of our revenues for the years ended December 31, 1997 and December 31,
1998 and for the nine months ended September 30, 1999, respectively. RSL COM is
not contractually required to purchase services from us, other than a minimum of
50 million minutes per year pursuant to the services agreement for two years
from the date of this offering. We cannot assure you that RSL COM will fulfill
its obligations under this agreement or that the contract will be renewed upon
its expiration. RSL COM resells a significant portion of the carrier
transmission services it purchases from us to third parties. Although we could
market our services directly to these third parties if RSL COM ceased purchasing
services from us, we cannot assure you that we would succeed in attracting these
customers or that these customers would purchase our services in the same volume
or on the same terms as from RSL COM.
WE DEPEND ON THE SERVICES RSL COM PROVIDES TO US
We are currently dependent upon RSL COM for leased line capacity, data
communications facilities, traffic termination services and physical space for
our equipment. Through our relationship with RSL COM, which owns or leases
substantial bandwidth for its own business, we have access to bandwidth. We are
able to take advantage of RSL COM's volume discounts and achieve cost
efficiencies that we could not achieve on our own. Although we have entered into
a services agreement with RSL COM for it to provide these services through 2004,
if RSL COM becomes unwilling or unable to provide its current level of services
to us during the term of such agreement or thereafter, we may not be able to
find replacement service providers on a timely basis. If we are required to
change providers, we would likely experience delays, operational difficulties
and increased expenses, and our ability to provide services to our users or
expand our operations may be impaired.
The inter-company agreements with RSL COM were made in the context of a
parent-subsidiary relationship and were not negotiated on an arms' length basis.
As a result, the terms of such agreement may be better or worse than the terms
that would have been negotiated by unaffiliated third parties for similar
arrangements.
RSL COM WILL CONTROL ALL MATTERS SUBMITTED TO A STOCKHOLDER VOTE
After completion of this offering, RSL COM will own all of our Class B
common stock and will therefore own approximately 96.1% of the voting power of
our company, or approximately 95.6% of the voting power if the underwriters'
over-allotment option is exercised in full.
As long as RSL COM continues to beneficially own shares of capital stock
representing more than 50% of the voting power of our outstanding capital stock,
RSL COM will be able to exercise a controlling influence over decisions
affecting our company, including:
o composition of our board of directors and, through it, the direction and
policies of our company, including the appointment and removal of
officers
o mergers or other business combinations involving our company
o acquisitions or dispositions of assets by our company
o future issuances of capital stock or other securities by our company
o incurrence of debt by our company
o amendments, waivers and modifications to any agreements between us and
RSL COM
o payment of dividends on our capital stock
o approval of our business plans and general business development
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In addition, six of our ten directors (or director nominees) are officers and/or
directors of RSL COM, or otherwise affiliated with RSL COM. As a result, the
ability of any of our other stockholders to influence the management of our
company is limited, which could have an adverse effect on the market price of
our stock.
WE ARE SUBJECT TO THE COVENANTS OF RSL COM'S INDENTURES WHICH RESTRICT OUR
ABILITY TO CONDUCT OUR BUSINESS
Although we are neither the debtor nor the guarantor under any of the
indentures that govern a substantial amount of RSL COM's debt, we are subject to
covenants by reason of our status as a restricted subsidiary of RSL COM under
such indentures. As of September 30, 1999, RSL COM had approximately
$1.2 billion of debt outstanding under these indentures. This debt is unsecured.
These restrictions significantly limit the ability of RSL COM and its restricted
subsidiaries, including our company, to incur additional indebtedness or create
liens on their assets. The limitations on indebtedness under the indentures
generally are based on the application of tests derived from RSL COM's
consolidated financial statements. Effectively, our ability to incur
indebtedness is limited by the amount of indebtedness that RSL COM and its
restricted subsidiaries, including our company, are permitted to incur under the
indentures. The limitations under RSL COM's restrictive indenture covenants
currently prohibit us from incurring any significant amount of additional debt.
We have also agreed with RSL COM not to take any action which would cause RSL
COM to default under its indentures and not to incur any debt, other than
inter-company debt, without its written consent so long as we are a restricted
subsidiary of RSL COM. In addition, currently the restrictions under the
RSL COM indentures effectively prohibit us from paying dividends and limit our
ability to make other distributions in respect of our capital stock, sell
assets, engage in mergers or acquisitions or make some types of investments.
Such restrictions also limit the ability of a third party to acquire a
controlling interest in our company. These restrictions may prohibit
transactions that would otherwise be beneficial to our company.
THE INTERESTS OF RSL COM MAY CONFLICT WITH OUR INTERESTS
The interests of RSL COM, our controlling stockholder and principal
customer, may conflict with our interests.
Services. We have entered into a services agreement with RSL COM for the
provision of traffic termination services, colocation rights and other network
support services. We provide carrier transmission services to RSL COM. Because
of these transactions and RSL COM's controlling position in our company,
conflicts of interest could arise relating to the nature, quality and pricing of
services or products provided by us to RSL COM or by RSL COM to us.
Financial Support. Historically, RSL COM has funded our working capital and
operating losses. As a result, we owe RSL COM $12.3 million, as of
September 30, 1999. Also, to the extent that we require additional working
capital we may need to turn to RSL COM. Because of RSL COM's control over us,
conflicts of interest could arise relating to the prepayment of borrowings, the
provision of additional funding and the terms of such funding and general issues
relating to the uses and sources of our funds.
Board Conflicts. Six of our ten directors (or director nominees) are
officers and/or directors of RSL COM, or otherwise affiliated with RSL COM. Our
directors who are also directors or officers of RSL COM will have fiduciary
duties, including duties of loyalty, to both companies and may have conflicts of
interest with respect to matters potentially involving or affecting us, such as
acquisitions, financings or other corporate opportunities that may be suitable
for both us and RSL COM. Some of these individuals and a number of our executive
officers own substantial amounts of RSL COM capital stock and/or options for
shares of RSL COM capital stock. Although we believe that these directors and
officers will be able to fulfill their fiduciary duties to our stockholders
despite their positions with RSL COM and their ownership of RSL COM capital
stock and options, there could be potential conflicts of interest when these
directors and officers are faced with decisions that could have different
implications for our company and RSL COM. There are no specific policies in
place with respect to any conflicts that may arise. We expect conflicts to be
resolved on a case-by-case basis, and in a manner consistent with applicable
law. For example, if a business opportunity were presented to both us and
RSL COM for consideration, directors affiliated with RSL COM would not
participate in our consideration of that opportunity. However, conflicts could
be resolved in a manner adverse to us which could harm our business.
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RSL COM MAY COMPETE WITH OUR COMPANY
RSL COM is in the communications business and may compete with us under
some circumstances. Under the services agreement between us and RSL COM, RSL COM
is prohibited from competing with us in providing Internet telephony services as
described in the services agreement, provided that we provide RSL COM with any
requested Internet telephony services promptly and with quality assurance.
However, this non-competition provision terminates on September 3, 2001 and the
scope of such provision is subject to the following limitations:
o RSL COM and its subsidiaries may acquire up to 20% in an entity providing
Internet telephony services
o RSL COM and its subsidiaries may be stockholders in entities providing
Internet telephony services, provided that Internet telephony services
are ancillary to the business of that entity
o the non-competition provision does not apply to RSL COM's subsidiaries
that become publicly traded companies
o Internet telephony services under the non-competition provision are
limited to (1) phone to phone services marketed as IP to the general
public, including both individuals and businesses and (2) the following
Web-based enhanced communication services: PC-to-phone, D3 box, Click IT,
Global Roaming, IP-initiated conference calls, Phone-to-PC, D3 Fax,
information services and white boarding
RSL COM'S CLASS B COMMON STOCK MAY BE TRANSFERRED TO A THIRD PARTY THAT WOULD
EFFECTIVELY CONTROL US
Although our Class B common stock generally converts to common stock
automatically upon transfer, RSL COM may transfer our Class B common stock to
permitted transferees, including entities controlled by RSL COM or its principal
stockholder, Ronald S. Lauder, and successors in interest of RSL COM. As a
result, a third party could acquire our Class B common stock and may become
party to our intercompany agreements. We cannot assume that a third party would
maintain good relations with us or maintain or renew our agreements with RSL
COM.
RISKS RELATED TO THIS OFFERING
FUTURE SALES OF CAPITAL STOCK MAY ADVERSELY AFFECT OUR STOCK PRICE
Future sales of capital stock in the market after this offering or the
perception that such sales could occur may adversely affect the market price of
our stock and make it difficult for us to raise additional capital through the
sale of equity at prices acceptable to us. Following this offering, we will have
approximately 8,018,132 shares of common stock, or approximately 8,918,132
shares of common stock outstanding if the underwriters exercise their
over-allotment option in full, and 19,569,459 shares of Class B common stock
outstanding. Of these shares, persons other than our affiliates (as this term is
defined under the Securities Act, and which includes RSL COM) may freely
transfer the shares of common stock sold in this offering without restriction or
further registration under the Securities Act. However, we have given RSL COM,
Yahoo! and CNET both demand and piggyback registration rights. For more
information about these registration rights, see "Related Party
Transactions--RSL COM--Registration Rights Agreement" and "Shares Eligible for
Future Sale--Registration Rights."
We have agreed that, without the prior written consent of Lehman Brothers
Inc., we will not, directly or indirectly, offer, sell or otherwise dispose of
any shares of capital stock or any securities which may be converted into or
exchanged for any shares of capital stock for a period of 180 days from the date
of this prospectus. RSL COM, Yahoo!, CNET and all of our officers and directors
have agreed under lock-up agreements that, without the prior written consent of
Lehman Brothers Inc., they will not, directly or indirectly, offer, sell or
otherwise dispose of any shares of capital stock or any securities which may be
converted into or exchanged for any shares of capital stock for a period of
180 days from the date of this prospectus, except that RSL COM may sell shares
of our capital stock to a purchaser or purchasers of the shares who agree to be
bound by the same restrictions that bind RSL COM. Without the prior written
consent of Lehman Brothers Inc., individuals participating in the directed share
program and employees holding an
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aggregate of approximately 395,000 shares of our common stock on the closing of
this offering will be prohibited from disposing shares of common stock for a
period of 90 days after the date of this prospectus, except that participants in
our directed share program who acquire 50,000 shares or more of our common stock
in the directed share program will be prohibited from disposing of that common
stock for 180 days after the date of this prospectus. Shares of capital stock
subject to these lock-up agreements will become eligible for sale in the public
market upon expiration of these lock-up agreements, subject to limitations
imposed by Rule 144 under the Securities Act for holders who are our affiliates.
YOU WILL EXPERIENCE IMMEDIATE AND SIGNIFICANT DILUTION OF BOOK VALUE PER SHARE
The initial public offering price of our common stock is substantially
higher than the net tangible book value per share of the outstanding common
stock immediately after this offering. Therefore, if you purchase our common
stock in this offering, you will incur immediate dilution of approximately
$11.77 in the net tangible book value per share of common stock from the price
you pay for our common stock in this offering.
A THIRD PARTY MAY BE DETERRED FROM ACQUIRING OUR COMPANY
The disproportionate voting rights of our Class B common stock relative to
our common stock could delay, deter or prevent a third party from attempting to
acquire control of us. This provision may have the effect of discouraging a
third party from making a tender offer or otherwise attempting to obtain control
of our company, even though such a change in ownership would be economically
beneficial to our company and our stockholders.
WE CANNOT GUARANTEE THAT A TRADING MARKET WILL DEVELOP FOR OUR COMMON STOCK
There has not been a public market for our common stock. We cannot predict
the extent to which a trading market will develop or how liquid that market
might become. The initial public offering price was determined by negotiation
between the representative of the underwriters and us and may not be indicative
of prices that will prevail in the trading market.
VOLATILITY OF OUR STOCK PRICE COULD ADVERSELY AFFECT OUR STOCKHOLDERS
The market price of our common stock is likely to be highly volatile and
could be subject to wide fluctuations in response to factors such as:
o variations in our actual or anticipated quarterly operating results or
those of our competitors
o announcements by us or our competitors of technological innovations
o introduction of new products or services by us or our competitors
o changes in financial estimates by securities analysts
o conditions or trends in the Internet industry
o changes in the market valuations of other Internet companies
o announcements by us or our competitors of significant acquisitions
o our entry into strategic partnerships or joint ventures
o sales of our capital stock by RSL COM
All of these factors are, in whole or part, beyond our control and may
materially adversely affect the market price of our common stock regardless of
our performance.
Investors may not be able to resell their shares of our common stock
following periods of volatility because of the market's adverse reaction to such
volatility. In addition, the stock market in general, and the market for
Internet-related and technology companies in particular, has been highly
volatile. The trading prices of many Internet-related and technology companies'
stocks have reached historical highs within the last 52 weeks and have reflected
relative valuations substantially above historical levels. During the same
period, such companies' stocks have also been highly volatile and have recorded
lows well below such historical
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highs. We cannot assure you that our stock will trade at the same levels of
other Internet stocks or that Internet stocks in general will sustain their
current market prices.
WE DO NOT INTEND TO PAY DIVIDENDS
We have never declared or paid any cash dividends on our common stock. We
intend to retain any future earnings to finance our operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future. In addition, indentures governing outstanding indebtedness
of RSL COM restrict our ability to declare or pay cash dividends, and, for the
foreseeable future, effectively prohibit such payments or declarations.
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that address, among
other things: development of services; expansion strategy; use of proceeds;
projected capital expenditures; liquidity; development of additional revenue
sources; development and expansion of marketing relationships; market acceptance
of Internet telephony; technological advancement; ability to develop "brand"
awareness and global expansion. These statements may be found in the sections of
this prospectus entitled "Prospectus Summary," "Risk Factors," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business" and in this prospectus generally. Our
actual results could differ materially from those anticipated in these
forward-looking statements as of result of various factors, including all the
risks discussed in "Risk Factors" and elsewhere in this prospectus.
We urge you to consider that statements which use the terms "believe," "do
not believe," "expect," "plan," "intend," "estimate," "anticipate" and similar
expressions are intended to identify forward-looking statements. These
statements reflect our current views with respect to future events and are based
on assumptions and are subject to risks and uncertainties.
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USE OF PROCEEDS
We estimate that the net proceeds we will receive from the sale of the
6,000,000 shares of common stock will be approximately $82.2 million
(approximately $94.8 million if the underwriters exercise their over-allotment
option in full) after deducting the underwriting discount and estimated expenses
of this offering.
We expect that we will use the net proceeds from this offering to be
allocated as follows:
o approximately $20 million to fund marketing and promotional activities
o approximately $10 million for capital expenditures
o the balance for general corporate purposes
The preceding allocations are only an estimate and the amounts that we
actually expend will depend upon several factors, including our available cash,
the success of our marketing and promotion activities and the availability of
new business opportunities.
Pending use of the net proceeds, we intend to invest the net proceeds in
interest-bearing, investment-grade instruments, certificates of deposit, or
direct or guaranteed obligations of the United States.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
do not anticipate paying any cash dividends on our capital stock in the
foreseeable future. We currently intend to retain future earnings, if any, to
finance our operations and to expand our business. In addition, indentures
governing outstanding indebtedness of RSL COM restrict our ability to declare or
pay cash dividends, and, for the foreseeable future, effectively prohibit such
payments or declarations. Any future determination to pay cash dividends will be
at the discretion of our board of directors and will be dependent upon our
financial condition, operating results, capital requirements and other factors
that our board of directors considers appropriate.
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CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999.
Our capitalization is presented:
(1) on an actual basis
(2) on a pro forma basis to give effect to:
o the issuance of 183,901 shares of common stock to Yahoo! (including
58,626 shares issued upon the exercise of a warrant at an exercise
price of $7.98 per share, assuming a cashless exercise) in exchange
for the offset of an account payable to Yahoo! in the amount of
$1 million
o the issuance of 1,085,943 shares of common stock to CNET for
approximately $11 million (excluding a warrant to purchase 466,028
shares of common stock)
o an increase in deferred compensation attributable to RSL COM
restricted units, representing the difference between the exercise
price of the restricted units and the deemed fair value of our
common stock
o an increase in deferred compensation attributable to 1,076,761
options issued to executive officers, representing the difference
between the fair value of the options as of September 30, 1999 and
the deemed fair value of these options
(3) on a pro forma as adjusted basis to give effect to the foregoing and
to:
o the sale of 6,000,000 shares of common stock offered by us in this
offering
o the issuance of 748,288 shares in exchange for RSL COM restricted
units that have vested at a weighted average exercise price of $0.31
per share
The table excludes:
o 1,076,761 shares of common stock issuable upon the exercise of options
outstanding as of September 30, 1999 under our 1999 Stock Incentive Plan
at a weighted average exercise price of $5.11 per share
o 198,784 shares issuable upon the exercise of options to be granted under
our 1999 Directors' Plan upon completion of this offering at an exercise
price equal to the initial offering price
o 372,976 shares issuable upon the exercise of options issued in exchange
for RSL COM restricted units that have not vested at a weighted average
exercise price of $1.80 per share
18
<PAGE>
Please read this table together with the sections of this prospectus
entitled "Selected Consolidated Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements and related notes included in this prospectus.
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, 1999
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents.................................................. $ 1,293 $ 12,293 $ 94,725
--------- --------- ---------
--------- --------- ---------
Long-term debt due to affiliates........................................... $ 12,307 $ 12,307 $ 12,307
--------- --------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value per share;
25,000,000 shares authorized; no shares issued and outstanding........ -- -- --
Common stock, $0.001 par value per share;
200,000,000 shares authorized; no shares issued and outstanding
(actual), 1,269,844 shares issued and outstanding (pro forma) and
8,018,132 shares issued and outstanding (pro forma as adjusted)....... -- 1 8
Class B common stock, $0.001 par value per share;
200,000,000 shares authorized; 19,569,459 shares issued and
outstanding........................................................... 20 20 20
Additional paid-in capital................................................. 37,177 63,093 145,518
Receivable for capital stock............................................... -- (1,000) (1,000)
Deferred compensation...................................................... (6,234) (15,048) (15,048)
Accumulated deficit........................................................ (27,125) (32,228) (32,228)
--------- --------- ---------
Total stockholders' equity............................................... 3,838 14,838 97,270
--------- --------- ---------
Total capitalization.................................................. $ 16,145 $ 27,145 $ 109,577
--------- --------- ---------
--------- --------- ---------
</TABLE>
19
<PAGE>
DILUTION
As of September 30, 1999, our pro forma consolidated net tangible book
value was $4,623,909, or $0.22 per share of capital stock. "Pro forma
consolidated net tangible book value per share" represents the total amount of
our pro forma consolidated tangible assets reduced by the amount of our
consolidated liabilities and divided by the number of shares of capital stock
outstanding on a pro forma basis after giving effect to:
o the issuance of 183,901 shares of common stock to Yahoo! (including
58,626 shares issued upon the exercise of a warrant at an exercise
price of $7.98 per share, assuming a cashless exercise) in exchange
for the offset of an account payable to Yahoo! in the amount of
$1 million
o the issuance of 1,085,943 shares of common stock to CNET for
$11 million (excluding a warrant to purchase 466,028 shares of
common stock)
After giving effect to the sale of 6,000,000 shares of common stock in this
offering and receipt of the estimated net proceeds from this offering, after
deducting the underwriting discount and estimated expenses of this offering, our
pro forma consolidated net tangible book value at September 30, 1999 would have
been approximately $86.8 million, or $3.23 per share. This represents an
immediate increase in pro forma consolidated net tangible book value of $3.02
per share to our existing investors and an immediate dilution of $11.77 per
share to new investors.
"Dilution per share" represents the difference between the price per share
to be paid by new investors and the pro forma consolidated net tangible book
value per share immediately after this offering. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share.............................................. $ 15.00
Pro forma consolidated net tangible book value per share at September 30, 1999..... $ 0.22
Increase in pro forma consolidated net tangible book value per share attributable
to new investors................................................................ 3.03
---------
Pro forma consolidated net tangible book value per share after this offering......... 3.23
---------
Dilution per share to new investors.................................................. $ 11.77
---------
---------
</TABLE>
The following table summarizes, as of September 30, 1999, the differences
between the total consideration paid and the average price per share paid by
existing investors and new investors with respect to the number of shares of
common stock purchased from us.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing investors............................... 20,839,303 78% $ 30,675,714 25% $ 1.47
New investors.................................... 6,000,000 22 90,000,000 75 15.00
---------- --- ------------ ---
Total.......................................... 26,839,303 100% $120,675,714 100%
---------- --- ------------ ---
---------- --- ------------ ---
</TABLE>
The foregoing table excludes:
o 748,288 shares issuable upon exchange of RSL COM restricted units
that have vested at a weighted average exercise price of $0.31 per
share
o 1,076,761 shares of common stock issuable upon the exercise of
options outstanding as of September 30, 1999 under our 1999 Stock
Incentive Plan at a weighted average exercise price of $5.11 per
share
o 198,784 shares issuable upon the exercise of options to be granted
under our 1999 Directors' Plan upon completion of this offering at
an exercise price equal to the initial offering price
o 372,976 shares issuable upon the exercise of options issued in
exchange for RSL COM restricted units that have not vested at a
weighted average exercise price of $1.80 per share
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
We derived the selected consolidated financial data presented below from
our consolidated financial statements and related notes included in this
prospectus. You should read the selected consolidated financial data together
with our consolidated financial statements and related notes and the section of
this prospectus entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Brightman Almagor & Co., a member firm of
Deloitte Touche Tohmatsu, independent certified public accountants, audited our
historical financial statements for the period June 1996 (inception) through
December 31, 1996 and as of and for the years ended December 31, 1997 and 1998
and the nine months ended September 30, 1999. Their report appears elsewhere in
this prospectus. The selected balance sheet data as of December 31, 1996 is
derived from an audited financial statement not included in this prospectus.
Statement of operations data and balance sheet data as of and for the nine
months ended September 30, 1998 have been derived from our unaudited
consolidated financial statements that have been prepared on the same basis as
the audited financial statements and, in the opinion of management, include all
adjustments, which consist only of normal recurring adjustments, necessary for a
fair presentation of the financial position and the results of operations for
these periods. Operating results for the nine months ended September 30, 1998
and 1999 are not necessarily indicative of the results that may be expected for
the full year.
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 1996 YEAR ENDED DECEMBER NINE MONTHS ENDED
(INCEPTION) TO 31, SEPTEMBER 30,
DECEMBER 31, ------------------- --------------------
1996 1997 1998 1998 1999
--------------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Affiliates...................................... $ -- $ 468 $ 3,896 $ 2,485 $ 4,077
Non-affiliates.................................. 1 778 1,742 1,184 2,355
--------- ------- ------- ------- --------
Total revenues................................ 1 1,246 5,638 3,669 6,432
Costs and operating expenses:
Cost of revenues................................ -- (1,065) (4,657) (2,649) (5,811)
Research and development expenses............... -- (294) (651) (479) (797)
Selling and marketing expenses.................. -- (632) (2,431) (1,603) (3,087)
General and administrative expenses (exclusive
of non-cash compensation expense)............. (179) (1,388) (1,842) (1,026) (2,080)
Non-cash compensation expense................... -- -- (743) (640) (8,926)
Amortization of goodwill........................ -- (197) (2,472) (1,714) (2,274)
--------- ------- ------- ------- --------
Total costs and operating expenses............ (179) (3,576) (12,796) (8,111) (22,975)
--------- ------- ------- ------- --------
Loss from operations.............................. (178) (2,330) (7,158) (4,442) (16,543)
Interest expense, net............................. -- (38) (186) (146) (915)
Minority interests................................ -- -- 223 -- --
--------- ------- ------- ------- --------
Net loss.......................................... $ (178) $(2,368) $(7,121) $(4,588) $(17,458)
--------- ------- ------- ------- --------
--------- ------- ------- ------- --------
Net loss per share--basic and diluted............. $ (0.03) $ (0.19) $ (0.37) $ (0.24) $ (0.89)
--------- ------- ------- ------- --------
--------- ------- ------- ------- --------
Weighted average shares outstanding--basic and
diluted......................................... 6,420 12,390 19,254 19,149 19,569
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
---------------------------- --------------------
1996 1997 1998 1998 1999
---- ------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................ $130 $ 3,196 $ 1,357 $ 432 $ 1,293
Working capital (deficiency)............................. 70 2,763 (3,232) (2,274) (3,890)
Total assets............................................. 396 8,403 25,676 22,337 24,582
Long-term debt due to affiliates......................... 344 -- 5,107 2,031 12,307
Total stockholder's equity (deficiency).................. (30) 6,272 12,370 14,800 3,838
</TABLE>
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read together with our consolidated financial statements
and the related notes thereto included in another part of this prospectus.
OVERVIEW
We are a global provider of IP telephony services, which include our
carrier transmission services and enhanced Web-based and other communications
services. We were founded in 1996 to capitalize on the growth of the Internet as
a communications tool by commercially offering IP telephony services. In July
1997, RSL COM acquired a majority interest in our company, and in April 1998, we
became a wholly-owned subsidiary of RSL COM after RSL COM acquired the remaining
outstanding shares of our capital stock from third parties.
Since our inception, our primary activities have included:
o developing our business model
o hiring management and other key personnel
o building our IP network
o offering PC-to-phone, phone-to-phone and carrier transmission services
o entering into marketing relationships to promote our enhanced IP
communication services
o developing new services
o developing our interactive communications portal and customer care center
Since RSL COM's investment in our company in July 1997, we have relied on
RSL COM almost exclusively for our financing needs. With the proceeds of this
offering, we will be less dependent upon RSL COM for our funding needs.
In addition, since RSL COM's investment in our company, we have provided
RSL COM with a majority of our network capacity which has enabled us to maximize
the use of our available network capacity. We currently generate revenues
primarily from carrier transmission services for RSL COM and other
telecommunications carriers. As we continue to expand our marketing and
promotional efforts for our enhanced IP communications services, we expect
revenue from these services, over time, to represent a majority of our total
revenues. This shift in revenue mix would minimize our reliance upon carrier
transmission services for our revenues. In order to increase the number of users
of these services we believe we will have to significantly increase our
marketing and advertising expenditures. For these reasons our historical
operating results may not necessarily be indicative of our future operating
performance.
Revenues
Revenues are derived from affiliates and non-affiliates. Revenues from
affiliates consist of revenues received from RSL COM for carrier transmission
services we provide to RSL COM. The majority of the services we provide to RSL
COM are resold by RSL COM to other communications companies, and the remainder
are used directly by RSL COM's customers. Revenues from non-affiliates consist
of revenues from carriers other than RSL COM for carrier transmission services
and revenues from users of our enhanced IP communications services, including
PC-to-phone and phone-to-phone. All revenues are recognized as the service is
performed. Revenues are currently derived from usage charges on a per minute
basis. We expect our minutes of use to increase over time. However, prices have
been decreasing due to significant competition. This pricing pressure has begun
to negatively impact our gross margins, particularly with respect to our carrier
transmission services.
Carrier transmission services to RSL COM accounted for 63.4% of our total
revenues for the nine months ended September 30, 1999 and 69.1% of our total
revenues in 1998. Carrier transmission services to non-affilates accounted for
15.5% of our total revenues for the nine months ended September 30, 1999 and
5.6% of our total revenues in 1998. The provision of enhanced IP communications
services accounted for 18.7% of our total revenues for the nine months ended
September 30, 1999 and 20.5% in 1998.
22
<PAGE>
Costs and Operating Expenses
Costs and operating expenses consist of cost of revenues, research and
development expenses, selling and marketing expenses, general and administrative
expenses and amortization of goodwill.
o Cost of revenues consist primarily of access, termination and
transmission costs paid to carriers that we incur when providing services
and fixed costs associated with leased transmission lines. The term of
our contracts for leased transmission lines is generally one year and
either party can terminate with prior notice. We incurred extraordinary
costs of approximately $1,596,000 in 1998 and $1,060,000 for the nine
months ended September 30, 1999 in integrating the hardware and software
purchased from Ericsson into our network, and anticipate that we will
incur additional costs of approximately $344,000 through the end of 1999.
To compensate us for our costs, Ericsson agreed to offset our payable to
them for network telecommunications equipment that we previously
purchased from them with a fair market value of $3 million, representing
Ericsson's reimbursement of costs incurred by us. As a result we
classified this payable as deferred revenues and costs which we recognize
as an offset to cost of revenues and research and development expenses as
they are incurred.
o Research and development expenses consist primarily of costs associated
with establishing our network and the initial testing of our services and
compensation expenses of software developers involved in new product
development and software maintenance. In the future, these expenses may
fluctuate as a percentage of revenue depending on the project undertaken
during the reporting period. Since our inception, we have expensed all
research and development costs in each of the periods in which they were
incurred.
o Selling and marketing expenses consist primarily of advertising and
promotional expenses incurred to attract potential users and network
partners. We expect to substantially increase our selling and marketing
expenses as we increase our marketing efforts in order to grow our user
base and increase the frequency of use by our registered users and new
users of our services. We anticipate that as we add new paid users we
will be able to spread these costs over a larger revenue base and
accordingly improve our operating margins.
o General and administrative expenses consist primarily of compensation and
benefits for management, finance and administrative personnel, deferred
compensation expense, occupancy costs, depreciation of fixed assets and
legal and accounting fees. We expect to hire additional personnel and to
incur expenses associated with being a public company, including costs of
directors' and officers' insurance and increased legal and accounting
fees.
o Amortization of goodwill consists of amortization of the goodwill related
to the purchase by RSL COM of all of the outstanding shares of our
capital stock. In July 1997, we issued shares representing 51% of
outstanding share captital to RSL COM for $5 million. No goodwill was
recorded as a result of this issuance. However, as a result of acquiring
a controlling interest in us, RSL COM recorded goodwill in the amount of
$450,000, representing our net liabilities. RSL COM then proceeded to
offer to purchase from our stockholders all of our outstanding shares it
did not already own. By April 1998, RSL COM had paid approximately
$14.7 million in cash and securities for the remaining 49% of our shares
that it did not own and RSL COM recorded goodwill in the amount of $14.7
million. As a result of these transactions, RSL COM "pushed down" a total
of approximately $15.2 million of goodwill to our financial statements,
accounted for in our financial statements as an increase in both goodwill
and additional paid-in capital of approximately $15.2 million in the
aggregate. The goodwill is being amortized by us over a five-year period.
The amortization of this goodwill has been reflected as a charge to
operations beginning in 1997. We have recorded amortization expense of
approximately $4.9 million through September 30, 1999. The future
amortization of the unamortized goodwill balance will result in charges
of approximately $750,000 in the fourth quarter of 1999, $3.0 million in
2000, $3.0 million in 2001, $3.0 million in 2002 and $500,000 in 2003.
We have not recorded any income tax benefit for net losses and credits
incurred for any period from inception to September 30, 1999. The utilization of
these losses and credits depends on our ability to generate taxable income in
the future. Because of the uncertainty of our generating taxable income, we have
recorded a full valuation allowance with respect to these deferred assets.
23
<PAGE>
Deferred Compensation Charge
We will have to recognize significant recurring charges relating to
non-cash compensation expense due to the options to purchase 1,076,761 shares of
our common stock granted with an exercise price of $5.11 per share on April 1,
1999. The Company will recognize additional compensation expense for the
issuance of shares of our common stock and options to purchase shares of our
common stock in exchange for restricted units granted by RSL COM to our
employees. These non-cash charges will be recognized over the vesting period of
the options to be issued in exchange for unvested restricted units and in the
fourth quarter of 1999 with respect to the shares of common stock to be issued
in exchange for vested restricted units. These charges will total approximately
$26.8 million, of which $9.7 million in deferred compensation expenses has been
previously amortized. As a result, we will recognize $9.7 million in the fourth
quarter of 1999, $5.1 million during the year ending December 31, 2000, and
$2.3 million over the period from January 1, 2001 through May 31, 2002.
In addition, we will record approximately $1.0 million of deferred
compensation expense related to the sale to Yahoo! of 183,901 shares of our
common stock (including a warrant to purchase 58,626 shares of common stock). In
lieu of purchasing the shares and warrant for cash, Yahoo! agreed to offset an
account payable in the amount of $1 million that we owe to Yahoo! under a
marketing and promotional agreement as consideration for the shares and warrant.
The deferred compensation expense represents the difference between each of the
purchase price of the common stock and the exercise price of the warrant as
compared to the fair value of the common stock at the date of sale. We will
amortize this deferred compensation expense over the one year life of our
marketing and promotion agreement with Yahoo!.
We will also record approximately $2.7 million of deferred compensation
expense related to the sale to CNET of 1,085,943 shares of our common stock and
a warrant to purchase 466,028 shares of common stock for approximately
$11 million. We will amortize the deferred compensation expense over the two
year life of our promotion agreement with CNET.
RESULTS OF OPERATIONS
The following table sets forth the statement of operations data presented
as a percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30,
---------------- ----------------------------------
1997 1998 1998 1999
------ ------ --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Affiliates............................................................ 37.6% 69.1% 67.7% 63.4%
Non-affiliates........................................................ 62.4 30.9 32.3 36.6
------ ------ ------- -------
Total revenues..................................................... 100.0 100.0 100.0 100.0
Costs and operating expenses:
Cost of revenues...................................................... 85.5 82.6 72.2 90.3
Research and development expenses..................................... 23.6 11.5 13.1 12.4
Selling and marketing expenses........................................ 50.7 43.1 43.7 48.0
General and administrative expenses (exclusive of non-cash
compensation expense).............................................. 111.4 32.7 28.0 32.3
Non-cash compensation expense......................................... -- 13.2 17.4 138.8
Amortization of goodwill.............................................. 15.9 43.9 46.7 35.4
------ ------ ------- -------
Total costs and operating expenses................................. 287.1 227.0 221.1 357.2
------ ------ ------- -------
Loss from operations.................................................... (187.1) (127.0) (121.1) (257.2)
Interest expense, net................................................... (3.0) (3.3) (4.0) (14.2)
Minority interests...................................................... -- 4.0 -- --
------ ------ ------- -------
(190.1)% (126.3)% (125.1)% (271.4)%
------ ------ ------- -------
------ ------ ------- -------
</TABLE>
24
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
Revenues
Affiliates. Revenues from affiliates were $4.1 million for the nine months
ended September 30, 1999 compared to $2.5 million for the nine months ended
September 30, 1998, an increase of $1.6 million, or 64.1%. The increase in
revenues from affiliates was due to an increase in sales of our services to RSL
COM. The increase in sales to RSL COM was due to the growth in our network
resulting in our ability to provide additional capacity to RSL COM and an
increase in demand for our services from RSL COM offset by decreases in prices.
Non-affiliates. Revenues from non-affiliates were $2.4 million for the
nine months ended September 30, 1999 compared to $1.2 million for the nine
months ended September 30, 1998, an increase of $1.2 million or 98.9%. Revenues
from carrier transmission services for telecommunications carriers other than
RSL COM were $1.0 million for the nine months ended September 30, 1999 compared
to $90,848 for the nine months ended September 30, 1998, an increase of
$928,418, or 1,021.9%. The increase was due primarily to an increased demand
from a larger customer base. Revenues from enhanced IP communications services
were $1.2 million for the nine months ended September 30, 1999 compared to
$729,414 for the nine months ended September 30, 1998, an increase of $499,051,
or 68.4%. The increase in revenues from enhanced IP communications services was
due to a greater number of PC-to-phone and phone-to-phone calls being placed by
an increasing user base.
Revenues from carrier transmission services to RSL COM and other
telecommunications carriers accounted for 79.2% and 74.7% of revenues for the
periods ended September 30, 1999 and 1998, respectively. Other than RSL COM, no
other customer accounted for greater than 5% of our revenues during these
periods. We expect that revenues from carrier transmission services to RSL COM
and other carriers will continue to account for a majority of our revenues
through at least the end of 2000.
Costs and Operating Expenses
Cost of revenues. Cost of revenues were $5.8 million for the nine months
ended September 30, 1999 compared to $2.6 million for the nine months ended
September 30, 1998. During the nine months ended September 30, 1999, we
recognized a reduction in our costs of revenues of $299,136 as compared to
$506,250 for the nine months ended September 30, 1998 as a result of the
reimbursement of certain costs from Ericsson, our primary equipment vendor.
Excluding this reimbursement, cost of revenues would have been $6.1 million for
the nine months ended September 30, 1999 compared to $3.2 million for the nine
months ended September 30, 1998, an increase of $2.9 million, or 93.7%. The
increase in cost of revenues (excluding the reimbursement) was due primarily to
the increased costs associated with the increase in carrier transmission
services.
Research and development expenses. Research and development expenses were
$797,273 for the nine months ended September 30, 1999 compared to $479,030 for
the nine months ended September 30, 1998. During the nine months ended
September 30, 1999, we recognized reimbursement from Ericsson for expenses we
incurred in research and development of $760,285 compared to $488,951 for the
nine months ended September 30, 1998. Excluding this reimbursement, research and
development costs would have been $1.6 million for the nine months ended
September 30, 1999 compared to $968,000 for the nine months ended September 30,
1998, an increase of $589,577, or 60.9%. The increase in research and
development expenses (excluding the reimbursement) was due to greater costs
incurred in hiring personnel to develop new services and enhancements to our
existing services.
Selling and marketing expenses. Selling and marketing expenses were
$3.1 million for the nine months ended September 30, 1999 compared to
$1.6 million for the nine months ended September 30, 1998, an increase of
$1.5 million, or 92.6%. The increase in selling and marketing expenses was due
to the expansion of our marketing and promotional activities.
General and administrative expenses. General and administrative expenses
(exclusive of non-cash compensation expenses) were $2.1 million for the nine
months ended September 30, 1999 compared to
25
<PAGE>
$1.0 million for the nine months ended September 30, 1998, an increase of
$1.1 million, or 102.7%. The increase in general and administrative expenses was
primarily due to additional personnel and increased occupancy costs. We expect
that general and administrative expenses will continue to increase as we pay
executive compensation previously paid by RSL COM.
Non-cash compensation expenses. Non-cash compensation expenses were
$8.9 million for the nine months ended September 30, 1999 compared to $640,165
for the nine months ended September 30, 1998, an increase of $8.3 million, or
1,294.4%. The increase in non-cash compensation expenses was due to the
recognition of compensation expense for grants of employee stock options and RSL
COM restricted units held by our employees that are to be converted into shares
of our common stock or options to purchase our common stock upon completion of
this offering.
Amortization of goodwill. Amortization of goodwill was $2.3 million for
the nine months ended September 30, 1999 compared to $1.7 million for the nine
months ended September 30, 1998, an increase of $559,300, or 32.6%. The increase
in amortization of goodwill was due to a significant increase in goodwill during
1998 that resulted from RSL COM's acquisition of the remaining outstanding
shares of our common stock that it did not already own.
Loss from Operations
Loss from operations was $16.5 million for the nine months ended
September 30, 1999 compared to $4.4 million for the nine months ended
September 30, 1998, an increase of $12.1 million, or 272.4%. The increase in
loss from operations was due primarily to the increase in costs and operating
expenses, including non-cash compensation expense, and a decrease in prices we
charged for carrier transmission services. We expect to continue to incur losses
for the foreseeable future.
Interest Expense, Net
Interest expense, net was $914,901 for the nine months ended September 30,
1999 compared to $145,910 for the nine months ended September 30, 1998, an
increase of $768,991 or 527.0%. The increase in interest expense was primarily
due to increased borrowings from RSL COM to finance our working capital and
capital expenditure requirements.
Net Loss
Net loss was $17.5 million for the nine months ended September 30, 1999
compared to $4.6 million for the nine months ended September 30, 1998, an
increase of $12.9 million, or 280.5%. The increase in net loss was due to the
foregoing factors.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues
Affiliates. Revenues from affiliates were $3.9 million for the year ended
December 31, 1998 compared to $467,842 for the year ended December 31, 1997, an
increase of $3.4 million, or 732.8%. The increase in revenues from affiliates
was due to an increase in sales of our services to RSL COM. The increase in
sales to RSL COM was attributable to the growth in our network resulting in our
ability to provide additional capacity to RSL COM and an increase in demand for
our services from RSL COM.
Non-affiliates. Revenues from non-affiliates were $1.7 million for the
year ended December 31, 1998 compared to $777,799 for the year ended
December 31, 1997, an increase of $964,142, or 124.0%. Revenues from carrier
transmission services for telecommunications carriers other than RSL COM were
$317,503 for the year ended December 31, 1998 compared to $56,882 for the year
ended December 31, 1997, an increase of $260,621, or 458.2%. Revenues from
enhanced IP communications services were $1.2 million for the year ended
December 31, 1998 compared to $202,643 for the year ended December 31, 1997, an
increase of $951,151, or 469.4%. The increase in revenues from carrier
transmission and enhanced IP communications services was due to an increase in
the destinations we could terminate traffic to as a result of the expansion
26
<PAGE>
of our network and an increasing user base. Revenues from equipment sales were
$270,644 for the year ended December 31, 1998 compared to $498,504 for the year
ended December 31, 1997, a decrease of $227,860, or 45.7%. The decrease was due
primarily to our decision to focus on enhanced IP communications services rather
than equipment sales. Equipment sales are not expected to constitute a material
portion of revenues in the future.
Costs and Operating Expenses
Cost of revenues. Cost of revenues were $4.7 million for the year ended
December 31, 1998 compared to $1.1 million for the year ended December 31, 1997.
For the year ended December 31, 1998, we recognized a reduction in cost of
revenues of $694,250 as a result of the reimbursement for certain costs from
Ericsson. Excluding this reimbursement, cost of revenues would have totalled
$5.4 million, an increase of $4.3 million, or 402.5%. The increase in cost of
revenues (excluding the reimbursement) was due primarily to the increased costs
associated with the significant increase in carrier transmission services.
Research and development expenses. Research and development expenses were
$650,140 for the year ended December 31, 1998 compared to $294,150 for the year
ended December 31, 1997. For the year ended December 31, 1998, we recognized
reimbursement from Ericsson for expenses we incurred in research and development
of $901,385. Excluding this reimbursement, research and development expenses
would have been $1.6 million, an increase of $1.3 million, or 427.5%. The
increase in research and development expenses (excluding the reimbursement) was
due to greater costs incurred in hiring personnel to develop new services and
enhancements to our existing services.
Selling and marketing expenses. Selling and marketing expenses were
$2.4 million for the year ended December 31, 1998 compared to $631,970 for the
year ended December 31, 1997, an increase of $1.8 million, or 284.7%. The
increase in selling and marketing expenses was due to the expansion of our
marketing and promotional activities.
General and administrative expenses. General and administrative (exclusive
of non-cash compensation expense) expenses for the year ended December 31, 1998
were $1.8 million compared to $1.4 million for the year ended December 31, 1997,
an increase of $454,764, or 32.8%. The increase in general and administrative
expenses was primarily due to additional personnel and increased occupancy
costs.
Non-cash compensation expense. Non-cash compensation expenses were
$742,780 for the year ended December 31, 1998 compared to zero for the year
ended December 31, 1997. The increase in non-cash compensation expense was due
to the recognition of compensation expense for grants of employee stock units.
Amortization of goodwill. Amortization of goodwill was $2.5 million for
the year ended December 31, 1998 compared to $197,249 for the year ended
December 31, 1997, an increase of $2.3 million, or 1,153.3%. The increase in
amortization of goodwill is due to an increase in goodwill which grew
significantly during 1998 as a result of RSL COM acquiring the remaining
outstanding shares of our company.
Loss from Operations
Loss from operations was $7.2 million for the year ended December 31, 1998
compared to $2.3 million for the year ended December 31, 1997, an increase of
$4.9 million, or 207.2%. The increase in loss from operations was due primarily
to the increase in costs and operating expenses and to a decrease in prices we
charged for carrier transmission services.
Interest Expense, Net
Interest expense, net was $186,295 for the year ended December 31, 1998
compared to $37,232 for the year ended December 31, 1997, an increase of
$149,063, or 400.4%. The increase in interest expense was due to increased
borrowings from RSL COM to support our working capital and capital expenditure
requirements.
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Net Loss
Net loss was $7.1 million for the year ended December 31, 1998 compared to
$2.4 million for the year ended December 31, 1997, an increase of $4.7 million,
or 200.8%. The increase in net loss was due to the foregoing factors.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE PERIOD FROM JUNE 1996 (INCEPTION)
TO DECEMBER 31, 1996
Revenues
Affiliates. Revenues from affiliates were $467,842 for the year ended
December 31, 1997. Revenues from RSL COM commenced in August 1997 shortly
following RSL COM's investment in us, and, accordingly, we did not generate any
revenues from RSL COM in 1996.
Non-affiliates. Revenues from non-affiliates were $777,799 for the year
ended December 31, 1997 compared to $933 for the seven month period ended
December 31, 1996. We commenced sales activities during the fourth quarter of
1996 and did not realize any material sales during 1996. Revenues from carrier
transmission services for telecommunications carriers other than RSL COM
commenced in 1997 and were $56,882 for the year. We did not commence the
commercial sale of enhanced IP communications services until the first quarter
of 1997. Revenues from enhanced IP communications services were $202,643 for the
year ended December 31, 1997. Revenues from equipment sales for the year ended
December 31, 1997 were $498,504.
Costs and Operating Expenses
Cost of revenues. Cost of revenues was $1.1 million for the year ended
December 31, 1997. No such costs were incurred during 1996 since sales and
services had not yet commenced.
Research and development expenses. Research and development expenses were
$294,150 for the year ended December 31, 1997. No such costs were incurred in
1996 since research and development activities had not yet commenced.
Selling and marketing expenses. Selling and marketing expenses were
$631,970 for the year ended December 31, 1997. No such costs were incurred in
1996 since marketing efforts had not yet commenced.
General and administrative expenses. General and administrative expenses
for the year ended December 31, 1997 were $1.4 million compared to $179,138 for
the seven month period ended December 31, 1996, an increase of $1.2 million, or
674.6%. The increase in general and administrative expenses was primarily due to
additional personnel and increased occupancy costs that we incurred in
connection with the commencement of our commercial activities, as well as fees
and expenses incurred in connection with a private placement during 1997.
Amortization of goodwill. Amortization of goodwill was $197,249 for the
year ended December 31, 1997. We did not have any intangible assets during 1996.
Loss from Operations
Loss from operations was $2.3 million for the year ended December 31, 1997
compared to $178,205 for the seven month period ended December 31, 1996. The
increase in loss from operations was due to the increased costs associated with
our commencing commercial operations and establishing our network
infrastructure.
Interest Expense, Net
Interest expense, net was $37,232 for the year ended December 31, 1997
compared to $397 for the seven month period ended December 31, 1996. The
increase in interest expense was primarily due to accrued interest on our
convertible notes issued in a private placement during 1996.
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Net Loss
Net loss was $2.4 million for the year ended December 31, 1997 compared to
$178,602 for the seven month period ended December 31, 1996. The increase in net
loss was a result of the foregoing factors.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception in June 1996, we have incurred significant operating
and net losses due in large part to the start-up and development of our
operations. As of September 30, 1999, we had an accumulated deficit of
approximately $27.1 million. We anticipate that we will continue to incur
operating and net losses as we implement our growth strategy.
From our inception, we funded losses and capital expenditures from cash
provided from financing activities, primarily the net proceeds of the private
placement of:
o capital stock sold to RSL COM for an aggregate amount of approximately
$5.0 million in July 1997
o capital stock and units of convertible notes and warrants to purchase our
capital stock sold to unrelated third parties for an aggregate amount of
approximately $0.6 million from July 1997 to April 1998
o capital stock sold to CNET for an aggregate amount of approximately
$11.0 million in October 1999
In July 1997, RSL COM acquired a 51% interest in our company for
approximately $5.0 million. Between July 1997 and April 1998, RSL COM acquired
all of the remaining shares of our outstanding capital stock from our
shareholders for approximately $14.7 million. In April 1998, our company was
merged into a wholly-owned subsidiary of RSL COM. Since RSL COM's acquisition of
a controlling interest in us in July 1997, RSL COM has funded our cash
requirements, which we have accounted for as inter-company loans bearing
interest at the rate of 14% per annum, due on demand after June 30, 2000. Upon
completion of an initial public offering by us, the maturity dates will be
extended to the first anniversary of the completion of such offering. As of
September 30, 1999, we owed approximately $12.3 million (principal and accrued
interest) to RSL COM.
Prior to the closing of this offering, RSL COM will provide us with a
$10 million line of credit (exclusive of the existing $12.3 million owed to RSL
COM as of September 30, 1999), due on demand after November 1, 2000 and bearing
interest at the rate of 14% per annum, which will be available to fund our
operating expenses. We are not subject to any negative or financial covenants
under either the RSL COM inter-company loans or line of credit. Although we are
neither the debtor nor the guarantor under any of the indentures that govern a
substantial amount of RSL COM's debt, we are subject to financial restrictions
by reason of our status as a restricted subsidiary of RSL COM under such
indentures. Such restrictions significantly limit and could prohibit the ability
of RSL COM and its restricted subsidiaries, including our company, to incur
additional indebtedness or to create liens on their assets. The limitations on
indebtedness under the indentures generally are based on the application of
tests derived from RSL COM's consolidated financial statements. Effectively, our
ability to incur indebtedness is limited by the amount of indebtedness that RSL
COM and its restricted subsidiaries, including our company, are permitted to
incur under the indentures. The limitations under RSL COM's restrictive
indenture covenants currently prohibit us from incurring any significant amount
of additional debt. We have further agreed with RSL COM that we will not incur
any debt other than inter-company debt without its written consent so long as we
are a restricted subsidiary.
In 1998 and during the nine months ended September 30, 1999, we incurred
approximately $6.0 million and $2.0 million, respectively, in capital
expenditures, including purchases of network components, the expansion of our
network and computer hardware and software costs. We expect to incur
approximately $10.0 million in additional capital expenditures through the end
of 2000.
As of September 30, 1999, we had approximately $1.3 million in cash and
cash equivalents. Principal uses of cash have been to fund operating losses,
working capital requirements and capital expenditures. We have had significant
negative cash flows from operating activities for each annual and quarterly
period to date.
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Net cash used in operating activities was $186,247 for the period from June
1996 to December 31, 1996, $1.6 million for the year ended December 31, 1997 and
$3.8 million for the year ended December 31, 1998. Net cash used in operating
activities was $2.8 million for the nine months ended September 30, 1998 and
$4.7 million for the nine months ended September 30, 1999. Net cash used in
operating activities in these periods consisted mostly of net operating losses
partially offset by increases in trade payables and deferred revenues.
Net cash used in investing activities was $205,809 for the period from June
1996 to December 31, 1996, $949,137 for the year ended December 31, 1997 and
$3.1 million for the year ended December 31, 1998. Net cash used in investing
activities was $2.0 million for both of the nine month periods ended
September 30, 1998 and 1999. Net cash used in investing activities in these
periods consisted mostly of capital expenditures for the purchase of computer
software and network equipment.
Net cash provided by financing activities was $522,048 for the period from
June 1996 to December 31, 1996, $5.6 million for the year ended December 31,
1997, and $5.0 million for the year ended December 31, 1998. Net cash provided
by financing activities was $2.0 million for the nine months ended
September 30, 1998 and $6.6 million for the nine months ended September 30,
1999. Cash provided by financing activities from June 1996 to December 31, 1997,
consisted primarily of proceeds from sales of capital stock and the issuance of
convertible notes and warrants to purchase capital stock, which was partially
offset by repayment of shareholder loans, short-term bank loans and loans from
RSL COM. For the year ended December 31, 1998 and the nine month periods ended
September 30, 1999 and 1998, cash provided by financing activities consisted of
borrowings from RSL COM.
RSL COM has agreed to continue to fund us through the earlier of the
completion of this offering and December 31, 2000. We believe that the net
proceeds from this offering, together with our existing cash and cash
equivalents, will be sufficient to meet our working capital requirements,
including operating losses, and capital expenditure requirements for at least
the next 18 months, assuming our business plan is implemented successfully.
Thereafter, we will be required to raise additional funds. Additional financing
may not be available when needed or, if available, such financing may not be on
terms favorable to us. If additional funds are raised through the issuance of
equity securities, our existing stockholders may experience significant
dilution. In addition, the indentures governing outstanding indebtedness of RSL
COM restrict our ability to incur indebtedness. We also have agreed with
RSL COM not to incur any debt (other than inter-company debt) without its
written consent so long as we are a restricted subsidiary of RSL COM. Those
limitations may require us to resort to other sources of funding, such as the
issuance of equity, we may need to rely upon RSL COM to provide any additional
capital to meet our working capital and capital expenditure requirements, and we
cannot assure you that RSL COM or any other third party will be willing or able
to provide additional capital on favorable terms or at all.
FRAUD PREVENTION
With the recent substantial growth of Internet use and e-commerce, the
Internet business community has been subject to significant credit card fraud.
We have attempted to reduce our exposure to such fraud by introducing various
advanced procedures and proprietary fraud prevention systems that monitor and
identify patterns and sources of credit card fraud and prevent fraudulent
transactions. We employ a full-time staff dedicated to monitoring fraudulent
activities. Once a fraud pattern is detected, the fraud pattern is brought to
the attention of our data programmers who seek to take appropriate action to
counter the fraudulent activity. As a result, we have been able to reduce our
credit card fraud exposure, which reached a peak of 19% of gross revenues during
1998, to less than 1% of gross revenues for the nine months ended September 30,
1999.
We have established reserves for bad debts in accordance with historical
levels of uncollectible receivables resulting primarily from such fraudulent
practices, on the basis of specific accounts receivable. Nevertheless, our
actual losses may exceed such reserves and could rise significantly above
anticipated levels. We cannot assure you that we will continue to be successful
in reducing or maintaining our current level of credit card fraud exposure.
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YEAR 2000 COMPLIANCE
The "Year 2000 issue" is the result of computer systems and programs using
two digits (rather than four) to identify a given year. Computer systems that
have time sensitive software may interpret the date code "00" as the year 1900
rather than the year 2000. This could result in a major system failure or
miscalculations or other computer errors causing disruptions of operations. The
potential for failures encompasses all aspects of our business, including our
computer systems and IP network, and could cause, among other things,
disruptions in the operation of the Internet and our interactive communications
portal and a temporary inability to engage in normal business activities.
Our State of Readiness
We may be affected by the Year 2000 issue related to our information
technology (IT) systems and non-IT systems operated by us or third parties.
Our IT systems include:
o gateways and gatekeepers developed by Ericsson
o routers developed by Cisco Systems, Inc.
o Hewlett-Packard Company Open View software
o software developed in-house to manage our network and support our portal
Our non-IT systems include:
o internal telephone systems
o leased office spaces and facilities
o office equipment
We completed a comprehensive assessment of the Year 2000 readiness of our
and third parties' IT and non-IT systems to ensure that these systems are, or
prior to December 31, 1999 will be, Year 2000 compliant. Our assessment plan
consisted of:
o conducting a comprehensive inventory of our IT and non-IT systems to
assess Year 2000 compliance
o testing our internally developed software and the commercial hardware and
software that support our network, Web site and other systems
o contacting third party vendors, suppliers and service providers of
material hardware, software and services necessary for the delivery of
our services to our users
o remediating any Year 2000 issues by repairing or, if necessary, replacing
any non-compliant systems
We completed our assesment plan which consisted of simulating and testing
the functioning of our entire network during the change from December 31, 1999
to January 1, 2000. We also successfully simulated and tested the functioning of
each individual component of our network during the change from December 31,
1999 to January 1, 2000. The tests were repeated several times and on each
occasion the network and each individual component of it functioned without any
interruption. We believe that the IT systems that we have developed internally
to operate our business are Year 2000 compliant based on the results of such
testing and because all of the software code for the systems that we have
internally developed is written with four digits to define the applicable year.
We have completed our assessment of our non-IT systems which we have identified
as containing embedded technology and, as a result, we are not aware of any Year
2000 issues relating to our non-IT systems which would cause disruptions in our
operations or impede our ability to provide services to our users.
Because third parties have developed and currently support many of the
systems we use, in addition to assessing our internal systems, a significant
part of our efforts have been to ensure that our externally developed IT and
non-IT systems are Year 2000 compliant. We have obtained confirmation from all
of our principal third party vendors, suppliers and service providers, including
Ericsson, Cisco and Hewlett-Packard,
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either directly in writing or via their Web sites, that they believe they have
resolved the Year 2000 issues relating to the systems, services and products
supplied to us.
Costs to Address Our Year 2000 Issues
To date, we have spent $50,000 on Year 2000 compliance issues through
September 30, 1999. Our costs primarily relate to the operating costs associated
with time spent by employees in the evaluation process and Year 2000 compliance
matters generally.
Risks of Our Year 2000 Issues
We are not currently aware of any Year 2000 compliance issues relating to
our systems that would cause disruptions in our operations or impede our ability
to provide our services. We cannot predict the extent to which the Year 2000
issue will affect our vendors, suppliers or service providers, or the extent to
which we would be vulnerable if such parties fail to resolve any Year 2000
issues on a timely basis. Year 2000 assessment and testing did not identify any
material non-compliant systems operated by us or our vendors, suppliers and
service providers. Therefore, the most reasonably likely worst case Year 2000
scenario is a systemic failure beyond our control, such as a prolonged
disruption or failure of the Internet or the telecommunications infrastructure.
Any failures or disruptions could prevent us from operating our network or
prevent users from accessing our portal and services, which could result in loss
of users, lost revenues, increased operating costs and material disruptions in
the operation of our business.
Our Contingency Plan
We do not currently have our own contingency plan to handle the most
reasonably likely worst case Year 2000 scenario that may occur if systems we are
dependent upon are not Year 2000 compliant and fail to operate effectively after
December 31, 1999. However, our systems are included in RSL COM's contingency
plans.
The primary goal of RSL COM's contingency plan is to identify, analyze and
correct any potential network or service interruptions related to Year 2000
problems that arise during the weekend of December 31, 1999 through Monday,
January 3, 2000. To achieve this goal, RSL COM intends to fully staff its
network operations centers, including ours, during the date change weekend to
monitor systems, and to take actions to ensure calls are completed, including
through the use of alternative quality back-ups to re-route traffic if
necessary. We expect that our network operations center will be in constant
communication with RSL COM's other network communications centers.
CURRENCY FLUCTUATIONS
We believe our exposure to foreign currency risk is immaterial. We have no
financial instruments denominated in any currency other than U.S. dollars and
are not party to any transactions that are sensitive to foreign currency
exchange rates. All of our revenues are in U.S. dollars and substantially all of
our costs are incurred in dollars, other than the salaries of our employees
located in Israel which are incurred in New Israeli Shekels, or NIS. Therefore,
we believe any appreciation of the NIS would have an immaterial effect on our
results of operations.
MARKET RISK
We believe our exposure to market risk is immaterial. We currently do not
invest in, or otherwise hold, for trading or other purposes, any financial
instruments subject to market risk.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position
No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use" (SOP No. 98-1). This statement is applicable to our 1999
financial statements and requires us to capitalize certain payroll and payroll
related costs and other costs that are
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directly related to the development of certain of our systems. We amortize these
costs over the anticipated life of the systems. The adoption of SOP No. 98-1 did
not have a material impact on our financial statements.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities." Statement of Position 98-5, which is effective for fiscal years
beginning after December 15, 1998, provides guidance on the financial reporting
of start-up costs and organization costs. It requires costs of start-up
activities and organization costs to be expensed as incurred. We have expensed
these costs historically and therefore the adoption of this standard had no
impact on our results of operations, financial position or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging
Activities," (SFAS No. 133) which establishes accounting and reporting standards
for derivative instruments and hedging activities. Generally, it requires that
an entity recognize all derivatives as either an asset or liability and measure
those instruments at fair value, as well as identify the conditions for which a
derivative may be specifically designed as a hedge. SFAS No. 133 is effective
for all fiscal years beginning after June 15, 2000. We do not currently engage
or plan to engage in derivative or hedging activities and therefore there will
be no material impact to our results of operations, financial position or cash
flows upon the adoption of this standard.
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BUSINESS
OVERVIEW
We are a global provider of IP telephony services, which include our
carrier transmission services and enhanced Web-based and other communications
services. We have built a privately-managed, global network using IP technology,
and we have primarily been using this network to transmit traffic for
communications carriers, including RSL Communication, Ltd., our parent company.
We are now using our expertise in IP telephony to provide our users with a
package of enhanced IP communications services. Our interactive communications
portal, www.deltathree.com, is a single on-line source for the communications
needs of our users anywhere in the world. By combining user-friendly, Web-based
access with the advanced functionality of our privately-managed, global IP
telephony network, we offer our users a comprehensive solution for IP
communications services.
We currently offer the following services:
o PC-to-phone service, which enables our users to make calls directly from
their personal computers to a telephone
o D3 Box, our unified messaging service, which permits our users to
conveniently retrieve through a single-source all voice mails, e-mails
and faxes through the Web or by phone
o Click IT, which allows a party to simultaneously view a Web site and talk
directly with the business sponsoring the Web site
o Phone-to-phone service, which enables our users to make calls and send
faxes using a traditional telephone and fax machine at less-expensive
rates than available through traditional carriers
o Global roaming service, which enables businesses and individuals to use a
single account number to access our network from locations throughout the
world using country-specific, toll-free access numbers
We provide our services at a cost that is generally lower than that charged
by traditional carriers, because we minimize our network costs by using
efficient packet-switched technology and because we generally avoid local access
charges and by-pass international settlement charges by routing international
long distance calls over our privately managed network.
Our user base for enhanced IP communications services is expanding. At
December 31, 1998, we had more than 185,000 users of our enhanced IP
communications services, and as of October 1, 1999, we had more than 875,000
users, which include users of both our prepaid and promotional services. We
offer some of our services on a prepaid basis while we offer other services
without charge to attract and retain users. Over 55,000 of our users have paid
for our services.
Carrier transmission services generated 79.2% of our total revenues for the
nine months ended September 30, 1999 and 74.7% in 1998. Enhanced IP
communications services generated 18.7% of our total revenues for the nine
months ended September 30, 1999 and 20.5% in 1998. Historically, substantially
all of our revenues from enhanced IP communications services have been generated
from PC-to-phone and phone-to-phone, as our other services were only recently
introduced.
OUR OPPORTUNITY
GROWTH OF THE INTERNET AND E-COMMERCE
The Internet has emerged as a significant global communications and
commercial medium, enabling millions of people worldwide to communicate and
providing businesses with an attractive means of marketing and selling their
products and services. International Data Corporation (IDC), a market research
firm, estimates that there were approximately 142 million Internet users
worldwide at the end of 1998, and that the
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number of users worldwide will increase to approximately 500 million at the end
of 2003. Internet users are increasingly using the Web as a way to communicate.
Jupiter Communications, a market research firm, estimates that approximately
92.3% of all Internet users regularly use e-mail and 20.6% of all Internet users
regularly participate in on-line "chat" rooms. Further, Jupiter estimates that
an additional approximate 5.2% of all Internet users occasionally use e-mail and
an additional 32.4% of all Internet users occasionally participate in on-line
"chat" rooms. In addition, a recent study by E-Marketer, a market research firm,
estimates that 9.4 billion e-mail messages are delivered daily. Internet users
are also increasingly using the Web to purchase goods and services. IDC
estimates that Internet users worldwide purchased more than $50.0 billion of
goods and services in 1998, and that commerce over the Internet will grow to
approximately $1.3 trillion of goods and services in 2003.
THE INCREASING SIGNIFICANCE OF IP COMMUNICATIONS
Historically, the communications services industry has transmitted voice
and data over separate networks using different technologies. Traditional
carriers have typically built telephone networks based on circuit switching
technology, which establishes and maintains a dedicated path for each telephone
call until the call is terminated. Although a circuit-switched system reliably
transmits voice communications, circuit switching does not efficiently use
transmission capacity. When a telephone call is placed, a circuit is
established, and the circuit remains dedicated for transmission of the call and
unavailable to transmit any other call.
Data networks have typically been built utilizing packet switching
technology, such as IP, which divides signals into packets that are
simultaneously routed over different channels to a final destination where they
are reassembled in the original order in which they were transmitted. Packet
switching provides for more efficient use of the capacity in the network because
the network does not establish dedicated circuits and does not require a fixed
amount of bandwidth to be reserved for each transmission. As a result,
substantially greater traffic can be transmitted over a packet-switched network,
such as the Internet, than a circuit-switched network.
Traditional telecommunications carriers have historically avoided the use
of packet switching for transmitting voice calls due to poor sound quality
attributable to delays and lost packets which prevent real-time transmission.
However, recent improvements in packet switching, compression and broadband
access technologies, improved hardware and the use of privately-managed networks
(such as our network) have significantly improved the quality of packet-switched
voice calls, allowing for real-time transmission. Service providers that use
privately managed networks are able to reduce packet loss and latency, or delay,
because they are able to control the amount, timing and route of data
transmitted.
As a result, packet switching technology is now allowing service providers
to converge their traditional voice and data networks and more efficiently
utilize their networks by carrying voice, fax and data traffic over the same
network. These improved efficiencies of packet-switching technology create
network cost savings that can be passed on to the consumer in the form of lower
long distance rates. In addition, international telephone calls carried over the
Internet or private IP networks are less expensive than similar calls carried
over circuit-switched networks primarily because they bypass the international
settlement process, which represents a significant portion of international long
distance tariffs.
IDC estimates that in 1999, approximately 2.7 billion minutes will be
carried over IP networks, generating approximately $0.6 billion in revenues. IDC
also estimates that by 2004, IP minutes (retail and wholesale) and revenues will
grow to approximately 135.0 billion minutes and approximately $20.7 billion,
representing estimated compound annual growth rates of 119% and 103%,
respectively.
Beyond cost savings, we believe that advanced IP communications
technologies will further the potential for the Internet to become the preferred
medium of communications and commerce. For example, the integration of voice
communications into the Web could serve to enhance existing text-based modes of
Internet communications, such as e-mail and online chat, by adding a live,
low-cost means to communicate. In addition, the advanced functionality of IP
communications will provide e-commerce shoppers with the ability to speak
directly with customer service representatives of on-line retailers providing
the on-line retailer with the ability to offer responsive, real-time customer
support and service.
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INCREASE IN MODES OF COMMUNICATION
The global communications services industry, encompassing voice, fax and
data transmission, is experiencing significant growth. We believe the growth in
global communications services is being driven by:
o globalization of the world's economies and the worldwide trend toward
communications deregulation and liberalization
o the growth of data and Internet traffic
o declining prices and a wider choice of products and services
o technological advances and greater investment in communications
infrastructure
In addition, technological advancements have allowed for multiple modes of
communication, such as cellular, voice-mail, e-mail and fax. We expect rapid
growth in demand for services that unify and simplify the communications needs
of users. For example, IDC expects that the market for unified messaging
services will be more than $3.0 billion in 2002 from virtually nothing in 1997
and 1998.
LIMITATIONS OF EXISTING IP COMMUNICATIONS SOLUTIONS
Although the growth of IP telephony historically has been limited by poor
sound quality attributable to delays and packet loss, recent technological
advancements have significantly improved the quality of packet-switched
telephone calls. As a result, several large long distance carriers, including
AT&T and Sprint, have announced IP telephony service offerings.
In addition, most smaller service providers have begun to offer low-cost
Internet telephony services from PCs to telephones and from telephones to
telephones. Many of these service providers, however, offer their services only
in certain geographic areas and provide limited services. In addition, many of
these service providers use the Internet for transmission, rather than a
privately-managed IP network. In using the Internet, rather than a
privately-managed IP network, for transmission, these service providers have
less control over the network management and monitoring functions that are
necessary to ensure quality of service. Most of these service providers have not
had the benefit of a well-capitalized parent company to help finance a global,
privately-managed network.
OUR SOLUTION
To capitalize on the above trends, we offer a comprehensive communications
solution that combines the power of the Internet's communications and e-commerce
capabilities with the advanced functionality of a privately-managed IP network.
Key advantages we offer our users include:
o A SINGLE SOURCE FOR ACCESSING EVERYDAY MODES OF COMMUNICATION. Our
interactive communications portal is a one-stop source which allows our
users to manage and access everyday modes of communication, including
voice, fax and e-mail.
o USER-FRIENDLY, WEB-BASED ACCESS. Simply by clicking on our interactive
communications portal, our users can make PC-to-phone calls directly from
their computers and access their D3 Box to send e-mail and retrieve and
forward voice mail, e-mail and faxes from anywhere in the world at any
time. We believe that this offers users a more convenient and efficient
communications experience than that of traditional methods.
o A PRIVATELY-MANAGED IP NETWORK PROVIDING HIGH-QUALITY SERVICE. Our
privately-managed IP network enables us to achieve quality of service
levels that may not be available by utilizing the often congested
Internet, where voice calls are mixed with unpredictable traffic from the
Web. Our network operations center allows us to monitor all aspects of
our network 24 hours a day, 7 days a week, to provide uninterrupted and
continuous service to our users.
o VOICE INTEGRATED ON-LINE RETAILING. Our Click IT service allows
e-commerce shoppers to place a call to customer service representatives
of on-line retailers and other Web-based businesses while viewing
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the retailers' or businesses' Web sites. This provides e-commerce
shoppers with the opportunity to receive live customer service and the
ability to provide credit card information directly to a customer service
representative, thereby increasing the likelihood of consummating an
on-line transaction.
o GLOBAL REACH. We operate a privately-managed, IP telephony network, with
45 POPs in 29 countries. We are able to offer services to our users by
providing local access to our network as well as global access to our
services through the Web. In addition, through our POPs and the call
termination services provided to us by RSL COM, we are able to
cost-effectively terminate IP voice and fax communications worldwide.
o LOWER COSTS. We are able to charge lower rates than traditional long
distance carriers because we minimize our network costs by using
packet-switched technology, and because we generally avoid local access
charges and by-pass international settlement charges by routing
international long distance calls over our privately-managed IP network.
o COMPREHENSIVE USER SUPPORT THROUGH OUR ON-LINE INTERACTIVE CUSTOMER CARE
CENTER. Through our interactive communications portal, we have moved and
consolidated traditional customer care functions onto the Web. Our
comprehensive customer care and real-time billing center, which is
accessible directly on the Web, provides our users with the ability to
access their deltathree.com account to check billing and usage
information, increase their prepaid accounts and electronically
communicate with a deltathree.com customer service representative.
OUR STRATEGY
Our goal is to be the leading provider of IP telephony services and to make
our interactive communications portal the leading one-stop solution for the
communications needs of individuals and businesses. To achieve our goal, we plan
to:
o BUILD STRONG BRAND RECOGNITION. To date, we have used both on-line and
traditional marketing programs to create what we believe to be one of the
leading brand names in enhanced IP communications. We believe that
aggressive brand-building is important to obtain and sustain our
leadership position and to continue to attract users to our interactive
communications portal. We intend to continue to invest in branding
through traditional, direct media advertising. We also intend to increase
significantly our investment in branding through marketing and
advertising relationships with Internet companies and Web portals with
strong brand names or high traffic volumes and through our on-line agent
program.
o EXPAND AND ENHANCE OUR SERVICE OFFERINGS. We believe that expanding our
services will be critical to establishing ourselves as the leading
communications portal. We intend to capitalize upon our experience in
providing IP telephony services by introducing additional enhanced IP
communications services that appeal to the communications needs of
individuals and businesses. We also seek opportunities to bring
e-commerce and other enhanced IP communications tools to individuals and
businesses who want to fully utilize the multimedia capabilities of their
existing Web sites. For example, we intend to introduce new services,
including D3 Fax, IP-initiated conference calls, phone-to-PC, information
services and white boarding, to further complement our current services.
o ENSURE A POSITIVE USER EXPERIENCE. We believe that user satisfaction and
loyalty are heavily influenced by a user's experience with our
interactive communications portal. In order to enhance our appeal to
users, we intend to continue developing our interactive communications
portal by adding new features and technology to make it more user
friendly and efficient.
o ESTABLISH ADDITIONAL SOURCES OF REVENUE. Currently our revenues are
principally derived from carrier transmission services and, in part, from
our enhanced IP communications services. We intend to establish
additional sources of revenues from advertising sources, including the
sale of banner advertisements on our interactive communications portal to
leading retailers and marketers, and from monthly charges combined with
usage charges for services.
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o PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES. We intend to bolster our
number of users and our services through strategic acquisitions,
including the acquisition of new technologies, and alliances that offer
opportunities to acquire users or accelerate our entry into offering
additional enhanced IP communications services.
OUR INTERACTIVE COMMUNICATIONS PORTAL
Our interactive communications portal, www.deltathree.com, acts as a
single-source, on-line solution for our users and on-line marketing agents.
Through our interactive communications portal, our users can:
o view a description of all of our services, including pricing information
o sign up for any of our services, including PC-to-phone, unified
messaging and phone-to-phone
o download our software
o recharge their account, either by entering their credit card information
or authorizing automatic recharging
o send a PC-to-phone call
o retrieve and forward their voice mail, e-mail and faxes through their D3
Box
o check real-time billing and usage information
o communicate by e-mail with a deltathree.com customer service
representative
o view answers to frequently-asked questions
Through our interactive communications portal, our on-line marketing agents
can:
o view a description of our on-line agent program
o sign up to serve as an on-line agent
o receive marketing tools to put on their own Web sites
o monitor their daily results
o view trends
o view commissions by promotions
OUR SERVICES
We provide a comprehensive package of enhanced IP communications services.
We provide some of our services on a prepaid or a per usage basis, while we
offer other services for free to attract and retain users.
CURRENT SERVICES
We currently provide the following services:
PC-to-phone. Our PC-to-phone service enables a user to conveniently and
inexpensively place a call to a standard telephone anywhere in the world
directly from a personal computer while remaining on-line. In order to use this
service, a user need only download our software for free from our Web site and
have access to the Internet. Once the software is downloaded, the user is able
to place a call from the user's PC and, while browsing the Web, speak to a party
who uses a standard telephone.
We are able to provide our PC-to-phone service at rates generally lower
than those charged for traditional circuit switched calls. We are able to charge
lower rates because our service utilizes packet-switched technology and because
it routes calls directly from the Internet onto our privately-managed IP network
and to the called destination, thus avoiding access and settlement rates
associated with traditional
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international and domestic long distance telecommunications services. Our
PC-to-phone service allows ease of use by enabling a user to make a call
directly from a personal computer.
D3 Box. Our unified messaging service enables a user to conveniently
retrieve e-mail, voice mail and faxes, as well as send e-mail, from a single
source. We offer a user the flexibility of retrieving messages by either logging
on to www.deltathree.com or by placing a call using a standard telephone. A user
retrieving messages through a computer can conveniently access and forward all
e-mail, voice mail and faxes, while a user retrieving messages through a
standard telephone can hear voice mail and have e-mail read by a
computer-simulated voice.
Click IT. Our Click IT service is a Web-based e-commerce service enabling
individuals and businesses to place a link on their Web sites which, when
clicked on by a user viewing the site, automatically initiates a telephone call
from the user's computer to a designated telephone number specified by the owner
of the Web site. In addition, a pop-up screen appears which advertises the
host's products and services. This service allows e-commerce and business Web
pages to support real-time voice calls from on-line customers. Our Click IT
service can also be used to enable a user to place a call from his or her PC to
any telephone number without having to download PC-to-phone software. We call
this service Click IT phone booth.
Phone-to-phone. Our phone-to-phone service enables a user to inexpensively
place a call or send a fax from a standard telephone or a fax machine to
anywhere in the world. Phone-to-phone calls originate and terminate on the PSTN,
but travel primarily over our privately-managed IP network. Through our
privately-managed IP network, we are able to carry phone-to-phone voice
communications traffic. Similar to our PC-to-phone service, our phone-to-phone
service is generally less expensive than traditional carriers' services. Users
can access this service by dialing a local or toll-free access number and
providing a pin number. Users are charged for toll and long distance calls on a
per-minute basis. We receive payment for these calls by debiting pre-paid user
accounts opened on-line and through the sale of pre-paid calling cards.
Global roaming. Our global roaming service enables businesses and
individuals to use a single account number to place phone-to-phone calls over
our network from locations throughout the world using country-specific,
toll-free access numbers, thereby bypassing local access charges. We currently
offer toll-free access numbers in Austria, Canada, Finland, France, Germany,
Hong Kong, Italy, Sweden, Switzerland, the United Kingdom and the United States.
Carrier transmission services. To maximize use of our available network
capacity, we offer carrier transmission services over our privately-managed IP
network to telecommunications carriers. RSL COM is currently our largest carrier
customer. RSL COM utilizes our network primarily to resell our transmission
services to other communications carriers, as well as for the traffic RSL COM
carries for its own retail customers.
FUTURE SERVICES
We intend to leverage our network to provide, and utilize our technological
expertise to develop, additional enhanced IP communications services. These
services will be accessible through our interactive communications portal.
We currently expect our future services will include the following:
<TABLE>
<CAPTION>
ENHANCED SERVICE SUMMARY DESCRIPTION
<S> <C>
IP-initiated conference calls............. Enables a user to set up a conference call through our interactive
communications portal either by sending a notice of the planned call
to all of the participants and having each participant dial a
toll-free number or by arranging for each of the participants to be
called by the automated system at the designated call time. This
service eliminates the need for a conference operator, thereby saving
time and money.
</TABLE>
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<TABLE>
<CAPTION>
ENHANCED SERVICE SUMMARY DESCRIPTION
<S> <C>
Phone-to-PC............................... Enables a user to receive phone calls directly through the user's PC
while remaining on-line. For example, a user on the Internet will
receive a pop-up screen stating that someone is calling. The user can
then choose to forward the call to voice mail or to answer the call
from the computer without logging off the Internet. We believe this
service will be attractive to users with a single telephone line, who
would otherwise miss incoming calls while on-line or would need to
install additional phone lines.
D3 Fax.................................... Enables users to conveniently send faxes directly from their computer
to a standard fax machine anywhere in the world over the Internet. To
use this service, a user only need download our software, set up a
deltathree.com account and be connected to the Web when they wish to
send a fax.
Information services...................... Enables a user to have easy access to communications information,
such as phone and e-mail directory services, with a single click on
our interactive communications portal. We believe this service will
further the use of our interactive communications portal as a single
source for users' communications needs.
White boarding............................ Enables multiple users to view and edit the same document on their
computers while speaking with each other through their PCs. We
believe this service will be an efficient and cost-effective tool for
businesses.
PC-to-PC.................................. A voice enabled IP phone and chat service that enables users to place
calls directly from their PC to other PCs while remaining on-line.
Like PC-to-phone, in order to use this product a user will need only
to download our software for free from our Web site and have access
to the Internet.
</TABLE>
CUSTOMER CARE
Our services are supported by our on-line interactive customer care and
billing center, which enables a user to set up a deltathree.com account, receive
an account number and a personal identification number, pay by credit card for
services, find answers to frequently asked questions and contact our customer
service representatives. Once a user has established an account, the user can
prepay for additional usage by credit card as well as access real-time detailed
information which includes call logs and transaction records. Through our
on-line billing system, a user can personalize the billing information to select
the data most relevant to the user.
Most user concerns can be addressed on-line. Users can find answers to many
of their questions by referring to the "frequently asked questions" information
section of our Web site. Other questions can be addressed by our customer
support department that responds to user inquiries primarily through e-mails. We
seek to respond to e-mail inquiries within 24 hours. We strive to continually
improve our customer care center on our interactive communications portal to
meet the evolving needs of our users.
OUR MARKETING, ADVERTISING AND PROMOTIONAL PROGRAMS
We have developed and will continue to develop diversified marketing,
advertising and promotional programs to stimulate demand for our services by
increasing brand awareness. In the past, we have allocated limited resources to
marketing, advertising and promoting our services, relying primarily on RSL COM
to generate demand for our services. We intend to increase our independent
marketing efforts substantially in
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order to increase our user base and to increase the frequency of use of our
services by our registered users and new users. We will also seek to form new
relationships with Internet businesses which we believe can promote our services
to a wide range of potential users and generate demand for our services.
Our marketing, advertising and promotional programs include:
ON-LINE MARKETING RELATIONSHIPS. We encourage other companies to link
their Web sites to us either by creating "communications centers" on their Web
sites or by placing a deltathree.com banner on their Web sites and directing
their customers to us for their communications needs. We pay fees for the
placement of these banners and, in addition, we offer these companies a
percentage of the revenue generated by users that click-through their Web site
to use our services. To date, we have entered into marketing relationships with
five Internet companies, as described below, and we are continuing to pursue
marketing relationships with other companies.
o Yahoo! In October 1999, we entered into a marketing and promotion
agreement with Yahoo! Under this agreement, Yahoo! has agreed to include banners
and other promotions on various Yahoo! domestic and international Web sites that
will link to areas of our Web site dedicated to our PC-to-phone service and
certain of our other enhanced IP communications services. Yahoo! will also send
e-mails to certain international and domestic registered users of Yahoo! e-mail
with exclusive offers for our PC-to-phone service. In addition, Yahoo! will
create and place on Yahoo! Broadcast.com audio advertisements for our enhanced
IP communications services. The initial term of this contract is one year. We
have committed to pay Yahoo! $850,000 per quarter, in addition to a $600,000
initial payment, for the services provided.
o CNET. In October 1999, we entered into a marketing and promotion
agreement with CNET. Under this agreement merchants on CNET's shopping sites
will be able to integrate our PC-to-phone software to enable users to make a
PC-to-phone call directly to such merchant from the CNET shopping site using our
Click IT service. In addition, CNET has agreed to display banners and other
promotions on its Web sites that will link to our Web site. The initial term of
the contract is two years. We have agreed to pay CNET $1,062,500 per quarter for
the services provided. We have committed to pay an additional $1,250,000 in each
year of the contract, a portion of which was allocated to the third quarter of
1999.
o CBS.com. In August 1999, we entered into a marketing agreement with
CBS.com. Under this agreement, we are the exclusive provider of enhanced IP
communications services, including PC-to-phone, phone-to-phone, unified
messaging and Click It services, on the CBS.com Web site. CBS will provide links
from its Web pages to our Web site and promote our services through co-branded
areas on its Web site, known as the "DeltaThree/CBS Communication Center," and
through a dedicated monthly e-mail to e-mail addresses contained in its
database. In addition, our advertising banners will be placed on the
CBSMarketWatch.com Web site. The term of this agreement is two years. We have
agreed to pay CBS $424,998 per quarter for the services provided.
o Sony.com. In August 1999, we entered into a marketing agreement with
Sony.com. Under this agreement, a co-branded area known as the "Communication
Center" will be established and will offer users links to our enhanced IP
communications services. Sony has agreed to include fixed links to the
Communication Center on the Sony.com Web site, which includes sonymusic.com,
sony.spe.com, station.sony.com and infobeat.com. The initial term of this
agreement is two years. We have agreed to pay Sony $180,000 per quarter for the
services provided.
o Xoom.com. In June 1999, we entered into a co-marketing agreement with
Xoom.com, Inc. Xoom will provides links to our interactive communications portal
and promotes our services through co-branded areas on its Web site and through
periodic e-mails to its customers. Xoom has established an IP "Communications
Hub" on its home page. In addition, under this agreement, Xoom will:
o integrate our services with the Xoom chat network of 250,000 chat
rooms
o offer our services with Xoom greeting cards
o integrate our services with Xoom's directory services (White Pages &
Yellow Pages)
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The initial term of this agreement is two years. We have agreed to pay Xoom
$240,000 per quarter for the services provided.
We continue to seek to identify additional Internet businesses and Web
portals with strong brand names or high traffic volumes with which we can
establish marketing relationships similar to those described above. We will
expense costs under these agreements as they are incurred. As we have only
recently entered into the marketing relationships described above, to date we
have not generated material revenue from them.
PRIVATE LABELING. We have entered into agreements with three service
providers to distribute our services under their own private labels. Instead of
sending customers to the deltathree.com interactive communications portal, a
service provider markets our services under its own brand name, while
contracting with us to provide the services under their private label. In our
agreements with these providers, we often stipulate that the provider's Web site
will say "powered by deltathree.com." Our private label customers include both
on-line and off-line providers who market our services to their customer base.
We believe service providers are attracted to our private label services because
it allows them to capitalize on their name recognition in their home market
while providing our high-quality, low-cost services.
Our agreement with MediaRing Pte Ltd was our first private labeling
agreement and served as our prototype for this promotional effort and serves as
a continuing source of revenues. Under this agreement, we integrate our
PC-to-phone service into MediaRing's PC-to-PC service, thereby providing
MediaRing's customers with a bundled package of communications services. Our
services are provided under MediaRing's brand name; however, MediaRing's Web
site states that it is "powered by deltathree.com." In addition, we also provide
the back-office and billing support for MediaRing.
ON-LINE AGENT COMMISSION PROGRAM. We have developed a Web-based agent
program that allows for rapid agent enrollment and agent account maintenance.
Through our on-line agent interactive center, any individual with their own Web
site can:
o take a tour of our on-line agent program
o complete an application to be an on-line agent
o be approved within 24-48 hours after completing the application
o if approved, execute our on-line agent agreement through a secured site
o receive an agent identification number and instructions on how to
proceed as an agent
o download deltathree.com banners to post on their Web site
o track the number of people who have clicked through to
www.deltathree.com and signed up for our services
o track the commissions that are due to them
Agents may devise their own marketing programs, including Web-links, direct
mail campaigns or co-branding of our services in select markets. Agents receive
as commissions a percentage of revenue generated from end users who sign up for
our services through the agent's Web site. We believe that providing our agents
with easy, on-line access to these marketing tools helps us to maximize the
number of agents selling our services while significantly reducing the resources
needed to recruit agents.
OFF-LINE AGENT COMMISSION PROGRAM. Our off-line agent commission program
allows non-Web agents to design their own marketing programs to solicit sales of
our services. Off-line agents market and advertise through traditional channels
such as newspaper and magazine advertisements, direct mail campaigns and
telemarketing campaigns. Off-line agents receive a percentage of revenue
generated from users who sign up for our services through the agent's programs.
We currently have relationships with more than 30 off-line agents that have
generated revenue for us.
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RESELLER PROGRAM. We offer individuals and businesses the opportunity to
become resellers of our services through our reseller program. Resellers are
able to purchase bulk deltathree.com account numbers at wholesale rates that
they are then able to resell to private individuals as either phone-to-phone
calling cards or PC-to-phone accounts.
DIRECT SALES. We have a direct sales force that is targeting organizations
that are currently not optimizing the marketing potential of their Web sites. As
with other on-line agents, we offer these on-line agents the opportunity to
market our services and products through their Web pages to generate revenue
from services we deliver as a result of links from their Web sites.
TRADITIONAL AND ON-LINE ADVERTISING. We intend to continue to advertise in
both traditional advertising mediums, such as direct mail, newspapers and
magazines, and through emerging on-line formats, such as banners.
INNOVATIVE MARKETING TOOLS. We intend to continue to develop innovative
marketing products and promotions to increase our user base. For example, in
December 1998, we introduced innovative voice-enabled electronic greeting cards
on a promotional basis. Sent over the Web, V-Greetings enable the recipient to
click on a link in the greeting card, automatically downloading our PC-to-phone
software allowing the recipient to place a free PC-to-phone call to the card
sender's standard telephone. V-Greeting cards are available on-line and are
designed to promote different holidays, such as Christmas, Chanukah, Valentine's
Day, Mother's Day and Chinese New Year and other special occasions. To date,
more than 700,000 V-Greeting cards have been sent. Of those V-Greeting cards
that have been sent, approximately 135,000 of the recipients have downloaded our
PC-to-phone software and made a free PC-to-phone call. We believe that V-
Greeting cards is an effective marketing tool to introduce our services to
potential users.
OUR NETWORK
In order to provide high-quality, low-cost service, we operate a
privately-managed, IP telephony network. By managing our network, we have the
ability to regulate traffic volumes for the communications traffic we carry and
directly control the quality of our services from our originating POP to the
termination point. In addition, our network allows us to avoid the significant
transmission delays associated with the highly congested Internet, which may
impede delivery of high-quality, reliable services to our users. As of October
1, 1999, our network consisted of:
o 45 POPs in 29 countries
o gateways, gatekeepers and routers at each POP
o hubs in New York, Los Angeles, London, Frankfurt and Hong Kong
o dedicated leased bandwidth
o interconnections with the RSL COM network
o peering arrangements with Internet backbone providers, enabling
transmission efficiency
o a technologically-advanced network operations center
POPS
We intend to further develop our network to increase our number of POPs. We
currently have 45 POPs in the following locations:
Austria (Vienna)
Bangladesh (Dhaka)
Belgium (Brussels)
Brazil (Rio de Janeiro)
Brazil (Sao Paulo)
Brazil (Sao Paulo 2)
China (Beijing)
China (Beijing 2)
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China (Beijing 3)
China (Shanghai)
Colombia (Bogota)
Colombia (Cali)
Czech Republic (Prague)
Ecuador (Quayaquil)
Finland (Helsinki)
France (Paris)
Germany (Frankfurt)
Greece (Athens)
Greece (Heraklion)
Greece (Rhodes)
Greece (Saloniki)
Holland (Rotterdam)
Hong Kong
Hungary (Budapest)
Iceland (Reykjavik)
India (Bombay)
Israel (Jerusalem)
Israel (Rosh Ha'ayin)
Israel (Tel Aviv)
Japan (Tokyo)
Korea (Seoul1)
Korea (Seoul2)
Malaysia (Kuala Lumpur)
Norway (Oslo)
Russia (Moscow)
Russia (Nijnei)
Russia (Samara)
Russia (St. Petersburg)
Singapore
Spain (Madrid)
Sweden (Stockholm)
Turkey (Istanbul)
United Kingdom (London)
United States (Los Angeles)
United States (New York)
GATEWAYS, GATEKEEPERS AND ROUTERS
The gateway acts as an entrance into and exit from our network for
communications traffic. At the origination POP, the gateway accepts the
communications traffic from the public switched telephone network (PSTN) and
compresses this traffic into IP packets for transmission over our network. The
gatekeeper determines the most cost-effective route for each packet of
communications traffic and the routers then direct the packets to their
destination. Upon termination, the gateway decompresses and reconverts the
packets into a circuit-switched signal, thereby enabling the traffic to exit our
network on to the PSTN. We use gateways and gatekeepers developed by Ericsson
and routers developed by Cisco.
HUBS
Our network has five hubs located in New York, Los Angeles, London,
Frankfurt and Hong Kong which serve as backbone points for our network and which
allow our network to directly interconnect with the PSTN and the Internet. In
addition, at each of our five hubs, we co-locate our gateways with the Ericsson
international gateway switches on RSL COM's network. Our multiple hub structure
provides us with the ability to handle high volumes of traffic transmitted over
our network. By establishing multiple hubs, we have greater flexibility to
choose from multiple bandwidth suppliers, allowing us to optimize quality and
cost savings. In addition, our multiple hub structure enables us to more
efficiently direct the routing of traffic. For example, communications traffic
between Belgium and France does not need to be routed to our New York hub but
can be sent through our London hub. This enables better use of allocated
bandwidth and reduces delay between originating and terminating sites.
LEASED BANDWIDTH
We connect our hubs and POPs through a network of dedicated leased
bandwidth. By leasing bandwidth, we can avoid using the Internet as our primary
means for the transmission of communications traffic. We can therefore avoid the
significant transmission delays associated with the highly-congested Internet,
which may impede delivery of high-quality, reliable services to our users.
Through our relationship with RSL COM, which owns or leases substantial
bandwidth for its own business, we have access to bandwidth. We are able to take
advantage of RSL COM's volume discounts and achieve cost efficiencies that we
could not achieve on our own. In addition, we also lease bandwidth directly or
indirectly from several other telecommunications carriers.
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INTERCONNECTIONS WITH RSL COM NETWORK
RSL COM interconnects its network with our network in addition to supplying
us with low-cost bandwidth. The interconnections with RSL COM provide us with
access to major PSTNs throughout the world, the ability to terminate
communications traffic virtually anywhere in the world and the ability to
terminate traffic over RSL COM's network in the event of a network failure.
PEERING
Our network also connects with Internet exchange points to provide access
to and from the Internet. We have direct and indirect peering arrangements with
Internet backbone providers in order to support IP services to and from the
Internet. These arrangements allow us to access the Internet directly,
minimizing the amount of time our users' communications traffic has to travel
over the Internet.
NETWORK OPERATIONS CENTER
To service our network effectively, we have established a network
operations center (NOC) which monitors and manages our network from a central
location, 7 days a week, 24 hours a day. The NOC monitors all aspects of our
network, including the routers, databases, switches, leased lines, Internet
connections, gatekeepers and gateways, to ensure that they are functioning at
optimal levels. In the event of a failure of any of these network components,
NOC personnel are provided with a real-time, systems-generated notification via
an instant messaging system consisting of pagers, cellular phones, screen
pop-ups and e-mail, which identifies the malfunction so that proper measures can
be taken to restore service in a timely fashion. Our NOC utilizes a combination
of proprietary and leading industry technologies based upon Hewlett-Packard Open
View software. By utilizing technologically-advanced, real-time management and
monitoring systems, we seek to reduce system downtime and ensure that our users
will not experience any noticeable interruption in their service.
ADVANTAGES OF OUR NETWORK
Our network is engineered to provide the following advantages:
o scalability. The software and hardware that we use in our network is
scalable, allowing for new POPs to be easily integrated into our network
with minimal incremental investment.
o flexibility. Our multiple hub structure and our interconnections with
RSL COM and other carriers provide us with numerous routing options and
greater flexibility to handle changing traffic patterns.
o rapid integration of services. We can introduce new services and
duplicate existing services without having to deploy additional equipment
at each POP on our network.
o manageability. Our privately-managed network allows us to directly
control the quality of our services over our network from one central
location.
o accessibility. Our privately-managed network allows users to gain access
to our enhanced services from any country in which a POP has been
established.
o global reach. By using our network, we are able to cost-effectively
terminate communications traffic to over 200 countries.
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PROPRIETARY RIGHTS
We rely or expect to be able to rely on patent, trademark and trade secret
laws, confidentiality agreements and other contractual arrangements with our
employees, strategic partners and others to protect our proprietary rights.
We have a registered trademark for "Delta Three(Registered)" in the United
States. We have submitted trademark applications for the name "Delta
Three(Trademark)" for the following jurisdictions: Brazil, Colombia, Japan,
Mexico, the Russian Federation, Venezuela and the European Community under EC
trademark regulation. In addition, we have submitted trademark applications in
the United States for the names "V-Greetings(Trademark)," "Click IT(Trademark),"
"D3 Fax(Trademark)," "deltathree.com(Trademark)," "D3 Box(Trademark)" and
"deltathree.com the Communications Portal(Trademark)." We do not currently own
any registered copyrights. In addition, we have filed one patent application in
each of the United States and Israel for a remote telephone configuration in
connection with our V-Greeting product. These applications may not result in any
patents or trademarks being issued and, if issued, these patents or trademarks
may not provide adequate protection against competitive technology and may not
be held valid and enforceable if challenged. In addition, other parties may
assert rights as inventors of the underlying technologies, which could limit our
ability to fully exploit the rights conferred by any patents that we receive.
Our competitors may be able to design around any of the patents that we receive,
and other parties may obtain patents that we would need to license or circumvent
in order to exploit our patents.
To further safeguard our intellectual property, we have a policy that
requires our employees to execute confidentiality and technology ownership
agreements when they begin their relationships with us.
For a discussion of recent litigation, see "--Legal Proceedings."
REGULATORY ENVIRONMENT
REGULATION OF IP TELEPHONY
The use of the Internet and private IP networks to provide telephone
service is a recent market development. While we believe that the provision of
voice communications services over the Internet and private IP networks is
currently permitted under United States law, some foreign countries have laws or
regulations that may prohibit voice communications over the Internet.
United States. We believe that, under United States law, based on specific
regulatory classifications and recent regulatory decisions, the IP
communications services that we provide constitute information services (as
opposed to regulated telecommunications services). As such, our services are not
currently regulated by the Federal Communications Commission (FCC) or any state
agencies charged with regulating telecommunications carriers. Nevertheless,
aspects of our operations may be subject to state or federal regulation,
including regulation governing universal service funding, disclosure of
confidential communications, copyright and excise tax issues. However, we cannot
assure you that our services will not be regulated in the future. Several
efforts have been made in the United States to enact federal legislation that
would either regulate or exempt from regulation communications services provided
over the Internet. Increased regulation of the Internet may slow its growth,
particularly if other countries also impose regulations. Such regulation may
negatively impact the cost of doing business over the Internet and materially
adversely affect our business, operating results, financial condition and future
prospects.
In addition, the FCC is currently considering whether to impose surcharges
or other common carrier regulations upon some providers of Internet and IP
telephony, primarily those which provide Internet and IP telephony services to
end users located within the United States. Although the FCC decided that
information service providers, including Internet and IP telephony providers,
are not telecommunications carriers, various companies have challenged that
decision. Congressional dissatisfaction with the FCC's conclusions could result
in requirements that the FCC impose greater or lesser regulation, which in turn
could materially adversely affect our business, financial condition, operating
results and future prospects. On April 10, 1998, the FCC issued a report to
Congress discussing its implementation of universal service provisions contained
in the 1996 amendments to the Communications Act of 1934. In the report, the FCC
indicated that it would examine the question of whether certain forms of
phone-to-phone IP telephony are information services or telecommunications
services. The two are treated differently in several respects, with certain
information services being more lightly regulated and not subject to universal
service contribution obligations. The FCC
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noted that it did not have, as of the date of the report, an adequate record on
which to make a definitive ruling, but that the record suggested that certain
forms of phone-to-phone IP telephony appear to have the same functionality as
non-IP telecommunications services and lack the characteristics that would
render them information services. In September 1998, two regional Bell operating
companies advised Internet and IP telephony providers that they would impose
access charges on Internet and IP telephony traffic. It is uncertain at this
time whether these companies will actually impose access charges or when such
charges will become effective. In addition, one of these regional Bell operating
companies has recently filed a petition with the FCC seeking the imposition of
access charges on phone-to-phone Internet and IP telephony services.
On September 29, 1999, the FCC released a notice of inquiry seeking
information on the extent to which phone-to-phone IP telephony services might
impact the accessibility of telecommunications services to people with
disabilities, including opportunities for achieving greater accessibility for IP
telephony and the extent to which IP telephony is now, or soon will be, an
effective substitute for conventional circuit-switched telephony. On
October 22, 1999, the FCC released a notice of proposed rulemaking on collecting
information on the status of local telephone service competition and the
deployment of advanced telecommunications capability. The FCC recognized that,
while it does not regulate Internet services, IP telephony may become an
important substitute for circuit-switched telephony and should be included in
evaluating local competition. Also, the FCC asked whether it should undertake a
more specific determination of the extent to which the Internet is being used to
provide telephony services.
If the FCC were to determine that certain services are subject to FCC
regulations as telecommunications services, the FCC may require providers of
Internet and IP telephony services to be subject to traditional common carrier
regulation, make universal service contributions, and/or pay access charges. It
is also possible that the FCC may adopt a regulatory framework other than
traditional common carrier regulation which would apply to Internet and IP
telephony providers. Any such determinations could materially adversely affect
our business, financial condition, operating results and future prospects to the
extent that they negatively affect our cost of doing business or otherwise slow
the growth of our business.
State regulatory authorities may also retain jurisdiction to regulate the
provision of intrastate Internet and IP telephony services. Several state
regulatory authorities have initiated proceedings to examine the regulation of
such services. Others could initiate proceedings to do so. If such regulations
are adopted, they could materially adversely affect our business, financial
condition, operating results and future prospects.
Based on information users provide to us when they sign up to use our
services, we estimate that approximately 55% of our IP communications services
are provided to carriers or users in the United States.
International. The regulatory treatment of Internet and IP telephony
outside of the United States varies widely from country to country. A number of
countries that currently prohibit competition in the provision of voice
telephony may also prohibit Internet and IP telephony. Other countries permit
but regulate Internet and IP telephony. Some countries will evaluate proposed
Internet and IP telephony service on a case-by-case basis and determine whether
it should be regulated as a voice service or as another telecommunications
service. Finally, in many countries, Internet and IP telephony has not yet been
addressed by legislation or regulatory action. Increased regulation of the
Internet and/or Internet and IP telephony providers or the prohibition of
Internet and IP telephony in one or more countries, or more aggressive
enforcement of existing regulations in such countries, could materially
adversely affect our business, financial condition, operating results and future
prospects.
For example, we believe that our services fall outside the classification
of regulated voice telephony services in the European Union. The European Union
regulatory regime distinguishes between voice telephony services and other
telecommunications services. In Services Directive 90/388/EEC, issued in 1990,
the European Commission required Member States to allow competition for all
telecommunications services except voice telephony and certain other services.
The Services Directive was amended in 1996 by Commission Directive 96/19/EC,
which required the liberalization of all telecommunications services, including
voice telephony, by January 1, 1998, except in certain member states that were
granted extended compliance periods. In addition, Directive 96/19/EC requires
that services other than voice telephony be subjected to no more than a general
authorization or declaration procedure. For purposes of these Directives, "voice
telephony" is defined as the commercial provision for the public of the direct
transport and switching of speech in real time between public switch network
termination points.
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On January 10, 1998, the Commission issued a Notice addressing whether IP
telephony was voice telephony and thus subject to regulation as voice telephony
by the Member States. As noted by the Commission, a determination that IP
telephony constitutes "voice telephony" may trigger significant regulatory
consequences with respect to, among other things, licensing requirements and
contributions to universal service funding. Consistent with its earlier
directives, the Commission stated that Internet telephony could properly be
considered voice telephony only if all elements of its "voice telephony"
definition were met. In this January 1998 Notice, the Commission concluded that
no form of IP telephony currently meets the definition of "voice telephony"
subject to Member States' regulation. The Commission noted, however, that its
conclusion that IP telephony cannot be considered voice telephony may not apply
to particular forms of service provisions where, for example, an IP telephony
service is marketed as an alternative form of voice telephony service, users can
dial out to any telephone number, and the provider guarantees the quality of the
IP voice service by bandwidth reservation and claims that the quality of the IP
voice service is the same as traditional voice telephony service. Accordingly,
the Commission concluded that while voice over the Internet services cannot "for
the time being" be generally classified as "voice telephony," the situation must
be kept under review in light of technological and market developments. The
Commission intends to review its Notice periodically.
On November 10, 1999, the Commission released a communication stating:
"Assuming that over time the voice over the Internet service meets the key
criteria for classification as voice telephony under the regulatory framework,"
this service would be regulated like other voice telephony services and covered
by general authorizations. A report by the Commission is scheduled for release
later in November 1999 on regulating quality of voice telephony services and
related consumer protection issues, and another report is scheduled for release
in December 1999 covering new Internet telecommunications services and their
impact on the European Union regulatory and policy framework. We cannot predict
what the content of such reports will be, or what impact, if any, they may have
on our business.
Based on the Commission's current position, providers of IP telephony
should be subjected to no more than a general authorization or declaration
requirement by the European Union Member States. The Member States of the
European Union are: Austria, Belgium, Denmark, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and the
United Kingdom. However, we cannot assure you that more stringent regulatory
requirements will not be imposed by individual Member States, since the
Commission's Notice is not binding on the Member States. The Member States
therefore are not obligated to reach the same conclusions as the Commission on
this subject so long as they adhere to the definition of "voice telephony" in
the Services Directive. In fact, France is currently conducting an investigation
into how IP telephony should be regulated. We cannot assure you that the
services provided over our network will not be deemed voice telephony subject to
heightened regulation by one or more EU Member States. Moreover, we cannot
assure you that our failure or the failure of any of our partners to obtain any
necessary authorizations will not have a material adverse effect on our
business, financial condition, operating results and future prospects.
As we make our services available in foreign countries, and as we
facilitate sales by our partners to end users located in foreign countries, such
countries may claim that we are required to qualify to do business in the
particular foreign country. Such countries may also claim that we are subject to
regulation, including requirements to obtain authorization for the provision of
voice telephony or other telecommunications services, or for the operation of
telecommunications networks. It is also possible that such countries may claim
that we are prohibited in all cases from providing our services or conducting
our business as conducted in those countries. Our failure to qualify as a
foreign corporation in a jurisdiction in which we are required to do so or to
comply with foreign laws and regulations could materially adversely affect our
business, financial condition, operating results and future prospects, including
by subjecting us to taxes and penalties and/or by precluding us from, or
limiting us in, enforcing contracts in such jurisdictions.
Our partners may also currently be, or in the future may become, subject to
requirements to qualify to do business in a particular foreign country, comply
with regulations, including requirements to obtain authorizations for the
provision of voice telephony or other telecommunications services or for the
operation of telecommunications networks, or to cease providing services or
conducting their business as conducted in that country. We cannot be certain
that our partners either are currently in compliance with any such
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requirements, will be able to comply with any such requirements, and/or will
continue in compliance with any such requirements. The failure of our partners
to comply with such requirements could materially adversely affect our business,
financial condition, operating results and future prospects.
One of our competitors recently disclosed that access to its PC-to-phone
service was blocked in certain countries in Asia and the Middle East by
government-controlled telecommunications companies, and that it intended to
negotiate agreements to continue to provide its services in those countries but
could not give assurances that such negotiations would be successful. Another of
our competitors recently disclosed that it has received a letter from the Israel
Minister of Communications requesting that it cease and desist terminating calls
over the Internet in Israel. Although we have not received any similar notices
from these regulators and we do not know specifically how these competitors
operate in such countries or why they received such notices, there can be no
assurance that such regulators or any other regulator may not block our service
or send us similar cease and desist orders in the future.
OTHER REGULATION AFFECTING THE INTERNET
United States. Congress has recently adopted legislation that regulates
certain aspects of the Internet, including on-line content, user privacy and
taxation. For example, the Internet Tax Freedom Act prohibits certain taxes on
Internet uses through October 21, 2001. We cannot predict whether substantial
new taxes will be imposed on our services after that date. In addition, Congress
and other federal entities are considering other legislative and regulatory
proposals that would further regulate the Internet. Congress is, for example,
currently considering legislation on a wide range of issues including Internet
spamming, database privacy, gambling, pornography and child protection, Internet
fraud, privacy and digital signatures. Various states have adopted and are
considering Internet-related legislation. Increased United States regulation of
the Internet may slow its growth, particularly if other governments follow suit,
which may negatively impact the cost of doing business over the Internet and
materially adversely affect our business, financial condition, results of
operations and future prospects.
International. The European Union has also enacted several directives
relating to the Internet. The European Union has, for example, adopted a
directive on data protection that imposes restrictions on the processing of
personal data which are more restrictive than current United States privacy
standards. Under the directive, personal data may not be collected, processed or
transferred outside the European Union unless certain specified conditions are
met. In addition, persons whose personal data is processed within the European
Union are guaranteed a number of rights, including the right to access and
obtain information about their data, the right to have inaccurate data
rectified, the right to object to the processing of their data for direct
marketing purposes and in certain other circumstances, and rights of legal
recourse in the event of unlawful processing. The Directive will affect all
companies that process personal data in, or receive personal data processed in,
the European Union, and may affect companies that collect or transmit
information over the Internet from individuals in the European Union Member
States. In particular, companies with establishments in the European Union may
not be permitted to transfer personal data to countries that do not maintain
adequate levels of data protection.
In addition, the European Union has adopted a separate, complementary
directive which pertains to privacy and the processing of personal data in the
telecommunications sector. This directive establishes certain requirements with
respect to, among other things, the processing and retention of subscriber
traffic and billing data, subscriber rights to non-itemized bills, and the
presentation and restriction of calling and connected line identification. In
addition, a number of European countries outside the European Union have
adopted, or are in the process of adopting, rules similar to those set forth in
the European Union directives. Although we do not engage in the collection of
data for purposes other than routing calls and billing for our services, the
data protection directives are quite broad and the European Union privacy
standards are stringent. Accordingly, the potential effect of these data
protection rules on the development of our business is uncertain.
COMPETITION
We compete in both the market for enhanced IP communications services and
the market for carrier transmission services. Each of these markets on a
stand-alone basis is highly competitive and has numerous service providers.
According to International Data Corporation (IDC), a market research firm,
by mid-1999 there were an estimated 300 IP telephony service providers
worldwide. In an August 1999 report on IP telephony services,
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IDC indicated that based on 1998 IP telephony minutes carried, we accounted for
9.8% of the market. According to this report, Net2Phone and Jens Corporation are
the only providers with greater market shares than ours, representing
approximately 39.4% and 16.4% of the market, respectively, in 1998. Jens
Corporation's services are directed primarily to callers based in Japan. IDC
further indicated that while most IP telephony traffic is carried by start-up
service providers, traditional carriers such as Singapore Telecom, Korea
Telecom, Telia and Bell Atlantic are establishing market presence.
ENHANCED IP COMMUNICATIONS SERVICES
The market for enhanced Internet and IP communications services is new and
rapidly evolving. We believe that the primary competitive factors determining
success in the Internet and IP communications market are:
o quality of service
o the ability to meet and anticipate customer needs through multiple
service offerings
o responsive customer care services
o price
Future competition could come from a variety of companies both in the
Internet and telecommunications industries. These industries include major
companies who have greater resources and larger subscriber bases than we have,
and have been in operation for many years. We also compete in the growing market
of discount telecommunications services including calling cards, prepaid cards,
call-back services, dial-around or 10-10 calling and collect calling services.
In addition, some Internet service providers have begun to aggressively enhance
their real time interactive communications, focusing initially on instant
messaging, although we expect them to begin to provide PC-to-phone services.
Internet and IP Telephony Providers. Many companies provide, or are
planning to provide, certain portions of the complete communications solution we
offer, including Net2Phone, Jens Corporation, JFAX.COM, GlocalNet and Poptel.
Traditional Telecommunications Carriers. Several traditional
telecommunications companies, including industry leaders such as AT&T, Sprint,
Deutsche Telekom, MCI WorldCom and Qwest Communications International, have
recently announced their intention to offer enhanced Internet and IP
communications services in both the United States and internationally. All of
these competitors are significantly larger than we are and have:
o substantially greater financial, technical and marketing resources
o larger networks
o a broader portfolio of services
o stronger name recognition and customer loyalty
o well-established relationships with many of our target customers
o an existing user base to which they can cross-sell their services
These and other competitors may be able to bundle services and products
that are not offered by us together with enhanced Internet and IP communications
services, which could place us at a significant competitive disadvantage. Many
of our competitors enjoy economies of scale that can result in lower cost
structure for transmission and related costs, which could cause significant
pricing pressures within the industry.
CARRIER TRANSMISSION SERVICES
We compete with telecommunications providers, long distance carriers and
other long distance resellers and providers of carrier services for our carrier
transmission services. Our primary competitors in providing carrier transmission
services include:
o long distance carriers, including AT&T, MCI WorldCom and Sprint
Corporation
o foreign carriers, including British Telecom, Deutsche Telekom and Nippon
Telegraph and Telephone Corporation
o global telecommunications alliances, including Global One and BT/AT&T
o emerging carriers providing transmission services over the Internet,
including ITXC Corp., iBasis and AT&T Global Clearinghouse
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o wholesale carrier providers, including STAR Telecommunications, Inc.,
GRIC Communications and Pacific Gateway Exchange
Competition for carrier traffic is primarily based on price. Decreasing
telecommunications rates have resulted in intense price competition and we
expect that competition will continue to increase significantly as
telecommunications rates decrease. Increased competition could force us to
further reduce our prices and profit margins, and may reduce our market share.
PROPERTIES
We maintain our executive offices at 430 Park Avenue, New York, New York,
occupying approximately 3,000 square feet, which we sub-lease from RSL COM. This
sub-lease extends until June 29, 2001. We pay RSL COM annual rent of $96,000 for
this space.
We lease a 1,184 square meter office, which houses our research and
development facilities, at the Jerusalem Technology Park, Jerusalem, Israel. The
term of this lease extends until January 31, 2003, with an option to extend the
lease for an additional five year period. We pay annual rent of approximately
$240,000 plus Israeli value-added tax. We sublease a portion of our facility to
third parties.
Under a services agreement with RSL COM, we share space for employees and
equipment at eight locations with RSL COM. One of these locations is 60 Hudson
Street, New York, New York. This space houses our international gateway and
domestic switches. RSL COM provides these facilities to us at no direct cost.
The services agreement expires September 3, 2004 with automatic extensions for
additional one-year terms unless terminated by one of the parties upon 30 days
notice prior to the end of the term.
EMPLOYEES
As of October 31, 1999, we employed 80 full-time and 10 part-time
employees, of which 74 are located in Israel and 16 are located in New York. We
consider our relationship with our employees to be good. None of our employees
is covered by collective bargaining agreements.
Generally, all male adult citizens and permanent residents of Israel under
the age of 51 are, unless exempt, obligated to perform up to 31 days of military
reserve duty annually. Additionally, all such residents are subject to being
called to active duty at any time under emergency circumstances. Some of the our
officers and employees are currently obligated to perform annual reserve duty.
While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business if conditions should change, and no prediction can
be made as to the effect on us of any expansion of such obligations.
LEGAL PROCEEDINGS
On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced a suit
against us, RSL COM and an RSL COM subsidiary in the United States District
Court for the Southern District of New York. Aerotel alleges that we are
infringing on a patent issued to Aerotel in November 1987 by making, using,
selling and offering for sale prepaid telephone card products in the United
States. Aerotel seeks an injunction to stop us from using the technology covered
by this patent, monetary damages in an unspecified amount and reimbursement of
attorneys' fees. This litigation was only recently filed and we are presently
evaluating these claims. We believe that we have meritorious defenses to the
claim and we intend to defend the lawsuit vigorously. However, the outcome of
the litigation is inherently unpredictable and an unfavorable result may have a
material adverse effect on our business, financial condition and results of
operations. Regardless of the ultimate outcome, the litigation could result in
substantial expenses to us and significant diversion of efforts by our
managerial and other personnel.
We are not a party to any other material litigation and are not aware of
any other pending or threatened litigation that could have a material adverse
effect on us or our business taken as a whole.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth certain information concerning our
directors, executive officers and key employees.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Elie C. Wurtman...................................... 30 Co-founder, Co-Chairman of the Company and Chairman
of the Board of Directors
Amos Sela............................................ 56 Chief Executive Officer, President and Director
Jacob A. Davidson.................................... 30 Co-founder and Co-Chairman of the Company
Mark J. Hirschhorn................................... 35 Vice President and Chief Financial Officer
Noam Bardin.......................................... 28 Co-founder, Vice President of Technology and Chief
Technology Officer
Shimmy Zimels........................................ 34 Vice President of Operations
Dr. Baruch D. Sterman................................ 38 Vice President of Research and Development and
Product Integration
Marc M. Tobin........................................ 33 General Counsel
Avery S. Fischer..................................... 32 Director
Itzhak Fisher........................................ 43 Director
Robert R. Grusky..................................... 42 Nominee Director*
Yadin Kaufmann....................................... 40 Nominee Director*
Jacob Z. Schuster.................................... 50 Director
Donald R. Shassian................................... 44 Director
Nir Tarlovsky........................................ 33 Director
Oakleigh Thorne...................................... 42 Nominee Director*
</TABLE>
- ------------------
* The nominees shall become directors upon closing of this offering.
ELIE C. WURTMAN co-founded our company and has been a co-chairman of our
company since October 1999 and the chairman of our board of directors since
April 1999. Mr. Wurtman was president and chief executive officer of our company
from November 1996 until March 1999 and acting vice president of sales and
marketing for our company from August 1998 to March 1999. Mr. Wurtman has served
as vice president of emerging technologies for RSL COM from April 1998 to May
1999. In November 1995, Mr. Wurtman co-founded Ambient Corporation, Inc., a
company which develops smartcard technology, and was a director of Ambient until
September 1999. Mr. Wurtman co-founded Pioneer Management Corporation, a holding
company involved in several high-tech ventures, and was a director from January
1992 to June 1996.
AMOS SELA has been chief executive officer and a director of our company
since April 1999 and president since October 1999. Prior to joining our company,
Mr. Sela was the director and deputy managing director of ISIS Information
Systems, a leading South African information technology systems integrator,
since September 1991. From 1991 to 1996, Mr. Sela served as vice president of
DCL Technologies Ltd, a company specializing in the growth and management of
high technology start-up companies. From 1983 to 1990, Mr. Sela served as
general manager of Gold Net Ltd., a value-added service provider of information
services. Mr. Sela received a masters in physics and mathematics from Hebrew
University in Jerusalem.
JACOB A. DAVIDSON co-founded our company and has been a co-chairman of our
company since October 1999. Mr. Davidson is not a director of our company. From
April 1999 to October 1999, Mr. Davidson acted as our president. From May 1996
to March 1999, Mr. Davidson served as chairman of the board of our company.
Mr. Davidson co-founded Ambient Corporation and served as its chief executive
officer and its chairman from June 1996 until September 1999. Mr. Davidson
co-founded Pioneer Management Corporation and was the managing director from
January 1992 to June 1996.
MARK J. HIRSCHHORN has been our vice president and chief financial officer
since April 1999. Prior to joining our company, Mr. Hirschhorn served in various
positions at RSL COM, including vice president-finance from August 1997 to May
1999, global controller from January 1996 to May 1999 and assistant secretary
from September 1996 to May 1999. From October 1987 to December 1995,
Mr. Hirschhorn was employed at Deloitte & Touche LLP, most recently as senior
manager.
NOAM BARDIN co-founded our company and has been vice president of
technology and chief technology officer since June 1997. Prior to serving as
vice president, Mr. Bardin served as our global network director from November
1996 to May 1997. From November 1995 to October 1996, Mr. Bardin served as
director of operations for Ambient Corporation. From January 1995 to October
1995, Mr. Bardin worked for several
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Israeli high-tech companies in helping to secure government grants and
assistance. Prior to 1995, Mr. Bardin attended Hebrew University.
SHIMMY ZIMELS has been our vice president of operations since July 1997.
Prior to joining our company, Mr. Zimels was the controller and vice president
of finance of Net Media Ltd., a leading Israeli-based Internet service provider,
from June 1995 to June 1997. From April 1991 to May 1995, Mr. Zimels was a
senior tax auditor for the Income Tax Bureau of the State of Israel.
DR. BARUCH D. STERMAN has been our vice president of research and
development and product integration since May 1998. Prior to joining our
company, Dr. Sterman worked as a consultant for Israeli businesses in database
design, billing systems, and automated data flow from August 1996 to May 1998.
After receiving a doctorate in Physics in June 1993, Dr. Sterman founded a
start-up company, Gal-Or Lasers, that developed a compact laser (of his own
design) for industrial and medical use.
MARC M. TOBIN has been our general counsel since August 1998 and our
corporate secretary since September 1999. Prior to joining our company, Mr.
Tobin served as corporate counsel to Slim Fast Foods Company from October 1991
to July 1998 and assistant corporate secretary from March 1995 to July 1998.
AVERY S. FISCHER has been a director of our company since September 1999
and was the secretary of our company from July 1997 until September 1999.
Mr. Fischer has served as vice president of legal affairs and general counsel of
RSL COM since January 1999 and legal counsel of RSL COM since January 1997. From
1994 to 1997, he was an associate with the law firm of Rosenman & Colin LLP, New
York, New York with a practice concentrating in mergers and acquisitions,
securities and general corporate counseling. From 1993 to 1994, Mr. Fischer was
an associate with the law firm of Shea & Gould, New York, New York, with a
practice concentrating in commercial and securities litigation.
ITZHAK FISHER has been a director of our company since July 1997.
Mr. Fisher was a co-founder of RSL COM and has been a director, president and
chief executive officer of RSL COM since its inception in 1994. From 1992 to
1994, Mr. Fisher served as general manager of Clalcom Inc., a telecommunications
company. From 1990 to 1992, Mr. Fisher served as the special consultant to the
president of BEZEQ, the Israel Telecommunication Corp., Israel's national
telecommunications company. Mr. Fisher co-founded, and was a director, president
and chief executive officer of Medic Media, Inc., a company engaged in the
business of renting telephone and television systems in hospitals throughout
Israel.
ROBERT R. GRUSKY has been appointed a director of our company effective
upon closing of this offering. Mr. Grusky has been President of RSL Investments
Corporation since April 1998 and Senior Advisor to Ronald S. Lauder since April
1997. From 1985 to 1997, Mr. Grusky was at Goldman, Sachs & Co. as a member of
its mergers and acquisitions department and later in its principal investment
area. In 1990, Mr. Grusky took a one-year leave of absence during which he was
appointed a White House Fellow by President Bush and served as Assistant to the
then Secretary of Defense Dick Cheney. He is a director of Central European
Media Enterprises, Ltd., ITI Holdings, S.A. and an advisory director of Tinicum
Capital Partners, L.P. He is also a member of the Board of Trustees of the
Hackley School and The Multiple Myeloma Foundation.
YADIN KAUFMANN has been appointed director of our company effective upon
the closing of this offering. Mr. Kaufmann is a co-founder of MainXchange Ltd.
and has served as its chairman from February 1997 until the present and as its
chief executive officer from February 1997 until January 1999. In 1990,
Mr. Kaufmann co-founded Veritas Venture Capital Management Ltd., a venture fund
that invests primarily in early-stage technology companies in Israel, and has
since 1990 been its co-managing director. From 1987 until 1995, he was involved
in the management of Athena Venture Partners, and from 1986 until 1987 he was an
associate at the law firm Herzog, Fox & Ne'eman. Mr. Kaufmann currently serves
on the Board of Directors of Carmel Biosensors Ltd.
JACOB Z. SCHUSTER has been a director of our company since May 1999. He has
been a director, executive vice president and assistant secretary of RSL COM
since 1994. Mr. Schuster served as treasurer of RSL COM from 1994 through 1998,
and was chief financial officer from February 1997 until December 1998.
Mr. Schuster has been president and treasurer of RSL Management Corporation
since November 1995 and executive vice president of RSL Investments Corporation
since March 1994. From 1986 to 1992, Mr. Schuster was a general partner and
treasurer of Goldman Sachs.
DONALD R. SHASSIAN has been a director of our company since May 1999. Mr.
Shassian has served as chief operating officer of RSL COM since August 1999, and
he has served as executive vice president, chief financial officer and treasurer
of RSL COM since January 1999. From 1993 through 1998, Mr. Shassian served as
senior vice president and chief financial officer of Southern New England
Telecommunications. From 1988 through 1993,
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Mr. Shassian served as a partner of Arthur Andersen LLP, providing audit and
business advisory services to companies in the telecommunications industry. In
1992, Mr. Shassian was named the partner-in-charge of Arthur Andersen's
telecommunications industry practice group for North America.
NIR TARLOVSKY has been a director of our company since July 1997.
Mr. Tarlovsky has served as the vice president of business development of RSL
COM since April 1995, and was a director of RSL COM from April 1995 until March
1997. Mr. Tarlovsky is also vice president of RSL COM North America, Inc., a
subsidiary of RSL COM. From 1992 to March 1995, Mr. Tarlovsky served as senior
economist of Clalcom. While at Clalcom, he was responsible for the development
of new international telecommunications ventures. Mr. Tarlovsky is also a
director of Telegate, a German operator services company.
OAKLEIGH THORNE has been appointed director of our company effective upon
closing of this offering. Since October 1996, Mr. Thorne has served as the
chairman and chief executive officer of TBG Information Investors, LLC, a
private equity partnership, and as the co-president of Blumenstein/Thorne
Information Partners I, L.P., a private equity partnership. He was president and
chief executive officer of Commerce Clearing House, a provider of tax and
business law information, software and services from April 1995 to August 1996,
and the executive vice president of Commerce Clearing House from January 1991 to
April 1995. Since March 1998, Mr. Thorne has been a director of Medscape, a
web-based healthcare company. He also serves as the chairman of the board of SCP
Communications.
DIRECTOR COMPENSATION
We do not pay our directors cash compensation. Directors are reimbursed for
the expenses they incur in attending meetings of the board or board committees.
Each director who is not our employee will be eligible to receive options to
purchase 24,848 shares of common stock upon completion of this offering, with an
exercise price equal to the initial public offering price. Under our 1999
Directors Plan, each non-employee director will be eligible to receive on an
annual basis options to purchase 10,000 shares of common stock with an exercise
price equal to the fair market value on the date of grant. See "1999 Directors'
Plan."
COMMITTEES OF THE BOARD OF DIRECTORS
Prior to or upon the completion of this offering, our board of directors
will create an executive committee, a compensation committee and an audit
committee.
We expect that our executive committee will be composed of at least three
directors. The executive committee will have such powers and duties as shall be
determined by the board of directors.
We expect that our compensation committee will be composed of three
directors, including at least two independent directors, to be appointed prior
to or soon after completion of this offering. The compensation committee will
have the authority to evaluate our compensation policies, determine our
executive compensation policies and guidelines and administer our stock option
and compensation plans.
We expect that our audit committee will be composed of three directors to
be appointed prior to or soon after completion of this offering. The audit
committee will be charged with the following responsibilities:
o recommending the engagement of independent accountants to audit our
financial statements
o discussing the scope and results of the audit with our independent
accountants
o reviewing the functions our management and our independent accountants
pertaining to our financial statements
o performing such other related duties and functions as are deemed
appropriate by the audit committee and the board of directors
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Executive compensation decisions in 1998 were made by RSL COM's
compensation committee, in the case of Mr. Wurtman and Mr. Davidson, and by
Mr. Wurtman and Mr. Davidson, with our board's approval, in the case of
Mr. Bardin. Following the closing of this offering, our compensation committee
will make all compensation decisions regarding our executive officers. In 1998
no interlocking relationship existed between our board of directors and the
board of directors or compensation committee of any other company, except that
Messrs. Wurtman and Davidson were directors of Ambient, the board of which makes
all compensation decisions for Ambient. Mr. Davidson was also Ambient's chief
executive officer. See "Related Party Transactions--Ambient."
54
<PAGE>
EXECUTIVE COMPENSATION
In 1998, RSL COM paid the compensation of our executive officers listed
below other than Mr. Bardin. In addition, during 1998, RSL COM employed
Mr. Hirschhorn, our current chief financial officer, as vice president of
finance of RSL COM, and in that position, Mr. Hirschhorn provided financial
services to us.
The following table sets forth information concerning the compensation
during the year ended December 31, 1998 for our then chief executive officer and
the other most highly compensated executive officers of the Company whose total
salary and bonus exceeded $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
1998 ANNUAL
COMPENSATION ($)
----------------------- LONG-TERM ALL OTHER
NAME AND PRINCIPAL POSITION(1) SALARY ($) BONUS ($) COMPENSATION COMPENSATION ($)
- ---------------------------------------------------------- ---------- --------- ------------ ----------------
<S> <C> <C> <C> <C>
Elie Wurtman, president and chief executive officer(2).... 153,000 162,500 -- --
Jacob Davidson, chairman of the board (2)................. 81,250 81,250 -- --
Noam Bardin, chief technology officer..................... 120,000 10,000 -- --
</TABLE>
- ------------------
(1) The positions stated are those held by the named executive officers in 1998.
(2) Mr. Wurtman and Mr. Davidson were paid by RSL COM.
OPTION GRANTS IN LAST FISCAL YEAR
Neither we nor RSL COM granted options or stock appreciation rights to the
named executive officers in 1998.
OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES
There were no option exercises by our named executive officers in 1998. The
following table sets forth information for the named executive offices with
respect to restricted units held as of December 31, 1998.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
RESTRICTED UNITS AT RESTRICTED UNITS AT
YEAR END (#) YEAR-END
SHARES ACQUIRED VALUE EXERCISABLE ($) EXERCISABLE
NAME ON EXERCISE (#) REALIZABLE /UNEXERCISABLE(1) /UNEXERCISABLE(2)
- ----------------------------------------------- --------------- ---------- ------------------- -------------------
<S> <C> <C> <C> <C>
Elie Wurtman................................... -- -- --/-- --/--
Jacob Davidson................................. -- -- --/-- --/--
Noam Bardin.................................... -- -- 248,483/0 515,851/0
</TABLE>
- ------------------
(1) The number of securities was calculated based on our decision to exchange
the vested restricted units on a one-for-one basis for shares of our common
stock effective upon closing of this offering.
(2) Value was calculated using a $2.08 per unit value based on the price paid by
RSL COM to acquire 30% of our outstanding share capital in 1998 and a
nominal exercise price.
STOCK OWNERSHIP OF OUR DIRECTORS AND EXECUTIVE OFFICERS
None of our executive officers or directors currently own any of our
capital stock. However, four of our executive officers hold an aggregate of
385,148 restricted units granted under the RSL COM 1997 stock incentive plan
described below with an exercise price of $0.004. In addition, in April 1999 we
granted options to purchase an aggregate of 1,076,761 shares of common stock at
an exercise price of $5.11 per share to Messrs. Sela, Wurtman, Davidson,
Hirschhorn, Bardin and Zimels, executive officers of our company. We
55
<PAGE>
also intend to grant options to purchase 24,848 shares of our common stock to
each of our directors who are not our employees under our proposed 1999
Directors' Plan. In addition, we expect that our executive officers, directors
and employees and RSL COM employees will be offered the opportunity to purchase
shares of our common stock at the initial public offering price in this offering
from the shares reserved for employees and directors of our company and RSL COM.
The following table sets forth information for our directors and executive
officers with respect to the options or restricted units they hold.
<TABLE>
<CAPTION>
VALUE OF
SHARES TO BE UNEXERCISED
PURCHASED PURSUANT TO IN-THE-MONEY
OPTIONS/RESTRICTED EXERCISE OPTIONS/RESTRICTED
DIRECTOR/OFFICER UNITS PRICE UNITS
- ----------------------------------------------------------- --------------------- ---------- ------------------
<S> <C> <C> <C>
Elie Wurtman............................................... 165,656 $ 5.11 $1,638,338
Amos Sela.................................................. 273,332 5.11 2,703,253
Jacob Davidson............................................. 115,959 5.11 1,146,835
Mark Hirschhorn............................................ 173,938 5.11 1,720,247
Noam Bardin................................................ 173,938/248,483 5.11/.004 5,446,498
Shimmy Zimels.............................................. 173,938/86,969 5.11/.004 3,024,434
Baruch Sterman............................................. 24,848 .004 372,621
Marc Tobin................................................. 24,848 .004 372,621
Itzhak Fisher.............................................. 24,848 15.00 --
Nir Tarlovsky.............................................. 24,848 15.00 --
Donald Shassian............................................ 24,848 15.00 --
Jacob Schuster............................................. 24,848 15.00 --
Yadin Kaufmann............................................. 24,848 15.00 --
Robert Grusky.............................................. 24,848 15.00 --
Avery Fischer.............................................. 24,848 15.00 --
Oakleigh Thorne............................................ 24,848 15.00 --
</TABLE>
We have adopted a policy to encourage all of our executive officers and
directors not to sell in excess of 50% of their holdings in us while they are
our employees or directors, except for personal estate planning or tax purposes.
STOCK OPTION INFORMATION; RSL COM 1997 STOCK INCENTIVE PLAN
Historically, we have not had a stock option plan. As of September 30, 1999
1,121,324 RSL COM restricted units granted to our employees were outstanding. Of
these, 836,147 restricted units granted in 1997 and 1998 have an exercise price
of $0.004; 189,262 restricted units granted in 1998 have an exercise price of
$2.08; and 95,915 restricted units granted in April 1999 have an exercise price
of $5.11. These restricted units were originally redeemable for shares of RSL
COM or cash (at RSL COM's discretion) based on the value of RSL COM attributable
to us. The restricted units generally vest over three-year periods and must be
redeemed by the employee before the seventh anniversary of their date of grant.
In connection with the offering, as of September 30, 1999, we committed to
exchange shares of our common stock or options to purchase shares of our common
stock for restricted units held, as follows:
(1) To holders of restricted units that have vested, we will issue
restricted shares of our common stock on a one-for-one basis, to be issued
under our 1999 Stock Incentive Plan upon payment of the related exercise
price; these restricted shares will fully vest 180 days after completion of
this offering.
(2) To holders of restricted units that have not yet vested, we will
issue options to purchase our common stock on a one-for-one basis; these
options will also be issued under our 1999 Stock Incentive Plan and will
have the same exercise price (adjusted for our 2.48-for-one stock split)
and vesting schedules as the RSL COM restricted units.
If all holders of restricted units exchange their restricted units for
shares of common stock or options to purchase common stock, then we will issue
748,288 restricted shares of common stock and options to purchase 372,976 shares
of common stock, in connection with this exchange.
56
<PAGE>
1999 STOCK INCENTIVE PLAN
We expect to adopt a stock incentive plan prior to the completion of this
offering. The purpose of the plan is to foster and promote the long-term
financial success of our company and materially increase shareholder value by
(a) motivating superior performance by means of performance-related incentives,
(b) encouraging and providing for the acquisition of an ownership interest in
our company by executive officers, other employees and consultants and
(c) enabling us to attract and retain the services of an outstanding management
team upon whose judgment, interest and effort the successful conduct of our
operations is largely dependent.
GENERAL. The plan provides for the grant of (i) incentive stock options
and non-incentive stock options to purchase our common stock; (ii) stock
appreciation rights, which may be granted in tandem with or independently of
stock options; (iii) restricted stock and restricted units; (iv) incentive stock
and incentive units; (v) deferred stock units; and (vi) stock in lieu of cash.
We have reserved 4,000,000 shares of our common stock for issuance upon exercise
of awards to be granted under the plan.
ADMINISTRATION. The plan will be administered by our compensation
committee or such other committee as designated by our board of directors. This
committee will be made up of at least two directors who are not our employees
and whose membership on the committee (i) does not adversely impact our ability
to deduct compensation payments made under the plan and (ii) will permit
recipients of awards to avail themselves of exemptions under federal securities
laws.
ELIGIBILITY AND EXTENT OF PARTICIPATION. The plan provides for
discretionary grants of awards to officers of the company within the meaning of
Rule 16a-1(f) of the Exchange Act and to other employees and consultants of the
company. Directors who are non-employees are prohibited from participating in
the plan. The maximum number of shares for which options or stock appreciation
rights may be granted to any one participant in a calendar year is 600,000 of
the shares of common stock available under the plan.
STOCK OPTIONS. Under the plan, the committee may grant both incentive and
non-incentive stock options for common stock of the company. The options
generally will have a term of seven years and will become exercisable in three
equal installments commencing on the first anniversary of the date of grant. The
purchase price per share payable upon exercise of an option will be established
by the committee; provided, however, that such option exercise price may be no
less than the fair market value of a share of our common stock on the date of
grant (or 110% of the fair market value, in the case of incentive stock option
grants to persons holding more than 10% of voting power of all classes of our
capital stock). The option exercise price is payable by one of the following
methods or a combination of methods to the extent permitted by the committee:
(i) in cash or its equivalent, or (ii) subject to the approval of the committee,
in shares of common stock owned by the participant for at least six months prior
to the date of exercise. The committee may provide that a participant who
delivers shares of common stock to exercise an option when the market value of
the common stock exceeds the exercise price of the option will be automatically
granted reload options for the number of shares delivered to exercise the
option. Reload options will be subject to the same terms and conditions as the
related option except that the exercise price will be the fair market value on
the date the reload option is granted and such reload option will not be
exercisable for six months.
STOCK APPRECIATION RIGHTS. The committee may grant stock appreciation
rights in tandem with or independently of a stock option. Stock appreciation
rights entitle the participant to receive the excess of the fair market value of
a stated number of shares of common stock on the date of exercise over the base
price of the stock appreciation right. The base price may not be less than 100%
of the fair market value of the common stock on the date the stock appreciation
right is granted. The committee will determine when a stock appreciation right
is exercisable, the method of exercise, and whether settlement of the stock
appreciation right is to be made in cash, shares of common stock or a
combination of cash and shares.
RESTRICTED STOCK AND RESTRICTED UNITS. The committee may grant awards in
the form of restricted stock and restricted units. For purposes of the plan,
restricted stock is an award of common stock and a restricted unit is a
contractual right to receive common stock (or cash based on the fair market
value of common stock). Such awards are subject to such terms and conditions, if
any, as the committee deems appropriate. Unless otherwise determined by the
committee, participants are entitled to receive either currently or at a
57
<PAGE>
future date, dividends or other distributions paid with respect to restricted
stock and, if and to the extent determined by the committee, either to be
credited with or receive currently an amount equal to dividends paid with
respect to the corresponding number of shares covered by restricted units.
Restricted stock and restricted units become vested and nonforfeitable and the
restricted period shall lapse upon the third anniversary of the date of grant
unless the committee determines otherwise.
INCENTIVE STOCK AND INCENTIVE UNITS. The plan allows for the grant of
awards in the form of incentive stock and incentive units. For purposes of the
plan, incentive stock is an award of common stock and an incentive unit is a
contractual right to receive common stock. Such awards will be contingent upon
the attainment, in whole or in part, of certain performance objectives over a
period to be determined by the committee. With regard to a particular
performance period, the committee has the discretion, subject to the plan's
terms, to determine the terms and conditions of such awards, including the
performance objectives to be achieved during such period and the determination
of whether and to what degree such objectives have been attained. Unless
otherwise determined by the committee, participants are entitled to receive,
either currently or at a future date, all dividends and other distributions paid
with respect to the incentive stock and, if and to the extent determined by the
committee, either to be credited with or receive currently an amount equal to
dividends paid with respect to the corresponding number of shares covered by the
incentive units.
ELECTIVE UNITS. On such date or dates established by the committee and
subject to such terms and conditions as the committee will determine, a
participant may be permitted to defer receipt of all or a portion of his annual
compensation and/or annual incentive bonus ("deferred annual amount") and
receive the equivalent amount in elective stock units based on the fair market
value of the common stock on the date of grant. To the extent determined by the
committee, a participant may also receive supplemental stock units for a
percentage of the deferred annual amount. On the date of a participant's
termination of employment, the participant will receive a number of shares of
common stock equal to the number of elective units and supplemental units held
on that date. Elective units carry no voting rights until the shares have been
issued. The committee will determine whether any dividend equivalents
attributable to elective units are paid currently or credited to the
participant's account and deemed reinvested in common stock. Elective units and
dividend equivalents with respect to the elective units are fully vested at all
times. Unless the committee provides otherwise, supplemental units and dividend
equivalents with respect to the supplemental units will become fully vested on
the third anniversary of the date the corresponding deferred amount would have
been paid.
STOCK IN LIEU OF CASH. The plan authorizes the committee to grant awards
of common stock to executive officers in lieu of all or a portion of an award
otherwise payable in cash pursuant to any bonus or incentive compensation plan
of the company, based on the fair market value of the common stock.
AMENDMENT AND TERMINATION. No awards may be granted under the plan after
the expiration of ten years from the date of the plan's adoption. The board of
directors or the committee may amend, suspend or terminate the plan or any
portion of it at any time. However, no amendment may be made to the plan without
shareholder approval if such amendment would (1) increase the number of shares
of common stock subject to the plan, (2) change the price at which options may
be granted, or (3) remove the administration of the plan from the committee.
1999 PERFORMANCE INCENTIVE PLAN
We expect to adopt a performance incentive plan prior to the completion of
this offering. The purpose of the plan is to assist the company and its
subsidiaries to attract, retain, motivate and reward the best qualified
executive officers and key employees by providing them with the opportunity to
earn competitive compensation directly linked to our performance.
GENERAL. Under the plan, bonuses are payable if we meet any one or more of
several performance criteria, which are to be set annually by the committee,
after receipt of the proposed annual budget for the coming year from management.
It is expected that proposed performance criteria for the coming year will be
presented by management in the fourth quarter of the current year and approved
not later than March 31 of the next year. It is expected that the period over
which performance is to be measured will be one year.
58
<PAGE>
The committee shall determine whether bonuses payable under the plan will
be paid in cash, shares of common stock or in any combination thereof, provided
that not less than 50% of any bonus shall be in cash. No more than 400,000
shares common stock may be issued under the plan.
ADMINISTRATION. The plan will be administered by our compensation
committee or such other committee as designated by our board of directors. This
committee will be made up of directors who are not our employees and whose
membership on the committee (i) does not adversely impact our ability to deduct
compensation payments made under the plan and (ii) will permit recipients of
awards to avail themselves of exemptions under federal securities laws. The
committee will establish the performance targets and certify whether such
performance targets have been achieved.
BONUS. Bonus amounts are determined as follows: if 100% of the
pre-established targets are achieved, participants will generally be eligible to
receive a bonus equal to their base salary for such year. If 120% of such
targets are achieved, the bonus potentially payable to participants will
generally equal twice their base salary for such year and, if 80% of such
targets are achieved, the bonus potentially payable to participants will
generally equal 25% of their base salary for such year. To the extent our
results exceed 80% of the targets but is less than 120% of the targets, the
amount of the bonus payable to participants will be adjusted proportionately
based on where such results fall within the ranges set forth above.
Once eligibility has been determined, a bonus, if applicable, will consist
of two components. Fifty percent of the amount determined pursuant to the
formula described above will be payable if the targets are achieved. Up to an
additional 50% of such amount will be payable in the discretion of the
committee. In addition, the plan permits the committee to grant discretionary
bonuses to participants, notwithstanding that a bonus would not otherwise be
payable under the plan, to recognize extraordinary individual performance.
ELIGIBILITY. Each executive officer of the company and each key employee
who is recommended by the chief executive officer and selected by the committee
and approved by the board of directors is eligible to receive a bonus under the
plan.
OTHER TERMS. No plan participant may receive a bonus with respect to any
plan year in excess of $1,000,000. The committee may impose conditions with
respect to an award of common stock, including conditioning the vesting of
shares on the performance of additional service. The committee may permit a
participant to receive all or a portion of his bonus payable in common stock. If
a participant's employment terminates prior to the completion of performance
period, the committee shall determine whether a prorated bonus may be paid to
such a participant. In addition, the plan permits a participant to elect to
defer payment of his or her bonus on terms and conditions established by the
committee.
AMENDMENT AND TERMINATION. Either the board of directors or the committee
may amend, suspend, discontinue or terminate the plan, provided that, unless the
board determines otherwise, any amendment or termination of the plan that
requires stockholder approval will not be effective until stockholder approval
is obtained.
1999 EMPLOYEE STOCK PURCHASE PLAN
We expect to adopt an employee stock purchase plan prior to the completion
of this offering. The purpose of the employee stock purchase plan is to align
employee and shareholder long-term interests by facilitating the purchase of
common stock by employees and to enable employees to develop and maintain
significant ownership of common stock.
GENERAL. The employee stock purchase plan is intended to comply with the
requirements of Section 423 of the Internal Revenue Code, and to assure the
participants of the tax advantages provided thereby. The number of shares of
our common stock available for issuance under the employee stock purchase plan
is limited to 1,350,000 shares of common stock.
ADMINISTRATION. The employee stock purchase plan will be administered by a
committee established by the board of directors. The committee may make such
rules and regulations and establish such procedures for the administration of
the employee stock purchase plan as it deems appropriate.
59
<PAGE>
ELIGIBILITY. All employees of the company and its designated subsidiaries
who have at least one year of service and work more than 20 hours per week and
five months in a calendar year will be eligible to participate in the employee
stock purchase plan, except that employees who are "highly compensated" within
the meaning of Section 414(q) of the Code and employees who are five percent or
more stockholders of the company or any parent or subsidiary of the company will
not be eligible to participate.
GRANTS. Pursuant to the employee stock purchase plan, each eligible
employee will be permitted to purchase shares of common stock up to two times
per calendar year through regular payroll deductions in an aggregate amount
equal to 1% to 10% of the employee's base pay, as elected by the employee, for
each payroll period. Under the employee stock purchase plan, a participant's
right to purchase shares of common stock may not accrue at a rate that exceeds
$25,000 of fair market value of common stock during any calendar year.
OFFERING PERIOD; PURCHASE PERIOD. The initial offering period will
commence on the first trading day on or after the effective date of the employee
stock purchase plan and end on the last trading day on or prior to the second
anniversary of the commencement date. Each subsequent offering period will have
a duration of approximately one year, commencing on the first trading day and
ending on the last trading day of each calendar year (commencing with calendar
year 2001). Each "purchase period" will have a duration of approximately six
months.
EXERCISE PRICE. As of the last day of each "purchase period" ending within
an "offering period," participating employees will be able to purchase shares of
common stock with payroll deductions for a purchase price equal to the lesser
of:
o 85% of the fair market value of common stock on the date the offering
period begins and
o 85% of the fair market value of common stock on the last day of the
purchase period.
A right to purchase shares which is granted to a participant under the
employee stock purchase plan is not transferable otherwise than by will or the
laws of descent and distribution.
1999 DIRECTORS' PLAN
We expect to adopt a directors' stock compensation plan prior to the
completion of this offering. The purposes of the directors' plan are to enable
us to attract, maintain and motivate qualified directors and to enhance a
long-term mutuality of interest between our directors and shareholders of our
common stock by granting our directors options to purchase our shares.
Under the directors' plan, on the first business day following each annual
meeting of our shareholders during the term of the directors' plan, each
director who is not an employee of our company will be granted options to
acquire 10,000 shares of our common stock with an exercise price per share equal
to the fair market value of a share of our common stock on the date of grant.
These options will have a seven-year term and will become exercisable on the
first anniversary of the date of grant. In addition, each director who is not an
employee of our company on the date of the completion of this offering will be
granted options to acquire 24,848 shares of our common stock with an exercise
price per share equal to the initial public offering price. Each individual who
becomes a director and is not an employee of our company following completion of
this offering will be granted options to acquire 24,848 shares of common stock
with an exercise price per share equal to the fair market value on the date of
grant. These options will have a seven-year term and will be immediately
exercisable, but if exercised, subject to the 180-day lock-up to be imposed on
our officers and directors. The maximum number of shares that may be issued
under the directors' plan is 600,000. The plan will terminate December 31, 2009,
unless sooner terminated by our stockholders.
EMPLOYMENT AGREEMENTS
We have entered into employment agreements with Messrs. Sela, Hirschhorn,
Wurtman, Davidson, Bardin and Zimels, each with the following principal terms:
o The agreement is effective as of April 1, 1999 and will end on March 31,
2002.
60
<PAGE>
o The employee is entitled to receive a base salary as stated below,
increased on each January 1, commencing January 1, 2001, by an amount
equal to his base salary then in effect, multiplied by the applicable
cost of living index during the prior year. The employee's base salary,
as adjusted for cost of living increases, may be further increased at the
option and in the discretion of the board of directors.
o The employee shall be granted options to purchase shares of our common
stock as set forth below, under our proposed 1999 Stock Incentive Plan,
at an exercise price of $5.11 per share. The employee's options are
exercisable in installments, as long as the employee is employed by us on
the applicable vesting date, and after an option is exercisable, that
option remains exercisable until the expiration of seven years from the
date of the agreement. If the employee is terminated for any reason prior
to September 30, 2000, following such date, any unvested options will
expire. If the employee is terminated for cause, following such date, all
options will expire. In the case of Messrs. Sela, Hirschhorn, Bardin and
Zimels, the options are exercisable in three equal installments on each
of April 1, 2000, 2001 and 2002. In the case of Messrs. Wurtman and
Davidson, 50% of the options are exercisable on April 1, 2000 and the
remaining options are exercisable in two equal installments on each of
April 1, 2001 and April 1, 2002.
o The employee's options are immediately exercisable in full upon a change
of control. The employee's options, following any termination of the
employee's employment, other than for cause, remain exercisable for the
lesser of two years and the remaining term of his options.
o If the employee's employment is terminated by us without cause or by the
employee for good reason, the employee is entitled to receive previously
earned but unpaid salary, vested benefits and a payment equal to his base
salary as in effect immediately prior to the termination date.
o If the employee dies or is unable to perform his duties, he or his
representative or estate or beneficiary will be paid, in addition to any
previously earned but unpaid salary and vested benefits, 12 months' total
base salary reduced, in the case of disability, by any disability
benefits he receives.
The following table sets forth the position, base salary and number of
shares of common stock represented by the options granted for each of Messrs.
Wurtman, Sela, Davidson, Hirschhorn, Bardin and Zimels, pursuant to their
respective employment agreements:
<TABLE>
<CAPTION>
OPTIONS TO
PURCHASE
SHARES OF
POSITION BASE SALARY COMMON STOCK
---------------------------------------- ----------- ------------
<S> <C> <C> <C>
Elie C. Wurtman......................... Co-Chairman of the Company and Chairman $ 180,000(1) 165,656
of the Board of Directors
Amos Sela............................... Chief Executive Officer and President $ 230,000 273,332
Jacob A. Davidson....................... Co-Chairman of the Company $ 180,000(1) 115,959
Mark J. Hirschhorn...................... Vice President and Chief Financial $ 200,000 173,938
Officer
Noam Bardin............................. Vice President of Technology and Chief $ 170,000 173,938
Technology Officer
Shimmy Zimels........................... Vice President of Operations $ 170,000 173,938
</TABLE>
- ------------------
(1) Messrs. Wurtman and Davidson will devote 50% of their time to us beginning
on April 1, 2000 and their base salaries will at that time be reduced to
$90,000 each.
Following RSL COM's purchase of Mr. Davidson's and Mr. Wurtman's interests
in us in July 1997, they entered into employment agreements with RSL COM dated
July 1997. These agreements terminated at the end of March 1999. They entered
into new employment agreements with us as of April 1, 1999.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of shares of our Class B common stock and common stock as of
October 20, 1999 and as adjusted to reflect the sale of the shares of common
stock offered under this prospectus, including shares offered in exchange for
RSL COM restricted units, and the beneficial ownership of shares of the capital
stock of RSL COM as of October 20, 1999 by:
o each person who we know owns beneficially more than 5% of our common
stock
o each of our directors individually
o each of our named executive officers individually
o all of our executive officers and directors as a group
The information in the table assumes the underwriters do not exercise their
option to purchase additional shares.
Unless otherwise indicated, to our knowledge, all persons listed below have
sole voting and investment power with respect to their shares of common stock.
Each person listed below disclaims beneficial ownership of their shares, except
to the extent of their pecuniary interests therein. Shares of common stock that
an individual or group has the right to acquire within 60 days of October 20,
1999 pursuant to the exercise of options are deemed to be outstanding for the
purpose of computing the percentage ownership of such person or group, but are
not deemed outstanding for the purpose of calculating the percentage owned by an
other person listed.
<TABLE>
<CAPTION>
SHARES OF DELTATHREE.COM
CAPITAL STOCK
BENEFICIALLY OWNED(1) SHARES OF RSL COM
-------------------------------------------------- CAPITAL STOCK
PERCENTAGE VOTING POWER BENEFICIALLY OWNED(2)
------------------ ------------------ ----------------------------------
BEFORE AFTER BEFORE AFTER VOTING
NUMBER OFFERING OFFERING OFFERING OFFERING NUMBER PERCENTAGE POWER
---------- -------- -------- -------- -------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PRINCIPAL STOCKHOLDERS:
RSL Communications, Ltd.
767 Fifth Avenue
Suite 4300,
New York, New York 10153............... 19,569,459 94.0% 70.9% 99.4% 96.1% -- --% --%
Ronald S. Lauder
c/o RSL Communications, Ltd. (3)....... 19,569,459 94.0 70.9 99.4 96.1 16,447,636(11) 29.7 57.6
CNET Investments, Inc.
150 Chestnut Street
San Francisco, California 94111........ 1,551,971(4) 7.3 5.5 * * -- -- --
DIRECTORS AND EXECUTIVE OFFICERS:
Itzhak Fisher(5)......................... -- -- (10) -- * 3,310,481(12) 6.0 11.5
Nir Tarlovsky(5)......................... -- -- (10) -- * 791,058(13) 1.4 *
Donald R. Shassian(5).................... -- -- (10) -- * 18,000(14) * *
Jacob Z. Schuster(5)..................... -- -- (10) -- * 1,689,404(15) 3.1 6.0
Yadin Kaufmann(6)........................ -- -- (10) -- * 1,000(16) * *
Robert R. Grusky(6)...................... -- -- (10) -- * 4,500(17) * *
Avery S. Fischer(5)...................... -- -- (10) -- * 5,980(18) * *
Oakleigh Thorne(6)....................... -- -- (10) -- * -- -- --
Elie C. Wurtman(7)....................... -- -- -- -- -- -- -- --
Jacob A. Davidson(7)..................... -- -- -- -- -- -- -- --
Noam Bardin(7)(8)........................ -- -- * * * 10,000(19) * *
All Directors and Executive Officers as a
group (fifteen persons)(9)(10)......... -- -- 2.1 * * 5,830,423 10.6 17.9
</TABLE>
- ------------------
* Less than 1%.
(1) Before this offering our outstanding share capital consists of
(a) 19,569,459 shares of Class B common stock, (b) 183,901 shares of common
stock issued to Yahoo! (including a warrant to purchase 58,626 shares of
common stock, assuming a cashless exercise) and (c) 1,085,943 shares of
common stock issued to CNET (excluding a warrant to purchase 466,028 shares
of common stock), and after this offering, unless otherwise indicated, our
outstanding share capital consists of (a) 19,569,459 shares of Class B
common stock and
(Footnotes continued on next page)
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(Footnotes continued from previous page)
(b) 8,018,132 shares of common stock (which includes shares of common stock
issued to Yahoo! and CNET, 58,626 shares of common stock issued to Yahoo!
upon a cashless exercise of a warrant and 748,288 shares issued in exchange
for RSL restricted units that had vested).
(2) RSL COM's outstanding share capital consists of 24,267,283 shares of
Class B common stock and 30,591,975 shares of Class A common stock. Shares
of Class B common stock of RSL COM are convertible at any time into shares
of Class A common stock of RSL COM for no additional consideration on a
share-for-share basis. Shares of Class A common stock of RSL COM are
entitled to one vote for each share and shares of Class B common stock of
RSL COM are entitled to 10 votes for each share.
(3) Ronald S. Lauder, together with a number of entities, including entities
formed for the benefit of charities and members of his family, own shares
of RSL COM's capital stock that enable him to vote more than 50% of RSL
COM's capital stock. As a result, he may be deemed to be the beneficial
owner of our capital stock owned by RSL COM. Mr. Lauder disclaims
beneficial ownership of these shares.
(4) Includes a warrant to purchase 466,028 shares of common stock.
(5) The address for the director listed is c/o RSL Communications, Ltd.
(6) Each of these is a nominee director, who will become directors upon closing
of this offering. The address for Mr. Grusky is c/o RSL Management
Corporation, 767 Fifth Avenue, New York, NY 10153. The address for
Mr. Kaufmann is 91 Medinat Hayehudim St., Herzlia Pituach 46120, Israel.
The address for Mr. Thorne is P.O. Box 871, Lake Forest, IL 60045.
(7) The address for director or executive officer listed is c/o us.
(8) Mr. Bardin holds 248,483 RSL COM restricted units that will be exchanged
for 248,483 shares of our common stock upon completion of this offering.
(9) Four of our sixteen directors and executive officers collectively hold
385,148 RSL COM restricted units that will be exchanged for 385,148 shares
of our common stock upon completion of this offering.
(10) On completion of this offering, we will issue to each of our seven
directors who is not an employee of our company options to purchase 24,848
shares of our common stock at an exercise price equal to the initial public
offering price. If exercised, the shares issued would represent less than
1% of our outstanding share capital.
(11) Consists of (a) 502,336 shares of Class A common stock of RSL COM,
(b) 15,481,527 shares of Class B common stock, (c) 3,873 shares of Class A
common stock issuable upon exercise of an equal number of currently
exercisable options granted to Mr. Lauder under RSL COM's 1997 Directors'
Compensation Plan and (d) 459,900 shares issuable upon exercise of a
warrant issued to Mr. Lauder. The shares of Class B common stock consist
of: (a) 9,496,295 shares owned by RSL Investments Corporation, a
corporation wholly owned by Mr. Lauder, (b) 1,814,579 shares owned by
EL/RSLG Media, of which The 1995 Estee Lauder RSL Trust, of which Mr.
Lauder is a trustee and the beneficiary is a 50% shareholder, (c) 907,290
shares owned by RAJ Family Partners, of which Mr. Lauder is a limited
partner and a shareholder of the general partner, and (d) 3,428,363 shares
owned directly by Mr. Lauder.
(12) Consists of (a) 177,839 shares of Class A common stock of RSL COM and
(b) 3,132,642 shares of Class B common stock of RSL COM owned by Fisher
Investment Partners, L.P., of which Mr. Fisher is the sole general partner
and the Fisher 1997 Family Trust is the sole limited partner. Mr. Fisher
disclaims beneficial ownership of these shares.
(13) Consists of (a) 718,915 shares of Class A common stock of RSL COM owned by
Tarlovsky Investment Partners, of which Mr. Tarlovsky is the sole general
partner and the Tarlovsky 1997 Family Trust is the sole limited partner and
(b) 72,143 shares of Class A common stock issuable upon exercise of an
equal number of currently exercisable options granted to Mr. Tarlovsky
under RSL COM's 1997 Stock Incentive Plan.
(14) Represents 18,000 shares of Class A common stock of RSL COM.
(15) Consists of (a) 1,189 shares of Class A common stock owned directly by Mr.
Schuster, (b) 41,656 shares of Class A common stock owned by Schuster
Family Partners, of which Mr. Schuster is the sole general partner and the
limited partners are some of his children, and (c) 1,646,559 shares of
Class B common stock owned by Schuster Family Partners. Mr. Schuster
disclaims beneficial ownership of the shares owned by Schuster Family
Partners.
(16) Represents 1,000 shares of Class A common stock of RSL COM.
(17) Represents 4,500 shares of Class A common stock of RSL COM.
(18) Represents 5,980 shares of Class A common stock of RSL COM.
(19) Represents 10,000 shares of Class A common stock of RSL COM.
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RELATED PARTY TRANSACTIONS
AMBIENT
In January 1998, we entered into a cooperation agreement with Ambient
Corporation, a public company founded by Elie Wurtman, a co-chairman of our
company and chairman of the board and Jacob Davidson, a co-chairman of our
company. Mr. Wurtman was a director of Ambient until September 1999.
Mr. Davidson was chief executive officer and chairman of Ambient from June 1996
until September 1999. Mr. Davidson owns a 7% interest in Ambient. Under the
cooperation agreement, we provided them with office services for approximately
$1,000 per month. We also rented approximately 150 square meters of our facility
in Jerusalem, Israel to Ambient. In addition, Ambient rented approximately 675
square feet of office space to us before we moved into our new facilities in
Jerusalem for a total of approximately $13,500. The cooperation agreement and
the sub-lease to Ambient were terminated as of September 1, 1999.
RSL COM
On July 23, 1997, RSL COM acquired 51% of our outstanding share capital.
From that date through March 31, 1998, RSL COM continued to purchase additional
shares from our other stockholders. On March 31, 1998, we entered into a merger
agreement with RSL COM and our remaining minority stockholders. Pursuant to the
agreement, we merged with and into a newly formed wholly-owned subsidiary of RSL
COM. Since RSL COM's acquisition of a controlling interest in us, RSL COM has
funded our cash requirements through inter-company loans bearing interest at the
rate of 14% per annum. As of September 30, 1999, we owed approximately
$12.3 million (principal and accrued interest) to RSL COM. The inter-company
loans is due on demand after September 30, 2000. Upon completion of an initial
public offering by us, the maturity dates will be extended to the first
anniversary of the completion of such offering. RSL COM will, upon completion of
this offering, provide us a $10 million line of credit (in addition to the
existing $12.3 million), bearing interest at the rate of 14% per annum, due on
demand after November 1, 2000. We have agreed with RSL COM that we will not
incur any debt other than inter-company debt without its written consent so long
as we are a restricted subsidiary.
Following the completion of this offering, RSL COM will be our controlling
stockholder and will own 100% of the outstanding Class B common stock, which
will represent approximately 96.1% of the combined voting power of all of our
outstanding capital stock and approximately 70.9% of the economic interest in
our company (or 95.6% and 68.7% if the underwriters' over-allotment option is
exercised in full).
For so long as RSL COM continues to beneficially own shares of capital
stock representing more than 50% of the combined voting power of our outstanding
capital stock, it will be able to approve any matter submitted to a vote of our
stockholders, including, among other things, the election of all members of the
board of directors. In addition, our non-competition provision in the services
agreement with RSL COM terminates on September 3, 2001. See "--Services
Agreement." Therefore, various conflicts of interest could arise between
ourselves and RSL COM.
RSL COM has advised us that it currently has no plans to dispose of the
shares of Class B common stock owned by it. However, RSL COM has no contractual
obligation to retain its shares of our Class B common stock, except RSL COM has
agreed, subject to specified exceptions, not to sell or otherwise dispose of any
shares of our Class B common stock for a period of 180 days from the date of
this prospectus without the prior written consent of Lehman Brothers Inc. This
lock-up agreement does not restrict RSL COM from selling shares of Class B
common stock to a purchaser or purchasers of the shares who agree to be bound by
the same restrictions that bind RSL COM. As a result, there can be no assurance
concerning the period of time during which RSL COM will retain its ownership of
our Class B common stock owned by it following the offering. See "--Registration
Rights Agreement."
INTERCOMPANY COMPLIANCE AGREEMENT
We have entered into an agreement with RSL COM under which we have agreed
not to take any action which would cause RSL COM to default under its
indentures. In order to help RSL COM comply with its indentures, we have also
agreed to obtain RSL COM's written consent before incurring any debt and to
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provide RSL COM with information that it requires for its reporting obligation
under its indentures and under the securities laws.
SERVICES AGREEMENT
We entered into a services agreement with RSL COM on July 23, 1997, which
was subsequently amended and restated as of September 3, 1999. As amended and
restated, the agreement extends to September 2, 2004, and is automatically
extended for additional one-year terms unless terminated by RSL COM or us. The
services agreement may be terminated by us or RSL COM for cause, by the
non-bankrupt party in the event of bankruptcy of the other party or by RSL COM
should RSL COM and/or its affiliates hold less than 50% of the voting control of
our outstanding common stock.
Services and Facilities
Under the agreement, if we require equipment space or limited office space
at any location where RSL COM maintains an office or equipment, RSL COM is
required to use its reasonable best efforts to provide us such space. However,
RSL COM is not obligated to provide us with office space for more than that
required by two full-time employees, and RSL COM is entitled to vacate space
without it being deemed a breach of the agreement. We are required to pay
RSL COM our proportionate share of all lease payments associated with such
office or equipment space. In addition, RSL COM is required to make reasonable
efforts to assist us in obtaining Internet, frame relay and dedicated lines from
third parties in countries where RSL COM has communication switches colocated
with our network servers at the same price that RSL COM pays such third parties.
As of September 30, 1999, we colocated offices in five locations and equipment
in five locations. RSL COM is also required to use its reasonable efforts to
purchase dedicated bandwidth connectivity on our behalf from third party
bandwidth suppliers at the same price as RSL COM pays such third party
suppliers. As a result, we realize certain bulk pricing benefits received by RSL
COM.
Under the services agreement, RSL COM is also required to provide us with
the following services:
o domestic inbound traffic termination--RSL COM is required to
terminate our domestic inbound traffic through RSL COM's switches in
countries where our servers and RSL COM's switches are co-located.
This termination service is provided to us at the then prevailing
fair market rates for such service.
o international outbound termination--RSL COM is required to terminate
our international outbound telephone traffic in each country where
our servers and RSL COM's switches are co-located and RSL COM has
contracted to receive such services in the ordinary course. This
termination service is provided to us at the then prevailing fair
market rates for such service.
o traffic origination--RSL COM is required to use its best efforts to
assist us in obtaining services, including toll-free services, from
local third parties which will provide our users with the ability to
access our network at the same rates offered by such third parties
to RSL COM in countries where our servers and RSL COM's switches are
colocated.
o use of RSL COM switches--RSL COM is required to provide us with use
of RSL's switches to connect our carrier customers in each location
where our servers and RSL COM's switches are colocated. The
termination rate is $0.01 per minute. We are charged for a minimum
usage of 100,000 minutes per month per switch per connection,
whether or not such minutes are used. In addition, RSL COM provides
our carrier customers billing and other similar customer-related
services at a charge of $0.01 per minute of carrier traffic usage.
Based on switches currently used, RSL COM charges us a minimum of
$7,000 per month.
o use of prepaid calling platform--RSL COM is required to provide us
with access to, and use of, RSL COM's prepaid calling platform in
each location where our servers and RSL COM's switches are
co-located. If we elect to use RSL COM's prepaid calling platform,
we will be charged for a minimum of 100,000 minutes per month. The
fee for using RSL COM's prepaid calling platform is $0.01 per minute
of traffic usage. In addition, RSL COM is required to
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provide us with additional customer-related services for our prepaid
calling services at a rate of $0.015 per minute of traffic usage. To
date, we have not elected to purchase such services.
In the event any of RSL COM's current or future strategic partner objects to RSL
COM providing us with any of the foregoing services, RSL COM can cease providing
the service to us. A strategic partner is a minority shareholder in RSL COM or
any RSL COM subsidiary owning more than 10% of the common stock of such entity.
However, RSL COM is required to use reasonable efforts to encourage its
strategic partners not to object. To date, no strategic partner has objected to
RSL COM providing us with these services.
Under the services agreement, we are required to provide Internet telephony
services and facilities to RSL COM necessary to route RSL COM's international
telecommunications traffic between all originations and destinations we service.
The agreement provides that we are required to use, at RSL COM's request, up to
50% of our network capacity to route RSL COM's international telecommunications
traffic between our origination and termination points. For a period two years
from the date of the closing of this offering, provided this offering occurs
prior to June 30, 2000, RSL COM has committed to purchase a minimum of
50 million minutes per annum of voice and fax transmission services from us. If
RSL COM fails in this commitment RSL COM will be required to pay us a shortfall
charge of 10% of the average daily weighted coverage price per minute charged by
us to RSL COM in the last three months of each annual period. If we are no
longer a subsidiary of RSL COM, RSL COM's minimum purchase obligation will
cease. These services are provided to RSL COM at the then prevailing fair market
rates. However, the services agreement does not specify procedures for
establishing such rates.
Marketing
Under the services agreement, we and RSL COM will engage in joint
marketing. Each of us is required to place, in a prominent location, a link on
its home page Web site to the other's home page Web site. We will also
cross-sell each other's products and services, including through promotional
materials and customer service representatives and other additional promotional
efforts. However, neither we nor RSL COM are required to market or promote a
product or service of the other if such product or service competes with the
other party's product or service.
Non-Competition
Under the services agreement between us and RSL COM, RSL COM is prohibited
from competing with us in providing Internet telephony services as described in
the services agreement, provided that we provide RSL COM with any requested
Internet telephony services promptly and with quality assurance. However, this
non-competition provision terminates on September 3, 2001 and the scope of such
provision is subject to the following limitations:
o RSL COM and its subsidiaries may acquire up to 20% in an entity providing
Internet telephony services;
o RSL COM and its subsidiaries may be stockholders in entities providing
Internet telephony services, provided that Internet telephony services
are ancillary to the business of that entity;
o the non-competition provision does not apply to RSL COM's subsidiaries
that become publicly traded companies; and
o Internet telephony services under the non-competition provision are
limited to (1) phone to phone services marketed as IP to the general
public, including both individuals and businesses and (2) the following
Web-based enhanced communication services: PC-to-phone, D3 box, Click IT,
Global Roaming, IP-initiated conference calls, Phone-to-PC, D3 Fax,
information services and white boarding.
CARRIER TRANSMISSION SERVICES
RSL COM purchases carrier transmission services from us. RSL COM accounted
for 37.6%, 69.1% and 63.4% of our revenues in the years 1997 and 1998 and for
the nine months ended September 30, 1999, respectively. Rates are established
based on market rates. The balance of our revenues in these periods were derived
from services provided to non-affiliates.
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REGISTRATION RIGHTS AGREEMENT
We have entered into an agreement with RSL COM under which we have given
RSL COM the right to require us on three occasions to register for sale the
shares of common stock they hold. RSL COM will not be allowed to exercise these
registration rights during the 180-day lock-up period. RSL COM also has an
unlimited number of "piggyback" registration rights. This means that any time we
register our common stock for sale, RSL COM will have the right to include their
common stock in that offering and sale.
We have agreed to pay all expenses that result from registration of
RSL COM's common stock under the registration rights agreement (other than
underwriting commissions for the common stock it sells and RSL COM's taxes). We
have also agreed to indemnify RSL COM against liabilities that may result from
their sale of common stock they hold, including Securities Act liabilities.
MANAGEMENT AGREEMENT
We have entered into an agreement with RSL COM pursuant to which RSL COM
has agreed from the time we complete this offering until such time as we are no
longer a subsidiary of RSL COM, RSL COM will provide to us the following
services:
o international legal services
o financial services, including assistance in accounting, financial
reporting, budgeting, business controls, tax and treasury related
matters
o corporate finance and mergers and acquisition advisory services
o assistance with network planning
o product development
o assistance with strategic planning
o availability of RSL COM management
We have agreed to pay to RSL COM $20,000 per month for these services, subject
to adjustments for inflation.
RSL COM PRIMECALL CO-BRANDING AND SERVICES AGREEMENT
We have entered into an agreement with RSL COM PrimeCall, a subsidiary of
RSL COM, to develop a prepaid IP calling card product. PrimeCall will arrange
for the production of the calling card, as well as assisting us with sales,
marketing and distribution. We will record all revenues from the sales of the
calling cards. In exchange for the services PrimeCall provides to us, we will
agree to establish and administer a Web site for PrimeCall to help enable
PrimeCall to market and sell its calling cards over the Web and place 500,000
RSL COM PrimeCall's banners on our site per month. We will oversee for PrimeCall
all billing, collections and fullfillment for on-line orders.
RELEASE AND INDEMNIFICATION AGREEMENT
We intend to enter into an agreement with RSL COM, pursuant to which we
will agree to release each other from any claims existing or arising from acts
or events occurring or failing to occur prior to the date of the agreement,
other than those arising from this agreement, the service agreement, the
registration rights agreement, the management agreement, the intercompany credit
agreement, the compliance agreement and other commercial transactions between us
and RSL COM. Further, we will agree to indemnify each other for breaches of the
existing agreements described above. We expect this agreement to be effective
upon completion of this offering.
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DESCRIPTION OF CAPITAL STOCK
Set forth below is a summary of the material provisions of our capital
stock. This summary does not purport to be complete. For a more detailed
description, see our amended and restated certificate of incorporation and
by-laws, copies of which we have filed as exhibits to the registration
statement.
Our authorized capital stock consists of 200,000,000 shares of Class A
common stock (which we refer to as common stock in this prospectus), 200,000,000
shares of Class B common stock and 25,000,000 shares of preferred stock, par
value $0.001 per share. Prior to this offering, we restated our certificate of
incorporation to reflect a 2.48 to one stock split of our common stock and
Class B common stock. Upon closing of the offering, there will be 8,018,132
shares of our common stock and 19,569,459 shares of our Class B common stock
outstanding.
COMMON STOCK AND CLASS B COMMON STOCK
General
The rights of holders of common stock are subject to the rights of holders
of any preferred stock which may be issued in the future. All outstanding shares
of common stock are, and the shares of common stock to be sold by us in this
offering when issued will be, duly authorized, validly issued, fully paid and
nonassessable. Upon liquidation, dissolution or winding up of our company, the
holders of common stock are entitled to share ratably in all net assets
available for distribution to stockholders after payment to creditors. The
holders of common stock and Class B common stock have identical rights except
with respect to voting, conversion and transfer. The common stock is not
redeemable and has no preemptive or conversion rights.
Voting Rights
Holders of our common stock are entitled to one vote per share on all
matters submitted for stockholder vote, except matters submitted to the vote of
another class or series of shares, while holders of Class B common stock are
entitled to ten votes per share. Holders of common stock and Class B common
stock are not entitled to cumulative voting rights. Cumulative voting for the
election of directors is not provided for in our amended and restated
certificate of incorporation, which means that the holders of a majority of the
shares voted can elect all of the directors then standing for election.
Dividends
Holders of common stock and Class B common stock are entitled to receive
dividends out of assets legally available for this purpose at the times and in
the amounts as the board of directors may from time to time determine. Holders
of our common stock and Class B common stock will share equally on a per share
basis in any dividend declared by the board of directors, subject to any
preferential rights of any outstanding preferred stock. Dividends consisting of
shares of common stock and Class B common stock may be paid only as follows:
(1) shares of common stock may be paid only to holders of common stock, and
shares of Class B common stock may be paid only to holders of Class B common
stock; and (2) the number of shares so paid will be equal on a per share basis
with respect to each outstanding share of common stock and Class B common stock.
We have not paid any dividends on our common stock and do not anticipate paying
any cash dividends on such stock in the foreseeable future. See the section of
this prospectus entitled "Dividend Policy" for more information.
Merger or Consolidation
In the event of a merger or consolidation, the holders of common stock and
Class B common stock will be entitled to receive the same per share
consideration, if any, except that if the consideration includes voting
securities (or the right to acquire voting securities, or securities
exchangeable for, or convertible into, voting securities), we are required,
unless the holders of Class B common stock agree, to provide for the holders of
Class B common stock to receive consideration entitling them to ten times the
number of votes per share as the consideration being received by holders of the
common stock.
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Conversion of Class B Common Stock
Our Class B common stock will be convertible into common stock on a
share-for-share basis at the option of the holder at any time, or automatically
upon transfer to a person or entity which is not a permitted transferee.
Permitted transferees will include RSL COM, its direct and indirect
majority-owned subsidiaries, successors of RSL COM following a merger,
consolidation or reorganization if RSL COM is not the surviving entity, or
Ronald S. Lauder or members of his family, a trust established by him for his
family members or entities controlled by him. Ronald S. Lauder is the
controlling shareholder of RSL COM. In the event a permitted transferee receives
Class B common stock and after that time ceases to qualify as a permitted
transferee, all Class B common stock held by that permitted transferee will
automatically convert into shares of our common stock.
PREFERRED STOCK
Our board of directors is empowered, without approval of the stockholders,
to cause shares of preferred stock to be issued from time to time in one or more
series, and the board of directors may fix the number of shares of each series
and the designation, powers, privileges, preferences and rights and the
qualifications, limitations and restrictions of the shares of each series.
The specific matters that our board of directors may determine include the
following:
o the designation of each series
o the number of shares of each series
o the rate of any dividends
o whether any dividends shall be cumulative or non-cumulative
o the terms of any redemption
o the amount payable in the event of any voluntary or involuntary
liquidation, dissolution or winding up of affairs of our company
o rights and terms of any conversion or exchange
o restrictions on the issuance of shares of the same series or any other
series
o any voting rights
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Our by-laws provide that directors and officers shall be indemnified by our
company to the fullest extent authorized by Delaware law, as it now exists or
may in the future be amended, against all expenses and liabilities reasonably
incurred in connection with services for or on behalf of us. The by-laws also
authorize us to enter into one or more agreements with any person that provide
for indemnification greater or different from that provided in the by-laws. To
the extent that indemnification for liabilities arising under the Securities Act
may be permitted for directors, officers and controlling persons of our company,
we have been advised that in the opinion of the Commission such indemnification
is against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
LIMITATION OF LIABILITY OF DIRECTORS
Our amended and restated certificate of incorporation provides, as
authorized by Section 102(b)(7) of the Delaware General Corporation Law (DGCL),
that our directors will not be personally liable to us or our stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability imposed by law, as in effect from time to time, for the following:
o any breach of the director's duty of loyalty to our company or our
stockholders
o any act or omission not in good faith or which involved intentional
misconduct or a knowing violation of law
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o unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the DGCL
o any transaction from which the director derived an improper personal
benefit
The inclusion of this provision in our amended and restated certificate of
incorporation may have the effect of reducing the likelihood of derivative
litigation against our directors, and may discourage or deter stockholders or
management from bringing a lawsuit against directors for breach of their duty of
care, even though such an action, if successful, might otherwise have benefitted
our company and our stockholders.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF OUR AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION AND BY-LAWS
Our amended and restated certificate of incorporation provides that we have
opted-out of the provisions of Section 203 of the Delaware General Corporation
Law. Section 203 prohibits a publicly held Delaware corporation from engaging in
a "business combination" with "interested stockholder" for a period of three
years after the date of the transaction in which the person became an interested
stockholder, unless:
o prior to such date, the board of directors of the corporation
approves either the business combination or the transaction that
resulted in the stockholder's becoming an interested stockholder;
o upon consummation of the transaction that resulted in the
stockholder's becoming an interested stockholder, the interested
stockholder owns at least 85% of the outstanding voting stock,
excluding shares held by directors, officers and certain employee
stock plans; or
o on or after the consummation date the business combination is
approved by the board of directors and by the affirmative vote at an
annual or special meeting of stockholders of at least 66 2/3% of the
outstanding voting stock that is not owned by the interested
stockholder.
For purposes of Section 203, a "business combination" includes, among other
things, a merger, asset sale or other transaction resulting in a financial
benefit to the interested stockholder, and an "interested stockholder" is
generally a person who, together with affiliates and associates of such person:
o owns 15% or more of the corporation's voting stock; or
o is an affiliate or associate of the corporation and was the owner of
15% or more of the outstanding voting stock of the corporation at
any time within the prior three years.
LISTING
Our common stock has been approved for quotation on The Nasdaq National
Market under the symbol "DDDC."
TRANSFER AGENT
Our transfer agent and registrar for our common stock is American Stock
Transfer and Trust Company. Its address is 40 Wall Street, New York, New York
10005, and its telephone number at this location is (212) 936-5100.
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SHARES ELIGIBLE FOR FUTURE SALE
After this offering, we will have 8,018,132 shares of common stock
outstanding. If the underwriters exercise their over-allotment option in full,
we will have 8,918,132 shares of common stock outstanding. In addition, we will
have 19,569,459 shares of Class B common stock outstanding, all of which will be
owned by RSL COM. All of the common stock sold in this offering will be freely
transferable without restriction or further registration under the Securities
Act, except for shares acquired by our directors and executive officers and our
affiliates. The shares of Class B common stock to be retained by RSL COM are not
being acquired under this offering and will have restrictions on resale.
LOCK-UP
We have agreed that, without the prior written consent of Lehman Brothers
Inc., we will not, directly or indirectly, offer, sell or otherwise dispose of
any shares of capital stock or any securities which may be converted into or
exchanged for any shares of capital stock for a period of 180 days from the date
of this prospectus. RSL COM, Yahoo!, CNET and all of our officers and directors
have agreed under lock-up agreements that, without the prior written consent of
Lehman Brothers Inc., they will not, directly or indirectly, offer, sell or
otherwise dispose of any shares of capital stock or any securities which may be
converted into or exchanged for any shares of capital stock for a period of
180 days from the date of this prospectus, except that RSL COM may sell shares
of our capital stock to a purchaser or purchasers of the shares who agree to be
bound by the same restrictions that bind RSL COM. Without the prior written
consent of Lehman Brothers Inc., individuals participating in the directed share
program and employees holding an aggregate of approximately 395,000 shares of
our common stock on the closing of this offering will be prohibited from
disposing shares of common stock for a period of 90 days after the date of this
prospectus, except that participants in our directed share program who acquire
50,000 shares or more of our common stock in the directed share program will be
prohibited from disposing of that common stock for 180 days after the date of
this prospectus. We can give no assurance as to how long RSL COM or any of the
other parties subject to the lock-up agreements will continue to hold its common
stock after this offering.
RULE 144
The shares of Class B common stock held by RSL COM and the shares of common
stock acquired by any of our affiliates will be subject to the resale
limitations of Rule 144 of the Securities Act. Rule 144 defines an affiliate as
a person that directly or indirectly, through one or more intermediaries,
controls or is controlled by, or is under common control with, the issuer.
In general, a stockholder subject to Rule 144 who has beneficially owned
shares of common stock of an issuer for at least one year may, within any
three-month period, sell up to the greater of:
o 1% of the total number of shares of common stock then outstanding or
o the average weekly trading volume of the common stock during the four
calendar weeks preceding the stockholder's required filing of notice of
sale
Rule 144 requires stockholders to aggregate their sales with other
stockholders with which it is affiliated for purposes of complying with this
volume limitation. A stockholder who has owned common stock for at least two
years, and who has not been an affiliate of the issuer for at least 90 days, may
sell common stock free from the volume limitation and notice requirements of
Rule 144.
We cannot estimate the number of shares of common stock that may be sold by
third parties in the future because these sales will depend on market prices and
other factors.
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REGISTRATION RIGHTS
After the closing of this offering, RSL COM or its transferees will be
entitled to request that we register their shares under the Securities Act. See
"Related Party Transactions--RSL COM--Registration Rights Agreement."
On October 18, 1999 in exchange for the offset of an account payable to
Yahoo! of $1 million, we issued to Yahoo! 183,901 shares of our common stock and
a warrant to purchase 58,626 shares of our common stock, assuming a cashless
exercise of a warrant to purchase 125,275 shares of our common stock at an
exercise price of $7.98 per share. The warrant will be automatically exercised
upon completion of this offering unless earlier exercised. The shares issued to
Yahoo! are subject to restrictions on resale. However, Yahoo! will be entitled
to request that we register their shares under the Securities Act beginning 180
days after completion of this offering and to include their shares and our
future registered equity offerings.
On October 20, 1999, we issued to CNET Investments, Inc. for approximately
$11 million, 1,085,943 shares of our common stock and warrants to purchase
466,028 shares of our common stock at an exercise price of $19.31 per share
exercisable for the term of our promotion agreement with CNET, Inc. CNET
Investments will be entitled to request that we register their shares under the
Securities Act beginning 180 days after completion of this offering and to
include their shares in our future registered equity offerings.
If RSL COM sells 75% or more of its equity interest in us, it has the right
to require Yahoo! and CNET to sell their holdings in us as well.
IMPORTANT UNITED STATES FEDERAL TAX CONSEQUENCES
OF OUR COMMON STOCK TO NON-U.S. HOLDERS
This is a general discussion of certain U.S. federal tax consequences of
the acquisition, ownership, and disposition of our common stock issued pursuant
to this offering by a holder that, for U.S. federal income tax purposes, is not
a "U.S. person" as we define that term below (a "Non-U.S. Holder"). We assume in
this discussion that you will hold our common stock as a capital asset
(generally, property held for investment). We do not discuss all aspects of U.S.
federal taxation that may be important to you in light of your individual
investment circumstances, such as special tax rules that apply to you, for
example, if you are a dealer in securities, financial institution, bank,
insurance company, tax-exempt organization, partnership or owner of more than 5%
of our common stock. Our discussion is based on current provisions of the
Internal Revenue Code of 1986, as amended, Treasury Regulations, judicial
opinions, published positions of the U.S. Internal Revenue Service, or the IRS,
and other applicable authorities, all as in effect on the date of this
prospectus and all of which are subject to differing interpretations or change,
possibly with retroactive effect. We have not sought, and will not seek, any
ruling from the IRS with respect to the tax consequences discussed in this
prospectus, and there can be no assurance that the IRS will not take a position
contrary to the tax consequences discussed below or that any position taken by
the IRS would not be sustained. We urge you to consult your tax advisor about
the U.S. federal tax consequences of acquiring, holding, and disposing of our
common stock, as well as any tax consequences that may arise under the laws of
any foreign, state, local, or other taxing jurisdiction.
For purposes of this discussion, a "U.S. person" means any one of the
following:
o a citizen or resident of the U.S.
o a corporation, partnership, or other entity created or organized in the
U.S. or under the laws of the U.S. or of any political subdivision of the
U.S.
o an estate, the income of which is includable in gross income for U.S.
federal income tax purposes regardless of its source
o a trust, the administration of which is subject to the primary
supervision of a U.S. court and that has one or more U.S. persons who
have the authority to control all substantial decisions of the trust
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DIVIDENDS
Dividends paid to a Non-U.S. Holder will generally be subject to
withholding of U.S. federal income tax at the rate of 30%. If, however, the
dividend is effectively connected with the conduct of a trade or business in the
U.S. by the Non-U.S. Holder, the dividend will be subject to U.S. federal income
tax imposed on net income on the same basis that applies to U.S. persons
generally, and, for corporate holders under certain circumstances, the branch
profits tax. Non-U.S. Holders should consult any applicable income tax treaties
that may provide for a reduction of withholding taxes. For purposes of
determining whether tax is to be withheld at a reduced rate as specified by a
treaty, we generally will presume that dividends we pay on or before
December 31, 2000, to an address in a foreign country are paid to a resident of
that country.
Under recently finalized Treasury regulations, which in general apply to
dividends that we pay after December 31, 2000, to obtain a reduced rate of
withholding under a treaty, a Non-U.S. Holder generally will be required to
provide certification as to that Non-U.S. Holder's entitlement to treaty
benefits. These regulations also provide special rules to determine whether, for
purposes of applying a treaty, dividends that we pay to a Non-U.S. Holder that
is an entity should be treated as paid to holders of interests in that entity.
GAIN ON DISPOSITION
A Non-U.S. Holder will generally not be subject to U.S. federal income tax,
including by way of withholding, on gain recognized on a sale or other
disposition of our common stock unless any one of the following is true:
o the gain is effectively connected with the conduct of a trade or business
in the U.S. by the Non-U.S. Holder
o the Non-U.S. Holder is a nonresident alien individual present in the U.S.
for 183 or more days in the taxable year of the disposition and certain
other requirements are met
o the Non-U.S. Holder is subject to tax pursuant to provisions of the U.S.
federal income tax law applicable to certain U.S. expatriates
o we are or have been during certain periods a "U.S. real property holding
corporation" for U.S. federal income tax purposes
If we are or have been a U.S. real property holding corporation, a Non-U.S.
Holder will generally not be subject to U.S. federal income tax on gain
recognized on a sale or other disposition of our common stock provided that:
o the Non-U.S. Holder does not hold (and has not held during certain
periods), directly or indirectly, more than 5% of our outstanding common
stock and
o our common stock is and continues to be traded on an established
securities market for U.S. federal income tax purposes
We believe that our common stock will be traded on an established
securities market for this purpose in any quarter during which it is quoted on
Nasdaq.
If we are or have been during certain periods a U.S. real property holding
corporation and the above exception does not apply, a Non-U.S. Holder will be
subject to U.S. federal income tax with respect to gain realized on any sale or
other disposition of our common stock as well as to a withholding tax (generally
at a rate of 10% of the proceeds). Any amount withheld pursuant to a withholding
tax will be creditable against a Non-U.S. Holder's U.S. federal income tax
liability.
Gain that is effectively connected with the conduct of a trade or business
in the U.S. by the Non-U.S. Holder will be subject to the U.S. federal income
tax imposed on net income on the same basis that applies to U.S. persons
generally, and, for corporate holders and under certain circumstances, the
branch profits tax, but will generally not be subject to withholding. Non-U.S.
Holders should consult any applicable income tax treaties that may provide for
different rules.
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UNITED STATES FEDERAL ESTATE TAXES
Our common stock that is owned or treated as owned by an individual who is
not a citizen or resident of the U.S. (as specially defined for U.S. federal
estate tax purposes) on the date of that person's death will be included in his
or her estate for U.S. federal estate tax purposes, unless an applicable estate
tax treaty provides otherwise.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Generally, we must report annually to the IRS and to each Non-U.S. Holder
the amount of dividends that we paid to a holder, and the amount of tax that we
withheld on those dividends. This information may also be made available to the
tax authorities of a country in which the Non-U.S. Holder resides.
Under current U.S. Treasury Regulations, U.S. information reporting
requirements and backup withholding tax will generally not apply to dividends
that we pay on our common stock to a Non-U.S. Holder at an address outside the
U.S. Payments of the proceeds of a sale or other taxable disposition of our
common stock by a U.S. office of a broker are subject to both backup withholding
at a rate of 31% and information reporting, unless the holder certifies as to
its Non-U.S. Holder status under penalties of perjury or otherwise establishes
an exemption. Information reporting requirements, but not backup withholding
tax, will also apply to payments of the proceeds of a sale or other taxable
disposition of our common stock by foreign offices of U.S. brokers or foreign
brokers with certain types of relationships to the U.S., unless the broker has
documentary evidence in its records that the holder is a Non-U.S. Holder and
certain other conditions are met or the holder otherwise established an
exemption.
Backup withholding is not an additional tax. Any amounts that we withhold
under the backup withholding rules will be refunded or credited against the
Non-U.S. Holder's U.S. federal income tax liability if certain required
information is furnished to the IRS.
The U.S. Treasury Department has promulgated final regulations regarding
the withholding and information reporting rules discussed above. In general,
those regulations do not significantly alter the substantive withholding and
information reporting requirements but unify current certification procedures
and forms and clarify reliance standards. The final regulations are generally
effective for payments made after December 31, 2000, subject to transition
rules.
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<PAGE>
UNDERWRITING
Under the underwriting agreement, which is filed as an exhibit to the
registration statement relating to this prospectus, each of the underwriters
named below, for whom Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner &
Smith Incorporated, U.S. Bancorp Piper Jaffray Inc., Lazard Freres & Co. LLC and
Fidelity Capital Markets, a division of National Financial Services Corporation,
are acting as representatives, has agreed to purchase from us the respective
number of shares of common stock shown opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERWRITERS OF COMMON STOCK
- ---------------------------------------------------------------------------- ----------------
<S> <C>
Lehman Brothers Inc......................................................... 3,048,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated.......................... 940,650
U.S. Bancorp Piper Jaffray Inc.............................................. 940,650
Lazard Freres & Co. LLC..................................................... 152,700
Fidelity Capital Markets,
a division of National Financial Services Corporation..................... 90,000
Banc of America Securities LLC.............................................. 90,000
Bear, Stearns & Co. Inc..................................................... 90,000
Deutsche Bank Securities Inc................................................ 90,000
Donaldson, Lufkin & Jenrette Securities Corporation......................... 90,000
A.G. Edwards & Sons, Inc.................................................... 90,000
Goldman, Sachs & Co......................................................... 90,000
Fahnestock & Co. Inc........................................................ 48,000
First Union Securities, Inc................................................. 48,000
Legg Mason Wood Walker, Inc................................................. 48,000
Brad Peery Inc.............................................................. 48,000
Pennsylvania Merchant Group Ltd............................................. 48,000
Prime Charter Ltd........................................................... 48,000
----------
Total..................................................................... 6,000,000
----------
----------
</TABLE>
The underwriting agreement provides that the underwriters' obligations to
purchase shares of common stock depend on the satisfaction of the conditions
contained in the underwriting agreement, and that if any of the shares of common
stock are purchased by the underwriters under the underwriting agreement, then
all of the shares of common stock which the underwriters have agreed to purchase
under the underwriting agreement must be purchased. The conditions contained in
the underwriting agreement include that:
o the representations and warranties made by us to the underwriters are
true
o there is no material change in the financial markets
o we deliver customary closing documents to the underwriters
The representatives had advised us that the underwriters propose to offer
the shares of common stock directly to the public at the public offering price
set forth on the cover page of this prospectus, and to selected dealers, who may
include the underwriters, at such public offering price less a selling
concession not in excess of $0.63 per share. The underwriters may allow, and the
selected dealers may reallow, a concession not in excess of $0.10 per share to
brokers and dealers. After the offering, the underwriters may change the
offering price and other selling terms.
The following table summarizes the underwriting discounts and commissions
we will pay. The underwriting discounts and commissions are equal to the public
offer price per share less the amount paid to us per share. The underwriting
discounts and commissions are equal to 7% of the public offering price.
<TABLE>
<CAPTION>
TOTAL
--------------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
--------- -------------- --------------
<S> <C> <C> <C>
Underwriting discounts and commissions to be
paid by us................................................ $ 1.05 $6,300,000 $7,245,000
</TABLE>
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We estimate that the total expenses of the offering, including
registration, filing and listing fees, printing fees and legal and accounting
expenses but excluding underwriting discounts and commissions, will be
approximately $1.5 million.
We have granted to the underwriters an option to purchase up to an
aggregate of 900,000 additional shares of common stock, exercisable solely to
cover over-allotments, if any, at the public offering price less the
underwriting discounts and commissions shown on the cover page of this
prospectus. The underwriters may exercise this option at any time, and from time
to time, until 30 days after the date of the underwriting agreement. To the
extent the underwriters exercise this option, each underwriter will be
committed, so long as the conditions of the underwriting agreement are
satisfied, to purchase a number of additional shares of common stock
proportionate to that underwriter's initial commitment as indicated in the
preceding table, and we will be obligated, under the over-allotment option, to
sell the shares of common stock to the underwriters.
We have agreed that, without the prior written consent of Lehman Brothers
Inc., we will not, directly or indirectly, offer, sell or otherwise dispose of
any shares of capital stock or any securities which may be converted into or
exchanged for any shares of capital stock for a period of 180 days from the date
of this prospectus. RSL COM, Yahoo! and CNET and all of our officers and
directors have agreed under lock-up agreements that, without the prior written
consent of Lehman Brothers Inc., they will not, directly or indirectly, offer,
sell or otherwise dispose of any shares of capital stock or any securities which
may be converted into or exchanged for any shares of capital stock for a period
of 180 days from the date of this prospectus, except that RSL COM may sell
shares of our capital stock to a purchaser or purchasers of the shares who agree
to be bound by the same restrictions that bind RSL COM. Without the prior
written consent of Lehman Brothers Inc., individuals participating in the
directed share program and employees holding an aggregate of approximately
395,000 shares of our common stock on the closing of this offering will be
prohibited from disposing shares of common stock for a period of 90 days after
the date of this prospectus, except that participants in our directed share
program who acquire 50,000 shares or more of our common stock in the directed
share program will be prohibited from disposing of that common stock for 180
days after the date of this prospectus. See "Shares Eligible for Future Sale."
Prior to the offering, there has been no public market for the shares of
common stock. The initial public offering price was negotiated between the
representatives and us. In determining the initial public offering price of the
common stock, the representatives considered prevailing market conditions, our
historical performance and capital structure, estimates of our business
potential and earning prospects, an overall assessment of our management and the
consideration of the above factors in relation to market valuation of companies
in related businesses.
Fidelity Capital Markets, a division of National Financial Services
Corporation, is acting as an underwriter in this offering, and will be
facilitating electronic distribution of information through the Internet,
intranet and other proprietary electronic technology.
Fidelity utilizes proprietary Internet, intranet and pager communications
technology to inform its investors of the commencement of an offering and the
availability of the preliminary prospectus. It places deal-specific information
on its Rule 134-compliant "New Issue Equity Calendar" Web page contained within
the Fidelity.com Web site. This information is presented in template format and
directs interested and eligible Fidelity customers either to contact a dedicated
Fidelity representative or to go (via hyperlink) to the Fidelity Electronic
Notification Services section of the Fidelity.com Web site to download an
electronic version of the preliminary prospectus.
Fidelity facilitates electronic delivery of preliminary prospectuses by
using a Web-based delivery platform. This Web platform is made available to all
Fidelity brokerage customers. These customers may sign-on to this Web site by
using the same "sign-on" password that allows them to access account, portfolio
and other types of client-specific information. The preliminary prospectuses are
made available for online viewing and downloading in the Adobe Portable Document
Format. In order to access the prospectuses, the customer is presented with
disclosure about the general risks relating to initial public offerings and
relevant regulatory requirements such as consent to electronic delivery. The
prospectus download/viewing screen is made available upon customer
acknowledgement of the information presented. Fidelity's internal systems
maintain a record of each downloading and viewing of a prospectus, in similar
fashion to the records that are maintained for traditional telephone and
mail-based events.
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Eligible Fidelity investors are able to submit conditional "offers-to-buy"
using only dedicated telephone representatives. Customers cannot place
conditional offers online. Each investor that submits a conditional offer to buy
will receive a copy of the preliminary prospectus in electronic or paper form.
All eligible Fidelity customers who have placed conditional offers-to-buy must
confirm their original conditional offers-to-buy with a dedicated Fidelity
representative on the expected pricing date.
We have agreed to indemnify the underwriters against liabilities relating
to the offering, including liabilities under the Securities Act, liabilities
arising from breaches of the representations and warranties contained in the
underwriting agreement, and liabilities incurred in connection with the directed
share program referred to below, and to contribute to payments that the
underwriters may be required to make for these liabilities.
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters and
selling group members to bid for and purchase shares of common stock. As an
exception to these rules, the representatives are permitted to engage in
transactions that stabilize the price of the common stock. These transactions
may consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the common stock.
The underwriters may create a short position in the common stock in
connection with the offering, which means that they may sell more shares of
common stock than are set forth on the cover page of this prospectus. If the
underwriters create a short position, then the representatives may reduce that
short position by purchasing common stock in the open market. The
representatives also may elect to reduce any short position by exercising all or
part of the over-allotment option described in this prospectus.
The underwriters have informed us that they do not intend to confirm sales
to discretionary accounts that exceed 5% of the total number of shares of common
stock offered by them.
The representatives also may impose a penalty bid on underwriters and
selling group members. This means that if the representatives purchase shares of
common stock in the open market to reduce the underwriters' short position or to
stabilize the price of the common stock, they may reclaim the amount of the
selling concession from the underwriters and selling group members who sold
those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of such purchases. The
imposition of a penalty bid could have an effect on the price of a security to
the extent that it were to discourage resales of the security by purchasers in
an offering.
Neither we nor any of the underwriters make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the common stock. In addition, neither
we nor any of the underwriters make any representation that the representatives
will engage in such transactions or that any such transaction, once commenced,
will not be discontinued without notice.
Purchasers of the shares of common stock offered in this prospectus may be
required to pay stamp taxes and other charges under the laws and practices of
the country of purchase, in addition to the offering price listed on the cover
of this prospectus.
At our request, Lehman Brothers Inc. has reserved up to 1,200,000 shares of
the common stock, or 20% of the common stock offered by this prospectus, for
sale pursuant to a directed share program to officers, directors and employees
(and their family members) of RSL COM and its affiliates (including us) and
friends of management of RSL COM and us. All of the persons purchasing the
reserved shares must commit to purchase no later than the close of business on
the day following the date of this prospectus. The number of shares available
for sale to the general public will be reduced to the extent these persons
purchase the reserved shares.
Lehman Brothers Inc. has served as co-manager for two security offerings
for RSL COM in the past and has received customary compensation for these
services. Lehman Brothers Inc. has also served as the solicitation agent in
connection with RSL COM's recent solicitation of consents from certain of its
noteholders and received $750,000 as compensation for this service.
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LEGAL MATTERS
The validity of the common stock offered by this prospectus will be passed
upon for us by Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York.
Certain legal matters in connection with the offering will be passed upon for
the underwriters by Weil, Gotshal & Manges LLP, New York, New York.
EXPERTS
Our consolidated financial statements as of December 31, 1997 and 1998 and
September 30, 1999 and for the period from June 1996 (inception) through
December 31, 1996 and the years ended December 31, 1997 and 1998 and the nine
month period ended September 30, 1999 included in this prospectus and in the
registration statement have been audited by Brightman Almagor & Co., a member
firm of Deloitte Touche Tohmatsu, independent auditors, as stated in their
report appearing in this prospectus, and are included in reliance upon the
report of that firm given upon their authority as experts in accounting and
auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
This prospectus constitutes a part of a registration statement on Form S-1
(together with all amendments, supplements, schedules and exhibits to the
registration statement, referred to as the registration statement) which we have
filed with the Commission under the Securities Act, with respect to the common
stock offered in this prospectus. This prospectus does not contain all the
information which is in the registration statement. Certain parts of the
registration statement are omitted as allowed by the rules and regulations of
the Commission. We refer you to the registration statement for further
information about our company and the securities offered in this prospectus.
Statements contained in this prospectus concerning the provisions of documents
filed as exhibits are not necessarily complete, and reference is made to the
copy so filed, each such statement being qualified in all respects by such
reference. You can inspect and copy the registration statement and the reports
and other information we file with the Commission under the Exchange Act at the
public reference room maintained by the Commission at Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. You can obtain
information on the operation of the public reference room by calling the
Commission at 1-800-SEC-0330. The same information will be available for
inspection and copying at the regional offices of the Commission located at 7
World Trade Center, 13th Floor, New York, N.Y. 10048 and at Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661. You can also obtain
copies of this material from the public reference room of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission
also maintains a Web site which provides on-line access to reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission at the address http://www.sec.gov.
Upon the effectiveness of the registration statement, we will become
subject to the information requirements of the Exchange Act. We will then file
reports, proxy statements and other information under the Exchange Act with the
Commission. You can inspect and copy these reports and other information of our
company at the locations set forth above or download these reports from the
Commission's Web site.
Our common stock has been approved for quotation on The Nasdaq National
Market. Reports, proxy statements and other information concerning us can be
inspected at the National Association of Securities Dealers, Inc., 1735
K Street, N.W., Washington, D.C. 20006.
RSL COM's Class A common stock is traded on Nasdaq under the symbol RSLC.
RSL COM is subject to the reporting requirements of the Exchange Act.
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<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DELTATHREE.COM, INC.
<TABLE>
<S> <C>
Independent Auditors' Report..................................................................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 and September 30, 1999.............. F-3
Consolidated Statements of Operations for the period from June 1996 (inception) to December 31,
1996 and for the years ended December 31, 1997 and 1998 and for the
nine months ended September 30, 1998 (unaudited) and 1999...................................... F-4
Consolidated Statements of Changes in Stockholder's Equity (Deficiency) for the period from
June 1996 (inception) to December 31, 1996 and for the years ended December 31, 1997 and 1998
and for the nine months ended September 30, 1999............................................... F-5
Consolidated Statements of Cash Flows for the period from June 1996 (inception) to December 31,
1996 and for the years ended December 31, 1997 and 1998 and for the
nine months ended September 30, 1998 (unaudited) and 1999...................................... F-6
Notes to Consolidated Financial Statements....................................................... F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
TO THE STOCKHOLDERS OF
DELTATHREE.COM, INC.
We have audited the accompanying consolidated balance sheets of
deltathree.com, Inc. (the "Company") as of December 31, 1997 and 1998 and
September 30, 1999 and the related consolidated statements of operations,
changes in stockholder's equity (deficiency) and cash flows for the period from
June 1996 (inception) to December 31, 1996 and each of the two years in the
period ended December 31, 1998 and for the nine months ended September 30, 1999.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the consolidated financial position of the Company as of
December 31, 1997 and 1998 and September 30, 1999, and the consolidated results
of its operations and cash flows for the period from June 1996 (inception) to
December 31, 1996 and each of the two years in the period ended December 31,
1998 and for the nine months ended September 30, 1999 in conformity with
generally accepted accounting principles.
BRIGHTMAN ALMAGOR & CO.
CERTIFIED PUBLIC ACCOUNTANTS (ISRAEL)
A MEMBER OF DELOITTE TOUCHE TOHMATSU
Tel Aviv, Israel
October 27, 1999, except for Note 12A as to which the date is November 19, 1999
F-2
<PAGE>
DELTATHREE.COM, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- SEPTEMBER 30,
1997 1998 1999
------------ ------------ -------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 3,196,082 $ 1,356,562 $ 1,292,887
Accounts receivable--net.......................................... 825,200 543,335 862,266
Due from affiliates............................................... -- 2,191,903 920,036
Prepaid expenses and other current assets......................... 166,287 620,676 1,151,652
------------ ------------ -------------
Total current assets................................................. 4,187,569 4,712,476 4,226,841
------------ ------------ -------------
Investments.......................................................... 105,000 90,000 90,000
------------ ------------ -------------
Property and equipment:
Telecommunications equipment...................................... 849,824 7,910,224 9,947,932
Furniture, fixtures and other..................................... 200,122 735,991 686,502
------------ ------------ -------------
1,049,946 8,646,215 10,634,434
Less accumulated depreciation..................................... (177,738) (376,792) (745,092)
------------ ------------ -------------
Property and equipment--net....................................... 872,208 8,269,423 9,889,342
------------ ------------ -------------
Goodwill--net........................................................ 3,183,875 12,488,125 10,214,490
Deposits............................................................. 54,549 115,497 161,374
------------ ------------ -------------
Total assets......................................................... $ 8,403,201 $25,675,521 $ 24,582,047
------------ ------------ -------------
------------ ------------ -------------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.................................................. $ 949,716 $ 4,301,763 $ 4,148,126
Due to affiliates................................................. 120,487 1,403,163 722,835
Deferred revenues and costs....................................... 159,778 1,610,081 734,465
Other current liabilities......................................... 194,295 629,096 2,511,002
------------ ------------ -------------
Total current liabilities............................................ 1,424,276 7,944,103 8,116,428
------------ ------------ -------------
Long-term liabilities:
Long-term debt due to affiliates.................................. -- 5,106,602 12,306,880
Severance pay obligations......................................... 26,775 233,247 320,340
------------ ------------ -------------
Total long-term liabilities.......................................... 26,775 5,339,849 12,627,220
------------ ------------ -------------
Convertible notes payable to affiliates.............................. 679,965 -- --
------------ ------------ -------------
Minority interests................................................... -- 21,399 --
------------ ------------ -------------
Total liabilities.................................................... 2,131,016 13,305,351 20,743,648
------------ ------------ -------------
Commitments and contingencies
Stockholder's equity:
Class A Common stock, authorized in September 1999--par value
$0.001; 200,000,000 shares authorized as of September 30, 1999;
no shares issued and outstanding at December 31, 1997 and 1998
and September 30, 1999.......................................... -- -- --
Class B Common stock --par value $0.001; 100,000,000, 200,000,000
and 200,000,000 shares authorized at December 31, 1997 and 1998
and September 30, 1999, respectively; 18,938,249, 19,569,460 and
19,569,460 issued and outstanding at December 31, 1997 and 1998
and September 30, 1999, respectively............................ 18,938 19,569 19,569
Preferred stock, authorized in September 1999--par value $0.001;
25,000,000 shares authorized as of September 30, 1999; no shares
issued and outstanding at December 31, 1997 and 1998 and
September 30, 1999.............................................. -- -- --
Additional paid-in capital........................................ 8,799,431 23,083,638 37,178,351
Deferred compensation............................................. -- (1,065,882) (6,234,375)
Accumulated deficit............................................... (2,546,184) (9,667,155) (27,125,146)
------------ ------------ -------------
Total stockholder's equity........................................... 6,272,185 12,370,170 3,838,399
------------ ------------ -------------
Total liabilities and stockholder's equity........................... $ 8,403,201 $25,675,521 $ 24,582,047
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
DELTATHREE.COM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 1996 NINE MONTHS ENDED
(INCEPTION) YEAR ENDED DECEMBER 31, SEPTEMBER 30,
TO DECEMBER 31, ---------------------------- -----------------------------
1996 1997 1998 1998 1999
--------------- ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Affiliates................... $ -- $ 467,842 $ 3,896,106 $ 2,484,541 $ 4,077,278
Non-affiliates............... 933 777,799 1,741,941 1,184,324 2,355,076
--------- ------------ ------------ ------------ ------------
Total revenues................. 933 1,245,641 5,638,047 3,668,865 6,432,354
Costs and operating expenses:
Cost of revenues............. -- 1,064,940 4,657,373 2,648,748 5,811,171
Research and development
expenses.................. -- 294,150 650,140 479,030 797,273
Selling and marketing
expenses.................. -- 631,970 2,431,371 1,603,221 3,087,336
General and administrative
expenses--(exclusive of
non-cash compensation
expense shown below)...... 179,138 1,387,682 1,842,446 1,025,861 2,079,809
Non-cash compensation
expense................... -- -- 742,780 640,165 8,926,220
Amortization of goodwill..... -- 197,249 2,472,214 1,714,335 2,273,635
--------- ------------ ------------ ------------ ------------
Total costs and operating
expenses..................... 179,138 3,575,991 12,796,324 8,111,360 22,975,444
--------- ------------ ------------ ------------ ------------
Loss from operations........... (178,205) (2,330,350) (7,158,277) (4,442,495) (16,543,090)
Interest expense, net.......... (397) (37,232) (186,295) (145,910) (914,901)
Minority interests............. -- -- 223,601 -- --
--------- ------------ ------------ ------------ ------------
Net loss....................... $(178,602) $ (2,367,582) $ (7,120,971) $ (4,588,405) $(17,457,991)
--------- ------------ ------------ ------------ ------------
--------- ------------ ------------ ------------ ------------
Net loss per share--basic and
diluted...................... $ (0.03) $ (0.19) $ (0.37) $ (0.24) $ (0.89)
--------- ------------ ------------ ------------ ------------
--------- ------------ ------------ ------------ ------------
Weighted average shares
outstanding--basic and
diluted...................... 6,420,194 12,390,043 19,253,855 19,148,652 19,569,459
--------- ------------ ------------ ------------ ------------
--------- ------------ ------------ ------------ ------------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
DELTATHREE.COM, INC.
STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
CLASS B TOTAL
COMMON STOCK ADDITIONAL STOCKHOLDER'S
--------------------- PAID-IN ACCUMULATED DEFERRED EQUITY
SHARES AMOUNT CAPITAL DEFICIT COMPENSATION (DEFICIENCY)
---------- ------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE
at June 1996 (Inception).................. -- $ -- $ -- $ -- $ -- $ --
Issuance of capital stock................... 7,659,507 7,659 140,831 -- -- 148,490
Net loss.................................... (178,602) (178,602)
---------- ------- ----------- ------------ ------------ -----------
BALANCE
at December 31, 1996...................... 7,659,507 7,659 140,831 (178,602) -- (30,112)
Issuance of capital stock................... 11,278,742 11,279 5,319,976 5,331,255
Recognition of pushdown of goodwill......... 3,338,624 3,338,624
Net loss.................................... (2,367,582) (2,367,582)
---------- ------- ----------- ------------ ------------ -----------
BALANCE
at December 31, 1997...................... 18,938,249 18,938 8,799,431 (2,546,184) -- 6,272,185
Conversion of debt and warrants to equity... 631,210 631 656,581 657,212
Deferred compensation expense............... 1,808,662 (1,808,662) --
Amortization of deferred compensation
expense................................... 742,780 742,780
Recognition of pushdown of goodwill......... 11,818,964 11,818,964
Net loss.................................... (7,120,971) (7,120,971)
---------- ------- ----------- ------------ ------------ -----------
BALANCE
at December 31, 1998...................... 19,569,459 19,569 23,083,638 (9,667,155) (1,065,882) 12,370,170
Deferred compensation expense............... 14,094,713 (14,094,713) --
Amortization of deferred compensation
expense................................... 8,926,220 8,926,220
Net loss.................................... (17,457,991) (17,457,991)
---------- ------- ----------- ------------ ------------ -----------
BALANCE
at September 30, 1999..................... 19,569,459 $19,569 $37,178,351 $(27,125,146) $(6,234,375) $ 3,838,399
---------- ------- ----------- ------------ ------------ -----------
---------- ------- ----------- ------------ ------------ -----------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
DELTATHREE.COM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 1996
(INCEPTION) YEAR ENDED DECEMBER 31,
TO DECEMBER 31, ---------------------------------------------------
1996 1997 1998
--------------- ------------------------ ------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss............................................ $(178,602) $ (2,367,582) $ (7,120,971)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 5,371 369,616 2,671,268
Amortization of deferred compensation........... -- -- 742,780
Write-down of investment........................ -- -- 25,000
Minority interests.............................. -- -- (223,601)
Increase in liability for severance pay......... -- 26,775 147,628
Provision for losses on accounts receivable..... -- 100,000 226,542
Changes in assets and liabilities:
Decrease (increase) in accounts receivable...... (22,173) (925,200) 78,216
Decrease (increase) in other current assets and
due from affiliates........................... (42,900) (198,263) (2,269,872)
Increase (decrease) in accounts payable......... 23,547 926,169 1,733,912
Increase (decrease) in deferred revenues........ -- -- (1,595,635)
Increase in current liabilities and due to
affiliates.................................... 28,510 446,050 1,826,832
--------- ------------ ------------
(7,645) 745,147 3,363,070
--------- ------------ ------------
Net cash used in operating activities............... (186,247) (1,622,435) (3,757,901)
--------- ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment................ (160,809) (889,137) (3,003,004)
Increase in deposits.............................. -- -- (60,948)
Equity investments................................ (45,000) (60,000) (25,000)
Other............................................. -- -- 15,000
--------- ------------ ------------
Net cash used in investing activities............... (205,809) (949,137) (3,073,952)
--------- ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of capital stock........... 148,490 5,331,255 --
Proceeds from issuance of convertible notes....... 343,558 520,000 --
Retirement of convertible notes................... -- (208,298) --
Proceeds (repayment) of long-term debt from
affiliates...................................... 30,000 (30,000) 5,000,000
Proceeds from short-term borrowings............... -- 24,705 --
Payment of other long-term debt................... -- -- (7,667)
--------- ------------ ------------
Net cash provided by financing activities........... 522,048 5,637,662 4,992,333
--------- ------------ ------------
Increase (decrease) in cash and cash equivalents.... 129,992 3,066,090 (1,839,520)
Cash and cash equivalents at beginning of period.... -- 129,992 3,196,082
--------- ------------ ------------
Cash and cash equivalents at end of period.......... $ 129,992 $ 3,196,082 $ 1,356,562
--------- ------------ ------------
--------- ------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest........................................ $ -- $ -- $ --
--------- ------------ ------------
--------- ------------ ------------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Conversion of convertible notes and warrants into
capital stock................................... $ -- $ -- $ 657,212
--------- ------------ ------------
--------- ------------ ------------
Assets acquired with vendor credits............... $ -- $ -- $ 3,000,000
--------- ------------ ------------
--------- ------------ ------------
Recognition of pushdown of goodwill............... $ -- $ 3,338,624 $ 11,818,964
--------- ------------ ------------
--------- ------------ ------------
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------
1998 1999
------------------ ------------------
<S> <C> <C>
Unaudited
Cash flows from operating activities:
Net loss............................................ $ (4,588,405) $(17,457,991)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 1,815,277 2,641,765
Amortization of deferred compensation........... 640,164 8,926,220
Write-down of investment........................ -- --
Minority interests.............................. -- (21,399)
Increase in liability for severance pay......... 8,578 39,679
Provision for losses on accounts receivable..... -- (294,074)
Changes in assets and liabilities:
Decrease (increase) in accounts receivable...... 432,883 (24,857)
Decrease (increase) in other current assets and
due from affiliates........................... (2,204,181) 742,428
Increase (decrease) in accounts payable......... 675,879 (153,637)
Increase (decrease) in deferred revenues........ (804,993) (875,616)
Increase in current liabilities and due to
affiliates.................................... 1,212,146 1,772,397
------------ ------------
1,775,753 12,752,906
------------ ------------
Net cash used in operating activities............... (2,812,652) (4,705,085)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment................ (1,941,092) (1,988,048)
Increase in deposits.............................. -- --
Equity investments................................ -- --
Other............................................. (25,000) --
------------ ------------
Net cash used in investing activities............... (1,966,092) (1,988,048)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of capital stock........... -- --
Proceeds from issuance of convertible notes....... -- --
Retirement of convertible notes................... -- --
Proceeds (repayment) of long-term debt from
affiliates...................................... 2,014,314 6,629,458
Proceeds from short-term borrowings............... -- --
Payment of other long-term debt................... -- --
------------ ------------
Net cash provided by financing activities........... 2,014,314 6,629,458
------------ ------------
Increase (decrease) in cash and cash equivalents.... (2,764,430) (63,675)
Cash and cash equivalents at beginning of period.... 3,196,082 1,356,562
------------ ------------
Cash and cash equivalents at end of period.......... $ 431,652 $ 1,292,887
------------ ------------
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for:
Interest........................................ $ -- $ --
------------ ------------
------------ ------------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Conversion of convertible notes and warrants into
capital stock................................... $ 657,212 $ --
------------ ------------
------------ ------------
Assets acquired with vendor credits............... $ 3,000,000 $ --
------------ ------------
------------ ------------
Recognition of pushdown of goodwill............... $ 11,818,964 $ --
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 -- BUSINESS DESCRIPTION
Description of business
Deltathree.com, Inc. (the "Company"), a Delaware
corporation, is a global provider of Internet Protocol
("IP") telephony services, which include the transmission of
voice and data traffic for communications carriers and the
provision of enhanced Web-based and other communications
services to individuals and businesses.
The Company was founded in 1996 to capitalize on the growth
of the Internet as a communications tool. The Company
commercially provides IP telephony services over a
privately-managed IP network. The Company operates a
privately-managed IP network with 45 points of presence
(POPs) in 29 countries as of October 27, 1999.
The Company has a limited operating history and its
prospects are subject to the risks, expenses and
uncertainties frequently encountered by companies in the new
and rapidly evolving markets for Internet and
telecommunications services. In addition, the Company is
financially dependent on RSL Communications Ltd. ("RSL COM")
(see below).
The Company's research and development activities are
conducted in Israel by its wholly owned subsidiary, Delta
Three Israel Ltd. ("Delta Ltd.").
In 1997, the Company established a 95%-owned subsidiary,
Internet Technologies Colombia SA ("SA"), to provide the
Company's network services in Colombia. In 1998, the Company
established a 51%-owned subsidiary, Eltel Services Company
Ltd. ("Eltel"), to provide the Company's network services in
the Philippines. Eltel ceased operations in 1998 and the
Company's investment in Eltel was written-off. In 1998, the
Company also established a 51%-owned subsidiary, Delta Three
Direct LLC ("Direct"), to provide direct marketing for the
Company. The Company is in the process of dissolving Direct.
As of September 30, 1999, the Company also had a 5% interest
in the share capital of Internet Telecom, Ltd., an Israeli
corporation engaged in research and development of Internet
telephony.
Acquisition of the Company by RSL COM
The Company is a wholly owned subsidiary of RSL COM, a
publicly traded multinational telecommunications company.
RSL COM and its subsidiaries and affiliates (excluding the
Company) are collectively referred to herein as "RSL COM" or
"Affiliates." Approximately 69% of the Company's revenues
for the year ended December 31, 1998 were derived from
transactions with RSL COM. (RSL COM has also provided the
Company with substantially all of the Company's working
capital since July 1997.)
In July 1997, the Company issued 8,150,895 shares of capital
stock to RSL COM pursuant to a stock purchase agreement with
RSL COM (representing 51% of the Company's outstanding
capital stock at that time) for aggregate gross
consideration of $5,000,000. In addition, at the time of the
closing under the stock purchase agreement, the Company
issued 2,353,440 shares of capital stock into escrow, which
were released to RSL COM in 1997 for no additional
consideration under the anti-dilution provisions of the
stock purchase agreement relating to the July 1997 issuance.
During the remainder of 1997, RSL COM acquired additional
shares of capital stock from the Company's existing
stockholders for aggregate consideration of $2,856,750. As
of December 31, 1997, RSL COM held approximately 75% of the
Company's outstanding capital stock.
By April 1998, RSL COM acquired the remaining outstanding
capital stock of the Company held by the Company's remaining
stockholders for total consideration of $11,818,964 and
F-7
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 -- BUSINESS DESCRIPTION (CONTINUED)
merged the Company with a newly formed, wholly owned
subsidiary of RSL COM, with the Company remaining as the
surviving corporation.
The acquisition of the Company by RSL COM has been
"pushed-down" into the Company's financial statements as of
July 1997, with an increase to both goodwill and additional
paid-in capital in the amount of $15,157,588. The goodwill
is being amortized by the Company over a five-year period.
2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation--The
consolidated financial statements include the accounts of
deltathree.com, Inc. and its subsidiaries. The results of
subsidiaries acquired or disposed of during the year are
included from the date of acquisition to the date of
disposal, if applicable. All significant intercompany
accounts and transactions have been eliminated in
consolidation. Each of the Company's subsidiaries has a
December 31 year end.
Use of Estimates--The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions,
primarily for allowances for doubtful accounts receivable
and the useful lives of fixed assets and intangible assets,
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.
Cash and Cash Equivalents--The Company considers all highly
liquid investments purchased with an original maturity of
three months or less to be cash equivalents.
Allowance for Doubtful Accounts--The Company estimates the
allowance for doubtful accounts by reviewing the status of
significant past due receivables and analyzing historical
bad debt trends and the Company then reduces accounts
receivables by such allowance for doubtful accounts to
expected net realizable value.
Investments--Investments in less than 20% of the share
capital of other companies are presented at cost. In the
event that management identifies a decline of an other than
temporary nature in the estimated fair value of an
investment to an amount below cost, such investment is
written down to fair market value.
Property and Equipment and Related Depreciation--Property
and equipment are stated at cost. Depreciation is calculated
using the straight-line method over the estimated useful
lives of the depreciable assets, which range from two to ten
years. Improvements are capitalized, while repair and
maintenance costs are charged to operations as incurred. The
useful life of telecommunications network equipment
purchased from Ericsson (see Note 11B) is 10 years. During
1998, $3.0 million of the Company's equipment purchases from
Ericsson was initially recorded in the Company's
consolidated balance sheets as a credit to property and
equipment and an offsetting debit to accounts payable. After
the Company reached agreement with Ericsson relating to
difficulties encountered by the Company in integrating
hardware and software purchased from Ericsson (see Note
11B), the Company reclassified the $3.0 million accounts
payable to deferred revenues and costs.
Goodwill and Related Amortization--Goodwill represents the
excess of cost over the fair value of the Company's net
assets, pushed down as a result of RSL COM's acquisition of
the Company, and is being amortized using the straight-line
method over five years.
F-8
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Impairment of Long-lived Assets and Goodwill--The Company's
long-lived assets and goodwill are reviewed for impairment
on a quarterly basis and whenever events or changes in
circumstances occur indicating that the net carrying amount
may not be recoverable. The Company reviews for impairment
by comparing the carrying value of the long-lived asset or
goodwill to the estimated undiscounted future cash flows
expected to result from the use of the long-lived assets
(and their eventual disposition) or the goodwill. If the sum
of the expected undiscounted future cash flows is less than
the carrying amount of assets, the Company would recognize
an impairment loss. The impairment loss, if determined to be
necessary, would be measured as the amount by which the
carrying amount of the long-lived asset or goodwill exceeds
the fair value of the long-lived asset or goodwill based on
estimated future discounted cash flows. The Company
determined that, as of December 31, 1997 and 1998 and
September 30, 1999, there had been no impairment in the
carrying value of long-lived assets or goodwill.
Revenue Recognition and Deferred Revenue--The Company
records revenue based on minutes (or fractions thereof) of
customer usage. The Company records payments received in
advance for prepaid services and services to be supplied
under contractual agreements as deferred revenue until such
related services are provided.
Cost of Revenues--Cost of revenues is comprised primarily of
access, transmission and termination costs based on actual
minutes in addition to monthly circuit lease costs and is
net of reimbursements from vendors.
Research and Development Expenses--Research and development
expenses, net of reimbursements from vendors, are expensed
as incurred.
Advertising Expenses--Advertising expenses are expensed as
incurred. For the period from June 30, 1996 to December 31,
1996, the years ended December 31, 1997 and 1998 and the
nine-month period ended September 30, 1999, advertising
expenses were approximately $0, $24,000, $124,000 and
$52,000, respectively.
Income Taxes--The Company accounts for income taxes under
the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes".
SFAS No. 109 establishes financial accounting and reporting
standards for the effect of income taxes that result from
activities during the current and preceding years. SFAS No.
109 requires an asset and liability approach for financial
reporting for income taxes. The Company's foreign
subsidiaries file separate income tax returns in the
jurisdiction of their operations.
Net Loss per Share--In accordance with the Company's
adoption of SFAS No. 128, "Earnings Per Share", the net loss
per share is calculated by dividing the net loss
attributable to capital stock by the weighted average number
of shares outstanding. Outstanding common stock options are
not included in the net loss per share calculation as their
effect is anti-dilutive. The adoption of SFAS No. 128 did
not materially affect the Company's presentation of net loss
per share.
Concentration of Credit Risk--The Company is subject to
concentrations of credit risk which consist principally of
trade accounts receivable and cash and cash equivalents.
The Company maintains its cash with various financial
institutions. The Company performs periodic evaluations of
the relative credit standing of these institutions.
F-9
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The majority of the Company's noncarrier customers prepay
for their services. The Company establishes an allowance for
doubtful accounts based upon factors surrounding the credit
risk of customers, historical trends and other information.
Fair Value of Financial Instruments--The carrying amounts of
cash and cash equivalents, accounts and other receivables
and accounts payable approximate fair value due to the
short-term maturity of these instruments. The carrying
amounts of outstanding borrowings approximate fair value due
to their short-term interest rate.
Effects of Recently Issued Accounting Standards--In June
1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 130, "Reporting Comprehensive Income." SFAS
No. 130 establishes new rules for the reporting and display
of comprehensive income and its components. The Company has
no elements of comprehensive income.
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for
derivative instruments and hedging activities. Generally, it
requires that an entity recognize all derivatives as either
an asset or liability and measure those instruments at fair
value, as well as identify the conditions for which a
derivative may be specifically designed as a hedge. SFAS No.
133 is effective for fiscal years beginning after June 15,
2000. The Company does not currently engage or plan to
engage in any derivative or hedging activities. The adoption
of SFAS No. 133 is not expected to have a material impact on
the Company.
During 1998, the Accounting Standards Executive Committee of
the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP No. 98-1"). The Company amortizes these
costs over the anticipated life of the systems. The adoption
of SOP No. 98-1 did not have a material impact on the
Company's financial statements.
Stock-based Compensation--The Company has adopted the
disclosure provisions of SFAS No. 123 "Accounting for
Stock-Based Compensation," and elected to continue the
accounting set forth in Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees."
The Company has provided the necessary pro forma disclosures
as if the fair value method had been applied (See Note 12F).
Segment Reporting--Effective January 1, 1998, the Company
adopted SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS No. 131
establishes standards for the way business enterprises
report information about operating segments, as well as
enterprise-wide disclosures about products and services,
geographic areas and major customers. See Note 15 for
enterprise-wide disclosures required by SFAS No. 131.
Unaudited Financial Statements--The unaudited interim
September 30, 1998 financial statements reflect all
adjustments (consisting only of normal recurring
adjustments) which are, in management's opinion, necessary
for a fair presentation of the results for the interim
period presented.
Reclassifications--Certain previously reported amounts have
been reclassified to conform with the current period
presentation.
3 -- ACCOUNTS RECEIVABLE-NET
Accounts receivable are stated net of an allowance for
doubtful accounts of $100,000, $326,542 and $32,468 at
December 31, 1997 and 1998 and September 30, 1999,
respectively.
F-10
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4 -- DUE FROM/TO AFFILIATES
The balances due from and due to Affiliates are for services
rendered and are non-interest bearing.
5 -- PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1997 1998 1999
-------- -------- -------------
<S> <C> <C> <C>
Prepaid commissions................................... $ -- $144,768 $ --
Deposits with credit card companies................... -- 199,401 150,000
Government of Israel (VAT refund and other)........... -- 59,763 106,161
Deposits with suppliers............................... -- 86,799 75,499
Prepaid expenses...................................... 20,455 28,055 669,121
Loan to employee...................................... -- 31,917 --
Other................................................. 145,832 69,973 150,871
-------- -------- -----------
Total prepaid expenses and other current
assets............................................ $166,287 $620,676 $ 1,151,652
-------- -------- -----------
-------- -------- -----------
</TABLE>
6 -- GOODWILL-NET
Goodwill consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- SEPTEMBER 30,
1997 1998 1999
----------- ------------ -------------
<S> <C> <C> <C>
Goodwill from acquisition of the Company by RSL COM
(see Note 1)...................................... $3,338,624 $15,157,588 $15,157,588
Deferred financing costs............................ 42,500 -- --
Less -- accumulated amortization.................... (197,249) (2,669,463) (4,943,098)
----------- ------------ -----------
Total goodwill--net................................. $3,183,875 $12,488,125 $10,214,490
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
7 -- OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1997 1998 1999
-------- -------- -------------
<S> <C> <C> <C>
Accrued expenses..................................... $ -- $361,187 $ 1,314,983
Employees and related expenses....................... 64,750 144,013 1,106,281
Deposits from customers.............................. -- 118,672 14,957
Other................................................ 129,545 5,224 74,781
-------- -------- -----------
Total other current liabilities...................... $194,295 $629,096 $ 2,511,002
-------- -------- -----------
-------- -------- -----------
</TABLE>
F-11
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8 -- LONG-TERM DEBT DUE TO AFFILIATES
The long-term debt issued in 1998 to RSL COM bears interest at a
fixed annual rate of 14% and is due on demand after September
30, 2000. Upon completion of an initial public offering by the
Company, the maturity date will be extended to the first
anniversary of the completion of such offering.
9 -- SEVERANCE PAY OBLIGATIONS
Delta Ltd., the Company's Israeli subsidiary, is subject to
certain Israeli law and labor agreements that determine the
obligations of Delta Ltd. to make severance payments to
dismissed employees and to employees leaving employment under
certain other circumstances. The obligation for severance pay
benefits, as determined by Israeli law, is based upon length of
service and the employee's most recent salary. This obligation
is partially funded through regular deposits made by Delta Ltd.
into unaffiliated severance pay funds and by the purchase from
unaffiliated insurance companies of managers' insurance
policies. Amounts funded are controlled by the fund trustees and
insurance companies and are not under the control and management
of Delta Ltd.
Expenses relating to employee termination benefits were $26,775,
$147,628, $8,578 and $39,679 for the years ended December 31,
1997 and 1998 and for the nine months ended September 30, 1998
(unaudited) and 1999, respectively. No expenses were incurred
for the period from June 1996 (inception) to December 31, 1996.
10 -- CONVERTIBLE NOTES PAYABLE TO AFFILIATES
During 1996 and 1997, RSL COM purchased from third parties
convertible notes issued by the Company. The notes were
convertible into capital stock at conversion rates of $0.80 and
$1.30, respectively. In connection with the issuance of the
notes, warrants were issued to purchase capital stock with
exercise prices of $0.80 and $1.30 per share. During 1998, all
of the notes were converted into, and warrants were exercised
for, shares of capital stock, in each case under their original
terms.
11 -- COMMITMENTS AND CONTINGENCIES
A. Services agreement with RSL COM
In July 1997, the Company entered into a three-year services
agreement with RSL COM. Pursuant to the services agreement
with RSL COM, RSL COM is required to use its reasonable best
efforts to provide the Company with certain office and
equipment space and to assist the Company in obtaining
Internet, frame-relay and dedicated lines from third parties.
In addition, RSL COM is required under the agreement to
provide the Company with various communications services at
rates set forth in the agreement. The agreement also provides
that the Company is required, at RSL COM's request, to use up
to 50% of its network capacity to route RSL COM's
international telecommunications traffic at rates set forth in
the agreement.
Based on a cost analysis performed by the Company, management
believes that the amounts reflected in the financial statements
pursuant to the above services agreement do not materially
differ from amounts which the Company would have recognized or
incurred in providing or obtaining equivalent services on an
arms-length basis. During September 1999, this agreement was
amended. Consistent with the original services agreement, the
amendment also supports the continued provision of services at
fair market value.
F-12
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
B. Technology and marketing agreement with Ericsson
In October 1997, the Company entered into a technology and
marketing alliance with Ericsson for the development and
deployment of advanced IP telephony gateways and communications
software. Under the alliance agreement, the Company is entitled
to purchase hardware and software on preferential terms.
During 1998, due to difficulties in integrating the hardware
and software purchased from Ericsson into the Company's
network, the Company incurred significant costs and anticipates
that it will incur additional costs in 1999. To compensate the
Company for its costs, Ericsson agreed to offset amounts owed
by the Company to Ericsson for network telecommunications
equipment previously purchased from Ericsson with a fair value
of $3 million. This offset represents Ericsson's reimbursement
of the costs previously incurred and expected to be incurred by
the Company. For the year ended December 31, 1998 and the nine
months ended September 30, 1999, the Company recognized
$901,385 and $760,285, respectively, as an offset to research
and development expenses, and $694,250 and $299,136,
respectively, as an offset to cost of revenues incurred in
respect of the network telecommunications equipment. The
remaining balance is reflected as deferred revenues and costs
and will be recorded as an offset to such costs as they are
incurred.
C. Other marketing and cooperation agreements
The Company has entered into marketing and cooperation
agreements with various other companies that maintain sites on
the Web. Pursuant to certain of these agreements, the Company
is obligated to pay commissions based on revenues derived from
such Web links.
D. Indentures governing debt of RSL COM
The Company is subject to covenants by reason of its status as
a restricted subsidiary of RSL COM under the indentures
governing a substantial amount of RSL COM's debt. These
restrictions significantly limit the ability of the Company to
incur additional indebtedness or create liens on its assets.
The Company's ability to incur indebtedness is limited by the
amount of indebtedness that RSL COM and the Company are
permitted to incur under the indentures. Such restrictions also
limit the Company's ability to pay dividends or make other
distributions in respect of the Company's capital stock, sell
assets, engage in mergers or acquisitions or make some types of
investments. These restrictions also limit the ability of a
third party to acquire a controlling interest in the Company.
These restrictions may prohibit transactions that would
otherwise be beneficial to the Company.
E. Lease commitments
The Company leases office space from RSL COM in New York at an
annual cost of $96,000. The lease term extends until June 2001.
In addition, the Company leases offices in Israel at an annual
cost of $240,000. The lease term extends until February 2003,
with an option to extend the lease for an additional five
years.
F-13
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
F. Legal Proceedings.
On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced
a suit against the Company, RSL COM and an RSL COM subsidiary
in the United States District Court for the Southern District
of New York. Aerotel alleges that the Company is infringing on
a patent issued to Aerotel in November 1987 by making, using,
selling and offering for sale prepaid telephone card products
in the United States. Aerotel seeks an injunction to stop us
from using the technology covered by this patent, monetary
damages in an unspecified amount and reimbursement of
attorneys' fees. This litigation was only recently filed and
the Company is presently evaluating these claims. The Company
believes that it has meritorious defenses to the claim and it
intends to defend the lawsuit vigorously. However, the outcome
of the litigation is inherently unpredictable and an
unfavorable result may have a material adverse effect on the
Company's business, financial condition and results of
operations. Regardless of the ultimate outcome, the litigation
could result in substantial expenses to the Company and
significant diversion of efforts by the Company's managerial
and other personnel.
12 -- STOCKHOLDERS' EQUITY
A. Stock Split.
The Company expects to revise its capital structure in
connection with its initial public offering to effect a
2.48-for-one stock split for each outstanding share of its
capital common stock. All references to per share amounts and
the number of shares in these financial statements have been
restated to reflect this expected stock split.
B. Description of capital stock
As of December 31, 1997, the Company's authorized share capital
was 100,000,000 shares of Class B common stock, par value
$0.001, of which 18,938,249 shares were issued and outstanding.
As of December 31, 1998, the Company's authorized share capital
was 200,000,000 shares of Class B common stock, par value
$0.001, of which 19,569,459 shares were issued and outstanding.
In September 1999, the Company authorized two additional
classes of capital stock, the Class A common stock, par value
$0.001, and preferred stock, par value $0.001. As of
September 30, 1999, the Company's authorized share capital was
200,000,000 shares of Class A common stock, of which none were
issued and outstanding, 200,000,000 shares of Class B common
stock, of which 19,569,459 shares were issued and outstanding,
and 25,000,000 shares of preferred stock,of which none were
issued and outstanding.
Effective upon the authorization of the Class A common stock,
each share of Class B common stock is convertible into one
share of Class A common stock at any time. The holders of the
Class B common stock are entitled to ten votes per share. The
holders of the Class A common stock are entitled to one vote
per share.
C. Yahoo! Inc. Transaction.
On October 18, 1999, the Company issued to Yahoo! Inc. ,
125,275 shares of Class A common stock and a warrant to
purchase 125,275 shares of Class A common stock at an exercise
price of $7.98 per share. The Company will record the $1.0
million purchase price of the 125,275 Class A common stock as
a receivable. The Company has a legal and enforceable right to
collect the $1.0 million in cash. The Company may elect to
offset the Yahoo! receivable against the first $1.0 million
due under a separate advertising and promotional agreement, as
F-14
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12 -- STOCKHOLDERS' EQUITY (CONTINUED)
described below. Assuming Yahoo! exercises the warrant
utilizing a cashless exercise, the Company will issue to
Yahoo! 41,963 shares of Class A common stock. The Company will
record approximately $1,007,000 of deferred compensation
expense related to the issuance of the shares representing the
difference between each of the purchase price of the Class A
common stock as compared to the initial public offering price
of the Class A common stock and the fair value of the warrant.
The fair value of the warrant has been measured by utilizing
the Black Scholes option pricing model. The Company will
amortize this deferred compensation expense over the one year
life of the Yahoo! advertising and promotion agreement
referred to below.
In addition, on October 18, 1999, the Company entered into a
binding advertising and promotion agreement whereby Yahoo! Inc.
will provide 226,038,600 page views to the Company over a one
year period commencing in December 1999. In consideration for
such, the Company will compensate Yahoo! Inc. $5,000,000. Under
the terms of the advertising and promotion agreement, the
company will make a cash payment of $1,600,000 on the effective
date of the agreement and an additional twelve cash payments of
$283,333 over the twelve months following the effective date.
The $5,000,000 will be charged to expense using the straight
line basis over the one year life of the contract.
D. CNET Transaction.
On October 20, 1999, the Company issued to CNET Investments,
Inc. 1,085,943 shares of common stock and a warrant to purchase
466,028 shares of Class A common stock at an exercise price of
$19.31 per share, or approximately $11.0 million in the
aggregate which was received in cash by the Company upon the
issuance of the shares. The Company will record approximately
$2.7 million of deferred compensation expense related to the
issuance of the shares representing the difference between each
of the purchase price of the Class A common stock as compared
to the initial public offering price of the Class A common
stock and the issuance of the warrant (using the Black Scholes
option pricing model for determining the fair value of the
warrant). The Company will amortize this deferred compensation
expense over the two year life of the CNET promotion agreement
referred to below.
In addition, the Company entered into a binding development and
promotion agreement with CNET, Inc., effective as of
September 22, 1999, whereby CNET, Inc. will provide various
promotions to the Company to assist the Company in promoting
its pc-to-phone product and related services. In consideration
for this promotion, the Company will compensate CNET, Inc. a
total of $11,000,000 over a two year period. In the first year,
the Company will pay CNET a one time payment of $330,000,
payments aggregating $920,000 for special promotions and
$354,166.66 per month. In the second year, the Company will pay
CNET an aggregate amount of $1,250,000 for special promotions
and $354,166.66 per month.
E. Restricted Units
As of December 31, 1998 and September 30, 1999, a total of
1,048,851 and 1,121,324 restricted units, respectively, had
been granted to employees of the Company under the 1997 RSL COM
Stock Incentive Plan. The restricted units were convertible to
shares of RSL COM Class A common stock or cash (at RSL COM's
discretion) based on the value of the Company on December 31 of
each year, as determined with reference to the value of RSL
COM. Of these restricted units, 836,147 have an exercise price
of $.0004 and were granted in 1997 and 1998 and 189,262 have an
exercise price of $2.08 and were granted in 1998. In April
1999, an additional 95,915 restricted units were granted to
employees of the Company with an exercise price of $5.11. The
majority of the restricted units vest over a three-year period
from the date of
F-15
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12 -- STOCKHOLDERS' EQUITY (CONTINUED)
grant and are exercisable for a period of seven years from the
date of grant. Upon completion of the Company's contemplated
initial public offering, the Company will issue shares of the
Company's Class A common stock in exchange for vested
restricted units on a one-for-one basis upon payment of the
related exercise price and will issue options to purchase
shares of the Company's Class A common stock in exchange for
unvested restricted units on a one-for-one basis, with the same
exercise prices (adjusted for the stock split referred to in
Note 12A) and vesting schedules as the corresponding restricted
units. For purposes of these financial statements, the Company
has assumed that the restricted units will convert into shares
of common stock on a one-for-one basis.
Pursuant to generally accepted accounting principles, the
restricted units are considered variable grants. Consequently,
changes in the fair value of the underlying shares at each
balance sheet date affect the aggregate amount of deferred
compensation recorded by the Company. The Company recorded
deferred compensation in connection with the restricted unit
grants of approximately $1,800,000 through December 31, 1998
and an additional $6,600,000 during the nine months ended
September 30, 1999, representing the difference between the
exercise price and the deemed fair value of the Company's
common stock at such date, based on a fair value of restricted
units of $2.08 and $8.18 per unit as of December 31, 1998 and
September 30, 1999, respectively. Such amount is included as a
reduction of stockholder's equity and is being amortized by
charges to operations over the vesting period. Amortization of
the deferred compensation amounted to $742,780 and $6,635,574
for the year ended December 31, 1998 and the nine months ended
September 30, 1999, respectively.
Upon completion of the Company's contemplated initial public
offering, the Company will record an additional $4.5 million of
deferred compensation expense for the difference between the
fair value of the restricted units and the deemed fair value of
the Company's Class A common stock, based on an assumed initial
public offering price of $12.00 per share.
F. Stock Options
In April 1999, the Company agreed to grant options to purchase
an aggregate of 1,076,761 shares of the Company's Class A
common stock at an exercise price of $5.11 to executive
officers of the Company, subject to completion of the Company's
contemplated initial public offering. Such options vest over a
three year period from the date of grant and are exercisable
for a period of seven years from the date of grant.
The Company recorded deferred compensation related to the
stock options of approximately $7,500,000 as of September 30,
1999, representing the difference between the exercise price
and the deemed fair market value of the Company's Class A
common stock at such date. Such amount is included as a
reduction of stockholder's equity and is being amortized by
charges to operations over the three year vesting period.
Amortization of the deferred compensation amounted to
$2,290,646 for the nine months ended September 30, 1999.
Had compensation cost for the Company's stock options and
restricted units been determined based on fair value at the
grant date in accordance with SFAS No. 123, the Company's pro
forma net loss and pro forma diluted net loss per share would
have been as follows:
F-16
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12 -- STOCKHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 1996
(INCEPTION)
TO YEAR ENDED DECEMBER 31,
DECEMBER 31, --------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Net loss:
As reported....................................... $ (178,602) $(2,367,582) $ (7,120,971)
---------- ------------ ------------
---------- ------------ ------------
Pro forma......................................... $ (178,602) $(2,367,582) $ (6,475,211)
---------- ------------ ------------
---------- ------------ ------------
Net loss per share--basic and diluted:
As reported....................................... $ (0.03) $ (0.19) $ (0.37)
---------- ------------ ------------
---------- ------------ ------------
Pro forma......................................... $ (0.03) $ (0.19) $ (0.34)
---------- ------------ ------------
---------- ------------ ------------
</TABLE>
For the purpose of presenting pro forma information required
under SFAS 123, the fair value of the restricted units and
option grants has been estimated on the date of grant using
the Black-Scholes option pricing model with a risk-free
interest rate of 6%, a 3-year expected life, zero expected
volatility and no dividends.
13 -- RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses (which commenced in 1997)
consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998
------------ ------------
<S> <C> <C>
Salaries and related expenses........... $ 91,318 $ 947,943
Consulting and advisory fees............ -- 196,981
Depreciation and amortization........... 83,057 41,214
Travel.................................. -- 146,432
Other................................... 119,775 218,955
------------ ------------
294,150 1,551,525
Less--reimbursement by Ericsson (see
Note 11B)............................. -- (901,385)
------------ ------------
Total research and development
expenses.............................. $ 294,150 $ 650,140
------------ ------------
------------ ------------
<CAPTION>
NINE MONTHS ENDED
--------------------------
1998 1999
------------ ------------
<S> <C> <C>
Unaudited
Salaries and related expenses........... $ 605,735 $ 1,137,619
Consulting and advisory fees............ -- --
Depreciation and amortization........... 46,295 85,451
Travel.................................. 121,609 94,551
Other................................... 194,342 239,937
------------ ------------
967,981 1,557,558
Less--reimbursement by Ericsson (see
Note 11B)............................. (488,951) (760,285)
------------ ------------
Total research and development
expenses.............................. $ 479,030 $ 797,273
------------ ------------
------------ ------------
</TABLE>
14 -- INCOME TAXES
A. Tax loss carryforwards
As of December 31, 1998, the Company had net operating loss
carryforwards generated in the U.S. and Israel of approximately
$3,000,000 and $3,300,000, respectively. The Company's U.S. net
operating loss carryforwards will expire at various dates
beginning in 2011 if not utilized. In addition, a portion of
those net operating loss carryforwards could be subject to
limitation due to RSL COM's acquisition of the Company. The
Company's net operating losses generated in Israel may be
carried forward indefinitely.
F-17
<PAGE>
DELTATHREE.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14 -- INCOME TAXES (CONTINUED)
B. In accordance with SFAS No. 109, the components of deferred
income taxes as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- SEPTEMBER 30,
1997 1998 1999
--------- ---------- -------------
<S> <C> <C> <C>
Net operating losses carryforwards................. $900,000 $3,500,000 $ 9,800,000
Less valuation allowance........................... (900,000) (3,500,000) (9,800,000)
--------- ---------- -----------
Net deferred tax assets............................ $ -- $ -- $ --
--------- ---------- -----------
--------- ---------- -----------
</TABLE>
As of December 31, 1997 and 1998 and as of September 30, 1999, a
valuation allowance of $900,000, $3,500,000 and $9,800,000,
respectively, is provided as the realization of the deferred tax
assets are not assured.
15 -- SEGMENT REPORTING, GEOGRAPHICAL INFORMATION AND MAJOR CUSTOMERS
The Company operates in a single industry segment, IP
communications services, and makes business decisions and allocates
resources accordingly.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------- -------------------------
1997 1998 1998 1999
---------- ------------ ----------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues by geographical location:
United States......................................... $ 679,821 $4,922,073 $3,060,431 $4,088,235
Europe................................................ 37,339 528,157 364,501 870,573
Argentina............................................. 284,202 33,432 40,092 113,309
Hong Kong and China................................... 149,232 -- 87,011 688,586
Other................................................. 95,047 154,385 116,830 671,651
---------- ---------- ----------- ----------
Total revenues...................................... $1,245,641 $5,638,047 $3,668,865 $6,432,354
---------- ---------- ----------- ----------
---------- ---------- ----------- ----------
Revenues from principal customers:
Affiliates............................................ $ 467,842 $3,896,106 $2,484,541 $4,077,278
---------- ---------- ----------- ----------
---------- ---------- ----------- ----------
Other principal customer.............................. $ 276,000 $ -- $ -- $ --
---------- ---------- ----------- ----------
---------- ---------- ----------- ----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1997 1998 1999
-------- ---------- -------------
<S> <C> <C> <C> <C>
Long-lived assets:
United States........................................... $448,424 $4,375,898 $ 1,722,038
Israel.................................................. 250,535 2,077,091 4,385,126
Other................................................... 173,249 1,816,434 3,782,178
-------- ---------- -----------
Total long-lived assets................................. $872,208 $8,269,423 $ 9,889,342
-------- ---------- -----------
-------- ---------- -----------
</TABLE>
F-18
<PAGE>
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<PAGE>
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<PAGE>
6,000,000 SHARES
[LOGO]
Common Stock
------------------------------
PROSPECTUS
November 22, 1999
------------------------------
LEHMAN BROTHERS
MERRILL LYNCH & CO.
U.S. BANCORP PIPER JAFFRAY
LAZARD FRERES & CO. LLC
FIDELITY CAPITAL MARKETS
a division of National Financial
Services Corporation
