<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 29, 1999
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
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 & 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. / /
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
DOLLAR AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED PER SHARE OFFERING PRICE REGISTRATION FEE
<S> <C> <C> <C> <C>
Common Stock, $.01 par value per share...... $65,000,000 $ $65,000,000 $18,070
</TABLE>
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 , 1999
SHARES
[LOGO]
DESTIA COMMUNICATIONS, INC.
(FORMERLY ECONOPHONE, INC.)
COMMON STOCK
-----------------
DESTIA COMMUNICATIONS, INC. IS OFFERING 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 $ AND $ PER SHARE.
-------------------
WE HAVE FILED AN APPLICATION FOR THE COMMON STOCK TO BE QUOTED ON THE NASDAQ
NATIONAL MARKET UNDER THE SYMBOL "DEST."
-------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 10.
-----------------
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 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>
[Description of artwork for inside front cover to be filed by pre-effective
amendment.]
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C> <C>
Prospectus Summary.................... 5
Risk Factors.......................... 10
Use of Proceeds....................... 23
Dividend Policy....................... 23
Certain Information................... 23
Capitalization........................ 24
Dilution.............................. 25
Selected Consolidated Financial
Data................................. 26
Management's Discussion and Analysis
of Financial Condition and Results of
Operations........................... 28
Industry Overview..................... 38
Business.............................. 40
<CAPTION>
PAGE
---------
<S> <C> <C> <C>
Management............................ 71
Certain Transactions.................. 79
Certain Indebtedness.................. 80
Principal Stockholders................ 84
Description of Capital Stock.......... 85
Shares Eligible for Future Sale....... 88
Certain United States Tax Consequences
to Non-United States Holders......... 90
Underwriters.......................... 92
Legal Matters......................... 96
Experts............................... 97
Additional Information................ 97
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 which 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. In 1997, there were 81.8 billion minutes of
international long distance traffic with the majority originating in the United
States and Europe. This volume is expected to grow at a compound annual growth
rate of 12% to 18% from 1997 to 2001.
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 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 and 1997 and the nine months ended September 30, 1998, our revenues
were $45.1 million, $83.0 million and $141.0 million, respectively.
Substantially all of our growth has been generated internally, rather than
through acquisitions. In addition, our retail focused strategy has allowed us to
generate strong gross margins. For 1996 and 1997 and the nine months ended
September 30, 1998, our gross margins were 21.6%, 23.2% and 26.9%, respectively.
ESTABLISHED INTERNATIONAL TELECOMMUNICATIONS NETWORK
Our network (the "Destia Network") is comprised of:
- 14 carrier-grade switches in operation, with seven in North America and
seven in Europe;
- an IRU from Frontier on its U.S. fiber optic network ("IRUs" are long-term
capacity leases);
- transatlantic IRUs;
- leased capacity and IRUs in Europe; and
- leased capacity in Canada.
5
<PAGE>
Additionally, as of the end of 1998, we have completed direct
interconnections with the dominant carriers (the "PTTs") in four of our major
European markets (the United Kingdom, Belgium, Germany and Switzerland) and have
signed interconnection agreements with the PTTs in France and 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 % of Destia and
following the offering will own approximately %.
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 proprietary 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>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered in:
The U.S. offering................. shares
The international offering........ shares
Total........................... shares(1)
Common stock to be outstanding
after the offering................ shares(1)(2)
Over-allotment option............... shares
Use of proceeds..................... We will receive net proceeds from the offering of
approximately $ 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. In addition, although we
are not currently engaged in negotiations regarding
any material acquisitions, 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."
Proposed Nasdaq National Market
symbol............................ DEST
</TABLE>
- ------------------------------
(1) Excludes the possible issuance of up to additional shares of common
stock pursuant to the exercise of the U.S. underwriters' over-allotment
option.
(2) As of , 1999, we had 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 shares of common stock at a
weighted average exercise price of $ per share and warrants (the
"Warrants") to purchase 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 to stock split to be
effected prior to the offering. See "Certain Information."
7
<PAGE>
SUMMARY FINANCIAL AND OTHER DATA
The following summary consolidated financial data for 1994, 1995, 1996 and
1997 are derived from our audited consolidated financial statements. The summary
consolidated financial data for 1993 was derived from our accounting records and
is unaudited. The summary consolidated financial data for the nine months ended
September 30, 1997 and 1998 and the balance sheet data as of September 30, 1998
are derived from our unaudited interim financial statements, which, in our
opinion, have been prepared on the same basis as our audited financial
statements and reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of our results of operations and
financial position for those periods. 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>
NINE
MONTHS
ENDED
SEPTEMBER
YEARS ENDED DECEMBER 31, 30,
------------------------------------------------------- ----------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997 1997
--------- --------- --------- ---------- ---------- ----------
<CAPTION>
(IN THOUSANDS, EXCEPT REVENUE PER MINUTE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................ $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 53,138
Cost of services........................................ 2,761 5,540 19,735 35,369 63,707 41,050
--------- --------- --------- ---------- ---------- ----------
Gross profit............................................ 767 2,983 7,755 9,734 19,296 12,088
Selling, general and administrative expense............. 497 2,013 7,087 16,834 37,898 22,521
Depreciation and amortization........................... 51 168 389 1,049 3,615 2,167
--------- --------- --------- ---------- ---------- ----------
Income (loss) from operations........................... 219 802 279 (8,149) (22,217) (12,600)
Interest income......................................... 6 6 19 84 3,689 1,846
Interest expense........................................ (25) (109) (167) (380) (11,437) (5,826)
Other income (expense).................................. 6 100 (10) 133 (163) 116
Provision for income taxes.............................. -- 73 -- -- -- --
--------- --------- --------- ---------- ---------- ----------
Net income (loss)....................................... $ 206 $ 726 $ 121 $ (8,312) $ (30,128) $ (16,464)
--------- --------- --------- ---------- ---------- ----------
--------- --------- --------- ---------- ---------- ----------
Net earnings (loss) per share:
Basic...................................................
Diluted.................................................
Weighted average number of shares of common stock
outstanding (basic and diluted)(1)....................
--------- --------- --------- ---------- ---------- ----------
--------- --------- --------- ---------- ---------- ----------
OTHER DATA:
Capital expenditures.................................... $ 605 $ 906 $ 1,677 $ 4,670 $ 19,021 $ 7,932
EBITDA(2)............................................... 276 1,070 658 (6,967) (18,765) (10,317)
Distributions to S Corporation shareholders(3).......... -- -- 499 227 -- --
Preferred dividends(4).................................. -- -- -- 281 879 879
Net cash provided by (used in) operating activities..... (190) 474 2,037 (6,006) (12,219) (14,734)
Net cash used in investing activities................... (741) (801) (1,206) (4,247) (13,267) (5,459)
Net cash provided by (used in) financing activities..... 1,051 292 (810) 16,419 145,844 146,243
Revenue per minute...................................... N/A .70 .57 .43 .25 .27
REGIONAL DATA(5):
Revenues
Continental Europe.................................... N/A $ 2,652 $ 5,025 $ 11,441 $ 15,741 $ 11,316
United Kingdom........................................ N/A 3,143 14,173 15,477 18,363 9,330
United States......................................... N/A 2,728 8,292 18,185 48,899 32,492
--------- --------- ---------- ---------- ----------
Total............................................... $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 53,138
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Minutes
Continental Europe.................................... N/A 1,957 3,856 8,351 17,239 11,241
United Kingdom........................................ N/A 4,532 20,592 27,968 68,810 29,951
United States......................................... N/A 5,707 23,411 68,247 244,095 156,835
--------- --------- ---------- ---------- ----------
Total............................................... 12,196 47,859 104,566 330,144 198,027
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
<CAPTION>
<S> <C>
1998
----------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................ $ 140,956
Cost of services........................................ 103,088
----------
Gross profit............................................ 37,868
Selling, general and administrative expense............. 57,121
Depreciation and amortization........................... 7,131
----------
Income (loss) from operations........................... (26,384)
Interest income......................................... 8,984
Interest expense........................................ (29,366)
Other income (expense).................................. (412)
Provision for income taxes.............................. --
----------
Net income (loss)....................................... $ (47,178)
----------
----------
Net earnings (loss) per share:
Basic...................................................
Diluted.................................................
Weighted average number of shares of common stock
outstanding (basic and diluted)(1)....................
----------
----------
OTHER DATA:
Capital expenditures.................................... $ 64,363
EBITDA(2)............................................... (19,665)
Distributions to S Corporation shareholders(3).......... --
Preferred dividends(4).................................. --
Net cash provided by (used in) operating activities..... (28,818)
Net cash used in investing activities................... (136,787)
Net cash provided by (used in) financing activities..... 174,354
Revenue per minute...................................... .23
REGIONAL DATA(5):
Revenues
Continental Europe.................................... $ 15,047
United Kingdom........................................ 45,555
United States......................................... 80,354
----------
Total............................................... $ 140,956
----------
----------
Minutes
Continental Europe.................................... 29,181
United Kingdom........................................ 211,478
United States......................................... 366,655
----------
Total............................................... 607,314
----------
----------
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
--------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED(6)
---------- --------------
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities...................................... $ 153,452
Restricted cash(7).................................................................... 40,024 40,024
Total assets.......................................................................... 367,323
Current portion of borrowings......................................................... 11,021 11,021
Long-term borrowings, less current portion............................................ 362,959 362,959
Redeemable convertible preferred stock................................................ 14,396 --
Total stockholders' equity (deficit).................................................. (81,138)
</TABLE>
- ------------------------------
(1) Weighted average numbers of shares have been retroactively restated to give
effect to the for 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 applicable 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) Regional revenue data and minute data for 1993 is not available.
(6) 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 September 30, 1998 and (iii) a
for stock split to be effected prior to the offering.
(7) 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 were required to reserve for the payment of the first six
scheduled interest payments due on the $155.0 million in total 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."
9
<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 late 1996 or after
that time. 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. These
expansion plans are subject to our obtaining any necessary authorizations,
including any governmental licenses, registrations or notifications that may be
required.
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.
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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.
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 in our customer support, billing, order provisioning and other
information processing capabilities. These initiatives will be costly.
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 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 are not engaged in any negotiations regarding any material acquisitions,
but intend to pursue selected acquisitions and strategic alliances. 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 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 September 30, 1998 we had total consolidated indebtedness of
approximately $374.0 million and a stockholders' deficit of approximately $81.1
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
September 30, 1998 to February 15, 2003 will accrete in value (i.e., effectively
increase in principal amount), by approximately $112.2 million. Thereafter,
interest on the 1998 Notes must be paid in cash. For the nine months ended
September 30, 1998, we had a net loss of $47.2 million, we had negative EBITDA
of $19.7 million and net cash used in operating activities was $28.8 million. We
expect to have operating losses and negative EBITDA and negative cash flow from
operations through at least 2000. We cannot be
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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.
We expect that the proceeds of this offering, together with an equipment
loan 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
regulatory liberalization. Competition results in customer "churn" or
"turnover." 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 AT&T's
alliance with British 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
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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 have no
plan to offer local service in the United States.
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.
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.
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 PTT with certain inherent competitive advantages over other
providers, including:
- their 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;
- their extensive, and in many cases exclusive, ownership of facilities;
- their 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. In Germany, Deutsche Telekom recently proposed, subject to
regulatory approval, levying a fee of approximately 50 Deutsche Marks ("DM") on
any customer that desires to change long distance service providers. In Greece,
regulatory restrictions prohibit us from offering long distance services other
than value-added services 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 PTT's
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 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."
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.
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Many of our larger competitors 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.
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 obtained approval to
reduce retail prices on domestic and international long distance services by an
average of 4.5% during each of 1999 and 2000. In the United Kingdom, the
national regulatory authority has put downward pressure on British Telecom's
retail prices by imposing a price cap on its retail prices for residential
services. In Germany, Deutsche Telekom has recently announced 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. 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. These rates were
traditionally set at arbitrary, artificially high levels that enabled many
carriers to enjoy high gross margins on international calls. International
settlement rates have been declining for the last several years and an
increasing number of calls are being placed outside the international settlement
rate system, resulting in drastically lower prices. Industry observers believe
that the combined effects of deregulation, excess transmission capacity,
advances in technology and the negligible marginal cost to a carrier that owns
its own switches and transmission facilities of carrying an international call,
are gradually causing the collapse of the international settlement rate system.
Practices such as "refile" (where traffic originating from a particular country
is rerouted through another country with a lower settlement rate), off
settlement rate terminations (where a local carrier agrees to terminate an
international call at rates below
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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 and MCI WorldCom 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.
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 multi level marketing program in the United Kingdom, where a
master agent could determine to terminate its business relationship (and that of
its sub-agents) with us and conduct business with a competitor, although the
agent would be contractually obligated to leave its customers with us.
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.
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."
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IMPORTANCE OF CARRIER AND OTHER WHOLESALE CUSTOMERS
Carrier customers generally are extremely price sensitive, generate very low
margin business and frequently 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.
From January 1, 1997 through September 30, 1998, our sales of transmission
capacity to carrier customers ranged from 13% 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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.
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 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 with applicable regulations.
In the United States, regulatory considerations that affect or limit our
business include, but are not limited to:
- restrictions on our use of leased lines;
- universal service fund contribution requirements;
- local access charges that we are required to pay to local exchange
carriers ("LECs");
- payphone access charges that we are required to pay;
- regulations relating to "slamming" and related penalties, which recently
have been severe; and
- regulations concerning use of customer proprietary information in cross
marketing efforts.
In Europe, regulatory considerations that affect or limit our business
include, but are not limited to:
- 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." Also see "Business--Regulation" for a
discussion of these and certain other regulatory risks and considerations
relevant to our business.
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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. However, 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 in Germany to Deutsche Telekom's network expires on
February 28, 1999. We expect our temporary interconnections in Belgium and
Germany to be extended until relevant national legislation or regulations,
respectively, pertaining to permanent interconnection are adopted, although
there can be no assurance that either of them will be extended. If we were to
lose either interconnection, we would need to obtain interconnection from
another carrier, which would increase our transmission costs in that country.
See "Business-- Regulation--Belgium" and "Business--Regulation--Germany."
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. 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 competitive
disadvantage to the LECs.
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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 the facilities of another carrier
or consortium of carriers (I.E., an IRU) 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 our desire
to provide services in more U.S. markets, we recently acquired a 20-year IRU
from Frontier to use 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. The buildout of Frontier's planned network is
approximately 60% completed and we expect it to be fully operational by the end
of 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.
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.
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."
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When we negotiate 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
ability to grow our business, which could have 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. 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 in connection with the 1997 Notes (the "1997 Indenture") and the
indenture in connection with the 1998 Notes (the "1998
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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. 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 %
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 or merging with 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 a merger or
acquisition at a premium price. These provisions include:
- authorizing the issuance of "blank check" preferred stock;
- providing for a classified Board of Directors with staggered, three-year
terms;
- prohibiting cumulative voting in the election of directors;
- limiting the removal of directors by the shareholders to removal for
cause;
- requiring a super-majority stockholder vote to effect certain amendments
to our Certificate of Incorporation and Bylaws;
- limiting the persons who may call special meetings of stockholders;
- prohibiting stockholder action by written consent except where unanimous;
and
- establishing 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.
20
<PAGE>
In addition, we intend to adopt a shareholder rights plan prior to the
completion of this offering. Our 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 or
merging with us, including in a transaction that results in stockholders
receiving a premium over the market price for the shares of common stock held by
them. 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 to the foregoing, under the 1997 Indenture and the 1998
Indenture, we must commence, within 30 days of the occurrence of a change of
control, an offer to purchase all the 1997 Notes and 1998 Notes then
outstanding, at a purchase price equal to 101% of the principal amount or
accreted value (as applicable) of such notes on the relevant payment date, plus
accrued interest (if any) to the payment date. See "Certain Indebtedness." We
cannot be certain whether we will have sufficient funds available at the time of
any change of control to make any payment required by the foregoing covenant (as
well as any payment that may be required pursuant to any other outstanding
indebtedness at the time, including our indebtedness to our equipment financing
lender). 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
Prior to this offering, you could not buy or sell our common stock publicly.
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 the 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;
- 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.
21
<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 the common stock and could impair our ability to raise capital
through the sale of additional stock. Immediately after this offering, we will
have shares of common stock outstanding or that are the subject of
currently exercisable options. The shares sold in this offering will be
freely tradable without restriction or further registration under the federal
securities laws unless purchased by our "affiliates" as that term is defined in
Rule 144 under the Securities Act ("Rule 144"). The remaining shares
of common stock outstanding on completion of this offering will be "restricted
securities" as that term is defined in Rule 144.
The shares of common stock that will be held by Princes Gate Investors
II, L.P. upon the conversion of its shares of its Series A Preferred Stock upon
completion of this offering will be entitled to certain registration rights. In
addition, Mr. Levy is entitled to certain demand and piggyback registration
rights with respect to his incentive stock options to purchase shares of
our common stock. See "Management" and "Underwriters."
Immediately after this offering, we also will have an additional
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 % of the outstanding common stock and
currently exercisable options to purchase common stock have executed lock-up
agreements that limit their ability to sell common stock. These stockholders
have agreed not to sell or otherwise dispose of any shares of 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 the outstanding common stock (which is negative). As a
result, investors purchasing common stock in this offering will incur immediate
substantial dilution. In addition, we have issued options and warrants to
acquire 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."
22
<PAGE>
USE OF PROCEEDS
The Company will receive net proceeds from the offering of approximately $
million (approximately $ million if the U.S. underwriters exercise
their over-allotment option in full), assuming that the common stock is offered
at $ , 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. The Company intends to use the net proceeds
to expand its sales and marketing activities, to make capital expenditures and
to fund working capital and general corporate purposes, including to fund
losses. In addition, although we are not currently engaged in negotiations
regarding any material acquisitions, 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
The 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. The Company plans to
retain earnings, if any, for use in the operation of its business and to fund
future growth. In addition, the Company's indentures and our equipment financing
agreement currently restrict the payment of dividends. See "Certain
Indebtedness."
CERTAIN INFORMATION
The 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.
The Company's logo and certain titles and logos of the Company's services
mentioned in this prospectus are the 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 Federal Communications
Commission ("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 shares of common stock, which will occur upon the closing of the
offering. The information in this prospectus also has been adjusted to reflect a
for split of our common stock to occur prior to the offering. 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 the
Company. As of January 25, 1999, there were shares of non-voting common
stock outstanding (on a post-split basis).
23
<PAGE>
CAPITALIZATION
The following table sets forth our cash and capitalization as of September
30, 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 of the Company 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
SEPTEMBER 30, 1998
-----------------------
<S> <C> <C>
ACTUAL AS ADJUSTED
---------- -----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Cash, cash equivalents, marketable securities and restricted cash........................ $ 193,476
----------
----------
Current portion of long-term debt and capital lease obligations.......................... $ 11,021 $ 11,021
---------- -----------
---------- -----------
Long-term debt and capital lease obligations:
Capital leases......................................................................... $ 191 $ 191
1997 Notes............................................................................. 150,100 150,100
1998 Notes............................................................................. 187,939 187,939
Other long-term debt................................................................... 24,729 24,729
---------- -----------
Total long-term debt and capital lease obligations................................. 362,959 362,959
Redeemable convertible preferred stock................................................... 14,396 --
Stockholders' equity (deficit):
Common stock--voting, $.01 par value, shares authorized, actual, and
shares authorized, as adjusted; shares issued and outstanding, actual and
shares issued and outstanding,
as adjusted (1)...................................................................... 200
Non-voting common stock, $.01 par value, shares authorized, actual and adjusted;
shares issued and outstanding, actual and shares issued and outstanding, as
adjusted............................................................................. 1
Additional paid-in capital (2)......................................................... 5,926
Accumulated other comprehensive income................................................. (313)
Accumulated deficit.................................................................... (86,952)
----------
Total stockholders' equity (deficit)............................................... (81,138)
----------
Total capitalization............................................................. $ 296,217
----------
----------
</TABLE>
- ------------------------------
(1) Actual amount as of September 30, 1998 does not include (i) shares of
common stock issuable upon the exercise of options to employees at a
weighted average exercise price of $ , (ii) shares of common
stock issuable upon conversion of the Series A Preferred Stock or (iii)
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 as of September 30, 1998 does not include items
(i) and (iii) of the preceding sentence. All shares numbers contained herein
give effect to the for 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.
24
<PAGE>
DILUTION
The pro forma net tangible book value of the Company's common stock as of
September 30, 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
$ , or approximately $ 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 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 shares of common
stock offered by the Company (based on an assumed initial public offering price
of $ 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 September 30, 1998 would have
been $ , or $ per share. This represents an immediate increase in pro
forma net tangible book value of $ per share to existing stockholders and
an immediate dilution in net tangible book value of $ 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............................ $
Pro forma net tangible book value per share as of September 30, 1998..... $
Increase in pro forma net tangible book value per share attributable to
new investors..........................................................
---------
Pro forma net tangible book value per share after the offering.............
---------
Dilution per share to new investors........................................ $
---------
---------
</TABLE>
The following table sets forth, on a pro forma basis as of September 30,
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 $
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............................. % $ million % $
New investors..................................... million
------------ --- ----------------- ---
Total......................................... % $ million %
------------ --- ----------------- ---
------------ --- ----------------- ---
</TABLE>
As of December 31, 1998, there were approximately shares subject to
outstanding options at a weighted average exercise price of approximately $
per share, and 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."
25
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data for 1994, 1995, 1996 and
1997 are derived from our audited consolidated financial statements, which have
been audited by Arthur Andersen LLP, independent public accountants. The
selected consolidated financial data for 1993 was derived from our accounting
records and is unaudited. The selected consolidated financial data for the nine
months ended September 30, 1997 and 1998 and the balance sheet data as of
September 30, 1998 are derived from our unaudited interim financial statements,
which, in our opinion, have been prepared on the same basis as our audited
financial statements and reflect all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of our results of
operations and financial position for those periods. 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>
NINE
MONTHS
ENDED
SEPTEMBER
YEARS ENDED DECEMBER 31, 30,
------------------------------------------------------- ----------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997 1997
--------- --------- --------- ---------- ---------- ----------
<CAPTION>
(IN THOUSANDS, EXCEPT REVENUE PER MINUTE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................ $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 53,138
Cost of services........................................ 2,761 5,540 19,735 35,369 63,707 41,050
--------- --------- --------- ---------- ---------- ----------
Gross profit............................................ 767 2,983 7,755 9,734 19,296 12,088
Selling, general and administrative expense............. 497 2,013 7,087 16,834 37,898 22,521
Depreciation and amortization........................... 51 168 389 1,049 3,615 2,167
--------- --------- --------- ---------- ---------- ----------
Income (loss) from operations........................... 219 802 279 (8,149) (22,217) (12,600)
Interest income......................................... 6 6 19 84 3,689 1,846
Interest expense........................................ (25) (109) (167) (380) (11,437) (5,826)
Other income (expense).................................. 6 100 (10) 133 (163) 116
Provision for income taxes.............................. -- 73 -- -- -- --
--------- --------- --------- ---------- ---------- ----------
Net income (loss)....................................... $ 206 $ 726 $ 121 $ (8,312) $ (30,128) $ (16,464)
--------- --------- --------- ---------- ---------- ----------
--------- --------- --------- ---------- ---------- ----------
Net earnings (loss) per share:
Basic...................................................
Diluted.................................................
Weighted average number of shares of common stock
outstanding (basic and diluted)(1)....................
--------- --------- --------- ---------- ---------- ----------
--------- --------- --------- ---------- ---------- ----------
OTHER DATA:
Capital expenditures.................................... $ 605 $ 906 $ 1,677 $ 4,670 $ 19,021 $ 7,932
EBITDA(2)............................................... 276 1,070 658 (6,967) (18,765) (10,317)
Distributions to S Corporation shareholders(3).......... -- -- 499 227 -- --
Preferred dividends(4).................................. -- -- -- 281 879 879
Net cash provided by (used in) operating activities..... (190) 474 2,037 (6,006) (12,219) (14,734)
Net cash used in investing activities................... (741) (801) (1,206) (4,247) (13,267) (5,459)
Net cash provided by (used in) financing activities..... 1,051 292 (810) 16,419 145,844 146,243
Revenue per minute...................................... N/A .70 .57 .43 .25 .27
REGIONAL DATA(5):
Revenues
Continental Europe.................................... N/A $ 2,652 $ 5,025 $ 11,441 $ 15,741 $ 11,316
United Kingdom........................................ N/A 3,143 14,173 15,477 18,363 9,330
United States......................................... N/A 2,728 8,292 18,185 48,899 32,492
--------- --------- ---------- ---------- ----------
Total............................................... $ 8,523 $ 27,490 $ 45,103 $ 83,003 $ 53,138
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Minutes
Continental Europe.................................... N/A 1,957 3,856 8,351 17,239 11,241
United Kingdom........................................ N/A 4,532 20,592 27,968 68,810 29,951
United States......................................... N/A 5,707 23,411 68,247 244,095 156,835
--------- --------- ---------- ---------- ----------
Total............................................... 12,196 47,859 104,566 330,144 198,027
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
<CAPTION>
<S> <C>
1998
----------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................................ $ 140,956
Cost of services........................................ 103,088
----------
Gross profit............................................ 37,868
Selling, general and administrative expense............. 57,121
Depreciation and amortization........................... 7,131
----------
Income (loss) from operations........................... (26,384)
Interest income......................................... 8,984
Interest expense........................................ (29,366)
Other income (expense).................................. (412)
Provision for income taxes.............................. --
----------
Net income (loss)....................................... $ (47,178)
----------
----------
Net earnings (loss) per share:
Basic...................................................
Diluted.................................................
Weighted average number of shares of common stock
outstanding (basic and diluted)(1)....................
----------
----------
OTHER DATA:
Capital expenditures.................................... $ 64,363
EBITDA(2)............................................... (19,665)
Distributions to S Corporation shareholders(3).......... --
Preferred dividends(4).................................. --
Net cash provided by (used in) operating activities..... (28,818)
Net cash used in investing activities................... (136,787)
Net cash provided by (used in) financing activities..... 174,354
Revenue per minute...................................... .23
REGIONAL DATA(5):
Revenues
Continental Europe.................................... $ 15,047
United Kingdom........................................ 45,555
United States......................................... 80,354
----------
Total............................................... $ 140,956
----------
----------
Minutes
Continental Europe.................................... 29,181
United Kingdom........................................ 211,478
United States......................................... 366,655
----------
Total............................................... 607,314
----------
----------
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
--------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED(6)
---------- --------------
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities...................................... $ 153,452
Restricted cash(7).................................................................... 40,024 40,024
Total assets.......................................................................... 367,323
Current portion of borrowings......................................................... 11,021 11,021
Long-term borrowings, less current portion............................................ 362,959 362,959
Redeemable convertible preferred stock................................................ 14,396 --
Total stockholders' equity (deficit).................................................. (81,138)
</TABLE>
- ------------------------------
(1) Weighted average numbers of shares have been retroactively restated to give
effect to the for 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 applicable 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) Regional revenue data and minute data for 1993 is not available.
(6) 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 September 30, 1998 and (iii) a
for stock split to be effected prior to the offering.
(7) 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 were required to
reserve for the payment of the first six scheduled interest payments due on
the 1997 Notes that we issued in the 1997 Unit Offering. Warrants also were
issued in the 1997 Unit Offering. See "Capitalization."
27
<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 OUR 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 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 the
number of minutes of telecommunications traffic carried at a fixed per minute
charge. The following table shows the total revenue and billable minutes of use
attributable to the Company's operations by region for the nine months ended
September 30, 1997 and 1998. Over time, the Company expects its European markets
to contribute an increasingly larger percentage of its revenues.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
<S> <C> <C> <C>
1997 1998 % CHANGE
--------- ---------- -------------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUE
United States.............................................. $ 32,492 $ 80,354 147%
United Kingdom............................................. 9,330 45,555 388%
Continental Europe......................................... 11,316 15,047 33%
--------- ---------- ---
Total...................................................... $ 53,138 $ 140,956 165%
--------- ---------- ---
--------- ---------- ---
BILLABLE MINUTES OF USE
United States.............................................. 156,835 366,655 134%
United Kingdom............................................. 29,951 211,478 606%
Continental Europe......................................... 11,241 29,181 160%
--------- ---------- ---
Total...................................................... 198,027 607,314 207%
--------- ---------- ---
--------- ---------- ---
</TABLE>
The Company generally prices its services at a discount to the primary
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 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 innovation and the availability of
substantial
28
<PAGE>
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 upon usage rather than sale.
COST OF SERVICES
The major components of the Company's cost of services include the cost of
origination, transmission and termination of traffic. In general, the Company
pays a per minute charge to originate and terminate calls. However, in
continental Europe, origination charges on calls utilizing local dial-up access
are paid by the Company's customers. In countries where the Company has
interconnection, it is able to originate and terminate calls more
cost-effectively, either pursuant to fixed price contractual arrangements with
PTTs or LECs or pursuant to a tariff.
The Company's transmission cost of services consists of expenses related to
leased lines and switched minutes. The Company typically acquires leased lines
on a fixed cost basis, which involves monthly payments regardless of usage
levels. Leased lines are used for specific point-to-point routes and have a
shorter duration than IRUs. Because the cost of leased lines involve 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 terminate calls in 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 origination and termination
charges. As the Company's minutes of traffic carried have grown, the Company has
obtained better pricing on switched minutes 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 and the
availability of substantial third-party transmission capacity.
A substantial 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.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
To date, the Company has sold its services primarily through independent
sales channels. Selling expenses have, therefore, primarily consisted of
commissions paid to agents and resellers. To a lesser extent, the Company also
has incurred selling expenses arising out of advertising and promotion costs,
sales by the Company's internal sales force and expenses related to its customer
service department. Since the consummation of the acquisition of VoiceNet during
the first quarter of 1998, 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 also intends to increase its
advertising expenses. The Company expects all of these costs to eventually
decline as a percentage of its revenues over time. General and administrative
expenses have increased primarily as a result of expanding the Company's
customer service, billing, financial reporting and other management information
systems and network management systems and organizational expenses related to
entering additional markets.
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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 the
amortization of goodwill from the purchase of VoiceNet and of the 30% interest
in Telco Global Communications ("Telco") that the Company did not already own.
As the Company expands the Destia Network, it will continue to add new
switching equipment and acquire additional IRUs, both of which will increase the
Company's depreciation expense. IRUs involve only fixed costs, with no per
minute charges, and are a more cost-effective means of transmitting traffic once
certain volume levels are reached. The Company recently acquired a 20-year IRU
from Frontier which provides it with fiber optic transmission capacity in the
United States and 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 will be offset, in part, by a decrease in its cost of services. As a
result, the Company's gross margins will improve, although the Company's net
income will not necessarily improve.
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. Thereafter, interest on the 1998 Notes will be required to be paid in
cash. See "Certain Indebtedness."
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
REVENUES. Revenues for the nine months ended September 30, 1998 increased
165% to $141.0 million from $53.1 million for the nine months ended September
30, 1997. Billable minutes of use increased 207% to 607.3 million in the first
nine months of 1998 from 198.0 million in the comparable prior year nine-month
period. The year-to-year revenue increase was primarily attributable to strong
customer growth in both the U.S. and U.K. markets.
Revenues for all products 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.
GROSS PROFIT. The gross profit margin of 26.9% reported for the nine-month
period ended September 30, 1998 increased 4.2% from the 22.7% achieved in the
nine-month period ended September 30, 1997. This increase was attributable to
network expansion and increased utilization of transmission capacity which
contributed to lower per-minute costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses in 1998 were $57.1 million, representing 40.5% of
revenue, compared to $22.5 million in 1997, or 42.4% of revenue. The decrease in
selling, general and administrative expenses as a percentage of revenues during
1998 was primarily attributable to the significant increase in revenues from the
nine-month period of the prior year.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $7.1 million for the nine-month period ended September 30, 1998
from $2.2 million for the nine-month period ended September 30, 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 and
amortization of costs
30
<PAGE>
associated with the Company's issuance of 1997 Notes and the 1998 Notes and the
amortization of goodwill from the purchase of VoiceNet and Telco.
INTEREST EXPENSE AND INTEREST INCOME. Interest expense increased to $29.4
million in 1998 from $5.8 million in the prior year comparable period. This
increase was attributable to the issuance of the 1997 Notes and the 1998 Notes.
Interest income increased to $9.0 million in 1998 from $1.8 million in the
comparable period of 1997. This increase was primarily due to interest income
earned on the investment of the net proceeds received in connection with these
offerings.
NET LOSS. The Company reported a net loss of $47.2 million for the
nine-month period ended September 30, 1998 compared to a net loss of $16.5
million for the comparable period of 1997. The increase is primarily due to the
higher level of selling, general and administrative expenses and higher debt
service costs.
The following table presents certain data concerning the Company's results
of operations for 1995, 1996 and 1997.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues..................................................... $ 27,490 $ 45,103 $ 83,003
Cost of services............................................. 19,735 35,369 63,707
Selling expenses, general and administrative expenses........ 7,087 16,834 37,898
Depreciation and amortization................................ 389 1,049 3,615
Net income (loss)............................................ 121 (8,312) (30,128)
</TABLE>
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 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, its
majority owned subsidiary. 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 ATL, a wholly-owned subsidiary of the Company. Average U.K. revenue
per minute decreased from $.55 per minute during 1996 to $.27 per minute during
1997. This reduction was due principally to sales of a larger percentage of
domestic long distance minutes, which are sold at lower rates than international
minutes, and to increased price competition.
In continental Europe, revenues increased by 38% to $15.7 million from $11.4
million. This increase was attributable to an increase in prepaid card services,
primarily in France and Germany. Average continental European revenue per minute
decreased from $1.37 per minute during 1996 to $.91 per minute during 1997. This
decrease was due to lower rates in France and Germany.
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<PAGE>
In the United States, 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 during the
period divided by the average monthly number of customers for the period.
Customers that have ceased using the Company's services during any given month
are those customers who used the Company's services during the prior month but
not during any subsequent month during the applicable period.
COST OF SERVICES. Cost of services increased to $63.7 million for 1997 from
$35.4 million for 1996. As a percentage of revenues, cost of services decreased
slightly to approximately 77% for 1997 from approximately 78% for 1996. Average
cost per minute for 1997 decreased to $.19 from $.34 for 1996. This was a result
of increased use of owned and leased line transmission capacity acquired by the
Company during the period, as well as obtaining better prices on switched
transmission capacity because of the growth of the Company's minutes of traffic
and more available capacity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $37.9 million for 1997 from $16.8 million
for 1996, and, as a percentage of revenues, were 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 has been charged to operations. 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.
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.
BAD DEBT EXPENSE. The Company had bad debt expense of $3.9 million for
1997, compared to bad debt expense of $2.0 million for 1996, which was due to
the $2.0 million charge relating to EI during 1996.
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.
32
<PAGE>
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.
1996 COMPARED TO 1995
REVENUES. Total revenues for 1996 increased by 64% to $45.1 million on
104.6 million billable minutes of use from $27.5 million on 47.9 million
billable minutes of use for 1995. Growth in revenues during 1996 was generated
primarily from an increase in minutes of traffic in existing markets, offset in
part by declining prices. At December 31, 1996, the Company had approximately
24,700 customer accounts, compared to approximately 26,400 customer accounts at
December 31, 1995. The reduction in the number of customer accounts was
attributable to the termination of the Company's relationship with EI discussed
below.
In the United Kingdom, revenues grew 9% to $15.5 million. The Company's U.K.
revenues were limited in 1996 due to a restructuring of the Company's U.K. sales
and marketing arrangements resulting from a change in its distribution strategy.
For the first five months of 1996, U.K. revenues increased substantially over
the corresponding period in 1995. On June 1, 1996, the Company effectively
terminated its joint venture with EI, pursuant to which EI had the exclusive
right to sell the Company's services in the United Kingdom. In exchange for the
Company being granted the right to compete in the United Kingdom, the Company
forgave a net receivable of $2.0 million and agreed to sell transmission to EI
at lower rates than that charged to the joint venture, thereby substantially
reducing revenues from U.K. sales during the second half of 1996 as compared to
the corresponding period in 1995. The Company ceased providing transmission
services to EI during November 1996 due to payment delinquencies by EI and
terminated its relationship with EI during December 1996. In connection with the
termination, EI agreed to pay the Company $2.2 million on an agreed upon payment
schedule, substantially all of which has been paid. In addition, the Company
agreed not to solicit sales from customers of the joint venture, subject to
certain permitted exceptions.
During 1996, average U.K. revenue per minute was $.55, down from $.69 in
1995. This reduction was attributable to price decreases resulting from
increased price competition, as well as the modification of the Company's
relationship with EI on June 1, 1996, which included a reduction in prices
charged to EI as compared to the prices charged to the Company's joint venture
with EI.
In continental Europe, revenues increased by 128% to $11.4 million. This
increase was attributable primarily to growth in prepaid card services of $7.2
million due to full year sales and increased marketing and, to a lesser extent,
growth in calling card services of $4.2 million. Average continental European
revenue per minute was $1.37, up from $1.30 in 1995. This increase was
principally due to an increase in higher priced prepaid card traffic.
In the United States, the Company's revenues grew 119% to $18.2 million,
primarily as a result of substantial increases in sales of international and
domestic long distance services of $7.8 million, prepaid card services of $2.6
million (which were introduced during the second half of 1995 and generated
minimal revenue during such year) and carrier services of $5.9 million, as well
as the introduction of calling card services of $1.9 million, which were sold
primarily through VoiceNet. Average U.S. revenue per minute was $.27 in 1996,
down from $.35 in 1995. This decrease was due principally to a reduction in
rates resulting from increased price competition attributable to pricing
reductions by larger carriers and sales of a larger percentage of domestic long
distance minutes, which are sold at lower rates than international minutes.
COST OF SERVICES. Cost of services increased to $35.4 million for 1996 from
$19.7 million for 1995 and, as a percentage of revenues, increased to 78% for
1996 from 72% for 1995. The increase as a percentage of revenues was primarily
due to the modification of the Company's relationship with EI on June 1, 1996,
pursuant to which the Company agreed to charge a lower transmission rate to EI,
thereby reducing
33
<PAGE>
margins on sales to EI. Average costs per minute for 1996 decreased to $.34 from
$.41 for 1995. This decrease was attributable to volume discounts resulting from
the higher volume of traffic carried and general price reductions on
transmission capacity.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $16.8 million for 1996 from $7.1 million
for 1995, and, as a percentage of revenues, increased to 37% in 1996 from 26% in
1995. This increase was primarily due to increases in the size of the Company's
customer service department and, starting in August 1996, a substantial increase
in the Company's management and staff in the areas of finance, network
management and information systems at its New York, New York, Brooklyn, New York
and College Station, Texas facilities, and the establishment of sales offices in
London during the second quarter of 1996 and in Paris, Brussels and Hamburg
during the third quarter of 1996 as well as expenses related to EI and
commissions paid to independent sales agents.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $1.0 million for 1996 from $.4 million for 1995. This increase was
substantially due to the depreciation expense associated with upgrades in the
Company's switch in New York and installation of multiplexing equipment in New
York and London.
BAD DEBT EXPENSE. The Company had bad debt expense of $2.0 million during
1996, compared to bad debt expense of $.2 million during 1995. For bad debt
expense in 1996, $2.0 million was attributable to the charge relating to EI
during 1996.
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
incur additional losses and have substantial additional capital expenditures.
The Company has utilized cash provided from financing activities to fund losses
and capital expenditures. The sources of this cash have primarily been the
proceeds from the sale of the 1997 Notes and the 1998 Notes and, to a lesser
extent, equipment-based financing.
As of September 30, 1998, the Company had $153.5 million of cash, cash
equivalents and marketable securities. The Company believes that the net
proceeds of this offering, 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 success of its business, its gross margins, and its selling, general
and administrative expenses, as well as other factors, many of which are not
within its control, including competitive conditions, regulatory developments
and capital costs. In the event that the Company's plans or assumptions change
or prove to be inaccurate, it may be required to delay or abandon some or all of
its development and expansion plans or the Company may be required to seek
additional sources of capital. Future sources may include public debt or equity
offerings or equipment financing. There can be no assurance that additional
financing arrangements will be available on acceptable terms.
In 1999, the Company plans to spend approximately $100 million for capital
expenditures on network equipment, back-office systems, the build-out of its
network operations center in St. Louis, Missouri, a transatlantic IRU 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 $28.8 million for
the nine months ended September 30, 1998, and was primarily attributable to a
net loss of $47.2 million and an increase in accounts receivable of $24.3
million, partially offset by an increase in accounts payable, accrued expenses
and other current liabilities of $18.5 million, and non-cash interest expense of
$12.6 million. Net cash used
34
<PAGE>
in investing activities of $136.8 million for the nine months ended September
30, 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 of $174.4
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.
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, and it acquired the customer
accounts of a long distance reseller, also located in the United Kingdom. The
Company is in the process of determining appropriate allocations of the purchase
prices and related amortization periods of the intangible assets.
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
30% 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 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.
Subsequent to September 30, 1998, the Company incurred certain other
non-operating cash commitments, including approximately $42.3 million in the
aggregate for a 20-year IRU from Frontier to use its U.S. fiber optic network
and for the purchase of a transatlantic IRU. As of December 31, 1998, the
Company pays 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
on the Frontier network, see "Business--The Destia Network--North American
Network."
The Company continually evaluates business opportunities, including
potential acquisitions. In addition, although the Company is not currently
engaged in negotiations regarding any material acquisitions, the Company may use
net proceeds of the offering to fund suitable strategic acquisitions. The
Company will seek to acquire or align itself with complimentary companies that
(1) offer attractive opportunities in new geographic markets (with an emphasis
on continental Europe), (2) have an established customer base or (3) have
innovative telecommunications services or technologies (such as data
transmission and Internet Services).
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 and
1998 Notes is in U.S. dollars. For the first nine months of 1998 and 1997,
approximately 43% and 38%, respectively, 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
35
<PAGE>
on the Company's revenues for the nine months ended September 30, 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 September 30, 1998 and
December 31, 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 will establish fixed
conversion rates, and adopt the euro as their new common legal currency.
Beginning on such date, the euro will trade on currency exchanges and 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.
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, in fact, be reduced as
the legacy currencies are converted to 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 June 1997, SFAS No. 130--"Reporting Comprehensive Income" and SFAS No.
131--"Disclosures about Segments of an Enterprise and Related Information" were
issued and are effective for periods beginning after December 15, 1997. SFAS No.
130 requires that all items recognized as comprehensive income be reported in
the financial statements. The components of other comprehensive income consist
primarily of foreign currency translation adjustments. SFAS No. 131 establishes
standards for reporting financial and descriptive information regarding an
enterprise's operating segments. Generally, financial information is required to
be reported on the basis that it is used internally for evaluation of segment
performance and deciding how to allocate resources to segments. This standard
increases disclosure only and has 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 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. 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
36
<PAGE>
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, financial
position or cash flows.
YEAR 2000 COMPLIANCE
The Company is engaged in an ongoing process of assessing its exposure to
the Year 2000 issue--the potential problems arising from computer systems that
were designed to use two digits, rather than four, to specify the year. The
Company has formed a project team (consisting of representatives from its
information technology, finance, business development, product development,
sales, marketing and legal departments) to address internal and external Year
2000 issues. By December 31, 1998, the Company had completed its internal review
of its financial and other computer systems (which include switching, billing
and other platforms) to assess Year 2000 issues. Based on this review, the
Company believes that the amount of work and expense required to address Year
2000 issues relating to its internal systems will not be material. The Company
is upgrading certain of its Northern Telecom switches to make them and their
related software Year 2000 compliant. The Company expects this upgrade to be
completed by June 30, 1999 at a cost of approximately $1.3 million. In addition,
the Company may be required to modify some of its other existing software. The
Company estimates that it will have updated all of its significant internal
systems to make them Year 2000 compliant and will be able to begin testing by
June 30, 1999.
In addition to assessing its own systems, the Company plans to retain a
consulting firm by the end of February 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 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 likely worst case Year 2000
scenario is disruption of its ability to route traffic over portions of its own
network, 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 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 million has been spent
through January, 1999, with the majority of expenditures expected to be incurred
in February, 1999. This estimate includes the accelerated cost of replacing
systems that are not Year 2000 compliant. Actual costs and 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 market
was liberalized only recently on January 1, 1998 and liberalization is still in
the process of being implemented in continental Europe. 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.
Generally, continental European telecommunications tariffs have been
designed to subsidize the provision of local service with high priced long
distance services. As a result, long distance services currently generate 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 tariffs 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 prices. While in some countries (such as France)
substantial rate rebalancing has already occurred, other countries (such as
Germany) have yet to make substantial progress. We believe that in the near
term, even once rates have been substantially rebalanced, long distance rates
will continue to subsidize the high overhead costs of the PTTs as the process of
restructuring their operations to become more competitive will take many years
to accomplish. However, there can be no assurance in this regard.
Implementation of interconnection agreements 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 leverage 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 Railtel (GTS and
others) and Circe (Viatel), as well as announced network construction by Level 3
and Global Crossing. At present, each of these networks is in various stages of
development. However, 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.
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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. In 1997, there were 81.8 billion minutes of
international long distance traffic with the majority originating in the United
States and Europe. This volume is expected to grow at a compound annual growth
rate of 12% to 18% from 1997 to 2001.
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 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 and 1997 and the nine months ended September 30, 1998, our revenues
were $45.1 million, $83.0 million and $141.0 million, respectively. In addition,
for 1996 and 1997 and the nine months ended September 30, 1998, we carried 104.6
million, 330.1 million and 607.3 million minutes of traffic, respectively.
Substantially all of our growth has been generated internally, rather than
through 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 carrier-grade switches in operation, with seven in North America and
seven in Europe;
- an IRU from Frontier on its U.S. fiber optic network;
- transatlantic IRUs;
- leased capacity and IRUs in Europe; and
- leased capacity in Canada.
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Additionally, as of the end of 1998, we have completed direct
interconnections with the PTTs in four of our major European markets (the United
Kingdom, Belgium, Germany and Switzerland) and have signed interconnection
agreements with the PTTs in France and 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 begin cross-marketing many of our
services, including 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 % of Destia and
following the offering will own approximately %.
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 proprietary 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 everyday 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 call 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;
- substantial barriers to entry because of the significant investments
required to develop sales and 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 and 1997 and the
nine months ended September 30, 1998, our gross margins were 21.6%, 23.2% and
26.9%, respectively. 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 during
1996 to $45.6 million for the nine months ended September 30, 1998, and our U.K.
customer accounts have increased from 1,029 at December 31, 1996 to 79,500 at
September 30, 1998. We believe we can continue to replicate this strategic focus
and further improve our growth and 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 core 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
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.
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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.
Alternatively, 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 and increase our gross margins. 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.
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.
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. 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 Internet services). We believe that our geographic reach and
management expertise create access to acquisition opportunities. Although we
from time to time engage in discussions concerning potential acquisitions, we
are not currently engaged in negotiations regarding any material acquisitions,
other than discussions related to the long-term lease or acquisition of fiber
optic transmission capacity in Europe.
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 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.
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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
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
<CAPTION>
<S> <C>
E-COMMERCE
SERVICES
---------------
Continental Europe
Belgium........................... --
France............................ --
Germany........................... --
Switzerland....................... --
United Kingdom...................... --
North America
United States..................... X
Canada............................ --
</TABLE>
INTERNATIONAL AND DOMESTIC LONG DISTANCE SERVICE. International and
domestic long distance service is service that is accessed from a customer's
billing location (I.E., their home or office) using "1xxx" access in the United
Kingdom, France and Belgium or "1+" access in the United States and Canada. In
Germany 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 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 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 Debit Phone-TM- prepaid service to residential
customers in the United Kingdom. Debit Phone 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
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from the customer's prepaid account balance. Debit Phone 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!-TM- in the United States. Presto! is our first e-commerce service and
the first service offered through what we intend to develop as an Internet-based
portal for telecommunications services. Presto! is a virtual prepaid account
that is purchased and recharged exclusively over the Internet at
www.prestocard.com. This service enables users to make international and
domestic long distance calls at competitive rates and to view their Presto! call
records on a real-time basis. We believe that Presto! is currently the only
prepaid service that can be purchased and recharged instantly over the Internet.
We intend to offer Presto! in Canada and our 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!, like our prepaid cards, does not require any billing support and does
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. By July of 1999, we plan to offer Internet access to
retail customers in Switzerland and Belgium, which we believe will increase
their 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.
- 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, 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.
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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.
From January 1, 1997 through September 30, 1998, sales of transmission
capacity to carrier customers ranged from 13% to 30% of our consolidated
revenues on a quarterly basis, comprising 13% of our consolidated revenues for
the quarter ending September 30, 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 carrier-grade Northern Telecom switches in operation, with seven in
North America and seven in Europe;
- nine POPs in North America and seven POPs in Europe, in addition to our
switch locations;
- over 100 interconnections to LEC tandems and LEC end-offices in the United
States, which provide us with direct interconnections to LECs;
- 20 interconnections to PTT networks in the United Kingdom and continental
Europe;
- a U.S. fiber optic transmission network backbone that we currently lease
from Qwest;
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- 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 favorable origination and termination
rates throughout 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 Canada and Europe;
- 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 locations 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
of up to 20 or 25 years (which is typically the entire economically 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
- 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
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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 the Company has experienced increased traffic, but do not
require a significant investment of infrastructure, human resources or
technology and have a shorter duration than IRUs. Because the cost of IRUs and
leased lines involve an initial capital outlay or a fixed monthly payment,
transmitting an increased portion of calls over these IRUs and leased lines
reduces 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
utilize carrier grade compression, or multiplexing, equipment where doing so
will not diminish the quality of the transmission.
As part of our expansion strategy, and as a result of increasingly
attractive pricing, we intend to acquire additional IRUs, including in
continental Europe. At present, all of our existing IRUs are operated and
maintained by third parties, while we lease the right to run calling traffic
through the fiber. To the extent cost efficient, we may acquire additional IRUs,
for which we will either control or install the network optronics, including
IRUs in "dark fiber". Under certain circumstances, acquiring these types of IRUs
may be more cost advantageous than acquiring IRUs in transmission capacity that
is operated and maintained by third parties, although it also involves certain
additional risks and, in some countries, additional regulatory compliance
requirements. See "Risk Factors--Dependence on Transmission Line Providers."
In addition, 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 in this build-out and for further
development and enhancement of our network control systems. 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.
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 are currently implementing an interactive voice
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response system that will permit customers to obtain up-to-date information
concerning their account and their most recent invoice by telephone.
For the first nine months of 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 everyday 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 2Q99E
London, England.......................... 2Q97 2Q97
Frankfurt, Germany....................... 3Q98 4Q98
Zurich, Switzerland...................... 3Q98 4Q98
Amsterdam, The Netherlands............... 4Q98 2Q99E
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 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.
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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 also expect to implement interconnection during the second
quarter of 1999 in France and The Netherlands, where we already have signed
interconnection agreements with the PTTs. 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 nine POPs in the United States and Canada. Our
North American switches, which are all interconnected, 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 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 throughout 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 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. We believe that approximately 60% of Frontier's planned network is
completed. We expect the Frontier U.S. fiber optic network to be fully
operational by the end of 1999, although there can be no assurance in this
regard. See "Risk Factors--Dependence on Transmission Line Providers."
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
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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 or to the PTT in the terminating country. At present, our only
gateway switch is in New York, although our London switch also has international
conversion capabilities. During 1999 and early 2000, we intend to upgrade our
switches in Miami and Los Angeles to have international gateway capabilities,
allowing them to also interface directly with protocols used by non-U.S.
carriers. The Miami gateway switch will interface primarily with carriers from
Latin America and the Caribbean and the Los Angeles gateway switch will
interface primarily with carriers from Asia.
CANADIAN EXPANSION. During the third quarter of 1998, we expanded the
Destia Network to Canada by installing a switch in Toronto. We plan to install a
POP in Montreal by July 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 the
Company as its long distance carrier and the LEC's or PTTs' switching
system already is programmed to direct long distance calls from the
customer's telephone to the nearest Destia Network switch.
- "1XXX" ACCESS. "1xxx" access, or prefix dialing, enables a long distance
customer in 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, 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
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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 higher greater 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.
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.
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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 a "packet") 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 lower
amounts of bandwidth, thus increasing the amount of information we transmit over
a given line and increasing the capacity of our network can carry 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, there can be no assurance that we will be successful in this regard.
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 Greece, Israel, the Ukraine, Denmark, Sweden, Italy,
Slovenia and Ireland. 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. 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 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 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
plan to market 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 intend to begin providing Internet
services in
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Switzerland by the second quarter of 1999 and expect to offer one year of free
Internet access to customers who sign up for our long distance services.
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 our 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
substantially 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
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 recently 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.
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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 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 ECONOTIPS 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 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
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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 are
currently implementing an interactive voice response system that will permit
customers to obtain up-to-date information concerning their account and their
most recent invoice. 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 the
nine months ended September 30, 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 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. 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
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anticipate that our interconnection with France Telecom will be fully
operational during the second quarter of 1999 since France Telecom has indicated
that we will be able to complete our interconnection by February 15, 1999.
However, there are often delays in executing and implementing interconnection.
See "Risk Factors--Need for Interconnection" and "--Regulation."
GERMANY. Germany is the largest market for telecommunications services in
continental Europe. Our 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 will begin marketing domestic long distance
services in the first quarter of 1999 because we completed interconnection in
the fourth quarter 1998. We also plan to begin marketing long distance services
to residential accounts in 1999. 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 first
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. 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.
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. During the first quarter of 1999, we intend to begin
providing Internet services in Switzerland and expect to offer one year of free
Internet access to customers who sign up for 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 the fourth telecommunications carrier 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 doubled and as of December 31, 1998 we had
approximately 7,000 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.
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
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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. We also intend to launch the Presto! card in
the United Kingdom during the second quarter of 1999.
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 our
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 America
Telemedia Limited ("ATL"), one of our wholly-owned subsidiaries, in London and
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 15 U.S. cities in which the Destia Network has a switch or
POP. Because of the U.S. market's size and receptiveness to new services, 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!
service in the United States over the Internet. We also intend to test (and
cross market) additional e-commerce services to Presto! customers due to their
predisposition to making purchases on-line.
As of December 31, 1998, we had six switches and nine 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 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. This build-out of Frontier's
planned network is approximately 60% completed and we expect it to be fully
operational by the end of 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 July 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. As of January 1, 1999, we were granted a license under this liberalized
regulatory regime to provide competitive telecommunications services. Additional
deregulation, which would permit us also to provide domestic long distance
service, is expected by January 1, 2000. We began providing
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services in Canada late in the fourth quarter of 1998 and intend to further
expand our internal sales force in Canada in 1999.
COMPETITION
The international telecommunications industry is highly competitive and
significantly affected by regulatory changes, marketing and pricing decisions of
the larger industry participants and the introduction of new services and
transmission methods made possible by technological advances. 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 will be allowed to enter the local telephone service markets, and cable
television companies and utilities will be allowed to enter both the local and
long distance telecommunications markets. In addition, competition has begun to
increase in the EU telecommunications markets in connection with the
deregulation of the telecommunications industry in most EU countries, which
began in January 1998. This increase in competition is likely to affect revenue
per minute and gross margin as a percentage of revenue.
NORTH AMERICA
UNITED STATES. In the United States, which is among the most competitive
and deregulated long distance markets in the world, competition is based
primarily upon pricing, customer service, network quality, and the ability to
provide value added services. As such, the long distance industry is
characterized by a high level of customer attrition or "churn," with customers
frequently changing long distance providers in response to the offering of lower
rates or promotional incentives by competitors. 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 are also expected
to become competitors in the long distance telecommunications industry, both
outside of their service territory and, upon satisfaction of certain conditions,
within their service territory. The Telecommunications Act prospectively
eliminated the restrictions on incumbent LECs, such as the RBOCs, from providing
long distance service. These provisions permit an RBOC to enter an
"out-of-region" long distance market immediately upon the receipt of any state
and/or federal regulatory approvals otherwise applicable in the provision of
long distance service. RBOCs must satisfy certain procedural and substantive
requirements, including obtaining FCC approval upon a showing that, in certain
instances, facilities-based competition is present in its market, that it has
entered into interconnection agreements that satisfy a 14-point checklist of
competitive requirements and that its entry into the in-region long distance
market is in the public interest before they are authorized to offer long
distance service in their regions. No RBOC is authorized to do so yet, but they
are expected to be authorized soon. When they are authorized, they will be very
formidable competitors. In particular, Bell Atlantic, which serves the New York
metropolitan and mid-Atlantic regions, is considered by industry observers to be
the most likely RBOC to be the first to be permitted to offer long distance
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services. 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.
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 GTE by Bell Atlantic, the merger of
WorldCom and MCI, AT&T's proposed acquisition of Telecommunications, Inc. and
AT&T's acquisition of Teleport Communications Group, Teleglobe's acquisition of
Excel Communications and SBC's acquisition of SNET are examples of some of the
business combinations that are being formed. 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") could also result in additional competitors entering the U.S.
telecommunications markets. Under the WTO Agreement, the U.S. and other members
of the WTO committed themselves to, among other things, opening their
telecommunications markets to foreign carriers. The FCC has adopted streamlined
procedures for processing market entry applications from foreign carriers,
making it easier for such carriers to compete in the U.S. There can be no
assurance that the WTO Agreement will not have a material impact on 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. 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, as well as the
next largest Stentor companies which have announced a proposed merger, as well
as non-Stentor companies, such as AT&T Canada, Teleglobe Canada, and Sprint
Canada. 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 for the first time.
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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 British Telecom
(that has recently announced a plan to contribute their international
facilities and personnel to a newly formed company that is likely to be a
substantially more formidable competitor);
- companies offering resold international telecommunications services; and
- other companies with business plans similar in varying degrees to 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. 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.
For a discussion of additional competitive factors that affect our business
in certain of our markets, 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.
See "Risk Factors--Need for Interconnection" for a discussion of certain
regulatory risks relating to our business. 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 state public service commissions
("PSCs"). The recent trend in the United States for both federal and state
regulation of
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telecommunications service providers has been in the direction of reduced
regulation. Although this trend facilitates market entry and competition by
multiple providers, it has also given AT&T, the largest international and
domestic long distance carrier in the United States, increased pricing and
market entry flexibility that has permitted it to compete more effectively with
smaller carriers, such as the company. In addition, the 1996 Telecommunications
Act has opened the United States market to increased competition, including for
RBOCs as well as current and former PTTs. We cannot be certain whether future
regulatory, judicial and legislative changes in the United States will not
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
with respect to our international or domestic service offerings.
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 and, thus, profit-maximizing fashion. For example, the FCC's private
line resale policy, part of its International Settlements Policy ("ISP"),
prohibits a carrier from reselling interconnected international private leased
circuits to provide switched services (known as "ISR") to or from a country
absent FCC authorization. The FCC recently modified its policy on private line
resale to allow such resale between the U.S. and a WTO member country for which
the FCC has not previously authorized the provision of switched services over
private lines upon a demonstration that (1) settlement rates for at least 50
percent of the settled U.S.-billed traffic between the U.S. and the country at
the foreign end of the private line are at or below the benchmark settlement
rate adopted by the FCC, or (2) where the country at the foreign end affords
resale opportunities "equivalent" to those available under U.S. law. Both
conditions must be present before the FCC will authorize private line resale
between the U.S. and a non-WTO member country for which the FCC has not
previously authorized the provision of private line resale. The following
countries have been approved by the FCC for ISR to date: Australia, Austria,
Belgium, Canada, Denmark, France, Germany, Hong Kong, Ireland, Italy, Japan,
Luxembourg, New Zealand, 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, although in both
cases around hubbing via "switched hubbing" is permitted to non-ISR-approved
countries. The policy may materially limit the best and most profitable 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 are also subject to the FCC's International Settlements Policy which
governs the settlement between U.S. carriers and their foreign correspondents of
the cost of terminating traffic over each other's network, the "benchmark"
settlement rates for such settlements, and permissible exceptions of these
policies. The FCC could find that, absent a waiver, certain terms of our foreign
carrier agreements do not meet the requirements of the International Settlements
Policy or that certain actions do not constitute permissible deviations from
this policy. 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 International Settlements Policy and it could, among other things,
issue a cease and desist order or impose fines if it finds that these agreements
conflict with the International Settlements Policy. We do not believe that any
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such fine or order would have a material adverse effect on our business or the
price of our common stock. In addition, the FCC is presently reconsidering
certain aspects of its ISP, including the complete elimination of its ISP and
contract filing requirements on competitive routes, elimination of these
requirements for arrangements with non-dominant carriers in WTO member countries
and allowing greater opportunities to engage in international simple resale. The
FCC also regulates foreign carrier affiliations.
The FCC and certain State 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. Additionally,
the FCC and certain State PSCs require notification of our name change from
Econophone, Inc. to Destia Communications, Inc. Although we believe that no
material penalties will result from our failure to notify the FCC and certain
State PSCs of the name change prior to its effectuation or from our failure to
seek prior approval or take certain actions, we cannot be certain whether this
will be the case.
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.
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 obtaining FCC approval upon a showing that in certain
situations 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.
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 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
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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 the
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.) and other ILECs are expected to file similar petitions in
the near future.
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. Subject to certain restrictions on transfers from the ILEC to the
affiliate, structural separation rules and nondiscrimination safeguards, these
separate affiliates would not be subject to the obligations imposed on ILECs
under Section 251(c), but would remain subject to the in-region interLATA
restrictions imposed on RBOCs and RBOC affiliates by Section 271. In the order,
the FCC did not specifically authorize ILECs to provide advanced services
through a separate affiliate immediately. ILECs may, of course, immediately
provide advanced services but until the separate affiliate is properly
established pursuant to rules to be promulgated following comment on the NPRM,
such provision of advanced services will be subject to Section 251. The outcome
of this proceeding could materially adverse affect our business and the price of
our common stock.
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 share of certain defined
telecommunications end-user revenue. Our revenues that are subject to the high
cost and low income fund are our quarterly interstate and gross end-user
telecommunications revenues. Our revenues for the schools and libraries and
rural health care fund are our estimated quarterly intrastate, interstate and
international gross end-user telecommunications revenues. Contribution factors
vary quarterly and we and other carriers are billed monthly. Contribution
factors for first quarter 1999 are: (i) 3.18% for the high cost and low income
funds (interstate and international revenues); and (ii) 0.58% for the schools,
libraries, and rural health care funds (intrastate, interstate and international
revenues). Because the contribution factors do vary quarterly, the annualized
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 incumbent LECs for origination and
termination of calls over local facilities. The FCC has significantly revised
its access charge rules in recent years to permit incumbent LECs greater pricing
flexibility and relaxed regulation of new switched access services in those
markets where there are other providers of access services. The Company
currently has agreements to terminate, originate or exchange traffic with a
variety of carriers who, in turn, may be subject to similar agreements with
other carriers or LECs. Any change in any of these agreements, whether by
operation of law or otherwise, may affect the company's costs or could disrupt
the company's ability to terminate, originate or exchange traffic and,
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therefore, have a material adverse effect on our company. The FCC has, for
example, created a new presubscribed interexchange carrier charge ("PICC") rate
element. The PICC is a flat-rate, per line charge that is recovered by LECs from
interexchange providers. Effective January 1, 1998, the initial maximum
permitted interstate PICC charge is $0.53 per month for primary residential
lines and single-line business lines and $1.50 per month for second and
additional residential lines. The initial maximum interstate PICC for multi-line
businesses are $2.75 per month, per line. The ceilings will be permitted to
increase over time. The FCC continues to adjust its access charge rules and has
indicated that it will promulgate additional rules sometime in 1999 that may
grant certain LECs further flexibility. While 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 fully pass
on such costs or that doing so will not result in a loss of customers. 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.
The 1996 Telecommunications Act also requires interexchange carriers to
compensate payphone owners when a payphone is used to originate a telephone call
through an access code or a toll-free number (including by means of a prepaid
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
calls using their payphone. 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. We expect the
FCC to issue a further remand order establishing a revised payphone compensation
rate during the first quarter of 1999.
The FCC also imposes requirements for the marketing of telephone services
and for obtaining customer authorization for changes in a customer's primary
long distance carriers. The FCC has recently imposed severe penalties on a
number of carriers for "slamming," the unauthorized change of a customer's
presubscribed long distance carrier. Under an order recently issued by the FCC,
carriers such as 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 have recently transferred the
authorizations to a recently created wholly-owned subsidiary, Econophone
Services, Inc. Certificates of authority can generally be conditioned, modified,
canceled, terminated or revoked by state regulatory authorities for failure to
comply with state law and/or rules, regulations and policies of the state
regulatory authorities.
Many states also impose various reporting and other requirements. A number
of state PSCs have adopted rules governing the markets of telephone services and
obtaining customer authorizations for changes of a customers' primary long
distance carrier. State commissions also regulate access charges and other
pricing for telecommunications services within each state. We may also be
required to contribute to universal service funds in some states.
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REGULATION OF THE INTERNET. The use of the Internet to provide telephone
service is a recent development. Currently, the FCC is considering whether or
not to impose surcharges or additional regulations upon certain providers of
Internet telephony. In an April 1998 report to Congress, the FCC indicated it
would examine the question of whether certain forms of "phone-to-phone" Internet
protocol telephony are information services or telecommunications services. It
noted that certain forms of phone-to-phone Internet telephony appeared to have
the same functionality as non-Internet protocol telecommunications services and
lacked the characteristics that would render them information services. If the
FCC were to determine that certain services are subject to FCC regulations as
telecommunications services, it may require these service providers to make
universal service contributions, pay access charges or be subject to traditional
common carrier regulation. State PSCs may also retain jurisdiction to regulate
the provision of intrastate Internet telephony services and could initiate
proceedings to do so.
PATENT RIGHTS RELATING TO PREPAID SERVICES. Various parties have claimed
that certain prepaid card providers are infringing upon patent rights held by
these parties relating to the provision of prepaid card services. 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 the European Commission ("EC"), consisting of the EU
member countries. The EU member countries include: Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands,
Portugal, Spain, Sweden and the United Kingdom. The EU is responsible for
creating pan-European policies and, through legislation, developing a regulatory
framework to ensure an open, competitive telecommunications markets.
As of January 1, 1998 the EU abolished all special or exclusive rights that
restrict the provision of telecommunications services. Specific directives have
been adopted, which include the Open Network Provision ("ONP") Leased Lines
Directive, the ONP Voice Telephony Directive, the ONP (Adaptation of the
Framework and Leased Lines to a Competitive Environment) Directive and the
Interconnection Directive, the latter of which would provide for equal access
and number portability on January 1, 2000. Equal access would enable a customer
to access our network over another operator's network, without dialing an access
code, by "preselecting" our company as its long distance carrier. However, Oftel
already has indicated that it will seek to defer the implementation of equal
access in the United Kingdom, and PTTs and/or regulators in certain other EU
jurisdictions also are expected to seek deferrals. Number portability would
enable customers to retain their existing telephone numbers when switching to
alternative carriers and is already available (although not universally) in the
United Kingdom. Additional directives, in addition to those described above,
remain to be adopted by the Council of the European Communities, although their
final content and timing of implementation cannot be predicted at this time.
Certain EU countries have temporary waivers from these EU deregulation
requirements: Greece and Portugal until January 1, 2000.
National governments also must pass legislation within their countries to
give effect to EC directives. Each EU member state in which we currently conduct
business will therefore continue to, in part, have a different regulatory
regime. The requirements for us to obtain necessary approvals vary considerably
from country to country and are expected to continue to so vary. See "Risk
Factors--Regulatory Restrictions."
WORLD TRADE ORGANIZATION INITIATIVES. The WTO recently concluded the WTO
Agreement, which opens the telecommunications markets of the signatory countries
to entry by foreign carriers on varying dates and to varying degrees. The WTO
Agreement became effective on February 5, 1998. Pursuant to the WTO Agreement,
U.S. companies would have foreign market access for local, long distance and
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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 subsidiary ATL, 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 ATL 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, British
regulators have indicated that it will seek to defer the implementation of equal
access in the United Kingdom until a later date.
BELGIUM. Since January 1, 1998, licensed operators have been able to
provide telephony services in Belgium. On July 15, 1998, the Royal Decree of
Voice Telephony removing the last remaining monopolies of Belgacom, the Belgium
PTT, was published. These permitted services include all of the services that we
currently provide in Belgium.
Providers of voice telephony services must apply for a voice telephony
license. We currently have a temporary voice telephony license and have applied
for a permanent license, although the Belgium Minister for Telecommunications
has not yet begun to grant permanent licenses. This temporary licensing regime
was recently extended to enable the Minister for Telecommunications to review
all license applications. We expect that our temporary license will continue to
be extended until the Minister for Telecommunications begins to issue permanent
licenses, although there can be no assurance that this will be the case. If our
license was not extended, we would not be able to provide services in Belgium.
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 lease, rather
than own, transmission lines in Belgium, 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 would increase our transmission costs in Belgium.
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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 ("ART"). Because we lease, rather than own, our transmission
lines in France, we are not required to have an infrastructure license. The ART
provides financial incentives to certain infrastructure providers. These
incentives provide carriers that own infrastructure with a cost advantage over
carriers that do not own infrastructure and are not available to 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. 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, requires a
license. We received a Class 4 license during the second quarter of 1998, which
enables us to provide voice telephone services within 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. Our current interconnection agreement with
Deutsche Telekom will expire on February 28, 1999. We expect it to be extended
before this time for a further temporary period, although there can be no
assurance in this regard. If we were to lose our interconnection with Deutsche
Telekom in Germany, we would need to obtain interconnection from another
carrier, which would increase our transmission costs in Germany. There is
currently a regulatory dispute in Germany between Deutsche Telekom and
competitive carriers. If Deutsche Telekom prevails in that dispute, it could put
us and other competitive carriers at an additional cost disadvantage versus
Deutsche Telekom.
Through our interconnection with Deutsche Telekom, our customers are able to
preselect us as their carrier.
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 AG, 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.
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 did not 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 international transmission to and
from Canada beginning on October 1, 1998. Full liberalization of
telecommunications services is expected to occur on January 1, 2000. We received
a license early in the first quarter of 1999 which authorizes us to provide to
offer international
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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. 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 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:
- 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........................ 38 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 Wittingham................. 47 Director of European Network Operations
Mark St. J. Courtney............... 39 Director of European Commercial and Regulatory Affairs
Gary S. Bondi...................... 47 Director
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
1994. 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, 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 NETWORK OPERATIONS. 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 OF 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 WITTINGHAM, DIRECTOR OF EUROPEAN NETWORK OPERATIONS. Mr. Wittingham
has been with the Company since 1995. Since joining the Company, Mr. Wittingham
has been responsible for the build-out of the European Network. Prior to joining
the Company. Mr. Wittingham was employed by Worldexchange Limited as a
Technologies Director for Europe from 1994 to 1995. From 1992 to 1994, Mr.
Wittingham 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. Mr. Bondi has served as a Director of the Company
since 1993. He served as Treasurer of the Company from 1993 through 1998. 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.
BOARD COMPOSITION
Prior to the completion of the offering, the Company's Board of Directors
will be divided into three classes of directors serving staggered terms. After
an initial transition period following the offering, directors in each class
will be elected to serve for three-year terms and until their successors are
elected and qualified. Each year, the directors of one class will stand for
election as their terms of office expire. will be designated as Class I
directors, with their terms of office expiring in ; will be
designated as Class II directors, with their terms of office expiring in ;
and will be designated Class III directors, with their terms of office
expiring in .
The Company's Board of Directors is currently set at five directors and has
no vacancies, which the Company's Bylaws authorize the Board of Directors to
fill. The Company intends to appoint one additional person who is not an officer
or an employee of the Company to the Board of Directors within 90 days after
consummation of this offering and is required to do so to maintain its listing
on the Nasdaq National Market.
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
73
<PAGE>
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
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 Munger
participated in deliberations concerning executive officer compensation during
1998. Alfred West and Alan L. Levy receive compensation as officers of the
Company. Stephen 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 $ and an attendance
fee of $ for each meeting of the Board of Directors. In addition, they
will receive an annual option grant to purchase number of shares of
common stock that will vest over a six month period from the date of the grant.
EXECUTIVE COMPENSATION
At December 31, 1998, the chief executive officer and other five most highly
compensated executive officers of the Company were Mr. Alfred West and Messrs.
Levy, Alward, Storin, Shorten and Grohman. The following table summarizes all
compensation awarded to, earned by or paid to Mr. West and Messrs. Levy, Alward,
Storin, Shorten and Grohman (Messrs. West, Levy, Alward, Storin, Shorten and
Grohman are referred to herein as the "Named Executive Officers" for 1997 and
1998).
74
<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 OPTIONS GRANTED COMPENSATION(1)
- -------------------------------------------- --------- ---------- ------------ --------------- ----------------
<S> <C> <C> <C> <C> <C>
Alfred West (2)............................. 1998 $ 323,784 $ 323,784(3) -- $ 4,725(4)
Chief Executive Officer 1997 323,784 422,992(5) -- --
Alan L. Levy (6)............................ 1998 250,000 157,500(3) -- --
President and Chief Operating Officer 1997 210,000 116,250(7) -- --
Kevin A. Alward (8)......................... 1998 198,000 -- --
President--North America
Phillip J. Storin (9)....................... 1998 165,000 -- --
Senior Vice President--Chief Financial
Officer
Richard L. Shorten, Jr. (10)................ 1998 165,000 -- --
Senior Vice President--General Counsel 1997 6,875 -- --
Abe Grohman (11)............................ 1998 144,167 -- -- --
Chief Information Officer 1997 29,167 -- --
</TABLE>
- ------------------------
(1) Does not include the value of certain personal benefits. The estimated
value of such personal benefits for each Named Executive Officer did not
exceed the lesser of $50,000 or 10% of the total annual salary and bonus
paid to the Named Executive Officer in 1998.
(2) See "--Employment Agreements and Arrangements" for a description of Mr.
West's Employment Agreement.
(3) Consists of 1997 bonus paid in 1998.
(4) Consists of compensation in respect of life insurance, of which Mr. West's
designee is the beneficiary, paid by the Company.
(5) Consists of $127,686 of 1996 bonus paid in 1997 and $295,306 of 1997 bonus
paid in 1997.
(6) See "--Employment Agreements and Arrangements" for a description of Mr.
Levy's Employment Agreement.
(7) Consists of $37,500 of 1996 bonus paid in 1997 and $78,750 of 1997 bonus
paid in 1997.
(8) Mr. Alward commenced employment with the Company during February 1998.
(9) Mr. Storin commenced employment with the Company during February 1998.
(10) Mr. Shorten commenced employment with the Company on December 15, 1997.
(11) Mr. Grohman commenced employment with the Company on October 20, 1997.
1996 FLEXIBLE INCENTIVE PLAN
The Company has adopted the 1996 Flexible Incentive Plan (the "Incentive
Plan"), which provides for the grant of incentive stock options ("ISOs") to
acquire shares of common stock to employees of the Company or any of its
subsidiaries, the grant of non-qualified stock options ("NQSOs") to acquire
shares of common stock, the sale or grant of Restricted Shares and Unrestricted
Shares (each, as defined in the Incentive Plan) and the grant of stock
appreciation rights ("SARs") to employees, directors and consultants. The
Incentive Plan also provides for Tax Offset Payments (as defined in the
Incentive Plan) to employees. The Incentive Plan provides for the award of up to
a maximum of shares of common stock and is administered by the Board of
Directors of the Company. The Company is required to seek the approval of its
stockholders to materially increase the number of shares of common stock that
may be issued under the Incentive Plan.
The Incentive Plan provides that, in the event of a merger, consolidation,
combination, exchange of shares, separation, spin-off, reorganization,
liquidation or other similar transaction, the Board of Directors
75
<PAGE>
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.
An amendment to the 1996 Incentive Plan provided that shares of
common stock may be in the form of Voting Stock and may be in the form of
Non-voting Stock. To the extent these shares are restricted, holders of
Restricted Voting Stock have the right to receive cash dividends with respect to
such shares and holders of Restricted Non-voting Stock cannot receive cash
dividends. Upon the consummation of the offering, any awards made or granted in
the form of shares of Non-voting Stock shall be converted into awards for Voting
Stock having the same terms and conditions as the award for Non-voting and, to
the extent awards for Non-voting Stock have been exercised prior to the
consummation of the offering, the shares of Non-voting Stock shall be
exchangeable for an equivalent number of shares of Voting Stock. In some cases,
the conversion of Non-voting Stock to Voting Stock may be subject to the payment
of a conversion price.
As of December 31, 1998, the Company had issued stock options to purchase
shares of common stock under the Incentive Plan, of which
were exercisable as of such date and Restricted Shares of which
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................................ 33.3% 2/2/2008
Phillip J. Storin.............................. 6.66% 2/2/2008
Richard L. Shorten, Jr......................... 1.67% 7/1/2008
Abe Grohman.................................... -- -- -- -- -- --
</TABLE>
The following table sets forth options exercised during 1998 and the fiscal
year-end value of unexercised options for each Named Executive Officer.
76
<PAGE>
OPTION EXERCISES IN 1998 AND 1998 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
NUMBER OF IN-THE-MONEY
SECURITIES UNDERLYING OPTIONS AT
UNEXERCISED OPTIONS DECEMBER 31,
SHARES AT DECEMBER 31, 1998 1998
ACQUIRED ON VALUE ------------------------- ---------------
NAME EXERCISE (1) REALIZED (1) EXERCISABLE UNEXERCISABLE EXERCISABLE
- ---------------------------------------- --------------- ----------------- ---------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Alfred West............................. -- -- -- -- --
Alan L. Levy............................ -- -- --
Kevin A. Alward......................... -- -- --
Phillip J. Storin....................... -- -- -- --
Richard L. Shorten, Jr.................. -- -- --
Abe Grohman............................. -- -- --
<CAPTION>
NAME UNEXERCISABLE
- ---------------------------------------- -----------------
<S> <C>
Alfred West............................. --
Alan L. Levy............................ --
Kevin A. Alward......................... --
Phillip J. Storin....................... --
Richard L. Shorten, Jr.................. --
Abe Grohman............................. --
</TABLE>
- ------------------------
(1) No options were exercised during 1998.
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.
In August 1996, the Company entered into an employment agreement with Alan
L. Levy (as thereafter amended, the "Levy Employment Agreement") pursuant to
which Mr. Levy serves as President and Chief Operating Officer of the Company.
The term of the Levy Employment Agreement extends until July 31, 1999, subject
to any earlier termination in accordance with the terms thereof. Pursuant to the
Levy Employment Agreement, Mr. Levy is entitled to receive an annual base salary
of $210,000 during each year of the term thereof, subject to increases in the
discretion of the Board of Directors. In addition, Mr. Levy is eligible to
participate in the Company's incentive compensation programs and to receive such
annual
77
<PAGE>
bonus or other compensation, including restricted stock or incentive stock
options, as may be determined by the Company's Board of Directors. Pursuant to
an incentive stock option agreement dated October 31, 1996, the Company granted
Mr. Levy incentive stock options to purchase shares of common stock at
an exercise price of $ per share. Mr. Levy is entitled to certain demand and
piggyback registration rights with respect to such shares. If Mr. Levy's
employment is terminated prior to July 31, 1999 by the Company without just
cause or if Mr. Levy and the Company do not enter into a new employment
agreement prior to the expiration of the Levy Employment Agreement, he will be
entitled to a severance payment equal to one year's base salary. See "Shares
Eligible for Future Sale."
Messrs. Shorten and Grohman do not have employment agreements with the
Company. As of January 1, 1998, the annual salary (exclusive of any bonus) for
Messrs. Shorten and Grohman was $165,000 and $140,000, respectively. The Company
has entered into a employment agreement with Mr. Alward and expects to enter
into an employment agreement with Mr. Storin providing for annual base salary of
$215,000 and $180,000, respectively. Messrs. Alward and Storin also were granted
options under the Incentive Plan during 1998. The Company expects to enter into
employment agreements with certain executive officers prior to the offering.
As part of the acquisition of VoiceNet on February 12, 1998, the Company
entered into employment contracts with the sellers of VoiceNet providing for
annual base salary of $180,000 each. The sellers of VoiceNet also were granted
options at an exercise price of $ 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
Securities and Exchange Commission (the "Commission"), such indemnification is
against public policy as expressed in the Securities Act and is therefore
unenforceable.
78
<PAGE>
CERTAIN TRANSACTIONS
RELATED PARTY LOANS
On December 9, 1992, the Company borrowed $200,000 from Mrs. Rose West, the
mother of Messrs. Alfred West and Steven West, pursuant to an unsecured
promissory note bearing interest at the rate of 9% per annum, payable on
maturity. The obligation matured on December 8, 1997 and, on such date, was
converted into a demand obligation. On November 16, 1993, the Company borrowed
$108,000 from Mrs. West pursuant to an unsecured promissory note that bears
interest at a rate of 18% per annum, payable at maturity, and that matured on
November 15, 1998. The Company plans to repay each of these loans prior to the
offering.
Since the third quarter of 1996, Alfred West has borrowed $230,191 from the
Company pursuant to unsecured, non-interest bearing notes, repayable upon
demand.
MINORITY INTEREST IN THE ECONOPHONE SERVICES GMBH
The brother-in-law of Mr. Alfred West owns a 28% interest in the Company's
Swiss subsidiary, Econophone Services GMBH.
79
<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.
80
<PAGE>
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.
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.
81
<PAGE>
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.
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 December 31, 1998, the
aggregate amount outstanding under all tranches of the NTFC Facility was $21.1
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 January 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
82
<PAGE>
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, 2000.
Borrowings from NTFC are secured by the equipment purchased therewith and
general intangibles and intangible property that is associated with such
equipment.
RELATED PARTY LOANS
In addition to the indebtedness described above, see "Certain Transactions"
for a description of certain other indebtedness of the Company.
83
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the common stock as of January 28, 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
- ------------------------------------------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Alfred West...................................... (3)
Steven West...................................... (4)
Gary Bondi....................................... (5)
Princes Gate Investors II, L.P.
c/o Morgan Stanley & Co. Incorporated
1585 Broadway New York, New York 10036......... (6)
Kevin A. Alward.................................. (7)
Abe Grohman......................................
Alan L. Levy.....................................
Stephen R. Munger................................ --
Richard L. Shorten, Jr...........................
Philip J. Storin.................................
All Directors and Executive Officers as a Group
(9 persons)....................................
</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 January 28,
1999. Shares which a person does not have the right to acquire within 60
days from January 28, 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, 95 Rte. 17, Paramus, NJ 07652.
(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 shares of common
stock, or a total of 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) Includes shares held by AT Econ Ltd. Partnership and held by AT
Econ Ltd. Partnership No. 2.
(4) Includes shares held by SS Econ Ltd. Partnership and shares
held by SS Econ Ltd. Partnership No. 2.
(5) Includes shares held by GS Econ Ltd. Partnership.
(6) Includes shares of Series A Preferred Stock, which were convertible
into shares of common stock that are owned by affiliates of Princes
Gate, over which Princes Gate has sole voting power.
(7) Includes shares held by Kevin Alward, shares held by Alward
Investment Associates LLC and shares held by Kevin and Belinda Alward
Grantor Retained Annuity Trust. The remainder includes shares issuable upon
the exercise of options.
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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 shares of voting common stock, shares of non-voting
common stock, shares of Series A Preferred Stock and 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 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 shares of non-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 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.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the common stock is American Stock
Transfer & Trust Company.
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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 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 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
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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.
SHAREHOLDER RIGHTS PLAN. The following summary of certain provisions of the
Company's Shareholder Rights Plan and the Shareholders' Right Agreement (the
"Rights Agreement"), dated as of , 1999 between the Company and
does not purport to be complete and is qualified in its entirety by
reference to the Rights Agreement, including the form of Rights Certificate
attached thereto, which is an exhibit to the registration statement. The Rights
Agreement contains provisions that could make it more difficult for a third
party to gain control of the Company and that could have the effect of delaying
or preventing a merger, tender offer or other takeover attempt to the Company.
In , 1999, the Board of Directors of the Company declared a dividend
of purchase rights (each, a "Right") for each share of the Company's common
stock outstanding as . Each Right entitles its holder to purchase from
the Company, until the earlier of , or the redemption of the Right,
shares of common stock at an exercise price of $ per right, subject to
certain adjustments or, under certain circumstances, to obtain additional shares
of common stock of the Company in exchange for each Right. The Right will not be
exercisable or transferable apart from common stock of the Company until the
earlier of 10 days following the public announcement that a person or affiliated
group has acquired or obtained the right to acquire 20% or more of the
outstanding common stock of the Company; or 10 days following the commencement
or announcement of an intention to make a tender offer or exchange offer, the
consummation of which would result in the ownership by a person or group of 20%
or more of the outstanding common stock of the Company. The Board of Directors
of the Company may redeem the Rights at a price $.01 per Right at any time prior
to the acquisition by a person of 20% or more of the outstanding common stock of
the Company.
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SHARES ELIGIBLE FOR FUTURE SALE
On completion of this offering, the Company will have 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 shares of common stock are issuable upon the exercise of
outstanding options under the Company's Incentive Plan at a weighted average
exercise price of $ . Of this amount, shares are presently
exercisable and are subject to the satisfaction of vesting criteria. In
addition, 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 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 (approximately shares immediately
after the offering) 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 Incentive 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 (or other securities
issuable upon exercise of the Warrants) 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 (or other securities
issuable upon exercise of the Warrants) 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.
Mr. Levy has been granted options to purchase shares of common
stock, of which are subject to the satisfaction of vesting criteria.
Pursuant to the Underwriting Agreement, Mr. Levy has agreed not to sell any
shares of common stock without the prior consent of Morgan Stanley during the
180-day Lockup Period.
Sales of a substantial number of shares of common stock after the offering
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....................................................................
-----------
International underwriters:
Morgan Stanley & Co. International Limited......................................
Credit Suisse First Boston (Europe) Limited.....................................
Lehman Brothers International (Europe)..........................................
-----------
Subtotal....................................................................
-----------
Total.....................................................................
-----------
-----------
</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.
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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.
93
<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
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 common stock has been approved for quotation, subject to official notice
of issuance, on the NASDAQ National Market under the symbol "DEST."
At the request of the Company, the underwriters will reserve up to
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.
94
<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 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 $560,000 in fees.
The Series A Preferred Stock is convertible into 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").
95
<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 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 under the Note Purchase Agreement. 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 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. There is a balance of $2.0
million outstanding on the line of credit which is payable upon demand by Morgan
Stanley.
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. Among the factors to be
considered in determining the initial public offering price will be 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-earnings ratios, 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.
96
<PAGE>
EXPERTS
Arthur Andersen LLP, independent public accountants, have audited the
Company's consolidated financial statements for 1996 and 1997, as set forth in
their report, which is included in this prospectus. The Company's consolidated
financial statements are included in this prospectus in reliance on their
report, given on their authority as experts in accounting and auditing.
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. Upon approval of the common stock for quotation on the
Nasdaq National Market, 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.
97
<PAGE>
DESTIA COMMUNICATIONS, 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, 1996 AND 1997............................................... F-3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997................. F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND
1997..................................................................................................... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AND FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997.............. F-7
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 (AUDITED) AND THE UNAUDITED PERIOD ENDING SEPTEMBER 30,
1998..................................................................................................... F-19
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE UNAUDITED THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30,
1997 AND 1998............................................................................................ F-20
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE UNAUDITED NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997 AND
1998..................................................................................................... F-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE UNAUDITED PERIODS ENDED SEPTEMBER 30, 1997 AND 1998..... F-22
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Destia Communications, Inc. (formerly Econophone, Inc.):
We have audited the accompanying consolidated balance sheets of Destia
Communications, Inc. (a Delaware corporation) and subsidiaries as of December
31, 1996 and 1997, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for each of the three years ended
December 31, 1997. 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. and subsidiaries as of December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years
ended December 31, 1997, in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Schedule listed in the index to the
financial statements is presented for the purpose of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audits of the basic financial statements, and in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Arthur Andersen LLP
New York, New York
February 12, 1998
F-2
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
---------- -----------
<S> <C> <C>
<CAPTION>
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............................................................. $6,271,641 $67,201,901
Accounts receivable, net of allowance for doubtful accounts of $761,372 and
$1,593,531, respectively............................................................ 7,946,042 16,796,253
Prepaid expenses and other current assets............................................. 863,735 1,867,941
Restricted cash and securities........................................................ -- 10,462,500
---------- -----------
Total current assets.............................................................. 15,081,418 96,328,595
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS net of accumulated depreciation and
amortization of $1,643,151 and $3,689,550, respectively (Note 4)...................... 6,242,472 23,216,765
Debt issuance costs..................................................................... -- 6,355,491
Other assets (Note 6)................................................................... 1,431,446 3,139,117
Restricted cash and securities.......................................................... -- 48,964,970
---------- -----------
Total assets...................................................................... $22,755,336 $178,004,938
---------- -----------
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable...................................................................... $5,190,086 $21,100,675
Accrued expenses and other current liabilities........................................ 6,188,847 5,355,975
Interest accrued on Senior Notes...................................................... -- 10,462,500
Short-term borrowings (Note 8)........................................................ 2,127,726 --
Current maturities of long-term debt (Note 8)......................................... 753,881 1,828,962
Current maturities of obligations under capital lease (Note 14)....................... 130,867 156,067
Current maturities of notes payable--related party (Note 12).......................... 7,884 315,493
Deferred revenue...................................................................... 859,803 2,567,606
---------- -----------
Total current liabilities......................................................... 15,259,094 41,787,278
LONG-TERM DEBT (Note 8)................................................................. 1,707,941 5,657,042
OBLIGATIONS UNDER CAPITAL LEASE (Note 14)............................................... 235,074 278,667
NOTES PAYABLE--RELATED PARTY (Note 12).................................................. 319,531 --
SENIOR NOTES............................................................................ -- 149,680,000
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note 11)............................... 13,357,940 14,327,588
COMMITMENTS AND CONTINGENCIES (Note 14)
STOCKHOLDERS' EQUITY (DEFICIT) (Note 10):
Common stock--voting, par value $.0001; authorized 29,250,000 shares; 20,000,000
shares issued and outstanding in 1995 and 1996...................................... 2,000 2,000
Non-Voting Common stock, par value $.0001; authorized 500,000 shares; no shares issued
and outstanding..................................................................... -- --
Additional paid-in capital............................................................ 481,870 6,081,870
Cumulative translation adjustment..................................................... -- (103,880)
Retained earnings (deficit)........................................................... (8,608,114) (39,705,627)
---------- -----------
Total stockholders' equity (deficit).............................................. (8,124,244) (33,725,637)
---------- -----------
Total liabilities and stockholders' equity (deficit).............................. $22,755,336 $178,004,938
---------- -----------
---------- -----------
</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
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
REVENUES...................................................................... $27,490,490 $45,102,882 $83,002,625
COST OF SERVICES.............................................................. 19,735,530 35,368,603 63,707,453
---------- ---------- -----------
Gross profit............................................................ 7,754,960 9,734,279 19,295,172
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.................................. 7,087,735 16,833,779 37,897,940
DEPRECIATION AND AMORTIZATION................................................. 388,508 1,049,651 3,615,283
---------- ---------- -----------
Income (loss) from operations........................................... 278,717 (8,149,151) (22,218,051)
OTHER INCOME.................................................................. 31,425 106,580 101,926
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net.................................... (41,097) 26,649 (264,521)
INTEREST EXPENSE, net......................................................... (147,826) (295,677) (7,747,219)
---------- ---------- -----------
Net income (loss)....................................................... $ 121,219 $(8,311,599) $(30,127,865)
---------- ---------- -----------
---------- ---------- -----------
BASIC EARNINGS (LOSS) PER SHARE (Note 2)...................................... $ .01 $ (0.43) $ (1.55)
---------- ---------- -----------
---------- ---------- -----------
PRO FORMA INFORMATION (Note 2):
Income before pro forma provision for income taxes.......................... $ 121,219
Pro forma provision for income taxes........................................ 41,214
----------
Pro forma net income.................................................... $ 80,005
----------
----------
PRO FORMA NET INCOME PER SHARE................................................ $ .00
----------
----------
WEIGHTED AVERAGE NUMBER OF BASIC COMMON SHARES OUTSTANDING (Note 2)........... 20,000,000 20,000,000 20,000,000
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL EARNINGS CUMULATIVE
----------------------- PAID-IN (ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL DEFICIT) ADJUSTMENT TOTAL
---------- ----------- ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994................... 20,000,000 $ 2,000 $ 391,883 $ 694,217 $ -- $ 1,088,100
Net income................................... -- -- -- 121,219 -- 121,219
Distribution of S Corporation Earnings....... -- -- -- (499,301) -- (499,301)
---------- ----------- ---------- ------------ ----------- ------------
BALANCE, December 31, 1995................... 20,000,000 2,000 391,883 316,135 -- 710,018
Distribution of S corporation earnings....... -- -- -- (316,135) -- (316,135)
Contribution of capital to C corporation..... -- -- 89,987 -- -- 89,987
Net loss..................................... -- -- -- (8,311,599) -- (8,311,599)
Accretion of preferred stock................. -- -- -- (15,115) -- (15,115)
Dividends on preferred stock................. -- -- -- (281,400) -- (281,400)
---------- ----------- ---------- ------------ ----------- ------------
BALANCE, December 31, 1996................... 20,000,000 2,000 481,870 (8,608,114) -- (8,124,244)
Net loss..................................... -- -- -- (30,127,865) -- (30,127,865)
Warrants..................................... -- -- 5,600,000 -- -- 5,600,000
Accretion of preferred stock................. -- -- -- (91,054) -- (91,054)
Dividends on preferred stock................. -- -- -- (878,594) -- (878,594)
Cumulative translation adjustment............ -- -- -- -- (103,880) (103,880)
---------- ----------- ---------- ------------ ----------- ------------
BALANCE, December 31, 1997................... 20,000,000 $ 2,000 $6,081,870 ($39,705,627) $(103,880) ($33,725,637)
---------- ----------- ---------- ------------ ----------- ------------
---------- ----------- ---------- ------------ ----------- ------------
</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
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................... $ 121,219 $(8,311,599) $(30,127,865)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization............................................. 388,508 1,049,651 3,615,283
Provision for doubtful accounts........................................... 721,215 290,762 832,159
Accreted interest expense................................................. -- -- 280,000
Changes in assets and liabilities:
Increase in accounts receivable........................................... (5,694,774) (887,670) (9,682,370)
Increase in prepaid expenses and other current assets..................... (189,879) (350,500) (1,004,206)
Increase in other assets.................................................. -- (1,514,284) (3,276,550)
Increase in accounts payable, accrued expenses and other current
liabilities............................................................. 6,196,439 3,351,953 14,973,832
Increase in interest accrued on senior notes.............................. -- -- 10,462,500
Increase in deferred revenue.............................................. 494,409 365,394 1,707,803
---------- ---------- -----------
Net cash provided by (used in) operating activities..................... 2,037,137 (6,006,293) (12,219,414)
---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................................... (1,206,077) (4,246,997) (13,266,837)
---------- ---------- -----------
Net cash used in investing activities................................... (1,206,077) (4,246,997) (13,266,837)
---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of preferred stock................................... -- 13,061,425 --
Proceeds from line of credit................................................ 1,760,000 800,000 --
Repayment of line of credit................................................. (1,860,000) (1,000,000) --
Proceeds from short term borrowing.......................................... -- 5,436,582 --
Repayments of short-term borrowings......................................... -- (3,308,855) (2,127,726)
Proceeds from long-term debt................................................ -- 2,232,195 --
Repayments of long-term debt................................................ (116,400) (447,910) (428,268)
Repayments of notes payable--related party.................................. (9,383) (10,636) (11,922)
Repayments of capital leases................................................ (85,379) (117,844) (232,612)
Dividends paid.............................................................. (499,301) (226,148) --
Proceeds from senior notes.................................................. -- -- 149,400,000
Proceeds from warrants...................................................... -- -- 5,600,000
Payment of debt issuance cost............................................... -- -- (6,355,491)
Proceeds from bridge loan................................................... -- -- 7,000,000
Repayments of bridge loan................................................... -- -- (7,000,000)
---------- ---------- -----------
Net cash provided by (used in) financing activities..................... (810,463) 16,418,809 145,843,981
---------- ---------- -----------
Increase in cash and cash equivalents, (including restricted cash and
securities)............................................................... 20,597 6,165,519 120,357,730
Cash and cash equivalents, beginning of period.............................. 85,525 106,122 6,271,641
---------- ---------- -----------
Cash and cash equivalents, end of period (including restricted cash and
securities)............................................................... $ 106,122 $6,271,641 $126,629,371
---------- ---------- -----------
---------- ---------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.................................................................. $ 193,455 $ 210,280 $ 504,981
Income Taxes.............................................................. 193,554 -- --
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Accretion of preferred stock................................................ $ -- $ 15,115 $ 91,054
Accrued dividends on preferred stock........................................ -- 281,400 878,594
Capital leases entered into................................................. 471,000 423,000 5,753,855
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. NATURE OF BUSINESS
Destia Communications Inc. (formerly Econophone Inc.) ("Destia") is a
rapidly growing switch-based provider of long-distance telecommunications
services in selected major U.S. and western European markets. Destia's customer
base consists primarily of residential customers, small- and medium-sized
businesses and other telecommunications carriers. In the United States and the
United Kingdom, Destia provides principally international and domestic long
distance, calling card, prepaid and carrier services. In continental Europe,
Destia provides principally international long distance, calling card and
prepaid services.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Destia and its
wholly owned subsidiaries, its 70% owned subsidiary, Telco Global Communications
Ltd. (England) and its 72% owned subsidiary, Econophone Services GmbH
(Switzerland) (collectively, the "Company"). The full amount of the net loss for
the year ended December 31, 1997 for Telco Global Communications Ltd. and
Econophone Services GmbH have been recorded in the consolidated financial
statements of the Company. All significant intercompany balances and
transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company records revenue based on minutes of service provided. Deferred
revenue consists of unused minutes on prepaid calling cards.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
less than three months when purchased.
PROPERTY AND EQUIPMENT
Depreciation of property and equipment is computed using the straight-line
method over the estimated useful lives of the respective assets, which range
from three to fifteen years. Beginning July 1996, the Company adjusted the
useful lives of equipment to be more reflective of their actual usefulness. The
change in estimate was accounted for on a going forward basis. The impact to the
1996 results of operations was not material. 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 year ended December 31, 1997, the Company incurred approximately
$897,000 of such costs and has included them in Other Assets. The capitalized
software development costs are reported at the lower of unamortized cost or net
realizable value. These costs are amortized on a straight-line basis over the
estimated useful life, generally two years. Such costs were immaterial, prior to
1997.
F-7
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
The Company's policy is to record long-lived assets at cost. In accordance
with Statement of Financial Accounting Standards No. 121 ("SFAS 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. At
December 31, 1996, the adoption of SFAS 121 did not have a material effect on
the Company. The Company amortizes these costs over the expected useful life of
the related asset.
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 taxable directly
to the shareholders. During 1996, the Company changed its tax status to a C
Corporation.
In the accompanying financial statements, pro forma income taxes have been
provided for at the expected effective rate as if the Company was a C
Corporation for the year ended December 31, 1995.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to be applied to taxable income in the year in which those temporary
differences are expected to be recovered or 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
Statement of Financial Accounting Standards No. 123 ("SFAS 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 13).
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, Statement of Financial Accounting Standards (SFAS) No.
130--"Reporting Comprehensive Income" and SFAS No. 131--"Disclosures about
Segments of an Enterprise and Related Information" were issued and are effective
for periods beginning after December 15, 1997. SFAS No. 130 establishes
standards for reporting comprehensive income and its components. SFAS No. 131
establishes standards for reporting financial and descriptive information
regarding an enterprise's operating segments. These standards increase
disclosure only and will have no impact on the Company's financial position or
results of operations, upon adoption.
F-8
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
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 sheet and a
weighted-average rate for the period on the statement 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 with the
current year's presentation.
PER SHARE DATA
During 1997, SFAS No. 128 "Earnings per Share" was issued and became
effective for the Company's December 31, 1997 financial statements. SFAS No. 128
establishes new standards for computing and presenting earnings per share (EPS).
The new standard requires the presentation of basic EPS and diluted EPS. Basic
EPS is calculated by dividing income available to common shareholders by the
weighted average number of shares of common stock outstanding during the period.
Diluted EPS is calculated by dividing income available to common shareholders by
the weighted average number of common shares outstanding adjusted to reflect
potentially dilutive securities. Diluted EPS has not been presented since the
inclusion of outstanding options would be antidilutive.
The following is the reconciliation of net income (loss) per share as of
December 31,
<TABLE>
<CAPTION>
1995 1996 1997
---------- ------------- --------------
<S> <C> <C> <C>
Net income (loss)................................. $ 121,219 ($ 8,311,599) ($ 30,127,865)
Less Dividends on Preferred Stock................. 0 (281,400) (878,594)
---------- ------------- --------------
Income (loss) available to common shareholders.... $ 121,219 $ (8,592,999) $ (31,006,459)
---------- ------------- --------------
---------- ------------- --------------
</TABLE>
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 107 ("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 AND SHORT-TERM DEBT
The carrying amount of the Company's short-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, 1997, the fair value based upon quotes from securities
dealers and carrying value of the Company's Senior Notes were $168,175,000 and
$149,680,000 respectively.
FOREIGN EXCHANGE CONTRACTS
The Company from time to time uses foreign exchange contracts relating to
its receivables to hedge foreign currency exposure and to control risks relating
to currency fluctuations in British Pounds, Belgian
F-9
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
3. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Francs and French Francs. The Company does not use derivative financial
instruments for speculative purposes and, at December 31, 1996, the Company had
no open foreign currency hedging positions. At December 31, 1997, the Company
had $300,000 of open foreign currency hedging positions.
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1996 1997
------------ -------------
<S> <C> <C>
Equipment........................................................ $ 7,189,102 $ 23,403,236
Computer software................................................ 182,963 1,365,820
Furniture and fixture............................................ 136,399 634,269
Leasehold improvements........................................... 377,159 1,502,990
------------ -------------
7,885,623 26,906,315
Less-Accumulated depreciation and amortization................... (1,643,151) (3,689,550)
------------ -------------
Property, equipment and leasehold improvements, net........ $ 6,242,472 $ 23,216,765
------------ -------------
------------ -------------
</TABLE>
Depreciation expense for the years ended December 31, 1996 and 1997, was
$1,008,402 and $2,296,855, respectively.
5. TERRITORIAL RIGHTS
In September 1994, the Company entered into a joint venture with Europhone
International Ltd. ("EI") to jointly market Econophone's services in the United
Kingdom. EI engaged in sales and marketing, while Econophone provided network
support, billing and transmission services.
In connection with the modification of the joint marketing arrangement which
occured in June 1996, EI granted the Company the right to compete with them in
exchange for forgiveness of the net receivable due to the Company of $2,000,000.
The Company charged this to operations in 1996 as an expense of the joint
venture.
6. OTHER ASSETS
Other assets consist primarily of security deposits and software development
costs.
7. FOREIGN OPERATIONS AND CONCENTRATIONS
FOREIGN OPERATIONS
The Company's trade accounts receivable are subject to credit risk. Although
diversified due to the large number of customers comprising the geographically
dispersed customer base, the Company does not require collateral or other
security to support its receivables. The Company's total sales, operating income
F-10
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
7. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
(before interest, foreign currency exchange and other income) and identifiable
assets by geographical area for the years ended and as of December 31, 1995,
1996 and 1997 are as follows:
<TABLE>
<CAPTION>
UNITED OTHER
ENGLAND STATES BELGIUM EUROPE CONSOLIDATED
------------- -------------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
1995
Revenues............................. $ 14,172,747 $ 8,292,415 $ 4,235,155 $ 790,173 $ 27,490,490
------------- -------------- ------------ ------------ --------------
------------- -------------- ------------ ------------ --------------
Operating income..................... $ 143,693 $ 84,074 $ 42,939 $ 8,011 $ 278,717
Corporate expenses................... (157,498)
--------------
$ 121,219
--------------
--------------
Account receivable................... $ 4,343,590 $ 900,883 $ 1,331,276 $ 773,385 $ 7,349,134
Other identifiable assets............ -- 2,183,642 397,675 -- 2,581,317
Corporate assets..................... 577,770
--------------
$ 10,508,221
--------------
--------------
1996
Revenues............................. $ 15,477,308 $ 18,185,110 $ 9,037,967 $ 2,402,497 $ 45,102,882
------------- -------------- ------------ ------------ --------------
------------- -------------- ------------ ------------ --------------
Operating loss....................... ($ 2,472,933) ($3,855,148) (1,472,157) (348,913) ($8,149,151)
Corporate expenses................... (162,448)
--------------
($8,311,599)
--------------
--------------
Accounts receivable.................. $ 2,282,951 $ 3,718,158 $ 1,487,965 $ 456,968 $ 7,946,042
Other identifiable assets............ 1,423,097 4,001,405 847,181 200,789 6,472,472
Corporate assets..................... 8,336,822
--------------
$ 22,755,336
--------------
--------------
1997
Revenues............................. $ 18,362,999 $ 48,898,882 $ 7,980,848 $ 7,759,896 $ 83,002,625
------------- -------------- ------------ ------------ --------------
------------- -------------- ------------ ------------ --------------
Operating loss....................... ($ 2,966,508) ($ 18,213,064) ($374,446) ($664,033) ($ 22,218,051)
Corporate expenses................... (7,909,814)
--------------
($ 30,127,865)
--------------
--------------
Accounts receivable.................. $ 5,252,202 $ 9,034,226 $ 1,250,317 $ 1,259,508 $ 16,796,253
Other identifiable assets............ 6,731,185 16,514,567 462,682 405,331 24,113,765
Corporate assets..................... 137,094,920
--------------
$ 178,004,938
--------------
--------------
</TABLE>
Management does not anticipate incurring losses on its trade receivables in
excess of established allowances based on factors surrounding the credit risk of
specific customers and historical trends.
The revenues of Europhone International accounted for $13.2 million or 48%
in 1995 and $14.2 million or 32% in 1996. The relationship was terminated in
December 1996.
F-11
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
7. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
SUPPLIERS
Sprint Communication, Inc. ("Sprint"), one of the Company's principal
suppliers of telephone lines, has a recorded lien on all accounts receivable of
the Company. This lien is subordinated to the debt owed to Israel Discount Bank
of New York (Note 8). For the years ended December 31, 1996 and 1997, Sprint
supplied approximately $9.4 million and $6.0 million respectively, of telephone
line usage to the Company. In addition, Switch Services, Inc. ('SSI") supplied
approximately $6.9 million of telephone line usage to the Company in 1997. These
amounts have been included in cost of services.
8. 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)................................ $ 1,633,136 $ 5,521,792 $ 7,154,928
Cable lines (b).............................. 195,826 135,250 331,076
Senior notes (c)............................. 149,680,000 149,680,000
------------ -------------- --------------
$ 1,828,962 $ 155,337,042 $ 157,166,004
------------ -------------- --------------
------------ -------------- --------------
</TABLE>
- ------------------------
(a) On May 28, 1996, Destia 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 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. As of December 31, 1997, the aggregate amount outstanding
under all tranches of the NTFC Facility was $7,154,928. 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 a Debt Service Coverage Ratio
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, Econophone must maintain specified minimum cash balances (certain
related business investments and acquisitions qualify as cash for the
foregoing purposes). Econophone also must have EBITDA (as defined in the
NTFC Facility) of not less than: negative $5,500,000 for the fiscal year
ending December 31, 1998; $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
F-12
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
8. BORROWINGS (CONTINUED)
fiscal year ending December 31, 2001. Destia was in compliance with these
covenants at December 31, 1997.
(b) The Company has six notes payable related to the purchase of cable lines.
Three of these notes bear interest at 12%, and mature through September
1998. The remaining three notes bear interest at LIBOR plus 5%, and mature
on June 30, 2001. These notes have quarterly principal and interest payments
ranging from $5,849 to $30,291.
(c) The 1997 Unit Offering
Destia completed on July 1, 1997 the Offering of 155,000 units (each a
"Unit"), each Unit consisting of one 13 1/2% Senior Note due 2007 of Destia
and one warrant (each a "Warrant") to purchase 8.167 shares of common stock
of Destia (the "Common Stock"). The Units were sold for an aggregate
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
Act.
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 of the net proceeds of the 1997 Unit Offering to purchase the Pledged
Securities, which were pledged as security for the payment of interest on
the principal of the 1997 Notes. Proceeds from the Pledged Securities are
being used by Destia to make interest payments on the 1997 Notes through
July 15, 2000. The Pledged Securities are being held by a trustee pending
disbursement.
Maturities of other long-term debt over the next five years are as follows:
<TABLE>
<S> <C>
1998............................................................ $2,144,455
1999............................................................ 1,689,280
2000............................................................ 1,688,848
2001............................................................ 1,499,620
2002............................................................ 779,294
---------
Total........................................................... $7,801,497
---------
---------
</TABLE>
9. TAXES
As a telephone carrier and reseller doing business in New York State, the
Company is required to file annual telephone and transmission tax returns in
accordance with New York 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. All of these taxes are included in
general and administrative expenses.
F-13
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
9. TAXES (CONTINUED)
As of December 31, 1997, the Company had a net operating loss carryforward
of approximately $36,000,000 which is available to reduce its future taxable
income and expires at various dates through 2012. A valuation allowance of
approximately $14,000,000 has been established against this amount due to the
uncertainties surrounding the utilization of the carryforward.
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 (the "EC") VAT Directive adopted in
1977 (the "VAT Directive"), providers of telecommunications services in the
European Union 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 foreign subsidiaries file separate tax returns and provide for
taxes accordingly.
10. STOCKHOLDERS' EQUITY (DEFICIT)
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 per 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 (Note 11). 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 has been retroactively restated to give effect to these transactions.
Included within additional paid in capital, is $5.6 million attributable to
the Warrants, which represents the portion of the issue price for the Units
attributable to the fair value of the Warrants. Such amount has been recognized
as a discount on the 1997 Notes and will be amortized over the term of the 1997
Notes. Each Warrant may be exercised for 8.167 shares of Common Stock at an
exercise price of $.01 per share. The Warrants are exercisable for 1,265,885
shares of Common Stock, in the aggregate. The fair value of the shares issuable
upon exercise of the Warrants was determined to be $4.43 per share based on an
agreement between Destia and the Placement Agent in connection with the 1997
Unit Offering. Among the factors considered in making such determinations were
the history of the prospects for the industry in which Destia competes, an
assessment of Destia's management, the present operations of Destia, the
historical results of operations of Destia and the trend of its revenues and
earnings, the prospects for future earnings of Destia, the general condition of
the securities markets at the time of the 1997 Unit Offering and the prices of
similar securities of generally comparable companies. The Warrants expire on
June 30, 2007.
F-14
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
11. 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 accrued monthly cumulative dividends on each
outstanding share at a rate of $1.00 per month. The accrued and unpaid dividends
compound monthly at a rate of 12% per year. The dividends began to accrue and
compound interest from the issuance date of the preferred stock and ceased to
accrue on July 1, 1997, when the Senior Notes were issued.
The mandatory redemption of the Series A Preferred is October 31, 2006. The
redemption shall be in cash.
Each holder of the Series A Preferred shall have the right, at the option of
the holder, to convert any of its shares of Series A Preferred, into a number of
fully paid and nonassessable whole 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, the shares of Series A
Preferred Stock outstanding were convertible into 3,420,701 shares 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 fully diluted basis), which was
22,564,000, multiplied by a fraction (i) the numerator of which is equal to the
stated value with respect to the shares of Series A Preferred Stock being so
converted, plus any dividends accrued thereon, and (ii) the denominator of which
is equal to $100.0 million plus the number of dollars received by Destia since
November 1, 1996 from the exercise of specified options or warrants.
12. RELATED PARTY TRANSACTIONS
The Company has notes payable at December 31, 1996 and 1997 due to various
related parties. These notes are unsecured, and accrue interest at annual rates
ranging from 9% to 18%. One note is a demand obligation while the others have
maturities which range through November 15, 1998.
The Company has a non-interest bearing note receivable at December 31, 1997
for approximately $215,000 from a related party.
The brother-in-law of Alfred West owns a 28% interest in Destia's Swiss
subsidiary, Econophone Services GmbH.
13. STOCK-BASED COMPENSATION PLANS
On October 31, 1996, the Board of Directors adopted the Destia, Inc. 1996
Flexible Incentive Plan (the "1996 Plan") and an Incentive Stock Option
Agreement with the Chief Operating and 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
F-15
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
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
------------- ---------------
<S> <C> <C>
Net Loss:
Available to $ (8,592,999) $ (31,006,459)
Common
Shareholders
Pro Forma (9,088,001) (31,797,731)
Basic EPS:
As Reported $ (.43) $ (1.55)
Pro Forma (.45) (1.59)
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts as additional awards in future years are
anticipated.
During 1996, under the 1996 Plan, the Company granted 10,000 options to
outside consultants. All transactions with individuals other than those
considered employees, as set forth within the scope of APB No. 25, must be
accounted for under the provisions of SFAS No. 123. Under SFAS No. 123, the fair
value of the options granted to the consultants as of the date of grant using
the Black-Scholes pricing model is $8,936. The NQSOs (as hereinafter defined)
were granted to the consultants for terms of up to ten years, at an exercise
price of $2.50 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. As of December 31, 1996
and 1997, 0 and 1,667 of the options granted to the consultants were
exercisable, respectively, and the expense recognized in 1996 and 1997 relating
to these options was $496 and $2,976, respectively.
The 1996 Plan authorizes the granting of awards, the exercise of which would
allow up to an aggregate of 3,000,000 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 have been
granted to key employees and directors for terms of up to ten years, at an
exercise price of $2.50, 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,
1996 and 1997, 226,527 and 1,109,250 options respectively, were exercisable
under the Company's 1996 Plan.
F-16
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
Option activity during 1996 and 1997 is as follows:
<TABLE>
<CAPTION>
1996 1997
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- --------------- ---------- ---------------
Outstanding at beginning of year...... -- -- 2,606,500 $ 2.50
Granted............................... 2,606,500 $ 2.50 294,945 5.00
Outstanding at end of year............ 2,606,500 2.50 2,901,445 2.74
---------- ---------- -----
---------- ---------- -----
Exercisable at end of year............ 226,527 2.50 1,109,250 2.50
Weighted average fair value of options
granted............................. .89 1.91
</TABLE>
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 1996 and 1997: risk-free interest rate of 6.23
percent for 1996 and 1997; expected life of three years for 1996 and 1997;
expected volatility of 43 percent for 1996 and 47% for 1997 and expected
dividend yield of zero percent for 1996 and 1997.
The following table summarizes information with respect to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ --------------------------------
NUMBER WEIGHTED AVERAGE NUMBER
EXERCISE OUTSTANDING AT REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
PRICE 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- ------------- -------------- ------------------- ----------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
$2.50-$5.00 2,901,445 8.97 $ 2.74 1,109,250 $ 2.50
</TABLE>
14. 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, 1997 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASE
------------ ----------
<S> <C> <C>
1998................................................................ $ 1,500,451 $ 156,067
1999................................................................ 1,535,221 159,311
2000................................................................ 1,593,025 97,105
2001................................................................ 1,629,640 21,481
2002................................................................ 1,450,602 770
------------ ----------
Total minimum lease payments........................................ $ 7,708,939 $ 434,734
------------ ----------
------------ ----------
</TABLE>
The rent expense for the year ended December 31, 1996 and 1997 was
approximately $394,000 and 1,378,000, respectively.
F-17
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In January, 1998, the Company obtained a line of credit from European
American Bank ("EAB") in the amount of $2,000,000 and a foreign exchange line in
the amount of $5,000,000, which are collateralized by $2,300,000 in time
deposits. Interest is charged at the prime rate in effect, and is payable
monthly from the date of advance of the line.
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 $990,000. These officers
are also eligible for annual bonuses based on performance.
On January 29, 1998, the Company received notice from the minority partner
in Telco, that pursuant to existing arrangements between them, it has elected to
exercise an option to cause the Company to acquire its interest in Telco. The
parties recently commenced negotiations with respect to the terms of such
acquisition, including the form and amount of the consideration. There can be no
assurance whether such acquisition ultimately will be consummated, and if
consummated, on terms favorable to the Company.
15. SUBSEQUENT EVENTS
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. Econophone has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996.
SENIOR DISCOUNT NOTES. During February 1998, the Company authorized the
issue and sale of Senior Discount Notes. The Notes will be unsecured
unsubordinated obligations of the Company, initially limited to $300 million
aggregate principal amount at maturity, and will mature on February 15, 2008,
Although for federal income tax purposes a significant amount of original issue
discount, taxable as ordinary income, will be recognized by the Holder as such
discount accrues from the Closing Date, no interest will be payable on the Notes
prior to February 15, 2003. From and after February 15, 2003, interest on the
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. Interest will be computed on
the basis of a 360-day year of twelve 30-day months.
F-18
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
--------------- ----------------
<S> <C> <C>
(SEE NOTE) (UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 67,202 $ 95,355
Marketable securities..................................................... -- 58,097
Accounts receivable, net of allowance for doubtful accounts of $1,594 and
$6,257, respectively.................................................... 16,796 36,476
Prepaid expenses and other current assets................................. 1,868 3,691
Restricted cash and securities............................................ 10,463 4,359
--------------- --------
Total current assets.................................................. 96,329 197,978
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, net of accumulated
depreciation and amortization of $3,690 and $8,377, respectively............ 23,217 82,894
Debt issuance costs........................................................... 6,355 12,612
Intangibles................................................................... -- 35,065
Other assets.................................................................. 3,139 3,109
Restricted cash and securities................................................ 48,965 35,665
--------------- --------
Total assets.......................................................... $ 178,005 $ 367,323
--------------- --------
--------------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable.......................................................... $ 21,100 $ 23,853
Accrued expenses and other current liabilities............................ 5,356 27,869
Interest accrued on Senior Notes.......................................... 10,463 4,359
Current maturities of long-term debt and capital leases................... 1,985 10,713
Current maturities of notes payable--related party........................ 315 308
Deferred revenue.......................................................... 2,568 4,004
--------------- --------
Total current liabilities............................................. 41,787 71,106
LONG-TERM DEBT AND CAPITAL LEASES............................................. 5,936 24,920
SENIOR NOTES 1997............................................................. 149,680 150,100
SENIOR DISCOUNT NOTES 1998.................................................... -- 187,939
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK............................... 14,328 14,396
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIENCY)
Common stock-voting, par value $.0001 at December 31, 1997 and $.01 at
September 30, 1998; authorized 29,250,000 shares;20,000,000 shares
issued and outstanding in 1997 and 1998................................. 2 200
Non-Voting common stock, par value $.0001 at December 31, 1997 and $.01 at
September 30, 1998; authorized 500,000 shares; 67,320 shares issued and
outstanding............................................................. -- 1
Additional paid-in capital................................................ 6,082 5,926
Accumulated other comprehensive income.................................... (104) (313)
Retained earnings (accumulated deficit)................................... (39,706) (86,952)
--------------- --------
Total stockholders' equity (deficiency)............................... (33,726) (81,138)
--------------- --------
--------------- --------
Total liabilities and stockholders' equity (deficiency)............... $ 178,005 $ 367,323
--------------- --------
--------------- --------
</TABLE>
Note: The December 31, 1997 Balance Sheet is derived from audited financial
statements.
F-19
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT BASIC LOSS PER SHARE)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------
1997 1998 1997 1998
--------- ------------- ---------- ----------
<S> <C> <C> <C> <C>
REVENUES........................................................ $ 22,692 $ 50,542 $ 53,138 $ 140,956
COST OF SERVICES................................................ 17,039 36,047 41,050 103,088
--------- ------------- ---------- ----------
Gross profit.................................................. 5,653 14,495 12,088 37,868
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.................... 9,625 22,364 22,521 57,121
DEPRECIATION AND AMORTIZATION................................... 1,098 3,030 2,167 7,131
--------- ------------- ---------- ----------
Loss from operations.......................................... (5,070) (10,899) (12,600) (26,384)
INTEREST EXPENSE................................................ (5,540) (10,863) (5,826) (29,366)
INTEREST INCOME................................................. 1,846 2,758 1,846 8,984
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net...................... 45 (32) 16 80
OTHER INCOME (EXPENSE).......................................... 13 (223) 100 (492)
--------- ------------- ---------- ----------
Net loss...................................................... ($ 8,706) ($ 19,259) ($ 16,464) ($ 47,178)
--------- ------------- ---------- ----------
--------- ------------- ---------- ----------
BASIC LOSS PER SHARE............................................ ($ 0.44) ($ 0.96) ($ 0.82) ($ 2.36)
--------- ------------- ---------- ----------
--------- ------------- ---------- ----------
WEIGHTED AVERAGE NUMBER OF BASIC COMMON SHARES OUTSTANDING...... 20,000 20,000 20,000 20,000
--------- ------------- ---------- ----------
--------- ------------- ---------- ----------
</TABLE>
F-20
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................................. ($ 16,464) ($ 47,178)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................................... 2,167 7,131
Provision for doubtful accounts......................................................... 317 4,663
Accreted interest expense............................................................... 140 12,574
Changes in assets and liabilities:
Increase in accounts receivable......................................................... (9,673) (24,343)
Increase in prepaid expenses and other current assets................................... (716) (1,823)
(Increase) decrease in other assets..................................................... (2,650) 262
Increase in accounts payable, accrued expenses and other current liabilities............ 10,795 18,460
Increase in deferred revenue............................................................ 1,350 1,436
--------- ---------
Net cash used in operating activities................................................... (14,734) (28,818)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment........................................................ (5,459) (56,363)
Net cash paid in acquisitions............................................................. -- (22,327)
Purchase of marketable securities--net.................................................... -- (58,097)
--------- ---------
Net cash used in investing activities................................................... (5,459) (136,787)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bridge loan................................................................. 7,000 --
Repayments of bridge loan................................................................. (7,000) --
Repayments of short-term borrowings....................................................... (2,127) --
Proceeds from long-term debt and capital leases........................................... -- 6,773
Repayments of long-term debt and capital leases........................................... (306) (1,096)
Repayments of notes payable--related party................................................ (9) (7)
Proceeds from senior discount notes....................................................... 149,400 175,785
Proceeds from warrants.................................................................... 5,600 0
Payment of debt issuance costs............................................................ (6,315) (7,144)
Issuance of common stock.................................................................. -- 43
--------- ---------
Net cash provided by financing activities............................................... 146,243 174,354
--------- ---------
Increase in cash and cash equivalents,
(including restricted cash)............................................................... 126,050 8,749
Cash and cash equivalents, beginning of period
(including restricted cash)............................................................... 6,272 126,630
--------- ---------
Cash and cash equivalents, end of period
(including restricted cash)............................................................... $ 132,322 $ 135,379
--------- ---------
--------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................................................ $ 372 $ 22,540
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Accretion of preferred stock.............................................................. $ 68 $ 68
Accrued dividends on preferred stock...................................................... 879 --
Capital leases executed................................................................... 2,472 8,000
Note issued for purchase of minority interest--Telco...................................... -- 14,035
DETAILS OF ACQUISITIONS:
Fair value of assets acquired............................................................. -- (1,936)
Goodwill.................................................................................. -- (21,092)
Liabilities assumed....................................................................... -- 701
--------- ---------
Net cash paid for acquisitions.......................................................... -- ($ 22,327)
--------- ---------
--------- ---------
</TABLE>
F-21
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Destia, Inc. ("Destia" or the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Certain
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted, although management believes that the
disclosures herein are adequate to make the information presented not
misleading. It is suggested that these financial statements be read in
conjunction with Destia's audited annual consolidated financial statements. In
the opinion of management, all adjustments (consisting of only normal recurring
adjustments) considered necessary for a fair presentation have been included.
Certain reclassifications have been made to 1997 information to conform to the
presentation used in 1998. Operating results for the three-month or nine-month
period ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1998.
NOTE B--SENIOR DISCOUNT NOTES
Destia consummated on February 18, 1998 its offering of $300.0 million
aggregate principal amount at maturity of Senior Discount Notes (the "1998
Notes"). The net proceeds of the offering were approximately $168.6 million.
Each 1998 Note has a principal amount at maturity of $1,000 and an initial value
of $585.95. The 1998 Notes will fully accrete to face value on February 15,
2003. The 1998 Notes mature on February 15, 2008. Interest on the 1998 Notes
will be paid in cash at a rate of 11% per annum on February 15 and August 15 of
each year, beginning August 15, 2003. On or after February 15, 2003, the 1998
Notes will be redeemable at the option of the Company, in whole or in part, at
specified redemption prices plus accrued and unpaid interest, if any. In
addition, prior to February 15, 2001, up to 35% of the aggregate principal
amount of the 1998 Notes may be redeemed at 111% of their accreted value with
the proceeds of one or more public equity offerings. On April 24, 1998 the
Company consummated an exchange offer for the 1998 Notes pursuant to which
holders of the 1998 Notes were entitled to exchange the 1998 Notes for
registered notes having terms identical to the 1998 Notes.
NOTE C--VOICENET ACQUISITION
On February 12, 1998 the Company acquired VoiceNet Corporation, 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. Destia has provided substantially all of VoiceNet's
transmission, billing and customer service functions since the inception of the
business relationship in April 1996.
The acquisition of VoiceNet has been 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 $0.4 million of the
initial purchase price reflects the underlying value of the assets acquired and
$20.6 million reflects goodwill. Goodwill is being amortized over 20 years. The
pro forma effect of the acquisition is not material for the nine-month period
ended September 30, 1998.
NOTE D--TELCO MINORITY INTEREST
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
F-22
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE D--TELCO MINORITY INTEREST (CONTINUED)
sale of prepaid cards. On July 17, 1998, the Company acquired the 30% minority
interest in Telco 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.
NOTE E--CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
less than three months when purchased.
NOTE F--COMPREHENSIVE INCOME
Effective March 31, 1998, Destia adopted Statement of Financial Accounting
Standards ("SFAS") No. 130 "Reporting Comprehensive Income", which establishes
standards for reporting and display of comprehensive income and its components
(revenue, expenses, gains, and losses) in a full set of general-purpose
financial statements. The components of other comprehensive income consist
primarily of foreign currency translation adjustments. For the nine months ended
September 30, 1998, the components of other comprehensive income were
immaterial.
NOTE G--CHANGE IN STATE OF INCORPORATION
In February 1998, the New York corporation "Econophone, Inc." was merged
into its wholly-owned subsidiary named "Econophone, 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.
NOTE H--PER SHARE DATA
Per share data is based on the standards of SFAS No. 128 "Earnings Per
Share", which requires the presentation of basic EPS and diluted EPS. Basic EPS
is calculated by dividing income available to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
Income available to common stockholders is calculated as net income less
dividends on preferred stock, which in the third quarter and nine-month period
ended September 30, 1997 were approximately $0 and $879,000, respectively. There
were no dividend on preferred stock in 1998. Diluted EPS has not been presented
since the inclusion of outstanding options would be antidilutive.
NOTE I--RETAINED EARNINGS (ACCUMULATED DEFICIT)
The change in retained earnings reflects net loss for the period, as well as
the accretion of preferred stock, which was approximately $23,000 for the
quarters ended September 30, 1997 and September 30, 1998, and approximately
$68,000 for the nine-month periods ended September 30, 1997 and September 30,
1998.
F-23
<PAGE>
[Outside Back Cover]
<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 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).
See Item 17 for a statement of the Company's undertaking as to the
Commission's position respecting indemnification arising under the Securities
Act.
II-1
<PAGE>
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 $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 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, at a rate of restricted
shares per Telco Option. Approximately 140,000 restricted shares will be awarded
as a result of the rollover. This transaction 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.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
1.1* ... Underwriting Agreement.
3.1* ... Amended and Restated Certificate of Incorporation.
3.2* ... Amended and Restated Bylaws.
4.1** ... Specimen of Econophone, Inc.'s 11% Senior Discount Note due 2008.
4.2** ... Indenture, dated as of February 18, 1998, between Econophone, Inc. and The Bank of New York, as
Trustee.
4.5** ... Specimen of Econophone, Inc.'s 13 1/2% Senior Note due 2007.
4.4** ... Indenture, dated as of July 1, 1997, between Econophone, 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, Econophone, Inc. and
Princes Gate Investors II, L.P.
10.2*** ... Securities Purchase Agreement, dated as of November 1, 1996, between Econophone, Inc. and Princes
Gate Investors II, L.P.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.3*** ... Note Purchase Agreement, dated as of April 24, 1997, between Econophone, Inc. and Morgan Stanley
Group Inc.
10.4*** ... Form of Note under Note Purchase Agreement.
10.5*** ... Placement Agreement, dated June 26, 1997, between Econophone, Inc. and The Bank of New York, as
Trustee.
10.6*** ... Notes Registration Rights Agreement, dated July 1, 1997, between Econophone, Inc. and Morgan Stanley
& Co., Incorporated
10.7** ... Notes Registration Rights Agreement, dated February 18, 1998, between Econophone, Inc. and Morgan
Stanley & Co., Incorporated.
10.8*** ... Warrant Agreement, dated as of July 1, 1997, between Econophone, Inc. and The Bank of New York, as
Warrant Agent, containing as an exhibit, a specimen Warrant Certificate.
10.9*** ... Warrant Registration Rights Agreement, dated as of July 1, 1997, between Econophone, Inc. and Morgan
Stanley & Co. Incorporated.
10.10** ... Placement Agreement, dated February 12, 1998, between Econophone, Inc. and Morgan Stanley Co.
Incorporated, as Placement Agent.
10.11***... Collateral Pledge and Security Agreement, dated July 1, 1997, between Econophone, Inc. and The Bank
of New York, as Trustee and Custodian.
10.12** ... Second Amended and Restated Equipment Loan and Security Agreement, dated as of January 28, 1998,
between Econophone, Inc. and NTFC Capital Corporation ("NTFC").
10.13***... Promissory Note, dated May 28, 1996, from Econophone, Inc. to NTFC.
10.14***... Promissory Note, dated March 27, 1997, from Econophone, Inc. to NTFC.
10.15***... Promissory Note, dated December 21, 1997 from Econophone, Inc., Inc. to NTFC.
10.16** ... Stock Purchase Agreement, dated January 28, 1998, between Econophone, Inc. and the shareholders of
Voicenet Corporation.
10.17***... Employment Agreement, dated August 1, 1996, between Econophone, Inc. and Alan Levy, as amended
October 31, 1996.
10.18***... Employment Agreement, dated January 1, 1997, between Econophone, Inc. and Alfred West.
10.19***... Amended and Restated Econophone, Inc. 1996 Flexible Incentive Plan.
10.20****.. Telecommunications Services Agreement between Frontier Communications of the West, Inc. and
Econophone, Inc., dated November 17, 1998
10.21* .. 1999 Flexible Incentive Plan
21.1* ... Subsidiaries of Econophone, Inc.
23.1 ... Consent of Arthur Andersen LLP.
23.2* ... Consent of Schulte Roth & Zabel LLP (contained in Exhibit 5.1).
</TABLE>
- ------------------------
* To be filed by pre-effective amendment.
** 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)
II-3
<PAGE>
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 City of Paramus, New Jersey on
the 29th day of January, 1999.
<TABLE>
<S> <C> <C>
DESTIA COMMUNICATIONS, INC.
By: /s/ RICHARD L. SHORTEN, JR.
-----------------------------------------
Name: Richard L. Shorten, Jr.
Title: Senior Vice President and General
Counsel
</TABLE>
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints
Alan L. Levy, Richard L. Shorten and Alfred West, or any one or more of them,
his true and lawful attorney-in-fact, for him and in his name, place and stead,
to sign any and all amendments (including post-effective amendments) to this
registration statement and to cause the same to be filed with the Securities and
Exchange Commission, hereby granting to said attorneys-in-fact full power and
authority to do and perform all and every act and thing whatsoever requisite or
desirable to be done in and about the premises as fully to all intents and
purposes as the undersigned might or could do in person, hereby ratifying and
confirming all acts and things that said attorneys-in-fact may do or cause to be
done by virtue of these presents.
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
/s/ ALFRED WEST Chairman of the Board of
- ------------------------------ Directors January 29, 1999
Alfred West (Principal Executive
Officer)
President, Chief Operating
/s/ ALAN L. LEVY Officer and Director
- ------------------------------ (Principal Financial and January 29, 1999
Alan L. Levy Accounting Officer)
/s/ GARY S. BONDI
- ------------------------------ Director January 29, 1999
Gary S. Bondi
/s/ STEVEN WEST
- ------------------------------ Director January 29, 1999
Steven West
/s/ STEPHEN MUNGER
- ------------------------------ Director January 29, 1999
Stephen Munger
</TABLE>
II-5
<PAGE>
Exhibit 10.20
================================================================================
[* * *] = 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:
Volume of Capacity
(in DS-O Miles) One-Time Network Charge Monthly Maintenance
------------------ ----------------------- -------------------
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*
*The monthly maintenance rate of [* * *] per DS-
-4-
<PAGE>
0 mile/month shall apply for the [* * *] 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 [* * *], 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 [* * *] thereafter, Frontier
shall have the right to purchase on a monthly basis up to a cumulative average
of [* * *] in Econophone Services, determined as of that date, to be offset as
described in this Paragraph. [* * *]
(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:
DSO-Rate/ Installation
Capacity Term Mi./Month Minimum Charge
-------- ---- --------- ------- ------------
DS-1 1 year [* * *] $200 $200
DS-1 2 years [* * *] $200 $200
DS-3 1 year [* * *] $500 $500
DS-3 2 years [* * *] $500 $500
-5-
<PAGE>
(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
-6-
<PAGE>
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 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.
-7-
<PAGE>
(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 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.
-8-
<PAGE>
(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.
(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
-9-
<PAGE>
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 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
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<PAGE>
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 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.
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<PAGE>
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.
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
OF THE WEST, INC. ECONOPHONE, INC.
By: /s/ Anthony J. Cassara By: /s/ Alan Levy
---------------------------------- -----------------------------------
Anthony J. Cassara Alan Levy
President - Carrier Services Group President & Chief Operating Officer
Date: Date:
-------------------------------- ---------------------------------
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<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
A-1
<PAGE>
CITY-PAIR AIR MILES DS3'S QUANTITY DSO MILES TARGET DATE
--------- --------- ----- -------- --------- -----------
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:
---------------------- ----------------------------------------------
DS-0 Miles DS3, OC-3, OC-12, OC-48, OC-3c, OC-12c, OC-48c
---------------------- ----------------------------------------------
0-2500 99.999%
---------------------- ----------------------------------------------
2501-4000 99.998%
---------------------- ----------------------------------------------
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:
DS-3
DS-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
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
January 28, 1999
