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ECONOPHONE, INC.
F O R M 8 - K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): February 17, 1999
DESTIA COMMUNICATIONS, INC.
(Formerly Econophone, Inc.)
(Exact name of each registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation)
33-33117 11-3132722
(Commission File Number) (IRS Employer Identification No.)
95 Rte. 17 South
Paramus, NJ 07652
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (201) 226-4500
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Item 5. Other Events.
On February 17, 1999, Destia Communications, Inc. (the "Company") filed
an amendment to a registration statement on Form S-1 (the "Registration
Statement"), initially filed with the Securities and Exchange Commission on
January 29, 1999, for an initial public offering of its common stock.
Included below are (i) the year-end "Management's Discussion and
Analysis of Financial Condition and Results of Operations" section of the
Registration Statement, (ii) the Consolidated Financial Statements as of
December 31, 1997 and 1998 and for the three years ended December 31, 1998
and the related footnotes thereto (the "Consolidated Financial Statements")
contained in the Registration Statement, and (iii) the Financial Statement
Schedule, Schedule II, Schedule of Valuation and Qualifying Accounts
(included at page S-1). As originally filed the Registration Statement
contained financial information through September 30, 1998. The inclusion of
such information herein is for disclosure purposes only and does not
constitute an offer to sell or a solicitation of an offer to purchase shares
of the Company's common stock or any other securities of the Company.
Some of the statements contained in the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" section may
constitute statements of future expectations and other forward-looking
statements pursuant to Section 21E of the Securities Exchange Act of 1934, as
amended. 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 the Company's network and/or customer base;
- inaccuracies in the Company's forecasts of telecommunications traffic
or customers;
- loss of a customer which provides the Company 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.
The Company undertakes no obligations to update or revise any forward-looking
statements, whether as a result of new information, future events or
otherwise.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a rapidly growing, facilities-based provider of domestic and
international long distance telecommunications services in North America and
Europe. Its extensive international telecommunications network allows it to
provide services primarily to retail customers in many of the largest
metropolitan markets in the United States, Canada, the United Kingdom, Belgium,
France, Germany and Switzerland.
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services, and wholesale transmission services. The
Company's approximately 350,000 customer accounts are diverse and include
residential customers, commercial customers, ethnic groups and
telecommunications carriers. In each of the Company's geographic markets, it
utilizes a multichannel distribution strategy to market its services to its
target customer groups.
REVENUES
The Company's revenues are primarily based on usage and are derived from (1)
the number of minutes of telecommunications traffic carried and, (2) generally,
a fixed per minute rate. The following table shows the total revenue and
billable minutes of use attributable to the Company's operations by region for
1996, 1997 and 1998. Over time, the Company expects its European markets to
contribute a larger percentage of its revenues.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1996 1997 1998
---------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUE
North America................................................................ $ 18,185 $ 48,899 $ 116,645
United Kingdom............................................................... 15,477 18,363 55,991
Continental Europe........................................................... 11,441 15,741 21,101
---------- ---------- ----------
Total.................................................................... $ 45,103 $ 83,003 $ 193,737
---------- ---------- ----------
---------- ---------- ----------
BILLABLE MINUTES OF USE
North America................................................................ 68,247 244,095 549,654
United Kingdom............................................................... 27,968 68,810 288,892
Continental Europe........................................................... 8,351 17,239 45,085
---------- ---------- ----------
Total.................................................................... 104,566 330,144 883,631
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The Company generally prices its services at a discount to the dominant
carrier (or carriers) (the "PTTs") in each of its markets. The Company has
experienced and expects to continue to experience declining revenue per minute
in all of its markets, particularly European markets, as a result of increased
competition. However, the Company believes such declines in revenue per minute
will be offset in part by an increased demand for long distance services and
declining costs of transmission. Historically, transmission costs in the
telecommunications industry have declined at a more rapid rate than prices due
to technological
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innovation and the availability of substantial transmission capacity. There can
be no assurance that this cost trend will continue.
The Company's revenues are recorded upon completion of calls. For prepaid
services, the Company's revenues are reported net of selling discounts and
commissions and are recorded based upon usage rather than at the time of initial
sale.
Revenues also include amounts billed to customers which are, in turn,
remitted to third parties, including universal service fund fees, fixed rate
access charges paid to local exchange carriers ("LECs") and payphone owner
compensation fees. These charges are expensed in cost of services in amounts
similar to corresponding amounts billed to customers and included in revenue.
COST OF SERVICES
The major components of the Company's cost of services are the cost of
origination, transmission and termination of traffic. Virtually all calls
carried by Destia must be originated or terminated on another carrier's local
facilities, for which the Company pays a per minute charge. These charges are
known as "access" or "termination" charges. In countries where the Company has
interconnection, it is able to originate and terminate calls more
cost-effectively, either pursuant to fixed price contractual arrangements with
PTTs or LECs or pursuant to a tariff.
The Company's transmission cost of services consists of expenses
related to leased lines and switched minutes. The Company typically acquires
leased lines on a fixed cost basis, which involve monthly payments regardless
of usage levels. Leased lines are used for specific point-to-point routes and
have a shorter duration than long-term capacity leases ("IRUs"). Because the
cost of leased lines is typically a fixed monthly payment, transmitting an
increased portion of the Company's calls over leased lines reduces its
incremental transmission costs. Accordingly, once certain traffic volume
levels are reached, leased line capacity is more cost effective than capacity
acquired on a variable cost basis, such as switched minutes.
To transmit calls to locations not covered by its network, the Company
acquires switched minutes from other carriers. Switched minutes are acquired on
a per minute basis (with volume discounts) and, accordingly, are a variable
cost. The cost of switched minutes also includes termination charges. As the
Company's minutes of traffic carried have grown, the Company has obtained better
pricing on switched minute transmission capacity. In general, the Company
expects its marginal cost of services will decline over time due to greater
usage of owned transmission capacity, technological innovation, increased
leverage with suppliers and the increasing availability of substantial
third-party transmission capacity.
A substantial and increasing portion of the Company's calls are also
transmitted over its IRUs. The cost of IRUs is expensed in depreciation and
amortization and is, therefore, not accounted for as part of cost of services.
Cost of services also includes amounts billed to customers which are, in
turn, remitted to third parties. See "--Revenues."
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A")
To date, the Company has sold its services primarily through
independent sales channels. Selling expenses have, therefore, primarily
consisted of commissions paid to agents. To a lesser extent, selling expenses
have also included advertising and promotion costs, sales by the Company's
internal sales force and expenses related to its customer service department.
Since completing the acquisition of VoiceNet Corporation ("VoiceNet") during
the first quarter of 1998, the Company's commissions paid to and retained by
VoiceNet (i.e., commissions not subsequently paid by VoiceNet to its
independent sales agents) have been eliminated.
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
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Company expands its customer base in new and existing markets, it intends to
increase its advertising expenses. The Company expects all of these costs to
eventually decline as a percentage of its revenues. General and administrative
expenses have increased primarily as a result of the Company's expansion of its
customer service, billing, financial reporting and other management information
systems. These expenses have also increased as a result of implementing more
extensive network management systems and organizational expenses related to
entering additional markets.
DEPRECIATION AND AMORTIZATION EXPENSE
The Company's depreciation and amortization expense is primarily
related to depreciation on the Company's IRUs and switching equipment,
amortization of costs associated with the issuance of the $155.0 million
principal amount of 13-1/2% Senior Notes due 2007 (the "1997 Notes") and
$300.0 million principal amount of 11% Senior Discount Notes due 2008 (the
"1998 Notes") and amortization of goodwill from the purchases of VoiceNet and
the minority interest in its subsidiary, Telco Global Communications ("Telco").
As the Company expands its 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 Communications of the West, Inc. which provides
Destia with fiber optic transmission capacity in the United States. The
Company also intends to acquire additional IRUs, particularly in Europe. To
the extent the Company's increased use of IRUs reduces its utilization of
leased lines and switched minutes, the increase in depreciation expense of
the IRUs will be offset by a decrease in the cost of services of leased lines
and switched minutes. As a result, although the Company's gross margins are
expected to improve, the Company's net income (loss) will not necessarily
improve to the same extent.
INTEREST EXPENSE
Prior to July 1, 1997, interest expense principally consisted of interest
payable in connection with equipment financing loans and short-term
indebtedness. The 1997 Notes and 1998 Notes currently constitute most of the
Company's interest expense. Annual interest expense for the 1997 Notes and 1998
Notes will aggregate $43.3 million in 1999. The 1998 Notes were issued at a
discount and accrete to their aggregate principal amount at maturity on February
15, 2003. Until that date, interest expense on the 1998 Notes will increase in
each period. Thereafter, interest on the 1998 Notes will accrue and be required
to be paid in cash semi-annually.
RESULTS OF OPERATIONS
The following table presents certain data concerning Destia's results of
operations for 1996, 1997 and 1998.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues....................................................................... $ 45,103 $ 83,003 $ 193,737
Cost of services............................................................... 35,369 63,707 140,548
Selling, general and administrative expenses................................... 16,834 37,898 80,092
Depreciation and amortization.................................................. 1,049 3,615 11,866
Net income (loss).............................................................. (8,312) (30,128) (68,944)
</TABLE>
1998 COMPARED TO 1997
REVENUES. Total revenues for 1998 increased by 133% to $193.7 million from
$83.0 million for 1997. Billable minutes of use increased 168% to 883.6 million
in 1998 from 330.1 million in 1997. The increases in revenues and billable
minutes were primarily attributable to strong customer growth in both the U.S.
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and U.K. markets. Revenues for all services increased substantially from 1997 to
1998. The increase in revenues resulting from the growth in billable minutes was
partially offset by per-minute price reductions caused by increased competition,
most significantly in the U.K. and continental European markets. This
competition was a primary factor in the decrease in average revenue per minute
from $.25 per minute during 1997 to $.22 per minute in 1998.
In North America, revenues grew by 139% to $116.6 million from $48.9
million. This increase was due principally to prepaid and calling card revenues.
The remainder of the increase resulted from increases in long distance revenues.
Average North American revenue per minute increased to $.21 per minute during
1998 from $.20 per minute during 1997. This increase was due principally to the
substantial growth of prepaid card sales, which typically carry a higher per
minute rate than long distance service, offset in part by rate decreases for
long distance services.
In the United Kingdom, revenues increased 205% to $56.0 million in 1998 from
$18.4 million in 1997, while the average revenue per minute decreased from $.27
per minute during 1997 to $.19 per minute during 1998. This reduction was due
principally to increased price competition.
In continental Europe, revenues increased by 34% to $21.1 million from $15.7
million. A portion of this revenue growth was attributable to a full year of
revenue reported for certain country operations that commenced during 1997.
Average continental European revenue per minute decreased from $.91 per minute
during 1997 to $.47 per minute during 1998, as a result of increased competition
brought about by deregulation of the Company's continental European markets.
GROSS MARGIN. The Company's gross margin for 1998 increased to 27.5% from
23.2% for 1997. This increase was attributable to (1) expansion of the Destia
Network (which shifted some expenses from cost of services to depreciation
expense), (2) migration of additional switched traffic onto the Destia Network,
(3) "least-cost" routing, (4) leveraging the Company's traffic volumes to
negotiate lower usage-based costs from domestic and foreign providers of
transmission capacity and (5) the Company's ability to obtain more cost
effective interconnect agreements. An improvement in gross margin does not
necessarily result in an equal improvement in net income (loss). See
"--Overview--Cost of Services."
SG&A. SG&A increased to $80.1 million for 1998 from $37.9 million for 1997,
and, as a percentage of revenues was 41% for 1998 and 46% for 1997. The decrease
in SG&A as a percentage of revenue during 1998 was primarily attributable to the
significant increase in revenues. The increase of $42.2 million in SG&A from
1997 was attributable to the expansion of the sales, operations and back office
infrastructure to support the significant retail sales growth the Company
experienced in 1998. During 1998 the Company expanded its management team and
significantly increased staffing levels in its customer service, network
management, management information systems and finance organizations. In
addition, substantial expenses were incurred in connection with entering new
markets and further developing existing marketing and sales channels. The
Company recorded bad debt expense of $7.4 million, or 3.8% of revenue, for 1998,
compared to bad debt expense of $3.9 million, or 4.7% of revenue, for 1997. This
decline in bad debt expense as a percent of revenue was primarily the result of
improved credit and collection procedures and controls.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $11.9 million for 1998 from $3.6 million for 1997. This increase
was substantially due to the continuing build-out of the Company's network in
the United States, the United Kingdom and continental Europe, amortization of
costs associated with the Company's issuance of the 1997 Notes and the 1998
Notes and amortization of goodwill from the purchases of VoiceNet and the
minority interest in Telco.
INTEREST EXPENSE AND INTEREST INCOME. Interest expense increased to $41.0
million in 1998 from $11.4 million in 1997. This increase was attributable to
the issuance of the 1997 Notes and the 1998 Notes. Interest income increased to
$11.5 million in 1998 from $3.7 million in 1997. This increase was primarily due
to interest income earned on the investment of the net proceeds received from
the 1998 Notes.
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NET LOSS. The Company reported a net loss of $68.9 million for 1998,
compared to a net loss of $30.1 million for 1997. The increase in net loss is
primarily due to the higher level of SG&A expenses and higher interest expense.
Net loss is expected to increase substantially over the near term, primarily due
to interest expense incurred on the 1998 Notes and the 1997 Notes.
1997 COMPARED TO 1996
REVENUES. Total revenues for 1997 increased by 84% to $83.0 million on
330.1 million billable minutes of use from $45.1 million on 104.6 million
billable minutes of use for 1996. Billable minutes of use increased by 216% for
1997 from 1996. Growth in revenues during 1997 primarily was attributable to
additional minutes of use, particularly in the United States, offset in part by
a substantial decline in prices, as a result of increased competition. This
competition was a primary factor for the average revenue per minute decrease
from $.43 during 1996 to $.25 during 1997. An additional factor in the decrease
in revenues per minute was a larger portion of national, as opposed to
international, minutes of use. The increase in revenues was primarily
attributable to sales by VoiceNet of $23.6 million for 1997, compared to $1.9
million for 1996.
In the United Kingdom, revenues increased by 19% to $18.4 million from
$15.5 million, primarily due to sales by Telco, which increased, to $10.6
million in 1997 from $1.3 million in 1996. Increases in U.K. revenue were
partially offset by the termination of the Company's business relationship
with Europhone International ("EI"), which accounted for $14.2 million in
revenues in 1996. During the fourth quarter of 1996, the Company began
marketing efforts in the U.K. through Telco. During 1997, U.K. revenues
consisted principally of $10.6 million from international and domestic long
distance and prepaid card services attributable to Telco, as well as $7.2
million from carrier services sold through America Telemedia Limited, a
wholly-owned subsidiary of the Company. Average U.K. revenue per minute
decreased from $.55 per minute during 1996 to $.27 per minute during 1997.
This reduction was due principally to sales of a larger percentage of domestic
long distance minutes, which are sold at lower rates than international
minutes, and to increased price competition.
In continental Europe, revenues increased by 38% to $15.7 million from $11.4
million. This increase was attributable to an increase in prepaid card services,
primarily in France and Germany. Average continental European revenue per minute
decreased from $1.37 per minute during 1996 to $.91 per minute during 1997. This
decrease was due to lower rates in France and Germany.
In North America, revenues grew by 169% to $48.9 million from $18.2 million.
This increase was due principally to calling card revenues attributable to sales
by VoiceNet, which were $23.6 million during 1997, compared to $1.9 million
during 1996. VoiceNet began reselling the Company's calling card services to
end-users during the second quarter of 1996. The remainder of the increase
resulted from increases in sales of carrier services, and, to a lesser extent,
international and domestic long distance and prepaid card services. Average U.S.
revenue per minute decreased to $.20 per minute during 1997 from $.27 per minute
during 1996. This reduction was due principally to sales of a larger percentage
of domestic long distance minutes, which are sold at lower rates than
international minutes, and to increased price competition.
During 1997, the Company experienced an average customer turnover or "churn"
rate of approximately 5% relating to U.S., U.K. and continental European "1+",
"1xxx" and calling card services. To date, the Company's revenues and margins
have not been materially impacted by its "churn" rate. The Company's "churn"
rate with respect to any given period consists of the average number of
customers that ceased using the Company's services during any month of the
period divided by the average monthly number of customers for the period.
Customers that have ceased using the Company's services during any given month
are those customers who used the Company's services during the prior month but
not during any subsequent month of the applicable period.
GROSS MARGIN. The Company's gross margin for 1997 increased to 23.2% from
21.6% for 1996. This increase was attributable to the Company's increased use of
owned and leased line transmission capacity
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and its ability to obtain lower prices on switched transmission capacity because
of increased traffic volumes and a greater availability of capacity generally.
SG&A. SG&A increased to $37.9 million for 1997 from $16.8 million for 1996,
and, as a percentage of revenues, was 46% for 1997 and 37% for 1996. The
increase primarily consisted of commissions paid to resellers (principally
VoiceNet) and independent agents, an increase in payroll costs related to
additional management and staff in the areas of finance, sales, customer
service, network management and information systems at the Company's Manhattan,
New York, Brooklyn, New York and College Station, Texas facilities, as well as
the London, Brussels, Hamburg and Paris offices. For 1996, a majority of the
expenses consisted of expenses related to EI and commissions paid to independent
sales agents.
In connection with the termination of the Company's joint venture with EI
during June 1996, EI granted the Company the right to compete with EI in the
United Kingdom in exchange for forgiveness of a net receivable due to the
Company of $2.0 million. The forgiveness of the receivable has been reclassified
as an expense of the joint venture and was charged to bad debt expense. The
Company previously had capitalized the U.K. territorial rights granted to it by
EI on its consolidated balance sheet and was amortizing the rights over a
15-year life. The Company subsequently decided to write off this asset,
resulting in an additional $1.9 million charge in 1996.
The Company recorded bad debt expense of $3.9 million, or 4.7% of revenue,
for 1997, compared to bad debt expense of $2.0 million, or 4.4% of revenue, for
1996. The charge in 1996 was related to EI.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $3.6 million for 1997 from $1.0 million for 1996. This increase was
substantially due to the depreciation associated with upgrades in the Company's
switch in New York and installation of multiplexing equipment in New York and
London, as well as amortization of costs associated with the 1997 Unit Offering.
INTEREST EXPENSE. The Company had $11.4 million of interest expense during
1997, as compared to interest expense of $0.4 million during 1996. Interest
expense has increased substantially as a result of the 1997 Unit Offering, with
$10.5 million of 1997 expense attributable to the 1997 Unit Offering.
NET LOSS. The Company had a net loss of $30.1 million during 1997, compared
to a net loss of $8.3 million during 1996. The increase is primarily due to
costs associated with increasing the internal infrastructure, building the
network, marketing, commissions paid to resellers and interest expense related
to the 1997 Notes.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses and made
substantial capital expenditures, due in large part to the start-up and
development of the Company's operations and the Destia Network. The Company will
continue to incur additional losses and have substantial additional capital
expenditures. The Company has utilized cash provided from financing activities
to fund losses and capital expenditures. The sources of this cash have primarily
been the proceeds from the sale of the 1997 Notes and the 1998 Notes and, to a
lesser extent, equipment-based financing.
As of December 31, 1998, the Company had $139.6 million of cash, cash
equivalents and marketable securities, as well as $40.5 million of restricted
cash and securities (which will be used to pay interest expense on the 1997
Notes through July 15, 2000). The Company believes that the net proceeds of this
offering, as well as equipment loans it expects to obtain and cash on hand, will
provide sufficient funds for the foreseeable future. However, the amount of the
Company's future capital requirements will depend on a number of factors,
including the success of its business, its gross margins, and its SG&A expenses,
as well as other factors, many of which are not within its control, including
competitive conditions and regulatory developments. In the event that the
Company's plans or assumptions change or prove to be inaccurate, it may be
required to delay or abandon some or all of its development and expansion plans
or the Company
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may be required to seek additional sources of capital. Future sources may
include public debt or equity offerings or equipment financings. There can be no
assurance that additional financing arrangements will be available on acceptable
terms.
The Company's capital expenditures during 1998 were approximately $76.7
million. These investments were made principally to support the continued
expansion of the Destia Network, including the purchase of telecommunications
equipment and the purchase of additional transatlantic IRUs. In addition, the
Company made investments related to the continued development of its back office
capabilities, including management information and network management systems.
In 1999, the Company plans to spend approximately $100 million for capital
expenditures on network equipment, back-office systems, the continued build-out
of its network operations center in St. Louis, Missouri, 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 $26.4 million for
1998 and was primarily attributable to a net loss of $68.9 million and an
increase in accounts receivable of $22.1 million partially offset by an increase
in accounts payable, accrued expenses and other current liabilities of $34.7
million and non-cash interest expense of $17.7 million. Net cash used in
investing activities of $119.1 million for 1998 was attributable to the purchase
of marketable securities, investments made primarily in switching and other
telecommunications equipment and IRUs and the VoiceNet acquisition. Net cash
provided by financing activities in 1998 of $177.6 million was primarily related
to the issuance of the 1998 Notes.
On February 12, 1998, the Company acquired VoiceNet, a major distribution
channel for the Company's calling card products. The initial purchase price was
$21.0 million, which was paid in cash. The sellers of VoiceNet also are entitled
to receive an earn-out based upon the revenue growth of the VoiceNet business.
The earn-out bonus will not have a material impact on the Company's liquidity.
The acquisition was accounted for under the purchase method of accounting.
Goodwill was recorded to the extent the purchase price exceeded the fair value
of the net assets purchased. Approximately $1.0 million of the initial purchase
price will reflect the underlying value of the assets acquired and $20.0 million
will reflect goodwill. The goodwill is being amortized over 20 years.
At the end of 1998, the Company completed two small acquisitions. In
November 1998, the Company acquired a controlling interest in America First
Ltd., a prepaid card distributor in the United Kingdom for approximately $5.5
million. The majority of the purchase price was recorded as goodwill and will
be amortized over 20 years. In December 1998, the Company also acquired the
customer list of a long distance reseller, also located in the United Kingdom.
The purchase price was allocated to the customer base and will be amortized
over 5 years.
In the United Kingdom, the majority of the Company's sales are made through
Telco, its majority owned subsidiary. On July 17, 1998, the Company acquired the
minority interest in Telco that it did not already own in exchange for a note in
the principal amount of approximately $14.0 million, payable by the Company in
quarterly installments, together with interest at a rate of 8.0% per annum, over
approximately three years. The entire purchase price is classified as goodwill,
which will be amortized over 20 years. In connection with such acquisition, (1)
Telco obtained ownership rights with respect to certain proprietary software
used in Telco's business and (2) the Company converted options to acquire Telco
shares held by Telco employees into grants of non-voting restricted shares of
the Company's common stock.
During 1998, the Company incurred certain other non-operating cash
commitments which, as of December 31, 1998, included approximately $42.3 million
in the aggregate for a 20-year IRU from Frontier to use portions of its U.S.
fiber optic network and for the purchase of a transatlantic IRU. As of December
31, 1998, the Company is required to pay approximately $1.2 million per quarter
as installments
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of principal on its equipment facility. In addition, the Company pays $20.9
million per annum as interest expense on the 1997 Notes. The Company has put
funds in escrow to cover this expense through July 15, 2000. For a discussion of
the Company's IRU from Frontier."
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).
MARKET RISK
The carrying value of cash and cash equivalents approximates fair value due
to the short-term, highly liquid nature of the cash equivalents, which have
maturities of three months or less. Interest rate fluctuations would not have a
significant effect on the fair value of cash equivalents held by the Company.
At December 31, 1998 the Company had debt in the amount of $396.8 million of
which $375.7 million is fixed interest debt. The remaining $21.1 million carries
adjustable interest rates equal to the 90-day commercial paper rate plus 395
basis points. A one percent change in the interest rate would change interest
payments by approximately $18,000 per month.
FOREIGN CURRENCY EXPOSURE
The Company is exposed to fluctuations in foreign currencies relative to the
U.S. dollar because the Company bills in local currency, while transmission
costs are largely incurred in U.S. dollars and interest expense on the 1997
Notes and 1998 Notes is in U.S. dollars. For each of 1998 and 1997,
approximately 40% of the Company's revenues were billed in currencies other than
the U.S. dollar, consisting primarily of British pounds and Belgian francs. The
effect of these fluctuations on the Company's revenues for 1998 and 1997 was
immaterial. As the Company expands its operations, a higher percentage of
revenues is expected to be billed in currencies other than the U.S. dollar. The
Company from time to time uses foreign exchange contracts relating to its trade
accounts receivables to hedge foreign currency exposure and to control risks
relating to currency fluctuations. The Company does not use derivative financial
instruments for speculative purposes. At December 31, 1998 and 1997, the Company
had $0 and $.3 million open foreign currency hedging positions, respectively.
EURO CONVERSION
On January 1, 1999, several member countries of the European Union
established fixed conversion rates and adopted the euro as their new common
legal currency. Since that date, the euro has traded on currency exchanges,
although the legacy currencies will remain legal tender in the participating
countries for a transition period between January 1, 1999 and January 1, 2002.
During the transition period, parties can elect to pay for goods and services
and transact business using either the euro or a legacy currency. Between
January 1, 2002 and July 1, 2002, the participating countries will introduce
euro currency coins and withdraw all legacy currencies.
The euro conversion may affect cross-border competition by creating
cross-border price transparency. The Company is assessing its pricing and
marketing strategy in order to insure that it remains competitive in a broader
European market. In addition, the Company is reviewing whether certain existing
contracts will need to be modified. The Company's currency risks and risk
management for operations in participating countries may be reduced as the
legacy currencies now trade at a fixed exchange rate against the euro. The
Company will continue to evaluate issues involving introduction of the euro.
However, based
10
<PAGE>
on current information and assessments, the Company does not expect that the
euro conversion will have a material adverse effect on its results of operations
or financial condition.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use software, dividing the development into three stages: (1) the
preliminary project stage, during which conceptual formulation and evaluation of
alternatives takes place, (2) the application development stage, during which
design, coding, installation and testing takes place and (3) the operations
stage during which training and maintenance takes place. Cost incurred during
the application development stage are capitalized, all other costs are expensed
as incurred. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company is currently evaluating the
impact of adopting SOP 98-1.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." SOP 98-5 requires that all non-governmental entities
expense the costs of start-up activities, including organization costs, as those
costs are incurred. SOP 98-5 is effective for financial statements for fiscal
years beginning after December 15, 1998. The Company has reviewed the provisions
of SOP 98-5 and does not believe adoption of this standard will have a material
effect on its results of operations.
YEAR 2000 COMPLIANCE
The Company is engaged in an ongoing process of assessing its exposure to
the Year 2000 issue--the potential problems arising from computer systems that
were designed to use two digits, rather than four, to specify the year. The
Company has formed a project team (consisting of representatives from its
information technology, finance, business development, product development,
sales, marketing and legal departments) to address internal and external Year
2000 issues. By December 31, 1998, the Company had completed its internal review
of its financial and other computer systems (which include switching, billing
and other platforms) to assess Year 2000 issues. Based on this review, the
Company believes that the amount of work and expense required to address Year
2000 issues relating to its internal systems will not be material. The Company
is upgrading certain of its Northern Telecom switches to make them and their
related software Year 2000 compliant. The Company expects this upgrade to be
completed by June 30, 1999 at a cost of approximately $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 the first quarter of 1999 to assist it in
conducting an external review of its significant customers, suppliers and other
third parties with which it does business, including significant equipment and
system providers and telecommunications service providers, to determine their
vulnerability to Year 2000 problems and any potential impact on the Company. In
particular, the Company may experience problems to the extent that other
telecommunications carriers are not Year 2000 compliant. The Company anticipates
that this external review and related third party review will be substantially
completed by September 30, 1999. The Company's ability to determine the status
of these third parties ability to address issues relating to the Year 2000
issues is limited and there is no assurance that these third parties will
achieve full Year 2000 compliance before the end of 1999.
The Company believes that its reasonably possible worst case Year 2000
scenario is disruption of its ability to route traffic over portions of its own
network or an inability to terminate calls to certain destinations, which would
require the Company to utilize other transmission capacity at greater cost. To
the extent that a limited number of carriers experience disruption in service
due to the Year 2000 issue, the
11
<PAGE>
Company's contingency plan is to obtain service from alternate carriers.
However, there is no assurance that alternate carriers will be available or, if
available, that the Company can purchase transmission capacity at a reasonable
cost. In addition, in many continental European countries there are no
alternative carriers to use. Significant Year 2000 failures in the systems of
the Company, alternate carriers and other third parties (or third parties on
whom they depend) would have a material adverse effect on the Company's business
and the price of its common stock.
The Company estimates the total cost for resolving its Year 2000 issues to
be approximately $2.0 million, of which approximately $.1 million has been spent
through January, 1999, with the majority of expenditures expected to be incurred
in the first quarter of 1999 in connection with upgrades of its Northern Telecom
switches. This estimate includes the accelerated cost of replacing systems that
are not Year 2000 compliant. Actual costs may, however, differ materially.
12
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
DESTIA COMMUNICATIONS, INC.
By: /s/ RICHARD L. SHORTEN, JR.
---------------------------
Name: Richard L. Shorten, Jr.
Title: Senior Vice President
and General Counsel
Dated: February 18, 1999
<PAGE>
EXHIBIT INDEX
23.1 Consent of Arthur Andersen LLP
99.1 Consolidated Financial Statements of the Company as of December 31, 1997
and 1998 and for the three years ended December 31, 1998 and the related
footnotes thereto
99.2 Financial Statement Schedule, Schedule II, Schedule of Valuation and
Qualifying Accounts.
<PAGE>
Exhibit 23.1
[Letterhead of Arthur Andersen LLP]
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
-----------------------------------------
As independent public accountants we hereby consent to the incorporation in
the Form 8-K of our report dated February 2, 1999. It should be noted that
we have not audited any financial statements of the company subsequent to
December 31, 1998 or performed any audit procedures subsequent to the date of
our report.
/s/ ARTHUR ANDERSEN LLP
- -------------------------
Arthur Andersen LLP
New York, New York
February 18, 1999
<PAGE>
DESTIA COMMUNICATIONS, INC.
(FORMERLY ECONOPHONE, INC.)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................................................... F-2
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1998............................................... F-3
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE YEARS ENDED DECEMBER 31, 1996, 1997
AND 1998................................................................................................. F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998...... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Destia Communications, Inc. (formerly Econophone, Inc.):
We have audited the accompanying consolidated balance sheets of Destia
Communications, Inc. (formerly Econophone, Inc.) (a Delaware corporation) and
subsidiaries as of December 31, 1997 and 1998, and the related consolidated
statements of operations, comprehensive loss, stockholders' deficit and cash
flows for each of the three years ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Destia
Communications, Inc. (formerly Econophone, Inc.) and subsidiaries as of December
31, 1997 and 1998, and the results of their operations and their cash flows for
each of the three years ended December 31, 1998, in conformity with generally
accepted accounting principles.
Arthur Andersen LLP
New York, New York
February 2, 1999
F-2
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
DECEMBER 31, DECEMBER 31,
-------------------- -------------
1997 1998 1998
--------- --------- -------------
<S> <C> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents...........................................
$ 67,202 $ 118,218
Marketable securities...............................................
-- 21,343
Accounts receivable, net of allowance for doubtful accounts of
$1,594 and $4,086, respectively...................................
16,796 33,351
Prepaid expenses and other current assets...........................
1,868 3,409
Restricted cash and securities......................................
10,463 9,590
--------- ---------
Total current assets..........................................
96,329 185,911
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS net of accumulated
depreciation and amortization of $3,690 and $12,418, respectively
(Note 5)..........................................................
24,113 107,249
Debt issuance costs.................................................
6,356 12,244
Intangible assets, net of accumulated amortization of $0 and $1,324,
respectively......................................................
-- 49,488
Other assets........................................................
2,242 2,439
Restricted cash and securities......................................
48,965 30,877
--------- ---------
Total assets..................................................
$ 178,005 $ 388,208
---------
--------- ---------
---------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable....................................................
$ 21,101 $ 33,352
Accrued expenses and other current liabilities (Note 7).............
5,356 31,131
Interest accrued on Senior Notes....................................
10,462 9,590
Current maturities of other long-term debt (Note 9).................
1,829 16,232
Current maturities of obligations under capital lease (Note 15).....
156 154
Current maturities of notes payable-related party (Note 13).........
315 308
Deferred revenue....................................................
2,568 4,739
--------- ---------
Total current liabilities.....................................
41,787 95,506
OTHER LONG-TERM DEBT (Note 9).......................................
5,657 37,379
OBLIGATIONS UNDER CAPITAL LEASE (Note 15)...........................
279 193
SENIOR NOTES (Note 9)...............................................
149,680 343,176
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note 12)...........
14,328 14,421 --
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS' DEFICIT (Note 11):
Common stock--voting, par value $.01; authorized 29,250,000 shares;
20,000,000, 20,000,000 and 23,420,171 shares issued and
outstanding at December 31, 1997 and 1998 and pro forma,
respectively......................................................
2 200 234
Common stock--non-voting, par value $.01; authorized
500,000 shares; 0, 75,760 and 75,760 shares issued and outstanding
at December 31, 1997 and 1998 and pro forma, respectively.........
-- 1 1
Additional paid-in capital..........................................
6,082 6,931 21,318
Accumulated other comprehensive loss................................
(104) (856) (856)
Accumulated deficit.................................................
(39,706) (108,743) (108,743)
--------- --------- -------------
Total stockholders' deficit...................................
(33,726) (102,467) (88,046)
--------- --------- -------------
Total liabilities and stockholders' deficit...................
$ 178,005 $ 388,208 $ 388,208
---------
--------- --------- -------------
--------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
REVENUES....................................................................... $ 45,103 $ 83,003 $ 193,737
COST OF SERVICES............................................................... 35,369 63,707 140,548
--------- ---------- ----------
Gross profit............................................................. 9,734 19,296 53,189
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES................................... 16,834 37,898 80,092
DEPRECIATION AND AMORTIZATION.................................................. 1,049 3,615 11,866
--------- ---------- ----------
Loss from operations..................................................... (8,149) (22,217) (38,769)
OTHER INCOME (LOSS)............................................................ 106 102 (747)
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net..................................... 27 (265) 86
INTEREST EXPENSE, net.......................................................... (296) (7,748) (29,514)
--------- ---------- ----------
Net loss................................................................. $ (8,312) $ (30,128) $ (68,944)
--------- ---------- ----------
--------- ---------- ----------
HISTORICAL:
LOSS PER SHARE (Note 2)
Basic.................................................................... $ (0.43) $ (1.55) $ (3.44)
Diluted.................................................................. $ (0.43) $ (1.55) $ (3.44)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (basic and diluted) (Note
2)........................................................................... 20,000 20,000 20,038
--------- ---------- ----------
PRO FORMA LOSS PER SHARE (unaudited) (Note 2):
Basic.................................................................... $ (0.40) $ (1.29) $ (2.94)
Diluted.................................................................. $ (0.40) $ (1.29) $ (2.94)
PRO FORMA WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (basic and
diluted) (Note 2)............................................................ 20,572 23,421 23,459
--------- ---------- ----------
</TABLE>
DESTIA COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
NET LOSS........................................................................ $ (8,312) $ (30,128) $ (68,944)
OTHER COMPREHENSIVE LOSS, net of tax:
FOREIGN CURRENCY TRANSLATION ADJUSTMENTS.................................. -- (104) (752)
--------- ---------- ----------
COMPREHENSIVE LOSS.............................................................. $ (8,312) $ (30,232) $ (69,696)
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
--------------------------------------------------
RETAINED
VOTING NON VOTING ADDITIONAL EARNINGS ACCUMULATED
------------------------ ------------------------ PAID-IN (ACCUMULATED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) LOSS
----------- ----------- ----------- ----------- ----------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995........ 20,000 $ 2 -- -- $ 392 $ 316 $ --
Distribution of S corporation
earnings........................ -- -- -- -- (316) --
Contribution of capital to C
corporation..................... -- -- -- -- 90 -- --
Net loss.......................... -- -- -- -- (8,312) --
Accretion of preferred stock...... -- -- -- -- (15) --
Dividends on preferred stock...... -- -- -- -- (281) --
----------- ----- --- ----- ----------- ------------ -------
BALANCE, December 31, 1996........ 20,000 2 -- -- 482 (8,608) --
Net loss.......................... -- -- -- -- -- (30,128) --
Warrants.......................... -- -- -- -- 5,600 -- --
Accretion of preferred stock...... -- -- -- -- -- (91) --
Dividends on preferred stock...... -- -- -- -- -- (879) --
Cumulative translation
adjustment...................... -- -- -- -- -- -- (104)
----------- ----- --- ----- ----------- ------------ -------
BALANCE, December 31, 1997........ 20,000 2 -- -- 6,082 (39,706) (104)
Net loss.......................... -- -- -- -- -- (68,944) --
Issuance of non voting restricted
shares.......................... -- -- 76 1 994 -- --
Accretion of preferred stock...... -- -- -- -- -- (93) --
Change in par value............... -- 198 -- -- (198) -- --
Cumulative translation
adjustment...................... -- -- -- -- -- -- (752)
Other............................. -- -- -- -- 53 -- --
----------- ----- --- ----- ----------- ------------ -------
BALANCE, December 31, 1998........ 20,000 $ 200 76 $ 1 $ 6,931 $ (108,743) $ (856)
----------- ----- --- ----- ----------- ------------ -------
----------- ----- --- ----- ----------- ------------ -------
<CAPTION>
TOTAL
---------
<S> <C>
BALANCE, December 31, 1995........ $ 710
Distribution of S corporation
earnings........................ (316)
Contribution of capital to C
corporation..................... 90
Net loss.......................... (8,312)
Accretion of preferred stock...... (15)
Dividends on preferred stock...... (281)
---------
BALANCE, December 31, 1996........ (8,124)
Net loss.......................... (30,128)
Warrants.......................... 5,600
Accretion of preferred stock...... (91)
Dividends on preferred stock...... (879)
Cumulative translation
adjustment...................... (104)
---------
BALANCE, December 31, 1997........ (33,726)
Net loss.......................... (68,944)
Issuance of non voting restricted
shares.......................... 995
Accretion of preferred stock...... (93)
Change in par value............... --
Cumulative translation
adjustment...................... (752)
Other............................. 53
---------
BALANCE, December 31, 1998........ $(102,467)
---------
---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................................... $ (8,312) $ (30,128) $ (68,944)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.............................. 1,049 3,615 11,866
Provision for doubtful accounts............................ 291 832 2,603
Accreted interest expense.................................. -- 280 17,711
Changes in assets and liabilities:
Increase in accounts receivable............................ (887) (9,682) (22,100)
Increase in prepaid expenses and other current assets...... (350) (1,004) (2,175)
Increase in other assets................................... (1,514) (3,277) (791)
Increase in accounts payable, accrued expenses and other
current liabilities...................................... 3,352 14,975 34,745
Increase (decrease) in interest accrued on senior notes.... -- 10,462 (872)
Increase in deferred revenue............................... 365 1,708 1,543
--------- --------- ---------
Net cash used in operating activities.................. (6,006) (12,219) (26,414)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid in acquisitions................................ -- -- (21,063)
Purchase of marketable securities, net....................... -- -- (21,343)
Purchases of property and equipment.......................... (4,247) (13,267) (76,686)
--------- --------- ---------
Net cash used in investing activities.................. (4,247) (13,267) (119,092)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of preferred stock.................... 13,061 -- --
Proceeds from line of credit................................. 800 -- --
Repayment of line of credit.................................. (1,000) -- --
Proceeds from short-term borrowings.......................... 5,437 -- --
Repayments of short-term borrowings.......................... (3,309) (2,128) --
Proceeds from long-term debt and capital leases.............. 2,232 -- 16,390
Repayments of long-term debt and capital leases.............. (566) (661) (7,497)
Repayments of notes payable-related party.................... (10) (12) (7)
Dividends paid............................................... (226) -- --
Proceeds from senior discount notes.......................... -- 149,400 175,785
Proceeds from issuance of warrants........................... -- 5,600 --
Payment of debt issuance costs............................... -- (6,355) (7,110)
Proceeds from bridge loan.................................... -- 7,000 --
Repayments of bridge loan.................................... -- (7,000) --
--------- --------- ---------
Net cash provided by financing activities.............. 16,419 145,844 177,561
--------- --------- ---------
Increase in cash and cash equivalents, (including restricted
cash)...................................................... 6,166 120,358 32,055
Cash and cash equivalents, beginning of period, (including
restricted cash)........................................... 106 6,272 126,630
--------- --------- ---------
Cash and cash equivalents, end of period, (including
restricted cash)........................................... $ 6,272 $ 126,630 $ 158,685
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................... $ 210 $ 505 $ 24,329
Income Taxes............................................... -- -- --
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Note issued for purchase of minority interest--Telco......... $ -- $ -- $ 14,035
Accretion of preferred stock................................. 15 91 93
Accrued dividends on preferred stock......................... 281 879 --
Capital leases executed and notes issued for asset
purchases.................................................. 423 5,754 14,250
DETAILS OF ACQUISITIONS:
Fair Value of assets acquired.............................. -- -- $ 1,896
Goodwill................................................... -- -- (50,759)
Liabilities assumed and notes issued....................... -- -- 27,800
--------- --------- ---------
Net cash paid for acquisitions............................. -- -- $ (21,063)
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-7
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1998
1. NATURE OF BUSINESS
Destia Communications, Inc. (formerly Econophone Inc.) ("Destia") is a
rapidly growing, facilities-based provider of domestic and international long
distance telecommunications services in North America and Europe. Its extensive
international telecommunications network allows it to provide services primarily
to retail customers in many of the largest metropolitan markets in the United
States, Canada, the United Kingdom, Belgium, France, Germany and Switzerland.
The Company provides its customers with a variety of retail
telecommunications services, including international and domestic long distance,
calling card and prepaid services, and wholesale transmission services. The
Company's 350,000 customer accounts are diverse and include residential
customers, commercial customers, ethnic groups and telecommunications carriers.
In each of the Company's geographic markets, it utilizes a multichannel
distribution strategy to market its services to its target customer groups.
In February 1998, the New York corporation "Econophone, Inc." (now known as
Destia Communications, Inc.) was merged into its wholly owned subsidiary named
"Econophone, Inc." (now known as Destia Communications, Inc.) which had been
incorporated in the State of Delaware, for the sole purpose of changing the
state of incorporation of the Company. The Delaware corporation was the
surviving entity in the merger. In connection with the foregoing, the par value
of the Company's common stock was changed to $.01 per share of voting and
non-voting common stock from $.0001.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Destia and its
wholly owned subsidiaries, its 72% owned subsidiary, Econophone Services GmbH
(Switzerland) and its 81.25% owned subsidiary America First, Ltd. (England)
(collectively, the "Company"). The full amount of the net loss for the year
ended December 31, 1997 and 1998 for Econophone Services GmbH and America First,
Ltd. have been recorded in the consolidated financial statements of the Company.
All significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company's revenues are primarily based on usage and are derived from (1)
the number of minutes of telecommunications traffic carried and, (2) generally,
a fixed per minute rate. For prepaid services, the Company's revenues are
reported net of selling discounts and commissions and are recorded based upon
usage rather than time of initial sale.
F-8
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
less than three months when purchased.
PROPERTY AND EQUIPMENT
Depreciation of property and equipment is computed using the straight-line
method over the estimated useful lives of the respective assets, which range
from three to fifteen years. Depreciation of IRUs is computed using the
straight-line method over the lease term. Amortization of leasehold improvements
is computed using the straight-line method over the lesser of the lease term or
estimated useful lives of the improvements.
INTERNAL-USE SOFTWARE
The Company capitalizes certain software development costs for internal use.
For the years ended December 31, 1997 and 1998, the Company incurred
approximately $897,000 and $1,925,000 respectively, of such costs and has
included them in Property, Equipment and Leasehold Improvements. The capitalized
software are amortized on a straight-line basis over the estimated useful life,
generally two years. Prior to 1997, such costs were immaterial.
INTANGIBLE ASSETS
Intangible assets represent the excess of cost of acquired businesses over
the underlying fair value of the tangible net assets acquired. Intangible assets
are amortized on a straight-line basis over their estimated period of benefit,
generally 5 - 20 years). The carrying value of goodwill is periodically reviewed
for impairment whenever events or changes in circumstances indicate that it may
not be recoverable.
LONG-LIVED ASSETS
The Company's policy is to record long-lived assets at cost. In accordance
with Statement of Financial Accounting Standards ("SFAS ") No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," these assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amounts of the assets may not be
recoverable. Furthermore, the assets are evaluated for continuing value and
proper useful lives by comparison to expected future cash projections. The
Company amortizes these costs over the expected useful life of the related
asset. As of December 31, 1998 the Company does not believe any impairment
exists with its long-lived assets.
INCOME TAXES
Prior to 1996, the Company was an S-Corporation for federal and state income
tax purposes and, as a result, the earnings of the Company were treated as
taxable income of the shareholders. During 1996, the Company changed its tax
status to a C-Corporation.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their
F-9
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to be applied to taxable income in the year in which
those temporary differences are expected to be recovered or settled. Deferred
income taxes are not provided on undistributed earnings of foreign subsidiaries
since such earnings are currently expected to be permanently reinvested outside
the United States.
STOCK-BASED COMPENSATION
SFAS No. 123 "Accounting for Stock-Based Compensation," encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation awards to employees and directors using the
intrinsic value method prescribed in Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation cost for stock options awarded to employees and
directors is measured as the excess, if any, of the fair value of the Company's
stock at the date of grant over the amount an employee or director must pay to
acquire the stock.
The Company accounts for stock-based compensation awards to outside
consultants and affiliates based on the fair value of such awards. Accordingly,
compensation costs for stock option awards to outside consultants and affiliates
is measured at the date of grant based on the fair value of the award using the
Black-Scholes option pricing model (See Note 14).
NEW ACCOUNTING PRONOUNCEMENTS
These standards increase disclosure only and have no impact on the Company's
financial position or results of operations. These standards have been adopted
in 1998 and have been reflected in the financial statements and notes for the
year ended December 31, 1998.
In March 1998, the American Institute of Certified Public Accountants (the
"AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use software, dividing the development into three stages: (1) the
preliminary project stage, during which conceptual formulation and evaluation of
alternatives takes place, (2) the application development stage, during which
design, coding, installation and testing takes place and (3) the operations
stage during which training and maintenance takes place. Costs incurred during
the application development stage are capitalized, all other costs are expensed
as incurred. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company has reviewed the provisions of
SOP 98-1 and does not believe adoption of this standard will have a material
effect on its results of operations, financial position or cash flows.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." SOP 98-5 requires that all non-governmental entities
expense the costs of start-up activities, including organization costs, as those
costs are incurred. SOP 98-5 is effective for financial statements for fiscal
years beginning after December 15, 1998. The Company has reviewed the provisions
of SOP 98-5 and does not believe adoption of this standard will have a material
effect on its results of operations.
F-10
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY EXCHANGE
The financial statements of all foreign subsidiaries were prepared in their
respective local currencies and translated into U.S. dollars based on the
current exchange rate at the end of the period for the balance sheets and an
average rate for the period on the statements of operations. Translation
adjustments generally are reflected as foreign currency translation adjustments
in the statement of stockholders' equity and, accordingly, have no effect on net
income. Foreign currency transaction adjustments are reflected in the statements
of operations.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
UNAUDITED PRO FORMA INFORMATION
The Company's historical capital structure is not indicative of its
prospective structure due to the automatic conversion of all shares of Series A
Redeemable Convertible Preferred Stock into common stock concurrent with the
closing of the Company's anticipated initial public offering ("IPO") (see Note
12 for conversion terms).
The unaudited pro forma consolidated balance sheet as of December 31, 1998,
reflects the conversion of 140,000 shares of the Series A Redeemable Convertible
Preferred Stock into approximately 3,421,000 shares of common stock.
Pro forma loss per share is computed using the weighted average number of
common shares outstanding during the period assuming the conversion of
convertible preferred stock issued into common stock as of the date of issuance.
PER SHARE DATA
During 1997, SFAS No. 128 "Earnings per Share" was issued and became
effective for the Company's December 31, 1997 financial statements. SFAS No. 128
establishes new standards for computing and presenting earnings per share
("EPS"). The new standard requires the presentation of basic EPS and diluted
EPS. Basic EPS is calculated by dividing income available to common shareholders
by the weighted average number of shares of common stock outstanding during the
period. Diluted EPS is calculated by dividing income available to common
shareholders by the weighted average number of common shares outstanding
adjusted to reflect potentially dilutive securities. Diluted EPS has not been
presented since the inclusion of outstanding options, warrants and convertible
preferred shares would be antidilutive.
F-11
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is the reconciliation of net loss per share as of December 31,
<TABLE>
<CAPTION>
1996 1997 1998
------------- -------------- --------------
<S> <C> <C> <C>
NUMERATOR
Net loss................................................ $ (8,312,000) $ (30,128,000) $ (68,944,000)
Less dividends on preferred stock....................... (281,000) (879,000) --
Less accretion of preferred stock....................... (15,000) (91,000) (93,000)
------------- -------------- --------------
Loss available to common shareholders................... $ (8,608,000) $ (31,098,000) $ (69,037,000)
------------- -------------- --------------
------------- -------------- --------------
DENOMINATOR
Weighted Average shares outstanding..................... 20,000,000 20,000,000 20,038,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board has issued SFAS No. 107 entitled
"Disclosures about Fair Value of Financial Instruments," which requires entities
to disclose information about the fair values of their financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
LONG-TERM DEBT
The carrying amount of the Company's current portion of long-term borrowings
approximates fair value. The fair value of the Company's long-term debt,
including current portions, is determined based on market prices for similar
debt instruments or on the current rates offered to the Company for debt with
similar maturities. As of December 31, 1998, the Company's senior notes were
made up of the 13 1/2% Senior Notes due 2007 (the "1997 Notes") issued July 1,
1997, and the 11% Senior Discount Notes due 2008 (the "1998 Notes") issued
February 12, 1998 (together the "Senior Notes"). The fair value of the 1997
Notes and the 1998 Notes, based upon quotes from securities dealers, were
$157,325,000 and $151,500,000, respectively.
4. DEBT AND EQUITY SECURITIES
The Company accounts for short-term investments in accordance with SFAS No.
115 "Accounting for Certain Investments in Debt and Equity Securities."
Short-term investments have an original maturity of more than three months and a
remaining maturity of less than one year. These investments are stated at cost
as it is the intent of the Company to hold these securities until maturity. The
funds are invested in compliance with the Company's bond indentures which
restrict the type, quality and maturity of
F-12
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
4. DEBT AND EQUITY SECURITIES (CONTINUED)
investments. The table below discloses the fair value of held-to-maturity
securities as of December 31, 1998.
<TABLE>
<CAPTION>
AGGREGATE
AGGREGATE FAIR VALUE GROSS GROSS
AMORTIZED DECEMBER 31, UNREALIZED UNREALIZED
COST BASIS 1998 HOLDING GAINS HOLDING LOSSES
-------------- ----------------- ------------- --------------
<S> <C> <C> <C> <C>
U.S. treasury notes........................... $ 38,949,000 $ 39,246,000 $ 365,000 $ (68,000)
Government agency notes....................... 54,438,000 54,611,000 173,000 --
Commercial paper.............................. 14,914,000 14,960,000 47,000 (1,000)
Other debt securities......................... 19,976,000 19,975,000 -- (1,000)
-------------- ----------------- ------------- --------------
$ 128,277,000 $ 128,792,000 $ 585,000 $ (70,000)
-------------- ----------------- ------------- --------------
-------------- ----------------- ------------- --------------
Included in cash and cash equivalents......... $ 66,467,000
Included in marketable securities............. 21,343,000
Included in current portion of restricted
cash........................................ 9,590,000
Included in non-current restricted cash....... 30,877,000
--------------
$ 128,277,000
--------------
--------------
</TABLE>
5. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1998
---------- -----------
<S> <C> <C>
Equipment......................................................... $23,403,000 $102,696,000
Computer software................................................. 2,263,000 9,257,000
Furniture and fixture............................................. 634,000 4,841,000
Leasehold improvements............................................ 1,503,000 2,873,000
---------- -----------
27,803,000 119,667,000
Less accumulated depreciation and amortization.................... (3,690,000) (12,418,000)
---------- -----------
Property, equipment and leasehold improvements, net............... $24,113,000 $107,249,000
---------- -----------
---------- -----------
</TABLE>
Depreciation expense for the years ended December 31, 1996, 1997 and 1998,
was $1,008,000, $2,297,000 and $8,728,000, respectively.
6. TERRITORIAL RIGHTS
In September 1994, the Company entered into a joint venture with Europhone
International Ltd. ("EI") to jointly market Destia's services in the United
Kingdom. EI engaged in sales and marketing, while Destia provided network
support, billing and transmission services.
In connection with the modification of this joint marketing arrangement,
which occurred in June 1996, EI granted the Company the right to compete with EI
in exchange for forgiveness of the net receivable due
F-13
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
6. TERRITORIAL RIGHTS (CONTINUED)
to the Company of $2,000,000. The Company charged this to operations in 1996 as
an expense of the joint venture.
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist primarily of accrued
carrier cost of $1,658,000 and $17,408,000 for 1997 and 1998, respectively.
F-14
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
8. FOREIGN OPERATIONS AND CONCENTRATIONS
FOREIGN OPERATIONS
The Company's trade accounts receivable are subject to credit risk, although
the customer base is diversified due its size and geographic dispersion. The
Company does not require collateral or other security to support its
receivables. The Company closely monitors extensions of credit and performs
ongoing evaluations of customer accounts to control the exposure to bad debt
risks. The Company's total sales, operating income (before interest, foreign
currency exchange and other income) and identifiable assets by geographical area
for the years ended and as of December 31, 1996, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
NORTH OTHER
UNITED KINGDOM AMERICA BELGIUM EUROPE CONSOLIDATED
--------------- -------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
1996
Revenues........................ $ 15,477,000 $ 18,185,000 $ 9,038,000 $ 2,403,000 $ 45,103,000
--------------- -------------- ------------- -------------- --------------
Operating loss.................. $ (2,473,000) $ (3,855,000) $ (1,472,000) $ (349,000) $ (8,149,000)
Corporate expenses.............. (163,000)
--------------
$ (8,312,000)
--------------
Accounts receivable............. $ 2,283,000 $ 3,718,000 $ 1,488,000 $ 457,000 $ 7,946,000
Property, equipment and
leasehold improvements........ 1,423,000 4,001,000 847,000 201,000 6,472,000
Corporate assets................ 8,337,000
--------------
$ 22,755,000
--------------
1997
Revenues........................ $ 18,363,000 $ 48,899,000 $ 7,981,000 $ 7,760,000 $ 83,003,000
--------------- -------------- ------------- -------------- --------------
Operating loss.................. $ (2,966,000) $ (18,213,000) $ (374,000) $ (664,000) $ (22,217,000)
Corporate expenses.............. (7,911,000)
--------------
$ (30,128,000)
--------------
Accounts receivable............. $ 5,252,000 $ 9,034,000 $ 1,250,000 $ 1,260,000 $ 16,796,000
Property, equipment and
leasehold improvements........ 6,731,000 16,515,000 463,000 405,000 24,114,000
Corporate assets................ 137,095,000
--------------
$ 178,005,000
--------------
1998
Revenues........................ $ 55,991,000 $ 116,645,000 $ 11,515,000 $ 9,586,000 $ 193,737,000
--------------- -------------- ------------- -------------- --------------
Operating income(loss).......... $ (16,474,000) $ (17,138,000) $ 905,000 $ (6,062,000) $ (38,769,000)
Corporate expenses.............. (30,175,000)
--------------
$ (68,944,000)
--------------
Accounts receivable............. $ 11,367,000 $ 19,096,000 $ 1,430,000 $ 1,458,000 $ 33,351,000
Property, equipment and
leasehold improvements........ 15,899,000 74,700,000 3,673,000 12,977,000 107,249,000
Corporate assets................ 247,608,000
--------------
$ 388,208,000
--------------
</TABLE>
The revenues of EI accounted for $14.2 million or 32% in 1996. The
relationship was terminated in December 1996.
F-15
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
9. BORROWINGS
At December 31, 1997, the Company was obligated under the following debt
agreements:
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------ -------------- --------------
<S> <C> <C> <C>
Long-term debt:
NTFC note (a).................................. $ 1,633,000 $ 5,522,000 $ 7,155,000
Notes Payable (b).............................. 196,000 135,000 331,000
1997 Notes (c)................................. -- 149,680,000 149,680,000
------------ -------------- --------------
$ 1,829,000 $ 155,337,000 $ 157,166,000
------------ -------------- --------------
------------ -------------- --------------
</TABLE>
At December 31, 1998, the Company was obligated under the following debt
agreements:
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------- -------------- --------------
<S> <C> <C> <C>
Long-term debt:
NTFC note (a)................................ $ 4,708,000 $ 16,434,000 $ 21,142,000
Notes payable (b)............................ 11,524,000 20,945,000 32,469,000
1997 Notes (c)............................... -- 150,240,000 150,240,000
1998 Notes (d)............................... -- 192,936,000 192,936,000
------------- -------------- --------------
$ 16,232,000 $ 380,555,000 $ 396,787,000
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
(a) On May 28, 1996, Destia entered into a credit facility with NTFC, which the
terms and amount of have been amended and increased, respectively, on
several occasions. On January 28, 1998, the NTFC credit facility was amended
and restated in its entirety in order to effect various amendments and
increase the amount of NTFC's commitment thereunder (such credit facility,
as amended and restated, is referred to herein as the "NTFC Facility"). The
NTFC Facility provides for borrowings by Destia and its subsidiaries to fund
certain equipment acquisition costs and related expenses. The NTFC Facility
provides for an aggregate commitment of NTFC of $24.0 million pursuant to
three tranches of $2.0 million, $3.0 million and $19.0 million. Loans
borrowed under each tranche of the NTFC Facility amortize in equal monthly
installments over a five year period ending on July 1, 2001, April 1, 2002
and January 1, 2003, respectively. Loans under the NTFC Facility accrue
interest at an interest rate equal to the 90-day commercial paper rate plus
395 basis points, subject to certain quarterly adjustments depending upon
financial performance. All of the equipment purchased with the proceeds of
the NTFC Facility has been pledged to NTFC. The NTFC Facility requires
Destia to maintain certain Debt Service Coverage Ratios, EBITDA (each
defined in the NTFC Facility) and minimum cash balances. Destia was in
compliance with these covenants at December 31, 1997. Destia obtained a
waiver of these covenants so that it was in compliance at December 31, 1998.
(b) At December 31, 1998 the Company has seven notes payable related to the
purchase of cable lines and acquisitions. These notes bear interest at rates
ranging from 5% to 12%, and have maturity dates from April 2001 to November
2008.
At December 31, 1997 the Company has six notes payable related to the
purchase of cable lines. Three of these notes bear interest at 12%, and
matures through September 1998. The remaining three notes bear interest at
LIBOR plus 5%, and mature on June 30, 2001. These notes have quarterly
principal and interest payments ranging from $5,849, to $30,291.
F-16
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
9. BORROWINGS (CONTINUED)
(c) Destia completed on July 1, 1997 the offering (the "1997 Unit Offering") of
155,000 units (each a "Unit"), each Unit consisting of one 1997 Note and one
warrant (each a "Warrant") to purchase 8.167 shares of common stock of
Destia. The Units were sold for an aggregate gross purchase price of $155.0
million. On December 5, 1997, the Company consummated an offer to exchange
the notes issued in the 1997 Unit Offering for $155.0 million of notes that
had been registered under the Securities Exchange Act of 1933.
The 1997 Notes are unsecured unsubordinated obligations of Destia, limited
to $155.0 million aggregate principal amount at maturity, and mature on July
15, 2007. Interest on the 1997 Notes accrues at the rate of 13 1/2% per
annum from the most recent interest payment date on which interest has been
paid or provided for, payable semiannually (to holders of record at the
close of business on the January 1 or July 1 immediately preceding the
interest payment date) on January 15 and July 15 of each year, commencing
January 15, 1998. At the closing of the 1997 Unit Offering, Destia used
$57.4 million of the net proceeds of the 1997 Unit Offering to purchase
restricted cash and securities, which were pledged as security for the
payment of interest on the principal of the 1997 Notes. Proceeds from the
restricted cash and securities are being used by Destia to make interest
payments on the 1997 Notes through July 15, 2000. The restricted cash and
securities are being held by a trustee pending disbursement.
(d) During February 1998, the Company issued the 1998 Notes. The 1998 Notes are
unsecured unsubordinated obligations of the Company, initially limited to
$300.0 million aggregate principal amount at maturity, and mature on
February 15, 2008. Although for Federal income tax purposes a significant
amount of original issue discount, taxable as ordinary income, was
recognized by the holders as such discount accrues from the closing date, no
interest is payable on the 1998 Notes prior to February 15, 2003. Interest
on the 1998 Notes will accrue at 11.0% from February 15, 2003 or from the
most recent Interest Payment Date to which interest has been paid or
provided for, payable semiannually (to holders of record at the close of
business on the February 1 or August 1 immediately preceding the Interest
Payment Date) on February 15 and August 15 of each year, commencing August
15, 2003.
Maturities of long-term debt (excluding the accretion of the 1998 Notes) over
the next five years are as follows:
<TABLE>
<S> <C>
1999.................................................................. $16,232,000
2000.................................................................. 14,567,000
2001.................................................................. 10,808,000
2002.................................................................. 4,837,000
2003 and thereafter................................................... 350,343,000
-----------
Total................................................................. $396,787,000
-----------
-----------
</TABLE>
10. TAXES
As a telephone carrier and reseller doing business in the U.S., the Company
is required to file annual telephone and transmission tax returns in accordance
with state tax laws. These returns include taxes on
F-17
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
10. TAXES (CONTINUED)
net worth, gross sales and gross profit. In addition, each type of tax requires
an additional tax surcharge. The Company also remits federal and state excise
taxes and other state and local sales taxes.
As of December 31, 1997 and 1998, the Company had a net operating loss
carryforward of approximately $36,000,000 and $80,000,000, respectively, which
is available to reduce its future taxable income and expires at various dates
through 2012. A full valuation allowance of approximately $14,000,000 and
$31,000,000, respectively, has been established against the deferred tax assets
due to the uncertainties surrounding the utilization of the carryforward. There
are no other significant timing differences.
A value added tax "VAT" is a tax charged on goods and services that is
designed to be borne by the ultimate end user of the goods and services.
Pursuant to the Sixth European Commission VAT Directive adopted in 1977 ("VAT
Directive"), providers of telecommunications services in the European Union (the
EU) are liable for VAT in the EU member state where the provider of the services
is established. The provider, in turn, charges VAT to its customers at the rate
prevailing in the provider's country of establishment. To date, the collection
of VAT by Destia does not appear to have a material adverse effect on its
ability to attract or retain customers and the collection of VAT has not
required Destia to reduce its prices to remain competitive.
Destia's non-U.S. subsidiaries file separate tax returns and provide for
taxes accordingly.
11. STOCKHOLDERS' EQUITY (DEFICIT)
In February 1998, the New York corporation "Econophone, Inc." (now known as
Destia Communications, Inc.) was merged into its wholly owned subsidiary named
"Econophone, Inc." (now known as Destia Communications, Inc.) which had been
incorporated in the State of Delaware for the sole purpose of changing the state
of incorporation of the Company. The Delaware corporation was the surviving
entity in the merger. In connection with the foregoing, the par value of the
Company's common stock was changed to $.01 per share of voting and non-voting
common stock.
On July 17, 1998, the Company acquired the minority interest in Telco that
it did not already own. In connection with such acquisition the Company
converted options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock. The shares carry the
same rights as the voting common stock, other than voting rights.
On November 1, 1996, the Company's Articles of Incorporation were amended to
change all of the authorized shares of common stock and non-voting common stock
from no par value per share to $.0001 par value per share, to increase the
number of shares of authorized common stock from 400 shares to 29,250,000
shares, to increase the number of authorized shares of non-voting common stock
from 19,600 shares to 500,000 shares and to authorize the issuance of 250,000
shares of preferred stock. Additionally, the Company effected a recapitalization
whereby the outstanding shares of common stock were converted on a 73,125:1
basis.
All information contained in the accompanying financial statements and
footnotes have been retroactively restated to give effect to these transactions.
Included within additional paid in capital, is $5.6 million attributable to
the Warrants, which represents the portion of the issue price for the Units
attributable to the fair value of the Warrants. Such amount has been recognized
as a discount on the 1997 Notes and will be amortized over the term of the
F-18
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
11. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
1997 Notes. Each Warrant may be exercised for 8.167 shares of common stock at an
exercise price of $.01 per share. The Warrants are exercisable for 1,265,885
shares of common stock, in the aggregate. The fair value of the shares issuable
upon exercise of the Warrants was determined to be $4.43 per share. Among the
factors considered in making such determinations were the history of the
prospects for the industry in which Destia competes, an assessment of Destia's
management, the present operations of Destia, the historical results of
operations of Destia and the trend of its revenues and earnings, the prospects
for future earnings of Destia, the general condition of the securities markets
at the time of the 1997 Unit Offering and the prices of similar securities of
generally comparable companies. The Warrants expire on June 30, 2007.
12. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
On November 1, 1996, the Company entered into a Securities Purchase
Agreement (the "Agreement") with Princes Gate Investors II, L.P., an affiliate
of Morgan Stanley & Co., Incorporated, whereby it authorized and issued 140,000
shares of $.01 par value Redeemable Convertible Preferred Stock (the "Series A
Preferred") for a purchase price of approximately $13,061,000, net of issuance
costs. The stated redemption value on the preferred stock is $14,000,000 (or
$100 per share). The Series A Preferred is senior to all other capital stock of
the Company.
The Series A Preferred accrue monthly cumulative dividends on each
outstanding share at a rate of $1.00 per month. The accrued and unpaid dividends
compound monthly at a rate of 12% per year. The dividends began to accrue and
compound interest from the issuance date of the preferred stock and ceased to
accrue on July 1, 1997, when the Senior Notes were issued.
The mandatory redemption of the Series A Preferred is October 31, 2006. The
redemption shall be in cash.
F-19
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
12. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
Each holder of the Series A Preferred shall have the right, at the option of
the holder, to convert any of its shares of Series A Preferred into a number of
fully paid and nonassessable shares of common stock. At any time, any holder of
Series A Preferred Stock may convert all or any portion thereof into common
stock of Destia. As of December 31, 1997 and 1998, the shares of Series A
Preferred Stock outstanding were convertible into 3,420,701 shares of common
stock and would convert automatically upon the Company closing an initial public
offering of common stock. The number of shares of common stock that each share
of Series A Preferred Stock is convertible into is equal to the number of shares
of common stock outstanding on November 1, 1996 (on a diluted basis), which was
22,564,000, multiplied by a fraction (i) the numerator of which is equal to the
stated value with respect to the shares of Series A Preferred Stock being so
converted, plus any dividends accrued thereon, and (ii) the denominator of which
is equal to $100.0 million plus the number of dollars received by Destia since
November 1, 1996 from the exercise of specified options or warrants.
13. RELATED PARTY TRANSACTIONS
The Company has notes payable due to various related parties. These notes
are unsecured, and accrue interest at annual rates ranging from 9% to 18%. These
notes are demand obligations.
The Company has a non-interest bearing note receivable at December 31, 1997
and 1998 for approximately $215,000 and $230,000, respectively, from a related
party.
The brother-in-law of Alfred West owns a 28% interest in Destia's Swiss
subsidiary, Econophone Services GmbH.
14. STOCK-BASED COMPENSATION PLANS
On October 31, 1996, the Board of Directors adopted the Destia
Communications, Inc. 1996 Flexible Incentive Plan (the "1996 Plan") and an
Incentive Stock Option Agreement with the then Chief Operating Officer and Chief
Financial Officer of the Company. The Company accounts for awards granted to
employees and directors under APB No. 25, under which no compensation cost has
been recognized for stock options granted. Had compensation cost for these stock
options been determined consistent with SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts:
<TABLE>
<CAPTION>
1996 1997 1998
------------- -------------- --------------
<S> <C> <C> <C>
Net Loss:
Available to Common Shareholders............ $ (8,593,000) $ (31,007,000) $ (68,944,000)
Pro Forma................................... (9,088,000) (31,798,000) (70,644,000)
Basic EPS:
As Reported................................. $ (.43) $ (1.55) $ (3.44)
Pro Forma................................... $ (.45) $ (1.59) $ (3.53)
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts since the Company anticipates additional awards in
the future.
Under the 1996 Plan, the Company granted 20,000 options to outside
consultants. All transactions with individuals other than those considered
employees, as set forth within the scope of APB No. 25, must
F-20
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
be accounted for under the provisions of SFAS No. 123. Under SFAS No. 123, the
fair value of the options granted to the consultants as of the date of grant
using the Black-Scholes pricing model is $33,019. The NQSOs (as hereinafter
defined) were granted to the consultants for terms of up to ten years and are
exercisable in whole or in part at stated times from the date of grant up to
three years from the date of grant. The 10,000 options granted to consultants
during 1996 and the 10,000 options granted to consultants during 1998 have an
exercise price of $2.50 and $5.00, respectively. As of December 31, 1997 and
1998, 3,333 and 11,667 of the options granted to the consultants were
exercisable, respectively, and the expense recognized in 1996, 1997 and 1998
relating to these options was $496, $2,976 and $9,666, respectively.
The 1996 Plan as amended authorizes the granting of awards, the exercise of
which would allow up to an aggregate of 4,600,000 shares of the Company's common
stock to be acquired by the holders of said awards. The awards can take the form
of Incentive Stock Options ("ISOs"), Non-qualified Stock Options ("NQSOs"),
Stock Appreciation Rights ("SARs"), Restricted Stock and Unrestricted Stock. The
SARs may be awarded either in tandem with options or on a stand-alone basis.
Awards may be granted to key employees, directors and consultants. ISOs and
NQSOs are granted in terms not to exceed ten years and become exercisable as set
forth when the award is granted. Options may be exercised in whole or in part.
The exercise price of the ISOs is the market price of the Company's common stock
on the date of grant. The exercise price of NQSOs shall never be less than the
par value of the Company's common stock. Any plan participant who is granted
ISOs and possesses more than 10% of the voting rights of the Company's
outstanding common stock must be granted an option price with at least 110% of
the fair market value on the date of grant and the option must be exercised
within five years from the date of grant. Under the Company's 1996 Plan, ISOs
and NQSOs have been granted to key employees and directors for terms of up to
ten years, 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, 1997 and 1998, 1,109,250 and 2,155,692 options
respectively, were exercisable under the Company's 1996 Plan.
Option activity during 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
1997 1998
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- ---------------- ---------- -----------------
Outstanding at beginning of year.................... 2,606,500 $ 2.50 2,901,445 $ 2.74
Granted............................................. 304,945 5.00 1,538,555 6.37
Cancelled........................................... (10,000) 2.50 (169,092) 3.04
Outstanding at end of year.......................... 2,901,445 2.74 4,270,908 4.00
Exercisable at end of year.......................... 1,109,250 2.50 2,155,692 2.74
Weighted average fair value of options granted...... 1.91 2.45
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997 and 1998: risk-free interest rate of 6.23%
and 5.43% for 1997 and 1998; expected life of three years for 1997 and 1998;
expected volatility of 47% for 1997 and 66% for 1998 and expected dividend yield
of zero percent for 1997 and 1998.
F-21
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
14. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following table summarizes information with respect to stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTION EXERCISABLE
---------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C>
NUMBER OUTSTANDING WEIGHTED AVERAGE NUMBER EXERCISABLE
EXERCISE AT REMAINING WEIGHTED AVERAGE AT WEIGHTED AVERAGE
PRICE DECEMBER 31, 1998 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 1998 EXERCISE PRICE
- ------------- ------------------- ------------------- ------------------- ------------------ -------------------
2$.50--$5.00.. 3,434,408 8.03 $ 3.17 2,155,692 $ 2.74
6$.75--$7.50.. 836,500 9.28 $ 7.42 -- --
</TABLE>
15. COMMITMENTS AND CONTINGENCIES
The Company has various lease agreements for offices, automobiles and other
property. Future minimum annual lease payments under the Company's operating and
capital leases with initial or remaining terms of one year or more at December
31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
------------- ----------
<S> <C> <C>
1999............................................................... $ 5,389,000 $ 154,000
2000............................................................... 4,140,000 91,000
2001............................................................... 3,529,000 67,000
2002............................................................... 2,988,000 35,000
2003 and thereafter................................................ 6,919,000 --
------------- ----------
Total minimum lease payments....................................... $ 22,965,000 $ 347,000
------------- ----------
------------- ----------
</TABLE>
The rent expense for the years ended December 31, 1996, 1997 and 1998 was
approximately $394,000, $1,378,000 and $2,824,000, respectively.
The Company has entered into employment agreements with certain officers
which expire by December 31, 1999. The aggregate commitment for future
compensation under these agreements is approximately $1,350,000. These officers
are also eligible for annual bonuses based on performance.
LONG-TERM LEASE AGREEMENT
On November 17, 1998, Destia reached an agreement with Frontier
Communications ("Frontier") to acquire a 20-year IRU to use portions of its U.S.
fiber optic network. The Company expects to begin using some of Frontier's
network by July 1999. Additionally, management expects that Frontier's fiber
optic network will be fully operational by the end of 1999. A portion of the
acquisition price was paid on November 17, 1998. The balance of the obligation
will be discharged over the next 36 months based upon the terms and conditions
of the agreement. Beginning in June 1999, Frontier shall have the right to
purchase on a monthly basis up to a cumulative average of one million dollars in
Destia services that will be offset against the remaining obligation in lieu of
additional cash payments. At the end of the 36-month period the balance
remaining will be settled with a cash payment. The acquisition price will be
amortized over 20 years and will commence at the date that the network becomes
substantially operational. The Company's total commitments are approximately
$42.3 million in the aggregate for the 20-year IRU from Frontier and for the
purchase of a transatlantic IRU.
F-22
<PAGE>
DESTIA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997 AND 1998
16. ACQUISITIONS
VOICENET ACQUISITION
A definitive agreement to acquire VoiceNet was entered into on January 28,
1998. The closing of the VoiceNet Acquisition occurred on February 12, 1998. The
initial purchase price for VoiceNet was $21.0 million and was paid out of cash
on hand. The sellers of VoiceNet also are entitled to receive an earn-out based
upon the revenue growth of the VoiceNet business for a period of up to one year
following the closing of the acquisition.
VoiceNet provides travellers and other callers with calling card services,
which are advertised primarily in in-flight magazines. Destia has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996.
TELCO MINORITY INTEREST ACQUISITION
In the United Kingdom, the majority of Destia's sales are made through Telco
Global Communications ("Telco"), its majority owned subsidiary that was
established during the fourth quarter of 1996. Telco's revenues are derived
primarily from international and domestic long distance services and the sale of
prepaid cards. On July 17, 1998, the Company acquired the 30% minority interest
in Telco it did not already own in exchange for approximately $14.0 million in
cash, payable by the Company in quarterly installments, together with interest
at a rate of 8.0% per annum, over approximately three years. The entire purchase
price is classified as goodwill, which will be amortized over 20 years. In
connection with such acquisition, (i) Telco obtained ownership rights with
respect to certain proprietary software used in Telco's business and (ii) the
Company converted options to acquire Telco shares held by Telco employees into
grants of non-voting restricted shares of the Company's common stock.
OTHER ACQUISITIONS
During November 1998, the Company completed two small acquisitions. It
acquired a controlling interest in America First Ltd. ("America First"), a
prepaid card distributor in the United Kingdom for approximately $5.5 million.
The majority of the purchase price was recorded as goodwill and will be
amortized over 20 years. The Company also acquired the customer list of a long
distance reseller, also located in the United Kingdom. The purchase price was
allocated to the customer base and will be amortized over 5 years.
17. SUBSEQUENT EVENTS (UNAUDITED)
INITIAL PUBLIC OFFERING
On February 1, 1999, the Company announced that it had filed a registration
statement with the Securities and Exchange Commission for an IPO of its common
stock, with the number of shares and price to be determined.
STOCK SPLIT
The financial statements retroactively reflect the for stock
split which occurred at the completion of the above offering.
F-23
<PAGE>
SCHEDULE II
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Charges
Balance at to costs Balance at
Beginning and end of
of period expenses Deductions(a) period
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
December 31,
1998.............................. $ 1,593,531 $ 7,392,234 $(4,899,663) $4,086,102
1997.............................. 761,372 3,890,525 (3,058,366) 1,593,531
1996.............................. 470,610 290,762 761,372
</TABLE>
- ------------------------
(a) Represents writeoffs, recoveries and other deductions.
S-1
