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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL PERIOD ENDED DECEMBER 31, 1998
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 333-
DESTIA COMMUNICATIONS, INC.
(formerly Econophone, Inc.)
(Exact name of Registrant as specified in its charter)
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<S> <C>
DELAWARE 11-3132722
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
95 ROUTE 17 SOUTH, PARAMUS, NEW 07652
JERSEY (Zip Code)
(Address of principal executive
offices)
</TABLE>
Registrant's telephone number, including area code: (201) 226-4500
------------------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
------------------------
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes X or No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
19,956,250 shares of common stock, par value $.01 per share ("Common Stock")
of the registrant is held by affiliates. 43,750 shares of Common Stock are held
by non-affiliates.
As of March 1, 1999 the Registrant had outstanding 20,000,000 shares of
voting Common Stock and 230,800 shares of non-voting Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
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INDEX
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PAGE NO.
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PART I
Item 1. Business................................................................................... 1
Item 2. Properties................................................................................. 39
Item 3. Legal Proceedings.......................................................................... 40
Item 4. Submission of Matters to a Vote of Security Holders........................................ 40
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................................................ 41
Item 6. Selected Consolidated Financial Data....................................................... 41
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................ 44
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................. 53
Item 8. Financial Statements and Supplementary Data................................................ 53
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................................................ 53
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 54
Item 11. Executive Compensation..................................................................... 56
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................................................. 61
Item 13. Certain Relationships and Related Transactions............................................. 62
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K................................................................................... 67
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, including,
without limitation, certain statements made in the sections hereof entitled
"Item 1. Business" and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations." Forward-looking statements are
statements other than historical information or statements of current condition.
Some forward-looking statements may be identified by use of terms such as
"believes," "anticipates," "intends" or "expects." These forward-looking
statements relate to the plans, objectives and expectations of Destia
Communications, Inc. ("Destia" or the "Company") for future operations and its
business and the telecommunications industry generally. In light of the risks
and uncertainties inherent in all future projections, the inclusion of
forward-looking statements in this Annual Report should not be regarded as a
representation by the Company or any other person that the objectives or plans
of the Company will be achieved. The Company's revenues and results of
operations are difficult to forecast and could differ materially from those
projected in the forward-looking statements as a result of numerous factors
affecting one or more of the Company's markets, including the following: (i) the
rate of expansion of the Company's network and/or customer base; (ii)
inaccuracies in the Company's forecasts of telecommunications traffic or
customers; (iii) loss of a customer or distributor that provides the Company
with significant revenues; (iv) concentration of credit risk; (v) highly
competitive market conditions; (vi) changes in or developments under laws,
regulations, licensing requirements or telecommunications standards; (vii)
changes in the availability of transmission facilities; (viii) currency
fluctuations; (ix) changes in retail or wholesale telecommunications rates; (x)
changes in international settlement rates; (xi) loss of the services of key
officers, such as Alfred West, the Chairman and Chief Executive Officer, or Alan
L. Levy, the President and Chief Operating Officer; and (xii) general economic
conditions. The foregoing review of important factors should not be construed as
exhaustive; the Company undertakes no obligation to release publicly the results
of any future revisions it may make to any forward-looking statement to reflect
events or circumstances after the date hereof, including the occurrence of
unanticipated events.
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PART I
ITEM 1. BUSINESS
The Company is a rapidly growing, facilities-based provider of domestic and
international long distance telecommunications services in North America and
Europe. The Company's extensive international telecommunications network allows
it to provide services primarily to retail customers in many of the largest
metropolitan markets in the United States, Canada, the United Kingdom, Belgium,
France, Germany and Switzerland. In 1997, there were 81.8 billion minutes of
international long distance traffic with the majority originating in the United
States and Europe. This volume is expected to grow at a compound annual growth
rate of 12% to 18% from 1997 to 2001.
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services, and wholesale transmission services. The
Company's approximately 350,000 customer accounts are diverse and include
residential customers, commercial customers, ethnic groups and
telecommunications carriers. In each of its geographic markets, the Company
utilizes a multichannel distribution strategy to market its services to its
target customer groups. The Company believes this strategy greatly enhances its
growth prospects and reduces its dependence on any one service, customer group
or channel of distribution.
The Company entered the U.S. market during 1993 and the U.K. market during
1995. In continental Europe, the Company commenced offering its services before
the January 1, 1998 full liberalization of telecommunications services in those
markets. The Company established operations in Belgium, France and Germany in
the first quarter of 1997 and Switzerland in the fourth quarter of 1997.
PRODUCTS AND SERVICES
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services. The Company's retail customer base is diverse
and includes residential customers, commercial customers and ethnic groups. In
addition, the Company also provides wholesale transmission services to carriers
and other wholesale customers. The Company's services are discussed below.
RETAIL SERVICES
The following table summarizes the Company's principal retail services in
its principal geographic markets.
<TABLE>
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RETAIL SERVICES
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<S> <C> <C> <C> <C>
INTERNATIONAL DOMESTIC
DISTANCE LONG CALLING CARD PREPAID
LONG DISTANCE SERVICES SERVICES
----------------- --------------- ------------------- -------------
Continental Europe
Belgium........................................ X X X X
France......................................... X X X
Germany........................................ X X X X
Switzerland.................................... X X X X
United Kingdom................................... X X X X
North America
United States.................................. X X X X
Canada......................................... X X X X
<CAPTION>
<S> <C>
E-COMMERCE
AND INTERNET
SERVICES
-----------------
Continental Europe
Belgium........................................
France.........................................
Germany........................................
Switzerland.................................... X
United Kingdom...................................
North America
United States.................................. X
Canada.........................................
</TABLE>
INTERNATIONAL AND DOMESTIC LONG DISTANCE SERVICE. International and
domestic long distance service is service that is accessed from a customer's
billing location (i.e., their home or office) using "1xxx" access in the United
Kingdom, France and Belgium or "1+" access in the United States and Canada. In
Germany
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and Switzerland, long distance service is accessed by using either "1+" or
"1xxxx" access. The Company's international and domestic long distance service
generally enables customers to call to any destination.
CALLING CARD SERVICES. The Company's calling card services are sold in all
of its principal markets and can be used in over 50 countries. In the United
States, the Company principally markets its calling cards under the VoiceNet-TM-
brand name.
In continental Europe, the Company believes that a substantial portion of
its calling card customers use this service from their home or office as an
alternative to the PTT for international calls. In contrast, in the United
Kingdom and the United States, the Company's calling cards are sold to customers
primarily for convenience when traveling. As the Company completes
interconnection in continental Europe and is able to provide both international
and domestic long distance service to its customers on a cost-efficient basis,
the Company intends to migrate home and office-based calling card customers to
its international and domestic long distance service. The Company's calling card
service will then be offered in continental Europe as a premium travel service.
In Europe and North America, the Company's calling card service is accessed
by dialing a national toll free number or a local access number. Calling card
customers can access the Company's services from outside their home country by
dialing an international toll free number, a national toll free number or a
local access number, depending on the country from which the customer is
calling. The Company can offer customers competitive domestic and international
long distance rates for calls from places where customers can use national
toll-free and local access numbers. For calls from places where customers can
only use international toll free numbers, the Company can offer customers
competitive rates only on international long distance calls.
The Company also intends to introduce an enhanced service, using its calling
card platform, which will allow a user's calls to "follow" him or her from the
home, to the office, to the mobile phone, while also enabling the user to screen
calls. This service is currently being developed for the Company by an outside
firm specializing in enhanced services. The Company expects to have this service
ready for its customers by the third quarter of 1999.
PREPAID SERVICES. The Company's prepaid card service is a prepaid version
of its calling card, with similar features and the same manner of use as its
calling card. The Company's prepaid cards generally can be used from the United
Kingdom, the United States, Belgium, Canada, Germany, France, Israel, Greece,
The Netherlands and Switzerland. The Company also sells prepaid cards that can
be used only from the country in which they are sold.
In 1998, the Company introduced its Telco Prepaid-TM- service to residential
customers in the United Kingdom. Telco Prepaid allows customers to access the
Company's services from their homes on a prepaid basis utilizing "1xxx" and
toll-free access. When the customer makes a domestic or international long
distance call, the Company's switch automatically recognizes the customer's
telephone number and deducts the cost of the call from the customer's prepaid
account balance. Telco Prepaid customers are able to replenish their balances by
purchasing vouchers or by phone with a credit card. Customers also can access
their account balance by phone using voice prompts.
E-COMMERCE SERVICES. As part of its strategy, the Company seeks to
introduce services that capitalize on the growing popularity of the Internet for
everyday commercial transactions. During the fourth quarter of 1998, the Company
introduced Presto!-TM- in the United States. Presto! is the Company's first e-
commerce service and the first service offered through what the Company intends
to develop as an Internet-based portal for telecommunications services. Presto!
is a virtual prepaid account that is purchased and recharged exclusively over
the Internet at www.prestocard.com. This service enables users to make
international and domestic long distance calls at competitive rates and to view
their Presto! call records on a real-time basis. The Company believes that
Presto! is currently the only prepaid service that can be purchased and
recharged instantly over the Internet. The Company intends to offer Presto! in
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Canada and its European markets and to develop additional e-commerce services
that take advantage of the growing use of the Internet.
The Company believes that e-commerce services offer it significant
opportunities for growth. In particular, the Company believes these services
will appeal to a highly desirable segment of the population that is
technologically proficient, makes a significant number of long distance calls
and represents a broad geographic base. In addition, e-commerce services offer a
number of other advantages. Presto!, like the Company's prepaid cards, does not
require any billing support and does not expose it to any credit risk. Also,
e-commerce services have lower associated sales and marketing and customer
service costs. The Company believes that e-commerce may, over time, become an
important distribution channel for certain other services.
INTERNET SERVICES. In February 1999 the Company began offering Internet
access to retail customers in Switzerland, and it expects to offer Internet
access to retail customers in Belgium by the end of the third quarter of 1999.
The Company believes offering Internet access will increase usage of its
services, provide it with additional revenue and further enhance its ability to
attract and retain customers. The Company intends to offer Internet access
during 1999 in selected additional European countries in which the Company has
interconnection, such as the United Kingdom and Germany. The legal regime
concerning Internet access services in Europe is under development. This also is
a new service that the Company has not provided before, which may present
implementation risks.
OTHER RETAIL SERVICES. The Company also provides the other retail services
described below. These services currently represent a relatively small portion
of the Company's revenues. The Company expects most of these services to
continue as ancillary service offerings.
- DEDICATED ACCESS SERVICE. Customers using this service lease a
transmission line that connects the customer's business directly to one of
the Company's switches or POPs. This service is marketed to high-volume
customers in the United States and can be used for voice, data, video and
the Internet. The Company intends to increase its sales and marketing
efforts for this service.
- TOLL-FREE SERVICE. The Company provides domestic toll-free service (i.e.,
"800", "888" or "877" service) to customers in the United States, the
United Kingdom, Belgium, Germany and Switzerland. The Company also
provides international toll-free services ("ITFS") for its customers in
Europe.
- DIRECTORY ASSISTANCE. In the United States, the Company provides
nationwide directory assistance service for its long distance customers 24
hours a day.
- LONG DISTANCE WIRELESS SERVICE. The Company offers domestic and
international long distance services to cellular telephone users in the
New York metropolitan area. Users access this service by dialing a local
access number or, in the case of Bell Atlantic Mobile customers, by
selecting Destia as their long distance provider. The Company intends to
market domestic and international long distance services to cellular
telephone users in selected metropolitan U.S. markets.
WHOLESALE SERVICES
CARRIER SERVICES. In the United Kingdom, Belgium, France, Germany and the
United States, the Company sells wholesale transmission capacity to carrier
customers who use the transmission capacity to service their end-user customers.
Carrier customers generally are extremely price sensitive, generate very low
margins and frequently move their traffic from carrier to carrier based solely
on small price changes in termination costs to particular destinations. Larger
carrier customers sometimes change providers on a daily basis. Furthermore,
smaller carrier customers are generally perceived in the telecommunications
industry as presenting a higher risk of payment delinquency or nonpayment than
other customers. In the deregulating markets in Europe, these risks are
particularly acute.
When the Company sells transmission capacity to carrier customers where all
or a portion of the traffic is transmitted on its IRUs or fixed-cost leased
lines that have unused capacity, the Company can
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generate additional revenues without incurring significant marginal costs. When
the Company sells carrier customers transmission capacity which the Company
purchases from third-party vendors, providing these services allows it to
increase the amount of transmission capacity that the Company purchases overall.
As a result, the Company is able to obtain even greater volume discounts on its
purchases of transmission capacity from these third-party vendors and therefore
generate higher margins and/or offer better pricing on its retail services.
During 1997 and 1998, sales of transmission capacity to carrier customers
ranged from 9% to 30% of the Company's consolidated revenues on a quarterly
basis, comprising 9% of the Company's consolidated revenues for the fourth
quarter of 1998. During 1999, the Company intends to increase its carrier
revenues, although its business will continue to be predominantly focused on
retail sales. In order to increase its carrier revenues, the Company has
increased its carrier services group to 12 people, located in the United States,
the United Kingdom and Germany, who are responsible for sales to carriers in
each of the cities the Destia Network (defined below) serves. In addition to
increasing carrier revenues, the Company also seeks to diversify its carrier
customer base to include more higher margin continental European traffic. See "-
Risk Factors--Importance of Carrier and Other Wholesale Customers."
OTHER WHOLESALE SERVICES. The Company sells transmission capacity to third
parties that offer their own branded products and services such as private label
calling cards. The Company believes that many of these customers buy
transmission from it not only for its prices, but also for access to its
software platform, which, among other things, allows them to utilize the
Company's software technology to process calls made with calling cards and
prepaid cards and perform specialized billing functions. In addition, the
Company also sells transmission capacity to resellers who in turn sell the
Company's long distance services to their customers. In 1999, the Company
intends to grow the reselling portion of its business, since this channel
typically has higher margins than wholesale carrier sales. See "--Risk
Factors--Importance of Carrier and Other Wholesale Customers."
THE DESTIA NETWORK
As of December 31, 1998, the Company's communications network (the "Destia
Network") was comprised of:
- 14 carrier-grade Northern Telecom switches in operation, with seven in
North America and seven in Europe;
- nine POPs in North America and seven POPs in Europe, in addition to the
Company's switch locations;
- over 100 interconnections to LEC tandems and LEC end-offices in the United
States, which provide the Company with direct interconnections to LECs;
- 20 interconnections to PTT networks in the United Kingdom and continental
Europe;
- a U.S. fiber optic transmission network backbone that the Company
currently leases from Qwest;
- a U.S. fiber optic transmission network that will consist of IRUs covering
more than 27 million DS-0 miles of fiber optic cable connecting 43 U.S.
markets. This transmission network will be leased from Frontier on a
long-term basis and will replace the Company's existing Qwest network. In
addition, the Frontier arrangement gives the Company favorable origination
and termination rates in the continental United States;
- a transcontinental transmission network consisting of IRUs and other
ownership interests, including rights on the AC-1, PTAT, TAT 12/13 and
CANTAT-3 transatlantic cables;
- leased capacity and IRUs in Europe and leased capacity in Canada;
- 32 network-based servers located in nine cities in continental Europe, the
United Kingdom and North America controlled by a centralized enhanced
services platform; and
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- an Internet protocol network overlay that permits point-to-point
transmission using packet-switched voice and data transmission technology.
This network overlay is currently deployed between certain of the
Company's European switches and between those switches and the Company's
switch in New York.
The Company intends to continue to make significant investments in network
infrastructure, particularly investments that will provide the Company with
long-term access to high-bandwidth capacity in European markets where the
Company is seeking to expand its customer base. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
NETWORK ECONOMICS
The major components of the Company's costs include the cost of origination,
transmission and termination. To the extent the Company can manage these costs
appropriately it believes that it can significantly improve its gross margins.
ORIGINATION AND TERMINATION. In general, the Company pays a per minute fee
to originate and terminate calls. In the United States, the Company can reduce
these costs by having direct interconnection to LECs through LEC tandems and
end-offices, which allows the Company to carry a larger portion of each call on
the Destia Network. In Europe, the Company can reduce these costs through
implementing direct interconnection with the local PTTs. In addition, by having
these interconnections, the Company is able to provide network access through
abbreviated dialing and to originate calls on its network in a greater number of
cities. Direct interconnection also provides better transmission quality and
greater reliability. However, there are often delays in executing and
implementing interconnection. See "--Risk Factors--Competition" and
"--Regulation."
TRANSMISSION CAPACITY. At present, the Company's transmission capacity
consists primarily of:
- IRUs, which are long-term capital leases of fiber optic cable for periods
of up to 20 or 25 years (which is typically the entire useful life of the
transmission facility);
- leased lines, which as the term is generally used in the
telecommunications industry, represent transmission capacity leased for a
shorter duration under an operating lease. The Company's leased lines
generally are leased for 12 to 36 months; and
- switched minutes, which are purchased from carriers on a per minute basis.
Switched minutes are used principally to carry traffic to destinations not
covered by the Destia Network. These purchases are made on an as-needed
basis and do not involve significant minimum purchase requirements.
In order to effectively manage its transmission costs, the Company utilizes
a mix of IRUs, leased lines and switched minutes. The Company typically seeks to
acquire IRUs that connect network cities which have significant calling traffic
between them. However, in regions where transmission capacity costs have been
rapidly declining, such as in continental Europe, the Company has instead
utilized leased lines and intends to obtain IRUs when the Company believes
prices for IRUs have sufficiently declined. Leased lines also permit the Company
to operate on a fixed-cost basis for certain routes where it has experienced
increased traffic, but do not require a significant investment of
infrastructure, human resources or technology and have a shorter duration than
IRUs. Because the cost of IRUs and leased lines involve an initial capital
outlay or a fixed monthly payment, transmitting an increased portion of calls
over these IRUs and leased lines reduces the Company's incremental transmission
costs and thereby enables it to offer services on a competitive basis and/or
increase the Company's gross margins. Once the Company has generated enough
traffic to cover the costs of IRUs and leased lines, there is no significant
marginal cost to the Company for carrying additional calls over these IRUs and
leased lines. In order to further increase the capacity of its IRUs, the Company
utilize carrier grade compression or multiplexing equipment.
As part of its expansion strategy, and as a result of increasingly
attractive pricing, the Company intends to acquire additional IRUs, including in
continental Europe. At present, all of its existing IRUs are
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operated and maintained by third parties, while the Company has the right to run
calling traffic through the fiber. To the extent cost efficient, the Company may
acquire additional IRUs including IRUs in "dark fiber." Under certain
circumstances, acquiring these types of IRUs may be more cost advantageous than
acquiring IRUs in transmission capacity that is operated and maintained by third
parties, although it also involves certain additional risks and, in some
countries, additional regulatory compliance requirements. See "--Risk
Factors--Dependence on Transmission Line Providers."
In addition, the Company can further reduce its transmission costs for
traffic on its network by increasing the amount of traffic routed by the
Company's switches. Because its switches are programmed to route traffic over
the lowest cost network service, depending upon cost and bandwidth availability,
traffic routed by the Company's switches can be delivered on a "least cost"
basis.
OTHER. In addition to the cost of origination, transmission and
termination, the other costs of its network relate primarily to switching
equipment, compression equipment, its Internet protocol overlay and
facility/network management and related software.
NETWORK OPERATIONS
NETWORK OPERATIONS CENTER. During the fourth quarter of 1998, the Company
established a network operations center in St. Louis, Missouri, which operates
on a 24-hour-a-day, 7-day-per-week basis. From this facility, the Company
monitors its operations in the United Kingdom, continental Europe and North
America. Performing these tasks from a centralized location enables the Company
to monitor the network more effectively and on a more cost-efficient basis. In
addition, the Company also has the capability to monitor its European network
from its network operations center in London.
During 1998, the Company began rolling out its St. Louis network operations
center and developing and enhancing its network control systems. The Company
expects to invest a total of approximately $3.0 million for the build-out of the
network operations center. Among the most significant of the improvements the
Company is undertaking is the installation of digital cross-connect systems
("DACs") equipment at each of its switch locations, which will enable the
Company to monitor, test and re-configure network facilities from a central
location to maintain transmission quality on its network.
INTEGRATED INFORMATION SYSTEMS. The development and integration of the
information systems that interface with the Destia Network are performed at the
Company's College Station, Texas, and Brooklyn, New York, facilities. One of the
principal development projects during 1998 was the development of a proprietary
integrated customer service database and billing system, called Service One-TM-,
which is currently in use for all of the Company's U.S. services. Service One
will afford greater flexibility as the Company increases service offerings and
will accommodate greater customer volume. In addition, the Company is currently
implementing an interactive voice response system that will permit customers to
obtain up-to-date information concerning their account and their most recent
invoice by telephone.
During 1998, the Company spent approximately $2.3 million to enhance
current, and develop new, network information systems. The Company expects to
invest approximately $2.4 million for these purposes during 1999. While the
Company believes that its current information systems are adequate for its near
term growth, additional investment will be required as the Company expands its
operations. See "--Risk Factors--Dependence on Effective Information Systems."
SOPHISTICATED OPERATIONAL CONTROL SYSTEMS. The Company's systems
development group has internally developed sophisticated proprietary software
and intranet systems to better manage its business and appropriately price its
services in each of its markets on a real-time basis. For example, the Company
has developed an interface with its network switches that allows the Company to
compile network information on a real-time basis, including the number of
minutes being routed through the Company's switch (and corresponding revenue),
points of origination and termination, sources of traffic (by area code, city
and carrier) and other traffic information. The Company use this information
every day in connection with "least cost" routing, pricing, cost and margin
analysis, identifying market opportunities and developing of
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the Company's sales and marketing and network expansion strategies, among other
things. The Company believes that these analytical tools allow its management
team to quickly identify new market growth and cost saving opportunities as well
as control its business in an environment of rapid growth. The Company believes
that it is one of the few competitive telecommunications companies that have
these types of analytical tools and to have integrated them into the Company's
daily operations.
EUROPEAN NETWORK
The Company has seven switches and seven POPs in continental Europe and the
United Kingdom. The location of the Company's European switches and the date of
completed interconnection of each are as follows:
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COMPLETED
CITY DATE OF OPERATION INTERCONNECTION
- ----------------------------------------------------------- ------------------- ---------------
<S> <C> <C>
Brussels, Belgium.......................................... 1Q97 4Q98
Paris, France.............................................. 1Q97 2Q99E
London, United Kingdom..................................... 2Q97 2Q97
Frankfurt, Germany......................................... 3Q98 4Q98
Zurich, Switzerland........................................ 3Q98 4Q98
Amsterdam, The Netherlands................................. 4Q98 2Q99E
Berlin, Germany............................................ 4Q98 4Q98
</TABLE>
The Company also own IRUs on the PTAT-1, CANTAT-3, TAT 12/13 and AC-1
transatlantic cables. As part of its expansion strategy, the Company intends to
acquire additional IRUs, including in continental Europe. See "--Network
Economics--Transmission Capacity."
The Destia Network's European hub is located in London. A large portion of
the Company's transatlantic calls between continental Europe and the United
States are routed through London because it is the most cost-effective routing
due to the low per minute marginal costs associated with the Company's
transatlantic IRUs. The Company also routes a substantial portion of its
international intra-European calls (e.g., Berlin to Paris) through its London
hub to take advantage of favorable transmission rates to and from London. These
rates are often lower than the costs of transmitting the call by a more direct
"off-net" route where the Destia Network does not have a transmission line
between the originating and terminating switch.
As a result of deregulation and geography, Frankfurt is emerging as a
popular European hub for telecommunications carriers, especially for calls to
and from Eastern Europe. The Company believes that it is well positioned to take
advantage of these market developments due to its Frankfurt switch and intend to
market its carrier services to carriers that route calls through Frankfurt.
In addition to adding new switches in continental Europe during 1998, the
Company further enhanced the Destia Network in continental Europe by entering
into and implementing direct interconnection agreements with the PTTs in
Belgium, Germany and Switzerland. The Company also expects to implement
interconnection during the second quarter of 1999 in France and The Netherlands,
where the Company already has signed interconnection agreements with the PTTs.
These agreements add to the interconnection that the Company has had in place
with British Telecom in the United Kingdom since the second quarter of 1997. The
Company's interconnection arrangements provide it with a direct connection to
the PSTN. By having a direct connection to the PSTN, the Company is able to
offer domestic long distance service, provide network access through abbreviated
dialing and originate and terminate calls in a greater number of cities and at a
substantially reduced cost.
In addition, in 1999, the Company intends to upgrade its POPs in Hamburg,
Germany and Vienna, Austria to switches and install POPs in Dublin, Ireland and
Milan, Italy.
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NORTH AMERICAN NETWORK
The Company has seven switches and nine POPs in the United States and
Canada. The Company's North American switches, which are all interconnected, are
located in the following cities:
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CITY DATE OF OPERATION
- ---------------------------------------------------------------------------- -------------------
<S> <C>
New York.................................................................... 3Q93
Los Angeles................................................................. 1Q98
Miami....................................................................... 3Q98
Washington, D.C............................................................. 3Q98
Toronto..................................................................... 3Q98
Chicago..................................................................... 4Q98
Dallas...................................................................... 4Q98
</TABLE>
U.S. NETWORK EXPANSION. In 1998, the Company substantially expanded its
U.S. network infrastructure by adding switches in Chicago, Dallas, Los Angeles,
Miami and Washington, D.C. The Company also added a number of POPs connecting
various cities to its network. All of the foregoing reduce the Company's
transmission costs.
During 1999, the Company intends to upgrade its POP in Atlanta, Georgia to a
switch. In addition, during 1999, the Company intends to add additional
connections to LEC tandem switches and LEC end-offices.
The Company currently obtains most of its U.S. fiber optic transmission
capacity from Qwest. Because of the substantial increase in its domestic traffic
and its desire to provide services in more U.S. markets, the Company recently
acquired a 20-year IRU from Frontier use portions of its U.S. fiber optic
network. This network will consist of more than 27 million DS-0 miles of fiber
optic cable connecting 43 markets and will replace the Company's Qwest network.
In addition, the Frontier arrangement also gives the Company favorable
origination and termination rates in the continental United States. This will
provide the Company with the cost benefits of having additional network access
and drop-off points in areas where it has not invested in its own switches or
POPs. The Company believes that the extensive reach of the Destia Network in the
United States following the addition of transmission capacity from Frontier will
provide it with a significant cost advantage over many of its competitors,
although relying primarily on one network provider for U.S. transmission
capacity also results in additional risks. See "--Risk Factors--Dependence on
Transmission Line Providers."
Frontier is in the process of building the fiber optic network that the
Company will use, and the Company expects this network to be completed and
substantially operational by the end of 1999. The Company expects to begin using
a portion of Frontier's network by July 1999.
GATEWAY SWITCH UPGRADES. Gateway switches permit the Company to convert
international protocols to U.S-based protocols. This ability to convert
protocols enables the Company to terminate inbound international traffic in the
United States for overseas carriers and to carry outbound international traffic
closer to its destination and at a lower cost before handing it off to another
carrier (such as the PTT) in the terminating country. At present, the Company's
only gateway switch is in New York, although the Company's London switch also
has international conversion capabilities. During 1999 and early 2000, the
Company intends to upgrade its switches in London, Miami and Los Angeles to have
international gateway capabilities, allowing them to also interface directly
with protocols used by non-U.S. carriers. The Miami gateway switch will
interface primarily with carriers from Latin America and the Caribbean and the
Los Angeles gateway switch will interface primarily with carriers from Asia.
CANADIAN EXPANSION. During the third quarter of 1998, the Company expanded
the Destia Network to Canada by installing a switch in Toronto. The Company
plans to install a POP in Montreal by the third
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quarter of 1999. This switch and POP will enable the Company to originate calls
in two of the largest long distance markets in Canada.
NETWORK ACCESS AND CALL ROUTING
NETWORK ACCESS. The Destia Network can be accessed through a variety of
methods, depending upon the service and the location from which the customer is
calling. These methods are as follows:
- "1+" ACCESS. "1+" access, also known as preselection or equal access,
enables a long distance customer to access the Destia Network from the
customer's premises by dialing "1" and then the number that the customer
is calling. "1+" access is currently available to the Company's customers
in the United States, Canada, Germany and Switzerland where the Destia
Network has a switch or POP. Using this access method, a customer does not
need to dial a special prefix access code because the customer has
preselected Destia as its long distance carrier and the LEC's or PTTs'
switching system already is programmed to direct long distance calls from
the customer's telephone to the nearest Destia Network switch.
- "1XXX" ACCESS. "1xxx" access, or prefix dialing, enables a long distance
customer in the Company's European countries (as well as the United
States) to access the Destia Network from the customer's premises by
dialing "1" and a code number and then the number the customer is calling.
- LOCAL DIAL-UP ACCESS. In continental European cities where the Company has
installed a switch or POP, customers can access the Company's
international and domestic long distance service and, in some cases,
prepaid card service, by dialing a local telephone number. Local dial-up
access reduces the Company's transmission costs for these calls because it
shifts the cost of accessing its switch to the customer. The reduction in
transmission costs enables the Company to increase its margins and/ or
reduce its retail prices on these calls, as well as to provide
competitively priced intra-European long distance service.
- INTERNATIONAL TOLL-FREE ACCESS. This access method allows customers to
access the Company's card-based services in selected continental European
markets by dialing an international toll-free number. This access method
is predominantly used by business travelers.
- NATIONAL TOLL-FREE ACCESS. Customers who access the Company's services in
this manner do so by dialing a national toll-free number. This access
method is available to customers who use the Company's calling card and
prepaid card services in the United States, the United Kingdom and
Germany.
- DEDICATED ACCESS. Carrier customers and high volume end-users can be
connected to the Company's switch by a dedicated leased line. The
advantages to the customer of dedicated access are simplified dialing,
faster call setup times and lower access costs if a sufficient volume of
calls is transmitted over the leased line. This service can be used for
voice, data, video and the Internet over a single leased line.
CALL ROUTING. Calls are routed to their destination through one or more of
the Company's switches. If the call originates in a network city with a switch,
the caller generally will dial into the network over local lines. These calls
will then be routed by the local service provider (a LEC in the U.S. and
typically a PTT in Europe) to the Company's switch. A call originating in a city
with a POP, which acts solely as a collection point for calls, generally will be
originated using one of the foregoing access methods and will be sent to the
POP. The call will then be transmitted from the POP to one of the Company's
switches on an owned or leased line comprising part of the Destia Network. If
the call originates in a city where the Company does not have a switch or POP,
the caller generally dials into the network using national or international
toll-free access, which is substantially less cost-efficient for the Company
than "1xxx," "1+" or local dial-up access. From the its switch, "least cost"
routing techniques are used to determine whether the call should be transferred
directly to the PSTN or routed to another one of its switches over an owned or
leased line and
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then transferred to the PSTN for termination. See "--Network Hardware and
Software--Least Cost Routing."
NETWORK HARDWARE AND SOFTWARE
CARRIER GRADE SWITCHES AND TECHNOLOGY. The Company use Northern Telecom
carrier grade switches throughout the Destia Network. The principal benefits of
carrier grade switches are their ability to (1) handle large, simultaneous call
volumes, (2) provide better quality service to customers, and (3) seamlessly
interconnect with local operators. Each of these benefits is discussed below:
- CALL CAPACITY. Carrier grade switches generally have more port capacity
than smaller switches, which enables them to route a greater number of
simultaneous calls.
- BETTER QUALITY SERVICE. Carrier grade switches provide higher transmission
quality, faster call setup times and better call completion rates than
smaller, less powerful switches. The Company's carrier grade switches also
have call completion capabilities that reduce the time needed to connect
calls and allow for more efficient use of transmission capacity.
- DIRECT INTERCONNECTION WITH PTT AND LEC NETWORKS. Carrier grade switches
enable the Company's network to interconnect directly with the networks of
PTTs and LECs, subject to applicable regulatory requirements and an
interconnection arrangement being in place. The benefits of direct
interconnection generally include better quality service, lower costs,
improved reliability and the ability to rapidly increase call-handling
capacity.
The Company believes that by utilizing the equipment of a single principal
supplier the Company is able to minimize the difficulties associated with
integrating equipment from various sources and with differing specifications. In
addition, it also enables the Company to develop a single proprietary software
to compile its network information since the Company does not need to
accommodate switches of different manufacturers. However, using equipment
principally from one supplier does entail certain risks. See "-Risk
Factors-Dependence on Its Principal Equipment Supplier."
SS7 TECHNOLOGY. Signaling System 7 technology (also known as "SS7"), which
is used primarily in the United States, performs two significant functions
within the Destia Network. SS7 facilitates faster call setup by sending messages
that precede the call and obtain information about its destination, such as
whether the destination number is available or engaged in a call. Second, SS7 is
able to look up destination numbers, such as toll-free "800" numbers, in a
central database. This allows the Destia Network to use intelligent call
routing.
The Company is currently migrating from SS7 services provided by third
parties on a per switch basis to using the Company's own SS7 equipment
throughout its U.S. network. The Company will then use one centralized provider
to enable it to make SS7 connections with LEC offices nationwide. This will
provide the Company with greater flexibility and will enable it to control
equipment usage, maintain network integrity and reduce costs.
The Company's SS7 technology will be supported from the St. Louis network
operations center. This will provide real time information on network usage and
integrity while allowing for instantaneous call tracing, monitoring, and fraud
detection.
LEAST COST ROUTING. Through a combination of hardware and software, the
Company's network enables it to perform "least cost" routing analysis, which
enables it to transmit a call over the most cost-efficient route during that
time of day. Prices for various destinations fluctuate on a daily basis. The
Company's least cost routing software enables it to continually revise its
routing tables, including accounting for fluctuations in currency exchange
rates, as the cost of certain routes change. The Company has a dedicated group
that is responsible for monitoring the routing of calls and seeking to minimize
its transmission costs.
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DIGITAL CROSS-CONNECT CAPABILITY. The Company is in the process of
installing DACs hardware and software at each of the Company's switches and
major POPs. DACs will enable the Company to monitor, test and re-configure
network facilities from a central location to maintain transmission quality on
the Destia Network.
INTERNET PROTOCOL OVERLAY. Currently, voice calls are carried by keeping a
circuit open between two (or more) parties. This is inefficient because it uses
transmission capacity even when the parties are silent. The Company's carrier
grade switches are capable of interfacing with TCP/IP, an Internet protocol
software, and the related hardware. TCP/IP technology would enable the Company
to provide simultaneous voice and data transmission over a single line, since
the technology compartmentalizes voice, data and/or video into digital pieces of
information (i.e., into "packets") before they are transmitted. The packets can
be sent separately over one or more lines and are then reassembled at the
destination switch prior to being converted into their original format. This is
a much more efficient use of transmission capacity than keeping a circuit open.
Packet-based transmission would enable the Company to transmit data and video
using less transmission capacity, thus increasing the amount of information the
Company can transmit over a given line and its network overall.
The Company has installed TCP/IP hardware and software manufactured by third
parties on selected transatlantic and European routes, which enable it to carry
traffic using Internet protocol technology over a portion of the Destia Network.
The Company is currently exploring various potential service applications. For
example, packet-based transmission would allow the Company to offer integrated
voice, fax and video services as well as Internet access over an ordinary
telephone line. However, the Company has very limited experience with IP
technology and many of its competitors are making substantial IP investments.
There can be no assurance that the Company will be successful with IP
technology.
OPERATING AGREEMENTS; TRANSIT AGREEMENTS
Through its affiliates, the Company has entered into operating, termination
and/or transit agreements with a number of overseas PTTs and competitive
carriers, including carriers in Greece, Israel, the Ukraine, Denmark, Sweden,
Italy, Slovenia and Ireland. As part of its strategy, and as market and
regulatory conditions warrant, the Company intends to enter into more of these
agreements with additional overseas carriers.
Operating and termination agreements provide the Company with more favorable
termination rates in the home country of the other carrier who is a party to the
agreement. The Company can directly interconnect with the local carrier who then
locally terminates all calls. These agreements also afford the Company more
control over the quality of the terminating segment of the Company's
international calls. In addition, operating agreements also increase the
Company's overall gross margins because its correspondent carriers are required
to send the Company a specified portion of their traffic that is bound for
markets covered by the Destia Network. The Company can charge "settlement rates"
for this traffic that substantially exceed its termination costs. Alternatively,
the additional gross margins on this return traffic enable the Company to price
its calls to a given country more competitively while still maintaining an
acceptable average gross margin on all calls both to and from that country.
Similarly, transit agreements are advantageous to the Company because they
provide it with more favorable transit rates to third countries. Such agreements
and switched hubbing arrangements may allow the Company to pay less than the
full settlement rate that the Company would otherwise have to pay if the Company
had a direct operating agreement with the terminating PTT. See "--Regulation"
for additional information concerning these types of agreements.
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SALES AND MARKETING
The Company reaches a broad range of customer groups through a variety of
marketing channels, including a direct sales force, independent sales agents,
multilevel marketing, customer incentive programs, advertising and the Internet.
As part of the Company's multichannel marketing approach, the Company tailors
its marketing to its specific geographic markets and services. The Company
believes this is an especially cost-effective means of marketing to its target
customers. In addition, the Company expects that its multichannel marketing
approach will facilitate its continued rapid growth while reducing the risks
associated with dependence on a limited number of distribution channels.
The Company markets its services at the local level through both independent
sales agents and an internal sales force, depending upon the particular
geographic market, customer group and service. The Company's independent sales
representatives, who generally are retained on a commission-only basis,
concentrate primarily on residential sales and sales to commercial accounts. The
Company's internal sales force concentrates primarily on sales to commercial
accounts, wholesale customers and other carriers. This internal sales force
includes a recently expanded carrier services group of 12 people located in the
United States, the United Kingdom and Germany who are responsible for sales to
carriers in each of the Destia Network cities. The Company's local internal
sales forces also typically advertise locally and provide support for its
independent sales representatives.
The Company recently changed its name to "Destia Communications, Inc." and
also developed a new company logo. The Company believes that its new name and
logo better emphasize its focus on providing innovative services. The Company
also believes that by establishing a widely recognized brand, the Company can
increase brand awareness among its target customers and facilitate
cross-marketing of additional services to its existing customers. After
completing the transition to the Destia name, which will occur after the
Company's contemplated initial public offering (the "Offering"), nearly all of
the Company's primary services will be either branded or co-branded with the
Destia name and logo. For information about the Offering, see "Item 7.
Management's Discussion and Analysis of Financial Conditions and Result of
Operations--Liquidity and Capital Resources."
CONTINENTAL EUROPE
The Company's sales and marketing strategy in most of its continental
European markets has been initially to concentrate on sales of prepaid services
through independent distribution channels since prepaid services operations
present a limited credit risk and independent distribution does not require
substantial initial investments. After gaining market acceptance and
establishing the Company's local sales and marketing infrastructure, the Company
typically has then introduced calling card services and, once a POP or switch is
installed, international long distance services. Concurrently, the Company also
has aggressively pursued interconnection arrangements with the local PTTs, which
allow the Company to provide national origination on a cost-effective basis.
Following interconnection, the Company further increases its sales and marketing
activities in a market in order to promote its services. As part of its initial
entry into a new market, the Company also typically has concentrated on sales in
ethnic communities since these market segments can be effectively targeted with
limited resources, enabling the Company to rapidly generate revenues, create
brand awareness and promote customer loyalty.
While its general sales and marketing strategy in continental Europe remains
consistent, the Company also tailors it to meet the needs of each particular
market. For example, in Belgium, the Company has generated significant revenues
by placing its prepaid cards (together with point of purchase displays) in many
highly visible locations such as bookstores, newsstands, kiosks and convenience
stores. In France, the Company concentrates on commercial accounts and employs
an internal sales force for this purpose. In Germany, the Company has an
internal sales force in Hamburg that primarily markets prepaid cards and
commercial long distance services. The Company also plans to market its "1+"
long distance services in Germany during the first quarter of 1999 through a
multilevel marketing program that is similar to the
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Company's U.K. program. In Switzerland, the Company markets its services through
indirect channels, supported by direct advertising in national media. The
Company also cross-markets its services in Switzerland. For example, the Company
began providing Internet services in Switzerland in February 1999 and introduced
a promotional program that offers one year of free Internet access to customers
who purchase its long distance services.
The Company also adapts successful marketing approaches from certain
countries to other continental European markets. For example, the Company
intends to advertise in national magazines and newspapers in Germany, which has
been effective in Switzerland. In addition, the Company intends to replicate the
success of its multilevel marketing program in the United Kingdom in its other
European markets.
The Company has an internal sales force based in each city in which the
Company has a switch except Amsterdam. In each of these cities, the Company is
expanding its internal sales forces and recruiting additional independent sales
representatives.
UNITED KINGDOM
In the United Kingdom, the Company markets its services nationally. The
Company offers substantially all of its U.K. services through Telco, its wholly
owned U.K. subsidiary.
The Company's residential domestic and international long distance service
and calling and prepaid cards are marketed primarily by independent sales
representatives through multilevel marketing. The Company believes that
multilevel marketing is the most cost-effective way to continue to increase its
U.K. residential and card-based customer revenues since it encourages
independent sales representatives to both sell services and recruit additional
independent sales representatives. Sales representatives are motivated to both
sell and recruit because they receive a commission based on their own sales and
sales of representatives recruited by them. A substantial number of these sales
representatives operate on a part-time basis, using the commissions from sales
of services as a secondary source of income. During December 1998, the Company
had approximately 4,000 independent sales representatives that received
commissions. In addition, the Company is one of only 150 companies, and the
first telecommunications company, to be accepted for membership in the Direct
Sellers Association, a nationally recognized U.K. industry trade group for
multilevel marketing.
The Company markets domestic and international long distance services to
U.K. commercial accounts and carrier services to carrier customers through a
direct sales force. The Company has adopted this approach for these services
since they are more complex and usually require a longer sales cycle.
The Company recently increased its U.K. prepaid card distribution
capabilities through its acquisition of a controlling interest in America First,
a well-recognized prepaid card distributor, during the fourth quarter of 1998.
The Company intends to migrate its U.K. prepaid card distribution to America
First because the Company believes that America First is well positioned as an
experienced and recognized distributor of prepaid phone cards in the London
area.
NORTH AMERICA
UNITED STATES. Prior to 1998, the Company marketed its services primarily
in the New York metropolitan area. During 1998, the Company significantly
expanded its marketing efforts beyond the New York metropolitan area to include
other U.S. network cities. The Company now has independent sales representatives
in all of its network cities and has internal sales representatives in New York,
Los Angeles, Miami and Washington, D.C.
The Company's international and domestic residential long distance services,
which are marketed primarily to ethnic communities, are sold primarily through
independent sales representatives. The Company targets ethnic communities for
these services because the Company believes that members of
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these communities generate above average international calling volumes, are not
as heavily targeted by other long distance providers as the general population
and enable the Company to build brand recognition in a well-defined community.
The Company intends to expand the use of independent sales representatives to
market its residential services in the United States beyond the ethnic market.
The Company's international and domestic long distance services for
commercial accounts are sold primarily through its internal sales force, which
targets accounts with significant calling volumes to European destinations. Many
business customers also require unified or other specialized billing formats.
Members of the Company's sales force work with customers to address their
billing needs such as providing monthly bills with breakdowns of usage by
account code, area code or department.
The Company's calling card services are marketed and co-branded under both
the VoiceNet and EconoCard-TM- brand names. VoiceNet calling cards are marketed
primarily through in-flight magazines, national magazines and newspapers and
through advertising materials placed in high traffic locations, such as
restaurants. The Company also markets VoiceNet calling cards through independent
sales representatives. EconoCard calling cards are marketed to ethnic groups in
conjunction with the Company's residential services.
Prepaid cards are sold under a variety of brand names in major metropolitan
areas and are primarily sold through wholesale distributors and other
independent sales representatives. These distinctively branded prepaid cards can
be accessed by dialing a local access number in the area in which the card was
purchased, which reduces the Company's costs and permits the Company to offer
lower rates than most of its competitors. This is important because prepaid card
customers are particularly price sensitive and frequently purchase prepaid cards
based on small differences in price for calls to specific destinations.
The Company currently is in the process of implementing a cross-marketing
program to VoiceNet customers to offer them the Company's "1+" long distance
service in the United States. The Company also has expanded its marketing of new
services to existing residential long distance customers by describing these
services regularly in the "DestiAdvisor" monthly insert included with each
customer bill. In addition, the Company has entered into affinity programs with
major credit card companies, such as First USA and GE Capital, to promote its
VoiceNet calling cards. These affinity programs include mass mailings in
customers' monthly billing statements that contain a preapproved VoiceNet
calling card which, when used by the customer, is automatically billed to the
customer's credit card account.
The Company uses an internal sales force to market to carrier customers and
other wholesale customers that purchase privately branded calling cards and
prepaid cards. The Company has adopted this sales approach for these services
since they are more complex and usually require a longer sales cycle.
CANADA. In Canada, the Company currently markets its services in Toronto
and Montreal primarily to ethnic communities that generate substantial
international calling volume. Marketing is being done primarily through
independent sales representatives and its internal sales representatives in
Canada. As the Company expands its customer base in Toronto and Montreal, the
Company intends to broaden its target customer groups, introduce additional
services and increase its internal sales and marketing capabilities.
CUSTOMER SERVICE
The Company is committed to providing its customers with superior customer
service and believes that the Company has developed the infrastructure necessary
to serve both its existing customer base and accommodate substantial growth with
minimal additional investment. The Company has a 24-hour-a-day customer service
department located in College Station, Texas, which, at December 31, 1998, had
157 full-time equivalent customer service representatives. In the United
Kingdom, the Company also maintains a 24-hour a day customer service department
that, at December 31, 1998, had 65 full-time equivalent customer service
representatives located at the Telco Global Communications ("Telco") facility in
London,
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England. In continental Europe, each country in the Destia Network has a
customer call center, which in the aggregate totaled 20 full-time equivalent
customer service representatives at December 31, 1998. At all of its customer
service facilities, the Company's customer service representatives handle both
service and billing inquiries. In addition, the Company's call centers all have
representatives that are multilingual.
The Company also has developed its own proprietary software systems to
better serve its customers. For example, in each of its network countries, the
Company's monthly bills are in the customer's native language and local currency
(and the Company has the ability to bill in euros). The Company also provides
detailed billing information for commercial customers that includes itemized
breakdowns of usage by account code and department. In addition, the Company is
currently implementing an interactive voice response system that will permit
customers to obtain up-to-date information concerning their account and their
most recent invoice. The Company believes that its customer-oriented philosophy
backed by the strength of its customer support infrastructure allows it to
differentiate itself from its competitors.
COMPANY OPERATIONS
Currently, the Company's extensive international telecommunications network
allows it to provide services in many of the largest metropolitan markets in the
United States, Canada, the United Kingdom, Belgium, France, Germany and
Switzerland. The Company's operations in each of its principal markets are
briefly described below.
CONTINENTAL EUROPE
A significant component of the Company's growth strategy is focused on the
continued development of its business in the deregulating telecommunications
markets of continental Europe. Prior to January 1, 1998, there were significant
regulatory limitations on the Company's ability to provide services in most
continental European countries. Now, as a result of EU and national regulatory
initiatives, the Company may provide a range of services in many of these
countries that is comparable to the services the Company provide in the United
States and the United Kingdom. In some cases, however, national regulatory
restrictions and technology issues (such as credit card verification for
e-commerce purchases) may limit its ability to do so. Subject only to these
limitations, in continental Europe the Company intends to offer the same range
of services that it offers in the United States and the United Kingdom.
BELGIUM. Belgium was the Company's third largest market based on revenues
for 1998. Sales of prepaid cards comprised the largest portion of the Company's
Belgian revenues, followed by revenues derived from international long distance
from commercial and residential customers.
Prior to January 1, 1998, due to regulatory limitations, the Company only
was able to provide a limited number of services in Belgium that included
international service utilizing international toll-free access and local access
for card-based services, but did not include domestic long distance service.
Since regulatory liberalization occurred on January 1, 1998, the Company has
expanded its services to include both domestic and international long distance
service. In addition, during the fourth quarter of 1998, the Company completed
its interconnection with Belgacom, the Belgian PTT. This interconnection
provides the Company with a total of 10 connection points with Belgacom,
including the Company's switch in Brussels, and permits the Company to provide
its services to customers anywhere in Belgium. This interconnection also permits
the Company to provide network access to its customers through abbreviated
dialing and enables it to originate and terminate calls in Belgium on a more
cost effective basis.
FRANCE. The Company has offered long distance service to customers in Paris
since the first quarter of 1997, in Marseilles and Nice since the fourth quarter
of 1997 and in Lyon and Toulouse since the fourth quarter of 1998. The Company's
revenues in France are currently predominantly generated by international long
distance services. Sales of prepaid cards comprise virtually all of the other
revenues. Most of the Company's customers have CLI (calling line identity),
which allows the Company's switches to recognize the number that the customer is
calling from, so that the customer can access its network without
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the need for a personal identification number. In addition, the Company provides
automatic dialers free of charge to its commercial accounts. Automatic dialers
eliminate the need for a customer to dial a prefix to use its services.
The Company's network includes a switch in Paris and POPs in Marseilles,
Toulouse, Nice and Lyon. During the fourth quarter of 1998, the Company entered
into an interconnection agreement with France Telecom that will enable the
Company's customers to access its long distance service from their home or
office through abbreviated dialing, although certain carriers (including France
Telecom) are able to provide direct, "1xxx" access. The Company anticipates that
its interconnection with France Telecom will be fully operational during the
second quarter of 1999 since France Telecom has indicated that the Company will
be able to complete its interconnection by the second quarter of 1999. However,
there are often delays in executing and implementing interconnection. See
"--Risk Factors--Need for Interconnection" and "--Regulation."
GERMANY. Germany is the largest market for telecommunications services in
continental Europe. The Company's principal service in Germany is its prepaid
card service, which the Company offers predominantly to commercial accounts. The
Company currently provides international long distance service, which the
Company markets primarily to commercial customers. The Company has offered this
service in Hamburg since the first quarter of 1997, in Berlin since the fourth
quarter of 1997 and in Frankfurt since the third quarter of 1998. The Company
began marketing domestic long distance services in the first quarter of 1999
because the Company completed interconnection in the fourth quarter 1998. The
Company also plans to begin marketing long distance services to residential
accounts in 1999. The Company intends to introduce its Presto! card in Germany
during the second quarter of 1999. In addition, in 1999, the Company intends to
roll out its successful U.K. multilevel marketing program in Germany and to
establish an internal sales force in Frankfurt. See " --Sales and
Marketing--United Kingdom."
As of December 31, 1998, the Company had switches in Berlin and Frankfurt
and a POP in Hamburg. The Company expects to upgrade its Hamburg POP to a switch
during the first quarter of 1999. The Company believes that its Frankfurt switch
will allow it to take advantage of the growing popularity of Frankfurt as a
European hub for telecommunication carriers, especially for calls to and from
Eastern Europe, and the Company intends to market its carrier services to
carriers that route calls through Frankfurt.
During the fourth quarter of 1998, the Company implemented its
interconnection with Deutsche Telekom, which enables the Company to offer
customers in its German network cities and the surrounding metropolitan areas,
both domestic and international long distance service through "1+" access. The
Company plans to add additional interconnection points in Germany in 1999 to
meet additional traffic or regulatory requirements, which will enable the
Company to originate and terminate traffic in most of the major cities in
Germany.
SWITZERLAND. Switzerland has been substantially deregulated. The Company's
principal service in Switzerland is international long distance. Customers may
preselect the Company as their long distance carrier and make long distance
calls on its network using "1+" dialing. During 1998, the majority of its
customers were commercial accounts. In February 1999, the Company began
providing Internet services in Switzerland and introduced a promotional program
that offers one year of free Internet access to customers who purchase its long
distance services.
The Company established a POP in Zurich during the third quarter of 1997 and
upgraded it to a switch in the third quarter of 1998. In addition, during
October 1998, the Company was the one of the first telecommunications carriers
to be interconnected to SwissCom, the PTT in Switzerland. This interconnection
enables the Company to originate and terminate traffic in Switzerland more cost
effectively, which provides it with a competitive advantage over those of its
competitors who do not currently have interconnection. Since the Company
completed its interconnection in October 1998, its number of customers has more
than doubled and as of December 31, 1998 the Company had approximately 7,000
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customer accounts in Switzerland. During the same period, the Company's Swiss
revenues also more than doubled. The Company intends to expand its customer base
significantly in Switzerland during 1999. The Company anticipates, however, that
additional competitive carriers will obtain interconnection rights from
SwissCom, which will lead to increased competition.
UNITED KINGDOM
Since 1991, the U.K. government has sought to encourage increased
competition in telecommunications services. As a result of regulatory
initiatives, the telecommunications market in the United Kingdom now resembles
the United States in terms of services and pricing.
International and domestic long distance services generated the largest
percentage of the Company's U.K. revenues during 1998. The Company has provided
these services in the London area since the fourth quarter of 1996 and
nationwide in the United Kingdom since the second quarter of 1997. The Company's
other principal services in the United Kingdom are prepaid cards and sales to
resellers and carrier customers. The Company also intends to launch the Presto!
card in the United Kingdom during the second quarter of 1999.
The Company offers all its residential, calling card and prepaid services in
the United Kingdom primarily through Telco. The Company believes that Telco has
been particularly successful marketing the Company's services in the United
Kingdom through its multilevel marketing program. The Company's prepaid card
services, which are currently offered by Telco, are being migrated to America
First, a prepaid card distributor that the Company acquired a majority interest
in during the fourth quarter of 1998. See "--Sales and Marketing--United
Kingdom."
The Company currently has five interconnection points in London that enable
the Company to provide its services throughout the United Kingdom. However, the
Company's U.K. customers currently are unable to preselect any carrier except
British Telecom as their long distance carrier and thus cannot access the
Company's services without first dialing a four-digit access code. Under EU
regulations, preselection is scheduled to become available by January 1, 2000,
although the U.K. regulator is seeking a waiver of this requirement until a
later date. In order to migrate more traffic on to its network, the Company is
marketing automatic dialers to its residential and commercial customers in order
to compete more effectively against British Telecom, which provides long
distance service without requiring the user to dial an access code. Customers
purchase or lease the dialer, which automatically dials the Company's network
access code for the customer.
The Company's European network (including the United Kingdom) is monitored
by ATL, one of its wholly owned subsidiaries, in London and the Company's
network operations center in St. Louis, Missouri.
NORTH AMERICA
UNITED STATES. The United States is one of the Company's original markets.
The Company has been providing international and domestic long distance service
in the New York metropolitan area since 1993. The Company now also provides its
calling card, prepaid card, wireless access to long distance and directory
assistance services nationally and provides its other services (primarily
residential and commercial long distance) in the 15 U.S. cities in which the
Destia Network has a switch or POP. Because of the U.S. market's size and
receptiveness to new services, the Company typically introduces new services in
the United States before its other markets. For example, during the last quarter
of 1998, the Company first introduced the Company's Presto! card in the United
States over the Internet. The Company also intends to test (and cross market)
additional e-commerce services to Presto! customers due to their predisposition
to making purchases on-line.
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As of December 31, 1998, the Company had six switches and nine POPs in the
United States, which enable the Company to originate domestic and international
long distance calls in many of the largest U.S. metropolitan areas. Because of
the substantial increase in its domestic traffic and its desire to provide
services in more U.S. markets, the Company recently acquired a 20-year IRU from
Frontier to use portions of its U.S. fiber optic network. This will replace the
Company's use of the Qwest network. Frontier is in the process of building its
fiber optic network that the Company will use, and the Company expects this
network to be completed and substantially operational by the end of 1999. The
Company expects to begin using a portion of Frontier's network by July 1999,
although there can be no assurance in this regard. In addition, the Frontier
arrangement will give the Company favorable origination and termination rates
throughout the continental United States. See "--The Destia Network--North
American Network--U.S. Network Expansion."
CANADA. The Company expanded its network into Canada during the third
quarter of 1998 by installing a switch in Toronto. The Company also plans to
install a POP in Montreal by July 1999. This switch and POP will enable the
Company to originate and terminate calls in Toronto and Montreal, two of the
largest long distance markets in Canada. The Company began providing services in
Canada late in the fourth quarter of 1998 and intends to further expand the
Company's internal sales force in Canada in 1999.
COMPETITION
The international telecommunications industry is highly competitive and
significantly affected by regulatory changes, marketing and pricing decisions of
the larger industry participants and the introduction of new services and
transmission methods made possible by technological advances. The Company
believes that long distance service providers compete principally on the basis
of price, customer service, product quality and breadth of services offered. In
each country of operation, the Company has numerous competitors. The Company
believes that as the international telecommunications markets continue to
deregulate, competition in these markets will increase, similar to the
competitive environment that has developed in the United States following the
AT&T divestiture in 1984. Prices for long distance calls in the markets in which
the Company competes have declined historically and are likely to continue to
decrease. Many of the Company's competitors are significantly larger, have
substantially greater financial, technical and marketing resources and larger
networks than the Company does.
Privatization and deregulation have had, and are expected to continue to
have, significant effects on competition in the industry. For example, as a
result of legislation enacted in the United States, Regional Bell Operating
Companies ("RBOCs") will be allowed to enter the long distance market, AT&T, MCI
WorldCom and other long distance carriers will be allowed to enter the local
telephone service markets, and cable television companies and utilities will be
allowed to enter both the local and long distance telecommunications markets. In
addition, competition has begun to increase in the EU telecommunications markets
in connection with the deregulation of the telecommunications industry in most
EU countries, which began in January 1998. This increase in competition is
likely to affect revenue per minute and gross margin as a percentage of revenue.
NORTH AMERICA
UNITED STATES. In the United States, which is among the most competitive
and deregulated long distance markets in the world, competition is based
primarily upon pricing, customer service, network quality, and the ability to
provide value added services. As such, the long distance industry is
characterized by a high level of customer attrition or "churn," with customers
frequently changing long distance providers in response to the offering of lower
rates or promotional incentives by competitors. The Company competes with major
carriers such as AT&T, MCI WorldCom and Sprint, as well as other national and
regional long distance carriers and resellers, many of whom are able to provide
services at costs that are lower than the Company's current costs. Many of these
competitors have greater financial,
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technological and marketing resources than the Company does. If any of the
Company's competitors were to devote additional resources to the provision of
international and/or domestic long distance telecommunications services to the
Company's target customer base, there could be a material adverse effect on the
Company's business.
As a result of the 1996 Telecommunications Act, the RBOCs are also expected
to become competitors in the long distance telecommunications industry, both
outside of their service territory and, upon satisfaction of certain conditions,
within their service territory. The Telecommunications Act prospectively
eliminated the restrictions on incumbent LECs, such as the RBOCs, from providing
long distance service. These provisions permit an RBOC to enter an
"out-of-region" long distance market immediately upon the receipt of any state
and/or federal regulatory approvals otherwise applicable in the provision of
long distance service. RBOCs must satisfy certain procedural and substantive
requirements, including obtaining FCC approval upon a showing that, in certain
instances, facilities-based competition is present in its market, that it has
entered into interconnection agreements that satisfy a 14-point checklist of
competitive requirements and that its entry into the in-region long distance
market is in the public interest before they are authorized to offer long
distance service in their regions. No RBOC is authorized to do so yet, but they
are expected to be authorized soon. When they are authorized, they will be very
formidable competitors. In particular, Bell Atlantic, which serves the New York
metropolitan and mid-Atlantic regions, is considered by industry observers to be
the most likely RBOC to be the first to be permitted to offer long distance
services. Because a substantial portion of the Company's customer base and
traffic originates in the New York metropolitan area, Bell Atlantic will be a
particularly formidable competitor. For long distance calls, Bell Atlantic will
have a substantial cost advantage, because it will not have to pay access fees
to a local carrier to originate the call. Access fees constitute a large portion
of a long distance carrier's cost of services, including the Company's.
The continuing trend toward business combinations and alliances in the
telecommunications is also creating significant new or more powerful competitors
to the Company. The proposed acquisitions of Frontier (the primary provider of
the Company's U.S. transmission capacity beginning at the end of 1999) by Global
Crossing and of GTE by Bell Atlantic, the merger of WorldCom and MCI, AT&T's
acquisition of Telecommunications, Inc. and AT&T's acquisition of Teleport
Communications Group, Teleglobe's acquisition of Excel Communications and SBC's
acquisition of SNET are examples of some of the business combinations that are
being formed. These combined entities may, now or in the future, be able to
provide bundled packages of telecommunications products, including local and
long distance services and data services and prepaid services, in direct
competition with the products offered or to be offered by us, and may be capable
of offering these products sooner and at more competitive rates than us.
For example, AT&T's recently announced agreement to acquire Smartalk, which
sells prepaid cards would, if consummated, provide AT&T with access to a major
distribution network for inexpensive prepaid cards, a market where AT&T has not
historically competed on the basis of price. AT&T's significant marketing
resources and extensive network would make it a formidable competitor in the
prepaid card market.
The World Trade Organization (the "WTO") recently concluded an agreement,
known as the WTO Basic Telecommunications Service Agreement (the "WTO
Agreement"), that could also result in additional competitors entering the U.S.
telecommunications markets. Under the WTO Agreement, the U.S. and other members
of the WTO committed themselves to, among other things, opening their
telecommunications markets to foreign carriers. The FCC has adopted streamlined
procedures for processing market entry applications from foreign carriers,
making it easier for such carriers to compete in the U.S. There can be no
assurance that the WTO Agreement will not have a material impact on the
Company's business.
The Company also expects increasing competition from Internet telephony
service providers, including Internet service providers. The use of the Internet
to provide telephone service is a recent development. To date, the FCC has
determined not to subject such services to the same FCC regulation as
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telecommunications services. Accordingly, Internet service providers are, today,
not subject to universal service contributions, access charge requirements, or
traditional common carrier regulation. The Company cannot predict the impact
that this continuing lack of regulation will have on the Company's business.
CANADA. The Canadian telecommunications market is highly competitive and is
dominated by a few established carriers whose marketing and pricing decisions
have a significant impact on the other industry participants, including the
Company. The Company competes with facilities-based carriers, other resellers
and rebillers, primarily on the basis of price. The principal facilities-based
competitors include the former Stentor partner companies, in particular, Bell
Canada, the dominant supplier of local and long distance services in the
provinces of Ontario and Quebec, BC Tel and Telus Communications, as well as the
next largest Stentor companies which have announced a proposed merger, as well
as non-Stentor companies, such as AT&T Canada, Teleglobe Canada, and Sprint
Canada. The Company also competes with ACC TelEnterprises which, until its
recent merger with AT&T Canada, was one of the largest resellers in Canada. The
former Stentor partner companies discontinued their partnership on January 1,
1999 and are now competing against one another for the first time.
EUROPE
In continental Europe, the Company's competitors include:
- PTTs;
- alliances such as Sprint's alliance with Deutsche Telekom and France
Telecom, known as "Global One", and AT&T's alliance with both British
Telecom and Japan Telecom (that has recently announced a plan to
contribute their international facilities and personnel to a newly formed
company that is likely to be a substantially more formidable competitor);
- companies offering resold international telecommunications services; and
- other companies with business plans similar in varying degrees to the
Company, including emerging public telephone operators who are
constructing their own networks and wireless network operators.
The Company believes that its continental European markets will continue to
experience increased competition and will begin to resemble the competitive
landscape in the United States and the United Kingdom. In addition, the Company
anticipates that numerous new competitors will enter the continental European
telecommunications market.
Competition is strong in the liberalized U.K. telecommunications market. In
the United Kingdom the Company's principal competitors are British Telecom, the
U.K. PTT, First Telecom and Cable & Wireless. The Company also face competition
from emerging licensed public telephone operators (who are constructing their
own facilities-based networks) and from resellers. The Company also competes
with wireless service providers and cable companies.
Furthermore, in certain European countries (including in France and Belgium)
"facilities based" carriers that make investments in infrastructure receive
lower interconnection rates than non-facilities based providers. The Company
does not expect to qualify for such a discount until the Company purchases more
fiber optic transmission capacity in Europe (particularly in France and
Belgium). In addition, certain of the Company's competitors offer customers an
integrated full service telecommunications package consisting of local and long
distance voice, data and Internet transmission. The Company does not currently
offer all of these types of service, which could have a material adverse effect
on its competitiveness.
See "--Risk Factors--Competition" and "--Risk Factors--Increasing Pricing
Pressures."
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REGULATION
Regulation of the telecommunications industry is changing rapidly both
domestically and globally. As an international telecommunications company, the
Company is subject to varying degrees of regulation in each of the jurisdictions
in which the Company provides its services. Laws and regulations, and the
interpretation of such laws and regulations, differ significantly among the
jurisdictions in which the Company operates. There can be no assurance that
future regulatory, judicial and legislative changes will not have a material
adverse effect on the Company or that domestic or international regulators or
third parties will not raise material issues with regard to the Company's
compliance or noncompliance with applicable regulations.
The regulatory framework in certain jurisdictions in which the Company
provides its services is described below:
UNITED STATES
In the United States, the Company's services are subject to the provisions
of the Communications Act of 1934, as amended by the 1996 Telecommunications
Act, the FCC regulations thereunder, as well as the applicable laws and
regulations of the various states administered by the relevant PSCs. The recent
trend in the United States for both federal and state regulation of
telecommunications service providers has been in the direction of reduced
regulation. Although this trend facilitates market entry and competition by
multiple providers, it has also given AT&T, the largest international and
domestic long distance carrier in the United States, increased pricing and
market entry flexibility that has permitted it to compete more effectively with
smaller carriers, such as the Company. In addition, the 1996 Telecommunications
Act has opened the United States market to increased competition from RBOCs. The
Company cannot be certain whether future regulatory, judicial and legislative
changes in the United States will materially affect its business.
The FCC currently regulates the Company as a non-dominant carrier with
respect to both its international and domestic interstate long distance
services. Although the FCC has generally chosen not to closely regulate the
charges, practices or classifications of non-dominant carriers, the FCC has
broad authority which includes the power to impose more stringent regulatory
requirements on the Company, to change its regulatory classification, to impose
monetary forfeiture, and to revoke its authority. In this increasingly
deregulated environment, however, the Company believes that the FCC is unlikely
to do so.
FCC INTERNATIONAL. In addition to the general requirement that the Company
obtain authority under Section 214 of the Communications Act and file a tariff
containing the rates, terms and conditions applicable to the Company's
international services, the Company also is subject to the FCC's international
service policies, certain of which may affect the Company's ability to provide
the Company's services in the most economical fashion. For example, the FCC's
private line resale policy prohibits a carrier from reselling interconnected
international private leased circuits to provide switched services (known as
"ISR") to or from a country absent FCC authorization. The FCC recently modified
its policy on private line resale to allow such resale between the U.S. and a
WTO member country for which the FCC has not previously authorized the provision
of switched services over private lines upon a demonstration that (1) settlement
rates for at least 50 percent of the settled U.S.-billed traffic between the
U.S. and the country at the foreign end of the private line are at or below the
benchmark settlement rate adopted by the FCC, or (2) where the country at the
foreign end affords resale opportunities "equivalent" to those available under
U.S. law. Both conditions must be present before the FCC will authorize private
line resale between the U.S. and a non-WTO member country for which the FCC has
not previously authorized the provision of private line resale. The following
countries are not subject to those limitations: Australia, Austria, Belgium,
Canada, Denmark, France, Germany, Hong Kong, Ireland, Italy, Japan, Luxembourg,
New Zealand, The Netherlands, Norway, Sweden, Switzerland, United Kingdom. The
practical implication for the Company of this
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policy is that the Company is restricted from (i) transmitting calls routed over
leased lines between New York and London onward over a leased line to
continental Europe (other than to a country approved for ISR); and (ii)
transmitting calls from continental European countries (other than those
approved for ISR) over leased lines from London and then onward over a leased
line between London and New York. The policy may materially limit the best use
of the Company's leased lines between New York and London and may result in
increased transmission costs on certain calls, which the Company is not able to
pass through to its customers.
The Company is also subject to the FCC's International Settlements Policy
("ISP") which governs the settlement between U.S. carriers and their foreign
correspondents of the cost of terminating traffic over each other's network. The
FCC could find that, absent a waiver, certain terms of the Company's foreign
carrier agreements or its actions do not meet the requirements of the ISP.
Although the FCC generally has not issued penalties in this area, it has
recently issued a Notice of Apparent Liability against a U.S. company for
violating the ISP and it could issue a cease and desist order or impose fines.
If the FCC were to impose such fines or order on the Company, the Company do not
believe that it would have a material adverse effect on its business.
The FCC and certain PSCs require prior approval of transfers of control,
including pro forma transfers of control resulting from corporate
reorganizations, and assignments of regulatory authorizations. Such requirements
may delay, prevent or deter a change in control of the Company. Although the
Company believes that no material penalties would result from its failure to
notify the FCC and certain PSCs of a change of control or from the Company's
failure to seek prior approval or take certain actions, the Company cannot be
certain whether this will be the case.
FCC DOMESTIC INTERSTATE. The Company is considered a non-dominant domestic
interstate carrier subject to minimal regulation by the FCC. The Company is not
required to obtain FCC authority to expand the Company's domestic interstate
operations, but the Company is required to maintain, and does maintain, a
domestic interstate tariff on file with the FCC. The FCC presumes the tariffs of
non-dominant carriers to be lawful. Therefore, the FCC does not carefully review
such tariffs. The FCC could, however, investigate the Company's tariffs upon its
own motion or upon complaint by a member of the public. As a result of any such
investigation, the FCC could order the Company to revise the Company's tariffs,
or the FCC could prescribe revised tariffs.
The 1996 Telecommunications Act is intended to increase competition in the
U.S. telecommunications markets. Among other things, the legislation contains
special provisions that eliminate the restrictions on incumbent LECs such as the
RBOCs from providing long distance service. These provisions permit an RBOC to
enter an "out-of-region" long distance market immediately upon the receipt of
any state and/or federal regulatory approvals otherwise applicable in the
provision of long distance service. The provisions also permit an RBOC to enter
the "in-region" long distance market if it satisfies procedural and substantive
requirements, including showing that facilities-based competition is present in
its market, that it has entered into interconnection agreements which satisfy a
14-point "checklist" of competitive requirements and that its entry into the
"in-region" long distance market is in the public interest.
A number of RBOCs have made initial applications for the approvals necessary
to enter their "in-region" long distance markets, although, to date, all such
applications have been denied on the basis that the RBOC has not satisfied the
list of competitive requirements. However, there have recently been extensive
discussions among the state PSCs, the FCC and RBOCs in order to develop a
definitive understanding of these requirements and the specific criteria to
measure their satisfaction. These discussions may lead to one or more successful
RBOC "in-region" applications in the future. In particular, Bell Atlantic, which
serves the New York metropolitan and mid-Atlantic regions is considered by
industry observers to be the most likely RBOC to be the first to be permitted to
offer long distance services. Because a substantial portion of the Company's
customer base and traffic originates in the New York
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metropolitan area, Bell Atlantic would be a particularly formidable competitor.
The Company expects that Bell Atlantic will have a cost advantage over the
Company because it will not need to pay access charges, which constitute a
substantial portion of the Company's cost of services. See "--Risk Factors--
Competition."
The 1996 Telecommunications Act also addresses a wide range of other
telecommunications issues that may potentially impact the Company's operations.
It is unknown at this time precisely the nature and extent of the impact that
the legislation will have on the Company. On August 1, 1996, the FCC adopted an
Interconnection Order implementing the requirements that incumbent LECs make
available to new entrants interconnection and unbundled network elements, and
offer retail local services for resale at wholesale rates. Important portions of
the FCC's order were subsequently overturned by a court order. However, on
January 25, 1999, the U.S. Supreme Court upheld most of the challenged rules,
finding that the FCC has significant jurisdiction to establish rules to promote
competition for competitive local exchange services. Although some of the FCC's
rules may be challenged in future proceedings and the Supreme Court decision
requires the FCC to conduct additional proceedings to determine new unbundling
standards, the Supreme Court decision seems likely to promote competition for
telecommunications services generally.
Section 706 of the Telecommunications Act gives the FCC the right to forbear
from regulating a market if the FCC concludes that such forbearance is necessary
to encourage the rapid deployment of advanced telecommunications capability.
Section 706 has not been used to date, but in January 1998, Bell Atlantic filed
a petition under Section 706 seeking to have the FCC deregulate entirely its
provision of packet-switched telecommunications services. Similar petitions were
filed later by the Alliance for Public Technology and US West Inc. (currently
Media One Group Inc.).
On August 7, 1998, the FCC released an order denying requests by the RBOCs
that it use Section 706 of the Telecommunications Act to forbear from regulating
advanced telecommunications services. Instead, the FCC determined that advanced
services are telecommunications services and that ILECs providing advanced
services are still subject to unbundling and resale obligations of Section
251(c) and the in-region interLATA restrictions of Section 271.
On the same day, the FCC released a Notice of Proposed Rulemaking ("NPRM")
proposing that ILECs be permitted to offer advanced services through separate
affiliates. Such affiliates would continue to be prohibited from completing
interLATA calls but would not be required to unbundle network elements under
Section 251(c).
The FCC has also significantly revised the universal service subsidy regime.
Beginning January 1, 1998, interstate carriers, such as the Company, as well as
certain other entities, became obligated to make FCC-mandated contributions to
universal service funds. These funds subsidize the provision of
telecommunications services in high cost areas and to low-income customers, as
well as the provisions of telecommunications and certain other services to
eligible schools, libraries and rural health care providers. The Company's share
of these federal subsidy funds will be based on its revenues. The Company's
revenues that are subject to the high cost and low income fund are its quarterly
interstate and gross end-user telecommunications revenues. The Company's
revenues for the schools and libraries and rural health care fund are its
estimated quarterly intrastate, interstate and international gross end-user
telecommunications revenues. Contribution factors vary quarterly and the Company
and other carriers are billed monthly. In addition, the FCC orders implementing
the universal service contribution obligation are subject to petitions seeking
reconsideration by the FCC and to certain appeals. Until such petitions and
appeals are decided, there can be no assurance as to how the orders will be
ultimately implemented or enforced or what effect the orders will have on
competition within the telecommunications industry or specifically on the
Company's competitive position. Contribution factors for first quarter 1999 are:
(i) 3.18% for the high cost and low income funds (interstate and international
revenues); and (ii) 0.58% for the schools, libraries, and rural health care
funds (intrastate, interstate and international revenues). Because the
contribution
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factors do vary quarterly, the annual impact on the Company cannot be estimated
at this time, although the Company does not expect it to be material.
The Company's costs of providing long distance services will also be
affected by changes in the access charge rates imposed by LECs for origination
and termination of calls over local facilities. The FCC has significantly
revised its access charge rules in recent years to permit incumbent LECs greater
pricing flexibility and relaxed regulation of new switched access services in
those markets where there are other providers of access services. The Company
currently has agreements to terminate, originate or exchange traffic with a
variety of carriers who, in turn, may be subject to similar agreements with
other carriers or LECs. Any change in any of these agreements, whether by
operation of law or otherwise, may affect the Company's costs or could disrupt
its ability to terminate, originate or exchange traffic and, therefore, have a
material adverse effect on the Company. The FCC has, for example, created a new
presubscribed interexchange carrier charge ("PICC") rate element. The PICC is a
flat-rate, per line charge that is recovered by LECs from interexchange
providers. Effective January 1, 1998, the initial maximum permitted interstate
PICC charge is $0.53 per month for primary residential lines and single-line
business lines and $1.50 per month for second and additional residential lines.
The initial maximum interstate PICC for multi-line businesses are $2.75 per
month, per line. The ceilings may increase over time. The FCC continues to
adjust its access charge rules and has indicated that it will promulgate
additional rules sometime in 1999 that may grant certain LECs further
flexibility. While the Company currently intends to pass through the costs of
both the PICC and its universal service fund contributions to its customers,
there can be no assurance that the Company will be able to or that doing so will
not result in a loss of customers.
The 1996 Telecommunications Act also requires interexchange carriers to
compensate payphone owners when a payphone is used to originate a telephone call
using a calling card. In orders issued in September and October of 1996, the FCC
established a compensation scheme that required all carriers to begin
compensating payphone owners on a per-call basis beginning October 7, 1997 at a
rate $.35 per call. On July 1, 1997, the United States Court of Appeals for the
District of Columbia ("D.C. Circuit") issued an opinion reversing in part the
FCC's payphone orders. The court ruled that the rate of $.35 per call was
arbitrary and capricious and remanded the case to the FCC for further
proceedings. The FCC, thereafter, issued a further rulemaking on compensation
for payphone owners. On October 9, 1997, the FCC ruled that interexchange
carriers are required to compensate payphone owners at a rate of $.284 for all
payphone calls. The FCC ruled that this compensation method will be effective
from October 7, 1997 through October 7, 1999. On May 15, 1998, the D.C. Circuit
remanded the order to the FCC, ruling that the $.284 rate established was
arbitrary and capricious, but did not vacate it. On February 4, 1999 the FCC
released an order which lowered the payphone compensation rate on a going
forward basis to $.240. For amounts already due, the FCC determined that the
payphone owners should be compensated at a rate of $.238.
The FCC also imposes requirements for the marketing of telephone services
and for obtaining customer authorization for changes in a customer's primary
long distance carriers. The FCC has recently imposed severe penalties on a
number of carriers for "slamming," the unauthorized change of a customer's
presubscribed long distance carrier. Under an order recently issued by the FCC,
carriers such as the Company are required to take certain additional steps to
prevent slamming. The FCC is continuing to reexamine its slamming rules.
STATES. The Company's predecessor corporation, Econophone, Inc., which was
incorporated in New York, received authorization, where necessary, either
pursuant to certification, the fulfillment of tariff requirements or
notification requirements, to provide long distance services in 49 states.
Following the reorganization of Econophone, Inc. as a Delaware corporation, the
authorizations were transferred to the Company. The Company in turn has recently
transferred the authorizations to a recently created wholly-owned subsidiary,
Econophone Services, Inc. Certificates of authority can generally be
conditioned,
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modified, canceled, terminated or revoked by state regulatory authorities for
failure to comply with state law and/or rules, regulations and policies of the
state regulatory authorities.
Many states also impose various reporting and other requirements. A number
of state PSCs have adopted rules governing the markets of telephone services and
obtaining customer authorizations for changes of a customers' primary long
distance carrier. State commissions also regulate access charges and other
pricing for telecommunications services within each state. The Company may also
be required to contribute to universal service funds in some states.
REGULATION OF THE INTERNET. The use of the Internet to provide telephone
service is a recent development. Currently, the FCC is considering whether or
not to impose surcharges or additional regulations upon certain providers of
Internet telephony. In an April 1998 report to Congress, the FCC indicated it
would examine the question of whether certain forms of "phone-to-phone" Internet
protocol telephony are information services or telecommunications services. It
noted that certain forms of phone-to-phone Internet telephony appeared to have
the same functionality as non-Internet protocol telecommunications services and
lacked the characteristics that would render them information services. If the
FCC were to determine that certain services are subject to FCC regulations as
telecommunications services, it may require these service providers to make
universal service contributions, pay access charges or be subject to traditional
common carrier regulation. State PSCs may also retain jurisdiction to regulate
the provision of intrastate Internet telephony services and could initiate
proceedings to do so.
PATENT RIGHTS RELATING TO PREPAID SERVICES. Various parties have claimed
that certain prepaid card providers are infringing upon patent rights held by
these parties relating to the provision of prepaid card services. The Company do
not expect that its prepaid card services will be found to infringe upon any
third-party patent rights, although there can be no assurance that the Company
would prevail if a claim were asserted by a third party. If the Company were
unable to provide its prepaid card services in the manner in which they
currently are provided, it could have a material adverse effect on its business.
EUROPEAN UNION
In Europe, the regulation of the telecommunications industry is governed at
a supra national level by the European Commission ("EC"), consisting of the EU
member countries. The EU member countries include: Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands,
Portugal, Spain, Sweden and the United Kingdom. The EU is responsible for
creating pan-European policies and, through legislation, developing a regulatory
framework to ensure an open, competitive telecommunications markets.
As of January 1, 1998 the EU abolished all special or exclusive rights that
restrict the provision of telecommunications services. Specific directives have
been adopted, which include the Open Network Provision ("ONP") Leased Lines
Directive, the ONP Voice Telephony Directive, the ONP (Adaptation of the
Framework and Leased Lines to a Competitive Environment) Directive and the
Interconnection Directive, the latter of which would provide for equal access
and number portability on January 1, 2000. Equal access would enable a customer
to access its network over another operator's network, without dialing an access
code, by "preselecting" Destia as its long distance carrier. However, Oftel, the
U.K. regulatory authority, already has indicated that it will seek to defer the
implementation of equal access in the United Kingdom, and PTTs and/or regulators
in certain other EU jurisdictions also are expected to seek deferrals. Number
portability would enable customers to retain their existing telephone numbers
when switching to alternative carriers and is already available (although not
universally) in the United Kingdom. Additional directives, in addition to those
described above, remain to be adopted by the Council of the European
Communities, although their final content and timing of implementation cannot be
predicted at this time. Certain EU countries have temporary waivers from these
EU deregulation requirements: Greece and Portugal until January 1, 2000.
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National governments also must pass legislation within their countries to
give effect to EC directives. Each EU member state in which the Company
currently conducts business will therefore continue to, in part, have a
different regulatory regime. The requirements for the Company to obtain
necessary approvals vary considerably from country to country and are expected
to continue to so vary. See "--Risk Factors-- Regulatory Restrictions."
WORLD TRADE ORGANIZATION INITIATIVES. The WTO recently concluded the WTO
Agreement, which opens the telecommunications markets of the signatory countries
to entry by foreign carriers on varying dates and to varying degrees. The WTO
Agreement became effective on February 5, 1998. Pursuant to the WTO Agreement,
U.S. companies would have foreign market access for local, long distance and
international services, either on a facilities basis or through resale of
existing network capacity on a reasonable and non-discriminatory basis. Although
the WTO Agreement may open additional markets to the Company or broaden the
permissible services that the Company can provide in certain markets, the WTO
Agreement also may subject the Company to greater competitive pressures in the
Company's markets, with the risk of losing customers to other carriers and
reductions in its rates.
UNITED KINGDOM. Licenses are needed to provide all the international
services that the Company provides in the United Kingdom. Licenses are granted
by the Secretary of State for Trade and Industry but enforced by the U.K.
regulatory authority under powers granted by the Telecommunications Act, 1984.
The Company has all of the necessary licenses to provide its services in the
United Kingdom.
International simple resellers, such as the Company, operate under
registrable class licenses. Through the Company's subsidiary ATL, the Company
has an International Simple Voice Resale Class License (the "ISVR"), which
entitles the Company to resell international message, telephone and private line
services. The ISVR license also enables ATL to interconnect with, and lease
capacity at wholesale rates from, British Telecom and other public
telecommunications operators. The Company also has an International Facilities
License, which authorizes the Company to provide international telecommunication
services over its own international infrastructure.
The Company's U.K. customers currently are unable to preselect the Company
as their long distance carrier. Equal access is scheduled to become available in
the United Kingdom on January 1, 2000 pursuant to relevant EU directives.
However, British regulators have indicated that they will seek to defer the
implementation of equal access in the United Kingdom until a later date.
BELGIUM. Since January 1, 1998, licensed operators have been able to
provide telephony services in Belgium. On July 15, 1998, the Royal Decree of
Voice Telephony removing the last remaining monopolies of Belgacom, the Belgium
PTT, was published. These permitted services include all of the services that
the Company currently provides in Belgium.
Providers of voice telephony services must apply for a voice telephony
license. The Company was recently granted a permanent license, which expires in
2014, by the Belgium Minister for Telecommunications.
In Belgium, "facilities-based" carriers that make investments in
infrastructure receive lower interconnection rates than non facilities-based
providers. These incentives provide carriers that own infrastructure with a cost
advantage over carriers that do not own infrastructure. Because the Company is
not a facilities-based carrier within the meaning of Belgian regulations, the
Company is not eligible for these incentives.
Preselection currently is unavailable to the Company's customers in Belgium.
The Belgian regulatory authorities have not yet introduced the regulations
setting forth the criteria that private carriers must satisfy in order to be
able to offer preselection to their customers.
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The Company's interconnection in Belgium has been granted on a temporary
basis until July 15, 1999 pending the adoption of certain new telecommunications
legislation in Belgium. Once this legislation has been adopted, the Company will
need to enter into a new interconnection agreement with Belgacom. If this new
legislation has not been adopted before July 15, 1999, the Company expects the
term of its Belgian interconnection to be extended. Furthermore, once the new
legislation is adopted, the Company expects to be able to enter into a new
interconnection agreement with Belgacom. However, there can be no assurance that
this will be the case with respect to either of the foregoing. If the Company
were to lose its interconnection with Belgacom in Belgium, the Company would
need to obtain interconnection from another carrier, which could increase its
transmission costs in Belgium.
FRANCE. Since January 1, 1998, licensed private service providers have been
able to offer domestic and international long distance voice telephony services
to the general public in France after obtaining a voice telephony license. The
Company's French subsidiary, Econophone SA, obtained its voice telephony license
during the third quarter of 1998. This license enables the Company to provide
all of its current services in France.
In order to own and control transmission infrastructure in France, a carrier
must obtain an infrastructure license from the Autorite de Regulation
T elecommunications ("ART"). Because the Company leases, rather than own, its
transmission lines in France, the Company is not required to have an
infrastructure license. The ART provides financial incentives to certain
infrastructure providers. These incentives provide carriers that own
infrastructure with a cost advantage over carriers that do not own
infrastructure and are not available to the Company.
Preselection currently is unavailable to the Company's customers in France.
In addition, seven carriers that have agreed to interconnect on a national basis
to the French PSTN in a substantial number of markets have been granted single
digit access for their customers. The Company is not one of these carriers.
GERMANY. On January 1, 1998, the German telecommunications market was
substantially liberalized. Through the Company's interconnection with Deutsche
Telekom and on the basis of the Company's carrier identification code, its
customers are able to preselect the Company as their carrier for certain
services. In Germany, the Company's activities are governed by the
Telecommunications Act of July 25, 1996 (the "German Telecommunications Act").
Under the German Telecommunications Act, the provision of "voice telephony
service," which includes services involving switching in Germany on the basis of
self-operated telecommunications networks, requires a license of Class 4 under
the Act. The Company received a geographically limited Class 4 license during
the second quarter of 1998, which enables the Company to provide voice telephony
services. Pursuant to rulings of the Regulatory Authority for Telecommunications
and Posts ("RegTP"), holders of geographically limited Class 4 licenses are only
entitled to obtain interconnection services which correspond to the areas
covered by such licenses. The Company has recently requested that its license be
expanded to cover all of Germany.
The German Telecommunications Act and the Network Access Ordinance require
public telecommunications network operators to offer interconnection at the
request of other network interconnection operators. This requires Deutsche
Telekom to allow other providers interconnection to its telecommunications
networks. During the fourth quarter of 1998, the Company entered into an
interconnection agreement with Deutsche Telekom which expired at the end of
February 1999. The Company initiated a legal action with the RegTP on February
25, 1999 that challenged the terms of interconnection being offered by Deutsche
Telekom and requested the RegTP to issue a preliminary order and a final order
requiring Deutsche Telekom to offer reasonable interconnection terms to ensure
continued interconnection of the Company's German network with Deutsche
Telekom's network. Deutsche Telekom, as a market-dominating operator, is
obligated to grant the Company access to Deutsche Telekom's network. In
addition, certain conditions of such network access may be determined by the
RegTP. Nevertheless it is
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uncertain if the RegTP will grant the Company network access on terms and
conditions acceptable to the Company. If Deutsche Telekom were permitted to
restrict its interconnection offer as currently proposed, the Company's
transmission costs in Germany could be increased and the coverage of services
offered by the Company could be limited. Several other competitive carriers are
now participating in this legal action, since the determination by RegTP on
these issues is likely to have industry-wide consequences for all competitive
carriers that interconnect with Deutsche Telekom in Germany.
SWITZERLAND. With the implementation of the Telecommunication Act of 1997
on January 1, 1998, Switzerland became a fully liberalized telecommunications
market. The provision of the Company's services in Switzerland does not require
a license, although the Company is required to make certain notice filings.
The Company's Swiss subsidiary, Econophone GmbH, signed an interconnection
agreement with Swisscom, the Swiss PTT, during the second quarter of 1998. The
Company's interconnection with Swisscom enables its customers to preselect the
Company as their long distance carrier in Switzerland.
CANADA
The domestic long distance market in Canada was first opened to resale
competition in 1990 and then to facilities-based competition in 1992. Although
Canada's international market was also opened to competition in 1992,
facilities-based competitors were not permitted to enter this market due to a
long-standing monopoly held by Teleglobe Canada. As a signatory to the WTO
Agreement, Canada agreed to end Teleglobe Canada's monopoly on Canada overseas
transmission facilities effective on October 1, 1998. The Company received a
license early in the first quarter of 1999 which authorizes the Company to
provide to offer international long distance services to the Company's customers
in Canada. The provision of domestic long distance services in Canada does not
require a license, although the Company is required to make certain notice
filings. As a reseller of long distance services, the Company is currently not
subject to any foreign ownership restrictions in Canada.
EMPLOYEES
As of December 31, 1998, the Company had 877 employees, an increase from the
408 employees that the Company had at December 31, 1997. The breakdown of the
Company's employees by region as of December 31, 1998 was as follows:
<TABLE>
<CAPTION>
REGION NUMBER OF EMPLOYEES
- ------------------------------------------------------------------------ -----------------------
<S> <C>
Continental Europe...................................................... 108
United Kingdom.......................................................... 247
North America........................................................... 522
---
Total................................................................... 877
</TABLE>
The Company's North American employees are based principally in its offices
in Paramus, New Jersey (executive offices); New York, New York; Brooklyn, New
York; College Station, Texas; and St. Louis, Missouri. In Europe, the Company's
employees are based principally in offices located in cities where the Company
has a switch. The Company has never experienced a work stoppage and its
employees are not represented by a labor union or a collective bargaining
agreement. The Company considers its employee relations to be good.
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<PAGE>
RISK FACTORS
LIMITED OPERATING HISTORY
The Company has a limited operating history. The Company was founded in 1992
and before 1994 only conducted minimal business. In addition, the Company has
only begun providing most of its current services in most of its current markets
since 1996 or later. See "--Business--Products and Services."
The Company has had limited experience in most of the markets the Company
currently serves and intends to significantly expand the scale and scope of its
operations in its markets. As part of this expansion, the Company intends to
introduce new services and features including enhanced services such as
voicemail, "follow me," data and Internet access services that the Company has
not historically offered to any significant extent. The Company also intends to
enter into new geographic markets where the Company currently does not have
operations. In 1999, the new geographic markets that the Company intends to
enter include Austria, Ireland, Italy and The Netherlands.
The Company's prospects must therefore be considered in light of the
foreseeable and unforeseeable risks, expenses, problems and delays inherent in
an early stage company substantially expanding its business in a rapidly
evolving industry and in new markets. Any of these factors could have a material
adverse effect on its business.
IMPLEMENTATION OF ITS EXPANSION PLANS
The Company is highly leveraged, which the Company hope will enhance the
return to its stockholders. However, its leverage makes its success, and the
return to its stockholders, extremely dependent on its ability to grow. To
successfully implement the Company's goal of expanding and enhancing its
business operations, the Company will need to:
- successfully implement its marketing strategies;
- continue the development, expansion and integration of its network;
- obtain satisfactory and cost-effective ownership interests and lease
rights from, and establish interconnection arrangements with, competitors
that own transmission lines (in certain cases, intra-national transmission
lines may be available only from a PTT);
- hire, retain and motivate highly productive sales personnel and
independent sales agents, particularly in Europe, where such individuals
are particularly difficult to identify and retain;
- continue to expand and develop its billing systems, order provisioning
processes, technical support, customer service and other back-office
capacity;
- enhance and expand its service features and offerings; and
- continue to attract and hire experienced corporate professionals.
If the Company fails to successfully implement these plans, it is likely
that its business would be materially adversely affected.
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EXPANSION COSTS AND RISKS WILL BE SIGNIFICANT
The Company will incur significant costs as the Company attempts to expand.
These costs generally will be incurred in advance of anticipated related
revenues, and may cause substantial and unanticipated fluctuations in the
Company's operating results.
To increase its customer base and enhance its support of its customers, the
Company intends to substantially increase its sales and marketing and customer
care expenses, especially in its newer geographic markets and over the Internet.
The Company plans to conduct new sales and marketing campaigns. The Company also
plans to hire additional internal sales personnel. In addition, the Company
intends to make significant investments in its customer support, billing, order
provisioning and other information processing capabilities. These initiatives
will be costly and will affect the Company's operating results.
The Company also will make substantial capital expenditures. For 1999, the
Company plans to spend approximately $100 million for capital expenditures on
network equipment, back-office systems, the continued build-out of the Company's
network operations center in St. Louis, Missouri, a transatlantic IRU and other
fiber optic transmission capacity. Actual capital expenditures may be
significantly different than the Company's current plans, in part because the
Company intends to be opportunistic in acquiring transmission capacity in a
dynamic market. The Company also expects to have substantial capital
expenditures after 1999. The Company may seek to finance its capital
expenditures by issuing additional debt or equity securities. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
RISKS OF POTENTIAL ACQUISITIONS
The Company is not engaged in any negotiations regarding any material
acquisitions, but intend to pursue selected acquisitions and strategic
alliances. The Company's ability to engage in acquisitions will be dependent
upon its ability to identify attractive acquisition candidates and, if
necessary, obtain financing on satisfactory terms. The challenges of
acquisitions include:
- potential distraction to management;
- integrating the acquired business's financial, computer, payroll and other
systems into the Company's own systems;
- implementing additional controls and information systems appropriate to a
growing company;
- unanticipated liabilities or contingencies from the acquired company; and
- reduced earnings due to increased goodwill amortization, increased
interest costs and costs related to integration.
If the Company is unsuccessful in meeting the challenges arising out of its
growth, the Company's business could be adversely affected.
SUBSTANTIAL INDEBTEDNESS, FUTURE LOSSES AND NEGATIVE EBITDA
As of December 31, 1998, the Company had total consolidated indebtedness of
$397.4 million and a stockholders' deficit of $102.5 million. Furthermore, the
11% Senior Discount Notes due 2008 that the Company issued during 1998 (the
"1998 Notes") currently do not pay interest in cash, and from January 1, 1999 to
February 15, 2003 will accrete in value (i.e., effectively increase in principal
amount), by approximately $107.1 million. Thereafter, interest on the 1998 Notes
must be paid in cash. For 1998, the Company had a net loss of $68.9 million, the
Company had negative EBITDA of $26.9 million and net cash used in operating
activities was $26.4 million. The Company expects to have operating losses and
negative EBITDA and negative cash flow from operations through at least 2000.
The Company cannot be certain
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that it will ever operate at profitable levels or have positive EBITDA or be
able to repay principal and interest on money that the Company has borrowed. The
Company's failure to achieve any of these results would materially adversely
affect its business.
The Company expects that the proceeds of the Offering, together with an
equipment loan that the Company expects to obtain and its other cash resources,
will be sufficient to fund its budgeted capital expenditures and operations
until the Company generates positive cash flow from operations. However, if the
Company makes any significant acquisitions of businesses or assets, or the
Company's business plans or assumptions prove to be inaccurate, the Company may
need to borrow more money, which would increase its overall indebtedness.
If the Company is unable to generate sufficient cash flows from operations
to pay principal and interest on its indebtedness, the Company may be required
to refinance some or all of it. If the Company is not able to refinance its
indebtedness on acceptable terms or to borrow additional money, it could be
forced to default on its indebtedness obligations. This would have a material
adverse effect on its business.
The indentures pertaining to the 1997 Notes and the 1998 Notes that the
Company has issued contain various restrictive covenants. All of these
restrictions, in combination with the Company's highly leveraged financial
situation, could:
- limit its ability to react to changing market conditions, changes in its
industry or economic downturns;
- place the Company at a competitive disadvantage if the Company is not able
to borrow money on acceptable terms for future acquisitions, capital
expenditures or other purposes;
- increase the losses the Company will need to fund and require the Company
to dedicate a substantial portion of the cash flow from its operations, if
any, to pay its interest expense, which would make it more difficult to
fund its needs or plans; and
- make it more difficult for the Company to satisfy its debt obligations.
See "Item 6. Selected Consolidated Financial Data" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
COMPETITION
The markets for all of the Company's services are extremely competitive and
the Company expects competition to continue to intensify, particularly in
continental Europe, where many regulatory barriers have recently been reduced as
part of an ongoing regulatory liberalization. Competition results in customer
"churn" or "turnover." The Company believes that competition in many of its
markets in Europe will eventually become as strong as competition in the United
States. For a discussion of price competition, see "--Increasing Pricing
Pressures."
Many of the Company's competitors are well-known, have substantially greater
financial, technical and marketing resources and larger networks than the
Company does, control a greater portion of their transmission lines and have
long-standing relationships with the Company's target customers and the
regulators in local markets. Many of the Company's larger competitors, such as
AT&T, MCI WorldCom, Sprint, British Telecom, Deutsche Telekom, France Telecom,
Belgacom and SwissCom already have universal name recognition. The Company also
competes with alliances such as AT&T's alliance with British Telecom (which
recently annouced that their alliance will include Japan Telecom). The Company
believes that many of these competitors will continue to increase the resources
that they devote to marketing and selling international and/or domestic long
distance services in each of the markets where the Company operate. As a result,
the Company will face increasing pressure upon its ability to acquire customers.
These competitive pressures could materially adversely affect the Company's
business.
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Many of the Company's larger competitors, particularly in the United States,
also offer customers an integrated full service telecommunications package
consisting of local and long distance voice, data and Internet transmission. The
Company does not currently offer all of these types of services and only intends
to add some or all of such offerings over time. In particular, the Company has
no plan to offer local service in the United States.
In the United States, the Company expects that, in the near future, the
RBOCs, which are the principal U.S. local telephone companies, also may compete
with the Company for long distance customers in their "in region" service areas.
RBOCs have to satisfy a list of competitive requirements before they are
authorized to offer long distance service to their local customers. No RBOC is
authorized to do so yet, but they are expected to be authorized soon. When they
are authorized, they will be very formidable competitors. In particular, Bell
Atlantic, which serves the New York metropolitan and mid-Atlantic regions, is
considered by industry observers to be the RBOC most likely to be the first
permitted to offer long distance services. Because a substantial portion of the
Company's customer base and traffic originates in the New York metropolitan
area, Bell Atlantic will be a particularly formidable competitor. For long
distance calls, Bell Atlantic will have a substantial cost advantage because it
will not have to pay "access fees" to a local carrier to originate the call.
Access fees constitute a large portion of a long distance carrier's cost of
services, including the Company's.
In many foreign markets where the Company does business, its principal
competitor is the government-owned or quasi-governmental PTT, which has a long
history of influence and control over the telecommunications market in its
country. This history provides the PTTs with certain inherent competitive
advantages over other providers, including:
- control of "interconnection," which is the direct connection at one or
more switches between a competing carrier (such as the Company) and the
PTT, which owns the lines to virtually every telephone in the country;
- extensive, and in many cases exclusive, ownership of facilities;
- the ability to delay or prevent equal access to lines; and
- the reluctance of some regulators to adopt policies and grant regulatory
approval that will result in increased competition for the local PTT.
For example, in England a caller must dial a four-digit prefix before every
call in order to select the Company's long distance service. If a customer does
not dial a prefix, the call is automatically carried by British Telecom. In
France, only seven carriers have been granted regulatory approval to provide
long distance service using a single digit prefix. The Company is not one of
these carriers. Thus, a caller in France must dial a four-digit prefix in order
to select the Company's long distance service (otherwise, the call will be
carried by a competitor). In Germany, Deutsche was granted the approval in June
1998 to charge the following one-time fees to any customer that permanently
changes long distance service providers (preselection): DM27 until the end of
1998, DM20 during 1999 and DM10 as of January 1, 2000. In Greece, regulatory
restrictions prohibit the Company from offering long distance services other
than "value-added" services or services to closed user groups (i.e., the Company
cannot offer services to the general public). Furthermore, because competition
has only recently been allowed in most of the Company's European markets, the
customers of PTTs may be reluctant to entrust their telecommunications needs to
new providers, such as Destia.
The Company also may experience competition from competitors that use new or
different technologies and/or transmission methods, including Internet service
providers, cable television companies, wireless telephone companies, satellite
owners and resellers, electric and other utilities, railways, microwave carriers
and large end users that have private networks. While few of these types of
competitors have been able to gain any material market share for the Company's
principal services to date, technological advances may enable one or more of
them to provide attractive alternative services. For example, the Company
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<PAGE>
expects flat-rate nationwide cellular or PCS phone plans to offer increasingly
formidable competition to the Company's calling card services. In the United
Kingdom, cable companies have been very successful in entering the
telecommunications market. See "Business--Products and Services."
INCREASING PRICING PRESSURES
The Company competes for customers based primarily on price. Price
competition for all of the Company's services is intensive, but it is
particularly acute for its U.S. prepaid card and calling card services.
The Company's larger competitors generally have lower per call transmission
costs than the Company has. They own more transmission capacity, have more
favorable interconnection rates and obtain larger volume discounts from
suppliers. The Company has no control over the prices set by its competitors,
and when its competitors reduce their prices, the Company must reduce its
prices.
Industry observers predict that prices will continue to drop. This trend
will in part be due to the increase in the number of carriers with international
transmission networks. By having their own international networks, carriers are
able to substantially reduce their variable transmission costs, which enables
them to offer lower retail and wholesale prices. If this trend continues, the
Company expects to experience a substantial reduction in its gross margins for
international calls, which, absent a substantial increase in traffic carried or
charges for additional services, would have a material adverse effect on its
business.
The Company expects that retail telecommunications rates in all of its
principal markets, particularly in continental Europe and Canada, will continue
to decrease rapidly. Some of the factors that will affect price competition for
its services are discussed below.
PRICE COMPETITION IN EUROPE
The Company anticipates that continuing deregulation will cause significant
retail price declines, similar to the price declines experienced in the United
States and being experienced in the United Kingdom as a result of deregulation
in those countries. The Company believes that European PTTs may react to
competition more aggressively than AT&T did in the U.S. after its divestiture in
the 1980s.
For example, each of the Company's PTT competitors in Europe has taken steps
to substantially reduce retail prices in an effort to protect its market share
and deter competitors. In this regard, France Telecom has recently announced
that it will reduce its prices by 10% on international services and by 12% on
domestic long distance services. In the United Kingdom, the national regulatory
authority has put downward pressure on British Telecom's retail prices by
imposing a price cap on its retail prices for residential services. In Germany,
Deutsche Telekom has recently announced significant reductions in its rates
which will reduce its retail long distance rates by as much as 60%. The RegTP
has indicated that it intends to approve these rate cuts.
In certain European countries, carriers that make significant investments in
infrastructure have cost advantages over other carriers. For example, in France
and Belgium, "facilities-based" carriers that make investments in infrastructure
receive lower interconnection rates than non-facilities-based providers. The
Company is not a "facilities-based" provider within the meaning of French and
Belgian regulations.
The rapid reduction of retail prices by PTTs in continental Europe places
increasing pressure on the Company to reduce its costs in order to preserve and
improve its gross margins. Because of the expansion of the Destia Network and
reductions in wholesale transmission costs, the Company has been able to avoid
substantial declines in gross margins. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Overview--Cost of
Services." As retail prices continue to fall, the Company will be subject to
increasing pressure, which could have a material adverse effect on its business.
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COLLAPSE OF THE INTERNATIONAL SETTLEMENT REGIME
Prices for international long distance calls are determined in part by
international settlement rates, which are the rates that a carrier (often a PTT)
charges to terminate an international call in its home country. Because these
rates were set by national monopolies, they were traditionally set at arbitrary,
artificially high levels that enabled many carriers to enjoy high gross margins
on international calls. With the introduction of competition in many countries,
international settlement rates have been declining for the last several years
and an increasing number of calls are being placed outside the international
settlement rate system, resulting in drastically lower prices. Industry
observers believe that the combined effects of deregulation, excess transmission
capacity, advances in technology and the negligible marginal cost to a carrier
that owns its own switches and transmission facilities of carrying an
international call, are gradually causing the collapse of the international
settlement rate system. Practices such as "refile" (where traffic originating
from a particular country is rerouted through another country with a lower
settlement rate), off settlement rate terminations (where a local carrier agrees
to terminate an international call at rates below the settlement rates) and
transit (where a carrier agrees to terminate another carrier's traffic to a
particular country at a negotiated price other than the settlement rate) are
becoming increasingly common.
Settlement rates also are being reduced as a result of regulatory
initiatives. Lower settlement rates are scheduled to be in effect for
substantially all countries over the next several years. Lower settlement rates
will reduce the Company's per call revenue, which could have a material adverse
effect on its business.
PRICE COMPETITION FROM INTERNET TELEPHONY
The increased use of voice services over the Internet also is expected to
result in a further reduction in prices. Competition from Internet telephony is
expected to come from both Internet service providers and telephone companies.
For example, AT&T, MCI WorldCom and ICG Communications have begun to offer voice
telecommunications services over the Internet at substantially reduced prices.
While the provision of voice telephony over the Internet historically has been
characterized by lower standards of quality, technological improvements may
result in Internet-based voice telephony becoming a strong competitor to voice
services that are typically offered by carriers today.
In the United States, providers of Internet telephony also benefit from an
inherent cost advantage because their traffic is considered data, rather than
voice telephony. This allows them to avoid paying access fees to RBOCs and other
local telephone companies, while providers of traditional long distance services
are required to pay such fees. Access fees constitute a large portion of a long
distance carrier's cost of services, including the Company's.
DEPENDENCE ON THIRD PARTY SALES ORGANIZATIONS
The Company sells a substantial portion of its services through indirect
channels of distribution, which consist of independent sales agents,
distributors and, to a lesser extent, resellers ("Third Party Agents").
The Company believes that its relationships with its Third Party Agents are
good. However, the Company does not have control over Third Party Agents or
their agents and employees. The Company therefore cannot be certain that they
will perform in a satisfactory manner or that their interests will be aligned
with the Company's. In addition, Third Party Agents also may terminate their
business relationships with the Company at any time, with little or no prior
notice. They could do this if the Company's competitors offer them increased
sales incentives. This risk is especially pronounced in the Company's
multi-level marketing program in the United Kingdom, where a master agent could
determine to terminate its business relationship (and that of its sub-agents)
with the Company and conduct business with a competitor, although the agent
would be contractually obligated to leave its customers with the Company.
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Unsatisfactory performance by Third Party Agents, or the termination by them of
their business relationship with the Company, would hinder its ability to
continue to grow and could have a material adverse effect on its business.
Recent European Union ("EU") regulations pertaining to commercial agents
provide sales agents with far greater protection than that provided by prior
legislation, and could result in increased termination payments in the event of
a dispute with a Third Party Agent.
The Company previously experienced disputes with some of its independent
sales agents. In connection with a change in the Company's distribution strategy
in the United Kingdom, in late 1996, the Company entered into a settlement
agreement with Europhone International ("EI"), the Company's former partner in a
U.K. sales and marketing joint venture. Under the terms of the settlement, among
other things, EI retained all of the rights in the customer list of the joint
venture. For 1996, the Company's joint venture with EI and sales of carrier
services to EI contributed 32% of its consolidated revenues and 92% of its U.K.
originated revenues. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--1997 Compared to 1996--SG&A."
IMPORTANCE OF CARRIER AND OTHER WHOLESALE CUSTOMERS
Carrier customers generally are extremely price sensitive, generate very low
margin business and move their traffic from carrier to carrier based solely on
small price changes. These changes occur as frequently as daily. Furthermore,
there are numerous examples of small carriers obtaining service and credit terms
from other carriers, reselling this service to customers at a loss in order to
quickly build revenue and then refusing to pay the carrier bills when they come
due. In the deregulating markets in Europe, these risks are particularly acute.
Therefore, the Company could be exposed to a material credit risk over a very
short period of time. The Company maintains a reserve for doubtful accounts
receivable and periodically writes off specific accounts receivable. The Company
believes that its credit criteria enable the Company to reduce its exposure to
these risks. However, the Company cannot be certain that its criteria will
afford adequate protection against these risks.
During 1997 and 1998, the Company's sales of transmission capacity to
carrier customers ranged from 9% to 30% of its consolidated revenues on a
quarterly basis. During 1999, the Company intends to increase its carrier
revenues, although its business will continue to be predominantly focused on
retail sales. This may make the Company more susceptible to the risks associated
with carrier customers.
REGULATORY RESTRICTIONS
Regulation of the telecommunications industry is changing rapidly, both
domestically and internationally. Although the Company believes that
deregulation efforts will create opportunities for the Company, they also
present risks.
As an international telecommunications company, the Company is subject to
varying degrees of regulation in each of the jurisdictions in which it provides
its services. Laws and regulations differ significantly among these
jurisdictions. There can be no assurance that future regulatory, judicial and
legislative changes will not have a material adverse effect on the Company or
that domestic or international regulators or third parties will not raise
material issues with regard to its compliance with applicable regulations.
In the United States, regulatory considerations that affect or limit the
Company's business include:
- restrictions on the Company's use of leased lines;
- universal service fund contribution requirements;
- access charges that the Company is required to pay to local exchange
carriers ("LECs");
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<PAGE>
- payphone access charges that the Company is required to pay;
- regulations and penalties relating to "slamming" (i.e., switching a
customer's Service without its permission); and
- regulations concerning use of customer proprietary information in cross
marketing efforts.
In Europe, regulatory considerations that affect or limit the Company's
business include:
- EU directives pertaining to equal access and number portability;
- implementation of national legislation giving effect to EU directives;
- EU directives relating to data protection and customer privacy; and
- temporary license and/or interconnection regimes.
In addition to the regulatory considerations indicated in this Risk Factor,
see also "--Need for Interconnection" and "Business--Regulation" for a
discussion of these and certain other regulatory risks and considerations
relevant to the Company's business.
NEED FOR INTERCONNECTION
In each jurisdiction in which the Company operates, a monopoly or former
monopoly owns the only line to an overwhelming majority of the telephones.
Therefore, the Company needs to interconnect with these monopolies or former
monopolies.
In the United States, LECs are required to provide interconnection at
regulated rates. Outside the United States, interconnection can be obtained
through interconnection agreements negotiated directly with the PTTs (such as
the Company's PTT interconnection agreements in the United Kingdom, Belgium,
Germany, France, The Netherlands and Switzerland), or indirectly through other
parties that have direct interconnection with the PTT. Interconnection
agreements with PTTs typically provide for substantially more favorable access
and termination rates and other benefits, such as the ability to offer customers
abbreviated dialing. As a practical matter, interconnection with the PTT is a
prerequisite to offering cost-effective services to customers in local markets.
The availability and rates of interconnection are determined on a
country-by-country basis. The failure to obtain interconnection on commercially
acceptable terms, particularly in key markets, could have a material adverse
effect on the Company's business.
CONSIDERATIONS AFFECTING INTERCONNECTION IN EUROPE
Regulations governing interconnection are not as developed and favorable to
the Company in most of continental Europe as in the United States and the United
Kingdom. The Company has been successful to date in obtaining interconnection in
most of its major network cities in continental Europe. However, the Company has
experienced delays in obtaining interconnection from some PTTs. The Company
cannot be certain that it will be able to maintain all of its interconnections,
obtain additional interconnection in current network cities (which would
increase the Company's ability to handle larger traffic volumes) or obtain
interconnection in additional cities, in each case on acceptable terms, on a
timely basis or at all. In addition, in continental European cities where the
Company has interconnection through private parties, the Company cannot be
certain that it will be able to satisfactorily migrate to interconnection
agreements with PTTs.
In continental Europe, the Company generally must obtain its local
connectivity directly from the PTTs, which are its primary competitors in that
region. The PTTs have only recently begun the process of providing
interconnection to other carriers and in many cases have delayed doing so.
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<PAGE>
The Company's interconnection to the PTT in Belgium has been granted on a
temporary basis pending the adoption of certain new telecommunications
legislation in Belgium. The Company's interconnection agreement in Germany
granting the Company access to Deutsche Telekom's network expired at the end of
February 1999. The Company initiated legal action before the RegTP to ensure
continued interconnection with Deutsche Telekom's network at reasonable
conditions. The Company expects its temporary interconnections in Belgium and
Germany to be extended until relevant national rules or interconnection
decisions are adopted, although there can be no assurance that either of them
will be extended. If the Company were to lose either interconnection, the
Company would need to obtain interconnection from another carrier, which would
increase its transmission costs in that country. See
"Business--Regulation--Belgium" and "Business--Regulation--Germany."
CONSIDERATIONS AFFECTING INTERCONNECTION IN THE UNITED STATES
In the United States, the Company obtains interconnection from LECs. Because
per minute retail rates on U.S. domestic long distance calls are low, the access
and termination costs charged by LECs to long distance providers make up a
significant portion of the total cost of these calls. If a LEC increases its
access and termination charges, the Company's margins on domestic long distance
calls to that LEC's home region would be materially adversely affected. In
addition, when LECs are able to offer long distance services to their local
customers, they will not have to pay these access charges. This will put the
Company at a price disadvantage to the LECs.
DEPENDENCE ON TRANSMISSION LINE PROVIDERS
Transmission lines are the connections that carry substantially all of the
Company's voice and data communications. The Company has not constructed its own
fixed transmission lines and the Company does not have any plans to do so.
Instead, the Company either acquires ownership or a long-term right to use
(i.e., an IRU) the facilities of another carrier or consortium of carriers, or
the Company leases its transmission capacity on a short-term basis.
RISKS RELATING TO U.S. TRANSMISSION ARRANGEMENTS
In the United States, the Company currently has a lease arrangement with
Qwest that provides the Company with most of the Company's U.S. transmission
capacity. By primarily using one transmission provider in the United States, the
Company is able to obtain more favorable leased line charges, although it
increases the Company's dependence on a single transmission provider.
Because of the substantial increase in the Company's domestic traffic and
its desire to provide services in more U.S. markets, the Company recently
acquired a 20-year IRU from Frontier to use portions of its U.S. fiber optic
network. This will replace the Company's use of the Qwest network. Frontier is
in the process of building the fiber optic network that the Company will use,
and the Company expects this network to be completed and substantially
operational by the end of 1999. The Company expects to begin using a portion of
Frontier's network by July 1999, although there can be no assurance in this
regard. If the Frontier U.S. fiber optic network is not completed within this
time frame, the Company will need to obtain more expensive transmission capacity
from other network providers, which will reduce the Company's gross margins on
substantially all of the Company's U.S. calls. See "Business--The Destia
Network-- North American Network."
Because the Company will obtain most of its U.S. transmission capacity from
Frontier, network failures or quality problems experienced by Frontier will
affect the Company. Furthermore, because the network will be managed by Frontier
and not by the Company's own personnel, the Company will not have the ability to
directly remedy network problems. If Frontier is not able to adequately manage
and maintain the network or its interconnection, the Company could experience
quality and reliability problems, which would require it to secure more
expensive transmission capacity. In the past, Frontier has experienced
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<PAGE>
problems with its existing network, which utilizes technology different from
that of its new network. The Company cannot be certain that similar problems
will not arise with Frontier's new network or with the technology utilized in
the network. This could have a material adverse effect on the Company's
business.
RISKS RELATING TO ACQUIRING LINES FROM PTTS
In several European countries, including France and Germany, the only
large-scale providers of transmission facilities are the PTTs. In these
countries, the Company may be required to acquire or lease transmission capacity
at artificially high rates from a provider that occupies a monopoly or near
monopoly position. In some areas, PTTs may not be required by law to provide the
Company with the transmission capacity that may be required to implement its
anticipated growth plans.
Even when PTTs are required by law to provide transmission capacity to other
carriers, the Company and other private carriers have experienced recurring and
substantial delays in the negotiation of leases and interconnection agreements
and in the commencement of operations.
RISKS RELATING TO CAPACITY PURCHASE AND LEASE TERMS
Under the Company's short-term lease arrangements, the Company typically
acquires transmission capacity on a fixed cost basis for a term of one month,
one year or, in the case of its current arrangement with Qwest, three years. The
Company's long-term capacity arrangements are for periods of up to 20 or 25
years. The Company's IRU from Frontier for the Company's domestic network and
its IRU agreements provide it with capacity on various transatlantic crossings
are long-term capacity arrangements. See "Business--The Destia Network--Network
Economics."
When the Company negotiates purchase and lease agreements and makes a
determination to acquire a long-term lease or ownership of transmission capacity
rather than a short-term lease, the Company must estimate the future supply and
demand for transmission capacity, as well as the Company's customer calling
patterns and traffic levels. The Company's profitability depends, in part, on
its ability to obtain capacity on a cost-effective basis and determine when it
is appropriate to buy transmission capacity or lease it on a long-term basis,
rather than to lease it on a short-term basis. The Company could suffer
competitive disadvantages if the Company bases its acquisitions of transmission
capacity on inaccurate projections.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
In order to bill its customers, the Company must record and process large
amounts of data quickly and accurately. While the Company believes its
management information systems currently are adequate, if its customer base
continues to increase, the Company will need to continue to make substantial
investments in new and enhanced information systems. If the Company encounters
delays or cost-overruns or suffer adverse consequences in implementing these
systems, there could be a material adverse effect on its business. See
"Business--The Destia Network--Network Operations."
As the Company's information systems suppliers revise and upgrade their
hardware, software and equipment technology, the Company may encounter
difficulties in integrating these new technologies into the Company's business;
in addition, these new revisions and upgrades may not be appropriate for its
business.
DEVALUATION AND CURRENCY RISKS
A substantial portion of the Company's revenues and expenses are denominated
in non-U.S. currencies, consisting principally of the British pound and the
currencies represented by the euro. Although the Company's business strategy
contemplates that an increasing portion of its revenues and expenses will be
denominated in non-U.S. currencies, a disproportionate portion of its expenses,
including interest and principal on the Company's indebtedness, will
nevertheless continue to be denominated in U.S. dollars.
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<PAGE>
This exposes the Company to fluctuations in the rate of exchange between foreign
currencies and the U.S. dollar. Significant exchange rate fluctuations could
have a material adverse effect on the Company's business.
At times, the Company use foreign exchange contracts to hedge foreign
currency exposure resulting from the Company's non-U.S. trade accounts
receivables. Because of the number of currencies involved, the Company's
constantly changing currency exposure and the fact that all foreign currencies
do not fluctuate in the same manner against the U.S. dollar, the Company cannot
quantify the effect of exchange rate fluctuations on its future financial
condition or results of operations.
DEPENDENCE ON KEY PERSONNEL; INTEGRATION OF MANAGEMENT AND OTHER PERSONNEL
The Company's success depends largely on the skills, experience and
performance of key members of its senior management team. If the Company loses
one or more of these key employees, particularly Alfred West or Alan L. Levy,
the Company's ability to successfully implement its ambitious business plan
could be materially adversely affected. The Company has employment agreements
with certain senior employees, but it cannot prohibit its employees from
leaving. See "Item 11. Executive Compensation."
Under its equipment financing agreement (the "NTFC Agreement"), the Company
may not cease to employ Mr. West (other than by reason of his death or
disability) or let Mr. West compete with the Company. If the Company were to
breach its equipment financing agreement, it would be in default, which would
require the Company to prepay all borrowings outstanding thereunder, which would
cause a default under the indenture for the 1997 Notes (the "1997 Indenture")
and the indenture for the 1998 Notes (the "1998 Indenture") and could require
prepayment of all amounts outstanding on the 1997 Notes and the 1998 Notes. That
would have a material adverse effect on the Company's business.
YEAR 2000 TECHNOLOGY RISKS
The Company faces certain risks arising from Year 2000 issues. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance" for a discussion of certain risks relating to
Year 2000 issues.
DEPENDENCE ON ITS PRINCIPAL EQUIPMENT SUPPLIER
The Company purchases a significant portion of its switching equipment from
Northern Telecom. The Company also relies on Northern Telecom for a substantial
portion of its technical support for this equipment. From time to time, Northern
Telecom also introduces software and hardware upgrades, which increase the
efficiency and/or features of the Company's switching equipment. These upgrades
frequently can be purchased only directly from Northern Telecom. Northern
Telecom is aware of the Company's reliance on them for its network hardware and
the Company believes that this may put the Company at a disadvantage in its
negotiations with them to acquire network hardware at reasonable prices. See
"Business--The Destia Network--Network Hardware and Software."
As the Company continues to expand the Destia Network, the Company cannot be
certain that it will be able to acquire all of the compatible equipment that it
requires. The Company's inability to acquire network hardware on a timely basis
or at a reasonable price could result in delays, operational problems or
increased expenses, any of which could have a material adverse effect on the
Company's business.
ITEM 2. PROPERTIES
Destia's executive offices and main operations center is located in Paramus,
New Jersey. Additionally, the Company leases a call center in College Station,
Texas, an operations center in Brooklyn, New York, a network operations center
in St. Louis, Missouri and has leased space for sales offices in several cities
in
39
<PAGE>
the United States, including most of the following U.S. switch locations of the
Company: New York, New York; Miami, Florida; Dallas, Texas; Chicago, Illinois;
Washington, D.C.; and Los Angeles, California.
Outside of the United States, Destia has switch sites in Amsterdam, The
Netherlands; Berlin, Germany; Brussels, Belgium; Frankfurt, Germany; London,
United Kingdom; Paris, France; Toronto, Canada; and Zurich, Switzerland. The
Company has corporate offices in London and Paris. Destia maintains smaller
sales offices in Antwerp, Belgium; Athens, Greece; Berlin, Germany; Hamburg,
Germany; Lyon, France; Marseilles, France; Montreal, Canada; Vienna, Austria;
and Zurich, Switzerland.
ITEM 3. LEGAL PROCEEDINGS
Destia is from time to time a party to litigation that arises in the
ordinary course of its business operations or otherwise. Other than the current
legal action filed by the Company with the RegTP in Germany concerning
interconnection with Deutsche Telekom, Destia believes that it is not presently
a party to any litigation that, if decided in a manner adverse to the Company,
would have a material adverse effect on its business or operations. For a
discussion of the legal action in Germany, see "Item 1.
Business--Regulation--Germany."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is no public trading market for Destia's Common Stock. The Company
recently filed a registration statement on Form S-1 to register its common stock
for sale. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources."
As of March 1, 1999, the outstanding shares of Common Stock were held
principally by four persons and certain estate planning vehicles which they
control. On November 1, 1996, Princes Gate Investors II, L.P. ("Princes Gate"),
an affiliate of Morgan Stanley & Co. Incorporated ("Morgan Stanley"), purchased
140,000 shares of Series A Preferred Stock, par value $.01 per share ("Series A
Preferred Stock") for a purchase price of $14.0 million, less $560,000 in fees.
The Series A Preferred Stock is convertible into 3,420,701 shares of Common
Stock. See "Item 13. Certain Relationships and Related Transactions."
The Company's predecessor corporation, Econophone, Inc., became a
sub-Chapter C corporation during the first quarter of 1996. The Company did not
pay dividends on its Common Stock during 1998 and does not intend to pay any
dividends on its Common Stock for the foreseeable future. The NTFC Facility, the
terms of the Series A Preferred Stock and the Indentures pertaining to the 1997
Notes and the 1998 Notes contain significant limitations on the Company's
ability to pay dividends, the foregoing instruments generally limiting dividends
to a portion of net income. The Company does not expect to generate net income
for at least several years.
The holders of Series A Preferred Stock were entitled to receive a dividend
payable at the rate of 12% per annum, which was cumulative and compounded
monthly. This dividend ceased to accrue on July 1, 1997. Accrued dividends will
not be paid in cash on any shares of Series A Preferred Stock prior to any
redemption or liquidation of such shares. See "Item 13. Certain Relationships
and Related Transactions."
On July 1, 1997, the Company consummated the 1997 Unit Offering, in respect
of which Morgan Stanley acted as the Placement Agent. All of the Units were
initially purchased by Morgan Stanley pursuant to Section 4(2) of the Securities
Act and resold to "qualified institutional buyers" pursuant to Rule 144A
thereunder. The Units were sold by the Company to Morgan Stanley for
$149,575,000, resulting in an aggregate discount of $5,425,000.
Each Warrant entitles the holder thereof to purchase 8.167 shares of Common
Stock from the Company at a price of $.01 per share, subject to adjustment for
certain dilutive events. The Warrants may be exercised at any time beginning on
July 1, 1998 and ending on July 1, 2007.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data (with the exception of
Other Data and Regional Data) for the years presented below was derived from the
audited consolidated financial statements of Destia. The audited consolidated
financial statements of Destia as of December 31, 1997 and 1998 and for each of
the three years in the period ended December 31, 1998, together with the notes
thereto and the related report of Arthur Andersen LLP, independent public
accountants, are included elsewhere herein. The information contained below
should be read in conjunction with "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Financial Statements
of Destia and the notes related thereto included elsewhere herein.
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<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1994 1995 1996 1997 1998
------------ ------------ ------------ ------------ ------------
<CAPTION>
(IN THOUSANDS, EXCEPT REVENUE PER MINUTE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................... $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 193,737
Cost of services........................... 5,540 19,735 35,369 63,707 140,548
------------ ------------ ------------ ------------ ------------
Gross profit............................... 2,983 7,755 9,734 19,296 53,189
Selling, general and administrative
expense.................................. 2,013 7,087 16,834 37,898 80,092
Depreciation and amortization.............. 168 389 1,049 3,615 11,866
------------ ------------ ------------ ------------ ------------
Income (loss) from operations.............. 802 279 (8,149) (22,217) (38,769)
Interest income............................ 6 19 84 3,689 11,516
Interest expense........................... (109) (167) (380) (11,437) (41,030)
Other income (expense)..................... 100 (10) 133 (163) (661)
Provision for income taxes................. 73 -- -- -- --
------------ ------------ ------------ ------------ ------------
Net income (loss).......................... $ 726 $ 121 $ (8,312) $ (30,128) $ (68,944)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Net earnings (loss) per share:
Basic and diluted.......................... .04 .01 (0.43) (1.55) (3.45)
Weighted average number of shares of common
stock outstanding (basic and diluted).... 20,000,000 20,000,000 20,000,000 20,000,000 20,000,000
OTHER DATA:
Capital expenditures and acquisitions...... $ 906 $ 1,677 $ 4,670 $ 19,021 $ 111,999
EBITDA(1).................................. 970 668 (7,100) (18,602) (26,903)
Distributions to S Corporation
shareholders(2).......................... -- 499 226 -- --
Preferred dividends(3)..................... -- -- 281 879 --
Net cash provided by (used in) operating
activities............................... 474 2,037 (6,006) (12,219) (26,414)
Net cash used in investing activities...... (801) (1,206) (4,247) (13,267) (119,092)
Net cash provided by (used in) financing
activities............................... 292 (810) 16,419 145,844 177,561
Revenue per minute......................... .70 .57 .43 .25 .22
REGIONAL DATA:
Revenues
Continental Europe....................... $ 2,652 $ 5,025 $ 11,441 $ 15,741 $ 21,101
United Kingdom........................... 3,143 14,173 15,477 18,363 55,991
North America............................ 2,728 8,292 18,185 48,899 116,645
------------ ------------ ------------ ------------ ------------
Total.................................. $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 193,737
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Minutes
Continental Europe....................... 1,957 3,856 8,351 17,239 45,085
United Kingdom........................... 4,532 20,592 27,968 68,810 288,892
North America............................ 5,707 23,411 68,247 244,095 549,654
------------ ------------ ------------ ------------ ------------
Total.................................. 12,196 47,859 104,566 330,144 883,631
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1994 1995 1996 1997 1998
------------ ------------ ------------ ------------ ------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................... 86 106 6,272 67,202 139,561
Restricted cash and securities (4)......... -- -- -- 59,427 40,467
Total assets............................... 4,034 10,508 22,755 178,005 388,208
Current portion of borrowings.............. 480 558 3,020 2,300 16,694
Long-term borrowings, less current
portion.................................. 639 719 2,263 155,616 380,748
Redeemable convertible preferred stock..... -- -- 13,358 14,328 14,421
Total stockholders' equity (deficit)....... 1,088 710 (8,124) (33,726) (102,467)
</TABLE>
- ------------------------
(1) "EBITDA" is defined as net income (loss) plus net interest expense, income
tax expense, and depreciation and amortization expense. The Company has
included information concerning EBITDA herein because this type of
information is commonly used in the telecommunications industry as one
measure of a Company's operating performance and liquidity. EBITDA is not
determined using GAAP and, therefore, the Company's EBITDA is not
necessarily comparable to EBITDA of other companies. EBITDA also does not
indicate cash provided by operating activities and should not be used as a
measure of the Company's operating income and cash flows from operations
under GAAP. Both of those measures are presented above. EBITDA should not be
considered either in isolation, as an alternative to or as more meaningful
than measures of performance determined in accordance with GAAP.
(2) The distributions reflected in this line item were declared when the Company
were a subchapter S corporation under U.S. tax law.
(3) The Series A Preferred Stock accrued monthly dividends at a compounded
monthly rate of 12% per year. The dividends began to accrue and compound
interest from November 1, 1996, the issuance date of the Series A Preferred
Stock, and ceased to accrue on July 1, 1997.
(4) The Company used $57.4 million of the net proceeds from the 1997 Unit
Offering to purchase a portfolio of U.S. government securities that the
Company reserved for the payment of the first six scheduled interest
payments due on the $155.0 million principal amount of the 1997 Notes that
it issued in the 1997 Unit Offering. Warrants also were issued in the 1997
Unit Offering.
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH DESTIA'S
FINANCIAL STATEMENTS, THE NOTES THERETO AND THE OTHER FINANCIAL DATA INCLUDED
ELSEWHERE IN THIS ANNUAL REPORT. THE FOLLOWING DISCUSSION INCLUDES CERTAIN
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS,
SEE "SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS" AND "ITEM 1.
BUSINESS--RISK FACTORS."
OVERVIEW
The Company is a rapidly growing, facilities-based provider of domestic and
international long distance telecommunications services in North America and
Europe. Its extensive international telecommunications network allows it to
provide services primarily to retail customers in many of the largest
metropolitan markets in the United States, Canada, the United Kingdom, Belgium,
France, Germany and Switzerland.
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services, and wholesale transmission services. The
Company's approximately 350,000 customer accounts are diverse and include
residential customers, commercial customers, ethnic groups and
telecommunications carriers. In each of the Company's geographic markets, it
utilizes a multichannel distribution strategy to market its services to its
target customer groups.
REVENUES
The Company's revenues are primarily based on usage and are derived from (1)
the number of minutes of telecommunications traffic carried and (2) generally, a
fixed per minute rate. The following table shows the total revenue and billable
minutes of use attributable to the Company's operations by region for 1996, 1997
and 1998. Over time, the Company expects its European markets to contribute a
larger percentage of its revenues.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1996 1997 1998
---------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUE
North America................................................................ $ 18,185 $ 48,899 $ 116,645
United Kingdom............................................................... 15,477 18,363 55,991
Continental Europe........................................................... 11,441 15,741 21,101
---------- ---------- ----------
Total........................................................................ $ 45,103 $ 83,003 $ 193,737
---------- ---------- ----------
---------- ---------- ----------
BILLABLE MINUTES OF USE
North America................................................................ 68,247 244,095 549,654
United Kingdom............................................................... 27,968 68,810 288,892
Continental Europe........................................................... 8,351 17,239 45,085
---------- ---------- ----------
Total........................................................................ 104,566 330,144 883,631
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The Company generally prices its services at a discount to the dominant
carrier (or carriers) in each of its markets. The Company has experienced and
expects to continue to experience declining revenue per minute in all of its
markets, particularly European markets, as a result of increased competition.
However, the Company believes such declines in revenue per minute will be offset
in part by an increased demand for long distance services and declining costs of
transmission. Historically, transmission costs in the
44
<PAGE>
telecommunications industry have declined at a more rapid rate than prices due
to technological innovation and the availability of substantial transmission
capacity. There can be no assurance that this cost trend will continue. See
"Item 1. Business--Risk Factors--Increasing Pricing Pressures."
The Company's revenues are recorded upon completion of calls. For prepaid
services, the Company's revenues are reported net of selling discounts and
commissions and are recorded based upon usage rather than at the time of initial
sale.
Revenues also include amounts billed to customers which are, in turn,
remitted to third parties, including universal service fund fees, fixed rate
access charges paid to LECs and payphone owner compensation fees. These charges
are expensed in cost of services in amounts similar to corresponding amounts
billed to customers and included in revenue.
COST OF SERVICES
The major components of the Company's cost of services are the cost of
origination, transmission and termination of traffic. Virtually all calls
carried by Destia must be originated or terminated on another carrier's local
facilities, for which the Company pays a per minute charge. These charges are
known as "access" or "termination" charges. In countries where the Company has
interconnection, it is able to originate and terminate calls more
cost-effectively, either pursuant to fixed price contractual arrangements with
PTTs or LECs or pursuant to a tariff.
The Company's transmission cost of services consists of expenses related to
leased lines and switched minutes. The Company typically acquires leased lines
on a fixed cost basis, which involve monthly payments regardless of usage
levels. Leased lines are used for specific point-to-point routes and have a
shorter duration than IRUs. Because the cost of leased lines is typically a
fixed monthly payment, transmitting an increased portion of the Company's calls
over leased lines reduces its incremental transmission costs. Accordingly, once
certain traffic volume levels are reached, leased line capacity is more cost
effective than capacity acquired on a variable cost basis, such as switched
minutes.
To transmit calls to locations not covered by its network, the Company
acquires switched minutes from other carriers. Switched minutes are acquired on
a per minute basis (with volume discounts) and, accordingly, are a variable
cost. The cost of switched minutes also includes termination charges. As the
Company's minutes of traffic carried have grown, the Company has obtained better
pricing on switched minute transmission capacity. In general, the Company
expects its marginal cost of services will decline over time due to greater
usage of owned transmission capacity, technological innovation, increased
leverage with suppliers and the increasing availability of substantial
third-party transmission capacity.
A substantial and increasing portion of the Company's calls are also
transmitted over its IRUs. The cost of IRUs is expensed in depreciation and
amortization and is, therefore, not accounted for as part of cost of services.
Cost of services also includes amounts billed to customers which are, in
turn, remitted to third parties. See "--Revenues."
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A")
To date, the Company has sold its services primarily through independent
sales channels. Selling expenses have, therefore, primarily consisted of
commissions paid to agents. To a lesser extent, selling expenses have also
included advertising and promotion costs, sales by the Company's internal sales
force and expenses related to its customer service department. Since completing
the acquisition of VoiceNet during the first quarter of 1998, the Company's
commissions paid to and retained by VoiceNet (i.e., commissions not subsequently
paid by VoiceNet to its independent sales agents) have been eliminated.
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<PAGE>
The Company is continuing to increase its internal sales force and this
expansion will significantly increase the selling expenses associated with
operating and staffing sales offices. In addition, as the Company expands its
customer base in new and existing markets, it intends to increase its
advertising expenses. The Company expects all of these costs to eventually
decline as a percentage of its revenues. General and administrative expenses
have increased primarily as a result of the Company's expansion of its customer
service, billing, financial reporting and other management information systems.
These expenses have also increased as a result of implementing more extensive
network management systems and organizational expenses related to entering
additional markets.
DEPRECIATION AND AMORTIZATION EXPENSE
The Company's depreciation and amortization expense is primarily related to
depreciation on the Company's IRUs and switching equipment, amortization of
costs associated with the issuance of the 1997 Notes and 1998 Notes and
amortization of goodwill from the purchases of VoiceNet and the minority
interest in Telco.
As the Company expands the Destia Network, it will continue to add new
switching equipment and acquire additional IRUs, both of which will increase the
Company's depreciation expense. IRUs involve only fixed costs, with no per
minute charges, and are a more cost-effective means of transmitting traffic once
certain volume levels are reached. The Company recently acquired a 20-year IRU
from Frontier which provides Destia with fiber optic transmission capacity in
the United States. The Company also intends to acquire additional IRUs,
particularly in Europe. To the extent the Company's increased use of IRUs
reduces its utilization of leased lines and switched minutes, the increase in
depreciation expense of the IRUs will be offset by a decrease in the cost of
services of leased lines and switched minutes. As a result, although the
Company's gross margins are expected to improve, the Company's net income (loss)
will not necessarily improve to the same extent.
INTEREST EXPENSE
Prior to July 1, 1997, interest expense principally consisted of interest
payable in connection with equipment financing loans and short-term
indebtedness. The 1997 Notes and 1998 Notes currently constitute most of the
Company's interest expense. Annual interest expense for the 1997 Notes and 1998
Notes will aggregate $43.3 million in 1999. The 1998 Notes were issued at a
discount and accrete to their aggregate principal amount at maturity on February
15, 2003. Until that date, interest expense on the 1998 Notes will increase in
each period. Thereafter, interest on the 1998 Notes will accrue and be required
to be paid in cash semi-annually.
RESULTS OF OPERATIONS
The following table presents certain data concerning Destia's results of
operations for 1996, 1997 and 1998.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues....................................................................... $ 45,103 $ 83,003 $ 193,737
Cost of services............................................................... 35,369 63,707 140,548
Selling, general and administrative expenses................................... 16,834 37,898 80,092
Depreciation and amortization.................................................. 1,049 3,615 11,866
Net income (loss).............................................................. (8,312) (30,128) (68,944)
</TABLE>
46
<PAGE>
1998 COMPARED TO 1997
REVENUES. Total revenues for 1998 increased by 133% to $193.7 million from
$83.0 million for 1997. Billable minutes of use increased 168% to 883.6 million
in 1998 from 330.1 million in 1997. The increases in revenues and billable
minutes were primarily attributable to strong customer growth in both the U.S.
and U.K. markets. Revenues for all services increased substantially from 1997 to
1998. The increase in revenues resulting from the growth in billable minutes was
partially offset by per-minute price reductions caused by increased competition,
most significantly in the U.K. and continental European markets. This
competition was a primary factor in the decrease in average revenue per minute
from $.25 per minute during 1997 to $.22 per minute in 1998.
In North America, revenues grew by 139% to $116.6 million from $48.9
million. This increase was due principally to prepaid and calling card revenues.
The remainder of the increase resulted from increases in long distance revenues.
Average North American revenue per minute increased to $.21 per minute during
1998 from $.20 per minute during 1997. This increase was due principally to the
substantial growth of prepaid card sales, which typically carry a higher per
minute rate than long distance service, offset in part by rate decreases for
long distance services.
In the United Kingdom, revenues increased 205% to $56.0 million in 1998 from
$18.4 million in 1997, while the average revenue per minute decreased from $.27
per minute during 1997 to $.19 per minute during 1998. This reduction was due
principally to increased price competition.
In continental Europe, revenues increased by 34% to $21.1 million from $15.7
million. A portion of this revenue growth was attributable to a full year of
revenue reported for certain country operations that commenced during 1997.
Average continental European revenue per minute decreased from $.91 per minute
during 1997 to $.47 per minute during 1998, as a result of increased competition
brought about by deregulation of the Company's continental European markets.
GROSS MARGIN. The Company's gross margin for 1998 increased to 27.5% from
23.2% for 1997. This increase was attributable to (1) expansion of the Destia
Network (which shifted some expenses from cost of services to depreciation
expense), (2) migration of additional switched traffic onto the Destia Network,
(3) "least-cost" routing, (4) leveraging the Company's traffic volumes to
negotiate lower usage-based costs from domestic and foreign providers of
transmission capacity and (5) the Company's ability to obtain more cost
effective interconnect agreements. An improvement in gross margin does not
necessarily result in an equal improvement in net income (loss). See
"--Overview--Cost of Services."
SG&A. SG&A increased to $80.1 million for 1998 from $37.9 million for 1997,
and, as a percentage of revenues was 41% for 1998 and 46% for 1997. The decrease
in SG&A as a percentage of revenue during 1998 was primarily attributable to the
significant increase in revenues. The increase of $42.2 million in SG&A from
1997 was attributable to the expansion of the sales, operations and back office
infrastructure to support the significant retail sales growth the Company
experienced in 1998. During 1998 the Company expanded its management team and
significantly increased staffing levels in its customer service, network
management, management information systems and finance organizations. In
addition, substantial expenses were incurred in connection with entering new
markets and further developing existing marketing and sales channels. The
Company recorded bad debt expense of $7.4 million, or 3.8% of revenue, for 1998,
compared to bad debt expense of $3.9 million, or 4.7% of revenue, for 1997. This
decline in bad debt expense as a percent of revenue was primarily the result of
improved credit and collection procedures and controls.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $11.9 million for 1998 from $3.6 million for 1997. This increase
was substantially due to the continuing build-out of the Company's network in
the United States, the United Kingdom and continental Europe, amortization of
costs associated with the Company's issuance of the 1997 Notes and the 1998
Notes and amortization of goodwill from the purchases of VoiceNet and the
minority interest in Telco.
47
<PAGE>
INTEREST EXPENSE AND INTEREST INCOME. Interest expense increased to $41.0
million in 1998 from $11.4 million in 1997. This increase was attributable to
the issuance of the 1997 Notes and the 1998 Notes. Interest income increased to
$11.5 million in 1998 from $3.7 million in 1997. This increase was primarily due
to interest income earned on the investment of the net proceeds received from
the 1998 Notes.
NET LOSS. The Company reported a net loss of $68.9 million for 1998,
compared to a net loss of $30.1 million for 1997. The increase in net loss is
primarily due to the higher level of SG&A expenses and higher interest expense.
Net loss is expected to increase substantially over the near term, primarily due
to interest expense incurred on the 1998 Notes and the 1997 Notes.
1997 COMPARED TO 1996
REVENUES. Total revenues for 1997 increased by 84% to $83.0 million on
330.1 million billable minutes of use from $45.1 million on 104.6 million
billable minutes of use for 1996. Billable minutes of use increased by 216% for
1997 from 1996. Growth in revenues during 1997 primarily was attributable to
additional minutes of use, particularly in the United States, offset in part by
a substantial decline in prices, as a result of increased competition. This
competition was a primary factor for the average revenue per minute decrease
from $.43 during 1996 to $.25 during 1997. An additional factor in the decrease
in revenues per minute was a larger portion of national, as opposed to
international, minutes of use. The increase in revenues was primarily
attributable to sales by VoiceNet of $23.6 million for 1997, compared to $1.9
million for 1996.
In the United Kingdom, revenues increased by 19% to $18.4 million from $15.5
million, primarily due to sales by Telco, which increased, to $10.6 million in
1997 from $1.3 million in 1996. Increases in U.K. revenue were partially offset
by the termination of the Company's business relationship with EI, which
accounted for $14.2 million in revenues in 1996. During the fourth quarter of
1996, the Company began marketing efforts in the U.K. through Telco. During
1997, U.K. revenues consisted principally of $10.6 million from international
and domestic long distance and prepaid card services attributable to Telco, as
well as $7.2 million from carrier services sold through America Telemedia
Limited ("ATL"), a wholly-owned subsidiary of the Company. Average U.K. revenue
per minute decreased from $.55 per minute during 1996 to $.27 per minute during
1997. This reduction was due principally to sales of a larger percentage of
domestic long distance minutes, which are sold at lower rates than international
minutes, and to increased price competition.
In continental Europe, revenues increased by 38% to $15.7 million from $11.4
million. This increase was attributable to an increase in prepaid card services,
primarily in France and Germany. Average continental European revenue per minute
decreased from $1.37 per minute during 1996 to $.91 per minute during 1997. This
decrease was due to lower rates in France and Germany.
In North America, revenues grew by 169% to $48.9 million from $18.2 million.
This increase was due principally to calling card revenues attributable to sales
by VoiceNet, which were $23.6 million during 1997, compared to $1.9 million
during 1996. VoiceNet began reselling the Company's calling card services to
end-users during the second quarter of 1996. The remainder of the increase
resulted from increases in sales of carrier services, and, to a lesser extent,
international and domestic long distance and prepaid card services. Average U.S.
revenue per minute decreased to $.20 per minute during 1997 from $.27 per minute
during 1996. This reduction was due principally to sales of a larger percentage
of domestic long distance minutes, which are sold at lower rates than
international minutes, and to increased price competition.
During 1997, the Company experienced an average customer turnover or "churn"
rate of approximately 5% relating to U.S., U.K. and continental European "1+",
"1xxx" and calling card services. To date, the Company's revenues and margins
have not been materially impacted by its "churn" rate. The Company's "churn"
rate with respect to any given period consists of the average number of
customers that ceased using the Company's services during any month of the
period divided by the average monthly number of customers for the period.
Customers that have ceased using the Company's services during any
48
<PAGE>
given month are those customers who used the Company's services during the prior
month but not during any subsequent month of the applicable period.
GROSS MARGIN. The Company's gross margin for 1997 increased to 23.2% from
21.6% for 1996. This increase was attributable to the Company's increased use of
owned and leased line transmission capacity and its ability to obtain lower
prices on switched transmission capacity because of increased traffic volumes
and a greater availability of capacity generally.
SG&A. SG&A increased to $37.9 million for 1997 from $16.8 million for 1996,
and, as a percentage of revenues, was 46% for 1997 and 37% for 1996. The
increase primarily consisted of commissions paid to resellers (principally
VoiceNet) and independent agents, an increase in payroll costs related to
additional management and staff in the areas of finance, sales, customer
service, network management and information systems at the Company's Manhattan,
New York, Brooklyn, New York and College Station, Texas facilities, as well as
the London, Brussels, Hamburg and Paris offices. For 1996, a majority of the
expenses consisted of expenses related to EI and commissions paid to independent
sales agents.
In connection with the termination of the Company's joint venture with EI
during June 1996, EI granted the Company the right to compete with EI in the
United Kingdom in exchange for forgiveness of a net receivable due to the
Company of $2.0 million. The forgiveness of the receivable has been reclassified
as an expense of the joint venture and was charged to bad debt expense. The
Company previously had capitalized the U.K. territorial rights granted to it by
EI on its consolidated balance sheet and was amortizing the rights over a
15-year life. The Company subsequently decided to write off this asset,
resulting in an additional $1.9 million charge in 1996.
The Company recorded bad debt expense of $3.9 million, or 4.7% of revenue,
for 1997, compared to bad debt expense of $2.0 million, or 4.4% of revenue, for
1996. The charge in 1996 was related to EI.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $3.6 million for 1997 from $1.0 million for 1996. This increase was
substantially due to the depreciation associated with upgrades in the Company's
switch in New York and installation of multiplexing equipment in New York and
London, as well as amortization of costs associated with the 1997 Unit Offering.
INTEREST EXPENSE. The Company had $11.4 million of interest expense during
1997, as compared to interest expense of $0.4 million during 1996. Interest
expense has increased substantially as a result of the 1997 Unit Offering, with
$10.5 million of 1997 expense attributable to the 1997 Unit Offering.
NET LOSS. The Company had a net loss of $30.1 million during 1997, compared
to a net loss of $8.3 million during 1996. The increase is primarily due to
costs associated with increasing the internal infrastructure, building the
network, marketing, commissions paid to resellers and interest expense related
to the 1997 Notes.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses and made
substantial capital expenditures, due in large part to the start-up and
development of the Company's operations and the Destia Network. The Company will
continue to incur additional losses and have substantial additional capital
expenditures. The Company has utilized cash provided from financing activities
to fund losses and capital expenditures. The sources of this cash have primarily
been the proceeds from the sale of the 1997 Notes and the 1998 Notes and, to a
lesser extent, equipment-based financing.
As of December 31, 1998, the Company had $139.6 million of cash, cash
equivalents and marketable securities, as well as $40.5 million of restricted
cash and securities (which will be used to pay interest expense on the 1997
Notes through July 15, 2000). The Company believes that the net proceeds of the
Offering, as well as equipment loans it expects to obtain and cash on hand, will
provide sufficient funds for the foreseeable future. However, the amount of the
Company's future capital requirements will depend on
49
<PAGE>
a number of factors, including the success of its business, its gross margins,
and its SG&A expenses, as well as other factors, many of which are not within
its control, including competitive conditions and regulatory developments. In
the event that the Company's plans or assumptions change or prove to be
inaccurate, it may be required to delay or abandon some or all of its
development and expansion plans or the Company may be required to seek
additional sources of capital. Future sources may include public debt or equity
offerings or equipment financing. There can be no assurance that additional
financing arrangements will be available on acceptable terms.
The Company's capital expenditures during 1998 were approximately $76.7
million. These investments were made principally to support the continued
expansion of the Destia Network, including the purchase of telecommunications
equipment and the purchase of additional transatlantic IRUs. In addition, the
Company made investments related to the continued development of its back office
capabilities, including management information and network management systems.
On January 29, 1999, the Company filed a preliminary Registration Statement
on Form S-1 ("Registration Statement") with the Commission to register shares of
its Common Stock in connection with an initial public offering. The Company
amended the Registration Statement on February 17, 1999 to include year-end
financial information for 1998. The Company has not yet begun to market the
Offering. The net proceeds from the Offering therefore cannot be estimated at
this time.
In 1999, the Company plans to spend approximately $100 million for capital
expenditures on network equipment, back-office systems, the continued build-out
of its network operations center in St. Louis, Missouri, transatlantic IRUs and
other fiber optic transmission capacity. Actual capital expenditures may be
significantly different from the Company's current plans, in part because the
Company intends to be opportunistic in acquiring transmission capacity in a
dynamic market. The Company also expects to have substantial capital
expenditures after 1999.
The Company's net cash used in operating activities was $26.4 million for
1998 and was primarily attributable to a net loss of $68.9 million and an
increase in accounts receivable of $22.1 million partially offset by an increase
in accounts payable, accrued expenses and other current liabilities of $34.7
million and non-cash interest expense of $17.7 million. Net cash used in
investing activities of $119.1 million for 1998 was attributable to the purchase
of marketable securities, investments made primarily in switching and other
telecommunications equipment and IRUs and the VoiceNet acquisition. Net cash
provided by financing activities in 1998 of $177.6 million was primarily related
to the issuance of the 1998 Notes.
On February 12, 1998, the Company acquired VoiceNet, a major distribution
channel for the Company's calling card products. The initial purchase price was
$21.0 million, which was paid in cash. The sellers of VoiceNet also are entitled
to receive an earn-out based upon the revenue growth of the VoiceNet business.
The earn-out bonus will not have a material impact on the Company's liquidity.
The acquisition was accounted for under the purchase method of accounting.
Goodwill was recorded to the extent the purchase price exceeded the fair value
of the net assets purchased. Approximately $1.0 million of the initial purchase
price will reflect the underlying value of the assets acquired and $20.0 million
will reflect goodwill. The goodwill is being amortized over 20 years.
At the end of 1998, the Company completed two small acquisitions. In
November 1998, the Company acquired a controlling interest in America First Ltd.
("America First"), a prepaid card distributor in the United Kingdom for
approximately $5.5 million. The majority of the purchase price was recorded as
goodwill and will be amortized over 20 years. In December 1998, the Company also
acquired the customer list of a long distance reseller, also located in the
United Kingdom. The purchase price was allocated to the customer base and will
be amortized over 5 years.
In the United Kingdom, the majority of the Company's sales are made through
Telco, its majority owned subsidiary. On July 17, 1998, the Company acquired the
minority interest in Telco that it did not already own in exchange for a note in
the principal amount of approximately $14.0 million, payable by the
50
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Company in quarterly installments, together with interest at a rate of 8.0% per
annum, over approximately three years. The entire purchase price is classified
as goodwill, which will be amortized over 20 years. In connection with such
acquisition, (1) Telco obtained ownership rights with respect to certain
proprietary software used in Telco's business and (2) the Company converted
options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock.
During 1998, the Company incurred certain other non-operating cash
commitments which, as of December 31, 1998, included approximately $42.3 million
in the aggregate for a 20-year IRU from Frontier to use portions of its U.S.
fiber optic network and for the purchase of a transatlantic IRU. As of December
31, 1998, the Company is required to pay approximately $1.2 million per quarter
as installments of principal on its equipment facility. In addition, the Company
pays $20.9 million per annum as interest expense on the 1997 Notes. The Company
has put funds in escrow to cover this expense through July 15, 2000. For a
discussion of the Company's IRU from Frontier, see "Item 1. Business--The Destia
Network--North American Network."
The Company continually evaluates business opportunities, including
potential acquisitions. In addition, although the Company is not currently
engaged in negotiations regarding any material acquisitions, the Company may use
net proceeds of the Offering to fund suitable strategic acquisitions. The
Company will seek to acquire or align itself with complementary companies that
(1) offer attractive opportunities in new geographic markets (with an emphasis
on continental Europe), (2) have an established customer base or (3) have
innovative telecommunications services or technologies (such as data
transmission and Internet services).
MARKET RISK
The carrying value of cash and cash equivalents approximates fair value due
to the short-term, highly liquid nature of the cash equivalents, which have
maturities of three months or less. Interest rate fluctuations would not have a
significant effect on the fair value of cash equivalents held by the Company.
At December 31, 1998 the Company had debt in the amount of $396.8 million of
which $375.7 million is fixed interest debt. The remaining $21.1 million carries
adjustable interest rates equal to the 90-day commercial paper rate plus 395
basis points. A one percent change in the interest rate would change interest
payments by approximately $18,000 per month.
FOREIGN CURRENCY EXPOSURE
The Company is exposed to fluctuations in foreign currencies relative to the
U.S. dollar because the Company bills in local currency, while transmission
costs are largely incurred in U.S. dollars and interest expense on the 1997
Notes and 1998 Notes is in U.S. dollars. For each of 1998 and 1997,
approximately 40% of the Company's revenues were billed in currencies other than
the U.S. dollar, consisting primarily of British pounds and Belgian francs. The
effect of these fluctuations on the Company's revenues for 1998 and 1997 was
immaterial. As the Company expands its operations, a higher percentage of
revenues is expected to be billed in currencies other than the U.S. dollar. The
Company from time to time uses foreign exchange contracts relating to its trade
accounts receivables to hedge foreign currency exposure and to control risks
relating to currency fluctuations. The Company does not use derivative financial
instruments for speculative purposes. At December 31, 1998 and 1997, the Company
had $0 and $.3 million open foreign currency hedging positions, respectively.
EURO CONVERSION
On January 1, 1999, several member countries of the EU established fixed
conversion rates and adopted the euro as their new common legal currency. Since
that date, the euro has traded on currency exchanges, although the legacy
currencies will remain legal tender in the participating countries for a
transition period between January 1, 1999 and January 1, 2002. During the
transition period, parties can
51
<PAGE>
elect to pay for goods and services and transact business using either the euro
or a legacy currency. Between January 1, 2002 and July 1, 2002, the
participating countries will introduce euro currency coins and withdraw all
legacy currencies.
The euro conversion may affect cross-border competition by creating
cross-border price transparency. The Company is assessing its pricing and
marketing strategy in order to insure that it remains competitive in a broader
European market. In addition, the Company is reviewing whether certain existing
contracts will need to be modified. The Company's currency risks and risk
management for operations in participating countries may be reduced as the
legacy currencies now trade at a fixed exchange rate against the euro. The
Company will continue to evaluate issues involving introduction of the euro.
However, based on current information and assessments, the Company does not
expect that the euro conversion will have a material adverse effect on its
results of operations or financial condition.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use software, dividing the development into three stages: (1) the
preliminary project stage, during which conceptual formulation and evaluation of
alternatives takes place, (2) the application development stage, during which
design, coding, installation and testing takes place and (3) the operations
stage during which training and maintenance takes place. Costs incurred during
the application development stage are capitalized, all other costs are expensed
as incurred. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company is currently evaluating the
impact of adopting SOP 98-1.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." SOP 98-5 requires that all non-governmental entities
expense the costs of start-up activities, including organization costs, as those
costs are incurred. SOP 98-5 is effective for financial statements for fiscal
years beginning after December 15, 1998. The Company has reviewed the provisions
of SOP 98-5 and does not believe adoption of this standard will have a material
effect on its results of operations.
YEAR 2000 COMPLIANCE
The Company is engaged in an ongoing process of assessing its exposure to
the Year 2000 issue--the potential problems arising from computer systems that
were designed to use two digits, rather than four, to specify the year. The
Company has formed a project team (consisting of representatives from its
information technology, finance, business development, product development,
sales, marketing and legal departments) to address internal and external Year
2000 issues. By December 31, 1998, the Company had completed its internal review
of its financial and other computer systems (which include switching, billing
and other platforms) to assess Year 2000 issues. Based on this review, the
Company believes that the amount of work and expense required to address Year
2000 issues relating to its internal systems will not be material. The Company
is upgrading certain of its Northern Telecom switches to make them and their
related software Year 2000 compliant. The Company expects this upgrade to be
completed by June 30, 1999 at a cost of approximately $1.3 million. In addition,
the Company may be required to modify some of its other existing software. The
Company estimates that it will have updated all of its significant internal
systems to make them Year 2000 compliant and will be able to begin testing by
June 30, 1999.
In addition to assessing its own systems, the Company plans to retain a
consulting firm by May 1999 to assist it in conducting an external review of its
significant customers, suppliers and other third parties with which it does
business, including significant equipment and system providers and
telecommunications service providers, to determine their vulnerability to Year
2000 problems and any potential impact on the
52
<PAGE>
Company. In particular, the Company may experience problems to the extent that
other telecommunications carriers are not Year 2000 compliant. The Company
anticipates that this external review and related third party review will be
substantially completed by September 30, 1999. The Company's ability to
determine the status of these third parties, ability to address issues relating
to the Year 2000 issues is limited and there is no assurance that these third
parties will achieve full Year 2000 compliance before the end of 1999.
The Company believes that its reasonably possible worst case Year 2000
scenario is disruption of its ability to route traffic over portions of its own
network or an inability to terminate calls to certain destinations, which would
require the Company to utilize other transmission capacity at greater cost. To
the extent that a limited number of carriers experience disruption in service
due to the Year 2000 issue, the Company's contingency plan is to obtain service
from alternate carriers. However, there is no assurance that alternate carriers
will be available or, if available, that the Company can purchase transmission
capacity at a reasonable cost. In addition, in many continental European
countries there are no alternative carriers to use. Significant Year 2000
failures in the systems of the Company, alternate carriers and other third
parties (or third parties on whom they depend) would have a material adverse
effect on the Company's business.
The Company estimates the total cost for resolving its Year 2000 issues to
be approximately $2.0 million, of which approximately $1.0 million has been
spent through March 1, 1999, with the majority of expenditures expected to be
incurred in the first two quarters of 1999 in connection with upgrades of its
Northern Telecom switches. This estimate includes the accelerated cost of
replacing systems that are not Year 2000 compliant. Actual costs may, however,
differ materially.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations".
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 of Part II is incorporated herein by
reference to the Consolidated Financial Statements filed with this report; see
Item 14 of Part IV.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the
directors, executive officers and other senior management of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------ --- ----------------------------------------------------------------
<S> <C> <C>
Alfred West............................... 37 Chief Executive Officer and Chairman of the Board of Directors
Alan L. Levy.............................. 39 President, Chief Operating Officer and Director
Kevin A. Alward........................... 32 President-North America
Phillip J. Storin......................... 48 Senior Vice President and Chief Financial Officer
Richard L. Shorten, Jr.................... 31 Senior Vice President and General Counsel
Abe Grohman............................... 38 Chief Information Officer
Daran M. Churovich........................ 44 Vice President of Global Network Engineering
Ines C. LeBow............................. 53 Vice President of Global Network Operations
Barry Toser............................... 40 Vice President of Global Carrier Services
Paolo Di Fraia............................ 38 Managing Director-Continental Europe
Michael Whittingham....................... 47 Director of International Project Development
Mark St. J. Courtney...................... 39 Director of European Commercial and Regulatory Affairs
Gary S. Bondi............................. 47 Director and Treasurer
Steven West............................... 48 Director
Stephen R. Munger......................... 41 Director
</TABLE>
ALFRED WEST, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD OF
DIRECTORS. Mr. West founded the Company in 1992. Prior to founding the Company,
Mr. West managed a family-owned textile trading company. Mr. West is the brother
of Steven West, a Director of the Company.
ALAN L. LEVY, PRESIDENT, CHIEF OPERATING OFFICER AND DIRECTOR. Mr. Levy has
served as the Company's Chief Operating Officer since August 1996, as a Director
since January 1997 and as President since August 1997. Mr. Levy also served as
Chief Financial Officer from August 1996 to January 1998. From October 1993 to
July 1996, Mr. Levy served as Executive Vice President and Managing Director,
Europe, as well as Chief Financial Officer, of Viatel, where, among other
things, Mr. Levy was responsible for the implementation of Viatel's European
strategy. Mr. Levy is a Certified Public Accountant.
KEVIN A. ALWARD, PRESIDENT-NORTH AMERICA. Mr. Alward has served as the
Company's President-North America since February 1998. From October 1996 to
January 1998, Mr. Alward served as Director, President and Chief Operating
Officer of TotalTel USA Communications. From September 1994 to October 1996, Mr.
Alward served as President of TotalTel, Inc., the principal operating subsidiary
of TotalTel USA Communications. From 1992 to 1994, Mr. Alward served as Senior
Vice President at TotalTel USA Communications and assumed the additional
responsibilities of Chief Operating Officer in 1993, a position he held until
1998. Mr. Alward also served from 1991 to 1992 as Vice President of Marketing at
TotalTel USA Communications, and from 1990 to 1991 as Manager of Sales. Mr.
Alward served as a sales account executive at TotalTel USA Communications from
1988 to 1990.
PHILLIP J. STORIN, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. Mr.
Storin has served as a Senior Vice President and the Chief Financial Officer of
the Company since February 1998. From May 1996 to January 1998, Mr. Storin
served as Senior Vice President and Chief Financial Officer of USLD
Communications Corp., and from October 1994 to May 1996 served as Vice President
and Corporate Controller. From July 1992 to October 1994, Mr. Storin served as
Vice President, Accounting at USLD Communications Corp. Before joining USLD
Communications Corp., Mr. Storin served for five years as Director of
54
<PAGE>
Accounting for Dell Computer Corporation. Prior to such time, Mr. Storin served
in various financial management positions at Datapoint Computer Corporation and
Westvaco Corporation. Mr. Storin is a Certified Public Accountant and a
Certified Management Accountant.
RICHARD L. SHORTEN, JR., SENIOR VICE PRESIDENT AND GENERAL COUNSEL. Mr.
Shorten has served as a Senior Vice President and the General Counsel of the
Company since December 1997. From September 1992 to December 1997, Mr. Shorten
was an associate at the New York law firm Cravath, Swaine & Moore, where he
specialized in a variety of areas of corporate representation, including
securities, finance and mergers and acquisitions.
ABE GROHMAN, CHIEF INFORMATION OFFICER. Mr. Grohman has served as the
Company's Chief Information Officer since October 1997. From September 1994 to
September 1997, Mr. Grohman was the Director of Management Information Systems
for LDM Systems Inc., a switchless reseller. From May 1986 to September 1994,
Mr. Grohman was President of DBA Consulting, an independent data processing
consulting company.
DARAN M. CHUROVICH, VICE PRESIDENT OF GLOBAL NETWORK ENGINEERING. Mr.
Churovich has served as the Company's Vice President of Global Network
Engineering since 1998. From 1996 to 1998, Mr. Churovich served as Director of
Switch Engineering at Brooks Fiber Properties, Inc. and was later promoted to
Senior Director-Network Engineering. Following a merger with Worldcom in 1997,
Mr. Churovich assumed the position of Director-Network Technology and
Integration. Prior to 1996, Mr. Churovich maintained a variety of positions
within different divisions at Western Electric, Inc., a subsidiary of AT&T.
INES C. LEBOW, VICE PRESIDENT OF GLOBAL NETWORK OPERATIONS. Ms. LeBow has
served as Vice President, Global Network Operations since June 1998. From May
1997 to May 1998, Ms. LeBow served as Vice President, Network Implementation of
Brooks Fiber Properties. From May 1995 to May 1997, Ms. LeBow served as National
Director, Planning and Engineering of MFS. From May 1982 to May 1995, Ms. LeBow
served in various engineering and operations positions at Contel ASC and GTE.
BARRY TOSER, VICE PRESIDENT OF GLOBAL CARRIER SERVICES. Mr. Toser has
served as the Company's Vice President of Global Carrier Services since January
1999. Previously, Mr. Toser was the Vice President of Sales for the North
American business unit of Alphanet Telecom from October 1997 to December 1998.
Prior to this, he was Vice President of U.S. Sales for Teleglobe International,
an international telecommunications organization. While at Teleglobe, Mr. Toser
directed the sales and service responsibilities for all carrier, commercial, and
RBOC accounts. Before joining Teleglobe, he was involved in sales, marketing and
customer retention activities for Cable and Wireless, Inc. from 1987 through
1995. Previous to Cable and Wireless, Inc. Mr. Toser spent six years with US
Sprint in sales, sales management, and marketing management.
PAOLO DI FRAIA, MANAGING DIRECTOR-CONTINENTAL EUROPE. Mr. Di Fraia has
served as the Company's Managing Director of Continental Europe since December
1998 and as European Finance Director since February 1998. Mr. Di Fraia served
as Viatel Inc.'s European Finance Director from January 1996 to February 1998.
From November 1994 to December 1995, Mr. Di Fraia served as European Controller
of the Company. From April 1989 to August 1994, Mr. Di Fraia was employed by
Philip Crosby Associates, S.A. as European Controller.
MICHAEL WHITTINGHAM, DIRECTOR OF INTERNATIONAL PROJECT DEVELOPMENT. Mr.
Whittingham has been with the Company since 1995. Since joining the Company, Mr.
Whittingham has been responsible for the build-out of the European Network.
Prior to joining the Company. Mr. Whittingham was employed by Worldexchange
Limited as a Technologies Director for Europe from 1994 to 1995. From 1992 to
1994, Mr. Whittingham served as a Vice President in charge of the European
Telecommunications Department at Marsh & McLennan.
55
<PAGE>
MARK ST. J. COURTNEY, DIRECTOR OF EUROPEAN COMMERCIAL AND REGULATORY
AFFAIRS. Mr. Courtney has served as the Company's Director of European
Commercial and Regulatory Affairs since September 1997. Mr. Courtney served as
Viatel Inc.'s European General Counsel from August 1995 and as Secretary of
Viatel from March 1996 to September 1997. From December 1992 to July 1995, Mr.
Courtney served as European and International Counsel for Legent, Inc., a
software company.
GARY S. BONDI, DIRECTOR AND TREASURER. Mr. Bondi has served as a Director
and Treasurer of the Company since 1993. Mr. Bondi is the President of Bondi,
Inc., a multinational trading firm specializing in non-ferrous metals that he
founded in 1987. Mr. Bondi is also the Chairman and Chief Executive Officer of
ECONergy Energy Company, Inc., a competitive energy provider that he founded in
1996.
STEVEN WEST, DIRECTOR. Mr. West has served as a Director of the Company
since 1993. Mr. West is a founding partner of SO Accurate Group., a refiner and
reprocessor of precious metals in the New York/ New Jersey metropolitan area
that was founded in 1982. Steven West is the brother of Alfred West, the
President, Chief Executive Officer and Chairman of the Board of Directors of the
Company.
STEPHEN R. MUNGER, DIRECTOR. Mr. Munger has served as a Director of the
Company since November 1997. Mr. Munger is a Managing Director in the Mergers,
Acquisitions and Restructuring Department of Morgan Stanley & Co. Incorporated
("Morgan Stanley") and is Head of the Private Investment Department. He joined
Morgan Stanley in 1988 as a Vice President in the Corporate Finance Department.
He became a Principal in 1990 and a Managing Director in 1993. In 1994, Mr.
Munger was Administrative Director of the Corporate Finance Department.
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
At December 31, 1998, the chief executive officer and five other most highly
compensated executive officers of the Company were Mr. Alfred West and Messrs.
Levy, Alward, Storin, Shorten and Grohman. The following table summarizes all
compensation awarded to, earned by or paid to Messrs. West, Levy, Alward,
Storin, Shorten and Grohman (Messrs. West, Levy, Alward, Storin, Shorten and
Grohman are referred to herein as the "Named Executive Officers" for 1997 and
1998).
56
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM
COMPENSATION SHARES OF COMMON
--------------------- ---------------- STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS OPTIONS GRANTED COMPENSATION(1)
- -------------------------------------- --------- ---------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Alfred West(2)........................ 1998 $ 323,784 $ 323,784 -- $ 4,725(3)
Chief Executive Officer 1997 323,784 295,306 -- 4,725(3)
1996 326,280 163,139 -- 5,171(3)
Alan L. Levy(4)....................... 1998 250,000 157,500 -- --
President and Chief Operating Officer 1997 210,000 78,750 -- --
1996 72,000 37,500 --
Kevin A. Alward(5).................... 1998 198,000 -- 500,000 --
President-North America 1997 -- -- -- --
1996
Phillip J. Storin(6).................. 1998 165,000 -- 100,000 --
Senior Vice President and 1997 --
Chief Financial Officer 1996 --
Richard L. Shorten, Jr.(7)............ 1998 165,000 25,000 --
Senior Vice President and General 1997 6,875 50,000 --
Counsel 1996 --
Abe Grohman(8)........................ 1998 144,167 -- -- --
Chief Information Officer 1997 29,167 -- -- --
1996 -- -- 50,000 --
</TABLE>
- ------------------------
(1) Does not include the value of certain personal benefits. The estimated value
of such personal benefits for each Named Executive Officer did not exceed
the lesser of $50,000 or 10% of the total annual salary and bonus paid to
the Named Executive Officer in 1998.
(2) See "Employment Agreements and Arrangements" for a description of Mr. West's
Employment Agreement.
(3) Consists of compensation in respect of life insurance, of which Mr. West's
designee is the beneficiary, paid by the Company.
(4) See "Employment Agreements and Arrangements" for a description of Mr. Levy's
Employment Agreement.
(5) Mr. Alward commenced employment with the Company during February 1998.
(6) Mr. Storin commenced employment with the Company during February 1998.
(7) Mr. Shorten commenced employment with the Company on December 15, 1997.
(8) Mr. Grohman commenced employment with the Company on October 20, 1997.
1996 FLEXIBLE INCENTIVE PLAN
The Company has adopted the 1996 Flexible Incentive Plan (the "Incentive
Plan"), which provides for the grant of incentive stock options ("ISOs") to
acquire shares of common stock to employees of the Company or any of its
subsidiaries, the grant of non-qualified stock options ("NQSOs") to acquire
shares of common stock, the sale or grant of Restricted Shares and Unrestricted
Shares (each, as defined in the Incentive Plan) and the grant of stock
appreciation rights ("SARs") to employees, directors and consultants. The
Incentive Plan also provides for Tax Offset Payments (as defined in the
Incentive Plan) to employees. The Incentive Plan provides for the award of up to
a maximum of 4,600,000 shares of common stock and is administered by the Board
of Directors of the Company. The Company is required to seek the
57
<PAGE>
approval of its stockholders to materially increase the number of shares of
common stock that may be issued under the Incentive Plan.
The Incentive Plan provides that, in the event of a merger, consolidation,
combination, exchange of shares, separation, spin-off, reorganization,
liquidation or other similar transaction, the Board of Directors of the Company
may, in its sole discretion, accelerate the lapse of Restricted Periods (as
defined in the Incentive Plan) and other vesting periods and waiting periods and
extend exercise periods applicable to any awards made under the Incentive Plan,
except that, upon a Change of Control (as defined in the Incentive Plan), if an
employee has been employed by the Company for the twelve month period preceding
the Change of Control, vesting of any options held by such employee
automatically will accelerate.
Subsequent amendments to the 1996 Incentive Plan increased the number of
authorized shares and provided that 4,350,000 shares of common stock may be in
the form of voting stock and 250,000 may be in the form of non-voting stock.
Holders of restricted voting stock have the right to receive cash dividends with
respect to such shares, while holders of restricted non-voting stock cannot
receive cash dividends. Upon the consummation of the offering, holders of
non-voting stock may elect, for a nominal exercise price, to convert shares of
non-voting stock into an equivalent number of shares of voting stock having the
same terms and conditions as the non-voting stock.
The Company is currently in the process of implementing its 1999 Flexible
Incentive Plan (the "1999 Incentive Plan"). The terms of the 1999 Incentive Plan
will be substantially similar to the terms of the Incentive Plan (except that
under the 1999 Incentive Plan options will automatically accelerate upon a
change of control, including unvested options held by employees that have been
employed by the Company for less than twelve months prior to the change of
control) and will provide for the award of up to a maximum of shares of common
stock. The 1999 Incentive Plan will be administered by the Board of Directors of
the Company.
As of March 1, 1999, the Company had issued stock options to purchase
5,105,408 shares of common stock (net of cancelled options) under the 1996
Incentive Plan, 2,632,337 of which were exercisable as of such date and 226,800
Restricted Shares of which 183,760 were vested.
The following table sets forth grants of options to purchase shares of
common stock of the Company made during 1998 to each Named Executive Officer.
OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
---------------------------------------------------------------- ANNUAL RATES OF STOCK
NUMBER OF % OF TOTAL OPTIONS PRICE APPRECIATION
SECURITIES GRANTED TO FOR OPTION TERM
UNDERLYING EMPLOYEES IN FISCAL EXERCISE PRICE EXPIRATION ---------------------
NAME OPTIONS YEAR 1998 PER SHARE($) DATE 5%($) 10%($)
- ----------------------------------------- ----------- ------------------- ----------------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Alan L. Levy............................. -- -- -- -- -- --
Kevin A. Alward.......................... 500,000 33.3% 7.50 2/2/2008 808,148 1,740,375
Alfred West.............................. -- -- -- -- -- --
Phillip J. Storin........................ 100,000 6.66% 5.00 2/2/2008 78,313 165,500
Richard L. Shorten, Jr................... 25,000 1.67% 7.50 7/1/2008 29,555 62,063
Abe Grohman.............................. -- -- -- -- -- --
</TABLE>
58
<PAGE>
The following table sets forth options exercised during 1998 and the fiscal
year-end value of unexercised options for each Named Executive Officer.
OPTION EXERCISES IN 1998 AND 1998 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE- MONEY OPTIONS AT
SHARES DECEMBER 31, 1998 DECEMBER 31, 1998
ACQUIRED ON VALUE ------------------------- ---------------------------
NAME EXERCISE(1) REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------------------- --------------- --------------- ---------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Alfred West............................. -- -- -- --
Alan L. Levy............................ -- 1,556,800 443,200 $ 6,616,400 $ 1,883,600
Kevin A. Alward......................... -- -- 500,000 -- --
Phillip J. Storin....................... -- -- -- 100,000 -- 175,000
Richard L. Shorten, Jr.................. -- -- 16,667 58,333 29,167 58,333
Abe Grohman............................. -- 16,667 33,333 29,167 58,333
</TABLE>
- ------------------------
(1) No options were exercised during 1998.
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
Destia has entered into an employment agreement with Alfred West (the "West
Employment Agreement"), effective as of January 1, 1997, pursuant to which Mr.
West serves as Chief Executive Officer and Chairman of the Board of Directors of
Destia. The term of the West Employment Agreement extends until December 31,
1999, subject to any earlier termination in accordance with the terms thereof.
Pursuant to the West Employment Agreement, Mr. West is entitled to receive an
annual base salary of not less than $330,000 for each year of the employment
term, subject to increases approved from time to time by the Board of Directors
of Destia or the compensation committee thereof and automatic increases each
January 1 by the percentage increase in the consumer price index in New York
over the consumer price index published the preceding January. In addition, Mr.
West is eligible to participate in Destia's incentive compensation programs and
to receive such annual bonus or other compensation, including restricted stock
or incentive stock options, as may be determined by Destia's Board of Directors.
Pursuant to the West Employment Agreement, Mr. West will be awarded an annual
bonus of between 25% and 75% of his annual base salary, subject to attainment of
certain performance goals as determined by the Board of Directors of Destia or
the compensation committee thereof. If Mr. West's employment is terminated prior
to December 31, 1999 by Destia without just cause or by Mr. West with good
reason (including upon a Change of Control, as defined in the West Employment
Agreement), he will be entitled to a severance payment equal to up to his annual
base salary for the greater of one year or the remainder of the employment term,
plus the continuation of his benefits for up to the greater of two years after
the date of termination and the remainder of his employment term. The West
Employment Agreement automatically will be renewed for successive one year
periods unless, at least six months prior to the expiration of the employment
term, either Mr. West or Destia shall notify the other that it does not wish to
extend the term. If Destia does not offer to renew the West Employment
Agreement, Mr. West will be entitled to a severance payment equal to one year's
base salary, plus a continuation of his medical and other welfare benefits for
one year.
In August 1996, Destia entered into an employment agreement with Alan L.
Levy (as thereafter amended, the "Levy Employment Agreement") pursuant to which
Mr. Levy serves as President and Chief Operating Officer of Destia. The term of
the Levy Employment Agreement extends until July 31, 1999,
59
<PAGE>
subject to any earlier termination in accordance with the terms thereof.
Pursuant to the Levy Employment Agreement, Mr. Levy is entitled to receive an
annual base salary of $210,000 during each year of the term thereof, subject to
increases at the discretion of the Board of Directors. In addition, Mr. Levy is
eligible to participate in Destia's incentive compensation programs and to
receive such annual bonus or other compensation, including restricted stock or
incentive stock options, as may be determined by Destia's Board of Directors.
Pursuant to an incentive stock option agreement dated October 31, 1996, Destia
granted Mr. Levy incentive stock options to purchase 2,000,000 shares of Common
Stock at an exercise price of $2.50 per share. Mr. Levy is entitled to certain
demand and piggyback registration rights with respect to such shares. If Mr.
Levy's employment is terminated prior to July 31, 1999 by Destia without just
cause or if Mr. Levy and Destia do not enter into a new employment agreement
prior to the expiration of the Levy Employment Agreement, he will be entitled to
a severance payment equal to one year's base salary.
In February 1998, Destia entered into an employment agreement with Phillip
J. Storin (as thereafter amended, the "Storin Employment Agreement") pursuant to
which Mr. Storin serves as Chief Financial Officer of Destia. The term of the
Storin Employment Agreement extends until February 2, 2001, subject to any
earlier termination in accordance with the terms thereof. Pursuant to the Storin
Employment Agreement, Mr. Storin is entitled to receive an annual base salary of
$180,000 during each year of the term thereof, subject to increases at the
discretion of the Board of Directors. In addition, Mr. Storin is eligible to
participate in Destia's incentive compensation programs and to receive such
annual bonus or other compensation, including restricted stock or incentive
stock options, as may be determined by Destia's Board of Directors. Mr. Storin
is entitled to receive stock options to purchase 100,000 shares of Common Stock
at an exercise price of $5.00 per share. If Mr. Storin's employment is
terminated prior to February 2, 2001 by Destia without just cause prior to the
expiration of the Storin Employment Agreement, he will be entitled to a
severance payment equal to one year's base salary.
The Company plans to enter into an employment agreement with Alan L. Levy in
connection with the Offering, pursuant to which Mr. Levy will continue to serve
as President and Chief Operating Officer of the Company. The Company expects
that Mr. Levy will be entitled to receive a base salary, incentive compensation,
options to purchase shares of Common Stock and certain additional payments in
the event of a change in control of the Company or a termination of Mr. Levy's
employment.
Messrs. Alward, Shorten and Grohman do not have employment agreements with
the Company. Messrs. Alward and Shorten were granted options under the Incentive
Plan during 1998. Mr. Grohman was not granted options under the Incentive Plan
during 1998.
As part of the acquisition of VoiceNet on February 12, 1998, the Company
entered into employment contracts with the sellers of VoiceNet providing for
annual base salary of $180,000 each. The sellers of VoiceNet also were granted
300,000 options in the aggregate at an exercise price of $5.00 per share under
the Incentive Plan during 1998.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company does not have a formal compensation committee. Decisions with
respect to compensation matters that otherwise would have been decided by a
compensation committee were made by the Board of Directors as a whole.
Alfred West, Alan L. Levy, Gary S. Bondi, Steven West and Stephen R. Munger
participated in deliberations concerning executive officer compensation during
1998. Alfred West and Alan L. Levy receive compensation as officers of the
Company. Stephen R. Munger is a Managing Director of Morgan Stanley and the
President of the General Partner of Princes Gate, which is an affiliate of
Morgan Stanley and which owns 140,000 shares of Series A Preferred Stock, all of
which will be converted into common stock upon the consummation of an initial
public offering by the Company. Morgan Stanley was the placement agent in
connection with the 1997 Unit Offering, 1998 Debt Offering and will be a
managing underwriter in connection with the Offering. See "-Executive
Compensation," "Item 5. Market for the Registrant's Common Equity and Related
Stockholders Matters" and "Item 13. Certain Relationships and Related
Transactions."
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<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership of the common stock as of March 1, 1999 by (i) each person
known by the Company to beneficially own more than 5% of the Company's voting
securities, (ii) each of the Company's directors, (iii) each of the Current
Named Executive Officers and (iv) all directors and executive officers of the
Company as a group.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF
NAME OF BENEFICIAL OWNER (1) OF COMMON STOCK COMMON STOCK (2)
- ---------------------------------------------------------------------------- ----------------- ---------------------
<S> <C> <C>
Alfred West................................................................. 11,000,000(3) 47.0%
Steven West................................................................. 4,350,000(4) 18.6%
Gary Bondi.................................................................. 4,306,250(5) 18.4%
Princes Gate Investors II, L.P. ............................................ 3,420,701(6) 14.6%
c/o Morgan Stanley & Co. Incorporated
1585 Broadway
New York, New York 10036
Kevin A. Alward............................................................. 400,000(7)(8) 1.7%
Abe Grohman................................................................. 16,667(9) *
Alan L. Levy................................................................ 1,779,200(10) 7.1%
Stephen R. Munger........................................................... -- --
Richard L. Shorten, Jr...................................................... 16,667(11) *
Philip J. Storin............................................................ 33,333(12) *
All Directors and Executive Officers as a Group (9 persons)................. 21,902,117 86.5%
</TABLE>
- ------------------------
* Less than one percent.
(1) Except where otherwise indicated, the Company believes that all persons
listed in the table, based on information provided by such persons, have
sole voting and dispositive power over the securities beneficially owned by
them, subject to community property laws, where applicable. For purposes of
this table, a person is deemed to be the "beneficial owner" of any shares
that such person has the right to acquire within 60 days from March 1, 1999.
Shares which a person does not have the right to acquire within 60 days from
March 1, 1999 are not reflected in this table. For purposes of computing the
percentage of outstanding shares held by each person named above on a given
date, any security that such person has the right to acquire within 60 days
is deemed to be outstanding, but is not deemed to be outstanding for the
purpose of computing the percentage ownership of any other person. Except
where otherwise indicated, the address of each person listed in the table is
c/o Destia Communications, Inc., 95 Rte. 17 South, Paramus, NJ 07652, Attn:
General Counsel.
(2) Determined on an as-converted basis, assuming the conversion of all issued
and outstanding shares of Series A Preferred Stock into common stock. Each
share of Series A Preferred Stock is convertible into 24.43 shares of common
stock, or a total of 3,420,701 shares of common stock. All of the shares of
Series A Preferred Stock will be converted into common stock upon
consummation of the Offering.
(3) Includes 860,000 shares held by AT Econ Ltd. Partnership and 85,000 held by
AT Econ Ltd. Partnership No. 2.
(4) Includes 860,000 shares held by SS Econ Ltd. Partnership and 85,000 shares
held by SS Econ Ltd. Partnership No. 2.
(5) Includes 860,000 shares held by GS Econ Ltd. Partnership.
(6) Includes 108,296 shares of Series A Preferred Stock, which were convertible
into 2,645,671 shares of common stock that are owned by affiliates of
Princes Gate, over which Princes Gate has sole voting power.
61
<PAGE>
(7) Includes 205,000 shares held by Kevin Alward, 20,000 shares held by Alward
Investment Associates LLC and 75,000 shares held by Kevin and Belinda Alward
Grantor Retained Annuity Trust. The remainder includes shares issuable upon
the exercise of options.
(8) Does not include options to purchase 400,000 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after March 1,
1999.
(9) Does not include options to purchase 58,333 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after March 1, 1999.
(10) Does not include options to purchase 220,800 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after March 1,
1999.
(11) Does not include options to purchase 83,333 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after March 1,
1999.
(12) Does not include options to purchase 66,667 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after March 1,
1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
INVESTMENT BY PRINCES GATE
On November 1, 1996, Princes Gate purchased 140,000 shares of Series A
Preferred Stock for a purchase price of $14.0 million, less $560,000 in fees.
The Series A Preferred Stock is convertible into 3,420,701 shares of Common
Stock.
SERIES A PREFERRED STOCK
Certain of the terms of the Series A Preferred Stock issued to Princes Gate
are described below. As a result of the consummation of the 1997 Unit Offering,
Destia was permitted pursuant to the terms of the Series A Preferred Stock to
amend its Certificate of Incorporation so that the restrictions therein with
respect to limitations on dividends, indebtedness, restricted payments and
transactions with shareholders and affiliates became no more restrictive than
the analogous covenants contained in the 1997 Indenture.
RANKING. The Series A Preferred Stock is senior to all other capital stock
of Destia, whether outstanding as of the date of issuance of the Series A
Preferred Stock or thereafter issued, as to dividend payments and distributions
upon liquidation, dissolution or the winding up of Destia.
VOTING RIGHTS. In addition to such other vote, if any, as may be required
by Delaware law, the affirmative vote of the holders of at least a majority of
the outstanding shares of Series A Preferred Stock, voting together as a single
class, shall be necessary to: (i) declare or pay any dividends on, or redeem or
otherwise acquire any other class or series of capital stock of Destia, except
to the extent provided for pursuant to the terms of any class or series of
capital stock approved by the affirmative vote of the holders of at least a
majority of the then outstanding shares of Series A Preferred Stock; (ii)
authorize an amendment to Destia's Certificate of Incorporation decreasing the
liquidation preference of the Series A Preferred Stock or otherwise adversely
affecting the preferences, rights or powers of the Series A Preferred Stock or
the Series A Warrants (defined below); (iii) effect a voluntary liquidation,
dissolution or winding up of Destia or the sale of all or substantially all of
its assets, or the merger, consolidation or recapitalization of Destia; or (iv)
amend the Certificate of Incorporation or bylaws in a manner or take any other
action that would in any way impair, limit or delay the ability of the holders
of the Series A Preferred Stock to exercise their voting rights, by written
consent or at any meeting of shareholders of Destia.
BOARD REPRESENTATION. The holders of Series A Preferred Stock have the
right to vote as a separate class to elect one director. This right terminates
at such time as certain specified holders cease to hold at least 50% of the
outstanding shares of Series A Preferred Stock or Destia consummates an initial
public
62
<PAGE>
offering of its Common Stock generating gross proceeds of at least $25.0 million
and registered with the Commission.
DIVIDENDS. The holders of Series A Preferred Stock were entitled to receive
a dividend payable at the rate of 12% per annum, which was cumulative and
compounded monthly. Dividends ceased to accrue and compound on the Series A
Preferred Stock upon the consummation of the 1997 Unit Offering. Dividends will
not be paid on any shares of Series A Preferred Stock prior to any redemption or
liquidation (as described below) of such shares. Subject to certain exceptions,
no dividends or other distributions, and no redemption, purchase or other
acquisition for value, are allowed to be made with respect to any share of, or
right to acquire, any other class or series of Destia's capital stock other than
the Series A Preferred Stock.
LIQUIDATION. Upon the liquidation, distribution of assets, dissolution or
winding up of Destia, a holder of Series A Preferred Stock shall be entitled to
receive, prior to the holders of Common Stock, $100 per share plus all accrued
and unpaid dividends thereon.
CONVERSION. At any time, any holder of Series A Preferred Stock may convert
all or any portion thereof into Common Stock of Destia. As of December 31, 1998,
the shares of Series A Preferred Stock outstanding were convertible into
3,420,701 shares of Common Stock. Destia may convert any of the shares of Series
A Preferred Stock into Common Stock upon the closing of an initial public
offering of its Common Stock generating gross proceeds of at least $25.0 million
and registered with the Commission. The number of shares of Common Stock that
each share of Series A Preferred Stock is convertible into is equal to the
number of shares of Common Stock outstanding on November 1, 1996 (on a fully
diluted basis), which was 22,564,000, multiplied by a fraction (i) the numerator
of which is equal to the stated value with respect to the shares of Series A
Preferred Stock being so converted, plus any dividends accrued thereon, and (ii)
the denominator of which is equal to $100.0 million plus the number of dollars
received by Destia since November 1, 1996 from the exercise of specified options
or warrants. The number of shares of Common Stock that each share of Series A
Preferred Stock is converted into is subject to antidilution adjustment in the
event of certain issuance's of Common Stock or rights, options, warrants or
convertible or exchangeable securities containing the right to acquire shares of
Common Stock at below fair market value.
REDEMPTION. Destia is required to redeem the Series A Preferred Stock on
October 31, 2006 at a price per share equal to $100 per share plus an amount
equal to all accrued dividends (whether or not declared) on the Series A
Preferred Stock to the date of redemption. Any holder of Series A Preferred
Stock has the option to cause Destia to redeem its shares in the event of (i) an
occurrence of certain changes of control, including if Alfred West ceases to own
voting securities representing at least 25% of the total voting power of the
outstanding voting securities of Destia, or a person or group becomes the
beneficial owner of voting securities representing more voting power than the
voting securities then owned by Mr. West, (ii) the taking of any action by
Destia without the approval, if required, of the holders of a majority of the
shares of the Series A Preferred Stock, (iii) non-compliance by Destia with
restrictions on certain transactions with affiliates and shareholders, (iv)
Destia's failure to maintain at least $10.0 million of "key man insurance" on
Mr. Alfred West until November 1, 1999 or (v) Destia's failure to limit its
business to the telecommunications business (and businesses reasonably related
or ancillary thereto). Except as provided in the foregoing, so long as the
indebtedness under the NTFC Facility is outstanding, Destia is not permitted to
redeem the Series A Preferred Stock for cash, unless NTFC (or its assignee)
waives this limitation in advance in writing. In connection with the Note
Purchase Agreement, Destia agreed to forego the right to redeem up to 40,000
shares of Series A Preferred Stock from Princes Gate at the stated value of $100
per share plus accrued dividends. See "Bridge Funding by Morgan Stanley Group."
LIMITATION ON INDEBTEDNESS. Destia and certain of its subsidiaries are not
permitted to incur any indebtedness except: (i) indebtedness in an aggregate
principal amount not to exceed $20.0 million
63
<PAGE>
outstanding at any time; (ii) indebtedness incurred solely to fund the
acquisition of assets used or useful in the telecommunications business; (iii)
indebtedness issued in the 1997 Unit Offering and the 1998 Offering; (iv)
indebtedness to Destia or certain subsidiaries; (v) certain indebtedness or
certain capital stock issued in exchange for, or the net proceeds of which are
used to exchange, refinance, refund or defease certain outstanding indebtedness
or capital stock, subject to certain exceptions; (vi) indebtedness (a) in
respect of performance bonds, bankers' acceptances and surety or appeal bonds
provided in the ordinary course of business, (b) under certain currency
agreements and interest rate agreements, subject to certain conditions, and (c)
arising from certain agreements providing for indemnification, adjustment of
purchase price or similar options, or from guarantees or letters of credit,
surety bonds or performance bonds securing any obligations of Destia or any of
its subsidiaries pursuant to such agreements, in any case incurred in connection
with the disposition of any business, assets or subsidiary of Destia, subject to
certain exceptions.
LIMITATION ON RESTRICTED PAYMENTS. Subject to certain exceptions, the
ability of Destia and certain subsidiaries to make investments is limited,
except for (i) an investment in Destia or certain subsidiaries; (ii) specified
temporary cash investments; (iii) payroll, travel and similar advances to cover
matters that are expected at the time of such advances ultimately to be treated
as expenses in accordance with generally accepted accounting principles; (iv)
notes and other evidences of indebtedness, not to exceed $2.0 million at any one
time outstanding; (v) stock, obligations or securities received in satisfaction
of judgments; (vi) relocation and similar loans to employees of Destia or its
subsidiaries not to exceed $150,000 at any one time outstanding; (vii) loans to
employees of Destia or its subsidiaries, in each case evidenced by an
unsubordinated promissory note, for the purpose of enabling such employees to
purchase capital stock of Destia, in an amount not to exceed $1.5 million at any
one time outstanding; and (viii) investments, not to exceed $5.0 million at any
one time outstanding, if the Board of Directors of Destia has determined that
such investments constitute strategic investments.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES. Subject to
certain exceptions, Destia may not, and may not permit any subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or assets,
or the rendering of any service) with any holder (or any affiliate of such
holder) of 5% or more of any class of capital stock of Destia or with any
affiliate of Destia, except for transactions on terms at least as favorable to
Destia or such subsidiary as could be obtained on an arm's-length basis from a
person that is not such an affiliate or 5% holder.
LIMITATION ON LIENS. Subject to certain exceptions, Destia may not, and may
not permit certain subsidiaries to create, incur, assume or suffer to exist any
lien on any of its assets or properties of any character, or any shares of
capital stock or indebtedness.
KEY MAN INSURANCE. Until November 1, 1999, Destia is required to maintain
in full force and effect "key man" insurance with a benefit of at least $10.0
million in the event of the death or long term incapacity of Mr. Alfred West,
naming Destia as sole beneficiary.
MAINTENANCE OF BUSINESS. Destia and certain of its subsidiaries are
required to limit their business to the telecommunications business and
businesses reasonably related or ancillary thereto.
SECURITYHOLDERS AGREEMENT
Mr. Alfred West, Destia and Princes Gate entered into a Securityholders
Agreement in connection with Princes Gate's investment in Destia (the
"Securityholders Agreement"). Certain terms of the Securityholders Agreement are
discussed below.
REGISTRATION RIGHTS. The holders of the Series A Preferred Stock are
entitled to certain registration rights with respect to the shares of Common
Stock issuable upon the conversion of the Series A Preferred
64
<PAGE>
Stock and the exercise of the Series A Warrants (as hereinafter defined) (all
such shares of Common Stock being "Registrable Shares"). If Destia proposes to
register any of its securities under the Securities Act, the holders of the
Series A Preferred Stock will be entitled to notice thereof and, subject to
certain restrictions, to include their Registrable Shares in such registration.
From November 1, 1999 until the consummation by Destia of an initial public
offering of Common Stock, holders of at least 50% of the outstanding Registrable
Shares may (subject to certain conditions) make a demand that Destia file a
registration statement under the Securities Act. Thereafter, holders of at least
25% of the outstanding Registrable Shares may make up to two demands of Destia
to file a registration statement under the Securities Act, subject to certain
conditions and limitations and provided that (i) in the discretion of the lead
underwriter of the prior offering, no demand may be made within 180 days after
the effective date of a prior demand registration and (ii) no two such demands
may be made within any twelve month period. A holder of the Series A Preferred
Stock's right to include shares in an underwritten registration is subject to
the right of the underwriters to limit the number of shares included in the
offering. Subject to certain limitations, Destia is required to bear all
registration, legal and other expenses in connection with these registrations
and must provide appropriate indemnification.
WARRANTS. If Destia has not consummated an initial public offering by
November 1, 2000, Destia will be required to issue warrants (the "Series A
Warrants") to the holders of the Series A Preferred Stock representing, in the
aggregate, 5% of the outstanding shares of Common Stock, calculated on a fully
diluted basis. Thereafter, at six month intervals until the consummation of an
initial public offering, Destia will be required to issue additional Series A
Warrants to such holders to purchase shares of Common Stock representing, in the
aggregate, 5% of the outstanding shares of Common Stock, calculated on a fully
diluted basis. The right of the holders of the Series A Preferred Stock to
receive additional Series A Warrants shall terminate at such time as the holders
of the Series A Preferred Stock own shares of Common Stock, Series A Preferred
Stock and Series A Warrants representing, in the aggregate, 25% of the Common
Stock, calculated on a fully diluted basis. The Series A Warrants will have an
exercise price of $.01 per share, a 10-year duration and will be subject to a
warrant agreement containing customary provisions acceptable to the holders of
the Series A Preferred Stock (including adjustments for stock splits, reverse
stock splits and reclassifications).
PARTICIPATION IN SALES BY MR. ALFRED WEST. Holders of the Series A
Preferred Stock have the right to participate on a pro rata basis in sales of
Common Stock by Mr. West on the same terms and conditions as Mr. West. Under
certain circumstances, Mr. West has a right to require such persons to transfer
their shares on a pro rata basis on the same terms and conditions as Mr. West.
If the transfer by Mr. West would constitute a change of control pursuant to the
terms of the Series A Preferred Stock, holders of the Series A Preferred Stock
will be entitled to require Destia to redeem their shares.
BRIDGE FUNDING BY MORGAN STANLEY GROUP
On April 24, 1997, Destia entered into the Note Purchase Agreement, pursuant
to which Morgan Stanley Group, an affiliate of Princes Gate, agreed to purchase
from Destia up to $15 million of Bridge Notes. Bridge Notes totaling $7.0
million were issued under the Note Purchase Agreement during 1997, the net
proceeds ($6.6 million) of which were used to fund equipment and other capital
expenditures and operations immediately following the consummation of the 1997
Unit Offering, all of the outstanding Bridge Notes ($7.0 million) were redeemed
and all accrued interest thereon ($143,750) paid. At such time, the facility
represented by the Note Purchase Agreement was terminated.
In connection with the Note Purchase Agreement, Destia agreed to (i) forego
the right to redeem up to 40,000 shares of Series A Preferred Stock from Princes
Gate at the stated value of $100 per share plus accrued dividends, (ii) pay up
to $100,000 of fees and expenses incurred by Morgan Stanley Group in connection
with the transactions contemplated by the Note Purchase Agreement and (iii)
grant to Morgan Stanley Group and its affiliates the right to act as sole
underwriter or placement agent in connection with the 1997 Unit Offering and to
act as lead underwriter in the event of Destia's initial public offering.
65
<PAGE>
PRIVATE PLACEMENT OF UNITS AND NOTES BY MORGAN STANLEY
Morgan Stanley, an affiliate of Princes Gate, acted as placement agent in
respect of the 1997 Unit Offering and the 1998 Offering. In connection with the
1997 Unit Offering and the 1998 Offering, Destia entered into Placement
Agreements with Morgan Stanley pursuant to which it purchased the Units or 1998
Notes for resale. The Placement Agreements provide, among other things, that
Destia and Morgan Stanley will indemnify each other against certain liabilities,
including liabilities under the Securities Act, and will contribute to payments
the other may be required to make in respect thereof. In addition, pursuant to
the Placement Agreements, Destia has certain obligations to register 1997 Notes,
Warrants, shares of Common Stock and 1998 Notes on a shelf registration
statement at the request, and for the benefit of, Morgan Stanley and any
successor thereto.
OTHER RELATED PARTY LOANS
RELATED PARTY LOANS
On December 9, 1992, the Company borrowed $200,000 from Mrs. Rose West, the
mother of Messrs. Alfred West and Steven West, pursuant to an unsecured
promissory note bearing interest at the rate of 9% per annum, payable on
maturity. The obligation matured on December 8, 1997 and, on such date, was
converted into a demand obligation. On November 16, 1993, the Company borrowed
$108,000 from Mrs. West pursuant to an unsecured promissory note that bears
interest at a rate of 18% per annum, payable at maturity, and that matured on
November 15, 1998.
Since the third quarter of 1996, Alfred West has borrowed $232,128 from the
Company pursuant to unsecured, interest bearing notes, repayable upon demand.
MINORITY INTEREST IN THE ECONOPHONE SERVICES GMBH
The brother-in-law of Mr. West owns a 28% minority interest in the Company's
swiss subsidiary, Econophone Services GmbH (Switzerland).
66
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2) Financial Statements. See Index to Consolidated Financial
Statements and Schedule which appears on Page F-1 herein.
(a)(3) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
3.1** Certificate of Incorporation of Destia Communications, Inc., as amended.
3.2** Bylaws of Destia Communications, Inc.
3.3 Certificate of Name Change from Econophone, Inc. to Destia Communications, Inc.
4.1** Specimen of Destia Communications, Inc.'s 11% Senior Discount Note due 2008.
4.2** Indenture, dated as of February 18, 1998, between Destia Communications, Inc. and The Bank of New
York, as Trustee.
4.3* Specimen of Destia Communications, Inc.'s 13% Senior Note due 2007.
4.4* Indenture, dated as of July 1, 1997, between Destia Communications, Inc. and The Bank of New York, as
Trustee.
10.1* Securityholders Agreement, dated as of November 1, 1996, between Alfred West, Destia Communications,
Inc. and Princes Gate Investors II, L.P.
10.2* Securities Purchase Agreement, dated as of November 1, 1996, between Destia Communications, Inc. and
Princes Gate Investors II, L.P.
10.3* Note Purchase Agreement, dated as of April 24, 1997, between Destia Communications, Inc. and Morgan
Stanley Group Inc.
10.4* Form of Note under Note Purchase Agreement.
10.5** Second Amended and Restated Equipment Loan and Security Agreement, dated as of January 28, 1998,
between Destia Communications, Inc. and NTFC Capital Corporation.
10.6** Stock Purchase Agreement, dated January 28, 1998, between Destia Communications, Inc. and the
shareholders of VoiceNet Corporation.
10.7 Amendment, dated April 16, 1998, to Stock Purchase Agreement between Destia Communications, Inc. and
the shareholders of VoiceNet Corporation.
10.8* Employment Agreement, dated August 1, 1996, between Destia Communications, Inc. and Alan Levy, as
amended October 31, 1996.
10.9* Employment Agreement, dated January 1, 1997, between Destia Communications, Inc. and Alfred West.
10.10 Employment Agreement, dated February 2, 1998, between Destia Communications, Inc. and Phillip J.
Storin.
10.11* Amended and Restated Destia Communications, Inc. 1996 Flexible Incentive Plan.
10.12 Amendment to 1996 Flexible Incentive Plan.
10.13 Stock Purchase Agreement, dated July 17, 1998, between Destia Communications, Inc. and certain
shareholders of Telco Global Communications.
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
10.14*** Telecommunications Services Agreement between Frontier Communications of the West, Inc. and
Econophone, Inc., dated November 17, 1998.
21.1 Subsidiaries of Destia Communications, Inc.
24.1 Power of Attorney.
</TABLE>
- ------------------------
* Previously filed as exhibits to Registration Statement on Form S-4,
Commission File number 333-33117, and hereby incorporated herein by
reference.
** Previously filed as exhibits to Registration Statement on Form S-4,
Commission File number 333-47711, and hereby incorporated herein by
reference.
*** Previously filed as exhibits to Registration Statement on Form S-1,
Commission File number 333-71463, and hereby incorporated herein by
reference.
(b) No Current Reports on Form 8-K were filed with the Commission during the
quarter ended December 31, 1998.
68
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
March 30, 1999 DESTIA COMMUNICATIONS, INC.
By: /s/ PHILLIP J. STORIN
-----------------------------------------
Phillip J. Storin
Chief Financial Officer (Principal
Financial and
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ ALFRED WEST Chief Executive Officer and March 30, 1999
- ------------------------------ Chairman of the Board of
Alfred West Directors (Principal
Executive Officer)
/s/ ALAN L. LEVY President, Chief Operating March 30, 1999
- ------------------------------ Officer and Director
Alan L. Levy
Director and Treasurer
- ------------------------------
Gary S. Bondi
Director
- ------------------------------
Steven West
* Director
- ------------------------------
Stephen Munger
<TABLE>
<S> <C> <C> <C>
*By: /s/ ALAN L. LEVY March 30, 1999
-------------------------
Alan L. Levy
Attorney-in-Fact
</TABLE>
* A manually signed Power of Attorney authorizing Alfred West, Alan L. Levy,
and Richard L. Shorten and each of them to sign this Form 10-K as
attorneys-in-fact has been filed with the Securities and Exchange Commission
as an exhibit to this Form 10-K.
69
<PAGE>
DESTIA COMMUNICATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................................................... F-2
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1998............................................... F-3
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE YEARS ENDED DECEMBER 31, 1996, 1997
AND 1998................................................................................................. F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998...... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Destia Communications, Inc. (formerly Econophone, Inc.):
We have audited the accompanying consolidated balance sheets of Destia
Communications, Inc. (formerly Econophone, Inc.) (a Delaware corporation) and
subsidiaries as of December 31, 1997 and 1998, and the related consolidated
statements of operations, comprehensive loss, stockholders' deficit and cash
flows for each of the three years ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Destia
Communications, Inc. (formerly Econophone, Inc.) and subsidiaries as of December
31, 1997 and 1998, and the results of their operations and their cash flows for
each of the three years ended December 31, 1998, in conformity with generally
accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commissions rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
New York, New York
February 2, 1999
F-2
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1998
---------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............................................................. $ 67,202 $ 118,218
Marketable securities.................................................................. -- 21,343
Accounts receivable, net of allowance for doubtful accounts of $1,594 and $4,086,
respectively......................................................................... 16,796 33,351
Prepaid expenses and other current assets.............................................. 1,868 3,409
Restricted cash and securities......................................................... 10,463 9,590
---------- -----------
Total current assets................................................................. 96,329 185,911
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS net of accumulated depreciation and
amortization of $3,690 and $12,418, respectively (Note 5).............................. 24,113 107,249
Debt issuance costs...................................................................... 6,356 12,244
Intangible assets, net of accumulated amortization of $0 and $1,324, respectively........ -- 49,488
Other assets............................................................................. 2,242 2,439
Restricted cash and securities........................................................... 48,965 30,877
---------- -----------
Total assets......................................................................... $ 178,005 $ 388,208
---------- -----------
---------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable....................................................................... $ 21,101 $ 33,352
Accrued expenses and other current liabilities (Note 7)................................ 5,356 31,131
Interest accrued on Senior Notes....................................................... 10,462 9,590
Current maturities of other long--term debt (Note 9)................................... 1,829 16,232
Current maturities of obligations under capital lease (Note 15)........................ 156 154
Current maturities of notes payable--related party (Note 13)........................... 315 308
Deferred revenue....................................................................... 2,568 4,739
---------- -----------
Total current liabilities............................................................ 41,787 95,506
OTHER LONG--TERM DEBT (Note 9)........................................................... 5,657 37,379
OBLIGATIONS UNDER CAPITAL LEASE (Note 15)................................................ 279 193
SENIOR NOTES (Note 9).................................................................... 149,680 343,176
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note 12)................................ 14,328 14,421
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS' DEFICIT (Note 11):.........................................................
Common stock-voting, par value $.01; authorized 29,250,000 shares; 20,000,000 and
20,000,000 shares issued and outstanding at December 31, 1997 and 1998,
respectively......................................................................... 2 200
Common stock non--voting, par value $.01; authorized 500,000 shares; 0 and 75,760
shares issued and outstanding at December 31, 1997 and 1998, respectively............ -- 1
Additional paid-in capital............................................................. 6,082 6,931
Accumulated other comprehensive loss................................................... (104) (856)
Accumulated deficit.................................................................... (39,706) (108,743)
---------- -----------
Total stockholders' deficit.......................................................... (33,726) (102,467)
---------- -----------
Total liabilities and stockholders' deficit.......................................... $ 178,005 $ 388,208
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
REVENUES....................................................................... $ 45,103 $ 83,003 $ 193,737
COST OF SERVICES............................................................... 35,369 63,707 140,548
--------- ---------- ----------
Gross profit................................................................. 9,734 19,296 53,189
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES................................... 16,834 37,898 80,092
DEPRECIATION AND AMORTIZATION.................................................. 1,049 3,615 11,866
--------- ---------- ----------
Loss from operations......................................................... (8,149) (22,217) (38,769)
OTHER INCOME (LOSS)............................................................ 106 102 (747)
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net..................................... 27 (265) 86
INTEREST EXPENSE, net.......................................................... (296) (7,748) (29,514)
--------- ---------- ----------
Net loss..................................................................... $ (8,312) $ (30,128) $ (68,944)
--------- ---------- ----------
--------- ---------- ----------
LOSS PER SHARE (Note 2)
Basic........................................................................ $ (0.43) $ (1.55) $ (3.44)
Diluted...................................................................... $ (0.43) $ (1.55) $ (3.44)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (basic and diluted) (Note
2)........................................................................... 20,000 20,000 20,038
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
DESTIA COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
NET LOSS........................................................................ $ (8,312) $ (30,128) $ (68,944)
OTHER COMPREHENSIVE LOSS, net of tax:
FOREIGN CURRENCY TRANSLATION ADJUSTMENTS...................................... -- (104) (752)
--------- ---------- ----------
COMPREHENSIVE LOSS.............................................................. $ (8,312) $ (30,232) $ (69,696)
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated
statements.
F-4
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands)
<TABLE>
<CAPTION>
COMMON STOCK
------------------------------------------------
RETAINED
VOTING NON VOTING ADDITIONAL EARNINGS ACCUMULATED
---------------------- ------------------------ PAID-IN (ACCUMULATED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) LOSS
--------- ----------- ----------- ----------- ----------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
December 31, 1995.............. 20,000 $ 2 -- $ -- $ 392 $ 316 $ --
Distribution of S corporation
earnings..................... -- -- -- -- -- (316) --
Contribution of capital to C
corporation.................. -- -- -- -- 90 -- --
Net loss....................... -- -- -- -- -- (8,312) --
Accretion of preferred stock... -- -- -- -- -- (15) --
Dividends on preferred stock... -- -- -- -- -- (281) --
--
--------- ----- --- ----------- ------------ -----
BALANCE,
December 31, 1996.............. 20,000 2 -- -- 482 (8,608) --
Net loss....................... -- -- -- -- -- (30,128) --
Warrants....................... -- -- -- -- 5,600 -- --
Accretion of preferred stock... -- -- -- -- -- (91) --
Dividends on preferred stock... -- -- -- -- -- (879) --
Cumulative translation
adjustment................... -- -- -- -- -- -- (104)
--
--------- ----- --- ----------- ------------ -----
BALANCE,
December 31, 1997.............. 20,000 2 -- -- 6,082 (39,706) (104)
Net loss....................... -- -- -- -- -- (68,944) --
Issuance of non voting
restricted shares............ -- -- 76 1 994 -- --
Accretion of preferred stock... -- -- -- -- -- (93) --
Change in par value............ -- 198 -- -- (198) -- --
Cumulative translation
adjustment................... -- -- -- -- -- -- (752)
Other.......................... -- -- -- -- 53 -- --
--
--------- ----- --- ----------- ------------ -----
BALANCE,
December 31, 1998.............. 20,000 $ 200 76 $ 1 $ 6,931 $ (108,743) $ (856)
--
--
--------- ----- --- ----------- ------------ -----
--------- ----- --- ----------- ------------ -----
<CAPTION>
TOTAL
-----------
<S> <C>
BALANCE,
December 31, 1995.............. $ 710
Distribution of S corporation
earnings..................... (316)
Contribution of capital to C
corporation.................. 90
Net loss....................... (8,312)
Accretion of preferred stock... (15)
Dividends on preferred stock... (281)
-----------
BALANCE,
December 31, 1996.............. (8,124)
Net loss....................... (30,128)
Warrants....................... 5,600
Accretion of preferred stock... (91)
Dividends on preferred stock... (879)
Cumulative translation
adjustment................... (104)
-----------
BALANCE,
December 31, 1997.............. (33,726)
Net loss....................... (68,944)
Issuance of non voting
restricted shares............ 995
Accretion of preferred stock... (93)
Change in par value............ --
Cumulative translation
adjustment................... (752)
Other.......................... 53
-----------
BALANCE,
December 31, 1998.............. $ (102,467)
-----------
-----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................................................ $ (8,312) $ (30,128) $ (68,944)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................. 1,049 3,615 11,866
Provision for doubtful accounts............................................... 291 832 2,603
Accreted interest expense..................................................... -- 280 17,711
Changes in assets and liabilities:
Increase in accounts receivable............................................... (887) (9,682) (22,100)
Increase in prepaid expenses and other current assets......................... (350) (1,004) (2,175)
Increase in other assets...................................................... (1,514) (3,277) (791)
Increase in accounts payable, accrued expenses and other current
liabilities................................................................. 3,352 14,975 34,745
Increase (decrease) in interest accrued on senior notes....................... -- 10,462 (872)
Increase in deferred revenue.................................................. 365 1,708 1,543
--------- ---------- ----------
Net cash used in operating activities....................................... (6,006) (12,219) (26,414)
--------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid in acquisitions................................................. -- -- (21,063)
Purchase of marketable securities, net........................................ -- -- (21,343)
Purchases of property and equipment........................................... (4,247) (13,267) (76,686)
--------- ---------- ----------
Net cash used in investing activities....................................... (4,247) (13,267) (119,092)
--------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of preferred stock..................................... 13,061 -- --
Proceeds from line of credit.................................................. 800 -- --
Repayment of line of credit................................................... (1,000) -- --
Proceeds from short-term borrowings........................................... 5,437 -- --
Repayments of short-term borrowings........................................... (3,309) (2,128) --
Proceeds from long-term debt and capital leases............................... 2,232 -- 16,390
Repayments of long-term debt and capital leases............................... (566) (661) (7,497)
Repayments of notes payable-related party..................................... (10) (12) (7)
Dividends paid................................................................ (226) -- --
Proceeds from senior discount notes........................................... -- 149,400 175,785
Proceeds from issuance of warrants............................................ -- 5,600 --
Payment of debt issuance costs................................................ -- (6,355) (7,110)
Proceeds from bridge loan..................................................... -- 7,000 --
Repayments of bridge loan..................................................... -- (7,000) --
--------- ---------- ----------
Net cash provided by financing activities................................... 16,419 145,844 177,561
--------- ---------- ----------
Increase in cash and cash equivalents, (including restricted cash)............ 6,166 120,358 32,055
Cash and cash equivalents, beginning of period, (including restricted cash)... 106 6,272 126,630
--------- ---------- ----------
Cash and cash equivalents, end of period, (including restricted cash)......... $ 6,272 $ 126,630 $ 158,685
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.................................................................... $ 210 $ 505 $ 24,329
Income Tax.................................................................. -- -- --
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Note issued for purchase of minority interest-Telco........................... -- -- 14,035
Accretion of preferred stock.................................................. 15 91 93
Accrued dividends on preferred stock.......................................... 281 879 --
Capital leases executed and notes issued for asset purchases.................. 423 5,754 14,250
DETAILS OF ACQUISITIONS:
Fair Value of assets acquired................................................. -- -- 1,896
Goodwill...................................................................... -- -- (50,759)
Liabilities assumed and notes issued.......................................... -- -- 27,800
--------- ---------- ----------
Net cash paid for acquisitions................................................ -- -- (21,063)
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-7
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1998
1. NATURE OF BUSINESS
Destia Communications, Inc. (formerly Econophone Inc.) ("Destia") is a
rapidly growing, facilities-based provider of domestic and international long
distance telecommunications services in North America and Europe. Its extensive
international telecommunications network allows it to provide services primarily
to retail customers in many of the largest metropolitan markets in the United
States, Canada, the United Kingdom, Belgium, France, Germany and Switzerland.
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services, and wholesale transmission services. The
Company's approximate 350,000 customer accounts are diverse and include
residential customers, commercial customers, ethnic groups and
telecommunications carriers. In each of the Company's geographic markets, it
utilizes a multichannel distribution strategy to market its services to its
target customer groups.
In February 1998, the New York corporation "Econophone, Inc." (now known as
Destia Communications, Inc.) was merged into its wholly owned subsidiary named
"Econophone, Inc." (now known as Destia Communications, Inc.) which had been
incorporated in the State of Delaware, for the sole purpose of changing the
state of incorporation of the Company. The Delaware corporation was the
surviving entity in the merger. In connection with the foregoing, the par value
of the Company's common stock was changed to $.01 per share of voting and
non-voting common stock from $.0001.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Destia and its
wholly owned subsidiaries, its 72% owned subsidiary, Econophone Services GmbH
(Switzerland) and its 81.25% owned subsidiary America First, Ltd. (England)
(collectively, the "Company"). The full amount of the net loss for the year
ended December 31, 1997 and 1998 for Econophone Services GmbH and America First,
Ltd. have been recorded in the consolidated financial statements of the Company.
All significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts 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.
REVENUE RECOGNITION
The Company's revenues are primarily based on usage and are derived from (1)
the number of minutes of telecommunications traffic carried and, (2) generally,
a fixed per minute rate. For prepaid services, the Company's revenues are
reported net of selling discounts and commissions and are recorded based upon
usage rather than time of initial sale.
F-8
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
less than three months when purchased.
PROPERTY AND EQUIPMENT
Depreciation of property and equipment is computed using the straight-line
method over the estimated useful lives of the respective assets, which range
from three to fifteen years. Depreciation of IRUs is computed using the
straight-line method over the lease term. Amortization of leasehold improvements
is computed using the straight-line method over the lesser of the lease term or
estimated useful lives of the improvements.
INTERNAL-USE SOFTWARE
The Company capitalizes certain software development costs for internal use.
For the years ended December 31, 1997 and 1998, the Company incurred
approximately $897,000 and $1,925,000 respectively, of such costs and has
included them in Property, Equipment and Leasehold Improvements. The capitalized
software are amortized on a straight-line basis over the estimated useful life,
generally two years. Prior to 1997, such costs were immaterial.
INTANGIBLE ASSETS
Intangible assets represent the excess of cost of acquired businesses over
the underlying fair value of the tangible net assets acquired. Intangible assets
are amortized on a straight-line basis over their estimated period of benefit,
(generally 5-20 years). The carrying value of goodwill is periodically reviewed
for impairment whenever events or changes in circumstances indicate that it may
not be recoverable.
LONG-LIVED ASSETS
The Company's policy is to record long-lived assets at cost. In accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," these assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amounts of the assets may not be
recoverable. Furthermore, the assets are evaluated for continuing value and
proper useful lives by comparison to expected future cash projections. The
Company amortizes these costs over the expected useful life of the related
asset. As of December 31, 1998 the Company does not believe any impairment
exists with its long-lived assets.
INCOME TAXES
Prior to 1996, the Company was an S-Corporation for federal and state income
tax purposes and, as a result, the earnings of the Company were treated as
taxable income of the shareholders. During 1996, the Company changed its tax
status to a C-Corporation.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to be applied to taxable income in the year in which those temporary
differences are expected to be recovered or
F-9
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
settled. Deferred income taxes are not provided on undistributed earnings of
foreign subsidiaries since such earnings are currently expected to be
permanently reinvested outside the United States.
STOCK-BASED COMPENSATION
SFAS No. 123 "Accounting for Stock-Based Compensation," encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation awards to employees and directors using the
intrinsic value method prescribed in Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation cost for stock options awarded to employees and
directors is measured as the excess, if any, of the fair value of the Company's
stock at the date of grant over the amount an employee or director must pay to
acquire the stock.
The Company accounts for stock-based compensation awards to outside
consultants and affiliates based on the fair value of such awards. Accordingly,
compensation costs for stock option awards to outside consultants and affiliates
is measured at the date of grant based on the fair value of the award using the
Black-Scholes option pricing model (See Note 14).
NEW ACCOUNTING PRONOUNCEMENTS
These standards increase disclosure only and have no impact on the Company's
financial position or results of operations. These standards have been adopted
in 1998 and have been reflected in the financial statements and notes for the
year ended December 31, 1998.
In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use software, dividing the development into three stages: (1) the
preliminary project stage, during which conceptual formulation and evaluation of
alternatives takes place, (2) the application development stage, during which
design, coding, installation and testing takes place and (3) the operations
stage during which training and maintenance takes place. Costs incurred during
the application development stage are capitalized, all other costs are expensed
as incurred. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company has reviewed the provisions of
SOP 98-1 and does not believe adoption of this standard will have a material
effect on its results of operations, financial position or cash flows.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." SOP 98-5 requires that all non-governmental entities
expense the costs of start-up activities, including organization costs, as those
costs are incurred. SOP 98-5 is effective for financial statements for fiscal
years beginning after December 15, 1998. The Company has reviewed the provisions
of SOP 98-5 and does not believe adoption of this standard will have a material
effect on its results of operations.
FOREIGN CURRENCY EXCHANGE
The financial statements of all foreign subsidiaries were prepared in their
respective local currencies and translated into U.S. dollars based on the
current exchange rate at the end of the period for the balance sheets and an
average rate for the period on the statements of operations. Translation
adjustments
F-10
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
generally are reflected as foreign currency translation adjustments in the
statement of stockholders' equity and, accordingly, have no effect on net
income. Foreign currency transaction adjustments are reflected in the statements
of operations.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
PER SHARE DATA
During 1997, SFAS No. 128 "Earnings per Share" was issued and became
effective for the Company's December 31, 1997 financial statements. SFAS No. 128
establishes new standards for computing and presenting earnings per share
("EPS"). The new standard requires the presentation of basic EPS and diluted
EPS. Basic EPS is calculated by dividing income available to common shareholders
by the weighted average number of shares of common stock outstanding during the
period. Diluted EPS is calculated by dividing income available to common
shareholders by the weighted average number of common shares outstanding
adjusted to reflect potentially dilutive securities. Diluted EPS has not been
presented since the inclusion of outstanding options, warrants and convertible
preferred shares would be antidilutive. The following is the reconciliation of
net loss per share as of December 31,
<TABLE>
<CAPTION>
1996 1997 1998
------------- -------------- --------------
<S> <C> <C> <C>
NUMERATOR
Net loss.......................................................... $ (8,312,000) $ (30,128,000) $ (68,944,000)
Less dividends on preferred stock................................. (281,000) (879,000) --
Less accretion of preferred stock................................. (15,000) (91,000) (93,000)
------------- -------------- --------------
Loss available to common shareholders............................. $ (8,608,000) $ (31,098,000) $ (69,037,000)
------------- -------------- --------------
------------- -------------- --------------
DENOMINATOR
Weighted average shares outstanding............................... 20,000,000 20,000,000 20,038,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board has issued SFAS No. 107 entitled
"Disclosures about Fair Value of Financial Instruments," which requires entities
to disclose information about the fair values of their financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
LONG-TERM DEBT
The carrying amount of the Company's current portion of long-term borrowings
approximates fair value. The fair value of the Company's long-term debt,
including current portions, is determined based on market prices for similar
debt instruments or on the current rates offered to the Company for debt with
similar maturities. As of December 31, 1998, the Company's senior notes were
made up of the 13 1/2% Senior Notes due 2007 (the "1997 Notes") issued July 1,
1997, and the 11% Senior Discount Notes due 2008 (the "1998 Notes") issued
February 12, 1998 (together the "Senior Notes"). The fair value of the
F-11
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
3. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
1997 Notes and the 1998 Notes, based upon quotes from securities dealers, were
$157,325,000 and $151,500,000, respectively.
4. DEBT AND EQUITY SECURITIES
The Company accounts for short-term investments in accordance with SFAS No.
115 "Accounting for Certain Investments in Debt and Equity Securities."
Short-term investments have an original maturity of more than three months and a
remaining maturity of less than one year. These investments are stated at cost
as it is the intent of the Company to hold these securities until maturity. The
funds are invested in compliance with the Company's bond indentures which
restrict the type, quality and maturity of investments. The table below
discloses the fair value of held-to-maturity securities as of December 31, 1998.
<TABLE>
<CAPTION>
AGGREGATE AGGREGATE GROSS GROSS
AMORTIZED FAIR VALUE UNREALIZED UNREALIZED
COST BASIS DECEMBER 31, 1998 HOLDING GAINS HOLDING LOSSES
-------------- ----------------- ------------- --------------
<S> <C> <C> <C> <C>
U.S. treasury notes........................... $ 38,949,000 $ 39,246,000 $ 365,000 $ (68,000)
Government agency notes....................... 54,438,000 54,611,000 173,000 --
Commercial paper.............................. 14,914,000 14,960,000 47,000 (1,000)
Other debt securities......................... 19,976,000 19,975,000 -- (1,000)
-------------- ----------------- ------------- --------------
$ 128,277,000 $ 128,792,000 $ 585,000 $ (70,000)
-------------- ----------------- ------------- --------------
-------------- ----------------- ------------- --------------
Included in cash and cash equivalents......... $ 66,467,000
Included in marketable securities............. 21,343,000
Included in current portion of restricted
cash........................................ 9,590,000
Included in non-current restricted cash....... 30,877,000
--------------
--------------
$ 128,277,000
--------------
--------------
</TABLE>
5. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
<S> <C> <C>
1997 1998
------------- --------------
Equipment..................................................... $ 23,403,000 $ 102,696,000
Computer software............................................. 2,263,000 9,257,000
Furniture and fixture......................................... 634,000 4,841,000
Leasehold improvements........................................ 1,503,000 2,873,000
------------- --------------
$ 27,803,000 $ 119,667,000
Less accumulated depreciation and amortization................ (3,690,000) (12,418,000)
------------- --------------
Property, equipment and leasehold improvements, net........... $ 24,113,000 $ 107,249,000
------------- --------------
------------- --------------
</TABLE>
Depreciation expense for the years ended December 31, 1996, 1997 and 1998,
was $1,008,000, $2,297,000 and $8,728,000, respectively.
F-12
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
6. TERRITORIAL RIGHTS
In September 1994, the Company entered into a joint venture with Europhone
International Ltd. ("EI") to jointly market Destia's services in the United
Kingdom. EI engaged in sales and marketing, while Destia provided network
support, billing and transmission services.
In connection with the modification of this joint marketing arrangement
which occurred in June 1996, EI granted the Company the right to compete with EI
in exchange for forgiveness of the net receivable due to the Company of
$2,000,000. The Company charged this to operations in 1996 as an expense of the
joint venture.
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist primarily of accrued
carrier cost of $1,658,000 and $17,408,000 for 1997 and 1998, respectively.
8. FOREIGN OPERATIONS AND CONCENTRATIONS
FOREIGN OPERATIONS
The Company's trade accounts receivable are subject to credit risk, although
the customer base is diversified due to its size and geographic dispersion. In
certain cases, the Company requires collateral or other security to support its
receivables. The Company closely monitors extensions of credit and performs
ongoing evaluations of customer accounts to control the exposure to bad debt
risks. The Company's total sales, operating income (before interest, foreign
currency exchange and other income) and identifiable assets by geographical area
for the years ended and as of December 31, 1996, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
UNITED NORTH OTHER
KINGDOM AMERICA BELGIUM EUROPE CONSOLIDATED
-------------- -------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
1996
Revenues................................. $ 15,477,000 $ 18,185,000 $ 9,038,000 $ 2,403,000 $ 45,103,000
-------------- -------------- ------------- -------------- --------------
-------------- -------------- ------------- -------------- --------------
Operating loss........................... $ (2,473,000) $ (3,855,000) $ (1,472,000) $ (349,000) $ (8,149,000)
Corporate expenses....................... (163,000)
--------------
$ (8,312,000)
--------------
--------------
Accounts receivable...................... $ 2,283,000 $ 3,718,000 $ 1,488,000 $ 457,000 $ 7,946,000
Property, equipment and leasehold
improvements........................... 1,423,000 4,001,000 847,000 201,000 6,472,000
Corporate assets......................... 8,337,000
--------------
$ 22,755,000
--------------
--------------
</TABLE>
F-13
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
8. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
<TABLE>
<CAPTION>
UNITED NORTH OTHER
KINGDOM AMERICA BELGIUM EUROPE CONSOLIDATED
-------------- -------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
1997
Revenues................................. $ 18,363,000 $ 48,899,000 $ 7,981,000 $ 7,760,000 $ 83,003,000
-------------- -------------- ------------- -------------- --------------
-------------- -------------- ------------- -------------- --------------
Operating loss........................... $ (2,966,000) $ (18,213,000) $ (374,000) $ (664,000) $ (22,217,000)
Corporate expenses....................... (7,911,000)
--------------
$ (30,128,000)
--------------
--------------
Accounts receivable...................... $ 5,252,000 $ 9,034,000 $ 1,250,000 $ 1,260,000 $ 16,796,000
Property, equipment and leasehold
improvements........................... 6,731,000 16,515,000 463,000 405,000 24,114,000
Corporate assets......................... 137,095,000
--------------
$ 178,005,000
--------------
--------------
1998
Revenues................................. $ 55,991,000 $ 116,645,000 $ 11,515,000 $ 9,586,000 $ 193,737,000
-------------- -------------- ------------- -------------- --------------
-------------- -------------- ------------- -------------- --------------
Operating income(loss)................... $ (16,474,000) $ (17,138,000) $ 905,000 $ (6,062,000) $ (38,769,000)
Corporate expenses....................... (30,175,000)
--------------
$ (68,944,000)
--------------
--------------
Accounts receivable...................... $ 11,367,000 $ 19,096,000 $ 1,430,000 $ 1,458,000 $ 33,351,000
Property, equipment and leasehold
improvements........................... 15,899,000 74,700,000 3,673,000 12,977,000 107,249,000
Corporate assets......................... 247,608,000
--------------
$ 388,208,000
--------------
--------------
</TABLE>
The revenues of EI accounted for $14.2 million or 32% in 1996. The
relationship was terminated in December 1996.
9. BORROWINGS
At December 31, 1997, the Company was obligated under the following debt
agreements:
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------- -------------- --------------
<S> <C> <C> <C>
Long-term debt:
NTFC note (a)................................ $ 1,633,000 $ 5,522,000 $ 7,155,000
Notes Payable (b)............................ 196,000 135,000 331,000
1997 Notes (c)............................... 149,680,000 149,680,000
------------- -------------- --------------
$ 1,829,000 $ 155,337,000 $ 157,166,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
At December 31, 1998, the Company was obligated under the following debt
agreements:
F-14
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
9. BORROWINGS (CONTINUED)
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------- -------------- --------------
<S> <C> <C> <C>
Long-term debt:
NTFC note (a)................................ $ 4,708,000 $ 16,434,000 $ 21,142,000
Notes Payable (b)............................ 11,524,000 20,945,000 32,469,000
1997 Notes (c)............................... -- 150,240,000 150,240,000
1998 Notes (d)............................... -- 192,936,000 192,936,000
------------- -------------- --------------
$ 16,232,000 $ 380,555,000 $ 396,787,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
- ------------------------
(a) On May 28, 1996, Destia entered into a credit facility with NTFC, which the
terms and amount of have been amended and increased, respectively, on
several occasions. On January 28, 1998, the NTFC credit facility was amended
and restated in its entirety in order to effect various amendments and
increase the amount of NTFC's commitment thereunder (such credit facility,
as amended and restated, is referred to herein as the "NTFC Facility"). The
NTFC Facility provides for borrowings by Destia and its subsidiaries to fund
certain equipment acquisition costs and related expenses. The NTFC Facility
provides for an aggregate commitment of NTFC of $24.0 million pursuant to
three tranches of $2.0 million, $3.0 million and $19.0 million. Loans
borrowed under each tranche of the NTFC Facility amortize in equal monthly
installments over a five year period ending on July 1, 2001, April 1, 2002
and January 1, 2003, respectively. Loans under the NTFC Facility accrue
interest at an interest rate equal to the 90-day commercial paper rate plus
395 basis points, subject to certain quarterly adjustments depending upon
financial performance. All of the equipment purchased with the proceeds of
the NTFC Facility has been pledged to NTFC. The NTFC Facility requires
Destia to maintain certain Debt Service Coverage Ratios, EBITDA (each
defined in the NTFC Facility) and minimum cash balances. Destia was in
compliance with these covenants at December 31, 1997. Destia obtained a
waiver of these covenants so that it was in compliance at December 31, 1998.
(b) At December 31, 1998 the Company has seven notes payable related to the
purchase of cable lines and acquisitions. These notes bear interest at rates
ranging from 5% to 12%, and have maturity dates from April 2001 to November
2008.
At December 31, 1997 the Company has six notes payable related to the
purchase of cable lines. Three of these notes bear interest at 12%, and
mature through September 1998. The remaining three notes bear interest at
LIBOR plus 5%, and mature on June 30, 2001. These notes have quarterly
principal and interest payments ranging from $5,849 to $30,291.
(c) Destia completed on July 1, 1997 the offering (the "1997 Unit Offering") of
155,000 units (each a "Unit"), each Unit consisting of one 1997 Note and one
warrant (each a "Warrant") to purchase 8.167 shares of common stock of
Destia. The Units were sold for an aggregate gross purchase price of $155.0
million. On December 5, 1997, the Company consummated an offer to exchange
the notes issued in the 1997 Unit Offering for $155.0 million of notes that
had been registered under the Securities Exchange Act of 1933.
The 1997 Notes are unsecured unsubordinated obligations of Destia, limited
to $155.0 million aggregate principal amount at maturity, and mature on July
15, 2007. Interest on the 1997 Notes accrues at the rate of 13 1/2% per
annum from the most recent interest payment date on which interest has been
paid or provided for, payable semiannually (to holders of record at the
close of business on
F-15
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
9. BORROWINGS (CONTINUED)
the January 1 or July 1 immediately preceding the interest payment date) on
January 15 and July 15 of each year, commencing January 15, 1998. At the
closing of the 1997 Unit Offering, Destia used $57.4 million of the net
proceeds of the 1997 Unit Offering to purchase restricted cash and
securities, which were pledged as security for the payment of interest on
the principal of the 1997 Notes. Proceeds from the restricted cash and
securities are being used by Destia to make interest payments on the 1997
Notes through July 15, 2000. The restricted cash and securities are being
held by a trustee pending disbursement.
(d) During February 1998, the Company issued the 1998 Notes. The 1998 Notes are
unsecured unsubordinated obligations of the Company, initially limited to
$300.0 million aggregate principal amount at maturity, and mature on
February 15, 2008. Although for Federal income tax purposes a significant
amount of original issue discount, taxable as ordinary income, was
recognized by the holders as such discount accrues from the closing date, no
interest is payable on the 1998 Notes prior to February 15, 2003. Interest
on the 1998 Notes will accrue at 11.0% from February 15, 2003 or from the
most recent Interest Payment Date to which interest has been paid or
provided for, payable semiannually (to holders of record at the close of
business on the February 1 or August 1 immediately preceding the Interest
Payment Date) on February 15 and August 15 of each year, commencing August
15, 2003.
Maturities of long-term debt (excluding the accretion of the 1998 Notes)
over the next five years are as follows:
<TABLE>
<S> <C>
1999.......................................................... $16,232,000
2000.......................................................... 14,567,000
2001.......................................................... 10,808,000
2002.......................................................... 4,837,000
2003 and thereafter........................................... 350,343,000
-----------
Total......................................................... $396,787,000
-----------
-----------
</TABLE>
10. TAXES
As a telephone carrier and reseller doing business in the U.S., the Company
is required to file annual telephone and transmission tax returns in accordance
with state tax laws. These returns include taxes on net worth, gross sales and
gross profit. In addition, each type of tax requires an additional tax
surcharge. The Company also remits federal and state excise taxes and other
state and local sales taxes.
As of December 31, 1997 and 1998, the Company had a net operating loss
carryforward of approximately $36,000,000 and $80,000,000, respectively, which
is available to reduce its future taxable income and expires at various dates
through 2012. A full valuation allowance of approximately $14,000,000 and
$31,000,000, respectively, has been established against the deferred tax assets
due to the uncertainties surrounding the utilization of the carryforward. There
are no other significant timing differences.
A value added tax "VAT" is a tax charged on goods and services that is
designed to be borne by the ultimate end user of the goods and services.
Pursuant to the Sixth European Commission VAT Directive adopted in 1977 ("VAT
Directive"), providers of telecommunications services in the European Union (the
F-16
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
10. TAXES (CONTINUED)
EU) are liable for VAT in the EU member state where the provider of the services
is established. The provider, in turn, charges VAT to its customers at the rate
prevailing in the provider's country of establishment. To date, the collection
of VAT by Destia does not appear to have a material adverse effect on its
ability to attract or retain customers and the collection of VAT has not
required Destia to reduce its prices to remain competitive.
Destia's non-U.S. subsidiaries file separate tax returns and provide for
taxes accordingly.
11. STOCKHOLDERS' EQUITY (DEFICIT)
In February 1998, the New York corporation "Econophone, Inc." (now known as
Destia Communications, Inc.) was merged into its wholly owned subsidiary named
"Econophone, Inc." (now known as Destia Communications, Inc.) which had been
incorporated in the State of Delaware for the sole purpose of changing the state
of incorporation of the Company. The Delaware corporation was the surviving
entity in the merger. In connection with the foregoing, the par value of the
Company's common stock was changed to $.01 per share of voting and non-voting
common stock.
On July 17, 1998, the Company acquired the minority interest in Telco that
it did not already own. In connection with such acquisition the Company
converted options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock. The shares carry the
same rights as the voting common stock, other than voting rights.
On November 1, 1996, the Company's Articles of Incorporation were amended to
change all of the authorized shares of common stock and non-voting common stock
from no par value per share to $.0001 par value per share, to increase the
number of shares of authorized common stock from 400 shares to 29,250,000
shares, to increase the number of authorized shares of non-voting common stock
from 19,600 shares to 500,000 shares and to authorize the issuance of 250,000
shares of preferred stock. Additionally, the Company effected a recapitalization
whereby the outstanding shares of common stock were converted on a 73,125:1
basis.
All information contained in the accompanying financial statements and
footnotes have been retroactively restated to give effect to these transactions.
Included within additional paid in capital, is $5.6 million attributable to
the Warrants, which represents the portion of the issue price for the Units
attributable to the fair value of the Warrants. Such amount has been recognized
as a discount on the 1997 Notes and will be amortized over the term of the 1997
Notes. Each Warrant may be exercised for 8.167 shares of common stock at an
exercise price of $.01 per share. The Warrants are exercisable for 1,265,885
shares of common stock, in the aggregate. The fair value of the shares issuable
upon exercise of the Warrants was determined to be $4.43 per share. Among the
factors considered in making such determinations were the history of the
prospects for the industry in which Destia competes, an assessment of Destia's
management, the present operations of Destia, the historical results of
operations of Destia and the trend of its revenues and earnings, the prospects
for future earnings of Destia, the general condition of the securities markets
at the time of the 1997 Unit Offering and the prices of similar securities of
generally comparable companies. The Warrants expire on June 30, 2007.
F-17
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
12. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
On November 1, 1996, the Company entered into a Securities Purchase
Agreement (the "Agreement") with Princes Gate Investors II, L.P., an affiliate
of Morgan Stanley & Co., Incorporated, whereby it authorized and issued 140,000
shares of $.01 par value Redeemable Convertible Preferred Stock (the "Series A
Preferred") for a purchase price of approximately $13,061,000, net of issuance
costs. The stated redemption value on the preferred stock is $14,000,000 (or
$100 per share). The Series A Preferred is senior to all other capital stock of
the Company.
The Series A Preferred accrue monthly cumulative dividends on each
outstanding share at a rate of $1.00 per month. The accrued and unpaid dividends
compound monthly at a rate of 12% per year. The dividends began to accrue and
compound interest from the issuance date of the preferred stock and ceased to
accrue on July 1, 1997, when the Senior Notes were issued.
The mandatory redemption of the Series A Preferred is October 31, 2006. The
redemption shall be in cash.
Each holder of the Series A Preferred shall have the right, at the option of
the holder, to convert any of its shares of Series A Preferred into a number of
fully paid and nonassessable shares of common stock. At any time, any holder of
Series A Preferred Stock may convert all or any portion thereof into common
stock of Destia. As of December 31, 1997 and 1998, the shares of Series A
Preferred Stock outstanding were convertible into 3,420,701 shares of common
stock and may convert upon the Company closing an initial public offering of
common stock. The number of shares of common stock that each share of Series A
Preferred Stock is convertible into is equal to the number of shares of common
stock outstanding on November 1, 1996 (on a diluted basis), which was
22,564,000, multiplied by a fraction (i) the numerator of which is equal to the
stated value with respect to the shares of Series A Preferred Stock being so
converted, plus any dividends accrued thereon, and (ii) the denominator of which
is equal to $100.0 million plus the number of dollars received by Destia since
November 1, 1996 from the exercise of specified options or warrants.
13. RELATED PARTY TRANSACTIONS
The Company has notes payable due to various related parties. These notes
are unsecured, and accrue interest at annual rates ranging from 9% to 18%. These
notes are demand obligations.
The Company has a non-interest bearing note receivable at December 31, 1997
and 1998 for approximately $215,000 and $230,000, respectively, from a related
party.
14. STOCK-BASED COMPENSATION PLANS
On October 31, 1996, the Board of Directors adopted the Destia
Communications, Inc. 1996 Flexible Incentive Plan (the "1996 Plan") and an
Incentive Stock Option Agreement with the then Chief Operating Officer and Chief
Financial Officer of the Company. The Company accounts for awards granted to
employees and directors under APB No. 25, under which no compensation cost has
been recognized for stock options granted. Had compensation cost for these stock
options been determined consistent with
F-18
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
SFAS No. 123, the Company's net income and earnings per share would have been
reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
1996 1997 1998
------------- ------------- --------------
<S> <C> <C> <C>
Net Loss:
Available to Common Shareholders.................................. $ (8,593,000) (31,007,000) $ (68,944,000)
Pro Forma......................................................... (9,088,000) (31,798,000) (70,644,000)
Basic EPS:
As reported....................................................... $ (.43) $ (1.55) $ (3.44)
Pro Forma......................................................... $ (.45) $ (1.59) $ (3.53)
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts since the Company anticipates additional awards in
the future.
Under the 1996 Plan, the Company granted 20,000 options to outside
consultants. All transactions with individuals other than those considered
employees, as set forth within the scope of APB No. 25, must be accounted for
under the provisions of SFAS No. 123. Under SFAS No. 123, the fair value of the
options granted to the consultants as of the date of grant using the
Black-Scholes pricing model is $33,019. The NQSOs (as hereinafter defined) were
granted to the consultants for terms of up to ten years and are exercisable in
whole or in part at stated times from the date of grant up to three years from
the date of grant. The 10,000 options granted to consultants during 1996 and the
10,000 options granted to consultants during 1998 have an exercise price of
$2.50 and $5.00, respectively. As of December 31, 1997 and 1998, 3,333 and
11,667 of the options granted to the consultants were exercisable, respectively,
and the expense recognized in 1996, 1997 and 1998 relating to these options was
$496, $2,976 and $9,666, respectively.
The 1996 Plan as amended authorizes the granting of awards, the exercise of
which would allow up to an aggregate of 4,600,000 shares of the Company's common
stock to be acquired by the holders of said awards. The awards can take the form
of Incentive Stock Options ("ISOs"), Non-qualified Stock Options ("NQSOs"),
Stock Appreciation Rights ("SARs"), Restricted Stock and Unrestricted Stock. The
SARs may be awarded either in tandem with options or on a stand-alone basis.
Awards may be granted to key employees, directors and consultants. ISOs and
NQSOs are granted in terms not to exceed ten years and become exercisable as set
forth when the award is granted. Options may be exercised in whole or in part.
The exercise price of the ISOs is the market price of the Company's common stock
on the date of grant. The exercise price of NQSOs shall never be less than the
par value of the Company's common stock. Any plan participant who is granted
ISOs and possesses more than 10% of the voting rights of the Company's
outstanding common stock must be granted an option price with at least 110% of
the fair market value on the date of grant and the option must be exercised
within five years from the date of grant. Under the Company's 1996 Plan, ISOs
and NQSOs have been granted to key employees and directors for terms of up to
ten years, and are exercisable in whole or in part at stated times from the date
of grant up to three years from the date of grant. At December 31, 1997 and
1998, 1,109,250 and 2,155,692 options respectively, were exercisable under the
Company's 1996 Plan.
F-19
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
Option activity during 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
1997 1998
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- --------------- ---------- ---------------
Outstanding at beginning of year.......................... 2,606,500 $ 2.50 2,901,445 $ 2.74
Granted................................................... 304,945 5.00 1,538,555 6.37
Cancelled................................................. (10,000) 2.50 (169,092) 3.04
Outstanding at end of year................................ 2,901,445 2.74 4,270,908 4.00
---------- ----- ---------- -----
---------- ----- ---------- -----
Exercisable at end of year................................ 1,109,250 2.50 2,155,692 2.74
Weighted average fair value of options granted............ $ 1.91 $ 2.45
</TABLE>
The fair value of each option grant is estimated using the Black-Scholes
option pricing model with the following weighted-average assumptions used for
grants in 1997 and 1998: risk-free interest rate of 6.23% and 5.43% for 1997 and
1998; expected life of three years for 1997 and 1998; expected volatility of 47%
for 1997 and 66% for 1998 and expected dividend yield of zero percent for 1997
and 1998.
The following table summarizes information with respect to stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTION EXERCISABLE
------------------------------------------- -----------------------------------------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED AVERAGE
REMAINING
EXERCISE NUMBER OUTSTANDING AT LIFE WEIGHTED AVERAGE NUMBER EXERCISABLE AT WEIGHTED AVERAGE
PRICE DECEMBER 31, 1998 CONTRACTUAL EXERCISE PRICE DECEMBER 31, 1998 EXERCISE PRICE
- ------------- ---------------------- ------------------- ----------------- --------------------- -----------------
2$.50-$5.00.. 3,434,408 8.03 $ 3.17 2,155,692 $ 2.74
6$.75-$7.50.. 836,500 9.28 $ 7.42 -- --
</TABLE>
15. COMMITMENTS AND CONTINGENCIES
The Company has various lease agreements for offices, automobiles and other
property. Future minimum annual lease payments under the Company's operating and
capital leases with initial or remaining terms of one year or more at December
31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
------------- ----------
<S> <C> <C>
1999................................................................................... $ 5,389,000 $ 154,000
2000................................................................................... 4,140,000 91,000
2001................................................................................... 3,529,000 67,000
2002................................................................................... 2,988,000 35,000
2003 and thereafter.................................................................... 6,919,000 --
------------- ----------
Total minimum lease payments........................................................... $ 22,965,000 $ 347,000
------------- ----------
------------- ----------
</TABLE>
The rent expense for the years ended December 31, 1996, 1997 and 1998 was
approximately $394,000, $1,378,000 and $2,824,000, respectively.
F-20
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has entered into employment agreements with certain officers
which expire by December 31, 1999. The aggregate commitment for future
compensation under these agreements is approximately $1,350,000. These officers
are also eligible for annual bonuses based on performance.
LONG-TERM LEASE AGREEMENT
On November 17, 1998, Destia reached an agreement with Frontier
Communications ("Frontier") to acquire a 20-year IRU to use portions of its U.S.
fiber optic network. The Company expects to begin using some of Frontier's
network by July 1999. Additionally, management expects that Frontier's fiber
optic network will be fully operational by the end of 1999. A portion of the
acquisition price was paid on November 17, 1998. The balance of the obligation
will be discharged over the next 36 months based upon the terms and conditions
of the agreement. Beginning in June 1999, Frontier shall have the right to
purchase on a monthly basis up to a cumulative average of one million dollars in
Destia services that will be offset against the remaining obligation in lieu of
additional cash payments. At the end of the 36-month period the balance
remaining will be settled with a cash payment. The acquisition price will be
amortized over 20 years and will commence at the date that the network becomes
substantially operational. The Company's total commitments are approximately
$42.3 million in the aggregate for the 20-year IRU from Frontier and for the
purchase of a transatlantic IRU.
16. ACQUISITIONS
VOICENET ACQUISITION
A definitive agreement to acquire VoiceNet was entered into on January 28,
1998. The closing of the VoiceNet Acquisition occurred on February 12, 1998. The
initial purchase price for VoiceNet was $21.0 million and was paid out of cash
on hand. The sellers of VoiceNet also are entitled to receive an earn-out based
upon the revenue growth of the VoiceNet business.
VoiceNet provides travelers and other callers with calling card services,
which are advertised primarily in in-flight magazines. Destia has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996.
TELCO MINORITY INTEREST ACQUISITION
In the United Kingdom, the majority of Destia's sales are made through Telco
Global Communications ("Telco"), its majority owned subsidiary that was
established during the fourth quarter of 1996. Telco's revenues are derived
primarily from international and domestic long distance services and the sale of
prepaid cards. On July 17, 1998, the Company acquired the 30% minority interest
in Telco it did not already own in exchange for approximately $14.0 million in
cash, payable by the Company in quarterly installments, together with interest
at a rate of 8.0% per annum, over approximately three years. The entire purchase
price is classified as goodwill, which will be amortized over 20 years. In
connection with such acquisition, (i) Telco obtained ownership rights with
respect to certain proprietary software used in Telco's business and (ii) the
Company converted options to acquire Telco shares held by Telco employees into
grants of non-voting restricted shares of the Company's common stock.
F-21
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
16. ACQUISITIONS (CONTINUED)
OTHER ACQUISITIONS
During November 1998, the Company completed two small acquisitions. It
acquired a controlling interest in America First Ltd. ("America First"), a
prepaid card distributor in the United Kingdom for approximately $5.5 million.
The majority of the purchase price was recorded as goodwill and will be
amortized over 20 years. The Company also acquired the customer list of a long
distance reseller, also located in the United Kingdom. The purchase price was
allocated to the customer base and will be amortized over 5 years.
17. SUBSEQUENT EVENTS (UNAUDITED)
INITIAL PUBLIC OFFERING
On February 1, 1999, the Company announced that it had filed a registration
statement with the Securities and Exchange Commission for an IPO of its common
stock, with the number of shares and price to be determined.
F-22
<PAGE>
SCHEDULE II
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT
BEGINNING CHARGES TO
OF COSTS AND BALANCE AT END
PERIOD EXPENSES DEDUCTIONS(A) OF PERIOD
----------- ------------ -------------- --------------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
December 31,
1998..................................................... $ 1,593,531 $ 7,392,234 $ (4,899,663) $ 4,086,102
1997..................................................... 761,372 3,890,525 (3,058,366) 1,593,531
1996..................................................... 470,610 290,762 -- 761,372
</TABLE>
- ------------------------
(a) Represents write-offs, recoveries and other deductions
S-1
<PAGE>
CERTIFICATE OF AMENDMENT
OF
THE CERTIFICATE OF INCORPORATION
OF
ECONOPHONE INC.
It is hereby certified that:
1. The name of the corporation (hereinafter called the
"corporation") is Econophone, Inc.
2. The certificate of incorporation of the corporation is hereby
amended by striking out Paragraph 1 thereof and by
substituting in lieu of said Paragraph the following new
Paragraph:
"1. The name of the corporation is Destia Communications,
Inc."
3. The amendment of the certificate of incorporation herein
certified has been duly adopted and written consent has been
given in accordance with Sections 228 and 242 of the General
Corporation Law of the State of Delaware.
Dated as of: January 28, 1999
--------------------------------
By: Richard L. Shorten, Jr
Title: Senior Vice President and
General Counsel
<PAGE>
AMENDMENT TO STOCK PURCHASE AGREEMENT
THIS AMENDMENT TO STOCK PURCHASE AGREEMENT ("this Amendment") is entered into as
of April 16, 1998, by and among Econophone, Inc., a New York corporation
("Buyer"); and Richard Masino, an individual domiciliary of the State of New
York ("Masino"), and Robert Wunder, an individual domiciliary of the State of
Connecticut ("Wunder"), together the former holders of all the issued and
outstanding shares of capital stock of VoiceNet Corporation, a New York
corporation ("the Company") (each of Masino and Wunder individually a "Seller"
and together, jointly and severally, the "Sellers").
RECITALS
The parties previously have entered into a Stock Purchase Agreement
dated as of January 28, 1998 ("the Agreement").
The parties mutually desire to amend the Agreement in certain respects,
and to restate and reconfirm the remaining unperformed terms and conditions of
the Agreement that are not amended hereby.
Now, therefore, in consideration of the foregoing covenants and
promises, and other good and valuable consideration, the parties agree as
follows:
1. All defined terms in the Agreement shall have the same meanings in
this Amendment, unless otherwise specified.
2. Section 3.1 of the Agreement is hereby deleted in its entirety and
the following text is substituted in place of the deleted provisions:
3.1 The Purchase Price payable in respect of the Shares shall be
increased by an amount (the "Earn-Out Bonus"), calculated and
paid as follows:
3.1.1 DURING THE PERIOD FROM AND INCLUDING APRIL 16, 1998
TO AND INCLUDING APRIL 15, 1999: the Earn-Out Bonus
shall be calculated on two components, computed over
the period from and including the 16th of each
calendar month to and including the 15th of the
following calendar month: (A) 4.08% of Base Year
Calling Card Revenues (as defined below), plus (B)
1.2% of Base Year Additional Revenues (as defined
below); PROVIDED, that no single element of Earn-Out
Bonus will be calculated on both of the separate
components specified in this subsection. For all
purposes of this subsection 3.1.1, the following
definitions shall apply:
1
<PAGE>
(w) "Base Year Calling Card Revenues" shall mean that
amount by which Net Monthly Revenues ("NMR", as
defined below) of Calling Card Services (defined
below) shall exceed US$3,500,000;
(x) "Base Year Additional Revenues" shall mean the
combined NMR of postpaid "1+", prepaid "1+", fixed
termination toll-free "800"/"888", reroutable
toll-free "800"/ "888", ITFS, and local access PIN
services generated by the VoiceNet business unit of
Econophone (collectively, the "Other Services"),
calculated upon the full US dollar increment above a
base of zero;
(y) "NMR" shall mean the gross monthly revenues of
Calling Card Services or Other Services, as the case
may be, generated by the VoiceNet business unit of
Econophone, but shall not include (a) universal
service charges and other access fees, payphone
surcharges and other surcharges, directory assistance
charges, line and installation charges, monthly fees,
taxes, promotional discounts, minimum usage charges,
fraudulent charges, or subsequently credited charges
for any of the foregoing, or (b) those revenues for
which Sellers or their Affiliates otherwise receive
commissions pursuant to separate agreements or
arrangements;
(z) "Calling Card Services" shall mean the following
calling card products and services only, and no other
products or services: (a) postpaid calling card
products and postpaid calling card services marketed
by the VoiceNet business unit of Econophone
(excluding postpaid calling card products and
services marketed by Econophone independently of the
VoiceNet business unit, other than those products or
services that were developed by the VoiceNet business
unit) and (b) prepaid calling card products and
prepaid calling card services marketed by the
VoiceNet business unit of Econophone (excluding
prepaid calling card products and services marketed
by Econophone independently of the VoiceNet business
unit, other than those products or services that were
developed by the VoiceNet business unit).
3.1.2 DURING THE PERIOD FROM AND INCLUDING APRIL 16, 1999
TO AND INCLUDING APRIL 15, 2000: the Earn-Out Bonus
shall be calculated on two components, computed over
the period from and including the 16th of each
calendar month to and including the 15th of the
following calendar month: (A) 2.5% of Second Year
Calling Card Revenues (as defined below), plus (B)
1.2% of Second Year
2
<PAGE>
Additional Revenues (as defined below); provided,
that no single element of Commission will be
calculated on both of the separate components
specified in this subsection. For all purposes of
this subsection 3.1.2, the following definitions
shall apply:
(w) "Second Year Calling Card Revenues" shall mean
that amount by which NMR of Calling Card Services
during the applicable month shall exceed the average
NMR of Calling Card Services for the three-month
period from and including January 16, 1999 through
and including April 15, 1999;
(x) "Second Year Additional Revenues" shall mean the
amount by which the combined NMR of Other Services
shall exceed the average combined NMR of Other
Services for the three-month period January 16, 1999
through April 15, 1999.
3.1.3 DURING THE PERIOD FROM AND INCLUDING APRIL 16, 2000
TO AND INCLUDING APRIL 15, 2001: the Commission shall
be calculated on two components, computed over the
period from and including the 16th of each calendar
month to and including the 15th of the following
calendar month: (A) 2.5% of Third Year Calling Card
Revenues (as defined below), plus (B) 1.2% of Third
Year Additional Revenues (as defined below);
provided, that no single element of Commission will
be calculated on both of the separate components
specified in this subsection. For all purposes of
this subsection 3.1.3, the following definitions
shall apply:
(w) "Third Year Calling Card Revenues" shall mean
that amount by which NMR of Calling Card Services
shall exceed the average of the actual monthly
revenues for the three-month period from and
including January 16, 2000 through and including
April 15, 2001;
(x) "Third Year Additional Revenues" shall mean the
amount by which the combined NMR of Other Services
shall exceed the average of the combined NMR of Other
Services for the three-month period from and
including January 16, 2000 through and including
April 15, 2001.
3.1.4 The actual amount of each monthly payment of Earn-Out
Bonus shall be the figure determined in accordance
subsection 3.1.1, 3.1.2 or 3.1.3 hereof, as the case
may be, less $15,000.
3.1.5 In the event that the Employment Agreements (as
defined in subsection 5.1.6 below) are terminated
pursuant to paragraphs (a),
3
<PAGE>
(b) or (c) of Section 8 thereof, any Earn-Out-Bonus
theretofore accrued but not paid up to the date of
such termination shall be due and payable in
accordance with the terms of subsection 3.2.1 of this
Agreement.
3. Section 3.2.1 of the Agreement is hereby deleted in its entirety and
the following text is substituted in place of the deleted provision:
3.2.1 The Earn-Out Bonus shall be computed and paid by
Econophone no later than the 10th day following the
conclusion of any billing cycle (currently the 15th
day of each calendar month) with respect to the
immediately preceding concluded billing cycle, and
shall be payable with respect to all complete billing
cycles (and on a pro rata basis for any partial
billing cycle) for so long as both Employment
Agreements (as defined in subsection 5.1.6 below)
continue in effect; PROVIDED, HOWEVER, that in the
event either Employment Agreement is terminated
pursuant to Section 8(d) thereof, with the effect
that no further Earn-Out Bonus shall be payable on
account of such termination, then Sellers shall be
entitled to a single final payment equal to the
amount (if any) by which the average of the last
three cycle payments of Earn-Out Bonus prior to the
termination exceeds six months' salary payable
pursuant to Section 8(d) of the Employment Agreement.
4. The Employment Agreements dated February 12, 1998, referenced in
Subsection 5.1.6 of the Agreement and annexed to the Agreement as Exhibits A-1
and A-2 are hereby terminated and shall be of no further force and effect. Each
of Sellers has entered into a replacement Employment Agreement dated as of the
same date as this Amendment, copies of which are annexed hereto as Exhibits A-1
and A-2, and all references in the Agreement to either or both of the Employment
Agreements shall hereafter mean the replacement Employment Agreements described
herein in this Paragraph 3.
5. All others terms and conditions of the Agreement shall remain in
full force and effect. In the event of any ambiguity between the provisions of
this Amendment and the language of the Agreement, the provisions of this
Amendment shall control.
4
<PAGE>
IN WITNESS WHEREOF, the parties have caused this Agreement to be duly
executed as of the date first written above.
SELLERS: BUYER:
RICHARD MASINO ECONOPHONE, INC.
________________________________ By: ________________________________
ROBERT WUNDER Name: ______________________________
________________________________ Title: _______________________________
5
<PAGE>
EXHIBIT A-1
WUNDER EMPLOYMENT AGREEMENT
6
<PAGE>
EXHIBIT A-2
MASINO EMPLOYMENT AGREEMENT
7
<PAGE>
Exhibit 10.10
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT (this "Agreement"), dated as of February 2, 1998,
is made by and between ECONOPHONE, INC., a Delaware corporation, having its
principal office at 45 Broadway, New York, New York 10006 ("Econophone") and Mr.
Phillip Storin ("Executive").
WHEREAS, Econophone desires to employ Executive and Executive desires
to provide services to Econophone;
NOW, THEREFORE, in consideration of the premises and of the other
mutual covenants and conditions contained herein and for other good and valuable
consideration, the sufficiency and receipt of which are hereby acknowledged,
Econophone and Executive agree as follows:
SECTION 1. EMPLOYMENT AND TERM. (a) Econophone hereby employs Executive
commencing as of the date hereof (the "Commencement Date"). The initial term of
Executive's employment shall be three years, subject to earlier termination as
specified herein (the "Employment Term"). Any renewal or extension of the
Employment Term and this Agreement shall be subject to the mutual agreement of
Executive and Econophone.
(b) Executive shall be employed as Senior Vice President - Chief
Financial Officer of Econophone, with powers and duties consistent with such
position, for the duration of the Employment Term. During the term of
Executive's employment by Econophone, Executive shall report to the President
and Chief Operating Officer of Econophone or to such other person as the Board
of Directors of Econophone shall direct.
(c) Executive shall be employed at the headquarters of Econophone in
the New York regional area, provided that until September 1, 1998, Executive
shall be permitted to maintain his principal residence outside of the New York
regional area and work at Econophone's headquarters in the New York regional
area on a limited basis so long as Executive at all times devotes his entire
business time, energy and skill to the performance of his duties hereunder.
SECTION 2. FULL-TIME EMPLOYMENT. (a) During Executive's employment by
Econophone, Executive shall devote Executive's entire business time, energy and
skill to the performance of Executive's duties hereunder and to the business of
Econophone. Executive shall faithfully and diligently perform such duties, shall
adhere to the instructions of the Chief Executive Officer, Chief Operating
Officer and Board of Directors of Econophone and shall use his best efforts to
promote the interests of Econophone consistent with the foregoing. Executive
shall adhere to all corporate policies of Econophone and, to the extent
applicable to Executive's duties hereunder, Econophone's subsidiaries and
affiliates. Executive shall not, directly or indirectly,
<PAGE>
alone or as a member of any partnership, or as an officer, director or executive
of any other corporation, partnership or other organization, be actively engaged
in or concerned with any other duties or pursuits which interfere with the
performance of his duties hereunder, or which may be inimical to or contrary to
the best interests of Econophone.
(b) Executive represents and warrants that he is free to be employed by
Econophone upon the terms contained in this Agreement and that he is not a party
to any employment contract or restrictive covenant or other arrangement which
could reasonably be expected to prevent, interfere with or hinder, or be deemed
to be breached by, full performance of his duties hereunder.
SECTION 3. COMPENSATION. (a) BASE SALARY. For all services rendered by
Executive in any capacity during Executive's employment under this Agreement,
including, without limitation, service as an executive, officer, or member of
any committee of Econophone or any of its subsidiaries or affiliates, Econophone
agrees to pay or cause to be paid to Executive a base salary at the rate of
$180,000 per annum, payable in equal installments in accordance with the
prevailing salary payment practices of Econophone in effect from to time (the
"Base Salary"). Executive's Base Salary shall be subject to review and increase
on an annual basis based upon changes in Executive's title, job description or
responsibilities. In the event that sickness or accident disability payments
under Econophone's insurance programs shall become payable to Executive in
respect of any period of Executive's employment hereunder the salary installment
payable to Executive hereunder in respect of his Base Salary on the next
succeeding salary installment payment date shall be an amount computed by
subtracting (i) the amount of such disability payments which shall have become
payable during the period between such date, from (ii) the salary installment
otherwise payable to Executive hereunder in respect of his Base Salary on such
date.
(b) BONUS. Executive shall be entitled to receive an annual bonus
payment from Econophone of up to 50% of Executive's Base Salary to be awarded at
the discretion of the Board of Directors of Econophone, based upon Executive's
contributions to Econophone with respect to the areas of responsibility outlined
on Exhibit A. For each year following the first year of the Employment Term,
Executive's bonus criteria shall be established by the Board of Directors prior
to the commencement of such year, and such bonus criteria may include targets
with respect to all or part of the items listed on Exhibit A, other qualitative
targets related to Executive's position and, to the extent applicable to other
senior executives of Econophone, financial performance criteria related to
Econophone all as may be determined by the Board of Directors. Any additional
bonus payable to the Executive shall be at the sole discretion of the Board of
Directors of Econophone and shall be made to the extent, at such time and in
such amount as determined by the Board of Directors of Econophone in its sole
discretion.
(c) INCENTIVE COMPENSATION. In addition to the other compensation
hereunder, the Company has granted to Executive as of the Commencement Date and
in accordance with
<PAGE>
Econophone's 1996 Flexible Incentive Plan (the "Plan"), 100,000 options to
acquire common stock of Econophone. The terms of the vesting and exercise of
such options shall be governed by the Incentive Stock Option Agreement attached
as Exhibit B hereto and the terms of the Plan.
(d) BENEFITS. Executive shall be entitled to participate in medical,
dental, life insurance and other benefits (collectively, the "Benefits") in
accordance with the prevailing policies of Econophone for executive employees.
SECTION 4. VACATION. Executive shall be entitled to an annual vacation
of three weeks (without deduction in salary or other compensation or Benefits).
Such vacation shall be taken at such time or times as may be convenient to the
operations of Econophone and shall be consistent with the prevailing vacation
policies of Econophone.
SECTION 5. REIMBURSEMENT FOR EXPENSES. Executive is authorized to incur
reasonable and necessary traveling expenses and other reasonable and necessary
traveling expenses and other reasonable and necessary disbursements for or on
behalf of Econophone in the performance of Executive's duties during Executive's
employment under this Agreement in accordance with Econphone's prevailing
expense incurrence policies. Econophone will reimburse Executive for all such
expenses in accordance with its prevailing expense reimbursement policies upon
presentation of a properly itemized account of such expenditures business
reasons for such expenditures. In addition, during the period from the date
hereof to and including August 31, 1998, Executive shall be entitled to
reimbursement for (i) the reasonable cost of weekly airfare between the New York
regional area and Texas (or, alternatively, the cost to fly a relative round
trip to New York over a weekend at a cost not to exceed the cost of airfare if
Executive were to travel to Texas from New York); (ii) reasonable expenses for
temporary housing in the New York regional area (including rent, utilities and
similar incidental expenses); (iii) the reasonable cost of airfare for two trips
to the New York regional area for Executive's spouse to search for permanent
housing and (iv) a tax "gross-up" payment to cover any additional income and
medicare tax expense to Executive arising from the expense reimbursements set
forth in this Section 5. Furthermore, upon relocation of Executive's principal
residence as contemplated by Section 1(c), hereof, Executive shall be entitled
to reimbursement for relocation expenses of up to $7,500 for household goods,
the company will also pay for the cost of airfaire for Executive and wife and
reasonable cost to transport two automobiles from Texas to New York.
SECTION 6. TERMINATION OF EMPLOYMENT BY ECONOPHONE. (a) TERMINATION.
Executive shall be subject to dismissal from his position as an executive of
Econophone at any time and with or without Cause. The effect of any termination
of the employment of Executive with Cause is set forth in Section 8(a) hereof.
The effect of any termination of the employment of Executive without Cause is
set forth in Section 8(d) hereof.
(b) DEFINITION OF CAUSE. The term "Cause" shall be defined to include:
(i) any wilful breach by Executive of the performance of any of his duties
pursuant to this Agreement; (ii) any
<PAGE>
wilful breach by Executive of any other obligation under this Agreement; (iii)
any attempt by Executive to secure any personal profit in connection with the
business of Econophone, other than as expressly provided for in this Agreement;
(iv) failure by Executive to devote sufficient business time to the affairs of
Econophone; (v) material breach by Executive of any of the representations or
warranties contained in this Agreement; (vi) activities of Executive inimical to
the best interests of Econophone; PROVIDED, HOWEVER, that such activities shall
not include mistakes in business judgment made in good faith; (vii) conviction
of, or a plea of NOLO CONTENDERE to, a felony or any act of fraud, whether or
not related to the affairs of Econophone; (viii) subject to Sections 6(c) and
6(d) below, death or disability of Executive; and (ix) any other
insubordination, dishonesty, moral turpitude or other misconduct that, in the
absence of any agreement in writing between the parties hereto, would entitle
Econophone to terminate Executive's employment in accordance with its prevailing
employment policies.
(c) TERMINATION BY REASON OF INCAPACITY. In the event that Executive
suffers a disability which prevents him from substantially performing his duties
under this Agreement for a period of at least sixty (60) calendar days within a
365-calender day period (whether consecutive or non-consecutive) (a
"Disability"), Econophone shall have the right to dismiss Executive for Cause
upon ten (10) calendar days written notice. In the event of any dispute between
Econophone and Executive as to whether Executive has suffered a Disability, the
determination of whether Executive has suffered a Disability shall be made by an
independent physician selected by Econophone, and the decision of such physician
shall be binding upon Econophone and Executive.
(d) TERMINATION BY DEATH. In the event Executive dies during the
Employment Term, this Agreement shall terminate automatically, such termination
to be effective on the date of Executive's death as if Executive had been
terminated for Cause as of such date.
SECTION 7. TERMINATION OF EMPLOYMENT BY EXECUTIVE. The employment of
Executive under this Agreement shall be deemed to have been terminated by
Executive for "Good Reason" if Executive voluntarily terminates employment
following the occurrence of a material breach by Econophone of any of its
obligations under this Agreement; PROVIDED, HOWEVER, that Executive shall
provide written notice of such material breach within thirty (30) days after
Executive's discovery of such material breach and Econophone shall have the
opportunity to cure such default within thirty (30) days after receipt of such
written notice. If Econophone does not cure the default within such time, then
Executive's employment shall be deemed to have been terminated for Good Reason
by Executive, thirty (30) days after receipt of such written notice by
Econophone, or such shorter period as Econophone may elect. No resignation or
other voluntary termination by Executive other than pursuant to this Section 7
shall be deemed under any circumstances to be a termination with Good Reason, a
"constructive termination" or otherwise not in breach of Executive's obligations
under this Agreement.
SECTION 8. EFFECT OF TERMINATION. (a) FOR CAUSE; WITHOUT GOOD REASON.
In the event
<PAGE>
of termination of this Agreement (x) by Econophone for Cause (except by reason
of death or Disability) or (y) by Executive without Good Reason, Econophone
shall pay to Executive any Base Salary accrued but not paid to Executive prior
to the date of such termination and Executive shall be entitled to any Benefits
which may then be due under any of the benefit or other plans in which Executive
is a participant. Executive shall forfeit any right to any bonus not previously
paid to Executive by Econophone and shall not be entitled to any further
compensation or benefits hereunder (including, without limitation, the
Benefits). In addition, Executive shall forfeit all unvested options held by
Executive in accordance with the terms of Executive's Incentive Stock Option
Agreement.
(b) BY REASON OF EXECUTIVE'S DEATH. In the event of the termination of
this Agreement by reason of the death of the Executive, Econophone (i) shall pay
Executive's legal representatives (A) any unpaid salary installment in respect
to Executive's Base Salary to the last day of the month in which Executive's
death occurs, and (B) any bonus previously awarded but not yet paid to the
Executive and (ii) shall continue to provide (subject to any applicable
eligibility criteria) any medical and dental benefits comprising part of the
Benefits (or comparable benefits) to the spouse and any dependents of Executive
at the time of Executive's death, for a period of twelve (12) months from the
last day of the month in which Executive's death occurs. In addition, Executive
shall forfeit all unvested options held by Executive at the time of his death in
accordance with the terms of Executive's Incentive Stock Option Agreement.
(c) BY REASON OF THE INCAPACITY OF THE EXECUTIVE. In the event of the
termination of this Agreement by reason of the Disability of the Executive,
Econphone (i) shall pay the Executive (A) Executive's Base Salary to the last
day of the month in which such termination occurs and (B) any bonus previously
awarded but not yet paid to the Executive and (ii) shall continue to provide
(subject to any applicable eligibility criteria) any medical benefits comprising
part of the Benefits (or comparable benefits) to Executive, Executive's spouse
and any dependants of Executive who enjoyed such medical benefits at the time of
Executive's Disability, for a period of twelve (12) months from the last day of
the month in which such termination occurs. In addition, Executive shall forfeit
all unvested options held by Executive at the time of his termination in
accordance with the terms of Executive's Incentive Stock Option Agreement.
(d) WITHOUT CAUSE; FOR GOOD REASON. In the event of termination of this
Agreement (x) by Econophone without Cause or (y) by Executive for Good Reason,
Econophone (i) shall pay the Executive (A) Executive's Base Salary through the
date of termination, in accordance with its prevailing salary payment practices
(as determined by Econophone in its sole discretion), (B) within 30 days of such
termination, a severance payment in the amount equal to six month's Base Salary
at the time of termination (provided if such termination occurs after Executive
shall have been employed by Econophone for more than one year then such
severence payment shall increase to one year's base salary at the time of
termination) and (C) any bonus previously awarded to but not yet paid to
Executive and (ii) shall continue to provide Executive with Benefits (or
comparable benefits), including (subject to applicable eligibility criteria)
medical
<PAGE>
benefits comprising a portion of the Benefits (or comparable benefits) in
respect of Executive's spouse and any dependents of the Executive as of the date
of such termination, until six (6) months following such termination (provided
if such termination occurs after Executive shall have been employed by
Econophone for more than one year then such benefits shall be continued for one
year from the date of termination). In addition, in the event that any such
termination without Cause or without Good Reason occurs in the first twelve (12)
months of Executive's employment by Econophone, 33,000 of the options granted to
Executive in accordance with the terms of Executive's Incentive Stock Option
Agreement shall become immediately vested and exercisable.
(e) SOLE REMEDY. Executive shall not be entitled to any form of
severance benefits, including, without limitation, benefits otherwise payable
under any of Econophone's regular severance policies, other than those set forth
herein. In consideration of the compensation and benefits available hereunder,
Executive, except as otherwise expressly provided in this Agreement,
unconditionally releases Econophone and its present and future Affiliates,
directors, officers, employees and agents, or any of them, from any and all
claims, liabilities and obligations of any nature pertaining to termination of
Executive's employment hereunder. Executive and Econophone further agree that
upon any termination of Executive's employment in accordance with the terms
hereof, each of Executive and Econophone shall act in good faith in connection
with any such termination and neither Executive nor Econophone shall disparage
or otherwise defame the business reputation of the other party hereto.
SECTION 9. NON-COMPETITION AND PERMITTED BUSINESS ACTIVITIES.
NON-COMPETE DURING EMPLOYMENT TERM. (a) Executive agrees that during the
Employment Term of this Agreement, except with the written consent of
Econophone, such Executive shall not (i) accept any form of employment with
remuneration from any business related to the provision of telecommunications
services (a "Competing Business") or (ii) hold any beneficial ownership
interest, directly or indirectly, in any Competing Business; provided however,
that none of the foregoing shall prohibit Executive from owning, for the purpose
of passive investment, less than 1% of any class of securities of another
publicly-held corporation.
(b) Executive agrees that during the term of this Agreement, and for a
period of twelve (12) consecutive months after termination of employment for any
reason, Executive shall not, except in the course of his duties hereunder,
directly or indirectly induce or attempt to induce or otherwise counsel, advise,
solicit or encourage any person to leave the employ of Econophone to accept
employment with any person or entity other than Econophone.
(c) Executive agrees that during the term of this Agreement, and for a
period of twelve (12) consecutive months after termination of such employment
for any reason, Executive shall not directly or indirectly solicit, induce or
attempt to solicit, induce or otherwise counsel, advise, or encourage any
customer, agent, dealer, distributor or consultant of Econophone to become a
customer, agent, dealer, distributor or consultant, directly or indirectly, of
another
<PAGE>
person or entity other than Econophone.
SECTION 10. OWNERSHIP OF WORK PRODUCT. (a) Executive acknowledges
that during the Employment Term, he may conceive of, discover, invent or create
inventions, improvements, new contributions, literary property, material, ideas
and discoveries, whether patentable or copyrightable or not (collectively, "Work
Product"), and that various business opportunities may be presented to him by
reason of his employment by Econophone. Executive acknowledges that, unless
Econophone otherwise agrees in writing, all such Work Product and business
opportunities shall be owned by and belong exclusively to Econophone and that he
shall have no personal interest therein.
(b) Executive shall further, unless Econophone otherwise agrees in
writing, (i) promptly disclose any such Work Product and business opportunities
to Econophone, (ii) assign to Econophone, upon request and without additional
compensation, the entire rights to such Work Product and business opportunities,
(iii) execute all documents necessary to carry out the foregoing and (iv) give
testimony in support of his inventorship or creation in any appropriate case
upon request of the senior management of Econophone. Executive agrees that he
will not assert any rights to any Work Product or business opportunity as having
been made or acquired by him prior to the date of this Agreement except for Work
Product or business opportunities, if any, disclosed to and acknowledged by
Econophone in writing prior to the date hereof.
(c) The provisions of this Section 10 shall survive for a period of
three (3) years following expiration, cancellation or other termination of this
Agreement.
SECTION 11. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. (a) Executive
shall hold in a fiduciary capacity for the benefit of Econophone all
Confidential Information (as defined below) and shall not, during the term of
Executive's employment hereunder or after the termination of such employment,
communicate or divulge any Confidential Information to, or use any Confidential
Information for the benefit of, any person (including Executive) other than
Econophone, affiliates of Econophone or persons designated in writing by
Econophone. "Confidential Information" shall mean customer lists, costs and
specifications of Econophone's products and services, know-how, trade secrets,
financial data, operational methods, marketing and sales information, marketing
plans and strategies, business plans, personnel information, research projects,
development plans or projects and all other information of a proprietary nature.
Upon termination of Executive's employment with Econophone for any reason
whatsoever, Executive shall promptly return to Econophone any documents or other
written, recorded or graphic matter containing, relating or referring to any
Confidential Information (and all copies and extracts thereof and any notes
relating thereto) in Executive's possession or control and deliver to Econophone
a written confirmation that all such Confidential Material has been so returned.
(b) The provisions of this Section 11 shall survive for a period of
three (3) years
<PAGE>
following expiration, cancellation or other termination of this Agreement.
SECTION 12. LIABILITY FOR ACTIONS OR INACTIONS; INDEMNIFICATION. (a)
Executive shall not be liable, in damages or otherwise, to Econophone for any
act or failure to act on behalf of Econophone, performed within the scope of his
authority conferred by the terms of his employment under this Agreement, unless
such act or omission constituted Cause or fraudulent or willful misconduct, was
performed or omitted in bad faith or constituted gross negligence.
(b) Econophone shall indemnify and hold harmless Executive from and
against any and all claims, losses, damages and expenses incurred by reason of
any acts, omission or alleged acts or omissions undertaken or omitted (a) in the
good faith belief that such act or omission was in furtherance of the business
of Econophone; (b) not in contravention of this Agreement; and (c) not in
contravention of the standard set forth in Section 12(a) hereof, incurred as a
result of any actual or threatened civil, criminal, administrative or
investigative action, proceeding or claim; PROVIDED, HOWEVER, that if Executive
ultimately is found by any court of competent jurisdiction or by any arbitrator
to have acted or omitted to act in a manner which is in contravention of the
standard set forth in any of the foregoing clauses (a), (b) or (c), Executive
shall repay all amounts paid or reimbursed by Econophone. Econophone shall not
be required to indemnify Executive for any amount paid or payable by Executive
in the settlement of any action, proceeding or investigation agreed to without
the written consent of Econophone (which consent shall not unreasonably be
withheld or delayed). Promptly after receipt by Executive of notice of his
involvement in any action, proceeding or investigation, Executive shall, if a
claim in respect thereof for indemnification is to be made by Executive against
Econophone under this Section, notify Econophone in writing of such involvement.
No failure by Executive to so notify Econophone shall relieve Econophone from
the obligation to indemnify Executive unless and to the extent that Econophone
shall have been actually prejudiced by such failure. To the extent it wishes,
Econophone shall be entitled to assume the defense of any action that is the
subject of this Section; PROVIDED, HOWEVER, that Executive may retain his own
counsel (i) at his own expense in order to participate in such defense, and (ii)
at the expense of Econophone if representation of both Executive and Econophone
would, in the reasonable judgment of Executive, be inappropriate due to actual
or potential differing interests between them.
(c) The provisions of this Section 12 shall survive for a period of
three (3) years following expiration, cancellation or other termination of this
Agreement.
SECTION 13. ENTIRE AGREEMENT. (a) This entire Agreement, together with
the Incentive Stock Option Agreement that is an Exhibit hereto, contains the
entire understanding of the parties with respect to the subject matter hereof
and supersedes any and all prior agreements and understandings, both written and
oral, of the parties with respect to the subject matter hereof.
SECTION 14. GOVERNING LAW; JURISDICTION; SERVICE OF PROCESS. (a) This
Agreement shall be governed by and construed in accordance with the laws of the
State of New York (other
<PAGE>
than its rules of conflicts of laws to the extent that the application of the
laws of another jurisdiction would be required thereby).
(b) With respect to any suit, action, or proceedings relating to this
Agreement ("Proceedings"), the parties irrevocably:
(i) submit to the non-exclusive jurisdiction of the courts of
the State of New York and the United States District Court located in
the Borough of Manhattan in New York City; and
(ii) waive any objection that they may have at any time to the
laying of venue of any Proceedings brought in any such court; waive any
claim that such Proceedings have been brought in an inconvenient forum;
and further waive the right to object, with respect to such
Proceedings, that such court does not have jurisdiction over such
party.
(c) The parties irrevocably consent to service of process given in the
manner provided for notices in Section. Nothing in this Agreement shall affect
the right of either party to serve process in any other manner permitted by law.
SECTION 15. SPECIFIC ENFORCEMENT. If Executive breaches, or threatens
to commit a breach of, any of the provisions of Sections 9, 10 or 11 hereof,
Econophone shall have the right and remedy to have such provision specifically
enforced by any court having jurisdiction, it being acknowledged and agreed that
any such breach or threatened breach will cause irreparable injury to Econophone
and that money damages will not provide an adequate remedy to Econophone.
Nothing in this Section 15 shall be construed to limit the right of Econophone
to collect money damages in the event of a breach of any of the provisions of
this Agreement, including, without limitation, Sections 9, 10 and 11 hereof.
SECTION 16. THIRD PARTY BENEFICIARIES. None of the provisions of this
Agreement shall be for the benefit of or enforceable by any third party,
including, without limitation, any creditor of Econophone or of Executive. No
such third party shall obtain any right under any provision of this Agreement or
shall by reason of any such provision make any claim in respect of any debt,
liability, or obligation (or otherwise) against Econophone.
SECTION 17. WAIVER OF JURY TRIAL. Each party waives, to the fullest
extent permitted by applicable law, any right it may have to a trial by jury in
respect of any litigation arising out of or relating to this Agreement and
Executive's employment by Econophone. Each party (a) certifies that no
representative, agent or attorney of the other party has represented, expressly
or otherwise, that such other party would not, in the event of litigation, seek
to enforce the foregoing waiver; and (b) acknowledges that it has been induced
to enter into this Agreement by, among other things, the mutual waivers and
certifications set forth in this Section.
<PAGE>
SECTION 18. EXPENSES. Each party hereto shall assume and pay its own
expenses incident to the negotiation and execution of this Agreement, the
preparation for carrying it into effect and the consummation of the transactions
contemplated hereby. Without limiting the generality of the foregoing, each
party shall pay all legal fees and other fees to consultants and advisors
incurred by it relating to this Agreement and such transactions and shall
indemnify and hold the other party harmless from and against any claims for such
expenses and fees.
SECTION 19. WAIVERS AND AMENDMENTS. This Agreement may be amended,
superseded, canceled, renewed or extended and the terms hereof may be waived,
only by a written instrument signed by each party, or, in the case of a waiver,
by the party waiving compliance. Except where a specific period for action or
inaction is provided herein, no delay on the part of a party in exercising any
right, power or privilege hereunder shall operate as a waiver thereof. Neither
any waiver on the part of a party of any such right, power or privilege, nor any
single or partial exercise of any such right, power or privilege shall preclude
any further exercise thereof or the exercise of any other such right, power or
privilege.
SECTION 20. NOTICES. All notices or other communications required or
permitted to be given hereunder shall be in writing and shall be delivered by
hand or sent, postage prepaid, by registered, certified or express mail or
reputable overnight courier service and shall be deemed given when so delivered
by hand, or if mailed, three days after mailing (one business day in the case of
express mail or overnight courier service), as follows:
if to Econophone:
Econophone, Inc.
45 Broadway, 30th Floor
New York, NY 10016
Attention: General Counsel
if to Executive:
Mr. Phillip Storin
3104 Riva Ridge
Austin, TX 78746
SECTION 21. CALCULATIONS. All calculations of Dollar amounts hereunder
shall be rounded to the nearest whole cent. Equidistant amounts shall be rounded
upwards.
SECTION 22. SEVERABILITY. If any provision of this Agreement, or the
application of such provision to any person or circumstance, shall be held
invalid, the remainder of this Agreement or the application of such provision to
other persons or circumstances shall not be affected thereby; PROVIDED, HOWEVER,
that the parties shall negotiate in good faith with respect to an equitable
modification of the provision or application thereof held to be invalid. To the
extent
<PAGE>
that it may effectively do so under applicable law, each party hereto hereby
waives any provision of law, which renders any provision of this Agreement
invalid, illegal or unenforceable in any respect.
SECTION 23. SUCCESSORS AND ASSIGNS. Except as otherwise specifically
provided in this Agreement, this Agreement shall be binding upon and inure to
the benefit of the parties, and their legal representatives, and permitted
successors and assigns.
SECTION 24. CAPTIONS. All headings, paragraph titles and captions
contained in this Agreement are inserted only as a matter of convenience and for
reference and in no way define, limit, extend or describe the scope of this
Agreement or the intent of any provisions hereof.
SECTION 25. COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be on original and all of which, when taken
together, shall together constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.
ECONOPHONE, INC.,
By: ___________________________
Alan Levy
President and COO
MR. PHILLIP STORIN
------------------------------
Phillip Storin
<PAGE>
Exhibit A
BONUS CRITERIA
<PAGE>
Exhibit B
INCENTIVE STOCK OPTION AGREEMENT
<PAGE>
Exhibit 10.12
AMENDMENT TO THE
AMENDED AND RESTATED
ECONOPHONE, INC.
1996 FLEXIBLE INCENTIVE PLAN
1. The first sentence of Section 1.2 of the Amended and Restated
Econophone, Inc. 1996 Flexible Incentive Plan (the "Plan") is amended to read as
follows:
The purpose of the Plan is to encourage and enable key employees and
consultants (subject to such requirements as may be prescribed by the
Committee) of the Corporation and its subsidiaries to acquire a
proprietary interest in the Corporation through the ownership of the
Corporation's voting common stock ("Voting Stock") and non-voting
common stock ("Non-voting Stock" and together with Voting Stock,
"Common Stock"), and other rights with respect to the Common Stock.
2. The first sentence of Section 2.2 of the Plan is amended to read as
follows:
The maximum aggregate number of shares Common Stock available for award
under the Plan is 4,600,000, subject to adjustment pursuant to Article
12 hereof, of which 4,350,000 may be in the form of Voting Stock and
250,000 may be in the form of Non-voting Stock.
3. The first sentence of Section 3.2 of the Plan is amended to read as
follows:
Subject to the express provisions of the Plan, the Committee at any
time or prior to the designation of the Committee, the Board, shall
have the power and authority (i) to grant Options and to determine the
purchase price of the Common Stock covered by each Option, the term of
each Option, the number of shares of Common Stock to be covered by each
Option, the time or times at which each Option shall become exercisable
and the duration of the exercise period applicable to each Option; (ii)
to designate Options as Incentive Stock Options or Non-qualified Stock
Options and to determine which Options, if any, shall be accompanied by
Tandem Stock Appreciation Rights; (iii) to grant Tandem Stock
Appreciation Rights and Nontandem Stock Appreciation Rights and to
determine the terms and conditions of such rights; (iv) to grant or
cause to be sold Restricted Shares and to determine the purchase price,
if any, of such shares and the vesting period and other conditions and
restrictions applicable to such shares; (v) to grant or cause to be
sold Unrestricted Shares and to determine the purchase price, if any,
of such shares; (vi) to determine the amount of, and to make, Tax
Offset Payments; (vii) to determine the directors, the employees and
the consultants to whom, and the time or times at which, Options, Stock
Appreciation Rights, Restricted Shares, Unrestricted Shares and Tax
Offset Payments shall be granted or made; (viii) to designate awards in
the form of shares of Voting Stock or Non-voting Stock, provided,
however, that, to the extent the form is not designated in the written
agreement relating to such award, the award shall be in the form of
Voting Stock; and (ix) to take all other actions contemplated to be
taken by the
1
<PAGE>
Board or the Committee under the Plan, including, but not limited to,
authorizing the amendment of any written agreement relating to any
award made thereunder.
4. The first sentence of Section 9.4 of the Plan is amended to read as
follows:
To the extent Restricted Shares are in the form of Voting Stock,
holders of such Restricted Shares shall have the right to receive any
cash dividends with respect to such shares and the right to vote such
shares and holders of Restricted Shares in the form of Non-voting Stock
shall not have any rights to receive cash dividends or to vote such
shares.
5. The first sentence of Section 9.5 of the Plan is amended to read as
follows:
Except as expressly provided in the written agreement relating to
Restricted Shares or as otherwise expressly determined by the Board in
its sole discretion, any Restricted Shares held by a director, employee
or consultant pursuant to the Plan shall be forfeited or subject to
repurchase by the Corporation at a price equal to the original price
paid therefor, if any, by the director, employee or consultant upon the
termination of his or her employment or consulting agreement with the
Corporation or its subsidiaries, as the case may be, prior to the
expiration or termination of the Restricted Period and the satisfaction
of any other conditions applicable to such Restricted Shares.
6. Article 12 of the Plan is amended to read as follows:
In the event of any change in the Common Stock by reason of any stock
dividend, stock split, recapitalization, merger, consolidation,
combination or exchange of shares, separation, spin-off,
reorganization, liquidation or the like, the number and kind of shares
represented by any awards and the purchase price per share thereof, if
any, shall be appropriately adjusted consistent with such change in
such manner as the Board may deem equitable to prevent dilution or
enlargement of the rights granted under any awards.
7. A new Section 15.9 is added to the Plan to read as follows:
15.9 PUBLIC OFFERING. Effective as of the consummation of an initial
public offering of the Common Stock, subject to the terms of the
written agreement relating to Restricted Shares or as otherwise
expressly determined by the Board in its sole discretion, any awards
made or granted in the form of shares of Non-voting Stock shall be
converted into awards for Voting Stock having the same terms and
conditions as the award for Non-voting Stock and, to the extent awards
for Non-voting Stock have been exercised prior to the consummation of
the initial public offering, the shares of Non-voting Stock shall be
exchangeable for an equivalent number of shares of Voting Stock.
2
<PAGE>
Exhibit 10.13
Dated 17 July 1998
ASHER GRATT
BERNARD LEBRECHT
GOLDVALLEY LIMITED
and
ECONOPHONE INC.
----------------------------
SHARE PURCHASE AGREEMENT
----------------------------
Slaughter and May
35 Basinghall Street
London EC2V 5DB
(CFIS/DHW)
<PAGE>
CONTENTS
Page
1. Interpretation 1
2. Sale and Purchase 4
3. Consideration 5
4. Completion 5
5. Sellers' Warranties 6
6. Restrictions on Sellers' Business Activities 7
7. Purchaser's Indemnity 8
8. Ancillary Agreements 8
9. Purchaser's Warranties 9
10. Provision of Business Information 9
11. Interest 10
12. Effect of Completion 10
13. Joint and Several Liability 10
14. Remedies and Waivers 10
15. Assignment 11
16. Further Assurance 11
17. Notices 11
18. Announcements 12
19. Confidentiality 13
20. Restrictive Trade Practices Act 1976 13
21. Costs and Expenses 13
<PAGE>
22. Counterparts 13
23. Time of Essence 14
24. Invalidity 14
25. Choice of Governing Law 14
26. Agent For Service 14
Schedule 1 Completion Arrangements 16
Schedule 2 Warranties 18
Schedule 3 Specified Personal Guarantees 20
Schedule 4 Employee Share Options 21
Schedule 5 Disclosed Liabilities 22
<PAGE>
THIS AGREEMENT is made on 17 July, 1998
Between:
1. ASHER GRATT of 24 Gilda Crescent, London, N16 5JP, England
("MR. GRATT")
2. BERNARD LEBRECHT of 13 Broom Lane, Salford, M7 4EQ, England
("MR. LEBRECHT")
(together called the "SELLERS")
3. GOLDVALLEY LIMITED of 312 High Road, London, N15 4BN (registered in
England No. 03269567) ("GVL").
AND
4. ECONOPHONE INC. of 45 Broadway, 30th Floor, New York, New York 10006,
USA (the "PURCHASER")
WHEREAS:-
(A) The Sellers have agreed to sell and the Purchaser had agreed to
purchase the Shares in each case on the terms and subject to the
conditions of this agreement.
(B) GVL was formerly the registered holder of the Shares and gives certain
warranties and undertakings in relation to the sale and purchase of
Shares.
NOW IT IS HEREBY AGREED as follows:-
1. INTERPRETATION
1.1 In this agreement and the schedules to it:-
IN THE "AGREED FORM" means in the form of the relevant document
contained in the bundle of agreed form
documents which has been initialled for the
purposes of identification only prior to the
execution of this agreement by or on behalf
of the Purchaser and the Sellers
incorporating any changes subsequently
agreed to be made by or on behalf of the
Purchaser and the Sellers;
<PAGE>
2
"BOOKS AND RECORDS" means books and records and includes,
without limitation, all notices, accounting
and tax records, correspondence, orders,
inquiries, and other documents and all
computer disks or tapes or other machine
legible programs or other records;
"BUSINESS DAY" means a day (other than a Saturday or
Sunday) on which banks are open for business
in the relevant territory;
"BUSINESS INFORMATION" means all information and know-how (whether
or not confidential and in whatever form
held);
"CLAIM" Means any claim in respect of the
Warranties;
"COMPANY" means Telco Global Communications of 312
High Road, London, N15 4BN, England
(registered in England no. 03243408);
"COMPLETION" means completion of the sale and purchase of
the Shares under this agreement and the
various other transactions referred to in
this agreement;
"COMPLETION DATE" Means the date of signing of this agreement
or such later date as Completion occurs
pursuant to CLAUSE 4.5(A);
"CONFIDENTIAL INFORMATION" means all information relating to this
agreement or any agreement or document
contemplated by this agreement and all
information relating to any party;
"EMPLOYEE SHARE OPTIONS" means options and similar interests granted
to certain employees of the Company to
participate in the capital of the Company,
full particulars of which are disclosed in
SCHEDULE 4;
"EMPLOYMENT AGREEMENT" means an employment agreement and restricted
share award to be entered into between the
Company and Mr Gratt in the Agreed Form;
<PAGE>
3
"INFORMATION TECHNOLOGY" means computer hardware, software, networks
and/or other information technology and any
aspect or asset of a business which relies
on computer hardware, software, networks
and/or other information technology (whether
embedded or otherwise);
"LEASE" means the lease between a subsidiary of the
Purchaser and Goldbury Limited of the
premises at 312 High Road, London, N15 4BN.
"LOAN NOTES" means loan notes to be issued by the
Purchaser pursuant to a loan note instrument
in the Agreed Form;
"NON-COMPETE PERIOD" means the period beginning at the signing of
this agreement and ending on the first
anniversary of the termination or expiry of
the Employment Agreement;
"SERVICE DOCUMENT" means a writ, summons, order, judgment or
other document relating to or in connection
with any proceedings in England and Wales
arising out of or in connection with this
agreement;
"SHARES" means all the ordinary shares in the capital
of the Company owned by the Sellers;
"SHARE PURCHASE DOCUMENTS" means this agreement together with those
documents expressly referred to or
contemplated by this agreement;
"SOFTWARE LICENCE AGREEMENT" means the agreement to be entered into
between the Company and Mr Gratt in the
Agreed Form concerning certain software;
"SPECIFIED PERSONAL GUARANTEES" means the personal guarantees of the
obligations of the Company given by the
Sellers, full particulars of which are
listed in SCHEDULE 3;
<PAGE>
4
"TAXATION" means and includes all forms of taxation and
statutory, governmental, supra-governmental,
state, principal, local governmental or
municipal impositions, duties, contributions
and levies, of any territory, whenever
imposed and all penalties, charges, costs
and interest relating thereto and without
limitation any deductions or withholdings of
any sort; and
"WARRANTIES" means the representation and warranties set
out in SCHEDULE 2 given by the Sellers and
GVL and "WARRANTY" shall be construed
accordingly.
1.2 In this agreement, unless otherwise specified:-
(A) references to clauses, sub-clauses, paragraphs and
sub-paragraphs and schedules are to clauses, paragraphs and
sub-paragraphs of, and schedules to, this agreement;
(B) references to warranty clauses are references to clauses of
SCHEDULE 2;
(C) references to writing shall include any modes of reproducing
words in a legible and non-transitory form;
(D) references to times of the day are to London time;
(E) headings to clauses and schedules are for convenience only and
do not affect the interpretation of this agreement;
(F) the schedules form part of this agreement and shall have the
same force and effect as if expressly set out in the body of
this agreement, and any reference to this agreement shall
include the schedules; and
(G) the wording "including" shall be deemed to be followed by the
words "without limitation".
2. SALE AND PURCHASE
2.1 The Sellers shall sell or procure the sale of and the Purchaser shall
purchase the Shares with all rights attached or accruing to them at
Completion.
2.2 At Completion the Sellers shall have the right to transfer to the
Purchaser legal and beneficial title to the Shares.
2.3 The Shares are, and shall be transferred free from liens, equities and
all charges and encumbrances and from all other rights exercisable by
or claims by third parties.
<PAGE>
5
2.4 The Purchaser shall be entitled to exercise all rights attached or
accruing to the Shares including, without limitation, the right to
receive all dividends, distributions or any return of capital declared,
paid or made by the Company on or after the Completion Date.
2.5 For the avoidance of doubt, Part 1 of the Law of Property
(Miscellaneous Provisions) Act 1994 shall not apply for the purposes of
this agreement.
3. CONSIDERATION
The total consideration for the sale of the Shares shall be the issue
by the Purchaser of Loan Notes to Mr Gratt in the principal sum of
US$9,824,500 and to Mr Lebrecht in the principal sum of US$4,210,500.
4. COMPLETION
4.1 Completion shall take place at 10 a.m. on the Completion Date at the
offices of Frere Cholmeley Bischoff.
4.2 At Completion the Sellers shall do those things listed in Part I of
SCHEDULE 1 and the Purchaser shall do those things listed in Part II of
SCHEDULE 1.
4.3 Neither the Purchaser nor the Sellers shall be obliged to complete this
agreement unless the other complies fully with the relevant
requirements of SUB-CLAUSE 4.2 and SCHEDULE 1.
4.4 The Purchaser shall not be obliged to complete the sale and purchase of
any of the Shares unless the sale and purchase of all the Shares is
completed simultaneously. This sub-clause shall not limit any other
clause of this agreement and in particular CLAUSE 14.
4.5 If the obligations of the Sellers or the Purchaser under SUB-CLAUSE 4.2
and SCHEDULE 1 are not complied with on the Completion Date the
Purchaser or (as the case may be) the Sellers may:-
(A) defer Completion until a date designated by the Purchaser (so
that the provisions of this CLAUSE 4 shall apply to Completion
as so deferred); or
(B) proceed to Completion as far as practicable (without limiting
its rights under this agreement); or
(C) treat this agreement as terminated for breach of a condition.
<PAGE>
6
5. SELLERS' WARRANTIES
5.1 GVL and Mr Gratt (and Mr Lebrecht in respect of warranty CLAUSE 1.2
only) jointly and severally represent and warrant to the Purchaser that
each of the Warranties will be accurate in all material respects at
Completion. If for any reason there is any interval of time between the
time of this agreement and Completion, the Warranties will continue to
be accurate in all respects as at Completion as if repeated thereon by
reference to the facts and circumstances then subsisting at that date
and on the basis that any reference in the Warranties, whether express
or implied, to the date of this agreement is substituted by a reference
to Completion.
5.2 The Sellers and GVL accept that the Purchaser is entering into this
agreement in reliance upon each of the Warranties.
5.3 The Sellers and GVL undertake (if any Claim is made against them in
connection with the sale of the Shares to the Purchaser) not to make
any corresponding or connected claim against the Company.
5.4 Each of the Warranties shall be construed as a separate and independent
warranty and (except where expressly provided to the contrary) shall
not be limited or restricted by reference to or inference from the
terms of any other Warranty.
5.5 Subject always to the provisions of paragraph 1.1 of SCHEDULE 6, if in
respect of or in connection with any breach of any of the Warranties or
any facts or matters warranted not being true any amount payable to the
Purchaser by any of the Sellers or GVL is subject to Taxation, such
payable amounts shall be paid to the Purchaser by the Sellers and GVL
so as to ensure that the net amount received by the Purchaser is equal
to the full amount payable to the Purchaser under this agreement.
5.6 Subject to CLAUSE 5.7, the Purchaser shall be entitled to set off any
sum agreed between the parties or adjudicated by a court having
appropriate jurisdiction to be payable by any of the Sellers or GVL
under this CLAUSE 5 against any sum or sums payable under the Loan
Notes.
5.7 If the Purchaser wishes to exercise its right of set-off under CLAUSE
5.6, it shall notify the Sellers and GVL of that fact. If at the end of
20 Business Days after the Sellers and GVL receiving such notification
the parties have not agreed a sum (if any) to be so set off, the
parties shall immediately appoint an appropriately qualified Queens
Counsel to provide an opinion on the Claim in respect of which the
Purchaser wishes to exercise its right of set off. If the parties fail
within 10 Business Days of the expiry of the 20 Business Day period to
agree on the appointment of a Queens Counsel, any party may refer the
question of such appointment to the Chairman for the time being of the
Council of the Bar, the Chairman's appointment being binding on all
parties. If the parties fail to agree on the terms of the instructions
to be submitted to the Queens Counsel, each party shall be entitled to
submit separate instructions (such instructions to be submitted no
later than 10 Business Days after the Queens
<PAGE>
7
Counsel's appointment) asking the Queens Counsel whether in his
opinion, and on the basis of the instructions sent to him, either (and
only either) the Purchaser would be more likely to succeed in its Claim
(in the amount claimed or any other lower amount determined by the
Queens Counsel to be appropriate) than the Sellers would be to defend
it or the Sellers would be more likely to defend the Claim than the
Purchaser would be to succeed in it (again in the amount claimed or any
other lower amount determined by the Queens Counsel to be appropriate)
and, subject to the requirements of this CLAUSE 5.7, it shall be the
responsibility of the Queens Counsel to determine at his or her
discretion the nature of his or her instructions. If, in the
determination of the Queens Counsel (which determination shall be final
and conclusive), the Purchaser would be more likely to succeed in its
Claim (in the amount claimed or any other lower amount determined by
the Queens Counsel to be appropriate) than the Sellers would be to
defend it, then once the parties have executed an appropriate escrow
agreement (in terms agreed between them or, in default of agreement
within 5 Business Days, determined by the Queens Counsel appointed as
above) and the Purchaser has paid the amount of the Claim (or any other
lower amount determined by the Queens Counsel to be appropriate) into
escrow, the Purchaser shall be entitled to set off any sums payable
under the Loan Notes against that amount pending settlement or final
determination of the Claim.
5.8 Where there is any breach of warranty clause 6 (ownership of assets) or
warranty clause 7 (no claims) the Purchaser shall, without prejudice to
its other remedies, be entitled to require the Sellers or GVL to, in
the case of warranty clause 6.1, convey or procure the conveyance to
the Company of such asset or interest or, in the case of warranty
clause 6.2, extinguish or procure the extinction of such interest or
the release from such contract or arrangement or, in the case of
warranty clause 7, release or procure the release of such debt or
obligation, as may be, in the reasonable opinion of the Purchaser,
necessary to remedy the breach, and CLAUSE 16 shall apply accordingly.
5.9 The provisions of SCHEDULE 6 shall apply to limit or excuse any
liability of the Sellers or GVL under CLAUSE 5.1, except in the case of
fraud or dishonesty on the part of any of the Sellers or GVL.
6. RESTRICTIONS ON SELLERS' BUSINESS ACTIVITIES
6.1 GVL and Mr Gratt severally undertake that they will not, either alone
or in conjunction with or on behalf of any other person, do any of the
following things:-
(A) disclose to any other person or (in any way which may be
detrimental to the business of the Purchaser or the Company as
carried on at the Completion Date) use any information which
is confidential to the Purchaser or the Company or their
respective businesses for so long as that information remains
confidential to the Purchaser or the Company or their
respective businesses;
<PAGE>
8
(B) without limitation to the provision of this clause, in
relation to a business which is competitive or likely to be
competitive with the business of the Purchaser or the Company
as carried on at the Completion Date, use any trade or
business name or distinctive mark, style or logo used by or in
the business of the Company or the Purchaser at any time or
anything intended or likely to be confused with it;
(C) within the Non-Compete Period and to the detriment of the
Company or the Purchaser, solicit the custom, in relation to
goods or services sold to any person by the Company or the
Purchaser in the course of their respective businesses, of
that person in respect of similar goods or services;
(D) within the Non-Compete Period and to the detriment of the
Company or the Purchaser, solicit or entice away from the
Purchaser or the Company any person, firm, company or
organisation at present an employee, agent or distributor of
the Company, provided that an employee of the Company who
responds to a publicly advertised job offer shall not be
regarded as having been solicited for the purposes of this
clause; nor
(E) assist any other person to do any of the foregoing things.
6.2 Each undertaking contained in this clause shall be construed as a
separate undertaking and if one or more of the undertakings is held to
be against the public interest or unlawful or in any way an
unreasonable restraint of trade, the remaining undertakings shall
continue to bind GVL and Mr Gratt.
6.3 Without prejudice to any other remedy which the Purchaser might have,
the parties acknowledge and agree that damages alone may not be an
adequate remedy for any breach by GVL or Mr Gratt of this CLAUSE 6, so
that in the event of a breach or anticipated breach of this CLAUSE 6,
the remedies of injunction and/or an order for specific performance
would in appropriate circumstances be available.
7. PURCHASER'S INDEMNITY
The Purchaser undertakes to hold each of the Sellers indemnified and
to keep them indemnified from and against all actions, claims,
proceedings, loss, damage, all payments, costs or expenses incurred by
each of them in relation to or arising out of the Specified Personal
Guarantees and any other guarantees or indemnities entered into by them
in respect of the obligations or liabilities of the Company.
8. ANCILLARY AGREEMENTS
8.1 In consideration of the Purchaser agreeing to purchase the Shares from
the Sellers, Mr Gratt agrees that he will enter into the Software
Licence Agreement.
<PAGE>
9
8.2 The Purchaser and the Sellers undertake to procure the execution by the
Company of the Software Licence Agreement.
8.3 The Purchaser and the Sellers undertake to procure the execution by the
Company of the Employment Agreement.
9. PURCHASER'S WARRANTIES
The Purchaser warrants to the Sellers and GVL that:
(A) It has the requisite power and authority to enter into and
perform this agreement.
(B) This agreement constitutes and the Share Purchase Documents
will, when executed, constitute binding obligations of the
Purchaser in accordance with their respective terms.
(C) The execution and delivery of, and the performance by the
Purchaser of its obligations under, this agreement and the
Share Purchase Documents will not:-
(i) result in a breach of any provision of its
constitutional documents;
(ii) result in a breach of, or constitute a default under,
any instrument to which the Purchaser is a party or
by which the Purchaser is bound; or
(iii) result in a breach of any order, judgment or decree
of any court or governmental agency to which the
Purchaser is a party or by which the Purchaser is
bound; or
(iv) require any consent of its shareholders which has not
been obtained.
10. PROVISION OF BUSINESS INFORMATION
10.1 Following Completion and without prejudice to any of the Warranties:-
(A) if any Business Information for the business of the Company is
not in the possession or under the control of the Purchaser or
the Company but is in the possession or under the control of
any of the Sellers or GVL, the Sellers and GVL shall severally
use their reasonable endeavours to procure that such Business
Information is provided promptly to the Purchaser; and
(B) if any Books or Records of any of the Sellers or GVL contain
Business Information which is required for the business of the
Company, the Sellers and GVL shall procure that copies of such
Books or Records are given promptly to the Purchaser.
<PAGE>
10
10.2 For the purposes of this clause and this agreement generally, "required
for the business" means any Business Information of the Company which
is or has in the last six years been used in the business of the
Company or if it will be needed by the Company to carry on the business
of the Company in the same manner as it is currently carried on or to
fulfil any of the present contracts, plans or projects of the Company
in relation to the business of the Company.
11. INTEREST
11.1 If any party defaults in the payment when due of any sum payable under
this agreement (whether determined by agreement or pursuant to an order
of a court or otherwise), the liability of such party shall be
increased to include interest on such sum from the date when such
payment is due until the date of actual payment (as well after as
before judgment) at a rate per annum of three per cent. above the base
rate from time to time of Barclays Bank PLC. Such interest shall accrue
from day to day and shall be compounded annually.
11.2 For the purposes of CLAUSE 11.1, sums payable under the Loan Notes
shall be deemed not to be sums payable under this agreement.
12. Effect of Completion
Any provision of this agreement and any other documents referred to in
it which is capable of being performed after but which has not been
performed at or before Completion and all Warranties and covenants and
other undertakings contained in or entered into pursuant to this
agreement shall remain in full force and effect notwithstanding
Completion.
13. JOINT AND SEVERAL LIABILITY
13.1 The obligations of the Sellers and GVL under this agreement are joint
and several unless otherwise specified.
13.2 If any liability of one of the Sellers or GVL is, or becomes illegal,
invalid or unenforceable in any respect, that shall not affect or
impair the liabilities of the other under this agreement.
14. REMEDIES AND WAIVERS
14.1 No delay or omission on the part of any party to this agreement in
exercising any right, power or remedy provided by law or under this
agreement or any other documents referred to in it shall:-
(A) impair such right, power or remedy; or
(B) operate as a waiver thereof.
<PAGE>
11
14.2 The single or partial exercise of any right, power or remedy provided
by law or under this agreement shall not preclude any other or further
exercise thereof or the exercise of any other right, power or remedy.
14.3 The rights, powers and remedies provides in this agreement are
cumulative and not exclusive of any rights, powers and remedies
provided by law.
15. ASSIGNMENT
15.1 The rights or benefits of or under this agreement and any agreements
referred to in this agreement may be assigned (together with any cause
of action arising in connection with any of them) by the Purchaser to a
wholly-owned subsidiary or holding company, or a fellow wholly-owned
subsidiary of the same holding company, of the Purchaser (each such
person being referred to as a "Connected Person" of the Purchaser).
15.2 Obligations under this agreement shall not be assignable.
16. FURTHER ASSURANCE
Each party shall from time to time, on being requested in writing to do
so by any other party, now or at any time in the future, do or procure
the carrying out of all such acts and/or execute or procure the
execution of all such documents as are reasonably necessary for giving
proper effect to this agreement and securing to that other party the
full benefit of the rights, powers and remedies conferred upon that
other party in this agreement.
17. NOTICES
17.1 Any notice to be given under this agreement shall be in writing and
shall either be delivered personally or sent by first class recorded
delivery post or facsimile transmission. Notices shall be addressed as
provided in SUB-CLAUSE 17.3 and if so addressed, shall be deemed to
have been served as follows:
(i) if personally delivered, at the time of delivery;
(ii) if posted, at the expiration of 48 hours after the envelope
containing the same was delivered into the custody of the
postal authorities;
(iii) is sent by air mail to an overseas address on the tenth
Business Day after the date of posting; and
(iv) if sent by facsimile transmission, at the time of
transmission.
17.2 In proving such service it shall be sufficient to prove that personal
delivery was made, or that the envelope containing such notice was
properly addressed and delivered
<PAGE>
12
into the custody of the postal authority as a prepaid first class
recorded delivery of that the facsimile was transmitted on a tested
line as the case may be.
17.3 The relevant addressee, address and facsimile number of each party for
the purposes of this agreement are:
NAME OF PARTY ADDRESS FACSIMILE NO.
------------- ------- -------------
THE PURCHASER 45 Broadway, 212 344 8448
30th Floor
New York
NY 10006
Attn: Richard Shorten
MR GRATT 24 Gilda Crescent, 0181 376 2605
London
N16 5JP
MR LEBRECHT 13 Broom Lane, 0161 792 0804
Salford
M7 4EQ
GVL 312 High Road 0181 806 2175
London
N15 4BN
Attn: Asher Gratt
18. ANNOUNCEMENTS
18.1 No announcement concerning the sale of the Shares or any ancillary
matter shall be made by any party without the prior written approval of
the other parties (such approval not to be unreasonably withheld or
delayed) unless the announcement is required by:-
(A) the law of any relevant jurisdiction;
(B) existing contractual obligations; or
(C) any securities exchange or regulatory or governmental body to
which a party is subject, wherever situated, whether or not
the requirement has the force of law.
18.2 The restrictions contained in this clause shall continue to apply after
Completion without limit in time.
<PAGE>
13
19. CONFIDENTIALITY
19.1 Each party undertakes to keep the Confidential Information of the other
parties strictly confidential and not to disclose it to third parties.
19.2 The obligations in CLAUSE 19.1 shall not apply to any Confidential
Information which is:-
(A) in or enters the public domain through no fault of another
party; or
(B) required to be disclosed by any applicable law or securities
exchange, regulatory or governmental body, provided that the
disclosing party gives the other parties prior written notice
of any such disclosure.
19.3 The restrictions contained in this clause shall continue to apply after
Completion of the sale and purchase of the Shares under this agreement
without limit in time.
20. RESTRICTIVE TRADE PRACTICES ACT 1976
If there is any provision of this agreement, or of any agreement or
arrangement of which this agreement forms part, which causes or would
cause this agreement or that agreement or arrangement to be subject to
registration under the Restrictive Trade Practices Act 1976, then
that provision shall not take effect until the day after particulars of
this agreement or of that agreement or arrangement (as the case may be)
have been furnished to the Director General of Fair Trading pursuant to
section 24 of that Act.
21. COSTS AND EXPENSES
Each party shall pay its own costs and expenses in relation to the
negotiations leading up to the sale of the Shares and to the
preparation, execution and carrying into effect of this agreement and
all other documents referred to in it, and the Sellers confirm that no
expense of whatever nature relating to the sale of the Shares has been
or is to be borne by the Company.
22. COUNTERPARTS
22.1 This agreement may be executed in any number of counterparts, and by
the parties on separate counterparts, but shall not be effective until
each party has executed at least one counterpart.
22.2 Each counterpart shall constitute an original of this agreement, but
all the counterparts shall together constitute but one and the same
instrument.
<PAGE>
14
23. TIME OF ESSENCE
Except as otherwise expressly provided, time is of the essence of this
agreement.
24. INVALIDITY
If at any time any provision of this agreement is or becomes illegal,
invalid or unenforceable in any respect under the law of any
jurisdiction, that shall not affect or impair:-
(A) the legality, validity or enforceability in that jurisdiction
of any other provision of this agreement; or
(B) the legality, validity or enforceability under the law of any
other jurisdiction of that or any other provision of this
agreement.
25. CHOICE OF GOVERNING LAW
This agreement shall be governed by and construed in accordance with
English law. The parties hereto agree that the English courts are to
have jurisdiction to settle any claim or matter arising under this
agreement and each party submits to the jurisdiction of the English
courts.
26. AGENT FOR SERVICE
26.1 The Purchaser irrevocably appoints American Telemedia Limited of
[insert address] to be its agent for the service of process in England.
It agrees that any Service Document may be effectively served on it in
connection with proceedings in England and Wales by service on its
agent.
26.2 A copy of any Service Document served on an agent shall be sent by post
to the Purchaser. Failure or delay in so doing shall not prejudice the
effectiveness of service of the Service Document.
IN WITNESS WHEREOF THIS AGREEMENT IS EXECUTED by the duly authorised
representatives of the parties on the day first written above as follows:-
Signed by ASHER GRATT
in the presence of:-
/s/ S. HERMER
4 JOHN CARPENTER ST.
LONDON EC 4
<PAGE>
15
Signed by BERNARD LEBRECHT
in the presence of:- AS ATTORNEY
/s/
AS PRECEDING
Signed by A. GRATT
duly authorised for and on behalf of
GOLDVALLEY LIMITED
in the presence of:-
/s/
AS PRECEDING
Signed by /s/ D. H. WILKS
DAVID HARDY WILKS
duly authorised for and on behalf of
ECONOPHONE INC.
in the presence of:-
SR.V.P.
<PAGE>
EXHIBIT 21.1
LIST OF SUBSIDIARIES OF DESTIA COMMUNICATIONS, INC.
NAME JURISDICTION
---- ------------
America First Ltd. United Kingdom
Destia Communications Services, Inc. Delaware
Destia Network Services Ltd. United Kingdom
Econophone AG Switzerland
Econophone GmbH Austria
ECONOphone GmbH Germany
Econophone, Ltd. Ireland
Econophone Netherlands B.V. Netherlands
Econophone NV Belgium
Econophone SA France
Econophone Services GmbH Switzerland
Telco Global Communications Ltd. United Kingdom
Voicenet Corporation New York
3461386 Canada, Inc. Canada
<PAGE>
EXHIBIT 24.1
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each undersigned director of
DESTIA COMMUNICATIONS, INC., a Delaware corporation, which intends to file with
the Securities and Exchange Commission, Washington, D.C., under the provisions
of the Securities Exchange Act of 1934, as amended, an Annual Report on Form
10-K for the year ended December 31, 1998 ("Annual Report"), hereby constitutes
and appoints ALFRED WEST, ALAN L. LEVY and RICHARD L. SHORTEN, JR. his true and
lawful attorneys-in-fact and agents, and each of them with full power to act
without the others, for him and in his name, place and stead, in any and all
capacities, to sign such Annual Report and any and all amendments thereto, and
to file such Annual Report and any and all amendments thereto with all exhibits
thereto, and any and all other documents in connection therewith, with the
Securities and Exchange Commission, and hereby grants unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform any and all other acts and things requisite and necessary or
advisable in connection with such Annual Report, and confirms all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereby.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand on the
30th day of March, 1999.
---------------------
Alfred West
---------------------
Alan L. Levy
---------------------
Stephen Munger
