<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC  20549

                                   FORM 10-Q

                      ----------------------------------

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934


For the quarter ended September 30, 2000

                                 OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

For the transition period from ____ to ____

                       Commission File Number:  0-22944

                         Capsule Communications, Inc.
                         ----------------------------
            (Exact name of Registrant as specified in its charter)

         Delaware                                      22-3055962
-------------------------------                        ----------
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
 incorporation or organization)

2 Greenwood Square, 3331 Street Road, Suite 275
Bensalem, Pennsylvania                                    19020
----------------------                                    -----
(Address of principal executive offices)                (Zip Code)

                                (215) 633-9400
                                --------------
             (Registrant's telephone number, including area code)

                                Not Applicable
                                --------------
(Former name, former address and former fiscalyear, if changed since last
report)


Indicate by check mark whether the Registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports); and,  (2) has been subject to
such filing requirements for the past 90 days.
                        Yes     X    No
                              -----     -----

Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.

                                     Outstanding at
                   Common Stock    November 14, 2000
                   ------------    -----------------
                      $.001            22,448,444
<PAGE>

                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                                   FORM 10-Q

                                     INDEX

       Page (s)
       --------
PART I
======

FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S>                      <C>                                         <C> <C>

Item 1.  Financial Statements

         Consolidated Balance Sheets
           September 30, 2000 (unaudited) and December 31, 1999                                    3 - 4

         Consolidated Statements of Operations
           Three and Nine Months Ended September 30, 2000 and 1999 (unaudited)                       5

         Consolidated Statements of Cash Flows
           Nine Months Ended September 30, 2000 and 1999 (unaudited)                                 6

         Notes to Consolidated Financial Statements (unaudited)                                    7 - 14

Item 2.  Management's Discussion and Analysis of Financial Condition
         and Results of Operations                                                                15 - 18

Item 3.  Quantitative and Qualitative Disclosure about Market Risk                                  18

PART II
=======

OTHER INFORMATION

Item 1.  Legal Proceedings                                                                          19

Item 2.  Changes in Securities and use of Proceeds                                                  19

Item 3.  Defaults upon Senior Securities                                                            19

Item 4.  Submission of Matters to a Vote of Security Holders                                        19

Item 5.  Other Information                                                                          19

Item 6.  Exhibits and Reports on Form 8-K                                                           19

SIGNATURE PAGE                                                                                      20
</TABLE>
<PAGE>

PART I
======

FINANCIAL INFORMATION

Item 1.
------
FINANCIAL STATEMENTS



                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>


                                                    September 30,    December 31,
                                                   2000 (unaudited)      1999
                                                   ----------------  ------------
<S>                                                <C>               <C>
                Assets
                ------

Current Assets
 Cash and cash equivalents                             $ 2,408,310    $   827,048
 Restricted cash                                           800,959        770,363
 Accounts receivable, net of allowance for
  doubtful accounts of $1,085,297 for 2000,
  and $1,711,853 for 1999                                5,949,662      5,772,799
 Prepaid expenses and other                                216,179        201,724
                                                       -----------    -----------

  Total Current Assets                                   9,375,110      7,571,934
                                                       -----------    -----------

Property and Equipment
 Telecommunications equipment                            4,255,311      4,120,775
 Equipment                                               2,119,108      1,863,177
 Software                                                  655,422        655,422
 Office furniture and fixtures                             180,159        161,282
 Leasehold improvements                                    675,765        668,820
                                                       -----------    -----------
                                                         7,885,765      7,469,476
 Less accumulated depreciation and amortization          5,122,701      4,459,111
                                                       -----------    -----------

  Total Property and Equipment, net                      2,763,064      3,010,365
                                                       -----------    -----------

Other assets                                               435,091        323,914
                                                       -----------    -----------

  Total                                                $12,573,265    $10,906,213
                                                       ===========    ===========

                      The accompanying notes are an integral part of these consolidated financial statements
</TABLE>

                                      -3-
<PAGE>

                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                          CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                    September 30,    December 31,
                                                   2000 (unaudited)     1999
                                                   ----------------  ------------


     LIABILITIES AND SHAREHOLDERS' EQUITY
     -------------------------------------


Current Liabilities
<S>                                                 <C>            <C>
 Note payable                                       $    984,602   $  1,036,507
 Capital lease obligations, current portion                9,155        153,289
 Accounts payable                                      6,698,899      5,085,368
 Accrued commissions                                     732,165        643,321
 Accrued expenses and other                            1,567,042      1,162,975
 State and Federal taxes payable                       1,211,686      1,039,966
 Deferred revenue                                        182,851             --
                                                    ------------   ------------

  Total Current Liabilities                           11,386,400      9,121,426
                                                    ------------   ------------


Common Shareholders' Equity
  Common stock, $.001 par, authorized
  100,000,000 shares; issued:
  22,667,444 shares in 2000
  20,925,944 shares in 1999                               22,667         20,926
 Additional paid-in capital                           14,653,457     12,087,332
 Accumulated deficit                                 (13,489,040)   (10,323,252)
                                                    ------------   ------------
                                                       1,187,084      1,785,006
Common stock held in treasury
 (219,000 shares in 2000 and 1999), at par value            (219)          (219)
                                                    ------------   ------------

                                                       1,186,865      1,784,787
                                                    ------------   ------------

  Total                                             $ 12,573,265   $ 10,906,213
                                                    ============   ============


                      The accompanying notes are an integral part of these consolidated financial statements
</TABLE>

                                      -4-
<PAGE>

                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (unaudited)

<TABLE>
<CAPTION>
                                                     Three Months Ended           Nine Months Ended
                                                        September 30,                September 30,
                                                        -------------                -------------
                                                    2000           1999           2000           1999
                                                    ----           ----           ----           ----

<S>                                             <C>           <C>            <C>            <C>
Revenues                                        $ 9,736,092    $10,827,823    $28,033,052    $30,250,139

Cost of sales                                     7,217,649      7,679,851     20,355,129     21,272,411
                                                -----------    -----------    -----------    -----------

Gross profit                                      2,518,443      3,147,972      7,677,923      8,977,728

Selling, general and administrative expenses      3,614,782      3,872,808     10,821,792     11,117,349
                                                -----------    -----------    -----------    -----------

Loss from operations                             (1,096,339)      (724,836)    (3,143,869)    (2,139,621)

Other income (expense)
  Interest income                                    46,927         34,791        103,118        103,371
  Interest expense                                  (37,315)       (45,503)      (125,038)      (134,965)
                                                -----------    -----------    -----------    -----------

Loss before income taxes                         (1,086,727)      (735,548)    (3,165,789)    (2,171,215)

Income tax expense                                       --             --             --             --
                                                -----------    -----------    -----------    -----------

Net loss                                         (1,086,727)      (735,548)    (3,165,789)    (2,171,215)

Preferred dividends                                      --             --             --         13,500
                                                -----------    -----------    -----------    -----------

Net loss attributable to common shareholders    $(1,086,727)   $  (735,548)   $(3,165,789)   $(2,184,715)
                                                ===========    ===========    ===========    ===========
Net loss per share attributable
  to common shareholders                              $(.05)         $(.04)         $(.15)         $(.11)
                                                ===========    ===========    ===========    ===========

Weighted average number of shares outstanding    22,448,444     20,390,496     21,444,404     19,819,088
                                                ===========    ===========     ==========     ==========


                      The accompanying notes are an integral part of these consolidated financial statements
</TABLE>

                                      -5-
<PAGE>

                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (unaudited)
<TABLE>
<CAPTION>

                                                                          Nine Months Ended
                                                                            September 30,
<S>                                                             <C>                 <C>
                                                                          2000          1999
                                                                          ------------------

OPERATING ACTIVIES
 Net income (loss) before preferred dividends                         $(3,165,789)  $(2,171,215)
 Adjustments to reconcile net income (loss)
 to net cash provided by (used-in) operating activities
  Issuance of stock options                                               141,340        20,807
  Depreciation and amortization                                           773,940       826,884
  Provision for bad debts                                                 529,939     1,152,275
  Changes in assets and liabilities which provided
  (used) cash:
   Accounts receivable                                                   (706,802)   (1,304,042)
   Prepaid expenses and other                                             (14,455)        4,055
   Other assets                                                          (221,528)       57,656
   Deferred revenue                                                       182,851        (2,887)
   Accounts payable and accrued expenses                                2,106,442     1,191,701
   State and Federal Taxes payable                                        171,720       108,322
                                                                      -----------   -----------

 Net cash used in operating activities                                   (202,342)     (116,444)
                                                                      -----------   -----------

INVESTING ACTIVITIES
 Purchase of property and equipment                                      (416,289)   (1,101,099)
 Increase in Restricted Cash                                              (30,596)           --
                                                                      -----------   -----------

 Net cash used in investing activities                                   (446,885)   (1,101,099)
                                                                      -----------   -----------

FINANCING ACTIVITIES
 Proceeds from private placement                                          900,000     1,530,000
 Proceeds from note payable subsequently converted to equity            1,500,000            --
 Proceeds from stock option exercises                                      26,528       265,567
 Increase (decrease) in notes payable net                                 (51,905)      432,442
 Repayment of capital lease obligations                                  (144,134)     (169,095)
 Preferred stock dividends                                                     --       (13,500)
                                                                      -----------   -----------

 Net cash provided by financing activities                              2,230,489     2,045,414
                                                                      -----------   -----------

Net increase in cash                                                    1,581,262       827,871

Beginning cash and cash equivalents                                       827,048     1,665,485
                                                                      -----------   -----------

Ending cash and cash equivalents                                      $ 2,408,310   $ 2,493,356
                                                                      ===========   ===========

                      The accompanying notes are an integral part of these consolidated financial statements
</TABLE>

                                      -6-
<PAGE>

                 CAPSULE COMMUNICATIONS, INC. AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  Background
--------------

Capsule Communications, Inc. (the "Company"), formerly known as US Wats, Inc.,
formed a new wholly-owned subsidiary in the State of Delaware under the name of
Capsule Communications, Inc.  At the Company's annual meeting of shareholders
held on November 24, 1999, the shareholders voted to approve the reincorporation
of the Company in Delaware by merging US Wats, Inc. into the new Delaware
subsidiary.  After receiving approval from the Public Utility Commissions of
various states in which US Wats, Inc. conducted business, the reincorporation
merger was effected under Delaware law on April 27, 2000.  The Company now
operates as a Delaware corporation under the name Capsule Communications, Inc.

On November 2, 2000, the Company entered into an Agreement and Plan of
Reorganization (the "Merger Agreement") with Startec Global Communications
Corporation ("Startec"), Stars Acquisition Corp. ("Stars"), G&A and FINDS.
Pursuant to the Merger Agreement, Stars will merge with and into the Company,
which will become a wholly-owned subsidiary of Startec, and each outstanding
share of Company common stock will be converted into a number of shares of
Startec common stock equal to the product of one times the Conversion Ratio,
rounded to the nearest .01 share (the "Merger"). Further information regarding
the Merger is set forth below under Footnote 6, Subsequent Events, and in the
Company's Current Report on Form 8-K filed on November 13, 2000.

The Company is a switch-based interexchange carrier providing long distance
telephone communications services primarily to small and medium-size business
customers as well as residential customers.  The Company also provides inbound
long distance services and local resale services as well as other
telecommunications services such as travel cards (calling cards), cellular,
paging, internet service, dedicated access, data services, pre-paid calling
cards (debit cards), international callback and carrier termination services.
The Company uses its own switches and facilities to originate, transport and
terminate calls for customers generally located between Maine and Norfolk,
Virginia and California (on-net areas).  Approximately 84% of the calls billed
by the Company were processed through the Company's own switches as of September
30, 2000.  For calls originating or terminating outside the Company's own
network (off-net area), the Company utilizes the services provided by other
telecommunications companies.

The Company's revenues are derived primarily from the transport of outgoing and
incoming calls, which are billed by the Company to end-users at specified rates.
Transport costs of these calls are billed to the Company from other carriers at
contractual rates.  These carriers supply the Company with call detail
information, which enables the Company to bill its customers depending upon the
Company's individual rates.  The combination of the efficiency of the Company's
network and facilities, and the purchase of long distance services in bulk from
other carriers allow the Company to offer competitive rates to small and medium-
sized businesses as well as residents.

The Company differentiates itself from a price-only sales approach by offering
various value-added services for its customers, through the use of its
customized software.  The Company's outbound long distance services, inbound
services, cellular, paging and internet services are provided on one combined
bill which includes various management reports.  The Company believes its
consultative approach to meeting its customers' needs distinguishes it from its
larger competitors.

The Company has recently instituted several private internet web sites from
which its agents are generating new orders electronically.  As a result, the
number of retail customers increased from approximately 15,000 in the quarter
ended September 30, 1999 to approximately 33,000 in the quarter ended September
30, 2000.  The Company expects to continue its efforts to expand this strategy
in order to generate new business.  Additionally, the Company has implemented a
program to resell local access services to its current and prospective customers
in six Verizon states under its favorable interconnection agreements.  Under
this new program, the Company added 1,652 new local access lines in the quarter
ended September 30, 2000.  Finally, in an effort to increase product lines, the
Company has recently implemented a marketing plan to resell Digital Subscriber
Line (DSL) services, where available, to its current and prospective customers,
which provides dedicated internet access at much greater speeds than existing
dial-up service.

                                      -7-
<PAGE>

All of the Company's customer support functions, such as customer service,
credit and collections, and administrative services are centrally located at the
Company's offices at 2 Greenwood Square, 3331 Street Road, Suite 275, Bensalem,
Pennsylvania 19020.  The Company's telephone number at that location is (215)
633-9400.

The accompanying unaudited interim consolidated financial statements and related
notes have been prepared pursuant to the rules and regulations of the Securities
and Exchange Commission and in the opinion of management, include all
adjustments necessary for a fair presentation of such financial statements.
Such adjustments consist only of normal recurring items.  Certain information
and note disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations.  Where appropriate, certain amounts in
the prior period financial statements have been reclassified to conform to the
current period presentation.  The results of operations for the three and nine
months ended September 30, 2000 are not necessarily indicative of results to be
expected for the full year.

The accompanying unaudited interim consolidated financial statements and related
notes should be read in conjunction with the financial statements and related
notes included in the Company's Form 10-K and Form 10-K/A for the year ended
December 31, 1999.


2.  Summary of Significant Accounting Policies
----------------------------------------------

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and
its four wholly-owned subsidiaries, USW Corporation, USW Enterprises, Inc.,
Carriers Group Inc., and US WATS of Virginia, Inc. after elimination of all
inter-company accounts, transactions and profits.

Business Segments

The Company's operations have been aggregated into a single reportable segment,
based on the similarity of its customers, products and methods of distribution,
as permitted under SFAS No. 131.

Revenue Recognition

The Company recognizes revenue based upon the customer's usage of services.  The
Company bills its customers for services on a monthly basis.  However, in some
instances, it bills certain customers on a more frequent basis.

Cash and Cash Equivalents

The Company considers cash in its bank and repurchase agreements with a maturity
of three months or less when purchased as cash and cash equivalents.

At certain times during the year, the Company has balances in its operating
accounts that in the aggregate exceed the $100,000 Federal Deposit Insurance
Corporation insurance limit.

                                      -8-
<PAGE>

Property and Equipment

Property and equipment are recorded at cost.  Depreciation is calculated for
financial reporting purposes using the straight-line method over the estimated
useful lives of the assets:

            Telecommunications equipment....................7 years
            Furniture fixtures and other....................5 years

Deferred Financing Costs

Loan origination costs are amortized over the term of the related loan, and are
included in other assets.

Goodwill

The Company records the excess of purchase price over the fair market value of
net assets acquired as goodwill.  Goodwill is amortized using the straight-line
method over 3 years and is included in other assets.

Accounts Payable

Accounts payable includes the cost of access charges due local telephone
companies and long distance transport purchased from long distance carriers.

Marketing

All costs related to marketing and advertising the Company's products and
services are expensed in the period incurred.

Use of Estimates

The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
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.

Loss per Common Share Attributable to Common Shareholders

Loss per common share attributable to common shareholders is computed by
dividing net loss after deduction of preferred stock dividends, if any, by the
weighted average number of common shares outstanding during the period.

For the three and nine months ended September 30, 2000 and 1999, the Company's
potential common stock equivalents had an anti-dilutive effect on loss per share
attributable to common shareholders and, therefore, diluted loss per common
share attributable to common shareholders has not been presented.

The following table summarizes those securities that could potentially dilute
loss per common share attributable to common shareholders in the future that
were not included in determining the fully diluted loss per common share
attributable to common shareholders as the effect is anti-dilutive.

                                      -9-
<PAGE>

<TABLE>
<CAPTION>
                                                                   Nine Months Ended September 30,
<S>                                                     <C>                  <C>
Potential Common Shares resulting from:                               2000                  1999
                                                                    -------               -------

Stock Options                                                       440,292               486,705

Stock Warrants                                                            0                     0

Cumulative, Convertible, Redeemable Preferred Stock                       0               198,901
                                                                    -------               -------

                                                                    440,292               685,606
                                                                    =======               =======


                                                                   Three Months Ended September 30,
<S>                                                     <C>                  <C>
Potential Common Shares resulting from:                               2000                  1999
                                                                    -------               -------

Stock Options                                                       100,439               423,125

Stock Warrants                                                            0                     0

Cumulative, Convertible, Redeemable Preferred Stock                       0                     0
                                                                    -------               -------

                                                                    100,439               423,125
                                                                    =======               =======
</TABLE>

Fair Value of Financial Instruments

The fair value of the Company's financial instruments such as accounts
receivable, accounts payable, and note payable approximate their carrying
amounts.

Carrying Value of Long-Term Assets

The Company evaluates the carrying value of long-term assets, including
property, plant and equipment, and other intangibles, based upon current and
anticipated undiscounted cash flows, and recognizes an impairment when such
estimated cash flows are less than the carrying value of the asset.  Measurement
of the amount of impairment, if any, is based upon the difference between
carrying value and fair value.

New Accounting Pronouncements

In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities."  This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and hedging activities.  It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value.  The Company will adopt this standard beginning in January, 2001
and is currently evaluating the effect it will have on the Company's financial
statements.

In December 1999, the Securities and Exchange Commission (the "SEC") issued
Staff Accounting Bulletin No. 101. Revenue Recognition in Financial Statements
("SAB No. 101"). SAB No. 101 provides guidance on the recognition, presentation
and disclosure of revenue in financial statements filed with the SEC and is
required to be adopted in the fourth quarter of fiscal years beginning after
December 15, 1999. The Company has not yet determined the impact SAB No. 101
will have on its consolidated financial position or results of operations.

                                      -10-
<PAGE>

Reclassification of Accounts

Certain reclassifications have been made to conform prior years' balances to the
current year presentation.


3.  Note Payable
----------------

The Company has a revolving $2,000,000 credit facility with Century Business
Credit Corporation, which is renewable for three successive one-year periods
beginning on May 11, 1999.  Interest on the revolving credit facility is
currently calculated at the prime lending rate plus 2 3/4%, on a minimum loan
balance of $750,000.  The loan is collateralized by accounts receivable and
fixed and intangible assets of the Company.  As of September 30, 2000, the
Company's outstanding balance on its credit facility was approximately $985,000
leaving approximately $1,015,000 available, based on collateral, for future
borrowing under the credit facility.

On March 22, 2000, the Company entered into Loan Agreements with Gold & Appel
Transfer, S.A. ("G&A") and the Foundation for the International Non-Governmental
Development of Space, a non-profit organization ("FINDS") two of the Company's
principal stockholders. Walt Anderson, a director of the Company, is also the
president and director of both G&A and FINDS. The terms of the Loan Agreements
called for the Company to borrow up to an aggregate $1,500,000 from G&A and
FINDS at a rate of 10% per annum and due and payable on March 1, 2001. The Loan
Agreements allowed the Company to repay the amounts loaned plus accrued interest
by issuing shares of the Company's common stock to the lenders. On May 19, 2000,
the Company exercised its option to repay the indebtedness under the Loan
Agreements and, on May 24, 2000, the Company issued to G&A and FINDS 333,333 and
666,667 shares of common stock, respectively, in full payment of the outstanding
principal of, and accrued interest on, the loans previously made by G&A and
FINDS to the Company in the respective original principal amounts of $1.0
million and $500,000. These amounts were recorded as common stock and additional
paid in capital-common stock as of June 30, 2000.

During 1999, the Company obtained a letter of credit in the amount of $752,000
for the potential settlement of litigation related to Mr. Scully (see footnote
4).


4.   Litigation
---------------

On June 13, 1997, Mark Scully, the former President and Chief Operating Officer
of the Company, filed a complaint against the Company, Kevin O'Hare, Aaron Brown
and Stephen Parker in the United States District Court for the Eastern District
of Pennsylvania.  Mr. Scully asserts various claims in connection with his
termination of employment with the Company on December 30, 1996.  In particular,
he alleges, among other things, breach of contract in connection with the
termination of certain stock options, breach of the alleged contract for
employment, breach of an asserted duty of good faith and fair dealing,
fraudulent and negligent misrepresentation, and civil conspiracy.  Mr. Scully
alleges damages of at least $1.6 million, plus attorneys' fees, costs and other
disbursements and the cost of COBRA payments and interest; $1 million of the
alleged damages claimed are punitive.  The Company contests the allegations of
the complaint and intends to vigorously defend against the action.  On June 9,
1999, the Court issued its decision and judgment was entered in favor of Mr.
Scully and against the Company and two former officers for the sum of
approximately $626,000, which was accrued during 1999, and required the Company
to establish an escrow amount equal to 120% of the judgment.  The balance in the
escrow account at September 30, 2000 was $800,959 and is recorded as restricted
cash.  The Court denied Mr.

                                      -11-
<PAGE>

Scully's claim for attorneys' fees and liquidated damages. The Company has
appealed the decision and maintains that the Court made a number of errors of
law and that the Court applied the wrong measure of damages. Mr. Scully has
appealed the judgment as well. The Appellate Court heard arguments on July 10,
2000 and a decision is pending.

On or about August 3, 1999, David John Marshall, on behalf of certain
underwriters at Lloyds of London ("Lloyds"), commenced litigation against the
Company and some of its former officers and directors in the Court of Common
Pleas, Montgomery County, Pennsylvania. Lloyds sought, inter alia, a declaratory
judgment holding that Lloyds is not responsible to the Company or some of its
former officers and directors for indemnification, defense or settlement costs
incurred in connection with the Scully litigation discussed above. The Company
maintained that the Lloyds policy was properly issued and that Lloyds was
responsible to the Company and its former officers and directors for
indemnification, defense or settlement costs incurred in connection with the
Scully litigation. On or about August 14, 2000, the Company and Lloyds reached a
settlement, pursuant to which Lloyds paid the Company $295,000 in return for a
release of all claims against Lloyds in connection with the Scully litigation
and the insurance policy at issue. The $295,000 was received and recorded in
accrued expenses in the quarter ended September 30, 2000.

On November 5, 1999, the Company filed a civil action lawsuit against Cominex,
LLC ("Cominex"), a former customer, in the United States District Court for the
Eastern District of Pennsylvania, to recover approximately $835,000 for unpaid
telephone services.  On February 4, 2000, the Court entered a stipulated
judgment in the Company's favor for approximately $835,000.  Under the
stipulated judgment, the Company could not proceed to collect or execute on any
assets of Cominex for a period of 90 days from the entry of the judgment, which
period expired on May 5, 2000.  Cominex has testified in connection with the
Company's execution efforts that it has no readily available assets.  As of this
date, there is no additional information concerning the likely recovery, if any,
on the judgment.

The Company is party, in the ordinary course of business, to other litigation
involving services rendered, contract claims and other miscellaneous causes of
action arising from its business.  The Company has established reserves relating
to its legal claims and believes that potential liabilities in excess of those
recorded will not have a material adverse effect on the Company's consolidated
financial statements, however, there can be no assurances to that effect.


5.  Investment Agreement
------------------------

On May 19, 2000, the Company entered into an Investment Agreement with G&A and
FINDS, two of the Company's principal stockholders, which was subsequently
amended on June 30, 2000. Pursuant to the Investment Agreement, such
stockholders jointly and severally agreed to purchase from the Company shares of
the Company's common stock on several installment dates, for an aggregate
purchase price of $3.0 million. In exchange, the Company agreed to issue to such
stockholders, a number of shares of its common stock, equal to the quotient that
results from dividing each investment amount by the higher of the 30-trading day
average closing price of the common stock prior to each transaction, or $1.25.

On June 30, 2000, pursuant to the Investment Agreement, the Company issued
720,000 shares of common stock to G&A for an aggregate price of $900,000.

On November 2, 2000, contemporaneous with its execution of the agreements
relating to the pending Startec Merger described below, the Company entered into
a Termination Agreement with G&A and FINDS, whereby the parties terminated the
Investment Agreement and released each other from their respective remaining
obligations under the Investment Agreement.

                                      -12-
<PAGE>

6.  Subsequent Events
----------------------

On November 2, 2000, the Company entered into an Agreement and Plan of
Reorganization (the "Merger Agreement") with Startec Global Communications
Corporation ("Startec"), Stars Acquisition Corp. ("Stars"), G&A and FINDS.
Pursuant to the Merger Agreement, Stars will merge with and into the Company,
which will become a wholly-owned subsidiary of Startec, and each outstanding
share of Company common stock will be converted into a number of shares of
Startec common stock equal to the product of one times the Conversion Ratio,
rounded to the nearest .01 share (the "Merger").

The Conversion Ratio will equal .1333 unless the weighted average of the daily
high and low trade prices for the Acquiror common stock reported on Nasdaq for
the 15 trading days ending on the last trading day before the Merger closing
date is less than $5.25 per share, in which event the Conversion Ratio will be
adjusted to the extent necessary to cause the consideration to be paid for each
7.5 shares of Company common stock to equal $5.25.  In no event, however, will
such adjustment increase the Conversion Ratio to an amount in excess of .1647.

Holders of options to purchase shares of Company common stock under the
Company's stock option plans will be entitled to receive an equivalent right as
of the consummation of the Merger.  For each existing Company stock option, the
number of Startec shares subject to the new stock option will equal the number
of Company shares formerly subject to the stock option multiplied by the
applicable Conversion Ratio rounded to the nearest whole share. The exercise
price of the new stock option will be equal to the exercise price per Company
share under the Company stock option divided by the applicable Conversion Ratio,
rounded to the nearest penny.

Completion of the Merger is subject to approval by the stockholders of both the
Company and Startec and to satisfaction of the other conditions contained in the
Merger Agreement. The Company and Startec each have the right to terminate the
Merger Agreement under certain circumstances, as more fully described in the
Merger Agreement.

To induce Startec to enter into the Merger Agreement, G&A and FINDS, which
together own approximately 74% of the outstanding shares of the Company's common
stock, each entered into a Voting Agreement with Startec and Stars, pursuant to
which such stockholders agreed, among other matters, to vote their shares in
favor of the Merger. As a result of these agreements, approval of the Merger by
Capsule's stockholders is assured. As an additional inducement to Startec to
enter into the Merger Agreement, G&A and FINDS agreed to accept a five-year
unsecured balloon payment promissory note in lieu of receiving a portion of the
shares of Startec common stock that would otherwise be payable to them pursuant
to the Merger.

Further information concerning the Merger is set forth in the Current Report on
Form 8-K filed on November 13, 2000.

                                      -13-
<PAGE>

7.  Other Sales Information
----------------------------

Net sales information by the Company's product groups for the nine months ended
September 30, 2000 and 1999 are summarized as follows:
<TABLE>
<CAPTION>

            <S>                             <C>          <C>   <C>          <C>
                                                2000               1999
                                            -----------        -----------
                                              Amount      %      Amount      %
                                            -----------        -----------

            Domestic 1+                     $15,263,363   53   $14,471,647   48
            International                     4,723,158   16     6,517,605   22
            Inbound                           4,486,186   17     5,308,969   17
            Wireless                            585,342    2       838,586    3
            Domestic Carrier Termination      2,975,003   12     3,113,332   10
                                            -----------  ---   -----------  ---
             Total                          $28,033,052  100%  $30,250,139  100%
                                            ===========  ===   ===========  ===

</TABLE>

                                      -14-
<PAGE>

Item 2.
------
Management's Discussion and Analysis of Financial Condition and Results of
Operations

Certain information contained herein may include "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. All statements included in this report other than statements of
historical facts, are forward-looking statements. Such statements are subject to
certain risks and uncertainties, including but not limited to: changes in
general economic conditions, increasing levels of competition in the
telecommunications industry, changes in telecommunications technologies, changes
in FCC regulations, the Company's reliance on transmission facilities based
carriers, risks involved in conducting international operations, the inability
to generate sufficient revenues to meet debt service obligations and operating
expenses, unanticipated costs associated with the Company's recent and future
acquisitions, the failure of the Company to manage its growth effectively, and
the failure of the Company to complete its Merger with Startec in a timely
fashion. Should one or more of these risks or uncertainties materialize, actual
results may vary materially from those estimated, anticipated or projected.
Although the Company believes that the expectations reflected by such forward-
looking statements are reasonable based on information currently available to
the Company, no assurance can be given that such expectations will prove to have
been correct. Cautionary statements identifying important facts that could cause
actual results to differ materially from the Company's expectations are set
forth in this report. All forward-looking statements included herein are
expressly qualified in their entirety by these cautionary statements.


RESULTS OF OPERATIONS

The Company's revenues increased for the quarter ended September 30, 2000 by
approximately $173,000 (2%) from the level recorded for the quarter ended June
30, 2000.  Revenues derived from retail sales through the agent channel
increased by approximately $403,000.  This was offset by a decrease in revenues
from the carrier channel (sales to other carrier customers) of approximately
$230,000.

Three Months ended September 30, 2000 compared with Three Months ended September
--------------------------------------------------------------------------------
30, 1999
--------

The Company's revenues for the quarter ended September 30, 2000 decreased by
approximately $1,092,000 (10%) over the third quarter ended September 30, 1999.
Approximately $1,052,000 (96%) of the revenue decrease from the quarter ended
September 30, 1999 was due to a decline in the Company's revenue from carrier
sales channel. This was mainly attributed to a decrease in minutes sold through
the carrier channel. Competitive pressures resulted in a decline of $.021 in the
Company's average retail rate per minute from the three months ended September
30, 1999 to $.078 in the three months ended September 30, 2000. However, the
decline in the average retail rate per minute was offset by an increase in
minutes and subscribers. The number of retail minutes increased by approximately
13,320,000 over the three months ended September 30, 1999. The number of retail
customers increased from approximately 15,000 in the quarter ended September 30,
1999 to approximately 33,000 in the quarter ended September 30, 2000.

For the quarter ended September 30, 2000, gross profit as a percentage of
revenue decreased to approximately 26% compared to approximately 29% for the
quarter ended September 30, 1999.  The decrease in gross profit margin is
attributed to the decline in retail rates occurring more rapidly than the
decline in cost per minute in the quarter ended September 30, 2000.  Overall,
the Company's gross profit decreased approximately $630,000, mainly due to the
decrease in retail rates as noted above.

Selling, general, and administrative ("SG&A") expenses for the quarter ended
September 30, 2000

                                      -15-
<PAGE>

decreased by approximately $258,000 over the amount for the quarter ended
September 30, 1999. The decrease was a result of a decrease in bad debt expense
of approximately $744,000, offset by an increase in salary expense of
approximately $212,000, an increase in compensation expense of approximately
$131,000 associated with the amendments of certain executive stock options and
an increase in other miscellaneous expenses of approximately $143,000. The
decrease in bad debt expense was attributed to a writeoff of a large carrier
account in the quarter ended September 30, 1999. For the quarter ended September
30, 2000, SG&A expense as a percentage of revenue increased to 37% compared to
36% for the quarter ended September 30, 1999.

Interest expense decreased approximately $8,000 for the quarter ended September
30, 2000, as compared to the quarter ended September 30, 1999.

The Company recorded a net loss for the quarter ended September 30, 2000 of
approximately $1,087,000, an increase of approximately $351,000 from the quarter
ended September 30, 1999. The net loss for the quarter ended September 30, 2000
was attributed to the decrease in revenues and gross profit as noted above.


Nine Months ended September  30, 2000 compared with Nine Months ended September
-------------------------------------------------------------------------------
30, 1999
--------

The Company's revenues for the nine months ended September 30, 2000 decreased by
approximately $2,217,000 (7%) over the nine months ended September 30, 1999.
This decrease was primarily due to a decrease in revenue derived from retail
sales through the agent and reseller channels of approximately $894,000 (40%).
This was mainly attributed to decreasing selling rates as a result of strong
competition in the marketplace. Competitive pressures resulted in a decline of
$.023 in the Company's average retail rate per minute from the nine months ended
September 30, 1999 to $.082 for the nine months ended September 30, 2000. Also,
approximately $1,323,000 (60%) of the revenue decrease was attributed to a
decline in revenue from the carrier sales channel as a result of similar
decreased selling prices forced by competition and a decrease in minutes sold
through the carrier channel.

The Company's gross profit for the nine months ended September 30, 2000
decreased approximately $1,300,000 (14%) over the nine months ended September
30, 1999.  The decrease in gross profit is due to the decrease in revenue as
well as a decline in retail rates occurring more rapidly than the decline in
cost per minute for the nine months ended September 30, 2000.  The Company's
gross profit margin decreased from approximately 30% for the nine months ended
September 30, 1999 to approximately 27% for the nine months ended September 30,
2000.

SG&A expenses for the nine months ended September 30, 2000 were approximately
$296,000 lower than the amount incurred for the nine months ended September 30,
1999. This was primarily a result of a decrease in bad debt expense of
approximately $622,000, a decrease in commission expense of approximately
$775,000 offset by an increase in salary expense of approximately $781,000, an
increase in compensation expense of approximately $131,000 associated with the
amendments of certain executive stock options and an increase in other
miscellaneous expenses of approximately $189,000. The decrease in bad debt
expense was primarily due to a writeoff of a large carrier account in the
quarter ended September 30, 1999. The decrease in commission expense was
primarily due to the decrease in retail sales as noted above and the
introduction of new agent commission programs in 2000. The increase in salary
expense was primarily due to an increase in headcount associated with a new
Affinity direct sales program introduced in the quarter ended December 31, 1999.
SG&A expenses for the nine months ended September 30, 2000 were approximately
39% of revenue, compared to approximately 37% for the nine months ended
September 30, 1999. This increase was primarily attributed to the decrease in
revenues as noted above.

Interest expense for the nine months ended September 30, 2000 decreased
approximately $10,000 from the nine months ended September 30, 1999.

                                      -16-
<PAGE>

The net loss for the nine months ended September 30, 2000 was approximately
$3,166,000, an increase of approximately $995,000 from the nine months ended
September 30, 1999. This increase was mainly attributed to the decrease in
revenues as well as the decrease in gross profit as a percentage of revenue as
noted above. Also, approximately $300,000 of the net loss for the nine months
ended September 30, 2000 was associated with the temporary duplicate network
costs incurred as a result of the migration of the network to the new switch in
Philadelphia. The Company was forced to pay duplicate network costs to its
underlying carriers through May 31, 2000 as a result of decommissioning network
facilities connected to the old switch in Philadelphia. In addition,
approximately $490,000 in salary and other SG&A expenses was incurred as a
result of the implementation of a new Affinity direct sales program. The program
was designed to target customers from Chambers of Commerce throughout the nation
and their members. Also, approximately $250,000 in legal, regulatory and
marketing expenses was incurred as a result of the Company's reincorporation
merger and name change to Capsule Communications, Inc. Finally, approximately
$131,000 in compensation expense was incurred as a result of the amendments of
certin executive stock options.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2000, cash and cash equivalents were approximately $3,209,000.
Cash flow used in operations in the first nine months of 2000 was approximately
$202,000.  Net cash used in investing activities was approximately $447,000,
which primarily resulted from the purchase of property and equipment.

Working capital deficiency at September 30, 2000 was approximately $2,011,000 as
compared to a deficiency of approximately $1,549,000 at December 31, 1999.  The
decrease in working capital was primarily due to the net loss as mentioned
above.

The Company's working capital ratio decreased from .83:1.00 from December 31,
1999 to .82:1.00 at September 30, 2000.  The Company's cash balance increased
approximately $1,612,000 from its balance at December 31, 1999.

On March 22, 2000, the Company entered into Loan Agreements with G&A and FINDS,
two of the Company's principal stockholders. Walt Anderson, a director of the
Company, is also the president and director of both G&A and FINDS. The terms of
the Loan Agreements called for the Company to borrow up to an aggregate
$1,500,000 from G&A and FINDS at a rate of 10% per annum and due and payable on
March 1, 2001. The Loan Agreements allowed the Company to repay the amounts
loaned plus accrued interest by issuing shares of the Company's common stock to
the lenders. On May 19, 2000, the Company exercised its option to repay the
indebtedness under the Loan Agreements and, on May 24, 2000, the Company issued
to G&A and FINDS 333,333 and 666,667 shares of common stock, respectively, in
full payment of the outstanding principal of, and accrued interest on, the loans
previously made by G&A and FINDS to the Company in the respective original
principal amounts of $1.0 million and $500,000. These amounts were recorded as
common stock and additional paid in capital-common stock as of June 30, 2000.

Also, on May 19, 2000, the Company entered into an Investment Agreement with G&A
and FINDS, which was subsequently amended on June 30, 2000. Pursuant to the
Investment Agreement, such stockholders jointly and severally agreed to purchase
from the Company additional shares of common stock on several installment dates
for an aggregate purchase price of $3.0 million. In exchange, the Company agreed
to issue to such stockholders a number of shares of its common stock, equal to
the quotient that results from dividing each investment amount by the higher of
the 30-trading day average closing price of the common stock prior to each
transaction, or $1.25.

                                      -17-
<PAGE>

On June 30, 2000, pursuant to the Investment Agreement, the Company issued
720,000 shares of common stock to G&A for an aggregate Purchase Price of
$900,000.

On November 2, 2000, contemporaneous with its execution of the agreements
relating to the pending Startec Merger, the Company entered into a Termination
Agreement with G&A and FINDS, whereby the parties agreed to terminate the
Investment Agreement and to release each other from their respective remaining
obligations under the Investment Agreement.

The Company anticipates that its cash on hand and available borrowings under its
revolving credit facility with Century Business Credit Corporation will be
sufficient to fund the costs of its operations until the closing of its Merger
with Startec, which is expected to occur during the first quarter of 2001.

Item 3
------

Quantitative and Qualitative Disclosure About Market Risk

Not applicable.

                                      -18-
<PAGE>

PART II
=======
Other Information


Item 1.  Legal Proceedings

           For a discussion of pending legal proceedings, see Note 4 to the
           Consolidated Financial Statements contained in this filing, which
           Note 4 is incorporated by reference into this Item 1.


Item 2.  Changes in Securities

           None.


Item 3.  Defaults upon Senior Securities

           None.


Item 4.  Submission of Matters to a Vote of Security Holders

           None.


Item 5.  Other Information

           On November 2, 2000, the Company entered into an Agreement and Plan
           of Reorganization with Startec Global Communications Corporation
           whereby the Company will become a wholly-owned subsidiary of Startec
           (see Footnote 6 Subsequent Events).


Item 6.  Exhibits and Reports on Form 8-K

           (a)  Exhibits:

                  Exhibit No. 27, Financial Data Schedule

           (b)  Reports on Form 8-K:

                  On July 11, 2000, the Company filed Form 8-K regarding the
                  amendment of an investment agreement as well as the issuance
                  of common shares for cash associated with the investment
                  agreement.

                                      -19-
<PAGE>

                                  SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



                              Capsule Communications, Inc.
                              (Registrant)



                              By:   /s/ Michael McAnulty
                                  ----------------------
                                  Michael McAnulty
                                  Chief Financial Officer



Dated:  November 14, 2000

                                      -20-