<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 16, 1999
REGISTRATION NO. 333-71463
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-1
---------------
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
DESTIA COMMUNICATIONS, INC.
(formerly Econophone, Inc.)
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 11-3132722
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) No.)
</TABLE>
95 RTE. 17 SOUTH
PARAMUS, NJ 07652
(201) 226-4500
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
------------------------
RICHARD L. SHORTEN, JR., ESQ.
SENIOR VICE PRESIDENT AND GENERAL COUNSEL
DESTIA COMMUNICATIONS, INC.
95 RTE. 17 SOUTH
PARAMUS, NJ 07652
(201) 226-4500
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------
PLEASE SEND COPIES TO:
MICHAEL R. LITTENBERG, ESQ. JAMES S. SCOTT, SR., ESQ.
SCHULTE ROTH & ZABEL LLP SHEARMAN & STERLING
900 THIRD AVENUE 599 LEXINGTON AVENUE
NEW YORK, NEW YORK 10022 NEW YORK, NEW YORK 10022
(212) 756-2000 (212) 848-4000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON
A DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF
1933, AS AMENDED, CHECK THE FOLLOWING BOX. / /
IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING
PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING BOX
AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER
EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. / /
IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(C)
UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. / /
IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(D)
UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. / /
IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434,
PLEASE CHECK THE FOLLOWING BOX. / /
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
PROSPECTUS (SUBJECT TO COMPLETION)
ISSUED APRIL 16, 1999
6,500,000 SHARES
[LOGO]
DESTIA COMMUNICATIONS, INC.
(FORMERLY ECONOPHONE, INC.)
COMMON STOCK
-----------------
DESTIA COMMUNICATIONS, INC. IS OFFERING 6,500,000 SHARES OF ITS COMMON STOCK.
THIS IS OUR INITIAL PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS
FOR OUR SHARES. WE ANTICIPATE THAT THE INITIAL PUBLIC
OFFERING PRICE WILL BE BETWEEN $9 AND $11 PER
SHARE.
-------------------
OUR COMMON STOCK HAS BEEN APPROVED FOR LISTING ON THE NASDAQ
NATIONAL MARKET UNDER THE SYMBOL "DEST."
-------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 11.
-----------------
PRICE $ A SHARE
-------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS COMPANY
------------------ ------------------ ------------------
<S> <C> <C> <C>
PER SHARE.......................................... $ $ $
TOTAL.............................................. $ $ $
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE NOT
APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS IS
TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
DESTIA COMMUNICATIONS, INC. HAS GRANTED THE U.S. UNDERWRITERS THE RIGHT TO
PURCHASE UP TO AN ADDITIONAL 975,000 SHARES TO COVER OVER-ALLOTMENTS. MORGAN
STANLEY & CO. INCORPORATED EXPECTS TO DELIVER THE SHARES TO PURCHASERS ON
, 1999.
-------------------
MORGAN STANLEY DEAN WITTER
CREDIT SUISSE FIRST BOSTON
LEHMAN BROTHERS
, 1999
<PAGE>
[Map of the Destia Network illustrating by geographic location (i) where Destia
maintains switches and points of presence, (ii) where Destia owns and/or leases
fiber routes, and (iii) other elements of the Destia Network].
[Montage of photographs illustrating certain of Destia's domestic and
international product offerings and advertisements.]
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C> <C>
Prospectus Summary.................... 5
Risk Factors.......................... 11
Use of Proceeds....................... 24
Dividend Policy....................... 24
Certain Information................... 24
Capitalization........................ 25
Dilution.............................. 26
Selected Consolidated Financial
Data................................. 27
Management's Discussion and Analysis
of Financial Condition and Results of
Operations........................... 29
Industry Overview..................... 39
Business.............................. 41
<CAPTION>
PAGE
---------
<S> <C> <C> <C>
Management............................ 73
Certain Transactions.................. 81
Certain Indebtedness.................. 82
Principal Stockholders................ 85
Description of Capital Stock.......... 86
Shares Eligible for Future Sale....... 89
Certain United States Tax Consequences
to Non-United States Holders......... 91
Underwriters.......................... 93
Legal Matters......................... 97
Experts............................... 98
Additional Information................ 98
Index to Consolidated Financial
Statements........................... F-1
</TABLE>
We have not taken any action to permit a public offering of the shares of
common stock outside the United States or to permit the possession or
distribution of this prospectus outside the United States. Persons outside the
United States who come into possession of this prospectus must inform themselves
about and observe any restrictions relating to the offering of the shares of
common stock and the distribution of this prospectus outside the United States.
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of common stock and
seeking offers to buy shares of common stock only in jurisdictions where offers
and sales are permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of the common stock. In this
prospectus, the "Company," "Destia," "we," "us" and "our" refer to Destia
Communications, Inc. and its subsidiaries, unless the context indicates
otherwise.
Until , 1999 (25 days after the commencement of the offering),
all dealers that buy, sell or trade in the common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This
delivery requirement is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
3
<PAGE>
FORWARD-LOOKING STATEMENTS
Some of the statements contained in this prospectus that are not historical
facts, including some statements made in the sections of this prospectus
entitled "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" are statements of future
expectations and other forward-looking statements pursuant to Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"). These statements are
based on management's current views and assumptions and involve known and
unknown risks and uncertainties that could cause actual results, performance or
events to differ materially from those expressed or implied in those statements,
including:
- the rate of expansion of Destia's network and/or customer base;
- inaccuracies in Destia's forecasts of telecommunications traffic or
customers;
- loss of a customer or distributor that provides Destia with significant
revenues;
- concentration of credit risk;
- highly competitive market conditions;
- changes in or developments under laws, regulations, licensing requirements
or telecommunications standards;
- changes in the availability of transmission facilities;
- currency fluctuations;
- changes in retail or wholesale telecommunications rates;
- changes in international settlement rates;
- 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
- general economic conditions.
The foregoing important factors should not be construed as exhaustive. We
undertake no obligations to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. See also
"Risk Factors" for additional cautionary statements identifying important
factors with respect to forward-looking statements contained in this prospectus
that could cause actual results to differ materially from results or
expectations referred to in the forward-looking statements.
4
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS CERTAIN INFORMATION CONTAINED ELSEWHERE IN THIS
PROSPECTUS. THIS SUMMARY IS NOT COMPLETE AND MAY NOT CONTAIN ALL OF THE
INFORMATION THAT YOU SHOULD CONSIDER BEFORE DECIDING TO PURCHASE OUR COMMON
STOCK. WE URGE YOU TO READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE "RISK
FACTORS" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES TO THOSE
STATEMENTS.
THE COMPANY
We are a rapidly growing, facilities-based provider of domestic and
international long distance telecommunications services in North America and
Europe. Our extensive international telecommunications network allows us 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, and we believe that we are well positioned to
capitalize on continued growth in these markets. In 1997, worldwide
international long distance traffic totaled 81.8 billion minutes, 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.
We provide our customers with a variety of retail telecommunications
services, including international and domestic long distance, calling card and
prepaid services, and wholesale transmission services. Our approximately 350,000
customer accounts are diverse and include residential customers, commercial
customers, ethnic groups and telecommunications carriers. In each of our
geographic markets, we utilize a multichannel distribution strategy to market
our services to our target customer groups. We believe this strategy greatly
enhances our growth prospects and reduces our dependence on any one service,
customer group or channel of distribution.
We entered the U.S. market during 1993 and the U.K. market during 1995. In
continental Europe, we commenced offering our services before the January 1,
1998 full liberalization of telecommunications services in those markets. Given
our early entry into many of our continental European markets, as well as our
established network, sales and marketing and customer support infrastructure, we
believe we are well positioned to further grow our business in continental
Europe.
COMPETITIVE STRENGTHS
We believe we have successfully distinguished ourselves from many of our
competitors and enjoy several competitive strengths.
PROVEN TRACK RECORD OF STRONG INTERNAL GROWTH
For 1996, 1997 and 1998, our revenues were $45.1 million, $83.0 million and
$193.7 million, respectively. Substantially all of our growth has been generated
internally, although we have made several minor acquisitions. In addition, our
retail focused strategy has allowed us to generate strong gross margins. For
1996, 1997 and 1998, our gross margins were 21.6%, 23.2% and 27.5%,
respectively. During the fourth quarter of 1998, our gross margins were 29.0%.
ESTABLISHED INTERNATIONAL TELECOMMUNICATIONS NETWORK
Our network (the "Destia Network") is comprised of:
- 14 operational carrier-grade switches, with seven in North America and
seven in Europe;
- an IRU from Frontier on portions of its U.S. fiber optic network ("IRUs"
are long-term capacity leases);
- transatlantic IRUs;
5
<PAGE>
- leased capacity and IRUs in Europe; and
- leased capacity in Canada.
In addition, we have completed direct interconnections with the dominant
carriers (the "PTTs") in five of our major European markets (the United Kingdom,
Belgium, Germany, France and Switzerland) and have signed an interconnection
agreement with the PTT in The Netherlands.
COST-EFFECTIVE MULTICHANNEL MARKETING
We reach a broad range of customer groups by using a variety of marketing
channels, including a direct sales force, independent sales agents, multilevel
marketing, customer incentive programs, advertising and the Internet. We believe
our multichannel approach is a cost-effective means of marketing to our target
customers and reduces the risks associated with dependence on a limited number
of distribution channels.
EXPERIENCED MANAGEMENT TEAM WITH SIGNIFICANT OWNERSHIP
Our management team includes a broad base of seasoned professionals from the
domestic and international telecommunications sector with expertise in
management, multinational sales and marketing, network operations and
engineering, finance and regulatory issues. On a fully-diluted basis, our senior
management and other employees currently own approximately 59% of Destia and
following the offering will own approximately 48%.
COMMITMENT TO SUPERIOR CUSTOMER SERVICE
We have developed the infrastructure to deliver high levels of customer
satisfaction, including local customer service in native languages and detailed
billing information in local currencies. This infrastructure, together with our
customer-oriented philosophy, allows us to differentiate ourselves from many of
our competitors.
SOPHISTICATED OPERATIONAL CONTROL SYSTEMS
We have internally developed sophisticated software and intranet systems
that enable us to better manage our business and appropriately price our
services in each of our markets on a real-time basis. We believe that these
systems allow us to quickly identify new market growth and cost saving
opportunities, as well as control our business in an environment of rapid
growth.
COMPANY STRATEGY
Our objective is to become a leading facilities-based provider of
telecommunications services in the largest metropolitan markets in Europe and
North America. The key elements of our growth strategy are as follows:
- focus on high margin retail business;
- leverage our existing network and customer support infrastructure;
- enhance the Destia Network and opportunistically enter new markets;
- expand our IP telephony capabilities; and
- pursue strategic acquisitions and alliances.
6
<PAGE>
SELECTED FIRST QUARTER 1999 RESULTS
Based on internal preliminary reports, our total revenues during the first
quarter of 1999 were approximately $62.5 million, representing an increase of
approximately 18% over our fourth quarter 1998 revenues, which were $52.8
million, and an increase of approximately 50% over our first quarter 1998
revenues, which were $41.7 million. The primary source of this growth was a
substantial increase in retail revenues in North America, the United Kingdom and
continental Europe. In North America, the increase was primarily attributable to
higher direct dial and prepaid calling card revenues and, to a lesser extent,
wholesale revenues. In Europe, we experienced a substantial percentage increase
in our presubscribed and "1xxx" long distance services, particularly in Belgium
and Switzerland, where we completed interconnection in late 1998. Furthermore,
we realized substantial growth in our prepaid card sales, particularly in the
United Kingdom and Germany. We expect our gross profit margins for the first
quarter of 1999 to be similar to the approximately 29% gross profit margins that
we reported for the fourth quarter of 1998. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-- Overview" for a
discussion of how gross margins are calculated.
The foregoing information concerning our total revenues for the first
quarter of 1999 is preliminary in nature, has not been reviewed or audited by
our independent accountants and is therefore subject to completion and/or
modification. In addition, complete financial information for the first quarter
of 1999 is unavailable at this time. Final and more extensive results of
operations information for the first quarter of 1999 will be contained in the
final prospectus for this offering and, prior to completion of this offering,
will be filed with the Securities and Exchange Commission (the "Commission")
pursuant to a pre-effective amendment to the Registration Statement on Form S-1
(the "Registration Statement"). Accordingly, the preliminary information
contained above concerning our total revenues for the first quarter of 1999
should be read in conjunction with that additional financial information when
made available.
7
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered in:
The U.S. offering................. 5,200,000 shares
The international offering........ 1,300,000 shares
Total........................... 6,500,000 shares(1)
Common stock to be outstanding
after the offering................ 31,087,507 shares(1)(2)
Over-allotment option............... 975,000 shares
Use of proceeds..................... We will receive net proceeds from the offering of
approximately $59.7 million. We intend to use the
net proceeds to expand our sales and marketing
activities, to make capital expenditures and to fund
working capital and general corporate purposes,
including to fund losses. Since we continuously
engage in discussions with potential acquisition
candidates, we may use net proceeds to fund suitable
strategic acquisitions.
Dividend policy..................... We do not intend to pay dividends on our common
stock. We plan to retain earnings, if any, for use
in the operation of our business and to fund future
growth. In addition, our indentures and our
equipment financing agreement currently restrict the
payment of dividends.
Risk factors........................ For a discussion of certain risks relating to our
company, its business and an investment in our
common stock, see "Risk Factors."
Nasdaq National Market symbol....... DEST
</TABLE>
- ------------------------------
(1) Excludes the possible issuance of up to 975,000 additional shares of common
stock pursuant to the exercise of the U.S. underwriters' over-allotment
option.
(2) As of April 1, 1999, we had 24,587,507 shares of common stock outstanding
after giving effect to the conversion of all outstanding shares of Series A
preferred stock ("Series A Preferred Stock") into common stock upon the
closing of the offering. The foregoing numbers of shares of common stock do
not include outstanding options to purchase 5,111,060 shares of common stock
at a weighted average exercise price of $4.20 per share, and warrants (the
"Warrants") to purchase 1,315,148 shares of common stock at an exercise
price of $.01 per share. See "Capitalization," "Management--1996 Flexible
Incentive Plan" and "Underwriters." All share numbers relating to common
stock contained herein give effect to the 1.04 for 1 stock split to be
effected prior to the offering. See "Certain Information."
8
<PAGE>
SUMMARY FINANCIAL AND OTHER DATA
The following summary consolidated financial data (with the exception of
other data and regional data) for 1994, 1995, 1996, 1997 and 1998 and as of
December 31, 1998 are derived from our audited consolidated financial
statements. The summary set forth below should be read in conjunction with, and
is qualified by reference to, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our financial statements and the
related notes included elsewhere in this prospectus.
<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)................................................... $ 0.03 $ 0.01 $ (0.41) $ (1.50) $ (3.31)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average number of shares of common stock outstanding (basic and
diluted)(1)........................................................... 20,778 20,778 20,778 20,778 20,846
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
OTHER DATA:
Capital expenditures and acquisitions................................... $ 906 $ 1,677 $ 4,670 $ 19,021 $ 111,999
EBITDA(2)............................................................... 1,070 658 (6,967) (18,765) (27,564)
Distributions to S Corporation shareholders(3).......................... -- 499 226 -- --
Series A Preferred Stock dividends(4)................................... -- -- 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>
9
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
---------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED(5)
----------- --------------
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities..................................... $ 139,561 $ 199,261
Restricted cash and securities(6).................................................... 40,467 40,467
Total assets......................................................................... 388,208 447,908
Current portion of borrowings........................................................ 16,694 16,694
Long-term borrowings, less current portion........................................... 380,748 380,748
Series A Preferred Stock............................................................. 14,421 --
Total stockholders' equity (deficit)................................................. (102,467) (28,346)
</TABLE>
- ------------------------------
(1) Weighted average numbers of shares have been retroactively restated to give
effect to the 1.04 for 1 stock split to be effected prior to the offering.
See "Certain Information."
(2) "EBITDA" is defined as net income (loss) plus net interest expense, income
tax expense, and depreciation and amortization expense. We have included
information concerning EBITDA in this prospectus 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 generally accepted accounting principles ("GAAP") and,
therefore, our EBITDA is not necessarily comparable to EBITDA of other
companies. EBITDA also does not indicate cash provided by operating
activities. You should not use our EBITDA as a measure of our operating
income and cash flows from operations under GAAP. Both of those measures are
presented above. You also should not look at our EBITDA in isolation, as an
alternative to or as more meaningful than measures of performance determined
in accordance with GAAP.
(3) The distributions reflected in this line item were declared when we were a
subchapter S corporation under U.S. tax law.
(4) 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.
(5) The as adjusted data give effect to (i) the offering, (ii) the conversion of
the Series A Preferred Stock into our common stock upon consummation of the
offering, as if these events had occurred on December 31, 1998 and (iii) a
1.04 for 1 stock split to be effected prior to the offering.
(6) We used $57.4 million of the net proceeds from our 1997 offering of units
(the "1997 Unit Offering") to purchase a portfolio of U.S. government
securities that we reserved for the payment of the first six scheduled
interest payments due on the $155.0 million principal amount of 13 1/2%
Senior Notes due 2007 (the "1997 Notes") that we issued in the 1997 Unit
Offering. Warrants also were issued in the 1997 Unit Offering. See
"Capitalization."
10
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE
ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY
KNOWN TO US OR THAT WE CURRENTLY THINK ARE IMMATERIAL MAY ALSO IMPAIR OUR
BUSINESS OPERATIONS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY
AFFECTED. IN SUCH CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND
YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.
LIMITED OPERATING HISTORY
We have a limited operating history. We were founded in 1992 and before 1994
only conducted minimal business. In addition, we have only begun providing most
of our current services in most of our current markets since 1996 or later. See
"Business--Products and Services."
We have had limited experience in most of the markets we currently serve and
intend to significantly expand the scale and scope of our operations in our
markets. As part of this expansion, we intend to introduce new services and
features including enhanced services such as voicemail, "follow me," data and
Internet access services that we have not historically offered to any
significant extent. We also intend to enter into new geographic markets where we
currently do not have operations. In 1999, the new geographic markets that we
intend to enter include Austria, Ireland, Italy and The Netherlands.
Our 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 our
business or the price of our common stock.
IMPLEMENTATION OF OUR EXPANSION PLANS
Our company is highly leveraged, which we hope will enhance the return to
our stockholders. However, our leverage makes our success, and the return to our
stockholders, extremely dependent on our ability to grow. To successfully
implement our goal of expanding and enhancing our business operations, we will
need to:
- successfully implement our marketing strategies;
- continue the development, expansion and integration of our 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 our billing systems, order provisioning
processes, technical support, customer service and other back-office
capacity;
- enhance and expand our service features and offerings; and
- continue to attract and hire experienced corporate professionals.
If we fail to successfully implement these plans, it is likely that our
business and the price of our common stock would be materially adversely
affected.
EXPANSION COSTS AND RISKS WILL BE SIGNIFICANT
We will incur significant costs as we attempt to expand. These costs
generally will be incurred in advance of anticipated related revenues, and may
cause substantial and unanticipated fluctuations in our operating results.
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To increase our customer base and enhance our support of our customers, we
intend to substantially increase our sales and marketing and customer care
expenses, especially in our newer geographic markets and over the Internet. We
plan to conduct new sales and marketing campaigns. We also plan to hire
additional internal sales personnel. In addition, we intend to make significant
investments to continue to expand and enhance our customer support, billing,
order provisioning and other information processing capabilities. These
initiatives will be costly and will affect our operating results.
We also will make substantial capital expenditures. For 1999, we plan to
spend approximately $100 million for capital expenditures on network equipment,
back-office systems, the continued build-out of our network operations center in
St. Louis, Missouri, a transatlantic IRU and other fiber optic transmission
capacity. Actual capital expenditures may be significantly different than our
current plans, in part because we intend to be opportunistic in acquiring
transmission capacity in a dynamic market. We also expect to have substantial
capital expenditures after 1999. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
We may seek to finance our capital expenditures by issuing additional debt
or equity securities. The issuance of debt would increase risk to our
stockholders. See "--Substantial Indebtedness, Future Losses and Negative
EBITDA." The issuance of equity would dilute our stockholders' ownership
interests in our company.
RISKS OF POTENTIAL ACQUISITIONS
We intend to pursue selected acquisitions and strategic alliances, some of
which may be material. We continuously engage in discussions with potential
acquisition candidates. Our ability to engage in acquisitions will be dependent
upon our 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 network and operations of acquired businesses into our
own;
- integrating the acquired business's financial, computer, payroll and other
systems into our own;
- 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.
It is possible that we will pay for acquisitions using our common stock,
which would dilute our stockholders' ownership interests in our company. If we
are unsuccessful in meeting the challenges arising out of our growth, our
business and the price of our common stock could be adversely affected.
SUBSTANTIAL INDEBTEDNESS, FUTURE LOSSES AND NEGATIVE EBITDA
As of December 31, 1998, we 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 we 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, we had a net loss of $68.9 million, we had negative
EBITDA of $27.6 million and net cash used in operating activities was $26.4
million. We expect to have operating losses and negative EBITDA and negative
cash flow from operations through at least 2000. We cannot be certain that we
will ever operate at profitable levels or have positive EBITDA or be able to
repay principal and interest on money that we have borrowed. Our failure to
achieve any of these results would materially adversely affect our business and
the price of our common stock.
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We expect that the net proceeds of this offering, together with equipment
loans that we expect to obtain and our other cash resources, will be sufficient
to fund our budgeted capital expenditures and operations until we generate
positive cash flow from operations. However, if we make any significant
acquisitions of businesses or assets, or our business plans or assumptions prove
to be inaccurate, we may need to borrow more money, which would increase our
overall indebtedness.
If we are unable to generate sufficient cash flows from operations to pay
principal and interest on our indebtedness, we may be required to refinance some
or all of it. If we are not able to refinance our indebtedness on acceptable
terms or to borrow additional money, we could be forced to default on our
indebtedness obligations. This would have a material adverse effect on our
business and the price of our common stock.
The indentures pertaining to the 1997 Notes and the 1998 Notes that we have
issued contain various restrictive covenants. See "Certain Indebtedness" for
details on these restrictions. All of these restrictions, in combination with
our highly leveraged financial situation, could:
- limit our ability to react to changing market conditions, changes in our
industry or economic downturns;
- place us at a competitive disadvantage if we are not able to borrow money
on acceptable terms for future acquisitions, capital expenditures or other
purposes;
- increase the losses we will need to fund and require us to dedicate a
substantial portion of the cash flow from our operations, if any, to pay
our interest expense, which would make it more difficult to fund our
company's needs or plans; and
- make it more difficult for us to satisfy our debt obligations.
See "Capitalization," "Selected Consolidated Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
COMPETITION
The markets for all of our services are extremely competitive and we expect
competition to continue to intensify, particularly in continental Europe, where
many regulatory barriers have recently been reduced as part of an ongoing
liberalization. Competition results in customer "churn" or "turnover" as well as
downward price pressure. We believe that competition in many of our markets in
Europe will eventually become as strong as competition in the United States. For
a discussion of price competition, see the Risk Factor entitled "--Increasing
Pricing Pressures."
Many of our competitors are well-known, have substantially greater
financial, technical and marketing resources and larger networks than we do,
control a greater portion of their transmission lines and have long-standing
relationships with our target customers and the regulators in local markets.
Many of our larger competitors, such as AT&T, MCI WorldCom, Sprint, British
Telecom, Deutsche Telekom, France Telecom, Belgacom and SwissCom already have
universal name recognition. We also compete with alliances such as British
Telecom's alliance with AT&T (which recently announced that their alliance will
include Japan Telecom). We believe 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 we operate. As a result, we will face increasing pressure upon our ability
to acquire customers. These competitive pressures could materially adversely
affect our business and the price of our common stock.
Many of our 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. We do not
currently offer all of these types of services and only intend to add some or
all of such offerings over time. In particular, we currently have no plan to
offer local service in the United States.
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In the United States, we expect that, in the near future, the Regional Bell
Operating Companies ("RBOCs"), which are the principal U.S. local telephone
companies, also may compete with us 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.
On April 13, 1999, Bell Atlantic filed its application with the New York Public
Service Commission. Because a substantial portion of our 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 ours. Moreover, should
Bell Atlantic's proposed acquisition of GTE be consummated, Bell Atlantic will
have even greater resources to compete in its service markets.
In many foreign markets where we do business, our 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 our 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 our 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. We are not one of these carriers. Thus, a
caller in France must dial a four-digit prefix in order to select our long
distance service (otherwise, the call will be carried by a competitor). In
Germany, Deutsche Telekom was granted the approval to charge one-time fees to
any customer that changes its preselected long distance service provider. During
1998, this fee was 20 Deutsche Marks ("DM") and is currently DM10. In Greece,
regulatory restrictions prohibit us from offering long distance services other
than value-added services, such as prepaid cards, or services to closed user
groups (i.e., we cannot offer services to the general public). Furthermore,
because competition has only recently been allowed in most of our European
markets, the customers of PTTs may be reluctant to entrust their
telecommunications needs to new providers, such as Destia.
We 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 our principal
services to date, technological advances may enable one or more of them to
provide attractive alternative services. For example, we expect flat-rate
nationwide cellular or PCS phone plans to offer increasingly formidable
competition to our calling card services. In the United Kingdom, cable companies
have been very successful in entering the telecommunications market. See
"Business--Products and Services."
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INCREASING PRICING PRESSURES
We compete for customers based primarily on price. Price competition for all
of our services is intensive, but it is particularly acute for our U.S. prepaid
card and calling card services.
Our larger competitors generally have lower per call transmission costs than
we have. They own more transmission capacity, have more favorable
interconnection rates and obtain larger volume discounts from suppliers. We have
no control over the prices set by our competitors, and when our competitors
reduce their prices, we must reduce our 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, we
expect to experience a substantial reduction in our 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 our
business and the price of our common stock.
We expect that retail telecommunications rates in all of our principal
markets, particularly in continental Europe and Canada, will continue to
decrease rapidly. Some of the factors that will affect price competition for our
services are discussed below.
PRICE COMPETITION IN EUROPE
We anticipate 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. We believe that European PTTs are reacting to competition more
aggressively than AT&T did in the U.S. following the break-up of its monopoly in
the 1980s.
For example, each of our 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 on average 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 announced that it will reduce its retail long distance
rates by as much as 60%.
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. We are
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 us to reduce our costs in order to preserve and improve
our gross margins. Because of the expansion of the Destia Network and reductions
in wholesale transmission costs, we have been able to avoid substantial declines
in gross margins. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview--Cost of Services." As retail
prices continue to fall, we will be subject to increasing pressure, which could
have a material adverse effect on our business and the price of our common
stock.
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
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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 our per call revenue, which could have a material adverse effect on
our business and the price of our common stock.
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 ours. This cost advantage in
favor of Internet telephony providers could have a material adverse effect on
our business and the price of our common stock.
DEPENDENCE ON THIRD PARTY SALES ORGANIZATIONS
We sell a substantial portion of our services through indirect channels of
distribution, which consist of independent sales agents, distributors and, to a
lesser extent, resellers ("Third Party Agents").
We believe that our relationships with our Third Party Agents are good.
However, we do not have control over Third Party Agents or their agents and
employees. We therefore cannot be certain that they will perform in a
satisfactory manner or that their interests will be aligned with ours. In
addition, Third Party Agents also may terminate their business relationships
with us at any time, with little or no prior notice. They could do this if our
competitors offer them increased sales incentives. This risk is especially
pronounced in our multilevel marketing program in the United Kingdom, where a
master agent could determine to terminate its business relationship (and that of
its sub-agents) with us and conduct business with a competitor. Unsatisfactory
performance by Third Party Agents, or the termination by them of their business
relationship with us, would hinder our ability to continue to grow and could
have a material adverse effect on our business and the price of our common
stock.
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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.
We previously experienced disputes with some of our independent sales
agents. In connection with a change in our distribution strategy in the United
Kingdom, in late 1996, we entered into a settlement agreement with Europhone
International ("EI"), our 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, our joint
venture with EI and sales of carrier services to EI contributed 32% of our
consolidated revenues and 92% of our U.K.-originated revenues. See "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, we could be exposed to a material credit risk over a very short
period of time. We maintain a reserve for doubtful accounts receivable and
periodically write off specific accounts receivable. We believe that our credit
criteria enable us to reduce our exposure to these risks. However, we cannot be
certain that our criteria will afford adequate protection against these risks.
During 1997 and 1998, our sales of transmission capacity to carrier
customers ranged from 9% to 30% of our consolidated revenues on a quarterly
basis. During 1999, we intend to increase our carrier revenues, although our
business will continue to be predominantly focused on retail sales. This may
make us more susceptible to the risks associated with carrier customers, which
could have a material adverse effect on our business and the price of our common
stock.
REGULATORY RESTRICTIONS
Regulation of the telecommunications industry is changing rapidly, both
domestically and internationally. Although we believe that deregulation efforts
will create opportunities for us, they also present risks, which could have a
material adverse effect on our business and the price of our common stock.
As an international telecommunications company, we are subject to varying
degrees of regulation in each of the jurisdictions in which we provide our
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 our company or that domestic
or international regulators or third parties will not raise material issues with
regard to our compliance with applicable regulations.
In the United States, regulatory considerations that affect or limit our
business include:
- restrictions on our use of leased lines;
- universal service fund contribution requirements;
- access charges that we are required to pay to local exchange carriers
("LECs");
- payphone access charges that we are 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 network information in
cross marketing efforts.
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In Europe, regulatory considerations that affect or limit our 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 our business.
NEED FOR INTERCONNECTION
In each jurisdiction in which we operate, a monopoly or former monopoly owns
the only line to an overwhelming majority of the telephones. Therefore, we need
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
our 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 our
business and the price of our common stock.
CONSIDERATIONS AFFECTING INTERCONNECTION IN EUROPE
Regulations governing interconnection are not as developed and favorable to
us in most of continental Europe as in the United States and the United Kingdom.
We have been successful to date in obtaining interconnection in most of our
major network cities in continental Europe. However, we have experienced delays
in obtaining interconnection from some PTTs. We cannot be certain that we will
be able to maintain all of our interconnections, obtain additional
interconnection in current network cities (which would increase our 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 we have interconnection through private
parties, we cannot be certain that we will be able to satisfactorily migrate to
interconnection agreements with PTTs.
In continental Europe, we generally must obtain our local connectivity
directly from the PTTs, which are our 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.
Our interconnection to the PTT in Belgium has been granted on a temporary
basis pending the adoption of certain new telecommunications legislation in
Belgium. Our interconnection agreement in Germany granting us access to Deutsche
Telekom's network expired at the end of February 1999, although we have
initiated legal action to maintain continued interconnection with Deutsche
Telekom's network. In the interim, we are currently still interconnected to
Deutsche Telekom's network. If Deutsche Telekom were permitted to restrict our
interconnection, our transmission costs in Germany would increase and the
services we could offer might be limited. We expect our 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. See
"Business--Regulation--Belgium" and "Business--Regulation--Germany."
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CONSIDERATIONS AFFECTING INTERCONNECTION IN THE UNITED STATES
In the United States, we obtain 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, our margins on domestic long distance calls to
that LEC's home region would be materially adversely affected. We are also
dependent upon LECs to implement the transfer of customers from other long
distance carriers to us in a timely and accurate manner. 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 us at a price disadvantage
compared to the LECs.
DEPENDENCE ON TRANSMISSION LINE PROVIDERS
Transmission lines are the connections that carry substantially all of our
voice and data communications. We have not constructed our own fixed
transmission lines and we do not have any plans to do so. Instead, we either
acquire ownership or a long-term right to use (I.E., an IRU) the facilities of
another carrier or consortium of carriers or we lease our transmission capacity
on a short-term basis.
RISKS RELATING TO U.S. TRANSMISSION ARRANGEMENTS
In the United States, we currently have a lease arrangement with Qwest that
provides us with most of our U.S. transmission capacity. By primarily using one
transmission provider in the United States, we are able to obtain more favorable
leased line charges, although it increases our dependence on a single
transmission provider.
Because of the substantial increase in our domestic traffic and U.S.-bound
foreign traffic and our desire to provide services in more U.S. markets, we
recently acquired a 20-year IRU from Frontier to use portions of its U.S. fiber
optic network. This will replace our use of the Qwest network. Frontier is in
the process of building the fiber optic network that we will use, and we expect
this network to be completed and substantially operational by the end of 1999.
We expect 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, we will need to obtain more
expensive transmission capacity from other network providers, which will reduce
our gross margins on substantially all of our U.S. calls. See "Business--The
Destia Network--North American Network."
Because we will obtain most of our U.S. transmission capacity from Frontier,
network failures or quality problems experienced by Frontier will affect us.
Furthermore, because the network will be managed by Frontier and not by our own
personnel, we will not have the ability to directly remedy network problems. If
Frontier is not able to adequately manage and maintain the network or our
interconnection, we could experience quality and reliability problems, which
would require us to secure more expensive transmission capacity. In the past,
Frontier has experienced problems with its existing network, which utilizes
technology different from that of its new network. We 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
our business and the price of our common stock. In addition, as a result of the
pending acquisition of Frontier by Global Crossing, there may be potential
operational and management integration issues that affect us.
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, we 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 us
with the transmission capacity that may be required to implement our anticipated
growth plans.
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Even when PTTs are required by law to provide transmission capacity to other
carriers, we 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 our short-term lease arrangements, we typically acquire transmission
capacity on a fixed cost basis for a term of one month, one year or, in the case
of our current arrangement with Qwest, three years. Our long-term capacity
arrangements are for periods of up to 20 or 25 years. Our IRU from Frontier for
our domestic network and our IRU agreements providing us with capacity on
various transatlantic crossings are long-term capacity arrangements. See
"Business--The Destia Network--Network Economics."
When we negotiate our purchase and lease agreements and make a determination
to acquire a long-term lease or ownership of transmission capacity rather than a
short-term lease, we must estimate the future supply and demand for transmission
capacity, as well as our customer calling patterns and traffic levels. Our
profitability depends, in part, on our 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. We could suffer competitive disadvantages if we base our
acquisitions of transmission capacity on inaccurate projections.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
In order to bill our customers, we must record and process large amounts of
data quickly and accurately. While we believe our management information systems
currently are adequate, if our customer base continues to increase, we will need
to continue to make substantial investments in new and enhanced information
systems. If we encounter delays or cost-overruns or suffer adverse consequences
in implementing these systems, there could be a material adverse effect on our
business and the price of our common stock. See "Business--The Destia
Network--Network Operations."
As our information systems suppliers revise and upgrade their hardware,
software and equipment technology, we may encounter difficulties in integrating
these new technologies into our business; in addition, these new revisions and
upgrades may not be appropriate for our business.
DEVALUATION AND CURRENCY RISKS
A substantial portion of our revenues and expenses are denominated in
non-U.S. currencies, consisting principally of the British pound and the
currencies represented by the euro. Although our business strategy contemplates
that an increasing portion of our revenues and expenses will be denominated in
non-U.S. currencies, a disproportionate portion of our expenses, including
interest and principal on our indebtedness, will nevertheless continue to be
denominated in U.S. dollars. This exposes us 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 our business and the
price of our common stock.
At times, we use foreign exchange contracts to hedge foreign currency
exposure resulting from our non-U.S. trade accounts receivables. Because of the
number of currencies involved, our constantly changing currency exposure and the
fact that all foreign currencies do not fluctuate in the same manner against the
U.S. dollar, we cannot quantify the effect of exchange rate fluctuations on our
future financial condition or results of operations.
DEPENDENCE ON KEY PERSONNEL; INTEGRATION OF MANAGEMENT AND OTHER PERSONNEL
Our success depends largely on the skills, experience and performance of key
members of our senior management team. If we lose one or more of these key
employees, particularly Alfred West or Alan L.
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Levy, our ability to successfully implement our ambitious business plan and the
price of our common stock could be materially adversely affected. We have
employment agreements with certain senior employees, but we cannot prohibit our
employees from leaving. See "Management--Executive Compensation" and
"Management--Employment Agreements and Arrangements."
Under our equipment financing agreement (the "NTFC Agreement"), we may not
cease to employ Mr. West (other than by reason of his death or disability) or
let Mr. West compete with us. If we were to breach our equipment financing
agreement, we would be in default, which would require us 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 our business and the price of our common stock.
YEAR 2000 TECHNOLOGY RISKS
We face certain risks arising from Year 2000 issues which could have a
material adverse effect on our business and the price of our common stock. See
"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 OUR PRINCIPAL EQUIPMENT SUPPLIER
We purchase a significant portion of our switching equipment from Northern
Telecom. We also rely on Northern Telecom for a substantial portion of our
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 our switching equipment. These upgrades frequently can be purchased
only directly from Northern Telecom. Northern Telecom is aware of our reliance
on them for our network hardware and we believe that this may put us at a
disadvantage in our negotiations with them to acquire network hardware at
reasonable prices. See "Business--The Destia Network--Network Hardware and
Software."
As we continue to expand the Destia Network, we cannot be certain that we
will be able to acquire all of the compatible equipment that we require. Our
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 our business and the price of our common
stock.
CONTROL BY PRINCIPAL STOCKHOLDERS
When this offering is completed, Alfred West, (our Chief Executive Officer
and Chairman of our Board of Directors), Steven West, (the brother of Alfred
West and a member of our Board of Directors), and Gary Bondi (a member of our
Board of Directors) will in total beneficially own or control approximately 58%
of our outstanding common stock. As a result of their percentage ownership of
our common stock, these stockholders will exert significant influence over all
matters requiring stockholder approval, including the election of directors and
approval of significant corporate transactions, which could delay or prevent
someone from acquiring us. See "Principal Stockholders."
ANTI-TAKEOVER PROVISIONS
Some of the provisions that may be included in our Certificate of
Incorporation and Bylaws may discourage, delay or prevent an acquisition of our
company at a premium price. These provisions:
- authorize the issuance of "blank check" preferred stock;
- prohibit cumulative voting in the election of directors;
- limit the removal of directors by the shareholders to removal for cause;
- require a super-majority stockholder vote to effect certain amendments to
our Certificate of Incorporation and Bylaws;
21
<PAGE>
- limit the persons who may call special meetings of stockholders;
- prohibit stockholder action by written consent except where unanimous; and
- establish advance notice requirements for nominations for election to the
Board of Directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
In addition, we intend to adopt a shareholder rights plan after the
completion of this offering. A shareholder rights plan would cause substantial
dilution to any person or group that attempts to acquire our company on terms
not approved in advance by our Board of Directors.
Section 203 of the Delaware General Corporation Law (the "DGCL") also
imposes certain restrictions on mergers and other business combinations between
us and any holder of 15% or more of our common stock. By its terms, the
prohibitions of Section 203 of the DGCL are not applicable to Messrs. Alfred
West, Steven West and Gary Bondi. See "Principal Stockholders." In addition,
certain of our employment agreements provide for payments to be made to the
employees thereunder if their employment is terminated in connection with a
change of control.
Certain provisions of the DGCL, our shareholder rights plan and some of our
employment agreements may delay, deter or prevent someone from acquiring us in a
transaction that results in stockholders receiving a premium over the market
price for the shares of common stock. See "Management--Employment Agreements and
Arrangements" and "Description of Capital Stock-- Provisions of the Certificate
of Incorporation, Bylaws and Delaware Law That May Have an Anti-takeover
Effect." In addition, the Federal Communications Commission (the "FCC") and
certain state public service commissions ("PSCs") require prior approval of
transfers of control, including PRO FORMA transfers of control resulting from
corporate reorganizations and assignments of regulatory authorization. Such
requirements may delay, prevent or deter a change in control of our company.
In addition to the foregoing, under the 1997 Indenture and the 1998
Indenture, we must offer to purchase all the 1997 Notes and 1998 Notes at a
purchase price equal to 101% of the principal amount or accreted value (as
applicable) of such notes. Our equipment financing debt has similar provisions.
See "Certain Indebtedness." The foregoing covenants may also deter third parties
from entering into a change of control transaction with us.
NO PRIOR PUBLIC MARKET FOR OUR COMMON STOCK; POTENTIAL VOLATILITY OF STOCK PRICE
There is no market for our common stock. An active public market for our
common stock may not develop or be sustained after the offering. The price of
our common stock is likely to change after the offering. See "Underwriters." The
market price of our common stock may fluctuate significantly in response to a
number of factors, (some of which are beyond our control), including:
- variations in operating results;
- changes in financial estimates by securities analysts;
- changes in market valuations of telecommunications companies;
- announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
- our success or failure to implement our expansion plans;
- an adverse decision by a regulatory agency in one of our primary markets;
- increases or decreases in reported holdings by insiders or mutual funds;
- additions or departures of key personnel;
- future sales of common stock; and
- stock market price and volume fluctuations generally.
22
<PAGE>
POTENTIAL EFFECT OF SHARES BECOMING AVAILABLE FOR SALE
Sales of a substantial number of shares of common stock after the offering
(or the perception that such sales might occur) could adversely affect the
market price of our common stock and could impair our ability to raise capital
through the sale of additional stock. Immediately after this offering, we will
have 33,698,061 shares of common stock outstanding or that are the subject of
currently exercisable options. The 6,500,000 shares sold in this offering will
generally be freely tradable without restriction. The 20,778,321 shares of our
common stock outstanding on completion of this offering will be "restricted
securities" as that term is defined in Rule 144 under the Securities Act ("Rule
144").
The 3,553,821 shares of common stock that will be held by Princes Gate
Investors II, L.P. when its shares of Series A Preferred Stock are converted
upon completion of this offering will be entitled to certain registration
rights. See "Underwriters."
Immediately after this offering, we also will have an additional
approximately 3,520,000 shares of common stock that are the subject of options
that are not currently exercisable. To the extent that these options are
properly exercised, the underlying shares of common stock will be freely
tradable immediately upon exercise of the options.
Stockholders holding more than approximately 80% of our outstanding common
stock and currently exercisable options to purchase our common stock have
executed lock-up agreements that limit their ability to sell such common stock.
These stockholders have agreed not to sell or otherwise dispose of any shares of
our common stock for a period of at least 180 days after the date of this
prospectus without the prior written approval of Morgan Stanley & Co.
Incorporated. When the lock-up agreements expire, these shares and the shares
underlying the options will become eligible for sale, in some cases subject to
the volume, manner of sale and notice requirements of Rule 144. See
"Management--Employment Agreements and Arrangements" and "Shares Eligible for
Future Sale."
ABSENCE OF DIVIDENDS
We have not paid dividends on our common stock since we became a subchapter
C corporation. We do not anticipate paying any dividends on our common stock for
the foreseeable future. In addition, the instruments governing our indebtedness
contain restrictions on our ability to declare and pay dividends. See "Dividend
Policy" and "Certain Indebtedness."
IMMEDIATE SUBSTANTIAL DILUTION
The initial public offering price will be substantially higher than the book
value per share of our outstanding common stock (which is negative). As a
result, investors purchasing our common stock in this offering will incur
immediate substantial dilution. In addition, we have issued options and warrants
to acquire our common stock at prices significantly below the initial public
offering price. To the extent these outstanding options or warrants are
ultimately exercised, there will be further dilution to investors in this
offering. See "Dilution."
23
<PAGE>
USE OF PROCEEDS
Our company will receive net proceeds from the offering of approximately
$59.7 million (approximately $68.8 million if the underwriters exercise their
over-allotment option in full), assuming that our common stock is offered at
$10.00 per share, the midpoint of the range set forth on the cover page of this
prospectus, and after deducting underwriting discounts and commissions and the
estimated expenses of the offering. Our company intends to use the net proceeds
to expand its sales and marketing activities and to make capital expenditures,
particularly in Europe, as well as to fund working capital and general corporate
purposes, including to fund losses. Since we continuously engage in discussions
with potential acquisition candidates, we may use net proceeds to fund suitable
strategic acquisitions. Pending the use of the net proceeds, we intend to
contribute them to an "Unrestricted Subsidiary," as defined in our indentures.
DIVIDEND POLICY
Our company has not declared or paid any cash dividends on its common stock
or other securities since it became a subchapter C corporation and it does not
intend to pay cash dividends in the foreseeable future. Our company plans to
retain earnings, if any, for use in the operation of its business and to fund
future growth. In addition, our company's indentures and our equipment financing
agreement currently restrict the payment of dividends. See "Certain
Indebtedness."
CERTAIN INFORMATION
Our company's principal executive offices are located at 95 Rte. 17 South,
Paramus, New Jersey 07652, and its telephone number is (201) 226-4500. Its World
Wide Web site address is www.destia.com. The information in its web site is not
incorporated by reference into this prospectus.
Our company's logo and certain titles and logos of our company's services
mentioned in this prospectus are our company's trademarks. Each trademark, trade
name or service mark of any other company appearing in this prospectus belongs
to its holder.
This prospectus includes statistical data (including FCC and International
Telecommunications Union ("ITU") data) concerning the telecommunications
industry that we obtained from industry publications. These publications
generally indicate that they have obtained information from sources that they
believe are reliable, but that they do not guarantee the accuracy and
completeness of the information. Although we believe that these industry
publications are reliable, we have not independently verified their data. We
also have not sought the consent of any of these publications to refer to their
data in this prospectus.
The information in this prospectus has been adjusted to reflect the
conversion of all 140,000 outstanding shares of the Series A Preferred Stock
into 3,553,821 shares of common stock, which will occur immediately prior to the
closing of the offering. The information in this prospectus also has been
adjusted to reflect this 1.04 for 1 split of our common stock and Non-Voting
Common Stock (as defined below). Except where specifically indicated, the
information in this prospectus does not take into account the exercise of any of
our outstanding options or warrants.
As used herein, common stock refers to the voting common stock of our
company. As of April 1, 1999, there were 151,474 shares of non-voting common
stock ("Non-Voting Common Stock") outstanding and 103,891 shares of restricted
voting common stock ("Restricted Voting Common Stock").
24
<PAGE>
CAPITALIZATION
The following table sets forth our cash and capitalization as of December
31, 1998 (i) on an actual basis and (ii) on an as adjusted basis after giving
effect to the offering and the conversion of all outstanding shares of Series A
Preferred Stock into shares of common stock. This information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and the related notes
thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, 1998
-----------------------
<S> <C> <C>
ACTUAL AS ADJUSTED
---------- -----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Cash, cash equivalents, marketable securities and restricted cash........................ $ 180,028 $ 239,728
---------- -----------
---------- -----------
Current portion of long-term debt and capital lease obligations.......................... $ 16,694 $ 16,694
---------- -----------
---------- -----------
Long-term debt and capital lease obligations:
Capital leases......................................................................... $ 193 $ 193
1997 Notes............................................................................. 150,240 150,240
1998 Notes............................................................................. 192,936 192,936
Other long-term debt................................................................... 37,379 37,379
---------- -----------
Total long-term debt and capital lease obligations................................. 380,748 380,748
Redeemable convertible preferred stock................................................... 14,421 --
Stockholders' equity (deficit):
Common stock--voting, $.01 par value, 29,250,000 shares authorized, actual, and
74,250,000 shares authorized, as adjusted; 20,778,321 shares issued and outstanding,
actual and 30,832,142 shares issued and outstanding,
as adjusted (1)...................................................................... 208 308
Non-voting common stock, $.01 par value, 500,000 shares authorized, actual and
adjusted; 135,890 shares issued and outstanding, actual and 135,890 shares issued and
outstanding, as adjusted............................................................. 1 1
Additional paid-in capital (2)......................................................... 6,923 80,944
Accumulated other comprehensive loss................................................... (856) (856)
Accumulated deficit.................................................................... (108,743) (108,743)
---------- -----------
Total stockholders' equity (deficit)............................................... (102,467) (28,346)
---------- -----------
Total capitalization............................................................. $ 292,702 $ 352,402
---------- -----------
---------- -----------
</TABLE>
- ------------------------------
(1) Actual amount outstanding does not include (i) 4,437,115 shares of common
stock issuable upon the exercise of options to employees at a weighted
average exercise price of $3.85, (ii) 3,553,821 shares of common stock
issuable upon conversion of the Series A Preferred Stock, (iii) 135,890
shares of common stock to be issued after the offering upon conversion of
outstanding shares of Non-Voting Common Stock, which will be convertible at
the option of the holder at a nominal exercise price, or (iv) 1,315,148
shares of common stock issuable upon exercise of the Warrants issued in
connection with the 1997 Unit Offering at an exercise price of $.01 per
share. As adjusted amount outstanding does not include items (i) and (iii)
of the preceding sentence. All share numbers contained herein give effect to
the 1.04 for 1 stock split to be effected prior to the offering. See
"Certain Information."
(2) Includes $5.6 million attributable to the Warrants, which represents the
portion of the issue price paid in the 1997 Unit Offering attributable to
the fair value of the Warrants. This amount has been recognized as a
discount on the 1997 Notes and is being amortized over the term of the 1997
Notes. The Warrants expire on June 30, 2007.
25
<PAGE>
DILUTION
The pro forma net tangible book value of the Company's common stock as of
December 31, 1998, giving effect to the conversion of all shares of the Series A
Preferred Stock into common stock on the closing of this offering, was
$(149,778,000), or approximately $(6.12) per share. "Pro forma net tangible book
value" per share represents the amount of total tangible assets of the Company
less total liabilities, divided by 24,468,032 shares of common stock outstanding
after giving effect to the conversion of the Series A Preferred Stock into
common stock. After giving effect to the issuance and sale of 6,500,000 shares
of common stock offered by the Company (based on an assumed initial public
offering price of $10.00 per share and after deducting estimated underwriting
discounts and commissions and estimated offering expenses payable by the
Company), the pro forma net tangible book value of the Company as of December
31, 1998 would have been $(90,078,000), or $(2.91) per share. This represents an
immediate increase in pro forma net tangible book value of $3.21 per share to
existing stockholders and an immediate dilution in net tangible book value of
$12.91 per share to new investors. Investors participating in this offering will
incur immediate, substantial dilution. The following table illustrates the per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.......................... $ 10.00
Pro forma net tangible book value per share as of December 31, 1998.... $ (6.12)
Increase in pro forma net tangible book value per share attributable to
new investors........................................................ 3.21
---------
Pro forma net tangible book value per share after the offering........... (2.91)
---------
Dilution per share to new investors...................................... $ 12.91
---------
---------
</TABLE>
The following table sets forth, on a pro forma basis as of December 31,
1998, after giving effect to the conversion of all outstanding shares of Series
A Preferred Stock into common stock on the closing of this offering, the
difference between the existing stockholders and the purchasers of shares of
common stock in this offering (at an assumed initial public offering price of
$10.00 per share) with respect to the number of shares of common stock purchased
from the Company, the total consideration paid and the average price paid per
share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- -------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders................................. 24,468,032 79% $ 14,000,000 18% $ 0.57
New investors......................................... 6,500,000 21 65,000,000 82 10.00
------------ --- ------------- ---
Total............................................. 30,968,032 100% $ 79,000,000 100%
------------ --- ------------- ---
------------ --- ------------- ---
</TABLE>
As of December 31, 1998, there were approximately 4,437,115 shares of common
stock subject to outstanding options at a weighted average exercise price of
approximately $3.85 per share, 135,890 shares of common stock issuable upon
conversion of shares of Non-Voting Common Stock and 1,315,148 shares of common
stock issuable upon the exercise of the Warrants at an exercise price of $.01
per share. To the extent outstanding options and Warrants are exercised, there
will be further dilution to new investors. See "Capitalization,"
"Management--Executive Compensation" and "Management--1996 Flexible Incentive
Plan."
26
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data (with the exception of
other data and regional data) for 1994, 1995, 1996, 1997 and 1998 and as of
December 31, 1998 are derived from our audited consolidated financial
statements, which have been audited by Arthur Andersen LLP, independent public
accountants. The selected consolidated financial data set forth below should be
read in conjunction with, and is qualified by reference to, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our financial statements and the related notes included elsewhere in this
prospectus.
<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)................................................ $ 0.03 $ 0.01 $ (0.41) $ (1.50) $ (3.31)
Weighted average number of shares of common stock outstanding (basic
and diluted)(1).................................................... 20,778 20,778 20,778 20,778 20,846
--------- --------- --------- --------- -------------
--------- --------- --------- --------- -------------
OTHER DATA:
Capital expenditures and acquisitions................................ $ 906 $ 1,677 $ 4,670 $ 19,021 $ 111,999
EBITDA(2)............................................................ 1,070 658 (6,967) (18,765) (27,564)
Distributions to S Corporation shareholders(3)....................... -- 499 226 -- --
Series A Preferred Stock dividends(4)................................ -- -- 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>
27
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
---------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED(5)
----------- --------------
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities..................................... $ 139,561 $ 199,261
Restricted cash and securities(6).................................................... 40,467 40,467
Total assets......................................................................... 388,208 447,908
Current portion of borrowings........................................................ 16,694 16,694
Long-term borrowings, less current portion........................................... 380,748 380,748
Series A Preferred Stock............................................................. 14,421 --
Total stockholders' equity (deficit)................................................. (102,467) (28,346)
</TABLE>
- ------------------------------
(1) Weighted average numbers of shares have been retroactively restated to give
effect to the 1.04 for 1 stock split to be effected prior to the offering.
See "Certain Information."
(2) "EBITDA" is defined as net income (loss) plus net interest expense, income
tax expense, and depreciation and amortization expense. We have included
information concerning EBITDA in this prospectus 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, our EBITDA is not necessarily
comparable to EBITDA of other companies. EBITDA also does not indicate cash
provided by operating activities. You should not use our EBITDA as a measure
of our operating income and cash flows from operations under GAAP. Both of
those measures are presented above. You also should not look at our EBITDA
in isolation, as an alternative to or as more meaningful than measures of
performance determined in accordance with GAAP.
(3) The distributions reflected in this line item were declared when we were a
subchapter S corporation under U.S. tax law.
(4) 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.
(5) The as adjusted data give effect to (i) the offering, (ii) the conversion of
the Series A Preferred Stock into our common stock upon consummation of the
offering, as if these events had occurred on December 31, 1998 and (iii) a
1.04 for 1 stock split to be effected prior to the offering.
(6) We used $57.4 million of the net proceeds from our 1997 Unit Offering to
purchase a portfolio of U.S. government securities that we reserved for the
payment of the first six scheduled interest payments due on the $155.0
million principal amount of the 1997 Notes that we issued in the 1997 Unit
Offering. Warrants also were issued in the 1997 Unit Offering. See
"Capitalization."
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH
FORWARD-LOOKING STATEMENTS. SEE "FORWARD-LOOKING STATEMENTS" (ON PAGE 4). SEE
ALSO "RISK FACTORS" AND THE COMPANY'S FINANCIAL STATEMENTS AND THE RELATED NOTES
INCLUDED ELSEWHERE IN THIS PROSPECTUS.
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 telecommunications
industry have declined at a more rapid rate than prices due to technological
29
<PAGE>
innovation and the availability of substantial transmission capacity. There can
be no assurance that this cost trend will continue. See "Risk
Factors--Increasing Pricing Pressures" and "Industry Overview."
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
for specific point-to-point routes on a fixed cost basis, which involve monthly
payments regardless of usage levels. Leased lines 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.
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 and EBITDA
are expected to improve, the Company's net income (loss) will not necessarily
improve to the same extent.
Cost of services also includes certain fees imposed by regulators and third
parties that are typically billed to customers together with an administrative
fee. 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
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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.
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 its subsidiary, Telco Global Communications ("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. Transmission over IRUs involves only fixed
costs, with no per minute charges, and is 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 and EBITDA 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. See "Certain Indebtedness."
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>
31
<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.
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<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 Destia Network Services,
Ltd. ("DNS"), 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
33
<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. 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 $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 and a $14.0 million equity investment
(less fees and expenses) by Princes Gate Investors.
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 this
34
<PAGE>
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 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 financings.
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 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 capital
expenditures related to the continued development of its back office
capabilities, including management information and network management systems.
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 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
35
<PAGE>
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 "Business--The Destia
Network--North American Network."
The Company continually evaluates business opportunities, including
potential acquisitions, and engages in discussions with potential acquisition
candidates. The Company may use funds to consummate 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 wireless or 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 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.
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<PAGE>
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. Cost 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 $0.9 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 during the second quarter of 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 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
37
<PAGE>
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 and the price of its common stock.
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 the end of the first quarter of 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 and the retention of
an outside consulting firm. This estimate includes the accelerated cost of
replacing systems that are not Year 2000 compliant. Actual costs may, however,
differ materially.
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INDUSTRY OVERVIEW
International telecommunications is one of the fastest growing segments of
the long distance industry, having experienced compounded annual growth in total
minutes of 14.3% from 1989 to 1997. Forecasts by the ITU project this growth to
continue at a compound annual growth rate of between approximately 12% and 18%
from 1997 to 2001. Based on this estimate, worldwide international long distance
traffic is projected to increase from approximately 81.8 billion minutes in 1997
to between approximately 128.7 and 158.6 billion minutes by the year 2001. The
market for these services is highly concentrated in more developed countries,
with approximately 43% of 1997 worldwide international long distance traffic
originating in Europe and 33% originating in the United States. In Europe,
domestic long distance services in each country also present a large, growing
market opportunity.
While the U.S. long distance market was liberalized in 1984 and the U.K.
long distance market was liberalized in 1992, the continental European voice
telephony market was liberalized only recently on January 1, 1998 and
liberalization is still in the process of being implemented. Generally,
substantial advances in the implementation of liberalization have taken place,
including (i) the establishment of national regulatory authorities, (ii)
licensing, (iii) network interconnection, (iv) universal service, (v) tariffs,
(vi) numbering and number portability and (vii) rights-of-way. EU deregulation
is intended to create a fully liberalized single market for continental European
telecommunications. As of August 1, 1998, there were over 180 operators within
the EU authorized to provide national public voice telephony and over 250
operators authorized to provide international public voice telephony.
Historically, continental European telecommunications rates have been
designed to subsidize the provision of local service with high priced long
distance services. As a result, long distance services generated a substantial
portion of the profitability of continental European PTTs. To become more
competitive in providing long distance, the PTTs are seeking to "rebalance"
their rates among local and long distance services. Generally, this presents
some political difficulty since rates for local service typically must rise to
support lower long distance rates. While in some countries (such as France)
substantial rate rebalancing has already occurred, other countries (such as The
Netherlands) have yet to rebalance rates. We believe that in the near term,
where rates have not been substantially rebalanced, long distance rates will
continue to subsidize the high overhead costs of the PTTs. However, significant
competitive rate reductions have occurred without rebalancing in some countries
(such as Germany) where the incumbent PTT has lost market share. Additional rate
reductions also remain a possibility in these and other countries. See "Risk
Factors--Increasing Pricing Pressures."
Implementation of interconnection is an important variable in the ability of
companies such as Destia to provide services on a competitive basis.
Interconnection allows a new competitor to use the facilities of existing
service providers, particularly PTTs, often at very attractive rates. Many
national regulators have established access charge regimes generally thought to
be favorable to new competitors. For example, in the New York City market (which
has been liberalized since 1984) companies generally pay $.013 per minute for
local termination of a long distance call. In Berlin and Paris (which have been
liberalized only since January 1, 1998) these rates are $.025 and $.020,
respectively. In addition to favorable rates established by regulation, we
believe that the entry of new European CLECs (I.E., competitive LECs) will
further drive down the costs of local access in Europe. Concerns regarding
interconnection include delays by reluctant PTTs in executing agreements and in
implementing interconnections.
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The cost of operating a retail long distance business in continental Europe
is declining rapidly as alternative wholesale networks are constructed. These
alternative networks include Ulysses (MCI WorldCom), Hermes Europe Railtel (GTS
and others) and Circe (Viatel), as well as announced network construction by
Level 3 and Global Crossing. At present, most of these networks are under
development, although portions of some of them are complete. Since these
projects have been announced or completed, pricing for European long-haul
facilities has begun to decline rapidly. For example, over a period of less than
one year, the price of an E-1 circuit from Brussels to London has fallen from
approximately $19,000 to approximately $10,400 per month. The Company believes
that these costs will continue to decline more rapidly than the prices for long
distance services due to the fact that (i) the market for retail national and
international long distance services in all EU countries is still dominated by
the PTTs who are reluctant to reduce prices and (ii) enhanced services and
generally lower prices will increase the demand for long distance services.
However, there can be no assurance in this regard. See "Risk
Factors--Competition" and "--Increasing Pricing Pressures."
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BUSINESS
We are a rapidly growing, facilities-based provider of domestic and
international long distance telecommunications services in North America and
Europe. Our extensive international telecommunications network allows us 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, and we believe that we are well positioned to
capitalize on the continued growth in these markets. In 1997, worldwide
international long distance traffic totaled 81.8 billion minutes 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.
We provide our customers with a variety of retail telecommunications
services, including international and domestic long distance, calling card and
prepaid services, and wholesale transmission services. Our approximately 350,000
customer accounts are diverse and include residential customers, commercial
customers, ethnic groups and telecommunications carriers. In each of our
geographic markets, we utilize a multichannel distribution strategy to market
our services to our target customer groups. We believe this strategy greatly
enhances our growth prospects and reduces our dependence on any one service,
customer group or channel of distribution.
We entered the U.S. market during 1993 and the U.K. market during 1995. In
continental Europe, we commenced offering our services before the January 1,
1998 full liberalization of telecommunications services in those markets. We
established operations in Belgium, France and Germany in the first quarter of
1997 and Switzerland in the fourth quarter of 1997. Given our early entry into
many of our continental European markets, as well as our established network,
sales and marketing and customer support infrastructure, we believe we are well
positioned to further grow our business in continental Europe.
COMPETITIVE STRENGTHS
The European and North American telecommunications industry is rapidly
evolving following the reduction of regulatory barriers, investment in new
transmission capacity and the development of new services and technologies. In
this dynamic environment, we believe we have successfully distinguished
ourselves from many of our competitors and enjoy several competitive strengths:
PROVEN TRACK RECORD OF STRONG INTERNAL GROWTH
For 1996, 1997 and 1998, our revenues were $45.1 million, $83.0 million and
$193.7 million, respectively. In addition, for 1996, 1997 and 1998, we carried
104.6 million, 330.1 million and 883.6 million minutes of traffic, respectively.
Substantially all of our growth has been generated internally, although we have
made several minor acquisitions. Our only significant acquisition to date, the
purchase of VoiceNet, solidified a key distribution channel, but had no direct
effect on our revenues or customer base. As we have grown our business, we have
focused on managing our growth in a manner that has enabled us to increase our
customer base and maintain our high standards of service quality and customer
support. We believe that our demonstrated ability to grow organically and manage
rapid growth provides us with a solid foundation to continue to grow our
business.
ESTABLISHED INTERNATIONAL TELECOMMUNICATIONS NETWORK
Since 1996, we have made substantial investments in expanding the Destia
Network. The Destia Network is comprised of:
- 14 operational carrier-grade switches with seven in North America and
seven in Europe;
- an IRU from Frontier on portions of its U.S. fiber optic network;
- transatlantic IRUs;
- leased capacity and IRUs in Europe; and
- leased capacity in Canada.
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In addition, we have completed direct interconnections with the PTTs in five
of our major European markets (the United Kingdom, Belgium, Germany, France and
Switzerland) and have signed an interconnection agreement with the PTT in The
Netherlands. Interconnection allows us to offer services to customers as a
domestic carrier through a direct connection to the PSTN and with lower access
costs. In expanding our network, we have used "carrier-grade" equipment, which
allows us to offer high quality services and expand our service offerings on a
cost-efficient basis. As a result of our network build-out program, we believe
that we are well-positioned to aggressively grow our revenues.
COST-EFFECTIVE MULTICHANNEL MARKETING
We reach a broad range of customer groups by using a variety of marketing
channels, including a direct sales force, independent sales agents, multilevel
marketing, customer incentive programs, advertising and the Internet. Our
multichannel approach allows us to tailor our marketing to specific geographic
markets and services. We believe this is an especially cost-effective means of
marketing to our target customers. For example, to sell our residential long
distance, calling card and prepaid services in the United Kingdom, we use a
multilevel marketing program. To market our VoiceNet-TM- calling card to U.S.
business travelers, we use advertisements in in-flight magazines and selected
well-known U.S. newspapers and magazines. For marketing our international and
domestic long distance and prepaid card services to metropolitan-area ethnic
communities, we use independent sales representatives who are part of the
targeted community, and we advertise in local, ethnic-oriented publications and
co-sponsor ethnic events. We also intend to cross-market many of our services.
For example, we recently started marketing our "1+" services to our VoiceNet
customer base. We expect that our multichannel marketing approach will
facilitate our continued rapid growth while reducing the risks associated with
dependence on a limited number of distribution channels.
EXPERIENCED MANAGEMENT TEAM WITH SIGNIFICANT OWNERSHIP
We believe we have an experienced and motivated management team that is
well-suited to continue leading the growth of our company. Our management team
includes a broad base of seasoned professionals from the domestic and
international telecommunications sector with expertise in management,
multinational sales and marketing, network operations and engineering, finance
and regulatory issues. Furthermore, in each of our geographic markets, we employ
local staffs in management, operations, sales and marketing and customer
service. These staffs are familiar with local technical issues, market dynamics,
customer preferences and cultural norms. On a fully diluted basis, our senior
management and other employees currently own approximately 59% of Destia and
following the offering will own approximately 48%.
COMMITMENT TO SUPERIOR CUSTOMER SERVICE
We are committed to providing our customers with superior customer service
and believe we have developed the infrastructure to deliver high levels of
customer satisfaction. For example, in all of our markets, we provide customers
with local customer service and billing support and, in the United States and
the United Kingdom, we provide this support 24 hours a day. In addition, for our
ethnic customers, we provide customer service in their native language. As of
December 31, 1998, we had 242 full-time equivalent customer service
representatives company-wide. We have also developed our own proprietary
software systems to better serve our customers. For example, in each of our
network countries, our monthly bills are in the customer's native language and
local currency (and we have the ability to bill in euros). We also provide
detailed billing information for commercial customers that includes itemized
breakdowns of usage by telephone number or by account code and department. We
believe that our customer support infrastructure, together with our
customer-oriented philosophy, differentiates us from many of our competitors.
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SOPHISTICATED OPERATIONAL CONTROL SYSTEMS
We have internally developed sophisticated software and intranet systems
that enable us to better manage our business and appropriately price our
services in each of our markets on a real-time basis. For example, we have
developed an interface with our network switches that allows us to compile
network information on a real-time basis, including the number of minutes being
routed through our switch (and corresponding revenue), points of origination and
termination, sources of traffic (by area code, city and carrier) and other
traffic information. We use this information every day in connection with "least
cost" routing, pricing, cost and margin analysis, identifying market
opportunities and developing our sales and marketing and network expansion
strategies. We believe these analytical tools allow us to quickly identify new
market growth and cost saving opportunities as well as control our business in
an environment of rapid growth.
COMPANY STRATEGY
Our objective is to become a leading facilities-based provider of
telecommunications services in the largest metropolitan markets in Europe and
North America that generate significant domestic and international traffic. The
key elements of our growth strategy are as follows:
FOCUS ON HIGH MARGIN RETAIL BUSINESS
Since our inception, the primary focus of our business has been to provide
services to retail customers. We believe that the advantages of focusing on
retail, instead of wholesale, customers include:
- higher margins;
- higher barriers to entry because of the significant investments required
to develop sales, marketing and customer support;
- more opportunities to bundle value-added services;
- more opportunities to build brand loyalty; and
- reduced credit and cancellation risk (compared to wholesale customers who
buy transmission services almost entirely based on price).
We believe that our retail focused strategy has been highly successful to
date and has allowed us to build strong gross margins. For 1996, 1997, 1998 and
the fourth quarter of 1998, our gross margins were 21.6%, 23.2%, 27.5% and
29.0%, respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview--Cost of Services" and
"--Depreciation and Amortization" for a description of how gross margins are
calculated. In addition, we have also achieved strong growth, particularly in
the largely deregulated U.S. and U.K. telecommunications markets. For example,
our U.K. revenues have increased from $15.5 million for 1996 to $56.0 million
for 1998, and our U.K. customer accounts have increased from approximately 1,000
at the end of 1996 to approximately 107,000 at the end of 1998. We believe we
can continue to replicate this strategic focus and further improve our revenue
growth and gross margin performance as we expand our retail presence in our
European and North American markets.
LEVERAGE OUR EXISTING NETWORK AND CUSTOMER SUPPORT INFRASTRUCTURE
We believe that our switching infrastructure and our sales and marketing and
customer support infrastructure in our European and North American markets will
enable us to expand our retail customer base in these markets. We will seek to
add to our customer base by increasing the size of our direct sales force,
targeting additional ethnic markets, expanding our global carrier services
group, introducing multilevel marketing in additional markets, increasing
advertising, co-branding our services, participating in affinity programs and
cross-marketing our services. Because our existing infrastructure was designed
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with the retail customer in mind, we believe that we can add customers rapidly
without sacrificing transmission quality or our established level of customer
service.
In addition to expanding our customer base, we will also seek to increase
our utilization of the Destia Network and thereby reduce our per minute costs
and increase our gross margins. In general, the incremental cost to us of
carrying calls on the Destia Network is much less than the incremental cost of
carrying calls over other carriers' networks. This is because the cost of our
IRUs and certain leased lines is fixed, regardless of how many calls we carry.
On the other hand, when we transmit calls over another carrier's network, we pay
a per minute charge. As a result, by increasing our amount of "on-net" traffic,
we can reduce our per minute costs. In addition, we also can better control call
quality. We intend to increase the utilization of our network by (1) migrating a
greater percentage of our overall traffic on to the Destia Network, (2)
increasing those sales and marketing initiatives that promote customer usage of
services that are provided in a Destia Network city, such as "1+" and "1xxx"
services, and (3) targeting carrier and other wholesale customers so we can
generate revenues from otherwise unused portions of the Destia Network.
ENHANCE THE DESTIA NETWORK AND OPPORTUNISTICALLY ENTER NEW MARKETS
As we continue to complete the build-out of our network, we intend to do so
in a cost-effective manner that provides us with the flexibility to introduce
new services, employ new technologies and reach new customers. For example, in
the United States our recent agreement with Frontier provides us with fiber
optic transmission capacity connecting 43 U.S. markets. In addition, the
Frontier arrangement gives us favorable origination and termination rates
throughout the continental United States. We also intend to continue to explore
opportunities to extend our network into additional markets which complement our
existing regional presences, or otherwise offer significant growth opportunities
for our company. For example, during 1999, we intend to install POPs and begin
marketing our services in selected cities in Ireland and Italy, to begin
marketing our services in Austria and The Netherlands and to expand our service
offerings in Greece.
EXPAND OUR IP TELEPHONY CAPABILITIES
We are currently deploying an Internet protocol ("IP") network overlay on
selected transatlantic and European routes. This network overlay enables us to
carry voice and data traffic using IP technology over portions of the Destia
Network. During 1999, we plan to expand our IP network overlay and explore new
IP-based service offerings for Destia customers. We will be able to offer
customers direct access to our network for both voice and data services using
cost-effective, off-the-shelf equipment located at the customer's premises. In
addition, this overlay will allow us to more efficiently use transmission
capacity. However, we have very limited experience with IP technology and many
of our competitors are making substantial IP investments. There can be no
assurance that we will be successful with IP technology.
PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES
To date, a substantial majority of our growth has been internally generated.
While we will continue to focus on internal growth, we also intend to pursue
selected acquisitions and strategic alliances and we continuously engage in
discussions with potential acquisition candidates. In particular, we will seek
to acquire or align ourselves 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 wireless or Internet services). We believe that our geographic
reach and management expertise create access to acquisition opportunities.
PRODUCTS AND SERVICES
We provide our customers with a variety of retail telecommunications
services, including international and domestic long distance, calling card and
prepaid services. Our retail customer base is diverse and
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includes residential customers, commercial customers and ethnic groups. In
addition, we also provide wholesale transmission services to carriers and other
wholesale customers. Our services are discussed below.
RETAIL SERVICES
The following table summarizes our principal retail services in our
principal geographic markets.
<TABLE>
<CAPTION>
RETAIL SERVICES
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTERNATIONAL LONG DOMESTIC LONG CALLING CARD PREPAID
DISTANCE DISTANCE SERVICES SERVICES
----------------------- ------------------- ----------------- -------------------
Continental Europe
Belgium.......................... X X X X
France........................... X 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..................... X
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, France and Switzerland, long distance service is accessed by using
either "1+" or "1xxxx" access. Our international and domestic long distance
service generally enables customers to call to any destination.
CALLING CARD SERVICES. Our calling card services are sold in all of our
principal markets and can be used in over 50 countries. In the United States, we
principally market our calling cards under the VoiceNet-TM- brand name.
In continental Europe, we believe that a substantial portion of our 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, our calling cards are sold to customers primarily for convenience
when traveling. As we complete interconnection in continental Europe and are
able to provide both international and domestic long distance service to our
customers on a cost-efficient basis, we intend to migrate our home- and
office-based calling card customers to our international and domestic long
distance service. Our calling card service will then be offered in continental
Europe as a premium travel service.
In Europe and North America, our calling card service is accessed by dialing
a national toll free number or a local access number. Calling card customers can
access our 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. We 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, we can offer customers competitive rates only on international long
distance calls.
We also intend to introduce an enhanced service, using our 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 us by an outside firm
specializing in enhanced services. We expect to have this service ready for our
customers by the third quarter of 1999.
PREPAID SERVICES. Our prepaid card service is a prepaid version of our
calling card, with similar features and the same manner of use as our calling
card. Our prepaid cards generally can be used from the
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United Kingdom, the United States, Belgium, Canada, Germany, France, Israel,
Greece, The Netherlands and Switzerland. We also sell prepaid cards that can be
used only from the country in which they are sold.
In 1998, we introduced our Telco Prepaid-TM- service to residential
customers in the United Kingdom. Telco Prepaid allows customers to access our
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,
our 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 our strategy, we seek to introduce services
that capitalize on the growing popularity of the Internet for everyday
commercial transactions. During the fourth quarter of 1998, we introduced
Presto! Card-TM- in the United States. During March 1999, we introduced presto
phone-TM- in the United Kingdom. Presto! Card and presto phone are our first
e-commerce services and the first services offered through what we intend to
develop as an Internet-based portal for telecommunications services. Presto!
Card and presto phone allow users to establish a virtual prepaid account that is
purchased and recharged exclusively over the Internet at www.prestocard.com and
www.prestophone.com, respectively. These services enable users to make
international and domestic long distance calls at competitive rates and to view
their call records on a real-time basis. We believe that Presto! Card and presto
phone are currently the only prepaid services that can be purchased and
recharged instantly over the Internet. We intend to offer these services in
Canada and our continental European markets and to develop additional e-commerce
services that take advantage of the growing use of the Internet.
We believe that e-commerce services offer us significant opportunities for
growth. In particular, we believe 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! Card and presto phone, like our other prepaid cards, do not require any
billing support and do not expose us to any credit risk. Also, e-commerce
services have lower associated sales and marketing and customer service costs.
We believe that e-commerce may, over time, become an important distribution
channel for certain other services.
INTERNET SERVICES. In February 1999 we began offering Internet access to
retail customers in Switzerland, and we expect to offer Internet access to
retail customers in Belgium by the end of the third quarter of 1999. We believe
offering Internet access will increase usage of our services, provide us with
additional revenue and further enhance our ability to attract and retain
customers. We intend to offer Internet access during 1999 in selected additional
European countries in which we have 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 we have not provided before
which may present implementation risks.
OTHER RETAIL SERVICES. We also provide the other retail services described
below. These services currently represent a relatively small portion of our
revenues. We expect 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
our 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.
We intend to increase our sales and marketing efforts for this service.
- TOLL-FREE SERVICE. We provide domestic toll-free service (I.E., "800",
"888" or "877" service) to customers in the United States, the United
Kingdom, Belgium, Germany and Switzerland. We also provide international
toll-free services ("ITFS") for our customers in Europe.
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- DIRECTORY ASSISTANCE. In the United States, we provide nationwide
directory assistance service for our long distance customers 24 hours a
day.
- LONG DISTANCE WIRELESS SERVICE. We offer 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 in certain area codes, by
selecting Destia as their long distance provider. We intend 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, we sell 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 we sell transmission capacity to carrier customers where all or a
portion of the traffic is transmitted on our IRUs or fixed-cost leased lines
that have unused capacity, we can generate additional revenues without incurring
significant marginal costs. When we sell carrier customers transmission capacity
which we purchase from third-party vendors, providing these services allows us
to increase the amount of transmission capacity that we purchase overall. As a
result, we are able to obtain even greater volume discounts on our purchases of
transmission capacity from these third-party vendors and therefore generate
higher margins and/or offer better pricing on our retail services.
During 1997 and 1998, sales of transmission capacity to carrier customers
ranged from 9% to 30% of our consolidated revenues on a quarterly basis,
comprising 9% of our consolidated revenues for the fourth quarter of 1998.
During 1999, we intend to increase our carrier revenues, although our business
will continue to be predominantly focused on retail sales. In order to increase
our carrier revenues, we have increased our 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
serves. In addition to increasing carrier revenues, we also seek to diversify
our carrier customer base to include more higher margin continental European
traffic. See "Risk Factors--Importance of Carrier and Other Wholesale
Customers."
OTHER WHOLESALE SERVICES. We sell transmission capacity to third parties
that offer their own branded products and services such as private label calling
cards. We believe that many of these customers buy transmission from us not only
for our prices, but also for access to our software platform, which, among other
things, allows them to utilize our software technology to process calls made
with calling cards and prepaid cards and perform specialized billing functions.
In addition, we also sell transmission capacity to resellers who in turn sell
our long distance services to their customers. In 1999, we intend to grow the
reselling portion of our 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 Destia Network was comprised of:
- 14 operational carrier-grade Northern Telecom switches with seven in North
America and seven in Europe;
- ten POPs in North America and seven POPs in Europe, in addition to our
switch locations;
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- over 100 interconnections to LEC tandems and LEC end-offices in the United
States, which provide us with direct interconnections to LECs;
- 20 points of interconnection to PTTs in the United Kingdom and continental
Europe;
- a U.S. fiber optic transmission network backbone that we currently lease
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 our existing Qwest network. In addition,
the Frontier arrangement gives us attractive 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
- 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 our European
switches and between those switches and our switch in New York.
See the inside cover of this prospectus for a graphic depiction of the
Destia Network. We intend to continue to make significant investments in network
infrastructure, particularly investments that will provide us with long-term
access to high-bandwidth capacity in European markets where we are seeking to
expand our customer base. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
NETWORK ECONOMICS
The major components of our costs include the cost of origination,
transmission and termination. To the extent we can manage these costs
appropriately we believe that we can significantly improve our gross margins.
ORIGINATION AND TERMINATION. In general, we pay a per minute fee to
originate and terminate calls. In the United States, we can reduce these costs
by having direct interconnection to LECs through LEC tandems and end-offices,
which allows us to carry a larger portion of each call on our network. In
Europe, we can reduce these costs through implementing direct interconnection
with the local PTTs. In addition, by having these interconnections, we are able
to provide network access through abbreviated dialing and to originate calls on
our 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, our transmission capacity consists
primarily of:
- IRUs, which are long-term capital leases of fiber optic cable for periods
typically of up to 20 or 25 years (which is usually 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. Our leased lines generally are
leased for 12 to 36 months; and
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- 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 our transmission costs, we utilize a mix of
IRUs, leased lines and switched minutes. We typically seek 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, we have instead utilized leased lines
and intend to obtain IRUs when we believe prices for IRUs have sufficiently
declined. Leased lines also permit us to operate on a fixed-cost basis for
certain routes where we have 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 our incremental
transmission costs and thereby enables us to offer services on a competitive
basis and/or increase our gross margins. Once we have generated enough traffic
to cover the costs of IRUs and leased lines, there is no significant marginal
cost to us for carrying additional calls over these IRUs and leased lines. In
order to further increase the capacity of our IRUs, we in some cases utilize
carrier grade compression or multiplexing equipment.
As part of our expansion strategy, and as a result of increasingly
attractive pricing, we intend to acquire additional IRUs, including in
continental Europe. Although our IRUs are currently operated and maintained by
third parties, we have the right to transmit our telecommunications traffic
through the fiber. To the extent cost efficient, we 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 operational costs and risks and, in some countries,
additional regulatory compliance requirements. See "Risk Factors--Dependence on
Transmission Line Providers."
In addition, we can further reduce our transmission costs for traffic on our
network by increasing the amount of traffic routed by our switches. Because our
switches are programmed to route traffic over the lowest cost network service,
depending upon cost and bandwidth availability, traffic routed by our switches
can be delivered on a "least cost" basis.
OTHER. In addition to the cost of origination, transmission and
termination, the other costs of our network relate primarily to switching
equipment, compression equipment, our Internet protocol overlay and
facility/network management and related software.
NETWORK OPERATIONS
NETWORK OPERATIONS CENTER. During the fourth quarter of 1998, we
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, we monitor our
operations in the United Kingdom, continental Europe and North America.
Performing these tasks from a centralized location enables us to monitor the
network more effectively and on a more cost-efficient basis. In addition, we
also have the capability to monitor our European network from our network
operations center in London.
During 1998, we began rolling out our St. Louis network operations center
and developing and enhancing our network control systems. We expect 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 we are undertaking is the
installation of digital cross-connect systems ("DACs") equipment at each of our
switch locations, which will enable us to monitor, test and re-configure network
facilities from a central location to maintain transmission quality on our
network.
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INTEGRATED INFORMATION SYSTEMS. The development and integration of the
information systems that interface with the Destia Network are performed at our
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 our U.S. services. Service One will afford greater
flexibility as we increase service offerings and will accommodate greater
customer volume. In addition, we recently implemented 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, we spent approximately $2.3 million to enhance current, and
develop new, network information systems. We expect to invest approximately $2.4
million for these purposes during 1999. While we believe that our current
information systems are adequate for our near term growth, additional investment
will be required as we expand our operations. See "Risk Factors--Dependence on
Effective Information Systems."
SOPHISTICATED OPERATIONAL CONTROL SYSTEMS. Our systems development group
has internally developed sophisticated proprietary software and intranet systems
to better manage our business and appropriately price our services in each of
our markets on a real-time basis. For example, we have developed an interface
with our network switches that allows us to compile network information on a
real-time basis, including the number of minutes being routed through our switch
(and corresponding revenue), points of origination and termination, sources of
traffic (by area code, city and carrier) and other traffic information. We use
this information every day in connection with "least cost" routing, pricing,
cost and margin analysis, identifying market opportunities and developing of our
sales and marketing and network expansion strategies, among other things. We
believe that these analytical tools allow our management team to quickly
identify new market growth and cost saving opportunities as well as control our
business in an environment of rapid growth. We believe that we are one of the
few competitive telecommunications companies that have these types of analytical
tools and to have integrated them into our daily operations.
EUROPEAN NETWORK
We have seven switches and seven POPs in continental Europe and the United
Kingdom. The location of our European switches and the date of completed
interconnection of each are as follows:
<TABLE>
<CAPTION>
DATE OF DATE OF
CITY OPERATION INTERCONNECTION
- ----------------------------------------- --------------- ---------------
<S> <C> <C>
Brussels, Belgium........................ 1Q97 4Q98
Paris, France............................ 1Q97 2Q99
London, United Kingdom................... 2Q97 2Q97
Frankfurt, Germany....................... 3Q98 4Q98
Zurich, Switzerland...................... 3Q98 4Q98
Amsterdam, The Netherlands............... 4Q98 3Q99E
Berlin, Germany.......................... 4Q98 4Q98
</TABLE>
We also own IRUs on the PTAT-1, CANTAT-3, TAT 12/13 and AC-1 transatlantic
cables. As part of our expansion strategy, we intend 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
our 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 our transatlantic IRUs. We also
route a substantial portion of our international intra-European calls (E.G.,
Berlin to Paris) through our London hub to take advantage of favorable
transmission rates to and from London. These rates are often
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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. We believe that we are well positioned to take
advantage of these market developments due to our Frankfurt switch and intend to
market our carrier services to carriers that route calls through Frankfurt.
In addition to adding new switches in continental Europe during 1998, we
further enhanced the Destia Network in continental Europe by entering into and
implementing direct interconnection agreements with the PTTs in Belgium, Germany
and Switzerland. We are currently in the final stage of testing our
interconnection with the PTT in France, and we expect to implement
interconnection with the PTT in The Netherlands during the third quarter of
1999. These agreements add to the interconnection that we have had in place with
British Telecom in the United Kingdom since the second quarter of 1997. Our
interconnection arrangements provide us with a direct connection to the PSTN. By
having a direct connection to the PSTN, we are 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, we intend to upgrade our POPs in Hamburg, Germany and
Vienna, Austria to switches and install POPs in Dublin, Ireland and Milan,
Italy.
NORTH AMERICAN NETWORK
We have seven switches and ten POPs in the United States and Canada. Our
North American switches, which are all interconnected and operational, are
located in the following cities:
<TABLE>
<CAPTION>
DATE OF
CITY 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, we substantially expanded our U.S. network
infrastructure by adding switches in Chicago, Dallas, Los Angeles, Miami and
Washington, D.C. We also added a number of POPs connecting various cities to our
network. All of the foregoing reduce our transmission costs.
During 1999, we intend to upgrade our POP in Atlanta, Georgia to a switch.
In addition, during 1999, we intend to add additional connections to LEC tandem
switches and LEC end-offices.
We currently obtain most of our U.S. fiber optic transmission capacity from
Qwest. Because of the substantial increase in our domestic traffic and our
desire to provide services in more U.S. markets, we recently acquired a 20-year
IRU from Frontier to 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 our Qwest network. In addition, the Frontier
arrangement also gives us favorable origination and termination rates in the
continental United States. This will provide us with the cost benefits of having
additional network access and drop-off points in areas where we have not
invested in our own switches or POPs. We believe that the extensive reach of the
Destia Network in the United States following the addition of transmission
capacity from Frontier will provide us with a significant cost advantage over
many
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of our 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 we will
use, and we expect this network to be completed and substantially operational by
the end of 1999. We expect to begin using a portion of Frontier's network by
July 1999.
GATEWAY SWITCH UPGRADES. Gateway switches permit us to convert
international protocols to U.S-based protocols. This ability to convert
protocols enables us 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. We currently have gateway switches
in New York and London. During 1999 and early 2000, we intend to upgrade our
switches in Miami and Los Angeles to have international gateway capabilities,
which will allow them to 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, we expanded the
Destia Network to Canada by installing a switch in Toronto. We plan to install a
POP in Montreal by the fourth quarter of 1999. This switch and POP will enable
us 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 our 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 our
company as its long distance carrier and the LEC's or PTT's 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 our 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 we have
installed a switch or POP, customers can access our international and
domestic long distance service and, in some cases, prepaid card service,
by dialing a local telephone number. Local dial-up access reduces our
transmission costs for these calls because it shifts the cost of accessing
our switch to the customer. The reduction in transmission costs enables us
to increase our margins and/or reduce our 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 our 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 our services in this
manner do so by dialing a national toll-free number. This access method is
available to customers who use our 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 our switch by a dedicated leased line. The advantages to the
customer of dedicated access are simplified dialing,
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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
our 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 our 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 our switches on an owned or leased line
comprising part of the Destia Network. If the call originates in a city where we
do 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 us than "1xxx," "1+" or local dial-up access. From our
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 our
switches over an owned or leased line and then transferred to the PSTN for
termination. See "--Network Hardware and Software--Least Cost Routing."
NETWORK HARDWARE AND SOFTWARE
CARRIER GRADE SWITCHES AND TECHNOLOGY. We 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. Our 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 our 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.
We believe that by utilizing the equipment of a single principal supplier we
are able to minimize the difficulties associated with integrating equipment from
various sources and with differing specifications. In addition, it also enables
us to develop a single proprietary software to compile our network information
since we do not need to accommodate switches of different manufacturers.
However, using equipment principally from one supplier does entail certain
risks. See "Risk Factors--Dependence on Our 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.
We are currently migrating from SS7 services provided by third parties on a
per switch basis to using our own SS7 equipment throughout our U.S. network. We
will then use one centralized provider to enable us to make SS7 connections with
LEC offices nationwide. This will provide us with greater flexibility and will
enable us to control equipment usage, maintain network integrity and reduce
costs.
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Our 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, our
network enables us to perform "least cost" routing analysis, which enables us to
transmit a call over the most cost-efficient route during that time of day.
Prices for various destinations fluctuate on a daily basis. Our least cost
routing software enables us to continually revise our routing tables, including
accounting for fluctuations in currency exchange rates, as the cost of certain
routes change. We have a dedicated group that is responsible for monitoring the
routing of calls and seeking to minimize our transmission costs.
DIGITAL CROSS-CONNECT CAPABILITY. We are in the process of installing DACs
hardware and software at each of our switches and major POPs. DACs will enable
us to monitor, test and re-configure network facilities from a central location
to maintain transmission quality on our 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. Our carrier grade
switches are capable of interfacing with TCP/IP, an Internet protocol software,
and the related hardware. TCP/IP technology would enable us 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 us to transmit data and video using less
transmission capacity, thus increasing the amount of information we can transmit
over a given line and our network overall.
We have installed TCP/IP hardware and software manufactured by third parties
on selected transatlantic and European routes, which enable us to carry traffic
using Internet protocol technology over a portion of the Destia Network. We are
currently exploring various potential service applications. For example,
packet-based transmission would allow us to offer integrated voice, fax and
video services as well as Internet access over an ordinary telephone line.
However, we have very limited experience with IP technology and many of our
competitors are making substantial IP investments. There can be no assurance
that we will be successful with IP technology.
OPERATING AGREEMENTS; TRANSIT AGREEMENTS
Through our affiliates, we have entered into operating, termination and/or
transit agreements with a number of overseas PTTs and competitive carriers,
including carriers in Denmark, Greece, Ireland, Israel, Italy, Poland, Romania,
Russia, Slovenia, Sweden and the Ukraine. As part of our strategy, and as market
and regulatory conditions warrant, we intend to enter into more of these
agreements with additional overseas carriers.
Operating and termination agreements provide us with more favorable
termination rates in the home country of the other carrier who is a party to the
agreement. We can directly interconnect with the local carrier who then locally
terminates all calls. These agreements also afford us more control over the
quality of the terminating segment of our international calls. In addition,
operating agreements also increase our overall gross margins because our
correspondent carriers are required to send us a specified portion of their
traffic that is bound for markets covered by the Destia Network. We can charge
"settlement rates" for this traffic that substantially exceed our termination
costs. We note, however, that the international settlement regime is collapsing.
See "Risk Factors--Increasing Price Pressure--Collapse of the International
Settlement Regime." Alternatively, the additional gross margins on this return
traffic enable us to price our 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 us because
they provide us with more favorable transit rates to third countries. Such
agreements and switched hubbing arrangements may allow us to pay less than the
full settlement rate we would otherwise have to pay if we 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
We reach 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
our multichannel marketing approach, we tailor our marketing to our specific
geographic markets and services. We believe this is an especially cost-effective
means of marketing to our target customers. In addition, we expect that our
multichannel marketing approach will facilitate our continued rapid growth while
reducing the risks associated with dependence on a limited number of
distribution channels.
We market our 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. Our independent sales representatives, who
generally are retained on a commission-only basis, concentrate primarily on
residential sales and sales to commercial accounts. Our 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. Our local internal sales forces also typically advertise locally and
provide support for our independent sales representatives.
We recently changed our name to "Destia Communications, Inc." and also
developed a new company logo. We believe that our new name and logo better
emphasize our focus on providing innovative services. We also believe that by
establishing a widely recognized brand, we can increase brand awareness among
our target customers and facilitate cross-marketing of additional services to
our existing customers. After completing the transition to the Destia name,
which will occur after the offering, nearly all of our primary services in all
our geographic markets will be either branded or co-branded with the Destia name
and logo.
CONTINENTAL EUROPE
Our sales and marketing strategy in most of our 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 our local
sales and marketing infrastructure, we typically have then introduced calling
card services and, once a POP or switch is installed, international long
distance services. Concurrently, we also have aggressively pursued
interconnection arrangements with the local PTTs, which allow us to provide
national origination on a cost-effective basis. Following interconnection, we
further increase our sales and marketing activities in a market in order to
promote our services. As part of our initial entry into a new market, we also
typically have concentrated on sales in ethnic communities since these market
segments can be effectively targeted with limited resources, enabling us to
rapidly generate revenues, create brand awareness and promote customer loyalty.
While our general sales and marketing strategy in continental Europe remains
consistent, we also tailor it to meet the needs of each particular market. For
example, in Belgium, we have generated significant revenues by placing our
prepaid cards (together with point of purchase displays) in many highly visible
locations such as bookstores, newsstands, kiosks and convenience stores. In
France, we concentrate
on commercial accounts and employ an internal sales force for this purpose. In
Germany, we have an internal sales force in Hamburg that primarily markets
prepaid cards and commercial long distance services. We also began marketing our
"1+" long distance services in Germany during the first quarter of 1999 through
a multilevel marketing program that is similar to our U.K. program. In
Switzerland, we market our services through indirect channels, supported by
direct advertising in national media. We also cross-market our services in
Switzerland. For example, we 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 our long distance services.
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We also adapt successful marketing approaches from certain countries to
other continental European markets. For example, we intend to advertise in
national magazines and newspapers in Germany, which has been effective in
Switzerland. In addition, we intend to replicate the success of our multilevel
marketing program in the United Kingdom in other European markets.
We have an internal sales force based in each city in which we have a switch
except Amsterdam. In each of these cities, we are expanding our internal sales
forces and recruiting additional independent sales representatives.
UNITED KINGDOM
In the United Kingdom, we market our services nationally. We offer all of
our U.K. services through Telco, our wholly-owned U.K. subsidiary.
Our residential domestic and international long distance service and calling
and prepaid cards are marketed primarily by independent sales representatives
through multilevel marketing. We believe that multilevel marketing is the most
cost-effective way to continue to increase our 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, we had approximately 4,000 independent sales
representatives that received commissions. In addition, we are one of only 150
companies, and the first telecommunications company, to be accepted for full
membership in the Direct Sellers Association, a nationally recognized U.K.
industry trade group for multilevel marketing.
We market domestic and international long distance services to U.K.
commercial accounts and carrier services to carrier customers through a direct
sales force. We have adopted this approach for these services since they are
more complex and usually require a longer sales cycle. We market and distribute
our presto phone virtual prepaid service, which is currently available only to
our long distance customers, directly to customers over the Internet.
We also increased our U.K. prepaid card distribution capabilities through
our acquisition of a controlling interest in America First, a well-recognized
prepaid card distributor, during the fourth quarter of 1998. We intend to
migrate our U.K. prepaid card distribution to America First because we believe
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, we marketed our services primarily in the New
York metropolitan area. During 1998, we significantly expanded our marketing
efforts beyond the New York metropolitan area to include other U.S. network
cities. We now have independent sales representatives in all of our network
cities and have internal sales representatives in New York, Los Angeles, Miami
and Washington, D.C.
Our international and domestic residential long distance services, which are
marketed primarily to ethnic communities, are sold primarily through independent
sales representatives. We target ethnic communities for these services because
we believe that members of these communities generate above average
international calling volumes, are not as heavily targeted by other long
distance providers as the general population and enable us to build brand
recognition in a well-defined community. We intend to expand the use of
independent sales representatives to market our residential services in the
United States beyond the ethnic market.
Our international and domestic long distance services for commercial
accounts are sold primarily through our 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
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of our 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.
Our 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. We also market VoiceNet calling cards through independent sales
representatives. EconoCard calling cards are marketed to ethnic groups in
conjunction with our 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 our costs and permits us to offer lower rates than most
of our 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.
We currently are in the process of implementing a cross-marketing program to
VoiceNet customers to offer them our "1+" long distance service in the United
States. We also have expanded our 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,
we have entered into affinity programs with major credit card companies, such as
First USA and GE Capital, to promote our 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.
We market and distribute our Presto! Card virtual prepaid service to
customers over the Internet and through an affinity program with the New Jersey
Devils professional hockey team.
We use an internal sales force to market to carrier customers and other
wholesale customers that purchase privately branded calling cards and prepaid
cards. We have adopted this sales approach for these services since they are
more complex and usually require a longer sales cycle.
CANADA. In Canada, we currently market our 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 our internal sales representatives in Canada. As we expand
our customer base in Toronto and Montreal, we intend to broaden our target
customer groups, introduce additional services and increase our internal sales
and marketing capabilities.
CUSTOMER SERVICE
We are committed to providing our customers with superior customer service
and believe that we have developed the infrastructure necessary to serve both
our existing customer base and accommodate substantial growth with minimal
additional investment. We have 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, we
also maintain 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 facility in London, England. In continental Europe, each country in
the Destia Network has a customer call center, which in the aggregate totalled
20 full-time equivalent customer service representatives at December 31, 1998.
At all of our customer service facilities, our customer service representatives
handle both service and billing inquiries. In addition, our call centers all
have representatives that are multilingual.
We also have developed our own proprietary software systems to better serve
our customers. For example, in each of our network countries, our monthly bills
are in the customer's native language and local currency (and we have the
ability to bill in euros). We also provide detailed billing information for
commercial customers that includes itemized breakdowns of usage by account code
and department. In addition, we have implemented an interactive voice response
system that will permit customers to obtain
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up-to-date information concerning their account and their most recent invoice.
We believe that our customer-oriented philosophy backed by the strength of our
customer support infrastructure allows us to differentiate ourselves from our
competitors.
COMPANY OPERATIONS
Currently, our extensive international telecommunications network allows us
to provide services in many of the largest metropolitan markets in the United
States, Canada, the United Kingdom, Belgium, France, Germany and Switzerland.
Our operations in each of our principal markets are briefly described below.
CONTINENTAL EUROPE
A significant component of our growth strategy is focused on the continued
development of our business in the deregulating telecommunications markets of
continental Europe. Prior to January 1, 1998, there were significant regulatory
limitations on our ability to provide services in most continental European
countries. Now, as a result of EU and national regulatory initiatives, we may
provide a range of services in many of these countries that is comparable to the
services we 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 our ability to do so.
Subject only to these limitations, in continental Europe we intend to offer the
same range of services that we offer in the United States and the United
Kingdom.
BELGIUM. Belgium was our third largest market based on revenues for 1998.
Sales of prepaid cards comprised the largest portion of our Belgian revenues,
followed by revenues derived from international long distance from commercial
and residential customers.
Prior to January 1, 1998, due to regulatory limitations, we only were 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, we have expanded our services to
include both domestic and international long distance service. In addition,
during the fourth quarter of 1998, we completed our interconnection with
Belgacom, the Belgian PTT. This interconnection provides us with a total of 10
connection points with Belgacom, including our switch in Brussels, and permits
us to provide our services to customers anywhere in Belgium. This
interconnection also permits us to provide network access to our customers
through abbreviated dialing and enables us to originate and terminate calls in
Belgium on a more cost effective basis.
FRANCE. We have offered international 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. We
began offering domestic long distance services in selected markets in France in
April 1999. Our 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 our customers have CLI (calling line
identity), which allows our switches to recognize the number that the customer
is calling from, so that the customer can access our network without the need
for a personal identification number. In addition, we provide automatic dialers
free of charge to our commercial accounts. Automatic dialers eliminate the need
for a customer to dial a prefix to use our services.
Our network includes a switch in Paris and POPs in Marseilles, Toulouse,
Nice and Lyon. During the fourth quarter of 1998, we entered into an
interconnection agreement with France Telecom that will enable our customers to
access our long distance service from their home or office through abbreviated
dialing, although certain carriers (including France Telecom) are able to
provide direct, "1xxx" access. We are currently in the final stage of testing
our interconnection with France Telecom. However, there may still be delays in
completing our interconnection. See "Risk Factors--Need for Interconnection" and
"-- Regulation."
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GERMANY. Germany is the largest market for telecommunications services in
continental Europe. Our current principal service in Germany is our prepaid card
service, which we offer predominantly to commercial accounts. We currently
provide international long distance service, which we market primarily to
commercial customers. We have 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. We began marketing domestic long distance
services in the third quarter of 1998 because we completed interconnection in
the fourth quarter 1998. We also began marketing long distance services to
residential accounts. We intend to introduce our Presto! Card in Germany during
the second quarter of 1999. In addition, in 1999, we intend to roll out our
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, we had switches in Berlin and Frankfurt and a POP
in Hamburg. We expect to upgrade our Hamburg POP to a switch during the third
quarter of 1999. We believe that our Frankfurt switch will allow us 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
we intend to market our carrier services to carriers that route calls through
Frankfurt.
During the fourth quarter of 1998, we implemented our interconnection with
Deutsche Telekom, which enables us to offer customers in our German network
cities and the surrounding metropolitan areas, both domestic and international
long distance service through "1+" access. Our interconnection agreement in
Germany granting us access to Deutsche Telekom's network expired at the end of
February 1999, although we have initiated legal action to maintain continued
interconnection with Deutsche Telekom's network. In the interim, we are
currently still interconnected to Deutsche Telekom's network. If Deutsche
Telekom were permitted to restrict our interconnection, our transmission costs
in Germany would increase and the services we could offer might be limited. We
expect to be able to maintain our interconnection to Deutsche Telekom's network
although there can be no assurance that this will be the case. See "Risk
Factors--Need for Interconnection--Considerations Affecting Interconnection in
Europe." We plan to add additional interconnection points in Germany in 1999 to
meet additional traffic or regulatory requirements, which will enable us to
originate and terminate traffic in most of the major cities in Germany. See
"Risk Factors--Competition."
SWITZERLAND. Switzerland has been substantially deregulated. Our principal
service in Switzerland is international long distance. Customers may preselect
our company as their long distance carrier and make long distance calls on our
network using "1+" dialing. During 1998, the majority of our customers were
commercial accounts. In February 1999, we began providing Internet services in
Switzerland and introduced a promotional program that offers one year of free
Internet access to customers who purchase our long distance services.
We 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,
we were one of the first telecommunications carriers to be interconnected to
SwissCom, the PTT in Switzerland. This interconnection enables us to originate
and terminate traffic in Switzerland more cost effectively, which provides us
with a competitive advantage over those of our competitors who do not currently
have interconnection. Since we completed our interconnection in October 1998,
our number of customers has more than quadrupled and as of April 1, 1999 we had
approximately 20,000 customer accounts in Switzerland. During the same period,
our Swiss revenues also more than doubled. We intend to expand our customer base
significantly in Switzerland during 1999. We anticipate, 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.
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International and domestic long distance services generated the largest
percentage of our U.K. revenues during 1998. We have 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. Our other principal services in the
United Kingdom are prepaid cards and sales to resellers and carrier customers.
In March 1999, we launched the presto phone virtual prepaid service.
We offer all our residential, calling card and prepaid services in the
United Kingdom primarily through Telco. We believe that Telco has been
particularly successful marketing our services in the United Kingdom through its
multilevel marketing program. Our prepaid card services, which are currently
offered by Telco, are being migrated to America First, a prepaid card
distributor that we acquired a majority interest in during the fourth quarter of
1998. See "--Sales and Marketing--United Kingdom."
We currently have five interconnection points in London that enable us to
provide our services throughout the United Kingdom. However, our U.K. customers
currently are unable to preselect any carrier except British Telecom as their
long distance carrier and thus cannot access our 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 our network, we are marketing automatic dialers to our 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 our network access code for the customer.
Our European network (including the United Kingdom) is monitored by DNS, one
of our wholly-owned subsidiaries, in London and by Destia through our network
operations center in St. Louis, Missouri.
NORTH AMERICA
UNITED STATES. The United States is one of our original markets. We have
been providing international and domestic long distance service in the New York
metropolitan area since 1993. We now also provide our calling card, prepaid
card, wireless access to long distance and directory assistance services
nationally and provide our other services (primarily residential and commercial
long distance) in the 16 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, we
typically introduce new services in the United States before our other markets.
For example, during the last quarter of 1998, we first introduced our Presto!
Card virtual prepaid service in the United States over the Internet. We also
intend to test (and cross market) additional e-commerce services to Presto! Card
customers due to their predisposition to making purchases on-line.
As of March 31, 1999, we had six switches and ten POPs in the United States,
which enable us to originate domestic and international long distance calls in
many of the largest U.S. metropolitan areas. Because of the substantial increase
in our domestic traffic and our desire to provide services in more U.S. markets,
we recently acquired a 20-year IRU from Frontier to use portions of its U.S.
fiber optic network. This will replace our use of the Qwest network. Frontier is
in the process of building its fiber optic network that we will use, and we
expect this network to be completed and substantially operational by the end of
1999. We expect 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 us favorable origination and termination rates throughout
the continental United States. See "--The Destia Network--North American
Network--U.S. Network Expansion."
CANADA. We expanded our network into Canada during the third quarter of
1998 by installing a switch in Toronto. We also plan to install a POP in
Montreal by the fourth quarter of 1999. This switch and POP will enable us to
originate and terminate calls in Toronto and Montreal, two of the largest long
distance markets in Canada. Like most of western Europe, Canada also has
recently liberalized its telecommunication laws. Since October 1, 1998, private
carriers have been able to provide international long distance service
originating in Canada. We began providing services in Canada late in the fourth
quarter of 1998 and intend to further expand our internal sales force in Canada
in 1999.
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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. We believe 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, we have numerous competitors. We believe 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 we compete have declined
historically and are likely to continue to decrease. Many of our competitors are
significantly larger, have substantially greater financial, technical and
marketing resources and larger networks than us.
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, RBOCs will be allowed to
enter the long distance market, AT&T, MCI WorldCom and other long distance
carriers can now enter the local telephone service markets, and cable television
companies and utilities can now 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. We compete 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 our current costs. Many of these competitors have
greater financial, technological and marketing resources than we do. If any of
our competitors were to devote additional resources to the provision of
international and/or domestic long distance telecommunications services to our
target customer base, there could be a material adverse effect on our business
and the price of our common stock.
As a result of the 1996 Telecommunications Act, the RBOCs can compete with
us 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. On April 13, 1999, Bell Atlantic filed its application with the New
York PSC. Because a substantial portion of our 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.
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Access fees constitute a large portion of a long distance carrier's cost of
services, including ours. Moreover, should Bell Atlantic's proposed acquisition
of GTE be consummated, Bell Atlantic will have even greater resources to compete
in its service markets.
The continuing trend toward business combinations and alliances in the
telecommunications is also creating significant new or more powerful competitors
to our company. The proposed acquisition of Frontier (the primary provider of
our U.S. transmission capacity beginning later in 1999) by Global Crossing and
of GTE by Bell Atlantic, the proposed acquisition of Ameritech by SBC, the
merger of WorldCom and MCI, AT&T's acquisitions of Telecommunications, Inc. and
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. Many of these combined entities have, or will have,
resources far greater than those of our company. 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 has already resulted 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 our
business.
We also expect 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 FCC regulation as telecommunications
services. Accordingly, Internet service providers are, today, not subject to
universal service contributions, access charge requirements, or traditional
common carrier regulation. On April 5, 1999, US West filed a petition with the
FCC asking the FCC to find that Internet telephony services are
telecommunications services, not enhanced services or information services, and
therefore should be subject to access charge and universal service obligations.
We cannot predict how the FCC will rule on US West's petition. Should the FCC
rule adversely to U.S. West, however, we cannot predict the impact that this
continuing lack of regulation will have on our 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 our
company. We compete 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, 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.
We also compete 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.
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EUROPE
In continental Europe, our 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 (the members of which have 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 us,
including emerging public telephone operators who are constructing their
own networks and wireless network operators.
We believe that our 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, we anticipate 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 our principal competitors are British Telecom, the U.K.'s
PTT, First Telecom and Cable & Wireless. We also face competition from emerging
licensed public telephone operators (who are constructing their own
facilities-based networks) and from resellers. We also compete 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. We do not
expect to qualify for such a discount until we purchase more fiber optic
transmission capacity in Europe (particularly in France and Belgium). In
addition, certain of our competitors offer customers an integrated full service
telecommunications package consisting of local and long distance voice, data and
Internet transmission. We do not currently offer all of these types of service,
which could have a material adverse effect on our competitiveness and the price
of our common stock.
See "Risk Factors--Competition" and "Risk Factors--Increasing Pricing
Pressures."
REGULATION
Regulation of the telecommunications industry is changing rapidly both
domestically and globally. As an international telecommunications company, we
are subject to varying degrees of regulation in each of the jurisdictions in
which we provide our services. Laws and regulations, and the interpretation of
such laws and regulations, differ significantly among the jurisdictions in which
we operate. There can be no assurance that future regulatory, judicial and
legislative changes will not have a material adverse effect on our company or
that domestic or international regulators or third parties will not raise
material issues with regard to our compliance or noncompliance with applicable
regulations.
The regulatory framework in certain jurisdictions in which we provide our
services is described below:
UNITED STATES
In the United States, our 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
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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. We cannot be certain whether future
regulatory, judicial and legislative changes in the United States will
materially affect our business and the price of our common stock.
The FCC currently regulates our 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 our company, to change our regulatory classification, to impose
monetary forfeiture, and to revoke our authority. In this increasingly
deregulated environment, however, we believe that the FCC is unlikely to do so.
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 our company. In a recently
released order, the FCC announced it will forebear from reviewing PRO FORMA
assignments and transfers of control of international Section 214
authorizations. Instead, only post-consummation notifications will be required
and then only in the case of PRO FORMA assignments, not PRO FORMA transfers of
control. The rules implementing these determinations are not, however, yet in
effect. Although we believe that no material penalties would result from our
failure to notify the FCC and certain PSCs of a change of control or from our
failure to seek prior approval or take certain actions where required, we cannot
be certain whether this will be the case.
FCC INTERNATIONAL. In addition to the general requirement that we obtain
authority under Section 214 of the Communications Act and file a tariff
containing the rates, terms and conditions applicable to our international
services, we also are subject to the FCC's international service policies,
certain of which may affect our ability to provide our 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 will allow ISR between the U.S. and a WTO member country
for which it has not previously authorized such service 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 FCC has authorized ISR to the following countries: 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 us of this policy is that we are
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 our leased lines between New York and London
and may result in increased transmission costs on certain calls, which we are
not able to pass through to our customers. We note, however, that on March 23,
1999, the FCC released an order simplifying the procedures for obtaining
authorization to provide ISR to previously unauthorized countries. Specifically,
the rules, which are not yet effective, will reduce both the amount of
information required of a carrier seeking authority to provide ISR to a
particular country and the FCC's decision making time. Additionally, the FCC is
expected to in the near future adopt rules removing competitive routes from the
ISR. While this should afford us additional flexibility, it may also increase
our competition on these routes.
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We are also subject to the FCC's International Settlements Policy ("ISP")
which governs the exchange of traffic and 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 our
foreign carrier agreements or our 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 take other action against a carrier violating
the ISP, including issuing a cease and desist order or imposing fines. If the
FCC were to impose such fines or other penalties on our company, we do not
believe that it would have a material adverse effect on our business or the
price of our common stock.
FCC DOMESTIC INTERSTATE. We are considered a non-dominant domestic
interstate carrier subject to minimal regulation by the FCC. We are not required
to obtain FCC authority to expand our domestic interstate operations, but we are
required to maintain, and do 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 our 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
us to revise our tariffs, or the FCC could prescribe revised tariffs.
In late 1996, the FCC ruled that interexchange carriers are no longer
required to file their tariffs for domestic interstate interexchange services.
In August 1997, the FCC affirmed its decision to end tariff filing requirements
for domestic interstate long distance services provided by non-dominant
carriers. The FCC also eliminated the requirement that non-dominant long
distance carriers disclose information on rates and terms of their products.
These detariffing orders have been stayed by the U.S. Court of Appeals for the
District of Columbia. Most recently, on March 18, 1999, the FCC adopted an order
that would permit the alternative of posting rates on a carrier's web site. This
order will not become effective until the Court affirms the FCC's mandatory
detariffing scheme.
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 our customer base
and traffic originates in the New York metropolitan area, Bell Atlantic would be
a particularly formidable competitor. We expect that Bell Atlantic will have a
cost advantage over our company because it will not need to pay access charges,
which constitute a substantial portion of our cost of services. See "Risk
Factors--Competition."
The 1996 Telecommunications Act also addresses a wide range of other
telecommunications issues that may potentially impact our operations. It is
unknown at this time precisely the nature and extent of the impact that the
legislation will have on us. On August 1, 1996, the FCC adopted an
Interconnection Order
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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).
On March 31, 1999, the FCC released its Collocation Order. The Collocation
Order strengthened collocation requirements applicable to incumbent local
exchange carriers ("ILECs") requiring ILECs to permit CLECs to collocate any
equipment used for interconnection or access to unbundled network elements even
if that equipment includes switching or enhanced service functions.
The FCC has also significantly revised the universal service subsidy regime.
Beginning January 1, 1998, interstate carriers, such as our 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. Our share of these
federal subsidy funds will be based on our revenues. Our revenues that are
subject to the high cost and low income fund are our interstate and
international gross end-user telecommunications revenues. Our revenues for the
schools and libraries and rural health care fund are our intrastate, interstate
and international gross end-user telecommunications revenues. Contribution
factors vary quarterly and we 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 our competitive position. Contribution factors for
second quarter 1999 are: (i) 3.05% for the high cost, insular 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 factors do vary quarterly, the annual impact
on our company cannot be estimated at this time, although we do not expect it to
be material.
Our 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 ILECs greater pricing
flexibility and relaxed
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regulation of new switched access services in those markets where there are
other providers of access services. 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 are scheduled to increase in July 1999 and then
yearly thereafter until they reach certain caps.
While we currently intend to pass through the costs of both the PICC and our
universal service fund contributions to our customers, there can be no assurance
that we will be able to or that doing so will not result in a loss of customers.
Additionally, we currently have 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 our company's costs or
could disrupt our company's ability to terminate, originate or exchange traffic
and, therefore, have a material adverse effect on our company.
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. Most recently, the FCC issued an order that clearly
established the definition of a "primary line." The FCC defines a primary
residential line to be "one residential line provided by a price cap LEC per
service location." The FCC retained its price cap rule definition of a single
line business subscriber line as a line for which the subscriber pays a rate
that is not described as a residential rate in the local exchange service tariff
and does not obtain more than one such line from a particular telephone company.
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. As a result of many
factors, including a complex and shifting regulatory scheme, many long distance
carriers have been the subject of compensation claims by payphone service
providers. Several lawsuits have been filed against the Company by payphone
service providers alleging that the Company owes such payphone service providers
compensation for completed access code and toll free calls that had been carried
over the Company's network during the 12 months prior to any claim being made.
The Company has paid all payphone compensation that it believes is due under the
most recent payphone compensation scheme and believes that the aggregate
liability to the Company of all such claims, if concluded in a manner adverse to
the Company, would not have a material adverse effect on the Company. However,
there can be no assurance that the Company will prevail in these lawsuits.
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." Under an order recently issued by the
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FCC, carriers such as our company are required to take certain additional steps
to prevent slamming. The FCC is continuing to reexamine its slamming rules.
STATES. Our 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 us. We in turn transferred the authorizations
to our wholly-owned subsidiary, Econophone Services, Inc., which recently
changed its name to Destia Communications Services, Inc. We are in the process
of notifying the various state PSCs and, where necessary, seeking approval in
connection with the name change. We cannot be certain that we will obtain all
necessary regulatory approvals in connection with the name change.
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. We may also be
required to contribute to universal service funds in some states. States
generally retain the right to sanction a carrier or to condition, modify,
cancel, terminate or revoke authorization to provide telecommunications services
within the state for failure to comply with state law and/or rules, regulations
and policies of the state regulatory authorities.
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 that
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. On April 5, 1999, US West filed a petition with the
FCC asking the FCC to find that IP telephony services are telecommunications
services, not enhanced services or information services, and therefore should be
subject to access charge and universal service obligations. We cannot predict
how the FCC will rule on US West's petition. 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. We do not
expect that our prepaid card services will be found to infringe upon any
third-party patent rights, although there can be no assurance that we would
prevail if a claim were asserted by a third party. If we were unable to provide
our prepaid card services in the manner in which they currently are provided, it
could have a material adverse effect on our business and the price of our common
stock.
EUROPEAN UNION
In Europe, the regulation of the telecommunications industry is governed at
a supra-national level by legislation passed by the European Commission, the
Council and the Parliament of the European Union ("EU"), (formerly the European
Communities), consisting of the EU member states: Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands,
Portugal, Spain, Sweden and the United Kingdom. The EU has adopted pan-European
policies through legislation and developed a regulatory framework to ensure an
open and competitive telecommunications market.
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As of January 1, 1998 the EU required all special or exclusive rights that
restrict the provision of telecommunications services to be abolished. Specific
directives have been adopted, which include the Open Network Provision ("ONP")
Framework Directive, the Leased Lines Directive, the Revised Voice Telephony
Directive, the ONP Adaptation of Full Competition Amending Directive and the
Interconnection Directive, the latter of which has been amended to provide for
carrier preselection and number portability on or before January 1, 2000.
Carrier preselection would enable a customer to access our network over the
fixed public telephone network of operators with significant market power
without dialing an access code, by "preselecting" our company as its long
distance carrier. However, Oftel, the U.K. regulatory authority, already has
indicated that it will seek to defer the implementation of carrier preselection
in the United Kingdom. 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. Some EU member
states have been granted temporary waivers from implementing certain EU
liberalization requirements and have only fully liberalized recently. Ireland
and Portugal have derogations until January 1, 2000 and Greece until January 1,
2001.
National governments must pass legislation within their countries to give
effect to EU directives. Each EU member state in which we currently conduct
business has implemented the EU directives differently and we will therefore
continue to operate under different national regulatory regimes. The
requirements for us to obtain necessary approvals vary between member states 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 us or broaden the permissible
services that we can provide in certain markets, the WTO Agreement also may
subject us to greater competitive pressures in our markets, with the risk of
losing customers to other carriers and reductions in our rates.
UNITED KINGDOM. Licenses are needed to provide all the international
services that we provide 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. We have all
of the necessary licenses to provide our services in the United Kingdom.
International simple resellers, such as our company, operate under
registrable class licenses. Through our U.K. subsidiary DNS, we have an
International Simple Voice Resale Class License (the "ISVR"), which entitles us
to resell international message, telephone and private line services. The ISVR
license also enables DNS to interconnect with, and lease capacity at wholesale
rates from, British Telecom and other public telecommunications operators. We
also have an International Facilities License, which authorizes us to provide
international telecommunication services over our own international
infrastructure.
Our U.K. customers currently are unable to preselect us 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, the
national regulatory authority is seeking to defer the implementation of carrier
preselection 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 we
currently provide in Belgium.
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Providers of voice telephony services must apply for a voice telephony
license. We were 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 we are not a
facilities-based carrier within the meaning of Belgian regulations, we are not
eligible for these incentives.
Preselection currently is unavailable to our 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.
Our 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, we will need to enter into a
new interconnection agreement with Belgacom. If this new legislation has not
been adopted before July 15, 1999, we expect the term of our Belgian
interconnection to be extended. Furthermore, once the new legislation is
adopted, we expect 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 we were to lose our interconnection with
Belgacom in Belgium, we would need to obtain interconnection from another
carrier, which could increase our 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. Our
French subsidiary, Econophone SA, obtained its voice telephony license during
the third quarter of 1998. This license enables us to provide all of our 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 de
T elecommunications. Because we lease, rather than own, our transmission lines
in France, we are not required to have an infrastructure license. France
Telecom's standard interconnection offer provides the carriers that own
infrastructure with a cost advantage over carriers that do not own
infrastructure and are not available to us.
Preselection currently is unavailable to our 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. We are not one of these carriers.
GERMANY. On January 1, 1998, the German telecommunications market was
substantially liberalized. Through our interconnection with Deutsche Telekom and
on the basis of our carrier identification code, our customers are able to
preselect us as their carrier for certain services. In Germany, our activities
are governed by the Telecommunications Act of July 25, 1996 (the "German
Telecommunications Act"). Under the German Telecommunications Act, the provision
of "voice telephone service," which includes services involving switching in
Germany, over a privately owned telecommunications network, requires a Class 4
license under the German Telecommunications Act. We received a Class 4 license
during the second quarter of 1998, which enables us to provide voice telephony
services throughout 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, we entered into an interconnection
agreement with Deutsche Telekom, which expired at the end of February 1999. We
initiated a legal action with the German regulatory authorities on February 25,
1999 that challenged the terms of interconnection being offered by Deutsche
Telekom and requested the German regulatory authorities to issue a
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preliminary order and a final order requiring Deutsche Telekom to offer
reasonable interconnection terms to maintain continued interconnection of our
German network with Deutsche Telekom's network.
A large number of other competitive carriers, government authorities and
industry associations are now participating in this legal action, since the
determination on these issues is likely to have industry-wide consequences for
all competitive carriers that interconnect with Deutsche Telekom in Germany.
Deutsche Telekom, as a market-dominating operator, is obligated to grant us
access to its network. In addition, certain conditions of such network access
may be determined by the regulatory authorities. Nevertheless, it is uncertain
if the regulatory authorities will grant us access on desirable terms and
conditions. If Deutsche Telekom were permitted to restrict our interconnection,
our transmission costs in Germany would increase and the services we could offer
might be limited.
SWITZERLAND. With the implementation of the Telecommunication Act of 1997
on January 1, 1998, Switzerland became a fully liberalized telecommunications
market. The provision of our services in Switzerland does not require a license,
although we are required to make certain notice filings.
Our Swiss subsidiary, Econophone GmbH, signed an interconnection agreement
with Swisscom, the Swiss PTT, during the second quarter of 1998. Our
interconnection with Swisscom enables our customers to preselect our company as
their long distance carrier in Switzerland.
AUSTRIA. We recently obtained a license from the Austrian regulator,
Telekom-Control-Commission, to provide public telephone service in Austria for
an unlimited time period. We are one of 13 telecommunications services providers
in Austria. We plan to file an application for interconnection in Austria.
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, most
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. We received a license
early in the first quarter of 1999 which authorizes us to provide to offer
international long distance services to our customers in Canada. The provision
of domestic long distance services in Canada does not require a license,
although we are required to make certain notice filings. As a reseller of long
distance services, we are currently not subject to any foreign ownership
restrictions in Canada.
EMPLOYEES
As of December 31, 1998, we had 877 employees, an increase from the 408
employees that we had at December 31, 1997. The breakdown of our employees by
region as of December 31, 1998 was as follows:
<TABLE>
<CAPTION>
NUMBER
REGION OF EMPLOYEES
- ------------------------------------------------------------ ---------------
<S> <C>
Continental Europe.......................................... 108
United Kingdom.............................................. 247
North America............................................... 522
---
Total....................................................... 877
</TABLE>
Our North American employees are based principally in our offices in
Paramus, New Jersey (executive offices); New York, New York; Brooklyn, New York;
College Station, Texas; and St. Louis, Missouri. In Europe, our employees are
based principally in offices located in cities where we have a
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switch. We have never experienced a work stoppage and our employees are not
represented by a labor union or a collective bargaining agreement. We consider
our employee relations to be good.
LITIGATION
We are from time to time a party to litigation that arises in the ordinary
course of our business operations or otherwise. We believe that we are not
presently a party to any litigation that, if decided in a manner adverse to us,
would have a material adverse effect on our business or operations.
PROPERTIES
All of our facilities are leased from third parties. Our principal
facilities are located in Paramus, New Jersey; College Station, Texas; Brooklyn,
New York; and London, England. Our network operations center is located in St.
Louis, Missouri. We also maintain sales offices in several cities in the United
States including in most switch locations and in the following European cities,
among others:
- Amsterdam, The Netherlands
- Antwerp, Belgium
- Athens, Greece
- Berlin, Germany
- Brussels, Belgium
- Frankfurt, Germany
- Hamburg, Germany
- London, England
- Lyon, France
- Marseilles, France
- Paris, France
- Vienna, Austria
- Zurich, Switzerland
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT
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 Accounting
for Dell Computer Corporation. Prior to such time, Mr. Storin served in various
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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
Regional Bell Operating Company 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.
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.
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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 the 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.
EDWARD C. SCHMULTS, age 68, is expected to join the Board of Directors of
the Company until the next election of directors. Mr. Schmults' appointment is
contingent upon the consummation of the offering. Mr. Schmults served as Senior
Vice President and General Counsel of GTE Corporation from February 1984 to June
1994. Mr. Schmults has held various positions in government, including Deputy
Attorney General of the United States under the Secretary of the U.S. Treasury
Department. Mr. Schmults was a partner with White & Case, a law firm in New York
City. Mr. Schmults is a Director of Greenpoint Financial Corp., The Germany
Fund, The Central European Equity Fund, Deutsche Portfolio and Deutsche Funds,
Inc.
BOARD COMPOSITION
The Company's Board of Directors is currently set at six directors and has
one vacancy, which the Company's Bylaws authorize the Board of Directors to
fill. The vacancy is expected to be filled by Edward C. Schmults, who will be an
outside director, following the consummation of this offering. The Company is
required to appoint an outside director to maintain its listing on the Nasdaq
National Market. A discussion on Mr. Schmults' biographical information is in
the preceding paragraph.
The Company's Bylaws provide that the authorized number of directors shall
be determined by the Board of Directors. Vacancies on the Board may be filled
only by a majority of the directors then in office, even if less than a quorum,
or by a sole remaining director.
Until the consummation of the offering, the holders of the Series A
Preferred Stock will have the right to vote as a separate class to elect one
director. Upon the consummation of the offering, all of the Series A Preferred
Stock will be converted into common stock and the former holders of the Series A
Preferred Stock will cease to have the right to separately elect a director.
Stephen Munger serves as the director designated by the Series A Preferred
Stockholders. Mr. Munger will continue as a member of the Board of Directors
following the consummation of the offering.
BOARD COMMITTEES
Following the completion of this offering, the Board of Directors will
designate a Compensation Committee and an Audit Committee. The Compensation
Committee will be comprised solely of independent directors and at least a
majority of the members of the Audit Committee will be independent
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directors. The Compensation Committee will establish remuneration levels for
certain officers of the Company and perform such functions as may be delegated
to it under certain of the Company's benefit and executive compensation
programs.
The Audit Committee will select and engage the independent public
accountants to audit the Company's annual financial statements. The Audit
Committee also will review and approve the planned scope of the annual audit.
The Board of Directors may from time to time establish certain other
committees to facilitate the management of the Company. Regular meetings of the
Board of Directors will be held quarterly.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the consummation of this offering, the Company did 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 Investors II, L.P. ("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 this offering. Morgan Stanley was the placement agent in
connection with the 1997 Unit Offering, 1998 Debt Offering and is a managing
underwriter in connection with this offering. See "--Executive Compensation" and
"Underwriters."
COMPENSATION OF DIRECTORS
It is anticipated that Directors who are not associated with the Company
will be paid an annual Board membership fee of $10,000 and an attendance fee of
$750 for each meeting of the Board of Directors and for each meeting of a
committee of the Board of Directors. In addition, Directors who are not
associated with the Company will receive an initial option grant of 12,000
shares of common stock upon appointment to the Board of Directors and an annual
option grant to purchase 6,000 shares of common stock during their term as a
Director. All such grants will have an exercise price equal to the market price
at the time of grant and will vest over a six month period from the date of the
grant.
EXECUTIVE COMPENSATION
At December 31, 1998, the chief executive officer and four other most highly
compensated executive officers of the Company were Mr. Alfred West and Messrs.
Levy, Alward, Storin and Shorten. The following table summarizes all
compensation awarded to, earned by or paid to Mr. West and Messrs. Levy, Alward,
Storin and Shorten (Messrs. West, Levy, Alward, Storin and Shorten are referred
to herein as the "Named Executive Officers" for 1997 and 1998).
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
---------------
SHARES OF
ANNUAL COMPENSATION COMMON STOCK
---------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY (1) BONUS (2) OPTIONS GRANTED COMPENSATION(1)
- ---------------------------------------------- --------- ---------- ---------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
Alfred West (3)............................... 1998 $ 323,784 $ 404,730 -- $ 4,725(4)
Chief Executive Officer 1997 323,784 295,306 -- $ 4,725(4)
Alan L. Levy (5).............................. 1998 250,000 250,000 -- --
President and Chief Operating Officer 1997 210,000 157,500 -- --
Kevin A. Alward (6)........................... 1998 198,000 110,000 519,458 --
President--North America
Phillip J. Storin (7)......................... 1998 165,000 82,110 103,892 --
Senior Vice President and Chief Financial
Officer
Richard L. Shorten, Jr. (8)................... 1998 165,000 41,250 25,973 --
Senior Vice President and General Counsel 1997 6,875 -- 51,946 --
</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) Bonus amounts apply to the year during which such bonuses were earned and
are recorded on an accrual basis instead of a cash basis.
(3) See "--Employment Agreements and Arrangements" for a description of Mr.
West's Employment Agreement.
(4) Consists of compensation in respect of life insurance, of which Mr. West's
designee is the beneficiary, paid by the Company.
(5) See "--Employment Agreements and Arrangements" for a description of Mr.
Levy's Employment Agreement.
(6) Mr. Alward commenced employment with the Company during February 1998.
(7) Mr. Storin commenced employment with the Company during February 1998.
(8) Mr. Shorten commenced employment with the Company on December 15, 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 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.
Amendments to the 1996 Incentive Plan are expected to be made prior to the
consummation of the offering that will increase the number of authorized shares
in respect of which options can be granted to 5,250,000 shares of voting common
stock and 250,000 shares of non-voting stock. Holders of restricted
77
<PAGE>
voting stock have the right to receive cash dividends with respect to such
shares. Upon the consummation of the offering, holders of Restricted Shares may
elect, for a nominal exercise price, to convert Restricted Shares held by them
into an equivalent number of shares of voting stock to be issued that shall have
the same terms and conditions as the Restricted Shares.
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 6.0 million shares
of common stock. The 1999 Incentive Plan will be administered by the Board of
Directors of the Company or a committee thereof.
As of April 1, 1999, the Company had issued stock options to purchase
5,111,060 shares of common stock under the Incentive Plan, 2,610,554 of which
were exercisable as of such date, and 151,474 Restricted Shares, of which 87,020
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
% OF TOTAL RATES OF STOCK PRICE
OPTIONS APPRECIATION FOR
NUMBER OF GRANTED TO OPTION
SECURITIES EMPLOYEES EXERCISE TERM
UNDERLYING IN FISCAL YEAR PRICE PER EXPIRATION ----------------------
NAME OPTIONS 1998 SHARE($) DATE 5%($) 10%($)
- ------------------------------------------- ----------- --------------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Alfred West................................ -- -- -- -- -- --
Alan L. Levy............................... -- -- -- -- -- --
Kevin A. Alward............................ 519,458 33.3% 7.22 2/2/2008 1,036,056 2,289,413
Phillip J. Storin.......................... 103,892 6.66% 4.81 2/2/2008 78,813 165,500
Richard L. Shorten, Jr..................... 25,973 1.67% 7.22 7/1/2008 29,555 62,063
</TABLE>
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 VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
SHARES AT 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............................ -- -- 1,617,384 460,448 6,616,400 1,883,600
Kevin A. Alward......................... -- -- -- 519,458 -- --
Phillip J. Storin....................... -- -- -- 103,892 -- 175,000
Richard L. Shorten, Jr.................. -- -- 17,316 60,603 29,167 58,333
</TABLE>
- ------------------------
(1) No options were exercised during 1998.
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<PAGE>
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
The Company 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 the Company. 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 the Company 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 the Company'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 the Company'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 the Company or the compensation
committee thereof. If Mr. West's employment is terminated prior to December 31,
1999 by the Company 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 the Company shall notify the other that it does not
wish to extend the term. If the Company 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.
The Board of Directors has retained an independent compensation consultant
to advise it concerning Mr. West's compensation. Prior to the consummation of
the offering, the Board of Directors intends to adopt new compensation for, and
enter into a new employment agreement with, Mr. West comensurate with his
position.
The Company also expects to enter into a new employment agreement with Alan
L. Levy (the "Levy Employment Agreement") prior to the consummation of the
offering, pursuant to which Mr. Levy will continue to serve as President and
Chief Operating Officer of the Company. Certain of the expected terms of this
agreement are summarized below. The term of the Levy Employment Agreement will
extend until the third anniversary of completion of the offering, subject to any
earlier termination in accordance with the terms thereof. Pursuant to the Levy
Employment Agreement, Mr. Levy will be entitled to receive an annual base salary
of $325,000 during each year of the term thereof ("Levy Base Salary"). In
addition, Mr. Levy will be entitled to receive incentive compensation ("Levy
Target Bonus") in a stated percentage of Levy Base Salary upon the achievement
of certain financial goals. Mr. Levy also will be entitled to receive options to
purchase 1,038,916 shares of common stock (as adjusted for the stock split)
vesting in equal amounts of 259,729 shares of common stock (as adjusted for the
stock split) on the second through fifth anniversaries of the offering. The
exercise price of options that vest on the second and third anniversaries of the
offering will be the offering price per share. The exercise price of options
that vest on the fourth and fifth anniversaries of the offering will be 1.5 and
2.0 times the offering price per share, respectively. In the event of a Change
of Control (as defined in the Levy Employment Agreement), unvested options will
vest immediately, while options whose exercise price is greater than the
Company's common stock price at the time of the Change of Control will
automatically convert into options to acquire common stock of the acquiring
entity at an equivalent exercise price. Mr. Levy also will be entitled to
receive severance benefits under certain circumstances. If there is no Change of
Control and his termination is (x) without cause, (y) voluntary and for good
reason on Mr. Levy's behalf or (z) due to the Company's failure to renegotiate
the Levy Employment Agreement at the end of its term, Mr. Levy will be entitled
to receive the Levy Base Salary, Levy Target Bonus and related benefits
("Severance Package") for the greater of the remaining term of the Levy
Employment Agreement or two years. If there is a Change of Control, and within
two years of such event Mr. Levy's termination is (i) without cause or (ii)
voluntary
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<PAGE>
and for good reason on Mr. Levy's behalf, then Mr. Levy will be entitled to
receive a Severance Package equal to a stated percentage of the Levy Base Salary
and an additional amount determined according to the Levy Target Bonus, as well
as reimbursement for any tax liability pursuant to the Code.
Destia has entered into employment agreements with Phillip J. Storin (the
"Storin Employment Agreement") and Kevin A. Alward (the "Alward Employment
Agreement") and plans to enter into an employment agreement with Richard L.
Shorten, Jr. (the "Shorten Employment Agreement"). The term of the Storin
Employment Agreement and the Alward Agreement each extends until February 2,
2001, and the term of the Shorten Employment Agreement is expected to extend
until January 1, 2001, in each instance subject to earlier termination in
accordance with the terms thereof. Pursuant to their employment agreements,
Messrs. Storin and Alward are entitled to receive an annual base salary of
$180,000 and $216,000, respectively, during each year of the term thereof. Mr.
Shorten is expected to receive an annual base salary of $180,000 during each
year of the term of the Shorten Employment Agreement. In each case, increases in
compensation shall be at the discretion of the Board of Directors. In addition,
Messrs. Storin and Alward are each eligible, and Mr. Shorten is expected to be
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. If
either of Messrs. Storin's or Alward's employment is terminated prior to January
1, 2001 by Destia without cause, they will be entitled to a severance payment
equal to one year's base salary. The Company expects that if Mr. Shorten's
employment is terminated prior to January 1, 2001 by Destia without cause, he
will be entitled to a severance payment equal to one year's base salary.
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. In total, the sellers of VoiceNet also were
granted 311,675 options at an exercise price of $4.81 per share under the
Incentive Plan during 1998.
LIMITATIONS ON OFFICERS' AND DIRECTORS' LIABILITY
The Company's Certificate of Incorporation indemnifies its officers and
directors to the fullest extent permitted by the DGCL. Under Section 145 of the
DGCL, a corporation may indemnify its directors, officers, employees and agents
and its former directors, officers, employees and agents and those who serve, at
the corporation's request, in such capacities with another enterprise, against
expenses (including attorneys' fees), as well as judgments, fines and
settlements in nonderivative lawsuits, actually and reasonably incurred in
connection with the defense of any action, suit or proceeding in which they or
any of them were or are made parties or are threatened to be made parties by
reason of their serving or having served in such capacity. The DGCL provides,
however, that such person must have acted in good faith and in a manner such
person reasonably believed to be in (or not opposed to) the best interests of
the corporation and, in the case of a criminal action, such person must have had
no reasonable cause to believe his or her conduct was unlawful. In addition, the
DGCL does not permit indemnification in an action or suit by or in the right of
the corporation where such person has been adjudged liable to the corporation,
unless, and only to the extent that, a court determines that such person fairly
and reasonably is entitled to indemnity for costs the court deems proper in
light of liability adjudication. Indemnity is mandatory to the extent a claim,
issue or matter has been successfully defended. The Certificate of Incorporation
and the DGCL also prohibit limitations on officer or director liability for acts
or omissions which resulted in a violation of a statute prohibiting certain
dividend declarations, certain payments to stockholders after dissolution and
particular types of loans. The effect of these provisions is to eliminate the
rights of the Company and its stockholders (through stockholders' derivative
suits on behalf of the Company) to recover monetary damages against an officer
or director for breach of fiduciary duty as an officer or director (including
breaches resulting from grossly negligent behavior), except in the situations
described above.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors or officers of the Company pursuant to the
foregoing provisions, the Company has been informed that, in the opinion of the
Commission, such indemnification is against public policy as expressed in the
Securities Act and is therefore unenforceable.
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<PAGE>
CERTAIN TRANSACTIONS
RELATED PARTY LOANS
The Company had outstanding loans of $308,000 due to Mrs. Rose West, the
mother of Messrs. Alfred West and Steven West. The Company has repaid these
loans in full.
Alfred West has borrowed $232,441 from the Company pursuant to unsecured,
interest bearing notes, repayable upon demand.
MINORITY INTEREST IN THE ECONOPHONE SERVICES GMBH
Mr. Samuel Gross, the brother-in-law of Mr. Alfred West, previously owned a
28% interest in the Company's Swiss subsidiary, Econophone Services GmbH. On
March 30, 1999, the Company acquired Mr. Gross' interest in Econophone Services
GmbH in exchange for 103,891 shares of Restricted Voting Common Stock.
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<PAGE>
CERTAIN INDEBTEDNESS
THE 1998 DEBT OFFERING
In connection with the 1998 Debt Offering, the Company issued $300.0 million
of 11% Senior Discount Notes due 2008 pursuant to the 1998 Indenture among the
Company and The Bank of New York, as trustee.
PRINCIPAL, MATURITY AND INTEREST
The 1998 Notes are unsecured unsubordinated obligations of the Company, and
mature on February 15, 2008. Interest on the 1998 Notes accrues at the rate of
11% per annum, payable semi-annually on February 15 and August 15 of each year.
OPTIONAL REDEMPTION
The 1998 Notes will be redeemable, at the Company's option, on or after
February 15, 2003 at the following redemption prices (expressed in percentages
of principal amount), plus accrued and unpaid interest, if any, to the
redemption date, if redeemed during the 12-month period commencing February 15
of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- ---------------------------------------------- ----------------
<S> <C>
2003.......................................... 105.500%
2004.......................................... 103.667%
2005.......................................... 101.833%
2006 and thereafter........................... 100.000%
</TABLE>
In addition, at any time prior to February 15, 2001, the Company may redeem
up to 35% of the aggregate principal amount of the 1998 Notes with the net
proceeds of one or more sales of common equity at a redemption price of 111.0%,
plus accrued and unpaid interest, if any, to the redemption date; PROVIDED that
at least $195.0 million aggregate principal amount of 1998 Notes remains
outstanding after each such redemption.
RANKING
The indebtedness evidenced by the 1998 Notes ranks PARI PASSU in right of
payment with all existing and future unsubordinated indebtedness of the Company
(including the 1997 Notes) and senior in right of payment to all existing and
future subordinated indebtedness of the Company.
COVENANTS
The 1998 Indenture restricts, among other things, the Company's ability to
incur additional indebtedness, pay dividends or make certain other restricted
payments, incur liens, engage in any sale and lease-back transaction, sell
assets, enter into certain transactions with affiliates or engage in merger
transactions. There are significant "carve-outs" and exceptions to these
covenants. In addition, the 1998 Indenture permits the Company's subsidiaries to
be deemed unrestricted subsidiaries under certain circumstances and thus not
subject to the restrictions of the 1998 Indenture.
REPURCHASE OF 1998 NOTES UPON A CHANGE IN CONTROL
If there is a Change in Control (as defined in the 1998 Indenture) the
Company must offer to purchase for cash all 1998 Notes for 101% of the
outstanding principal amount, plus accrued interest.
EVENTS OF DEFAULT
The 1998 Indenture contains standard events of default, including, but not
limited to, (i) defaults in the payment of principal, premium or interest, (ii)
defaults in the compliance with covenants contained in the 1998 Indenture, (iii)
cross defaults on more than $5.0 million of other indebtedness, (iv) failure to
pay more than $5.0 million of judgments that have not been stayed by appeal or
otherwise and (v) the bankruptcy of the Company or certain of its subsidiaries.
82
<PAGE>
THE 1997 UNIT OFFERING
In connection with the 1997 Unit Offering, the Company issued $155.0 million
of 13 1/2% Senior Notes due 2007 pursuant to an Indenture among the Company and
The Bank of New York, as trustee. The terms of the 1997 Notes are substantially
similar to those of the 1998 Notes. See "--The 1998 Debt Offering."
PRINCIPAL, MATURITY AND INTEREST
The 1997 Notes are unsecured unsubordinated obligations of the Company, and
mature on July 15, 2007. Interest on the 1997 Notes accrues at the rate of
13 1/2% per annum payable on January 15 and July 15 of each year. The Company
purchased certain securities which were pledged as security for the payment of
interest on the principal of the 1997 Notes. Proceeds from these securities are
being used by the Company to make interest payments on the 1997 Notes through
July 15, 2000.
OPTIONAL REDEMPTION
The 1997 Notes will be redeemable, at the Company's option, on or after July
15, 2002, at the following redemption prices (expressed in percentages of
principal amount), plus accrued and unpaid interest, if any, if redeemed during
the 12-month period commencing July 15 of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- ---------------------------------------------- ----------------
<S> <C>
2002.......................................... 106.750%
2003.......................................... 103.375%
2004 and thereafter........................... 100.000%
</TABLE>
In addition, at any time prior to July 15, 2000, the Company may redeem up
to 35% of the aggregate principal amount of the 1997 Notes with the net proceeds
of one or more sales of common equity at a redemption price of 113.50%, plus
accrued and unpaid interest, if any, to the redemption date; PROVIDED that at
least $100.0 million aggregate principal amount of 1997 Notes remains
outstanding after each such redemption.
RANKING
The indebtedness evidenced by the 1997 Notes ranks PARI PASSU in right of
payment with all existing and future unsubordinated indebtedness of the Company
(including the 1998 Notes) and senior in right of payment to all existing and
future subordinated indebtedness of the Company.
COVENANTS
The 1997 Indenture restricts, on substantially the same terms as the 1998
Indenture, among other things, the Company's ability to incur additional
indebtedness, pay dividends or make certain other restricted payments, incur
liens, engage in any sale and lease-back transaction, sell assets, enter into
certain transactions with affiliates or engage in merger transactions. There are
significant "carve-outs" and exceptions to these covenants. In addition, the
1997 Indenture permits, under the same circumstances as the 1998 Indenture, the
Company's subsidiaries to be deemed unrestricted subsidiaries and thus not
subject to the restrictions of the 1997 Indenture.
REPURCHASE OF 1997 NOTES UPON A CHANGE IN CONTROL
If there is a Change in Control (as defined in the 1997 Indenture), the
Company must offer to purchase for cash all 1997 Notes for 101% of the
outstanding principal amount, plus accrued interest.
EVENTS OF DEFAULT
The 1997 Indenture contains standard events of default, including, but not
limited to, (i) defaults in the payment of principal, premium or interest, (ii)
defaults in the compliance with covenants contained in the 1997 Indenture, (iii)
cross defaults on more than $5.0 million of other indebtedness, (iv) failure to
pay more than $5.0 million of judgments that have not been stayed by appeal or
otherwise and (v) the bankruptcy of the Company or certain of its subsidiaries.
The events of default contained in the 1997 Indenture are the same as those
contained in the 1998 Indenture.
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<PAGE>
NTFC VENDOR FINANCING
On May 28, 1996, the Company entered into a credit facility with NTFC, which
has been amended and increased as to amount 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 the
Company 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 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. As of March 31, 1999, the aggregate
amount outstanding under all tranches of the NTFC Facility was $19.8 million.
Loans under the NTFC Facility accrue interest at an interest rate equal to the
90-day commercial paper rate plus 395 basis points, (an interest rate of 8.90%
as of April 1, 1999), 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 permits the incurrence of indebtedness (including
contingent obligations), the creation of liens and transactions with affiliates
on substantially the same terms as the 1998 Indenture.
The NTFC Agreement prohibits the Company from making any distribution or any
redemption of capital stock, directly or indirectly, other than nominal payments
in lieu of the issuance of fractional shares upon an exercise of options,
warrants or similar agreements or conversion rights and other than any
repurchase of Warrants in connection with a repurchase offer by the Company.
Except in connection with certain transactions with affiliates not involving a
change of control, the Company may not enter into or become the subject of, any
merger, acquisition of consolidation, or liquidate, wind-up or dissolve itself
(or suffer any liquidation or dissolution), or convey, sell, lease, transfer or
otherwise dispose of all or any substantial part of its business or assets.
In addition, the Company may not enter into any new business or make any
material change in any of its business objectives, purpose and operations from
those related to the telecommunications industry.
Pursuant to the NTFC Agreement, the Company may not cease to employ Alfred
West (other than by reason of his death or disability) or suffer to exist any
material competition by any of Alfred West, Steven West or Gary Bondi, with the
business now or hereafter conducted by the Company.
The NTFC Facility requires the Company to maintain a Debt Service Coverage
Ratio (as defined therein) for each quarter through December 31, 1999 of not
less than 1.10 to 1.00 and for each fiscal quarter thereafter of not less than
1.25 to 1.00. In addition, the Company must maintain specified minimum cash
balances (certain related business investments and acquisitions qualify as cash
for the foregoing purposes). The Company also must have EBITDA (as defined in
the NTFC Facility) of not less than: $3,000,000 for the fiscal year ending
December 31, 1999; $10,000,000 for the fiscal year ending December 31, 2000; and
$10,000,000 for the fiscal year ending December 31, 2001. Under the Company's
current expansion plans, it does not expect to be in compliance with the
foregoing covenants. The Company is in the process of renegotiating these
covenants to provide the Company with additional flexibility in achieving its
expansion plans and believes that new covenant thresholds will be agreed to with
NTFC prior to the consummation of the offering.
Borrowings from NTFC are secured by the equipment purchased therewith and
general intangibles and intangible property that is associated with such
equipment.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the common stock as of April 1, 1999, and as adjusted to
reflect the sale by the Company of the shares of common stock offered hereby, 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>
SHARES BENEFICIALLY
OWNED SHARES BENEFICIALLY OWNED
PRIOR TO OFFERING(1)(2) AFTER THE OFFERING(1)
----------------------- -------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT(3)
- ------------------------------------------------------- ------------ --------- ------------ -----------
<S> <C> <C> <C> <C>
Alfred West............................................ 11,428,076(4) 46.7% 11,428,076(4) 36.9%
Steven West............................................ 4,519,285(5) 18.5% 4,519,285(5) 14.6%
Gary Bondi............................................. 4,473,832(6) 18.3% 4,473,832(6) 14.4%
Princes Gate Investors II, L.P.
c/o Morgan Stanley & Co. Incorporated
1585 Broadway New York, New York 10036............... 3,553,821(7) 14.5% 3,553,821(7) 11.5%
Kevin A. Alward........................................ 415,566 (9) 1.7% 415,566 (9) 1.3%
Alan L. Levy........................................... 1,906,156 10) 7.2% 1,906,156 10) 5.8%
Stephen R. Munger...................................... -- -- -- --
Richard L. Shorten, Jr................................. 17,316 11) * 17,316 11) *
Phillip J. Storin...................................... 34,630 12) * 34,630 12) *
------------ --------- ------------ -----------
All Directors and Executive Officers as a Group (8
persons)............................................. 22,794,862 85.9% 22,794,862 69.0%
</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 April 1, 1999.
Shares which a person does not have the right to acquire within 60 days from
April 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, 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 25.38 shares of common
stock, or a total of 3,553,821 shares of common stock. All of the shares of
Series A Preferred Stock will be converted into common stock upon
consummation of this offering.
(3) Assumes that the underwriters' overallotment option is not exercised.
(4) Includes 893,468 shares held by AT Econ Ltd. Partnership and 88,308 held by
AT Econ Ltd. Partnership No. 2.
(5) Includes 893,468 shares held by SS Econ Ltd. Partnership and 88,308 shares
held by SS Econ Ltd. Partnership No. 2.
(6) Includes 893,468 shares held by GS Econ Ltd. Partnership.
(7) Includes 112,510 shares of Series A Preferred Stock, which were convertible
into 2,748,630 shares of common stock that are owned by affiliates of
Princes Gate, over which Princes Gate has sole voting power.
(8) Includes 212,978 shares held by Kevin Alward, 20,778 shares held by Alward
Investment Associates LLC and 77,919 shares held by Kevin and Belinda Alward
Grantor Retained Annuity Trust. The remainder includes shares issuable upon
the exercise of options.
(9) Does not include options to purchase 415,566 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after April 1,
1999.
(10) Does not include options to purchase 171,676 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after April 1,
1999.
(11) Does not include options to purchase 86,576 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after April 1,
1999.
(12) Does not include options to purchase 69,261 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after April 1,
1999.
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DESCRIPTION OF CAPITAL STOCK
THE FOLLOWING SUMMARY OF CERTAIN PROVISIONS OF THE COMPANY'S CAPITAL STOCK
DOES NOT PURPORT TO BE COMPLETE AND IS SUBJECT TO, AND QUALIFIED IN ITS ENTIRETY
BY, THE CERTIFICATE OF INCORPORATION AND BYLAWS AND BY THE PROVISIONS OF
APPLICABLE LAW. COPIES OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
HAVE BEEN FILED AS EXHIBITS TO THE REGISTRATION STATEMENT OF WHICH THIS
PROSPECTUS IS A PART.
GENERAL
On the closing of this offering, the authorized capital stock of the Company
will consist of 74,250,000 shares of voting common stock, 500,000 shares of
Non-Voting Common Stock and 250,000 shares of preferred stock without
designation. Simultaneously with the closing of this offering, all of the
outstanding shares of Series A Preferred Stock will be converted into common
stock. The Company presently does not intend to issue additional shares of
preferred stock.
COMMON STOCK
Upon the consummation of this offering, there will be 30,832,142 shares of
voting common stock (referred to herein as "common stock" or "voting common
stock") outstanding (assuming no exercise of outstanding options or warrants).
In addition, there will be 151,474 shares of Non-Voting Common Stock outstanding
and 103,891 shares of Restricted Voting Common Stock outstanding. All
outstanding shares of common stock are fully paid and nonassessable, and the
shares of common stock that will be issued on completion of this offering will
be fully paid and nonassessable.
The holders of voting common stock are entitled to one vote per share on all
matters to be voted on by the stockholders. The holders of Non-Voting Common
Stock do not have voting rights, except to the extent required by law. Except as
indicated below, the other terms of the voting common stock and Non-Voting
Common Stock are the same.
Subject to preferences that may be applicable to any outstanding series of
preferred stock, the holders of voting common stock and Non-Voting Common Stock
are entitled to receive ratably any dividends that may be declared from time to
time by the Board of Directors. The Company does not intend to, and is currently
not permitted to, pay any dividends. See "Dividend Policy." In the event of the
liquidation, dissolution or winding-up of the Company, the holders of voting
common stock are entitled to share ratably in all assets remaining after payment
of liabilities, subject to prior distribution rights of preferred stock, if any,
then outstanding. The voting common stock and Non-Voting Common Stock have no
preemptive or conversion rights or other subscription rights, except that the
Non-Voting Common Stock is convertible into voting common stock upon the
consummation of the offering. There are no redemption or sinking fund provisions
applicable to the common stock or Non-Voting Common Stock.
PREFERRED STOCK
The Board of Directors has the authority to issue up to 250,000 shares of
preferred stock in one or more series and to fix rights, preferences, privileges
and restrictions thereof, including dividend rights, dividend rates, conversion
rights, voting rights, terms of redemption, redemption prices, liquidation
preferences and the number of shares constituting any series or the designation
of such series, without further vote or action by the stockholders. The issuance
of shares of preferred stock (and the Board's ability to do so) may have the
effect of delaying, deferring or preventing a change in control of the Company
without further action by the stockholders and may adversely affect the voting
and other rights of the holders of common stock.
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TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the common stock is American Stock
Transfer & Trust Company.
PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW THAT MAY
HAVE AN ANTI-TAKEOVER EFFECT
CERTIFICATE OF INCORPORATION AND BYLAWS. Certain provisions in the
Company's Amended and Restated Certificate of Incorporation and Bylaws
summarized below may be deemed to have an anti-takeover effect and may delay,
deter or prevent a tender offer or takeover attempt that a stockholder might
consider to be in its best interests, including attempts that might result in a
premium being paid over the market price for the shares held by stockholders.
The Company's Amended and Restated Certificate of Incorporation provides
that, subject to any rights of holders of preferred stock to elect additional
directors under specified circumstances, the number of directors of the Company
will be fixed as specified in the Bylaws. The Bylaws will provide that, subject
to any rights of holders of preferred stock to elect additional directors under
specified circumstances, the number of directors will be fixed at six unless the
Board of Directors, by vote of a majority of the directors, votes that such
number shall be increased or decreased. In addition, the Amended and Restated
Certificate of Incorporation and Bylaws provide that, subject to any rights of
holders of preferred stock, and unless the Company's Board of Directors
otherwise determines, any vacancies may be filled by the affirmative vote of a
majority of the remaining members of the Board, though less than a quorum, or by
a sole remaining director, and except as otherwise provided by law, any such
vacancy may not be filled by the stockholders.
The Company's Bylaws provide for an advance notice procedure for the
nomination, other than by or at the direction of the Board of Directors, of
candidates for election as directors as well as for other stockholder proposals
to be considered at annual meetings of stockholders. In general, notice of
intent to nominate a director or raise matters at such meetings will have to be
received in writing by the Company at its principal executive offices not less
than 120 days prior to the first anniversary of the previous year's annual
meeting of stockholders, and must contain certain information concerning the
person to be nominated or the matters to be brought before the meeting and
concerning the stockholder submitting the proposal. The Company's Amended and
Restated Certificate of Incorporation and Bylaws also provide that special
meetings of stockholders may be called only by certain specified officers of the
Company or by any such officer at the request in writing of the Board of
Directors; special meetings of stockholders cannot be called by stockholders. In
addition, the Company's Amended and Restated Certificate of Incorporation will
provide that any action required or permitted to be taken by stockholders may
not be effected by written consent unless unanimous.
The foregoing provisions of the Certificate of Incorporation and Bylaws
could discourage potential acquisition proposals and could delay or prevent a
change in control of the Company. These provisions are intended to enhance the
likelihood of continuity and stability in the composition of the Board of
Directors and in the policies formulated by the Board of Directors and to
discourage certain types of transactions that may involve an actual or
threatened change of control of the Company. These provisions are designed to
reduce the vulnerability of the Company to an unsolicited acquisition proposal.
The provisions also are intended to discourage certain tactics that may be used
in proxy fights. However, such provisions could have the effect of discouraging
others from making tender offers for the Company's shares and, as a consequence,
they also may inhibit fluctuations in the market price of the Company's shares
that could result from actual or rumored takeover attempts. Such provisions also
may have the effect of preventing changes in the management of the Company. See
"Risk Factors--Anti-Takeover Provisions."
DELAWARE TAKEOVER STATUTE. The Company is subject to Section 203 of the
DGCL, which, subject to certain exceptions, prohibits a Delaware corporation
from engaging in any "business combination" (as
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defined below) with any "interested stockholder" (as defined below) for a period
of three years following the date that such stockholder became an interested
stockholder, unless: (i) prior to such date, the board of directors of the
corporation approved either the business combination or the transaction that
resulted in the stockholder becoming an interested stockholder; (ii) on
consummation of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding those shares owned (x) by persons who are directors and also
officers and (y) by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or (iii) on or subsequent
to such date, the business combination is approved by the board of directors and
authorized at an annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least 66 2/3% of the outstanding voting
stock that is not owned by the interested stockholder.
Section 203 defines "business combination" to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (iii) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested stockholder; (iv)
any transaction involving the corporation that has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (v) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an "interested stockholder" as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have 31,087,507 shares of
common stock outstanding. Of this amount, the shares offered hereby will be
available for immediate sale in the public market as of the date of this
prospectus. An additional 6,130,518 shares of common stock are issuable upon the
exercise of outstanding options under the Company's 1996 Flexible Incentive Plan
and 1999 Flexible Incentive Plan at a weighted average exercise price of $5.16.
Of this amount, options for 2,610,554 shares are presently exercisable and
3,519,964 are subject to the satisfaction of vesting criteria. In addition,
1,315,148 shares of common stock are issuable upon the exercise of the Warrants
at $0.01 per share. The Warrants expire on June 30, 2007.
In addition, after the offering, the Company believes that it will have
greater flexibility in consummating acquisitions and/or strategic alliances and
may use shares of its common stock as an alternative form of consideration in
such transactions.
The Company, its directors and executive officers, have agreed pursuant to
the Underwriting Agreement and other agreements that they will not sell any
common stock without the prior consent of Morgan Stanley for a period of 180
days from the date of this prospectus (the "180-day Lockup Period").
Approximately 20,732,868 additional shares will be available for sale following
the expiration of the 180-day Lockup Period.
The outstanding shares of common stock not issued in connection with this
offering are available for sale in the public market, subject to the 180-day
Lockup Period and compliance with the requirements of Rule 144. In general,
under Rule 144 as currently in effect, a person (or persons whose shares are
aggregated) who has beneficially owned shares for at least one year is entitled
to sell within any three-month period commencing 90 days after the date of this
prospectus a number of shares that does not exceed the greater of (i) 1% of the
then outstanding shares of common stock or (ii) the average weekly trading
volume during the four calendar weeks preceding such sale, subject to the filing
of a Form 144 with respect to such sale. A person (or persons whose shares are
aggregated) who is not deemed to have been an affiliate of the Company at any
time during the 90 days immediately preceding the sale who has beneficially
owned his or her shares for at least two years is entitled to sell such shares
pursuant to Rule 144(k) without regard to the foregoing volume limitations.
Persons deemed to be affiliates must always sell pursuant to the volume
limitations under Rule 144, even after the applicable holding periods have been
satisfied. The Company is unable to estimate the number of shares that will be
sold under Rule 144, since this will depend on the market price for the common
stock of the Company, the personal circumstances of the sellers and other
factors.
The Company intends to file a registration statement on Form S-8 under the
Securities Act to register shares of common stock reserved for issuance under
the Company's 1996 Flexible Incentive Plan 1999 Flexible Incentive Plan and
Employee Stock Purchase Plan, thus permitting the resale of such shares by
nonaffiliates in the public market without restriction under the Securities Act.
The Company intends to register these shares on Form S-8, along with options
that have not yet been issued under the Company's Incentive Plan as of the date
of this prospectus but may in the future be issued under the Incentive Plan.
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 Stock (the "Registrable Shares"). If the
Company proposes to register any of its securities under the Securities Act, the
holders of the Registrable Shares will be entitled to notice thereof, and
subject to certain restrictions, to include their Registrable Shares in such
registration. In addition, immediately following the consummation of this
offering, holders of at least 25% of the outstanding Registrable Shares may make
up to two demands of the Company 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 immediately 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.
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If the Company proposes to file a Registration Statement with the Commission
with respect to an offering of any shares of common stock for cash (other than
an offering registered solely on Form S-4 or S-8 or any successor form thereto)
and other than the initial public offering of shares of common stock if no
shareholder of the Company participates therein, then all the holders of the
Warrants shall have the right within 20 days after delivery of notice by the
Company, subject to certain conditions and limitations, to request in writing
that the Company include all or a portion of the shares of common stock issued
or issuable upon exercise of such holder's Warrants in such registration
statement, to the extent that such shares of common stock are subject to
restrictions on transfer.
Sales of a substantial number of shares of common stock after the offering
(or the perception that such sales might occur) could adversely affect the
market price of the common stock and could impair our ability to raise capital
through the sale of additional equity securities. See "Risk Factors--Potential
Effect of Shares Becoming Available for Sale."
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CERTAIN UNITED STATES TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS
The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of common stock by a
Non-U.S. Holder. For this purpose, a "Non-U.S. Holder" is any person or entity
that is, for U.S. federal income tax purposes, a foreign corporation, a
non-resident alien individual, a foreign partnership or a foreign estate or
trust. This discussion does not address all aspects of U.S. federal income and
estate taxes that may be relevant to such Non-U.S. Holders in light of their
particular circumstances (such as certain tax consequences applicable to
pass-through entities) and does not deal with foreign, state and local tax
consequences. Furthermore, this discussion is based on provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the regulations
promulgated thereunder ("Treasury Regulations") and administrative and judicial
interpretations thereof, as of the date hereof, all of which are subject to
change, possibly with retroactive effect.
An individual may, subject to certain exceptions, be deemed to be a resident
alien (as opposed to a non-resident alien) with respect to any current calendar
year if (i) the individual was present in the United States on at least 31 days
during such year and (ii) the sum of the number of days on which such individual
was present in the U.S. during the current year, one-third of the number of such
days during the first preceding year, and one-sixth of the number of days during
the second preceding year, equals or exceeds 183 days. Resident aliens are
subject to U.S. federal income tax as if they were U.S. citizens.
EACH PROSPECTIVE PURCHASER OF COMMON STOCK IS ADVISED TO CONSULT A TAX
ADVISOR WITH RESPECT TO CURRENT AND POSSIBLE FUTURE U.S. TAX CONSEQUENCES OF
ACQUIRING, HOLDING AND DISPOSING OF COMMON STOCK AS WELL AS ANY TAX CONSEQUENCES
THAT MAY ARISE UNDER THE LAWS OF ANY STATE, LOCAL OR FOREIGN JURISDICTION.
DIVIDENDS
The Company does not intend to, and currently is not permitted to, pay any
dividends. See "Dividend Policy." In the event that dividends are paid on shares
of common stock, however, dividends paid to a Non-U.S. Holder of common stock
generally will be subject to withholding of U.S. federal income tax at a 30%
rate or at such lower rate as may be specified by an applicable income tax
treaty. However, dividends that are effectively connected with the conduct of a
trade or business by the Non-U.S. Holder within the United States and, where a
tax treaty applies, are attributable to a U.S. permanent establishment of the
Non-U.S. Holder, are not subject to the withholding tax, but instead are subject
to U.S. federal income tax on a net income basis at applicable graduated
individual or corporate rates. Any such effectively connected dividends received
by a foreign corporation may, under certain circumstances, be subject to an
additional "branch profits tax" at a rate of 30% (or lower applicable treaty
rate).
In the event that the Company is permitted to and decides to pay dividends
at some future date, Non-U.S. Holders generally will be required to (i) in the
case of dividends effectively connected with the conduct of a U.S. trade or
business by the Non-U.S. Holder, supply an Internal Revenue Service ("IRS") form
to the withholding agent on which such holder provides its U.S. tax
identification number and (ii) otherwise, comply with IRS certification
procedures to obtain the benefits of a reduced rate of U.S. withholding tax
under an applicable income treaty.
GAIN ON DISPOSITION OF COMMON STOCK
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain recognized on a sale or other disposition of common stock
unless (i) the gain is effectively connected with a trade or business of the
Non-U.S. Holder in the United States and, where a tax treaty applies, is
attributable to a U.S. permanent establishment of the Non-U.S. Holder, (ii) in
the case of a Non-U.S. Holder who is an individual and holds the common stock as
a capital asset, such holder is present in the United States for 183 or more
days in the taxable year of the sale or other disposition and certain other
conditions are met, (iii) the Non-U.S. Holder is an individual who is subject to
tax pursuant to certain
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provisions of the Code applicable to U.S. expatriates or (iv) the Company is or
has been a "U.S. real property holding corporation" (a "USRPHC") for U.S.
federal income tax purposes and, in the event that the common stock is
considered "regularly traded," the Non-U.S. Holder held directly or indirectly
at any time during the five-year period ending on the date of disposition more
than five percent of the common stock. The Company believes it is not and does
not anticipate becoming a USRPHC for U.S. federal income tax purposes. However,
because the determination of USRPHC status is based upon the composition of the
assets of the Company from time to time, there can be no assurance that the
Company will not become a USRPHC.
An individual Non-U.S. Holder who has gain that is described in clause (i)
above will, unless an applicable treaty provides otherwise, be taxed on the net
gain derived from the sale under regular graduated U.S. federal income tax rates
and will not be subject to the withholding tax. An individual Non-U.S. Holder
described in clause (ii) above will be subject to a flat 30% tax on the gain
derived from the sale, which may be offset by certain U.S.-source capital
losses.
If a Non-U.S. Holder that is a foreign corporation falls under clause (i)
above, it will be taxed on its gain under regular graduated U.S. federal income
tax rates and may be subject to an additional branch profits tax at a 30% rate,
unless it qualifies for a lower rate under an applicable income tax treaty.
FEDERAL ESTATE TAX
Common stock owned or treated as owned by an individual Non-U.S. Holder at
the time of death will be included in such holder's gross estate for U.S.
federal estate tax purposes, unless an applicable estate tax treaty provides
otherwise, and therefore may be subject to U.S. federal estate tax.
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
The Company must report annually to the IRS and to each Non-U.S. Holder the
amount of dividends, if any, paid to such holder and the tax, if any, withheld
with respect to such dividends. Copies of the information returns reporting such
dividends and withholding may also be made available to the tax authorities in
the country in which the Non-U.S. Holder resides under the provisions of an
applicable income tax treaty or certain other agreements.
Backup withholding at a 31% rate generally will not apply to dividends paid
prior to January 1, 2000 to a Non-U.S. Holder at an address outside the United
States (unless the payer has knowledge that the payee is a U.S. person). A
Non-U.S. Holder will generally be subject to backup withholding with respect to
dividends paid after December 31, 1999 unless applicable IRS certification
requirements (or, in the case of payments made outside the United States with
respect to an offshore account, certain documentary evidence procedures) are
satisfied.
Payment of the proceeds of a sale of common stock effected by or through a
U.S. office of a broker is subject to both backup withholding and information
reporting unless the beneficial owner provides the payer with its name and
address and certifies under penalties of perjury that it is a Non-U.S. Holder,
or otherwise establishes an exemption. In general, backup withholding and
information reporting will not apply to a payment of the proceeds of a sale of
common stock by or through a foreign office of a broker. If, however, such
broker is, for U.S. federal income tax purposes, a U.S. person, a controlled
foreign corporation, a foreign person that derives 50% or more of its gross
income for a certain period from the conduct of a trade or business in the
United States or, effective after December 31, 1999, another U.S.-related person
described in Section 1.6049-5(c)(5) of the Treasury Regulations, such payments
will be subject to information reporting (but not backup withholding), unless
(i) such broker has documentary evidence in its records that the beneficial
owner is a Non-U.S. Holder and certain other conditions are met or (ii) the
beneficial owner otherwise establishes an exemption.
Any amounts withheld under the backup withholding rules generally will be
allowed as a refund or a credit against the Non-U.S. Holder's U.S. federal
income tax liability provided the required information is furnished in a timely
manner to the IRS.
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UNDERWRITERS
Under the terms and subject to the conditions contained in an Underwriting
Agreement dated the date hereof (the "Underwriting Agreement"), the U.S.
underwriters named below, for whom Morgan Stanley & Co. Incorporated, Credit
Suisse First Boston Corporation and Lehman Brothers Inc. are acting as U.S.
representatives, and the international underwriters named below, for whom Morgan
Stanley & Co. International Limited, Credit Suisse First Boston (Europe) Limited
and Lehman Brothers International (Europe) are acting as international
representatives, have severally agreed to purchase, and the Company has agreed
to sell to them, the respective number of shares of our common stock set forth
opposite the names of such underwriters below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- --------------------------------------------------------------------------------- ----------
<S> <C>
U.S. underwriters:
Morgan Stanley & Co. Incorporated..............................................
Credit Suisse First Boston Corporation.........................................
Lehman Brothers Inc............................................................
----------
Subtotal................................................................... 5,200,000
----------
International underwriters:
Morgan Stanley & Co. International Limited.....................................
Credit Suisse First Boston (Europe) Limited....................................
Lehman Brothers International (Europe).........................................
----------
Subtotal................................................................... 1,300,000
----------
Total.................................................................... 6,500,000
----------
----------
</TABLE>
The U.S. underwriters and the international underwriters, and the U.S.
representatives and the international representatives, are collectively referred
to as the "underwriters" and the "representatives," respectively. The
Underwriting Agreement provides that the obligations of the several underwriters
to pay for and accept delivery of the shares of our common stock offered hereby
are subject to the approval of certain legal matters by their counsel and to
certain other conditions. The underwriters are obligated to take and pay for all
of the shares of common stock offered hereby (other than those covered by the
U.S. underwriters' over-allotment option described below) if any such shares are
taken.
Pursuant to the Agreement between U.S. and International Underwriters, each
U.S. underwriter has represented and agreed that, with certain exceptions:
- it is not purchasing any shares (as defined herein) for the account of
anyone other than a United States or Canadian person (as defined herein);
and
- it has not offered or sold, and will not offer or sell, directly or
indirectly, any shares or distribute any prospectus relating to the shares
outside of the United States or Canada or to anyone other than a United
States or Canadian person.
Pursuant to the Agreement between U.S. and International Underwriters, each
international underwriter has represented and agreed that, with certain
exceptions:
- it is not purchasing any shares for the account of any United States or
Canadian person; and
- it has not offered or sold, and will not offer or sell, directly or
indirectly, any shares or distribute any prospectus relating to the shares
in the United States or Canada or to any United States or Canadian person.
93
<PAGE>
With respect to any underwriter that is a U.S. underwriter and an
international underwriter, the foregoing representations and agreements made by
it in its capacity as a U.S. underwriter apply only to it in its capacity as a
U.S. underwriter and made by it in its capacity as an international underwriter
apply only to it in its capacity as an international underwriter. The foregoing
limitations do not apply to stabilization transactions or to certain other
transactions specified in the Agreement between U.S. and International
Underwriters. As used herein, "United States" or "Canadian person" means any
national or resident of the United States or Canada, or any corporation,
pension, profit-sharing or other trust or other entity organized under the laws
of the United States or Canada or of any political subdivision thereof (other
than a branch located outside the United States and Canada of any United States
or Canadian person), and includes any United States or Canadian branch of a
person who is otherwise not a United States or Canadian person. All shares of
common stock to be purchased by the underwriters under the Underwriting
Agreement are referred to herein as the "shares."
Pursuant to the Agreement between U.S. and International Underwriters, sales
may be made between the U.S. underwriters and international underwriters of any
number of shares as may be mutually agreed. The per share price of any shares so
sold shall be the public offering price set forth on the cover page hereof, in
United States dollars, less an amount not greater than the per share amount of
the concession to dealers set forth below.
Pursuant to the Agreement between U.S. and International Underwriters, each
U.S. underwriter has represented that it has not offered or sold, and has agreed
not to offer or sell, any shares, directly or indirectly, in any province or
territory of Canada or to, or for the benefit of, any resident of any province
or territory of Canada in contravention of the securities laws thereof and has
represented that any offer or sale of shares in Canada will be made only
pursuant to an exemption from the requirement to file a prospectus in the
province or territory of Canada in which such offer or sale is made. Each U.S.
underwriter has further agreed to send to any dealer who purchases from it any
of the shares a notice stating in substance that, by purchasing such shares,
such dealer represents and agrees that it has not offered or sold, and will not
offer or sell, directly or indirectly, any of such shares in any province or
territory of Canada or to, or for the benefit of, any resident of any province
or territory of Canada in contravention of the securities laws thereof and that
any offer or sale of shares in Canada will be made only pursuant to an exemption
from the requirement to file a prospectus in the province or territory of Canada
in which such offer or sale is made, and that such dealer will deliver to any
other dealer to whom it sells any of such shares a notice containing
substantially the same statement as is contained in this sentence.
Pursuant to the Agreement between U.S. and International Underwriters, each
international underwriter has represented and agreed that:
- it has not offered or sold and, prior to the date six months after the
closing date for the sale of the shares to the international underwriters,
will not offer or sell, any shares to persons in the United Kingdom except
to persons whose ordinary activities involve them in acquiring, holding,
managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United
Kingdom within the meaning of the Public Offers of Securities Regulations
1995;
- it has complied and will comply with all applicable provisions of the
Financial Services Act 1986 with respect to anything done by it in
relation to the shares in, from or otherwise involving the United Kingdom;
and
- it has only issued or passed on and will only issue or pass on in the
United Kingdom any document received by it in connection with the offering
of the shares to a person who is of a kind described in Article 11(3) of
the Financial Services Act 1986 (Investment Advertisements) (Exemptions)
Order 1996 (as amended) or is a person to whom such document may otherwise
lawfully be issued or passed on.
94
<PAGE>
Pursuant to the Agreement between U.S. and International Underwriters, each
international underwriter has further represented that it has not offered or
sold, and has agreed not to offer or sell, directly or indirectly, in Japan or
to or for the account of any resident thereof, any of the shares acquired in
connection with the distribution contemplated hereby, except for offers or sales
to Japanese international underwriters or dealers and except pursuant to any
exemption from the registrations requirements of the Securities and Exchange Law
and otherwise in compliance with applicable provisions of Japanese law. Each
international underwriter has further agreed to send to any dealer who purchases
from it any of the shares a notice stating in substance that, by purchasing such
shares, such dealer represents and agrees that it has not offered or sold, and
will not offer or sell, any of such shares, directly or indirectly, in Japan or
to or for the account of any resident thereof except for offers or sales to
Japanese international underwriters or dealers and except pursuant to any
exemption from the registration requirements of the Securities and Exchange Law
and otherwise in compliance with applicable provisions of Japanese law, and that
such dealer will send to any other dealer to whom it sells any of such shares a
notice containing substantially the same statement as is contained in this
sentence.
The Underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the cover
page hereof and part to certain dealers at a price that represents a concession
not in excess of $ a share under the public offering price. Any underwriter
may allow, and such dealers may reallow, a concession not in excess of $ a
share to other underwriters or to certain other dealers. After the initial
offering of the shares of common stock, the offering price and other selling
terms may from time to time be varied by the representatives.
The Company has granted to the U.S. underwriters an option, exercisable for
30 days from the date of this prospectus, to purchase up to an aggregate of
975,000 additional shares of common stock at the public offering price set forth
on the cover page hereof, less underwriting discounts and commissions. The U.S.
underwriters may exercise such option solely for the purpose of covering
over-allotments, if any, made in connection with the offering of the shares of
common stock offered hereby. To the extent such option is exercised, each U.S.
underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional shares of common stock as
the number set forth next to such U.S. underwriter's name in the preceding table
bears to the total number of shares of common stock set forth next to the names
of all U.S. underwriters in the preceding table. If the U.S. underwriters'
option is exercised in full, the total price to the public for this offering
would be $ , the total underwriters' discounts and commissions would be
$ and total proceeds to the Company would be $ .
The underwriters have informed the Company that each principal underwriter
in this offering may, subject to the approval of Morgan Stanley & Co.
Incorporated, sell to discretionary accounts over which such principal
underwriter exercises discretionary authority. The underwriters have further
informed the Company that they estimate that such sales will not exceed in the
aggregate five percent of the total number of shares of common stock offered by
them.
The Company has been approved for listing on the Nasdaq National Market
under the symbol "DEST."
At the request of the Company, the underwriters will reserve up to 325,000
shares of common stock to be issued by the Company and offered hereby for sale,
at the initial offering price, to directors, officers, employees of the Company
and others, who will agree to hold their shares for at least 180 days after the
date of this prospectus. This directed share program will be administered by
Morgan Stanley & Co. Incorporated. The number of shares of common stock
available for sale to the general public will be reduced to the extent such
individuals purchase such reserved shares. Any reserved shares which are not so
purchased will be offered by the underwriters to the general public on the same
basis as the other shares offered hereby.
95
<PAGE>
Each of the Company and certain directors and executive officers of the
Company and Princes Gate has agreed that, without the prior written consent of
Morgan Stanley & Co. Incorporated on behalf of the underwriters, it will not,
during the period ending 180 days after the date of this prospectus:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right
or warrant to purchase, lend, or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock; or
- enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the
common stock;
whether any such transaction described above is to be settled by delivery of
common stock or such other securities, in cash or otherwise.
The restrictions described in the previous paragraph do not apply to:
- the sale of shares to the underwriters;
- the issuance by the Company of shares of common stock upon the exercise of
an option or a warrant or the conversion of a security outstanding on the
date of this prospectus of which the underwriters have been advised in
writing;
- transactions by any person other than the Company relating to shares of
common stock or other securities acquired in open market or other
transactions after the completion of the offering.
In order to facilitate the offering, the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
common stock. Specifically, the underwriters may agree to sell (or allot) more
shares than the 6,500,000 shares of common stock the Company has agreed to sell
to them. This over-allotment would create a short position in the common stock
for the underwriters' account. To cover any over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering, if the syndicate repurchases previously
distributed common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. The underwriters have reserved the
right to reclaim selling concessions in order to encourage underwriters and
dealers to distribute the common stock for investment, rather than for
short-term profit taking. Increasing the proportion of the offering held for
investment may reduce the supply of common stock available for short-term
trading. Any of these activities may stabilize or maintain the market price of
the common stock above independent market levels. The underwriters are not
required to engage in these activities, and may end any of these activities at
any time.
From time to time, certain of the underwriters have provided, and may
continue to provide, investment banking services to the Company.
The Company and the underwriters have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act.
TRANSACTIONS WITH MORGAN STANLEY
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 $0.9 million of fees
and expenses. The Series A Preferred Stock is convertible into 3,553,821 shares
of common stock. The Series A Preferred Stock will be converted into common
stock upon the closing of this offering (the shares of Series A Preferred Stock
so converted are referred to herein as the "Conversion Shares").
96
<PAGE>
SECURITYHOLDERS AGREEMENT
Mr. Alfred West, the Company and Princes Gate entered into a Securityholders
Agreement in connection with Princes Gate's investment in the Company (the
"Securityholders Agreement"). This agreement will survive the closing of this
offering and will apply to the Conversion Shares. Certain terms of the
Securityholders Agreement are discussed below.
REGISTRATION RIGHTS. Holders of the Conversion Shares have certain
"piggy-back" registration rights. Following this offering, holders of at least
25% of the outstanding Registrable Shares (as defined in the Securityholders
Agreement) may make up to two demands of the Company to file a registration
statement under the Securities Act, subject to certain conditions and
limitations.
PARTICIPATION IN SALES BY MR. ALFRED WEST. Holders of the Conversion Shares
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.
BRIDGE FUNDING BY MORGAN STANLEY GROUP
In April 1997, Morgan Stanley Group Inc. ("Morgan Stanley Group"), an
affiliate of the lead underwriter in this offering and Princes Gate, agreed to
purchase from the Company up to $15.0 million of Bridge Notes. Bridge Notes
totaling $7.0 million were issued. The net proceeds from the Bridge Notes sold
by the Company were $6.6 million and were used to fund equipment and other
capital expenditures and operations. All of the outstanding Bridge Notes ($7.0
million) have been paid. Morgan Stanley Group received customary fees in
connection with the Bridge Notes.
In connection with the Note Purchase Agreement, the Company granted 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 Company's initial public offering.
LOAN TO MR. ALFRED WEST
In October 1997, Morgan Stanley, through its Private Wealth Management
division, provided Mr. Alfred West with a $3.0 million line of credit which is
collateralized with 2.7 million common shares. In April 1999, Morgan Stanley
increased the line of credit to $4.0 million. There is a balance of $2.4 million
outstanding on the line of credit on April 13, 1999, which is payable to Morgan
Stanley upon demand.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock. The initial public offering price will be determined by negotiations
between the Company and the U.S. representatives. The factors considered in
determining the initial public offering price include the future prospects of
the Company and its industry in general, revenues, earnings and certain other
financial operating information of the Company in recent periods, and the
price-revenue ratios, market prices of securities and certain financial and
operating information of companies engaged in activities similar to those of the
Company. The estimated initial public offering price range set forth on the
cover page of this preliminary prospectus is subject to change as a result of
market conditions and other factors.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed on for the
Company by Schulte Roth & Zabel LLP New York, New York. Certain legal matters in
connection with the offering will be passed on for the underwriters by Shearman
& Sterling New York, New York.
97
<PAGE>
EXPERTS
The financial statements as of December 31, 1997 and 1998 and for the three
years ended December 31, 1998, included in this prospectus and elsewhere in the
registration statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
ADDITIONAL INFORMATION
The Company is subject to the informational requirements of the Securities
Act, and, in accordance therewith, files reports and other information with the
Commission. Such reports and other information can be inspected and copied at
the public reference facilities maintained by the Commission at: Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549; Northwestern
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and
Seven World Trade Center, 13th Floor, New York, New York 10048. Copies of such
material also can be obtained from the Public Reference Section of the
Commission, at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549,
at prescribed rates. The Commission maintains a web site that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission. The address of such site is
http://www.sec.gov. The Company's common stock has been approved for quotation
on the Nasdaq National Market, and such reports, proxy and information
statements and other information also can be inspected at the office of Nasdaq
Operations, 1735 K Street, N.W., Washington, D.C. 20006.
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the common stock offered hereby.
This prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules to the Registration
Statement. For further information with respect to the Company and the common
stock offered hereby, reference is made to the Registration Statement and the
exhibits and schedules filed as a part of the Registration Statement. Statements
contained in this prospectus concerning the contents of any contract or any
other document to which this prospectus refers are not necessarily complete.
Each such statement is qualified in all respects to any underlying contract or
document filed as an exhibit to the Registration Statement. The Registration
Statement, including exhibits and schedules thereto, may be inspected without
charge at the Commission's principal office in Washington, D.C., and copies of
all or any part thereof may be obtained from such office after payment of fees
prescribed by the Commission.
The Company intends to provide its stockholders with annual reports
containing consolidated financial statements audited by an independent public
accounting firm.
98
<PAGE>
DESTIA COMMUNICATIONS, INC.
(FORMERLY ECONOPHONE, INC.)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<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>
After the stock split described in Note 17 of the Notes to Consolidated
Financial Statements is effected we expect to be in a postion to render the
following report.
Arthur Andersen LLP
New York, New York
February 2, 1999
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.
F-2
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
DECEMBER 31, DECEMBER 31,
-------------------- -------------
1997 1998 1998
--------- --------- -------------
<S> <C> <C> <C>
(UNAUDITED)
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;
20,778,321, 20,778,321 and 24,332,142 shares issued and
outstanding at December 31, 1997 and 1998 and pro forma,
respectively......................................................
2 208 243
Common stock--non-voting, par value $.01; authorized
500,000 shares; 0, 135,890 and 135,890 issued and outstanding at
December 31, 1997 and 1998 and pro forma, respectively............
-- 1 1
Additional paid-in capital..........................................
6,082 6,923 21,309
Accumulated other comprehensive loss................................
(104) (856) (856)
Accumulated deficit.................................................
(39,706) (108,743) (108,743)
--------- --------- -------------
Total stockholders' deficit...................................
(33,726) (102,467) (88,046)
--------- --------- -------------
Total liabilities and stockholders' deficit...................
$ 178,005 $ 388,208 $ 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)
--------- ---------- ----------
--------- ---------- ----------
HISTORICAL
LOSS PER SHARE (basic and diluted) (Note 2).................................... $ (0.41) $ (1.50) $ (3.31)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (basic and diluted) (Note
2)........................................................................... 20,778 20,778 20,846
--------- ---------- ----------
PRO FORMA LOSS PER SHARE (basic and diluted)(unaudited) (Note 2):.............. $ (2.83)
PRO FORMA WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (basic and
diluted) (Note 2)............................................................ 21,373 24,332 24,400
--------- ---------- ----------
</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........ 20,778 $ 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........ 20,778 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........ 20,778 2 -- -- 6,082 (39,706) (104)
Net loss.......................... -- -- -- -- -- (68,944) --
Issuance of non voting restricted
shares.......................... -- -- 136 1 994 -- --
Accretion of preferred stock...... -- -- -- -- -- (93) --
Change in par value............... -- 206 -- -- (206) -- --
Cumulative translation
adjustment...................... -- -- -- -- -- -- (752)
Other............................. -- -- -- -- 53 -- --
----------- ----- --- ----- ----------- ------------ -------
BALANCE, December 31, 1998........ 20,778 $ 208 136 $ 1 $ 6,923 $ (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,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
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,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................... $ 210 $ 505 $ 24,329
Income Taxes............................................... -- -- --
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 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.
Destia entered the US market in 1993 and the UK market in 1995. In continental
Europe, Destia commenced offering its service before the January 1, 1998
liberalization of telecommunications services in those markets.
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. See Note 17.
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 one 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
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)
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 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.
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)
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 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.
UNAUDITED PRO FORMA INFORMATION
The Company's historical capital structure is not indicative of its
prospective structure due to the automatic conversion of all shares of Series A
Redeemable Convertible Preferred Stock into common stock concurrent with the
closing of the Company's anticipated initial public offering ("IPO") (see Note
12 for conversion terms).
The unaudited pro forma consolidated balance sheet as of December 31, 1998,
reflects the conversion of 140,000 shares of the Series A Redeemable Convertible
Preferred Stock into approximately 3,554,000 shares of common stock.
Pro forma loss per share is computed using the weighted average number of
common shares outstanding during the period assuming the conversion of
convertible preferred stock issued into common stock as of the date of issuance.
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. All outstanding options,
warrants and convertible preferred shares would be antidilutive. Therefore,
their effect has been excluded from the calculation of diluted EPS.
F-11
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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..................... 20,778,000 20,778,000 20,846,000
------------- -------------- --------------
------------- -------------- --------------
</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 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
F-12
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
4. DEBT AND EQUITY SECURITIES (CONTINUED)
investments. The table below discloses the fair value of held-to-maturity
securities as of December 31, 1998.
<TABLE>
<CAPTION>
AGGREGATE
AGGREGATE FAIR VALUE GROSS GROSS
AMORTIZED DECEMBER 31, UNREALIZED UNREALIZED
COST BASIS 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,
-----------------------
1997 1998
---------- -----------
<S> <C> <C>
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.
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
F-13
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
6. TERRITORIAL RIGHTS (CONTINUED)
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.
F-14
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
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 its size and geographic dispersion. The
Company does not require 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. Bad debt expense is recorded quarterly and is based on the Company's
historical bad debt write-off experience. Actual write-offs are charged against
the bad debt allowance as certain accounts are determined to be uncollectable.
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>
NORTH OTHER
UNITED 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
--------------
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>
F-15
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
8. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
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:
<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.
F-16
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
9. BORROWINGS (CONTINUED)
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
matures 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 8.485 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 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>
F-17
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
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
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." 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.
F-18
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
11. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
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 1,315,148
shares of common stock, in the aggregate. The fair value of the shares issuable
upon exercise of the Warrants was determined to be $4.26 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.
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.
F-19
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
12. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
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 3,553,821 shares of common
stock and would convert automatically 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. (See Note 17 for a discussion of the repayment of
certain indebtedness).
The Company has an interest bearing note receivable at December 31, 1997 and
1998 for approximately $215,000 and $230,000, respectively, from a related
party.
The brother-in-law of Alfred West owns a 28% interest in Destia's Swiss
subsidiary, Econophone Services GmbH. (See Note 17 for a discussion of the
Company's acquisition of such interest)
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 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............ $ (8,608,000) $ (31,098,000) $ (69,037,000)
Pro Forma................................... (9,103,000) (31,889,000) (70,737,000)
Basic EPS:
As Reported................................. $ (0.41) $ (1.50) $ (3.31)
Pro Forma................................... $ (0.44) $ (1.53) $ (3.39)
</TABLE>
F-20
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
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 20,778 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 10,389 options granted to consultants during 1996 and the
10,389 options granted to consultants during 1998 have an exercise price of
$2.41 and $4.81, respectively. As of December 31, 1997 and 1998, 3,463 and
12,121 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, at various exercise prices 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, 1,152,418 and 2,239,583 options respectively, were
exercisable under the Company's 1996 Plan.
Option activity during 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
1997 1998
----------------------------- -----------------------------
<S> <C> <C> <C> <C>
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- ----------------- ---------- -----------------
Outstanding at beginning of year.................... 2,707,935 $ 2.41 3,014,358 $ 2.64
Granted............................................. 316,812 4.81 1,598,429 6.13
Cancelled........................................... (10,389) 2.41 (175,672) 2.93
Outstanding at end of year.......................... 3,014,358 2.64 4,437,115 3.85
Exercisable at end of year.......................... 1,152,418 2.41 2,239,583 2.74
Weighted average fair value of options granted...... 1.84 2.36
</TABLE>
F-21
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The fair value of each option grant is estimated on the date of grant 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>
NUMBER OUTSTANDING WEIGHTED AVERAGE NUMBER EXERCISABLE
EXERCISE AT REMAINING WEIGHTED AVERAGE AT WEIGHTED AVERAGE
PRICE DECEMBER 31, 1998 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 1998 EXERCISE PRICE
- ------------- ------------------- ------------------- ------------------- ------------------ -------------------
2$.41--$4.81.. 3,568,062 8.03 $ 3.05 2,239,583 $ 2.64
6$.50--$7.22.. 869,053 9.28 $ 7.14 -- --
</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.
As of December 31, 1998, 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. See Note 17 for a discussion regarding employment agreements
entered into after such date.
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
F-22
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 for a period of up to one year
following the closing of the acquisition.
VoiceNet provides travellers 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.
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.
F-23
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
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 initial public
offering of its common stock, with the number of shares and price to be
determined.
STOCK SPLIT
The financial statements retroactively reflect the 1.04 for 1 stock split
which will occur immediately prior to the completion of the above offering.
ACQUISITION OF MINORITY INTEREST IN SUBSIDIARY
On March 30, 1999, the Company acquired the 28% minority interest in
Econophone Services GmbH (Switzerland). The entire purchase price is classified
as goodwill, which is amortized over 20 years.
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
For a discussion on recent employment agreements and arrangements with
certain officers of the Company, see "Management--Employment Agreements and
Arrangements" in the Registration Statement.
REPAYMENT OF CERTAIN INDEBTEDNESS
The related party notes described in Note 13 have been repaid in full.
F-24
<PAGE>
[LOGO]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Company in connection
with the sale of common stock being registered. All amounts are estimates except
the SEC registration fee, the NASD filing fee and the NASDAQ National Market
listing fee.
<TABLE>
<S> <C>
SEC Registration fee.............................................................. $ 18,070
NASD Filing fee................................................................... *
NASDAQ National Market listing fee................................................ *
Printing and engraving expenses................................................... *
Legal fees and expenses........................................................... *
Accounting fees and expenses...................................................... *
Blue sky fees and expenses........................................................ *
Transfer agent fees............................................................... *
Miscellaneous fees and expenses................................................... *
<CAPTION>
---------
<S> <C>
Total............................................................................. $ *
<CAPTION>
---------
---------
</TABLE>
- ------------------------
* To be completed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Destia's Certificate of Incorporation indemnifies its officers and directors
to the fullest extent permitted by the DGCL. Under Section 145 of the DGCL, a
corporation may indemnify its directors, officers, employees and agents and
those who serve, at the corporation's request, in such capacities with another
enterprise, against expenses (including attorneys' fees), as well as judgments,
fines and settlements in nonderivative lawsuits, actually and reasonably
incurred in connection with the defense of any action, suit or proceeding in
which they or any of them were or are made parties are threatened to be made
parties by reason of their serving or having served in such capacity. The DGCL
provides, however, that such person must have acted in good faith and in a
manner such person reasonably believed to be in (or not opposed to) the best
interests of the corporation and, in the case of a criminal action, such person
must have had no reasonable cause to be believe his or her conduct was unlawful.
In addition, the DGCL does not permit indemnification in an action or suit by or
in the right of the corporation, where such person has been adjudged liable to
the corporation, unless, and only to the extent that, a court determines that
such person fairly and reasonably is entitled to indemnity for costs the court
deems proper in light of liability adjudication. Indemnity is mandatory to the
extent a claim, issue or matter has been successfully defended. The Certificate
of Incorporation and the GCL also prohibit limitations on officer or director
liability for acts or omissions which resulted in a violation of a statute
prohibiting certain dividend declarations, certain payments to stockholders
after dissolution and particular types of loans. The effect of these provisions
is to eliminate the rights of Destia and its stockholders (through stockholders'
derivative suits on behalf of Destia) to recover monetary damages against an
officer or director for breach of fiduciary duty as an officer or director
(including breaches resulting from grossly negligent behavior), except in the
situations described above. These provisions will not limit the liability of
directors or officer under the federal securities laws of the United States. The
foregoing summary of Destia's Certificate of Incorporation, as amended, is
qualified in its entirety by reference to the relevant provisions thereof (filed
as Exhibit 3.1).
In addition, Destia has entered into indemnification agreements with its
directors and officers providing for, among other things, indemnification to the
extent permitted under Delaware law.
II-1
<PAGE>
See Item 17 for a statement of the Company's undertaking as to the
Commission's position respecting indemnification arising under the Securities
Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since January 1, 1996, the Company has issued and sold the following
securities:
1. On November 1, 1996, the Company sold Princes Gate Investors II, L.P.
140,000 shares of Series A Preferred Stock with an aggregate liquidation
preference of $14.0 million for an aggregate purchase price of $13.44 million.
This sale was privately negotiated and did not involve a public offering and was
exempt from registration under the Securities Act in reliance on Section 4(2) of
such Act.
2. On April 24, 1997, the Company entered into a Note Purchase Agreement
pursuant to which Morgan Stanley Group purchased an aggregate amount of $7.0
million of Bridge Notes. Morgan Stanley Group acted as placement agent in this
transaction and received approximately $400,000 in fees and expenses in
connection with the transaction. This sale was privately negotiated and did not
involve a public offering and was exempt from registration under the Securities
Act in reliance on Section 4(2) of such Act.
3. On July 1, 1997, the Company sold $155.0 million of 13 1/2% Senior Notes
due 2007 and warrants to purchase 1,315,148 shares of voting common stock. This
issuance was underwritten by Morgan Stanley & Co. Incorporated who acted as
placement agent for this transaction and received fees of $5.425 million. All of
the Units were initially purchased by Morgan Stanley & Co. Incorporated pursuant
to Section 4(2) of the Securities Act and resold to "qualified institutional
buyers" pursuant to Rule 144A thereunder.
4. On February 18, 1998, the Company sold $300.0 million aggregate principal
amount at maturity of 11% Senior Discount Notes due 2008. This issuance was
underwritten by Morgan Stanley & Co. Incorporated who also received fees of
$6.152 million. All of such Notes were initially purchased by Morgan Stanley &
Co. Incorporated pursuant to Section 4(2) of the Securities Act and resold to
"qualified institutional buyers" pursuant to Rule 144A thereunder.
5. On July 14, 1998, the Company acquired the 30% minority interest in Telco
Global Communications Limited from Gold Valley Limited for a cash payment of
$13.75 million. The acquisition also included the rollover of employee options
in Telco into the Company's restricted Share awards. Approximately 145,448
restricted shares will be awarded as a result of the rollover. This transaction
was privately negotiated, did not involve a public offering and was exempt from
registration under the Securities Act in reliance on Section 4(2) of such Act.
6. On March 30, 1999, the Company acquired Mr. Samuel Gross' 28% interest in
Econophone Services GmbH, the Company's Swiss subsidiary. In exchange, Mr. Gross
received 103,891 restricted shares of the Company's common stock. This
transaction was privately negotiated, did not involve a public offering and was
exempt from registration under the Securities Act in reliance on Section 4(2) of
such Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
1.1* .. Form of Underwriting Agreement.
3.1* .. Amended and Restated Certificate of Incorporation.
3.2* .. Amended and Restated Bylaws.
3.3 .. Certificate of Name Change from Econophone, Inc. to Destia Communications, Inc. (incorporated by
reference to Form 10-K filed by the Company for the year ended December 31, 1998).
4.1** .. Specimen of Destia Communications, Inc.'s 11% Senior Discount Note due 2008.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.2** .. Indenture, dated as of February 18, 1998, between Destia Communications, Inc. and The Bank of New
York, as Trustee.
4.5** .. Specimen of Destia Communications, Inc.'s 13 1/2% 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.
4.5* .. Specimen of Common Stock certificate.
5.1* .. Opinion of Schulte Roth & Zabel LLP regarding legality.
8.1* .. Opinion of Schulte Roth & Zabel LLP regarding tax matters (contained in Exhibit 5.1).
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 Voice Net Corporation (incorporated by reference to Form 10-K filed by the
Company for the year ended December 31, 1998).
10.8* .. Employment Agreement, dated , 1999, between Destia Communications, Inc. and Alan Levy.
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 (incorporated by reference to Form 10-K filed by the Company for the year ended December 31,
1998).
10.11 .. Employment Agreement, dated February 2, 1998, between Destia Communications, Inc. and Kevin Alward.
10.12* .. Employment Agreement, dated January 1, 1999, between Destia Communications, Inc. and Richard L.
Shorten, Jr.
10.13*** .. Amended and Restated Destia Communications, Inc. 1996 Flexible Incentive Plan.
10.14 .. Amendment to 1996 Flexible Incentive Plan (incorporated by reference to Form 10-K filed by the
Company for the year ended December 31, 1998).
10.15 .. Stock Purchase Agreement, dated July 17, 1998, between Destia Communications, Inc. and certain
shareholders of Telco Global Communications (incorporated by reference to
Form 10-K filed by the Company for the year ended December 31, 1998).
10.16****.. Telecommunications Services Agreement between Frontier Communications of the West, Inc. and Destia
Communications, Inc., dated November 17, 1998.
10.17* .. 1999 Flexible Incentive Plan.
21.1 .. Subsidiaries of Destia Communications, Inc. (incorporated by reference to Form 10-K filed by the
Company for the year ended December 31, 1998).
23.1 .. Consent of Arthur Andersen LLP.
23.2* .. Consent of Schulte Roth & Zabel LLP (contained in Exhibit 5.1).
27.1 .. Financial Data Schedule.
</TABLE>
- ------------------------
* To be filed by pre-effective amendment.
II-3
<PAGE>
** 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-4,
Commission file number 333-33117, and hereby incorporated herein by
reference.
****Portions of the exhibit have been omitted pursuant to a request for
confidential treatment.
(b) Financial Statement Schedule
Schedule II--Schedule of Valuation and Qualifying Accounts (included
at page S-1)
ITEM 17. UNDERTAKINGS
A. The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933.
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table
in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
B. Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense or any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the Borough of Paramus, New Jersey on
the 16th day of April, 1999.
<TABLE>
<S> <C> <C>
DESTIA COMMUNICATIONS, INC.
By: /s/ PHILLIP J. STORIN
-----------------------------------------
Name: Phillip J. Storin
Title: Chief Financial Officer and Senior
Vice President (Principal Financial and
Accounting Officer)
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, the Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
Chief Executive Officer
and
* Chairman of the Board of
- ------------------------------ Directors
Alfred West (Principal Executive
Officer)
*
- ------------------------------ President, Chief Operating
Alan L. Levy Officer and Director
*
- ------------------------------ Director and Treasurer
Gary S. Bondi
*
- ------------------------------ Director
Steven West
*
- ------------------------------ Director
Stephen Munger
</TABLE>
<TABLE>
<S> <C> <C> <C>
*By: /s/ RICHARD L. SHORTEN, JR.
-----------------------------------
Richard L. Shorten, Jr., April 16, 1999
Attorney-in-fact
</TABLE>
Original powers of attorney authorizing Alan L. Levy, Richard L. Shorten and
Alfred West and each of them to sign this amendment on behalf of the directors
and officers of the Registrant indicated above are held by the Registrant and
available for examination pursuant to Rule 302(b) of Regulation S-T.
II-5
<PAGE>
SCHEDULE II
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
CHARGES
BALANCE AT TO COSTS BALANCE AT
BEGINNING AND END OF
OF PERIOD EXPENSES DEDUCTIONS(A) 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 writeoffs, recoveries and other deductions.
S-1
<PAGE>
Exhibit 10.11
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.
Kevin Alward ("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 President - North America 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.
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, 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
<PAGE>
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
$216,000 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 between 25% and 75% 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. Such annual bonus shall be payable no
later than 45 days after the end of each year during the Employment Term. 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 Econophone's 1996 Flexible Incentive Plan (the "Plan")
500,000 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, 401(k) savings and other benefits (collectively, the
"Benefits") in accordance with the prevailing
<PAGE>
policies of Econophone for executive employees. In addition, Executive shall be
entitled to a reimbursement for automobile expenses of up to $750.00 per month.
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 and the
business reasons for such expenditures.
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 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; PROVIDED
FURTHER, HOWEVER, that in the case of actions constituting Cause pursuant to
clauses (i), (ii), (iv), (v) or (vi) above that are susceptible to cure,
Econophone shall provide Executive with no less than 30 days notice of such
deficiencies prior to any termination as a result thereof and, during such prior
notice period, shall afford Executive the opportunity to remedy such deficiency
to Econophone's reasonable satisfaction.
<PAGE>
(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 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
<PAGE>
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;
provided that if Executive's death occurs in the first twelve (12) months of
Executive's employment by Econophone, then 100,000 of the options granted to
Executive in accordance with the terms of Executive's Incentive Stock Option
Agreement shall become immediately vested and exercisable.
(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;
provided that if Executive's termination by reasons of Disability occurs in the
first twelve (12) months of Executive's employment by Econophone, then 100,000
of the options granted to Executive in accordance with the terms of Executive's
Incentive Stock Option Agreement shall become immediately vested and
exercisable.
(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 (6) 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 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 by Econophone without Cause or by Executive for Good Reason occurs
in the first twelve (12) months of Executive's employment by Econophone, 100,000
of the options granted to Executive in accordance with the terms of Executive's
Incentive Stock Option Agreement shall become immediately vested and
exercisable.
<PAGE>
(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 5% 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 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.
<PAGE>
(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 following expiration, cancellation or other termination of this
Agreement.
SECTION 12. LIABILITY FOR ACTIONS OR INACTIONS; INDEMNIFICATION.
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
<PAGE>
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 the expiration,
cancellation or other termination of this Agreement until any liability under
all applicable statutes of limitations is barred.
(d) The provisions of this Section 12 are in addition to any
indmnifications rights that Executive may have pursuant to Econophone's
Certificate of Incorporation, By-laws and/or policies applicable to executive
employees.
SECTION 13. ENTIRE AGREEMENT. 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 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:
<PAGE>
(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 14 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.
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
<PAGE>
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. Kevin Alward
182 Powell Road
Allendale, NJ 07401
with a copy to:
John Kandravy, Esq.
Shanley & Fisher, P.C.
131 Madison Avenue
Morristown, NJ 07962
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
<PAGE>
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 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:
---------------------------
Name:
Title:
MR. KEVIN ALWARD
---------------------------
<PAGE>
Exhibit A
BONUS CRITERIA
--------------
<PAGE>
Exhibit B
INCENTIVE STOCK OPTION AGREEMENT
--------------------------------
<PAGE>
Exhibit 10.16
CONFIDENTIAL DOCUMENT
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
[* * *] = Intentionally omitted pursuant to a confidential treatment request and
separately filed with the Securities and Exchange Commission.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TELECOMMUNICATIONS SERVICES AGREEMENT
BETWEEN
FRONTIER COMMUNICATIONS OF THE WEST, INC.
AND
ECONOPHONE, INC.
DATED NOVEMBER 17, 1998
<PAGE>
TELECOMMUNICATIONS SERVICES AGREEMENT
This Telecommunications Services Agreement ("Agreement") is
entered into as of November 17, 1998 between the provider of service, Frontier
Communications of the West, Inc. f/k/a West Coast Telecommunications, Inc. on
behalf of itself and its affiliates ("Frontier"), a California corporation
located at 90 Castillian Drive, Goleta, California 93117 and Econophone, Inc.
("Econophone"), a Delaware corporation with its principal place of business
located at 95 Route 17 South, Paramus, New Jersey 07652 (hereinafter, Frontier
and Econophone may be referred to in the aggregate as "Parties", and each
singularly as a "Party").
PURPOSE
Econophone desires to purchase telecommunications services in
the form of the right to use Capacity in the Frontier Network as set forth more
fully herein. The rights granted hereunder do not provide Econophone with any
ownership interest or other rights to control of, modification of, or other use
of, t he Frontier Network, except as set forth specifically herein. Econophone
intends to capitalize its payments for Capacity hereunder and amortize them over
the Initial Term of this Agreement. The Parties agree as follows:
DEFINITIONS
"Affiliate" means any current or future person or entity (i)
which directly or indirectly controls or is controlled by, or is under common
control with, a party hereto or (ii) at least fifty percent (50%) of which is
held beneficially or of record by a party hereto or one of its subsidiaries.
"Capacity" means the dedicated transmission capability of a
given portion of the Frontier Network designed to transmit digital signals at a
stated rate and otherwise perform in accordance with the specifications
applicable to the portion of the Frontier Network utilized to provide the
Capacity. All Capacity shall be provided by network facilities inclusive of all
electronics and other equipment necessary for the intended operation of the
Capacity. All Capacity is collectively referred to herein as the "Services."
"Capacity Rights" means the right to use "as is and where is,"
for the purposes described herein, the stated amount of Capacity on a Frontier
Network Segment; provided that, as stated above, the Capacity Rights granted
hereunder do not provide Econophone with any ownership interest in or other
rights to control, modify, or otherwise use the Frontier Network except as
specifically set forth herein.
"Frontier Network" means the new SONET network that is
currently under construction and described more fully herein.
"Frontier Network Segment" means the portions of the Frontier
Network between the city pairs defined in Exhibit A, attached hereto and made a
part hereof, and such other exhibits as the Parties may, from time to time,
execute and attach hereto ("Exhibits").
<PAGE>
"Impositions" means all taxes, fees levies, imposts, duties,
charges or withholdings of any nature (including, without limitation, gross
receipts taxes and license and permit fees), except income, estate, franchise or
transfer taxes, together with any penalties, fines or interest thereon arising
out of the transactions contemplated by this Agreement and/or imposed upon the
Frontier Network by any federal, state or local government or other public
taxing authority.
"POP" means the point of presence where the Capacity is
delivered to a party.
1. SERVICES.
(a) Frontier hereby grants to Econophone the Capacity
Rights, for the purposes described herein, in the miles of DS-3 and OC-3 circuit
capacity described in Paragraph 4(b) below.
(b) Econophone understands that the Services will be
provided on a new SONET network that is currently under construction and that
once the Frontier Network is constructed, the Services may be provided by
Frontier or any Frontier Affiliate. Frontier will advise Econophone of
construction progress on no less than a monthly basis. Except as expressly set
forth in the following subparagraphs, all Capacity comprising a portion of the
Capacity Rights shall be delivered to Econophone at a cross-connect panel
located in the Frontier POP in each designated city as set forth in Exhibit A
hereto. Unless Econophone has separately arranged for collocation space in any
such Frontier facility, it shall be the responsibility of Econophone to obtain
any required transiting facilities or local distribution facilities to
interconnect with the Frontier Network.
(c) Frontier shall use commercially reasonable best
efforts to provide the Capacity on or prior to the Target Dates as set forth on
Exhibit A. However, in the event that it is unable to provide Capacity to
Econophone for any Frontier Network Segment within ninety (90) days of the
Target Date as set forth in Exhibit A, Frontier shall provide Econophone a
credit equal to the difference between the agreed upon price for that Segment as
set forth in Exhibit A, together with all reasonable associated maintenance
charges and other expenses, and the price paid by Econophone for service for
such Segment to an alternative provider, together with all reasonable associated
maintenance charges and other expenses, in accordance with this Paragraph from
the period commencing on such ninetieth day until the applicable Service
Availability Date, as defined in Paragraph 2(c) below. Frontier and Econophone
shall work together in good faith to procure such service from an alternative
provider at a rate reasonably acceptable to both parties. In the event that
Frontier fails to cooperate in such effort, or in the event that Econophone has
not obtained alternative capacity within one hundred five (105) days after the
applicable Target Date, Econophone shall have the right to procure such
replacement service itself.
(d) Econophone shall have the right to resell
Capacity on the Frontier Network to third parties, provided that Econophone
shall not acquire additional Capacity Rights solely for the purpose of the
domestic resale of bulk capacity.
-2-
<PAGE>
2. DELIVERY.
(a) At delivery, the Capacity shall comply with the
specifications set forth in Exhibit B hereto (Capacity Specifications). Frontier
shall test the Capacity or cause the Capacity to be tested to verify that the
Capacity is operating in accordance with the applicable specifications described
in Exhibit B.
(b) In the event the results of any Capacity
acceptance test show that the Capacity is not operating within the parameters of
the applicable specifications set forth in Exhibit B, Frontier shall
expeditiously take such action as shall be reasonably necessary, with respect to
such portion of the Capacity as does not operate within the parameters of the
applicable specifications, to bring the operating standards of such portion of
the Capacity within such parameters.
(c) Frontier shall notify Econophone when the test of
the Capacity acceptance test are within the parameters of the specifications in
Exhibit B with respect to the tested Capacity. If Econophone fails to notify
Frontier of any material non-compliance with respect to the Capacity within five
(5) business days after its receipt of notice of such test results, Econophone
shall be deemed to have accepted such Capacity. The date of notice of acceptance
(or deemed acceptance) of the Econophone Capacity shall be the "Service
Availability Date" for that Capacity. Following notice by Econophone of any
material non-compliance as set forth above, Frontier shall promptly use
commercially reasonable best efforts to correct such non-compliance and shall,
upon correction, notify Econophone. If Econophone fails to notify Frontier of
any remaining material non-compliance with respect to such Capacity within five
(5) business days after receipt of notice of such correction, Econophone shall
be deemed to have accepted such Capacity.
3. TERM OF THE AGREEMENT. This Agreement is binding on the
Parties upon the date of execution by both Frontier and Econophone ("Effective
Date") and, subject to the termination provisions of this Agreement, shall
remain in effect for a period of 20 years from the Service Availability Date (as
defined in Paragraph 1(d) above) for the first circuit to be available to
Econophone pursuant to this Agreement ("Initial Term"). Within six months prior
to the end of the Initial Term the parties, will negotiate in good faith to
determine whether and upon what terms this Agreement will renew for an
additional term. If the parties fail to reach agreement as to the terms of any
renewal, this Agreement will terminate as of the end of the Initial Term.
4. RATES; BILLING AND PAYMENT; MINIMUM COMMITMENTS.
(a) In consideration of the grant of Capacity Rights
as described in Paragraph 1(a) above, Econophone shall pay Frontier for the
Services at the rate of [* * *] per DS-O channel mile for the Initial Term (the
"Base Rate"). Econophone shall be obligated to pay the Base Rate for the
Services for the entire Initial Term as a non-recurring charge in the amount of
[* * *] ("Total Non-recurring Charge"). Econophone is also liable for applicable
taxes and governmental assessments with respect to its use of the Services.
Econophone shall pay Frontier 10% of the Total Non-recurring Charge [* * *] upon
execution of this Agreement. Such
-3-
<PAGE>
amount shall be sent by wire transfer to the designated Frontier account within
72 hours of signature by Frontier.
(b) If the total circuit capacity purchased hereunder
equals or is less than 30,000,000 DS-O channel miles, there will be no
adjustment to the Base Rate. If the total circuit capacity purchased hereunder
is greater than 30,000,000 DS-O channel miles, Econophone shall pay Frontier as
follows:
<TABLE>
<CAPTION>
Volume of Capacity One-Time Network
(in DS-O Miles) Charge Monthly Maintenance
--------------- ----------------- -------------------
<S> <C> <C>
First 30,000,000 [* * *]/DS-0 Mile [* * *]/DS-0 Mile*
30,000,001 - 50,000,000 [* * *]/DS-0 Mile [* * *]/DS-0 Mile
Over 50,000,000 [* * *]/DS-0 Mile [* * *]/DS-0 Mile
</TABLE>
*The monthly maintenance rate of [* * *] per DS-0 mile/month shall
apply for the first [* * *] years of this Agreement for the first
30,000,000 DS-0 miles only. Thereafter, maintenance pricing shall be
[* * *] for the remaining [* * *] years of the initial term regardless
of volume. The monthly maintenance rate of [* * *] shall apply
incrementally to increases in volume above 30,000,000 miles for the
entire Initial Term of the Agreement.
(c) Frontier may purchase services from Econophone
("Econophone Services") on a monthly basis. During the period commencing as of
the Effective Date and continuing for a period of [* * *] months, Frontier shall
pay Econophone for the Econophone Services at the applicable rates, terms and
conditions agreed upon by the parties, pursuant to Econophone's Carrier Services
Agreement, to be negotiated and entered into by parties. During the period
commencing with the [* * *] after the Effective Date and continuing for
thirty-six (36) months thereafter, Frontier shall have the right to purchase on
a monthly basis up to a cumulative average of one million dollars ($1,000,000)
in Econophone Services, determined as of that date, to be offset as described in
this Paragraph. During that thirty-six (36) month period, each party shall
provide the other party a quarterly statement of amounts owed that party to the
other party, but, after the sixth month, neither party shall be required to make
nay payment under this Agreement for the Services or for the Econophone
Services, up to the amount set forth above, [* * *]. Frontier shall pay
Econophone in cash or equivalents on a monthly basis any undisputed amounts due
for the Econophone Services in excess of the amount set forth above at the rates
agreed upon by the parties. Disputes will be administered in accordance with
Section 6. At the end of such period, the parties shall net out all amounts due
by Frontier for the Econophone Services against the remaining ninety percent
(90%) of the Total Non-recurring Charge, plus any other amounts due Frontier
pursuant to this Agreement. The party owing money when such charges are netted
out will pay the other party the amount owed within thirty (30) days of receipt
of an invoice from the other party.
-4-
<PAGE>
(d) In addition to the Total Non-recurring Charge,
Econophone shall pay maintenance charges during the Initial Term at the rate per
DS-O channel mile per month set forth in Paragraph 4(b) beginning on the Service
Availability Date for each circuit. Maintenance charges are invoiced to
Econophone monthly in advance.
(e) Econophone shall have the right to purchase DS-1
or DS-3 capacity in addition to the Services described in Paragraph 1(a) for
one-year or two-year terms at the following rates, provided that such circuits
are on the Frontier Network:
<TABLE>
<CAPTION>
DSO-Rate/ Installation
Capacity Term Mi./Month Minimum Charge
-------- ---- --------- ------- ------
<S> <C> <C> <C> <C>
DS-1 1 year [***] $200 $200
DS-1 2 years [***] $200 $200
DS-3 1 year [***] $500 $500
DS-3 2 years [***] $500 $500
</TABLE>
(f) As part of this Agreement, Frontier shall
provide Econophone, for a period of thirty (30) months commencing March 1,
1999, where available to Frontier, DS-3 capacity in a quantity not to exceed
8,532 DS-3 miles (5.7 million DS-0 miles) [***]. Econophone shall have the
right to resell such capacity, regardless of any other provision of this
Agreement. After such thirty-month period, any DS-3 facilities installed
pursuant to this Paragraph may be terminated at any time by Econophone upon
thirty (30) days prior written notice to Frontier, and, if not terminated by
Econophone, such facilities shall be priced at [***]/DS-0 mile. During the
thirty-month period, any facilities installed pursuant to this Paragraph
shall be subject to a $500/DS-3 minimum and a $500/DS-3 installation charge.
Econophone shall have the right to obtain no more than four (4) DS-3s on any
one City Pair.
(g) Frontier will provide three to one (DS-3 to DS-1)
multiplexing where available at the monthly rate of $100 per DS-1 end.
(h) Frontier will permit Econophone to order local
loops onto Frontier's existing local loop facilities where capacity is
available. Frontier agrees to provide such local loop facilities at Frontier's
then-current cost for such facilities, including all applicable recurring and
non-recurring charges.
(i) Frontier will investigate the possibility of
providing DS-3 capacity to Econophone through its Buffalo, New York and Windsor
Tunnel, Michigan border crossings. If Frontier determines that such capacity is
available, Frontier shall make it available to Econophone at pricing to be
determined at that time.
(j) Payment terms are net 30 days. Maintenance
charges are invoiced to Econophone monthly in advance. Any undisputed amounts on
an invoice not paid by its due
-5-
<PAGE>
date shall bear late payment fees at the rate of 1-1/2% per month (or such lower
amount as may be required by law) until paid.
(k) If Econophone is delinquent in payment of any
invoice and Frontier does not have security from Econophone equal to
Econophone's prior month's maintenance charges, Econophone shall provide such
additional security as Frontier may reasonably request in writing.
(l) The pricing in this Agreement and any Exhibit is
limited to Services provided between "on-net" Frontier city pair nodes both
resident on Frontier's SONET-ring network.
5. USE OF CAPACITY; NETWORK ACCESS AND CONFIGURATION.
(a) Econophone and its designees shall have access,
in accordance with Frontier's generally applicable standards, to the Frontier
POPs at the endpoints of each Frontier Network Segment and shall have the right
to interconnect with the Frontier Network according to the standards and
procedures regularly established by Frontier.
(b) Except as otherwise specifically provided in this
Agreement or an Exhibit, Econophone shall be responsible for its own
configuration and use of the Capacity. Econophone is responsible for ordering
all facilities and equipment necessary for its interconnection to Frontier's
Network for use of the Services. Econophone shall be liable for all costs and
expenses of interconnection, including without limitation, the installation,
testing, maintenance and operation of equipment and facilities.
(c) In the event that Econophone desires to
reconfigure any circuit it acquires hereunder so as to be different than the
configuration set forth on Exhibit A hereto, Econophone shall notify Frontier of
its desired reconfiguration. Subject to mutually agreeable available, Frontier
will implement the reconfiguration of the Capacity as requested by Econophone,
subject to the following condition:
Subsequent to the initial configuration, a
Non-Recurring Charge ("NRC") equal to US$42,500 shall be applicable to each
reconfiguration requested by Econophone which requires the physical rerouting of
a circuit on which Capacity is provided. As an example and without limiting the
generality of the above, if Capacity is being provided between New York and Los
Angeles via Denver, and a new drop and insert point is desired in Denver, the
NRC would apply.
6. BILLING DISPUTES. The Parties agree that time is of the
essence for payment of all invoices. Econophone shall provide written notice and
supporting documentation for any good-faith dispute it may have with an invoice
provided by the other party ("Dispute") within 60 business days after
Econophone's receipt. If Econophone does not report a Dispute within the 60
business day period, Econophone shall have waived its dispute rights for that
invoice. The parties will use reasonable efforts to resolve timely Disputes
within 30 business days after its receipt of the Dispute notice. If a Dispute is
not resolved within the 30 business day period to
-6-
<PAGE>
Econophone's satisfaction, then at Econophone's request the Dispute will be
referred to an executive officer of Frontier. If the Dispute is not resolved
within 15 business days after the referral, then either Party may commence an
action in accordance with Section 14, provided that the prevailing Party in such
action shall be entitled to payment of its reasonable attorney fees and costs by
the other Party.
7. TERMINATION RIGHTS.
(a) Either Party may terminate this Agreement upon
the other Party's insolvency, dissolution or cessation of business operations.
Frontier may terminate this Agreement for Econophone's failure to pay any
delinquent Invoice, or to maintain any other assurance of payment that may be
required hereunder, within five business days following Purchaser's receipt of
written notice from Frontier.
(b) In the event of a breach of any material term or
condition of this Agreement by either party or a material breach by either party
of any other agreement between Econophone (or any Affiliate or subsidiary of
Econophone) and Frontier (or any Affiliate of Frontier) (other than a failure to
pay amounts owed pursuant to this Agreement which is covered under (a) above),
in addition to any other available remedies, the other Party may terminate this
Agreement upon 30 days written notice, unless the breaching Party cures the
breach during the 30 days period, or, if such breach cannot reasonably be cured
with such 30 day period, the breaching Party begins to cure the breach within
such period, notifies the other party in writing of the steps that it is taking
to cure such breach and diligently pursues such cure until completed.
8. QUALITY ASSURANCE, WARRANTIES AND LIMITATION OF LIABILITY.
(a) Service shall be provided by Frontier in
accordance with the applicable technical standards set forth in Exhibit B and
those established for dedicated circuit capacity by the telecommunications
industry for a digital SONET fiber optic network, except that in the event of a
conflict, Exhibit B shall govern. FRONTIER MAKES NO OTHER WARRANTY, EXPRESS OR
IMPLIED, WITH RESPECT TO TRANSMISSION, EQUIPMENT OR SERVICE PROVIDED HEREUNDER,
AND EXPRESSLY DISCLAIMS ANY WARRANTY OF MERCHANTABILITY OR FITNESS FOR ANY
PARTICULAR PURPOSE OR FUNCTION.
(b) Frontier will provide, or cause to be provided,
the maintenance necessary to keep the Capacity in accordance with the standards
set forth in Exhibit B and applicable industry technical standards throughout
the Initial Term and any renewal terms, except that in the event of a conflict,
Exhibit B shall govern.
(c) Frontier warrants that the Capacity shall operate
in accordance with the standards established by Frontier for the Frontier
Network generally (hereinafter the "Technical Standards"). If Frontier
determines that the Capacity is not being provided in accordance with the
Technical Standards, Frontier shall use reasonable best efforts under the
circumstances to confirm the Capacity to the Technical Standards.
-7-
<PAGE>
(d) Frontier shall use commercially reasonable best
efforts to ensure that vendor communications software and/or hardware used to
provide the Capacity are fully Year 2000 complaint. As the sole remedy for
breach of the foregoing, Frontier shall use commercially reasonable best efforts
to make the vendor communications software and/or hardware fully Year 2000
complaint.
(e) Frontier shall use its best efforts to minimize
service interruptions, outages and degradations due to maintenance. For
interruptions, outages or degradations of greater than thirty (30) minutes which
are not caused by (i) Econophone or third parties, (ii) a scheduled
interruption, or (iii) force majeure, Frontier shall credit Econophone in
accordance with the following formula. The credit is computed by calculating the
monthly charge for the affected circuit, using the Initial Term and the rates
set forth in Paragraph 3(b) above and multiplying that monthly charge by the
ratio that the number of hours (including fractional parts calculated to the
nearest tenth of an hour) in the period of interruption bears to 720 (each month
is considered to have 720 hours). Interruptions are measured from the time
Econophone notifies Frontier of the interruption by expeditious means, until the
interruption is corrected.
(f) In no event shall either Party be liable to the
other Party for incidental and consequential damages, loss of goodwill,
anticipated profit, or other claims for indirect damages in any manner related
to this Agreement or the Services.
9. TAXES, FEES AND OTHER GOVERNMENTAL IMPOSITIONS. Each party
shall be independently responsible for any Impositions properly payable with
respect to the Capacity acquired by said party pursuant to the
Telecommunications Services Agreement entered into hereunder. Further, the
parties agree that they will cooperate with each other and coordinate their
mutual efforts concerning audits, or other such inquiries, filings, reports,
etc., as may relate solely to the activities or transactions arising from or
under this Agreement, which may be required or initiated from or by any duly
authorized governmental tax authority.
10. INDEMNIFICATION. Each Party shall defend and indemnify the
other Party and its directors, officers, employees, representatives and agents
from any and all claims, taxes, penalties, interest, expenses, damages, lawsuits
or other liabilities (including without limitation, reasonable attorney fees and
court costs) relating to or arising out of (i) acts or omissions in the
operation of its business; (ii) its breach of this Agreement; and (iii) its
intentional acts or omissions or negligence; provided, however, Frontier shall
not be liable and shall not be obligated to indemnify Econophone, and Econophone
shall defend and indemnify Frontier hereunder, for any claims by any third
party, including Purchaser's customers, with respect to services provided by
Econophone which may incorporate any of the Services.
11. RELATIONSHIP OF THE PARTIES. The relationship between
Econophone and Frontier shall not be that of partners, agents, or joint
venturers for one another, and nothing contained in this Agreement shall be
deemed to constitute a partnership or agency agreement between them for any
purposes, including but not limited to federal income tax purposes. Econophone
and Frontier, in performing any of their obligations hereunder, shall be
independent
-8-
<PAGE>
contractors or independent parties and shall discharge their contractual
obligations at their own risk.
12. FORCE MAJEURE. Other than with respect to failure to make
payments due hereunder, neither Party shall be liable under this Agreement for
delays, failures to perform, damages, losses or destruction, or malfunction of
any equipment, or any consequence thereof, caused or occasioned by, or due to
fire, earthquake, flood, water, the elements, labor disputes or shortages,
utility curtailments, power failures, explosions, civil disturbances,
governmental actions, shortages of equipment or supplies, unavailability of
transportation, acts or omissions of third parties, or any other cause beyond
its reasonable control.
13. WAIVERS. Failure of either Party to enforce or insist upon
compliance with the provisions of this Agreement shall not be construed as a
general waiver or relinquishment of any provision or right under this Agreement.
14. ASSIGNMENT. Neither Party may assign or transfer its
rights or obligations under this Agreement without the other Party's written
consent, which consent may not be unreasonably withheld or delayed, except in
accordance with the terms of this Paragraph. Either party may assign this
Agreement to its parent, successor in interest, or an Affiliate or subsidiary
with written notice, but without the other party's consent; provided that, in
the case of an assignment by Econophone, the assignee must meet all of
Frontier's standard credit requirements. Any assignment or transfer without the
required notice and/or consent is void.
15. CONFIDENTIALITY. Each Party agrees that all information
furnished to it by the other Party, or to which it has access under this
Agreement, shall be deemed the confidential and proprietary information or trade
secrets (collectively referred to as "Proprietary Information") of the
Disclosing Party and shall remain the sole and exclusive property of the
Disclosing Party (the Party furnishing the Proprietary Information referred to
as the "Disclosing Party" and the other Party referred to as the "Receiving
Party"). Each Party shall treat the Proprietary Information and the contents of
this Agreement in a confidential manner and, except to the extent necessary in
connection with the performance of its obligations under this Agreement or as
required by applicable law, neither Party may directly or indirectly disclose
the same to anyone other than its employees or agents on a need to know basis
and who agree to be bound by the terms of this Section, without the written
consent of the Disclosing Party.
16. INTEGRATION. This Agreement and all Exhibits and other
attachments incorporated herein, represent the entire agreement between the
Parties with respect to network capacity and supersede and merge all prior
agreements, promises, understandings, statements, representations, warranties,
indemnities and inducements to the making of this Agreement relied upon by
either Party, whether written or oral.
17. GOVERNING LAW. This Agreement is subject to the laws of
New York, excluding its choice of law principles. The Parties agree that any
action to enforce or interpret the terms of this Agreement shall be instituted
and maintained only in either the Federal Court for the Western District of New
York, or if jurisdiction is not available in Federal Court, then a
-9-
<PAGE>
state court located in Rochester, New York. Each party hereby consents to the
jurisdiction and venue of such courts and waives any right to object to such
jurisdiction and venue.
18. NOTICES. All notices, including but not limited to,
demands, requests and other communications required or permitted hereunder (not
including invoices) shall be in writing and shall be deemed to be delivered when
actually received, whether upon personal delivery or if sent by facsimile with
confirmed receipt, certified mail, return receipt requested, or overnight
delivery. All notices shall be addressed to the Parties at the addresses set
forth in the preamble, or to such other address as each of the Parties hereto
may notify the other.
19. COMPLIANCE WITH LAWS. During the term of this Agreement,
the Parties shall comply with all local, state and federal laws and regulations
applicable to this Agreement and to their respective businesses. In particular,
each party warrants that it shall comply with federal and state tariffing
obligations.
20. PUBLICITY. The parties shall cooperate in developing the
content and timing of all press releases and all other publicity related to the
transactions contemplated herein. Neither party shall issue a press release or
other publicity concerning such transactions without the other party's prior
consent.
21. SEVERABILITY. If any term, covenant or condition contained
herein shall, to any extent, be invalid or unenforceable in any respect under
the laws governing this Agreement, the remainder of this Agreement shall not be
affected thereby, and each term, covenant or condition of this Agreement shall
be valid and enforceable to the fullest extent permitted by law.
22. NON-SOLICITATION.
During the first two years of the initial term hereof, neither
party shall directly solicit for employment any employee of the other party, at
anytime, or its Affiliates as of the date hereof.
-10-
<PAGE>
23. SURVIVAL OF PROVISIONS.
Any obligations of the Parties relating to monies owed, as
well as those provisions relating to confidentiality, limitations on liability
and indemnification, survive termination of this Agreement.
The Parties, by their duly authorized representatives, have
executed this Agreement on the dates set forth below.
FRONTIER COMMUNICATIONS ECONOPHONE, INC.
OF THE WEST, INC.
By: By:
---------------------------------- -----------------------------
Anthony J. Cassara Alan Levy
President - Carrier Services Group President & Chief Operating
Officer
Date: Date:
---------------------------------- -----------------------------
-11-
<PAGE>
EXHIBIT A
CITY PAIRS
<TABLE>
<CAPTION>
CITY-PAIR AIR MILES DS3'S QUANTITY DSO MILES TARGET DATE
--------- --------- ----- -------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Atlanta Charlotte 227 1 1 152,544 4/99
Atlanta Orlando 398 1 1 267,456 11/99
Chicago Battlecreek 129 1 1 86,688 1/99
Chicago Des Moines 310 1 1 208,320 2/99
Chicago Detroit 227 1 1 152,544 1/99
Chicago Kansas City 411 1 1 276,192 3/99
Chicago Milwaukee 81 1 1 54,432 1/99
Chicago Minneapolis 352 1 1 236,544 3/99
Chicago Minneapolis 352 1 1 236,544 3/99
Chicago St. Louis 261 1 1 175,392 3/99
Dallas Denver 659 1 1 442,848 11/98
Dallas Houston 224 1 1 150,528 11/98
Dallas San Antonio 250 1 1 168,000 1/99
Dallas Tulsa 235 1 1 157,920 1/99
Detroit Cleveland 107 1 1 71,904 3/99
Indianapolis Columbus 168 1 1 112,896 4/99
Indianapolis Louisville 107 1 1 71,904 3/99
LA Phoenix 359 1 1 241,248 3/99
LA St. Louis 1,585 1 1 1,065,120 3/99
LA Seattle 966 1 1 649,152 3/99
Miami Orlando 201 1 1 135,072 11/99
NY Albany 136 1 1 91,392 4/99
NY Philadelphia 81 1 1 54,432 4/99
NY Poughkeepsie 69 1 1 46,368 1/99
Philadelphia Harrisburg 93 1 1 62,496 3/99
Washington Baltimore 36 1 1 24,192 4/99
Washington Pittsburgh 190 1 1 127,680 4/99
Washington Raleigh 229 1 1 153,888 1/99
Chicago Denver 917 3 1 1,848,672 3/99
Chicago Detroit 227 3 1 457,632 3/99
Chicago Indianapolis 165 3 1 332,640 11/98
Chicago Indianapolis 165 3 1 332,640 11/98
Chicago NYC 711 3 1 1,433,376 3/99
Dallas Atlanta 721 3 1 1,453,536 4/99
DC Atlanta 541 3 1 1,090,656 4/99
Denver LA 829 3 1 1,671,264 3/99
LA Dallas 1,240 3 1 2,499,840 3/99
LA San Diego 108 3 1 217,728 1/99
LA San Francisco 350 3 1 705,600 3/99
Miami Atlanta 599 3 1 1,207,584 6/99
NY Boston 191 3 1 385,056 3/99
NY Buffalo 294 3 1 592,704 6/99
NY LA 2,442 3 1 4,923,072 3/99
</TABLE>
A-1
<PAGE>
<TABLE>
<CAPTION>
CITY-PAIR AIR MILES DS3'S QUANTITY DSO MILES TARGET DATE
--------- --------- ----- -------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
NY Miami 1,093 3 1 2,203,488 5/99
NY Newark 9 3 1 18,144 12/98
NY Washington 204 3 1 411,264 5/99
Total DS-0 Miles: 27,458,592(1)
</TABLE>
(1) Additional Miles to be determined but not less than 30,000,000.
A-2
<PAGE>
EXHIBIT B
CAPACITY SPECIFICATIONS
1.1 SONET: Synchronous Optical Network is a family of optical transmission
rates and interface standards allowing inter-networking of products
from different vendors. Base optical rate is 51.804 Mb/s. Higher rates
are direct multiples. DS3, OC-3, OC-12, OC-48, OC-3c, OC-12c, and
OC-48c circuit performance will be measured using two parameters:
Availability and Error-Free Seconds.
1.2 Availability is a measure of the relative amount of time during which
the circuit is available for use. According to CITT and ANSI
definitions, unavailability begins when the Bit Error Ratio (BER) in
each second is worse than 1.0 E-3 for a period of 10 consecutive
seconds.
Inter Office Channel (IOC): An Inter Office Channel refers to the
Frontier Network between the points of presence (POP).
Optical Carrier level 1 (OC-1): The optical signal that results from an
optical conversion of an electrical STS-1 signal (51.840 Mb/s). This
signal forms the basis of the interface.
OC-3: Optical Carrier level 3 signal operating at 155.520 Mb/s. OC-12:
Optical Carrier level 12 signal transmitting at 622.080 Mb/s. OC-48:
Optical Carrier level 48 signal transmitting at 2488.32 Mb/s.
Point of Presence (POP): A physical location where a long distance
carrier terminates lines before connecting to the local exchange
carrier, another carrier, or directly to a customer.
1.3 The availability objective for all circuits between Frontier Network
Interface points specified above is to provide performance levels over
a 12 month period as follows:
<TABLE>
<CAPTION>
DS-0 Miles DS3, OC-3, OC-12, OC-48, OC-3c, OC-12c, OC-48c
---------- ----------------------------------------------
<S> <C>
0-2500 99.999%
2501-4000 99.998%
</TABLE>
1.4 Scheduled maintenance is excluded from the performance objective stated
above.
1.5 Error-Free Seconds (EFS) and Error Seconds (ES) are the primary measure
of error performance. An Error-Free Second is defined as any second in
which no bit errors are received. Conversely, an Error Second is any
second in which one or more bit errors are received.
B-1
<PAGE>
1.6 INTERCONNECT SPECIFICATIONS:
1.6.1 The Econophone interconnection point of DS-3 signals at the
Frontier location will be at an industry standard (DSX-1) &
DSX-3) digital cross-connect panel.
1.6.2 The DS-3 signals terminating at the Frontier digital
cross-connect panels will meet the electrical specifications
as defined in AT&T Compatibility Bulletin (CB) N. 119, Issue
3, October, 1979.
1.6.3 The Frontier Digital Network will be compatible with the Bell
System hierarchical clock synchronization methods and stratum
levels as described in Bellcore Technical Advisory
(GR436-Core).
1.7 GENERAL PERFORMANCE OBJECTIVES:
<TABLE>
<S> <C> <C>
DS-3
zS-0 Miles EFS BER
0-250 99.988% 10-15
251-500 99.983% 10-15
501-1000 99.971% 10-15
1001-1500 99.959% 10-15
1501-2000 99.948% 10-15
2001-2500 99.936% 10-15
2501-3000 99.925% 10-15
3001-3500 99.913% 10-15
3501-4000 99.902% 10-15
OC-3, (C-12, OC-48, OC-3C, OC-12C, OC-48C
DS-0 Miles EFS BER
0-250 99.989% 10-15
251-500 99.984% 10-15
501-1000 99.974% 10-15
1001-1500 99.964% 10-15
1501-2000 99.954% 10-15
2001-2500 99.944% 10-15
2501-3000 99.933% 10-15
3001-3500 99.923% 10-15
3501-4000 99.913% 10-15
</TABLE>
1.8 RESTORATION INTERVALS:
To be agreed upon by the parties within two (2) business days after
execution of this Agreement by both parties.
B-2
<PAGE>
1.9 ESCALATION PROCEDURES:
To be agreed upon by the parties within two (2) business days after
execution of this Agreement by both parties.
2.0 TECHNICAL ASSUMPTIONS:
The Frontier Network is currently under construction. As soon as the
SONET backbone on the Frontier Network is commercially available, the
following technical assumptions shall apply:
Circuits to originate and terminate on SONET backbone
High speed protection switching: 1 for N, where N=2
B-3
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Destia Communications, Inc.
As independent public accountants, we hereby consent to the use of our
reports and to all references to our Firm included in or made part of this
registration statement.
Arthur Andersen LLP
New York, New York
April 13, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION (in thousands) EXTRACTED
FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 118,218
<SECURITIES> 21,343
<RECEIVABLES> 37,437
<ALLOWANCES> 4,086
<INVENTORY> 0
<CURRENT-ASSETS> 185,911
<PP&E> 119,667
<DEPRECIATION> 12,418
<TOTAL-ASSETS> 388,208
<CURRENT-LIABILITIES> 95,506
<BONDS> 380,748
0
14,421
<COMMON> 208
<OTHER-SE> (102,675)
<TOTAL-LIABILITY-AND-EQUITY> 388,208
<SALES> 193,737
<TOTAL-REVENUES> 193,737
<CGS> 140,548
<TOTAL-COSTS> 140,548
<OTHER-EXPENSES> 72,700
<LOSS-PROVISION> 7,392
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (68,944)
<INCOME-TAX> 0
<INCOME-CONTINUING> (68,944)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (68,944)
<EPS-PRIMARY> (3.31)
<EPS-DILUTED> (3.31)
</TABLE>
