UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____________ to ___________
Commission File Number: 333-48371
FACILICOM INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-2065185
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1401 New York Avenue, NW
9th Floor
Washington, D.C. 20005
(202) 496-1100
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of December 1, 1998, there were 225,741 shares of common stock outstanding,
par value $.01 per share.
FACILICOM INTERNATIONAL, INC.
Form 10-K
TABLE OF CONTENTS
PART I: Page
Item 1. Business 3
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II:
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 19
Item 6. Selected Financial Data 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 27
Item 8. Financial Statements and Supplementary Data 28
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure 28
PART III:
Item 10. Directors and Executive Officers of the Registrant 28
Item 11. Executive Compensation 30
Item 12. Security Ownership of Certain Beneficial Owners and Management 34
Item 13. Certain Relationships and Related Transactions 35
PART IV.
Item 14. Exhibits, Financial Statements and Reports on Form 8-K 37
Signature 38
2
PART I
This document contains various "forward-looking statements", as defined in the
Private Securities Litigation Reform Act of 1995, that are based on management's
beliefs as well as assumptions made by and information currently available to
management. Such statements are subject to various risks and uncertainties
which could cause actual results to vary materially from those contained in such
forward-looking statements. Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, estimated, expected or projected.
Certain of these risks and uncertainties are described in the Company's
Registration Statement on Form S-4 filed under the Securities Act of 1933, as
amended, and declared effective on June 2, 1998, including the section entitled
"Risk Factors".
ITEM 1. BUSINESS
OVERVIEW
FaciliCom International, Inc. (the "Company" or "FCI") is a rapidly growing
multinational carrier focused on providing international wholesale
telecommunications services to other carriers worldwide. FCI provides these
services over a carrier-grade international network consisting of
12 international gateway switches in the United States ("U.S."), Sweden,
Denmark, Norway, Finland, the Netherlands, France, Germany and the United
Kingdom ("U.K."), as well as transmission capacity owned and leased on a fixed-
cost basis that connects its switches in the U.S. and Europe. FCI's network and
its operating and interconnection agreements with Postal, Telephone and
Telegraph Companies ("PTT") enable it to offer high quality services to its
carrier customers at competitive rates. In addition to wholesale services, as of
September 30, 1998, FCI provided domestic and international long distance
services on its network to over 43,300 retail customers in Sweden, Denmark and
Finland through FaciliCom International Sweden AB formerly Nordiska Tele8 AB
("Tele8" or "FCI-Sweden") and FaciliCom Finland AB formerly Oy Teleykkanen AB
("Tele1" or "FCI-Finland"). FCI believes that its multinational, facilities-
based approach and its established carrier status in Europe through its
subsidiary, FCI-Sweden, provide it with significant competitive advantages
including control over transmission quality and reduced termination and network
costs, as well as high quality local sales and customer service.
FCI was founded to capitalize on opportunities that have developed for
facilities-based carriers as a result of (i) the increasing demand for
international telecommunications services worldwide, (ii) the rapid pace of
deregulation of the approximately $61 billion international telecommunications
market and (iii) the erosion of the international Accounting Rate Mechanism
("ARM"). Demand for international telecommunications services is expected to
increase as a result of a number of factors, including worldwide economic
growth, global deregulation, technological advancements and the introduction of
new services. FCI believes that, as in the U.S., deregulation in Europe, Latin
America, Asia and the Pacific Rim will accelerate demand for international
telecommunications services and lead to the establishment of new carriers in
these markets. FCI believes that it is well positioned to capture international
traffic from established and emerging carriers seeking carrier-grade network
quality, competitively priced network services and flexible, responsive
technical support and customer service.
The Company's target customer base consists primarily of PTTs and other first-
tier carriers, emerging carriers and wireless carriers with international
traffic. PTTs and other first-tier carriers generally have their own
international networks, but will use carriers such as FCI for overflow traffic
and least-cost routing. Emerging carriers and wireless carriers constitute
rapidly growing industry segments that generally rely on PTTs and wholesale
carriers such as the Company to provide international connectivity. As of
September 30, 1998, the Company provided service to 139 carriers, including nine
of the ten largest U.S. carriers (based on outbound international traffic),
three wireless carriers and 27 multinational carriers that originate traffic in
more than one of the Company's existing markets.
To offer high quality international services and to control its termination
and network costs, FCI invests in fiber optic cable systems and international
gateway switches in locations and on routes where customer demand justifies such
fixed asset investments. As of September 30, 1998, FCI had implemented an
international network comprising (i) eight NorTel and four Ericsson
international gateway switches located in New York, New York; Jersey City, New
Jersey; Miami, Florida; Los Angeles, California; Malmo, Sweden; Oslo, Norway;
Helsinki, Finland; Paris, France; Frankfurt, Germany; Amsterdam, The
Netherlands; Copenhagen, Denmark and London, U.K.; (ii) owned and leased
capacity in 12 fiber optic cable systems connecting the Company's
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international gateway switches in the U.S. and Europe: CANTAT-3, CANUS-1, TAT
12/13, Kattegatt, Odin, FLAG, Hermes Network, Qwest Network, AC-1 (through
Qwest), Southern Cross, UK-Netherlands 14 and DKS-18; and (iii) Points of
Presence ("PoPs") in two U.S. and six European cities for origination and
termination of international traffic. During the fiscal year ending September
30, 1999 ("Fiscal 1999"), the Company plans to install five additional switches
in Brussels, Belgium; Milan, Italy; Madrid, Spain; Vienna, Austria and Zurich,
Switzerland. In addition, the Company plans to invest in fiber optic
transmission capacity connecting North America, Europe, Latin America, Asia and
the Pacific Rim. Furthermore, in October 1998 the Company entered into an
agreement with Tele Danmark Consult for the manufacture, supply and installation
of a submarine cable, named FCI One, between Sweden and Denmark. FCI One, a 48-
strand fiber optic submarine cable, is expected to be operational by the first
quarter of calendar year 1999. As of September 30, 1998, FCI had invested $115
million in network facilities and plans to invest an additional $100 million
during the next fiscal year.
FCI currently has operating agreements with 20 foreign carriers, 16 of which
are the PTTs in their respective countries and interconnection agreements with
nine carriers, seven of which are the PTTs in their respective countries. The
Company's operating and interconnection agreements permit it to terminate
traffic directed to correspondent carriers in these countries, provide for the
Company to receive return traffic under operating agreements and provide for the
Company to originate traffic through access codes in those countries where an
interconnection agreement is in place. The Company is currently negotiating
additional operating and interconnection agreements with carriers in Europe,
Latin America, Asia and the Pacific Rim.
INDUSTRY
Overview. The international long distance industry, which principally
consists of the transport of voice and data traffic from one country to another,
is undergoing a period of fundamental change that has resulted, and is expected
to continue to result, in significant growth in usage of international
telecommunications services. According to TeleGeography 1999, in 1997 the
international long distance telecommunications industry accounted for
approximately $66 billion in revenues and 82 billion minutes of use, up from
approximately $27 billion in revenues and 22 billion minutes of use in 1988.
According to TeleGeography 1999, it is estimated that by the year 2001 this
market will have expanded to $80 billion in revenues and 159 billion minutes of
use, representing compound annual growth rates from 1997 of 4.7% and 18.0%,
respectively.
The Company believes that growth in international long distance services is
being driven by (i) the globalization of the world's economies and the worldwide
trend toward deregulation of the telecommunications sector, (ii) declining
prices and a wider selection of products and services driven by greater
competition resulting from deregulation, (iii) increased telephone accessibility
resulting from technological advances and greater investment in
telecommunications infrastructure, including deployment of wireless networks and
(iv) increased international business and leisure travel. The Company believes
that growth of traffic originated in markets outside the U.S. will be higher
than growth in traffic originated within the U.S. due to recent deregulation in
many foreign markets and increasing access to telecommunications facilities in
emerging markets.
Deregulation has encouraged competition, which in turn has prompted carriers
to offer a wider selection of products and services at lower prices. In recent
years, prices for international long distance services have decreased
substantially and are expected to continue to decrease in most of the markets in
which the Company currently competes. Several long distance carriers in the U.S.
have introduced pricing strategies that provide for fixed, low rates for both
domestic and international calls originating in the U.S. The Company believes
that revenue losses resulting from competition-induced price decreases have been
more than offset by cost decreases, as well as an increase in telecommunications
usage. For example, based on Federal Communications Commission ("FCC") data for
the period 1989 through 1995, per minute settlement payments by U.S.-based
carriers to foreign PTTs fell 31.4%, from $0.70 per minute to $0.48 per minute.
Over this same period, however, per minute international billed revenues fell
only 13.7%, from $1.02 in 1989 to $0.88 in 1995. The Company believes that as
settlement rates and costs for leased capacity continue to decline,
international long distance will continue to provide high revenues and gross
margin per minute.
The Company believes that the market opportunity for facilities-based
international wholesale carriers will continue to be attractive due to a number
of factors, including (i) the increasing demand for international
4
telecommunications services worldwide, (ii) the rapid pace of deregulation of
the approximately $61 billion international telecommunications market and (iii)
the erosion of the international ARM.
Regulatory and Competitive Environment. Prior to deregulation, long distance
carriers were generally government-owned monopoly carriers such as British
Telecom plc in the U.K., Tele Danmark AS ("Tele Danmark") in Denmark and Telia
AB in Sweden. Deregulation of a particular telecommunications market has
typically started with the introduction of a second long distance carrier,
followed by the governmental authorization of multiple carriers. In the U.S.,
one of the first deregulated markets, deregulation began in the 1960s with MCI's
authorization to provide long distance service and was followed in 1984 by
AT&T's divestiture of the Regional Bell Operating Companies ("RBOCs") and, most
recently, by the passage of the 1996 Telecommunications Act. Deregulation has
occurred elsewhere, such as the U.K., Sweden and Denmark, and is currently being
implemented in other countries, including most EU countries, several Latin
American countries and selected Asian countries.
In addition, on February 15, 1997, the U.S. and 68 other countries signed the
World Trade Organization Basic Telecom Agreement ("WTO Agreement") and agreed to
open their telecommunications markets to competition and foreign ownership
starting January 1, 1998. These 69 countries represent approximately 90% of
worldwide telecommunications traffic. The Company believes that the WTO
Agreement will provide FCI with significant opportunities to compete in markets
where it did not previously have access, and to provide end-to-end facilities-
based services to and from these countries.
The FCC recently released an order that significantly changes U.S. regulation
of international services in order to implement the United States' "open market"
commitments under the WTO Agreement (the "Foreign Participation Order"). Among
other measures, the FCC's order (i) eliminated the FCC's Effective Competitive
Opportunities ("ECO") test for applicants affiliated with carriers in WTO member
countries, while imposing new conditions on participation by dominant foreign
carriers, (ii) allowed nondominant U.S. carriers to enter into exclusive
arrangements with nondominant foreign carriers and scaled back the prohibition
on exclusive arrangements with dominant carriers and (iii) adopted rules that
will facilitate approval of flexible alternative settlement payment
arrangements.
The Company believes that the Foreign Participation Order will have the
following effects on U.S. carriers: (i) fewer impediments to investments in U.S.
carriers by foreign entities; (ii) increased opportunities to enter into
innovative traffic arrangements with foreign carriers located in WTO member
countries; (iii) new opportunities to engage in international simple resale
("ISR") to additional foreign countries; and (iv) modified settlement rates
offered by foreign affiliates of U.S. carriers to U.S. carriers to comply with
the FCC's settlement rate benchmarks. In accordance with an order issued on
April 22, 1998 the FCC authorized ISR to a number of additional foreign
countries, specifically, France, Belgium, Denmark, Germany, Luxembourg, and
Norway.
While the Foreign Participation Order is expected to increase competition for
international telecommunications services, and reduce prices for such services,
the Company believes that the order will provide it with opportunities to enter
into innovative and potentially more advantageous traffic arrangements with
foreign carriers from WTO member countries, thereby allowing the Company to
provide an increased volume of service in a more cost effective manner.
Moreover, the Company believes that the opportunities to enter into innovative
arrangements as well as the creation of new opportunities for carriers to engage
in ISR to additional foreign countries likely will result in an increasing
amount of international traffic and, therefore, an increasing demand for
services provided by international wholesale carriers such as the Company.
International Traffic Dynamics. A long distance telephone call consists of
three parts--origination, transport and termination. Generally, a domestic long
distance call originates on a local network and is transported to the network of
a long distance carrier, which in many countries is the same as the local
carrier. The call is then carried over the long distance network to another
local exchange network where the call is terminated. An international long
distance call is similar to a domestic long distance call, but typically
involves at least two long distance carriers: the first carrier transports the
call from the country of origination, and the second carrier terminates the call
in the country of termination. These long distance telephone calls are
classified as one of three types of traffic. For example, a call made from the
U.S. to the U.K. is referred to as outbound traffic for the U.S. carrier and
inbound traffic for the U.K. carrier. The third type of traffic, international
transit traffic, originates and terminates outside a particular country, but is
transported through that country on a carrier's network. Since most major
international
5
fiber optic cable systems are connected to the U.S. and international long
distance prices are substantially lower in the U.S. than in other countries, a
large volume of international transit traffic is routed through the U.S.
International calls are transported by land-based or undersea cable or via
satellites. A carrier can obtain voice circuits on cable systems either through
ownership or leases. Ownership in cables is acquired either through Indefeasible
Right of Use ("IRU") or Minimum Assignable Ownership Units ("MAOU"). The
fundamental difference between an IRU holder and an owner of MAOUs is that the
IRU holder is not entitled to participate in management decisions relating to
the cable system. Between two countries, a carrier from each country owns a
"half-circuit" of a cable, essentially dividing the ownership of the cable into
two equal components. Additionally, any carrier may generally lease circuits on
a cable from another carrier. Unless a carrier owns a satellite, capacity also
must be leased from one of several existing satellite systems.
Accounting Rate Mechanism. Under the ARM, which has been the traditional
model for handling traffic between international carriers, traffic is exchanged
under bilateral carrier agreements, or operating agreements, between carriers in
two countries. Operating agreements generally are three to five years in length
and provide for the termination of traffic in, and return of traffic to, the
carriers' respective countries at a negotiated accounting rate, known as the
Total Accounting Rate ("TAR"). In addition, operating agreements provide for
network coordination and accounting and settlement procedures between the
carriers. Both carriers are responsible for costs and expenses related to
operating their respective halves of the end-to-end international connection.
Settlement costs, which typically equal one-half of the TAR, are the fees owed
to another international carrier for transporting traffic on its facilities.
Settlement costs are reciprocal between each party to an operating agreement at
a negotiated rate (which must be the same for all U.S.-based carriers, unless
the FCC approves an exception). For example, if a foreign carrier charges a U.S.
carrier $0.30 per minute to terminate a call in the foreign country, the U.S.
carrier would charge the foreign carrier the same $0.30 per minute to terminate
a call in the U.S. Additionally, the TAR is the same for all carriers
transporting traffic into a particular country, but varies from country to
country. The term "settlement costs" arises because carriers essentially pay
each other on a net basis determined by the difference between inbound and
outbound traffic between them. The following chart illustrates an international
long distance call originating in the U.S. using the ARM:
[GRAPH APPEARS HERE]
Operating agreements typically provide that a carrier will return terminating
traffic ("return traffic") to a carrier in proportion to the traffic it receives
from that carrier. Return traffic generally is more profitable than outgoing
traffic because the settlement rate per minute is substantially greater than the
incremental cost of terminating a call in the country due to the lack of
marketing expense and billing costs, as well as the lower cost structure
associated with terminating calls within the country. Generally, there is a six-
month lag between outbound traffic and the allocation of the corresponding
return traffic and, in certain instances, a minimum volume commitment must be
achieved before qualifying for receipt of return traffic.
Alternative Calling Procedures. As the international long distance market is
being deregulated, long distance companies have devised alternative calling
procedures ("ACPs") in order to complete calls more economically than under the
ARM. Some of the more significant ACPs include (i) transit, (ii) refiling or
"hubbing" and (iii) ISR. The most common method is transit, which allows traffic
between two countries to be carried through a third country on another carrier's
network. This procedure, which requires agreement among the particular long
distance companies
6
and the countries involved, generally is used either for overflow traffic during
peak periods or where the direct circuit may not be available or justified based
on traffic volume. Refiling or "hubbing" of traffic, which takes advantage of
disparities in settlement rates between different countries, allows traffic to a
potential country to be treated as if it originated in another country that
enjoys lower settlement rates with the destination country, thereby resulting in
lower overall costs on an end-to-end basis. U.S.-based carriers generally are
beneficiaries of refiling on behalf of other carriers because of low
international rates in the U.S. The difference between transit and refiling is
that, with respect to transit, the carrier in the destination country has a
direct relationship with the originating carrier, while with refiling, the
carrier in the destination country is likely not to even know the identity of
the originating carrier. The choice between transit and refiling is determined
primarily by cost. With ISR, a carrier may completely bypass the settlement
system by connecting an international leased line to the Public Switched
Telephone Network ("PSTN") of a foreign country or directly to customers'
premises, which may be expected to result in reduced costs for such carrier. It
may be anticipated that routes where ISR is permitted will benefit from
increased competition, reduced prices, and increased demand. As discussed above,
it is anticipated that the Foreign Participation Order will create new
opportunities for carriers to engage in ISR to additional foreign countries. As
noted above, the FCC has recently authorized ISR to additional foreign
countries, specifically, France, Belgium, Denmark, Germany, Luxembourg, and
Norway.
Description of Operating Markets. As of September 30, 1998, FCI terminated
traffic through a combination of operating and interconnection agreements,
refiling, resale and ISR to over 200 countries worldwide and originated traffic
in the U.S., Sweden, Denmark, Norway, Finland, the Netherlands, the U.K., France
and Germany. The Company intends to establish facilities that will permit it to
originate traffic in five additional markets (Belgium, Switzerland, Italy, Spain
and Austria) by the end of Fiscal 1999.
United States. With a population of approximately 268 million people, the
U.S. has a telecommunications services market that generated revenues of
approximately $231.2 billion in 1997 according to the FCC. The U.S. long
distance market is highly deregulated and is the largest in the world. According
to the FCC, in 1997 long distance telephone revenues were approximately $100.8
billion, including approximately $17.7 billion from international services
(representing 17.5% of the total market). According to TeleGeography 1999, AT&T
is the largest international long distance carrier in the U.S. market, with
market share of approximately 45.3% of international outgoing minutes in 1997,
while MCI, Sprint and WorldCom had market shares of 26.0%, 12.2% and 3.3%,
respectively. AT&T, MCI WorldCom and Sprint constitute what generally is
regarded as the first-tier in the U.S. long distance market. Other large long
distance companies with more limited ownership of transmission capacity, such as
Frontier and Qwest, constitute the second-tier of the industry. The remainder of
the U.S. long distance market is comprised of several hundred smaller companies,
largely resellers, which are known as third-tier carriers.
Sweden. With a population of approximately nine million people, Sweden has a
telecommunications market that generated approximately $6.0 billion in revenues
in 1996 according to the International Telecommunications Union (the "ITU").
Sweden has fully liberalized its telecommunications market. Telia AB, the
Swedish PTT and Tele-2 AB accounted for approximately 66.0% and 22.0%,
respectively, of the market for international outgoing minutes in 1997 according
to TeleGeography 1999. Telia AB is a member of the Unisource consortium and is
also authorized to provide facilities-based end-to-end services between the U.S.
and Sweden.
Denmark. With a population of approximately five million people, Denmark has
a telecommunications market that generated approximately $3.6 billion in
revenues in 1996 according to the ITU. The Danish Parliament recently approved
legislation to liberalize its telecommunications industry. The new law allows
carriers to provide public voice services and to build and lease networks. Most
services, including voice telephony, may be provided under a general class
license. The international telecommunications market in Denmark has been
historically dominated by the PTT, Tele Danmark, which, according to
TeleGeography 1999, accounted for approximately 82.0% of the international
market in 1997.
United Kingdom. With a population of over 58 million people, the U.K. has a
telecommunications market that generated approximately $25.4 billion in revenues
in 1995 according to the ITU. According to Oftel, the U.K.'s international and
domestic long distance services market accounted for approximately $6.6 billion
in revenues in the 12 months ended March 31, 1997. In addition to British
Telecom plc and Mercury Communications Ltd. there are
7
over 50 companies in the U.K. that presently hold licenses authorizing the
operation of systems which may be connected to foreign systems.
Finland. With a population of approximately five million people, Finland's
telecommunications services market generated approximately $3.1 billion in
revenues in 1997 according to the Telecommunications Administration Center,
Finland's telecommunications regulator. Finland has fully liberalized the
provision of voice telephony services, and has recently eliminated its licensing
requirements for the construction of fixed telecommunications networks.
According to TeleGeography 1999, in 1997 the Finish PTT, Sonnera Ltd (formerly
Telecom Finland), accounted for approximately 58.9% of the international
outgoing minutes, while Finnet Group and Telia accounted for 28.2% and 9.3%,
respectively.
Norway. With a population of approximately 4.4 million people, Norway's
telecommunications services market generated approximately 481 million minutes
of international telecommunications outbound traffic in 1997, according to
TeleGeography 1999. The Norwegian telecommunications market for data
transmission, voice telephony, paging and other mobile services and satellite
communications has been fully liberalized since January 1, 1998. Until the
liberalization in 1998, the Norwegian PTT, Telenor AS, accounted for 100% of the
outgoing international minutes.
France. With a population of approximately 58 million people, France's
telecommunications services market will generate approximately $28.5 billion in
revenues in 1998 from public voice telephony, network (switched data and leased
lines) and mobile telephony services, according to the European Commission. As
of January 1998, all telecommunications services were open to competition in
France, including the provision of public voice telephony. Cable and Wireless,
Esprit Telecom, RSL Com, IBM, Infonet, Equant (SITA), Teleglobe SAS, and
alliances such as Global One, Concert, AT&T, Unisource and World Partner have
recently entered the French market to compete with the French PTT, France
Telecom.
The Netherlands. With a population of approximately 15.6 million people, the
Dutch telecommunications services market will generate approximately $9.0
billion in revenues in 1998 from public voice telephony, network and mobile
telephony services, according to the European Commission. The Dutch
telecommunications infrastructure, public switched voice telephony and telex
markets were liberalized on July 1, 1997. The Netherlands may amend its
telecommunications regulatory system with the enactment of a new
Telecommunications Act prior to the end of 1998. The Dutch PTT, KPN, accounted
for approximately 97% of the market for outgoing international minutes in 1997,
according to TeleGeography 1999.
Germany. With a population of over 81 million people, the German
telecommunications market is the third largest in the world with an estimated
$41.5 billion in revenues in 1998 according to the European Commission. Germany
is Europe's most lucrative telecommunications market, accounting for 25% of the
total market. Pursuant to the Telecommunications Act of 1996, all
telecommunications services, both national and international, including public
voice telephony, are open to competition in Germany as of January 1, 1998.
Until January 1998, the German PTT, Deutsche Telekom A.G., operated the German
telephony market under a monopolistic regime. New competitors such as Mannesman
Arcor AG Co., O.tel.o Communications GmbH & Co. and VIAG Interkom GmbH & Co.,
have just recently entered the market.
Other Markets. As liberalization occurs in other European countries and in
Asia and the Pacific Rim, the Company intends to establish operating facilities
and/or obtain licenses to provide telecommunications services as market
conditions permit. The combined population of other European markets in which
the Company intends to install facilities during Fiscal 1999, including Austria,
Belgium, Italy, Spain and Switzerland, is approximately 122 million people with
combined international telecommunications traffic, according to TeleGeography
1999, of 8.0 billion minutes, which represented 9.8% of worldwide international
traffic in 1997. The combined population of Australia, Japan and New Zealand,
other countries in which the Company intends to install facilities in the
future, is approximately 148 million people and, according to TeleGeography
1999, the combined international telecommunications traffic generated in those
markets in 1997 was approximately 3.7 billion minutes.
STRATEGY
FCI's objective is to become a leading provider of high quality, competitively
priced, dedicated and switched wholesale international telecommunications
services to established and emerging carriers worldwide. To achieve
8
this objective, the Company intends to continue to expand its carrier-grade
international network and to offer competitively priced network services
comparable in quality to that of major PTTs and first-tier carriers while
providing highly responsive technical support and customer service. The key
elements of the Company's strategy are as follows:
. Increase multinational presence. FCI seeks to expand its operations by
cultivating relationships with PTTs in strategic locations worldwide and
establishing operations in markets with significant international traffic
as soon as deregulation enables facilities-based carriers to enter such
markets. The Company believes that its ability to originate traffic from
multiple markets will allow it to benefit from the relatively high growth
of non-U.S. originated traffic, to serve multinational carriers and to
increase the use of its facilities. As part of its business strategy, the
Company may enter into strategic alliances with, acquire assets or
businesses from, or invest in, companies that are complementary to its
current operations. The Company has a dedicated Business Development Group,
which focuses on developing relationships with correspondent carriers, and
which facilitates new market entry.
. Expand carrier-grade international infrastructure. FCI intends to expand
its carrier-grade international network. The Company uses switches similar
to those used by first-tier carriers and PTTs, and continues to implement
advanced features, such as asynchronous transfer mode ("ATM") technology,
which will permit the Company to transmit voice and data services over a
single platform. The Company believes that increasing the percentage of
minutes of traffic it carries on-net will enable it to increase margins and
profitability and ensure quality of service. By the end of Fiscal 1999, the
Company expects to have such on-net capability on 23 of the top 50
international traffic routes.
. Focus on wholesale market. FCI's customer base consists primarily of
established and emerging competitive carriers and PTTs that purchase the
Company's services on a wholesale basis. The Company believes that the
wholesale telecommunications market will offer significant growth
opportunities as traditional international traffic settlement mechanisms
are replaced by competitive cost-based systems. In addition, liberalization
of telecommunications markets worldwide is expected to lead to the
establishment of new carriers and resellers that require high quality
international connectivity at competitive rates. FCI believes that its
wholesale strategy enables it to generate the high traffic volumes required
to justify investments in network infrastructure, while controlling
selling, general and administrative expenses.
. Maintain efficient operations and low cost base. The Company seeks to
maintain efficient operations and a low cost base through a disciplined
incremental approach to investments in fixed assets, strict control over
selling, general and administrative expenses and the operation of a
centralized, highly efficient network control center for its global
network, which enable the Company to be price competitive.
NETWORK
General. The Company has successfully installed an international facilities-
based network comprised of international gateway switches, related peripheral
equipment and fiber optic cable systems, as well as leased satellite and cable
capacity. FCI believes its installation of a facilities-based network will
permit it to terminate an increasing percentage of traffic on-net, allowing the
Company to control both the quality and cost of telecommunications services it
provides to its customers. To provide high quality telecommunications services,
the Company's network employs digital switching and fiber optic technologies,
uses CCITT7 and SS7 signaling and is supported by comprehensive monitoring and
technical services. In addition, the Company is continuing to implement an ATM
network that will permit the Company to transmit voice and data services over a
single platform, enabling the Company to diversify its service offerings.
The Company currently operates four major gateway switches in the U.S. and
similar switches in Sweden, Denmark, Norway, Finland, the Netherlands, France,
Germany and the U.K. These international gateway switches are connected by fiber
optic cable systems. The Company operates two additional PoPs in the U.S. and
six additional PoPs in Europe which allow it to originate and terminate traffic
outside of the international gateway cities. The Company also operates an earth
station in Sweden which provides satellite coverage of all of Africa and most of
Asia through INTELSAT, to which the Company is a signatory. Using a combination
of owned network
9
facilities, capacity leased on a fixed-cost basis and the resale of third party
capacity, the Company is able to provide service to any country in the world.
The Company carries international traffic traditionally carried between U.S.
and foreign international long distance carriers over its own network. In
addition, FCI's international gateway switches and European hubs allow the
Company to terminate traffic within countries, thereby ensuring quality and
lowering termination costs. The following chart illustrates a typical on-net
international long distance call originating in the U.S.
[GRAPH APPEARS HERE]
Operating and Interconnection Agreements. The Company's strategy is
substantially based on its ability to enter into: (i) operating agreements with
PTTs in countries that have yet to become deregulated so the Company can
terminate traffic in, and receive return traffic from, that country; (ii)
operating agreements with PTTs and emerging carriers in foreign countries whose
telecommunications markets have deregulated so it can terminate traffic in such
countries; and (iii) interconnection agreements with the PTT in each of the
countries where the Company has operating facilities (e.g., the U.K.) so it can
originate and terminate traffic in that country. The Company believes that FCI-
Sweden's status as an established carrier in Sweden has been a significant
factor in enabling the Company to enter into operating agreements with first-
tier carriers in Europe. As of September 30, 1998, FCI had operating agreements
with 16 PTTs and four alternative carriers. The Company believes that it has
more operating agreements with European PTTs than most other emerging carriers.
These operating agreements allow the Company to terminate traffic at lower rates
than by resale in markets where it cannot establish an on-net connection due to
the current regulatory environment. As of September 30, 1998, FCI had
interconnection agreements with seven PTTs and two alternative carriers. The
Company believes that it would not be able to serve its customers at competitive
prices without such operating or interconnection agreements.
Fiber Optic Cable Systems. The Company seeks ownership positions in fiber
optic cable systems where it believes its customers' demand will justify the
investment in those fixed assets. To link its switches in the U.S. and in
Europe, the Company currently either owns or leases capacity on a number of
fiber optic cable systems, including purchased capacity on the CANTAT-3, CANUS-
1, TAT 12/13, Kattegatt, FLAG, UK-Netherlands 14, AC-1 (through Qwest), Qwest
Network, Hermes Network, Southern Cross, DKS-18 and Odin fiber optic cable
systems. The Company believes that its current and projected volume of wholesale
international traffic makes its investment in these fiber optic cable systems
cost-effective. FCI-Sweden participated in a consortium that included Tele
Danmark, TeleNordia and Swedish Rail, which constructed and currently operates a
fiber cable (DKS-18) between Sweden and Denmark. Furthermore, in October 1998
the Company entered into an agreement with Tele Danmark Consult for the
manufacture, supply and installation of a submarine cable, named FCI One,
between Sweden and Denmark. FCI One, a 48-strand fiber optic submarine cable,
is expected to be operational by the first quarter of calendar year 1999.
In addition, the Company is one of the signatory members of the Fiber-optic
Link Around the Globe ("FLAG") project, which, when completed, will be the
world's longest undersea fiber optic cable, originating in the U.K. and
terminating in Japan. FLAG will enable the Company to (i) target markets in
Bangladesh, China, Hong Kong, India, Italy, Japan, Malaysia, Pakistan, Singapore
and Spain and (ii) provide high quality seamless services over Company-owned
fiber optic cable to those regions by connecting to the Company's facilities in
Europe. The Company's ability to provide seamless telecommunications services to
the countries served by FLAG is contingent upon its ability to enter into
operating agreements with PTTs or other carriers in such countries. The Company
plans to invest in and acquire additional capacity in Europe, Latin America,
Asia and the Pacific Rim, and to expand capacity to
10
existing markets. The Company may also seek ownership positions in digital
microwave systems that link major sources and destinations of international
traffic to (i) lower the cost of its international connections to a particular
country or region and/or (ii) bypass a transmission facility "bottleneck" that
constrains the Company's ability to enter the international market in that
country or region.
The Company believes that no single MAOU or IRU agreement is material to the
Company's financial condition or its historical or intended business operations.
With the passage of time, an increasing amount of fiber optic cable capacity is
becoming available and the terms and pricing of such capacity have become
effectively commoditized. Accordingly, the Company believes that, if one or more
such agreements were to terminate, the Company would be able to replace, at
similar costs and within reasonable time periods, similar capacity on competing
fiber optic cable systems through MAOU purchases and/or IRU lease agreements.
Further, the Company believes that the current rights and obligations of the
Company as a MAOU owner would be unchanged if the Company were to acquire
capacity on a competing fiber optic cable system.
International Gateway and Domestic Switches. As of September 30, 1998, the
Company operated eight NorTel DMS 250/300 international gateway switches located
in Jersey City, New Jersey, Miami, Florida, Los Angeles, California, Paris,
France, Frankfurt, Germany, Copenhagen, Denmark, Amsterdam, The Netherlands and
London, U.K., and three Ericsson AXE-10 international gateway switches
located in New York, New York, Helsinki, Finland and Malmo, Sweden. The Company
also operates smaller Ericsson switches in Sweden and Norway for aggregating
regional and domestic traffic and is considering the installation of similar
switches in other European countries for the same purpose. In addition, the
Company has PoPs to terminate and originate traffic in Tampa, Florida and
Washington, D.C. in the U.S and Stockholm and Gothenburg in Sweden and Hamburg,
Dusseldorf, Stuttgart and Cologne in Germany.
The Company's plans for expanding its switching network in Europe include the
addition of switches in Belgium, Italy, Spain, Austria and Switzerland during
Fiscal 1999. FCI is also considering installing switches in Latin American,
Asian and other Pacific Rim countries, as well as additional European locations.
Backbone Transmission Network. The Company connects its switches over a
frame relay backbone network, which the Company began to upgrade to ATM during
1998. ATM, which will be completed during Fiscal 1999, will enable the Company
to combine switched voice, private line and data traffic on the same
international circuits. For example, the Company will be able to add Internet
capability and integrate Internet traffic with its existing traffic.
Satellite Facilities. The Company owns and operates the Swedish
International Teleport, an INTELSAT, Standard B, 13-meter earth station in
Malmo, Sweden that connects to an INTELSAT satellite over the Indian Ocean.
Through its signatory status, the Company can acquire satellite transmission
capacity on a preferential basis worldwide. The earth station and INTELSAT
satellite, which provide coverage to Africa and most of Asia, currently connect
customers on the Indian subcontinent with locations in Europe and North America
on a private line basis. The Company uses this facility to provide connectivity
with carriers in developing countries before international cable capacity
becomes available in such countries and on low-volume international routes. The
Company is negotiating agreements with several Asian carriers to interconnect
with Sweden for the transmission of public switched-voice traffic through the
Company's earth station.
Network Monitoring and Technical Support. The Company's resilient network
has diverse switching and routing capabilities. For example, on the high volume
North America to Europe routes the Company splits customer traffic between its
U.S. based international gateway switches, over three transatlantic cable routes
and over its European based international gateway switches. All gateway switches
have backup power systems, and each cable has built-in redundancies that reroute
traffic in the event of an interruption in cable service.
The Company has technical staff located in the U.S. and Europe which provide
support for the network. The Company's technical staff located in Europe
provides network management and operations support for the Company's Ericsson
switches. The Company is migrating away from an agreement with Northern Telecom
to provide network management and operations services for the Company's NorTel
switches. In its place, the Company is implementing GTE/TCSI's Worldwin
Operational Support System. This modular system architecture provides the
Company with an integrated proactive network operations, network message
management and customer contact system. Upon completion of the implementation
by March 31, 1999, the Company will fully
11
support all network management and operations functions 24 hours a day, 7 days a
week from a central location in Washington, D.C.
SERVICES
FCI offers high quality international telecommunications services over its own
international network and by interconnecting its network with the networks of
other carriers. The Company provides primarily wholesale international
telecommunications services and, to a limited extent, retail domestic and
international long distance services in Sweden, Denmark and Finland. For the
fiscal years ended September 30, 1998 and 1997, wholesale services represented
approximately 92.5% and 94.6%, respectively, of the Company's consolidated
revenues and retail services represented approximately 7.5% and 5.4%,
respectively, of such consolidated revenues.
Wholesale Services. The Company provides wholesale international long
distance voice services to carrier customers located in the U.S., Sweden,
Denmark, Norway, Finland, France, Germany, the Netherlands and the U.K. FCI
provides wholesale termination to over 200 countries using a mix of owned
facilities, operating and interconnection agreements and resale agreements. The
Company terminates international network traffic to the U.S. and eight
international business units over its own network, and traffic to 18 countries
using operating agreements. In addition to wholesale voice services, the Company
also intends to offer value-added, back office and billing services to its
wholesale customers in Europe. The Company believes that offering additional
services on a wholesale basis will increase customer loyalty and lead to higher
margins. Wholesale value-added services are expected to include international
toll-free numbers, pre-paid calling cards, data services and network access
through European carrier access codes.
Retail Services. FCI provides international and domestic long distance voice
services to retail customers within Sweden, Denmark and Finland using carrier
access codes and service through pre-paid calling cards. The Company plans to
provide pre-selected long distance services in Sweden, Denmark and Finland, as
soon as regulations prescribe equal access. In addition, FCI provides
international private line service to business customers, and intends to offer
international toll-free services and data services to business customers.
CUSTOMERS
The Company's wholesale marketing strategy is to offer wholesale international
telecommunications services to the broadest range of carriers, focusing on
carriers that originate traffic in multiple locations. The Company's wholesale
customers include first-tier carriers and PTTs as well as emerging facilities-
based, switched-based, switchless and wireless carriers that purchase the
Company's services for resale to their own customers. As of September 30, 1998,
the Company provided service to 139 carriers, including nine of the ten largest
U.S. carriers based on outbound international traffic, three European wireless
carriers and 27 multinational carriers that originate traffic in more than one
of the Company's existing markets. For the fiscal year ended September 30, 1998,
the Company's ten largest customers accounted for 34.4% of the Company's
revenues. For the fiscal year ended September 30, 1998, no one single customer
accounted for more than 10% of the Company's total revenues. The Company
anticipates that the percentage of revenues attributable to its largest
customers will decrease as its customer base grows. The Company's agreements
with its customers do not currently establish minimum term or usage
requirements.
The Company uses a comprehensive credit screening process when identifying new
customers, which the Company believes has resulted in a bad debt expense ratio
below the industry average. For the fiscal years ended September 30, 1998 and
1997, FCI's bad debt expenses represented approximately 2.0% and 1.8%,
respectively, of its consolidated revenues. The Company rates its potential
customers' creditworthiness based on several factors, including: (i) traditional
bank and trade (e.g., Dun & Bradstreet) reports; (ii) internal assessments of
the Company's exposure based on the costs of terminating international traffic
in certain countries and the capacity requested by the proposed carrier; and
(iii) references provided by the potential customer. Depending on the results of
the Company's credit analysis, a customer's payment terms and/or billing cycle
may be adjusted to shorten the length of time the Company's receivables are
outstanding (and the corresponding risk to the Company). In addition, the
Company may require a customer to post collateral in the form of a security
deposit or an irrevocable letter of credit.
12
The Company's target market for retail services in Sweden, Denmark and Finland
is primarily small- and medium-size businesses, residential customers, travelers
and marketing organizations.
SALES AND MARKETING
FCI's approach to marketing and selling wholesale services consists of local
sales staff, who are responsible for day-to-day relationships with local carrier
representatives and who have experience in the industry and long standing
relationships with such carriers. In addition to local direct sales, the Company
has a multinational Global Account Group, which coordinates sales to major
international accounts in multiple locations and is responsible for client
relationships at the senior management level. The Company has several
international carrier customers which use FCI to transport traffic from multiple
locations. FCI focuses on hiring and retaining experienced marketing and sales
people with extensive knowledge of the industry and who have existing
relationships with decision makers at carrier customers. FCI conducts retail
sales and marketing in Sweden, Denmark and Finland through agents and a direct
sales force.
MANAGEMENT INFORMATION SYSTEMS
The need to bill customers timely and accurately, and to monitor and manage
network traffic profitability, requires the accurate operation of management
information systems ("MIS"). To accommodate these needs, the Company currently
contracts with Armstrong Holdings, Inc. ("Armstrong" or "AHI"), for its billing
and MIS services. Armstrong, through its subsidiary Armstrong International
Telecommunications, Inc. ("AIT"), owns 84.0% of the outstanding stock of the
Company.
Armstrong provides billing, financial accounting and specialized information
technology ("IT") services to its subsidiary companies, including the Company,
from its data processing center headquartered in Butler, Pennsylvania.
Armstrong's subsidiaries include domestic local exchange telephone companies and
cable television companies. Based on its knowledge of billing in the
telecommunications industry, Armstrong has developed customized systems to
provide call collection, processing, rating, reporting and bill rendering for
the Company. These customized systems enable the Company to (i) analyze
accurately its traffic, revenues and margins by customer and by route on a daily
basis, (ii) validate carrier settlements and (iii) monitor least cost routing of
customer traffic.
The Company believes that contracting with Armstrong for these customized
systems gives the Company a strategic advantage over many emerging carriers
because the Company receives timely and accurate reporting of its customer
traffic, revenues and margins without incurring the significant costs associated
with developing and maintaining its own data center. The Armstrong data center
utilizes an IBM AS/400 with full disaster recovery and back-up facilities and
provides 24 hours per day, seven days per week data center support. Armstrong
provides the Company with experienced IT professionals and programmers to
further customize and support the Company's growing and changing MIS needs. To
date, the Company has not experienced any significant delays in billing
customers. The Company attempts to bill its customers within five business days
after a billing cycle has been completed. The Company believes that its
arrangement with Armstrong enables it to effectively and efficiently manage the
Company's growing IT requirements.
Pursuant to a contract it signed with the Company, Armstrong will provide
billing and MIS support for the Company and its subsidiaries on terms that the
Company believes are competitive with similar services offered in the industry.
This contract extends through September 30, 2002.
In consultation with Armstrong's IT staff, the Company is currently
implementing an advanced billing and MIS software solutions to provide billing
for enhanced products and services and to further enhance the Company's ability
to monitor its growing operations.
COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change precipitated by advances in technology and regulation.
The Company's competitors in the international wholesale switched long distance
market include large facilities-based multinational carriers and PTTs, smaller
facilities-based wholesale
13
long distance service providers in the U.S. and overseas that have emerged as a
result of deregulation, switched-based resellers of international long distance
services and international joint ventures and global alliances among many of the
world's largest telecommunications carriers. International telecommunications
providers such as the Company compete on the basis of price, customer service,
transmission quality, breadth of service offerings and value-added services, and
the Company's carrier customers are especially price sensitive.
Within the U.S.-based international telecommunications services market, the
Company competes with AT&T, MCI WorldCom and Sprint, and to a lesser extent,
with other emerging international carriers. Many of these providers have
considerably greater financial and other resources and more extensive domestic
and international communications networks than the Company. The Company
anticipates that it will encounter additional competition as a result of the
formation of global alliances among large long distance telecommunications
providers. Recent examples of such alliances include AT&T's alliance with
Unisource, known as "Uniworld" (scheduled to terminate in mid 2000); AT&T's
recent alliance with Italy's STET/Telecom Italia to serve international
customers with a primary focus on the Latin American and European regions;
AT&T's recently announced alliance with British Telecom plc; Sprint's alliance
with Deutsche Telekom and France Telecom, known as "Global One" and Qwest's
alliance with KPN NV. Consolidation in the telecommunications industry may
create even larger competitors with greater financial and other resources. The
effect of the proposed mergers and alliances could create increased competition
in the telecommunications services market and potentially reduce the number of
customers that purchase wholesale international long distance services from the
Company. Because many of the Company's current competitors are also the
Company's customers, the Company's business would be materially adversely
affected to the extent that a significant number of such customers limit or
cease doing business with the Company for competitive or other reasons.
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of new product and service offerings and
increasing satellite and undersea cable transmission capacity for services
similar to those provided by the Company. Such technologies include satellite-
based systems, such as those proposed by Iridium LLC and Globalstar, L.P.,
utilization of the Internet for international voice and data communications and
digital wireless communication systems such as PCS. The Company is unable to
predict which of many possible future product and service offerings will be
important to maintain its competitive position or what expenditures will be
required to develop and provide such products and services.
The 1996 Telecommunications Act permits, and is designed to promote,
additional competition in the intrastate, interstate and international
telecommunications markets by both U.S.-based and foreign companies, including
the RBOCs. RBOCs, as well as other existing or potential competitors of the
Company, have significantly more resources than the Company. The Company also
expects that competition from carriers will increase in the future as
deregulation increases in telecommunications markets worldwide. In addition, the
Company believes that the FCC's order implementing the United States' "open
market" commitments under the WTO Agreement will make it easier for certain
foreign carriers to enter the U.S. market, thereby increasing competition in the
U.S. market for the Company. As a result of these and other factors, there can
be no assurance that the Company will continue to compete favorably in the
future.
The Company believes that it competes favorably on the basis of price,
transmission quality and customer service. The number of the Company's
competitors is likely to increase as a result of the new competitive
opportunities created by the WTO Agreement. FCI believes, however, that its
focus on providing wholesale international services will enable it to benefit
from the emergence of new carriers because FCI will be able to provide them with
switched international telecommunications services. FCI believes that FCI-
Sweden, its Swedish subsidiary, provides the Company with a competitive
advantage because of FCI-Sweden's existing relationships with European PTTs.
FCI-Sweden's relationships with other PTTs allow the Company to accelerate its
in-country presence in certain markets, to obtain administrative leases in
Europe and to negotiate operating agreements.
LICENSES AND REGULATION
United States. In the U.S., provision of the Company's services is subject
to the provisions of the 1934 Communications Act, as amended by the 1996
Telecommunications Act, and the FCC regulations thereunder, as well as the
applicable laws and regulations of the various states administered by the
relevant state public service commission ("PSC"). The FCC and relevant state
PSCs continue to regulate ownership of transmission facilities,
14
provision of services and the terms and conditions under which the Company's
services are provided. Non-dominant carriers, such as the Company, are required
by federal and state law and regulations to file tariffs listing the rates,
terms and conditions of the services they provide. The FCC and certain state
agencies also impose prior approval requirements on transfers of control. With
regard to international services, the FCC administers a variety of international
service regulations, including the ISP. The ISP governs the permissible
arrangements between U.S. carriers and their foreign correspondents to settle
the cost of terminating traffic over each other's networks, the rates for such
settlement and permissible deviations from these policies. As a consequence of
the increasingly competitive global telecommunications market, the FCC has
adopted a number of policies that permit carriers to deviate from the ISP under
certain circumstances if such deviation would promote competition. The FCC also
requires carriers such as the Company to report any affiliations, as defined by
the FCC, with foreign carriers.
Regulatory requirements pertinent to the Company's operations will continue to
evolve as a result of the WTO Agreement, federal legislation, court decisions,
and new and revised policies of the FCC and state PSCs. The FCC continues to
refine its international service rules to promote competition, reflect and
encourage liberalization in foreign countries and reduce international
accounting rates toward cost. The FCC adopted new lower accounting rate
"benchmarks" that became effective January 1, 1998. Under the FCC's new
benchmarks, after a transition period of one to four years depending on a
country's income level, U.S. carriers will be required to pay foreign carriers
significantly lower rates for the termination of international services.
International Service Regulation. International common carriers, such as the
Company, are required to obtain authority under Section 214 of the
Communications Act and file a tariff containing the rates, terms and conditions
applicable to their services prior to initiating their international
telecommunications services. The Company has obtained "global" Section 214
authority from the FCC to use, on a facilities and resale basis, various
transmission media for the provision of international switched and private line
services. Non-dominant international carriers, such as the Company, must file
their international tariffs and any revisions thereto with one day's notice. The
Company has filed international tariffs for switched and private line services
with the FCC. Additionally, international telecommunications service providers
are required to file copies of their contracts with other carriers, including
foreign carrier agreements, with the FCC within 30 days of execution. The
Company has filed each of its foreign carrier agreements with the FCC. The FCC's
rules also require that the Company periodically file a variety of reports
regarding the volume of its international traffic and revenues and use of
international facilities. In addition to the general common carrier principles,
the Company is also required to conduct its facilities-based international
business in compliance with the FCC's ISP, or an FCC-approved alternative
accounting rate arrangement. In addition, the FCC has decided to allow U.S.
carriers, subject to certain competitive safeguards, to propose methods to pay
for international call termination that deviate from traditional bilateral
accounting rates and the ISP.
The Company's FCC authorization also permits the Company to resell
international private lines interconnected to the PSTNs for the provision of
switched services between the United States and (i) those countries that have
been found by the FCC to offer "equivalent opportunities" to U.S. carriers and
(ii) any WTO member country if settlement rate for at least 50% of the settled
U.S.-billed traffic on the route in question is at or below the settlement rate
benchmark. To date, the FCC has found that appropriately licensed U.S. carriers
may provide such services to the following markets: Australia, Austria, Belgium,
Canada, Denmark, France, Germany, Hong Kong (data and facsimile services only),
Italy, Japan, Luxembourg, The Netherlands, New Zealand, Norway, Sweden,
Switzerland and the U.K. ("Approved Countries"). The FCC currently imposes
certain restrictions upon the use of the Company's private lines between the
U.S. and Approved Countries. The Company may not route traffic to or from the
U.S. over a private line between the U.S. and an Approved Country (e.g., the
U.K.) if such traffic originates or terminates in a third country, such third
country has not been found by the FCC to offer "equivalent" resale opportunities
and the traffic is not routed to or from the third country and the Approved
Country via a publicly available service. Following implementation of the Full
Competition Directive by EU member states, and the WTO Agreement by the
signatories, the FCC may authorize the Company to originate and terminate
traffic over its private line between the U.S. and the U.K. and (pursuant to ISR
authority) over additional private lines to additional member states if the FCC
finds that such additional member states meet the criteria for Approved
Countries. Once a carrier makes such a showing and the FCC approves ISR on a
route, all carriers holding a global section 214 authorization will be permitted
to offer ISR on that route. The Company anticipates that these new opportunities
to engage in ISR will result in reduced costs and prices, increased competition
and increased demand on these routes.
15
The FCC's Policies on Transit and Refile. The Company may engage in the
practice whereby a carrier routes, through its facilities in a third country,
traffic originating from one country and destined for another country. The FCC
has permitted third country calling where all countries involved consent to the
routing arrangements (referred to as "transiting"). Under certain arrangements
referred to as "refiling," the carrier in the destination country does not
consent to receiving traffic from the originating country and does not realize
the traffic it receives from the third country is actually originating from a
different country. To date, the FCC has made no pronouncement and is not
considering any formal proposals to find that refiling arrangements are
inconsistent with U.S. or ITU regulations.
Domestic Service Regulation. The Company's provision of domestic long
distance service in the U.S. is subject to regulation by the FCC and relevant
state PSCs, which regulate interstate and intrastate rates, respectively. The
majority of the states require the Company to register or apply for
certification prior to initiating intrastate interexchange telecommunications
services. Fines and other penalties also may be imposed for such violations.
Europe. In Europe, each country regulates its telecommunications industry.
The member states of the European Union (consisting of: Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The
Netherlands, Portugal, Spain, Sweden and the U.K.) are obligated to implement
legislation issued by the European Commission, which is responsible for creating
pan-European policies and developing a regulatory framework to ensure an open,
competitive telecommunications market.
In 1990, the European Commission issued the Services Directive requiring each
EU member state to abolish existing monopolies in telecommunications services
with the exception of voice telephony. The intended effect of the Services
Directive was to permit the competitive offering of all services, other than
voice telephony, including value-added services and voice services to closed
user groups ("CUGs"). However, as a consequence of local implementation of the
Services Directive through the adoption of national legislation, there are
differing interpretations of the definition of prohibited voice telephony and
permitted value-added and CUG services. Voice services accessed by customers
through leased lines are permissible in all EU member states. The European
Commission has generally taken a narrow view of the services classified as voice
telephony, declaring that voice services may not be reserved to the PTTs if (i)
dedicated customer access is used to provide the service, (ii) the service
confers new value-added benefits on users (such as alternative billing methods)
or (iii) calling is limited by a service provider to a group having legal,
economic or professional ties.
In March 1996, the EU adopted the Full Competition Directive containing two
provisions which required EU member states to allow the creation of alternative
telecommunications infrastructures by July 1, 1996, and which reaffirmed the
obligation of EU member states to abolish the PTTs' monopolies in voice
telephony by 1998. The Full Competition Directive encouraged EU member states to
accelerate liberalization of voice telephony. Certain EU countries may delay the
abolition of the voice telephony monopoly based on exemptions established in the
Full Competition Directive. These countries include Luxembourg (July 1, 1998),
Spain (November 30, 1998), Portugal and Ireland (January 1, 2000) and Greece
(December 31, 2000). Luxembourg, Spain and Ireland have already implemented the
Full Competition Directive in whole or in part.
Each EU member state in which the Company currently conducts or plans to
conduct its business has a different regulatory regime and such differences are
expected to continue beyond January 1998. The requirements for the Company to
obtain necessary approvals vary considerably from country to country and are
likely to change as competition is permitted in new service sectors.
Asia, Pacific Rim and Latin America. The extent and timing of
liberalization, and the scope and nature of regulation varies among the Pacific
Rim, Asian and Latin American countries. The Company's ability to provide voice
telephony services is restricted in some Asian, Pacific Rim and Latin American
countries e.g., China which remains largely closed to competition. The Company
has a pending application to provide international telecommunications services
in Hong Kong, where the regulator has encouraged limited competition. On July 1,
1997, the People's Republic of China resumed sovereignty over Hong Kong, and
there can be no assurance that China will continue the existing licensing regime
with respect to the Hong Kong telecommunications industry. In New Zealand,
regulation of the Company's proposed provision of telecommunications services is
relatively permissive, and the Company has been granted registration as an
international services operator.
16
The Company's services in Japan are or will be subject to regulation by the
Ministry of Post and Telecommunications (the "Japanese Ministry") under the
Telecommunications Business Law (the "Japanese Law"). In Japan, the Company must
obtain a license as a Type I facilities-based business before it provides
telecommunications services over its own facilities. It must register as a
Special Type II business before it provides telecommunications services over
international circuits leased from another carrier, or provides domestic service
in Japan over leased circuits if the volume of traffic exceeds a certain amount.
A registered Special Type II business may provide over leased lines value-added
and/or basic telecommunications services, and/or services to closed user groups.
The Company must notify the Japanese Ministry as a General Type II business only
if it provides domestic service in Japan over leased circuits and does not
exceed the traffic threshold that would require Special Type II. Although the
Japanese government until recently prohibited greater than 33.0% foreign
ownership of a Type I business, as well as the resale of international private
lines interconnected to the PSTN at both ends, the Japanese Ministry is now
awarding authorizations to foreign-affiliated carriers to provide
telecommunications services using their own facilities and to resell
interconnected international private lines. The Japanese Ministry also regulates
the interconnection charges imposed by Type I businesses, and must approve
intercarrier agreements between Type I carriers or between Type I and Special
Type II carriers. The Company has also filed an application in Japan requesting
a Type I (facilities-based) telecommunications license requesting authorization
to allow the Company to construct and operate its own network facilities, as
well as to originate and terminate traffic over resold lines. The Type I license
process is onerous and involves extensive consultation with the Japanese
Ministry. To date, WorldCom is the only U.S.-based carrier to have successfully
completed the process and been awarded a Type I license.
Licenses. Consistent with its global strategy, the Company or its local
operating subsidiary has received facilities-based and resale authorization to
provide telecommunications services in Austria, Canada, Sweden, Denmark, The
Netherlands, Germany, El Salvador, Finland, France, Italy, Norway, Guatemala,
Switzerland and the U.K. The Company also participates in the numbering plans of
Sweden, Denmark, Finland, The Netherlands, Norway, Switzerland and the U.K. The
Company is also licensed in Belgium as a provider of non-reserved services,
including voice services for CUGs and value-added services, and has requested
additional authorization to provide ISR. The Company has been awarded access
codes in El Salvador, Denmark, Finland, France, Guatemala, Italy, Norway,
Sweden, Switzerland and the U.K. to allow the Company to operate as a
facilities-based provider of international telecommunications services. The
Company has been granted registration by the New Zealand Ministry of Commerce as
an operator under the Telecommunications (International Services) Regulation
1994.
The Company has pending applications for various authorizations in Spain and
Hong Kong. The Company also anticipates filing requests for authorization to
provide services open to competition in Australia, Belgium, Japan, Peru and
Spain where it is engaging in discussions with foreign regulators, as well as in
other countries as appropriate in furtherance of its strategic goal of
establishing a multinational presence.
In the U.S., the Company has obtained facilities and resale licenses from the
FCC. In addition, the Company is certified or registered to provide intrastate
interexchange telecommunications services or may provide such services based
upon its unregulated status in 42 states. Applications for certification are
pending in 8 states. State issued certificates of authority to provide
intrastate interexchange telecommunications services generally can be
conditioned, modified, canceled, terminated or revoked by state PSCs for failure
to comply with state law and/or the rules, regulations and policies of the state
PSCs.
EMPLOYEES
As of September 30, 1998, the Company had 210 employees. None of the Company's
employees are covered by a collective bargaining agreement. Management believes
that the Company's relationship with its employees is good.
INTELLECTUAL PROPERTY AND PROPRIETARY INFORMATION
Intellectual Property. The Company owns U.S. registration number 2,107,157
for the service mark FaciliCom International(R) for international long distance
telecommunications services. The Company relies primarily on common law rights
to establish and protect its intellectual property, its name, products and long
distance services. There can be no assurance that the Company's measures to
protect its intellectual property will deter or prevent the
17
unauthorized use of the Company's intellectual property. If the Company is
unable to protect its intellectual property rights, including existing
trademarks and service marks, it could have a material adverse effect upon the
Company's business, financial condition and results of operations.
Proprietary Information. To protect rights to its proprietary know-how and
technology, the Company requires certain of its employees and consultants to
execute confidentiality and invention agreements that prohibit the disclosure of
confidential information to anyone outside the Company. These agreements also
require disclosure and assignment to the Company of discoveries and inventions
made by such persons while employed by the Company. There can be no assurance
that these agreements will not be breached, that the Company will have adequate
remedies for any such breach or that the Company's confidential information will
not otherwise become known or be independently developed by competitors or
others.
ITEM 2. PROPERTIES
The Company leases certain office space and switch location space under
operating leases and subleases that expire at various dates through November
2008, including the Company's principal headquarters in Washington, D.C. The
principal offices currently leased or subleased by the Company as of September
30, 1998 are as follows:
SQUARE LEASE
LOCATION FOOTAGE EXPIRATION
--------- --------- -------------
Washington, DC (Corporate Headquarters)...................... 49,602 March 2008
New York, NY (Switch Location)............................... 1,500 August 2000
Jersey City, NJ (Switch Location)............................ 2,404 July 1999
Los Angeles, CA (Switch Location)............................ 5,350 November 2002
Miami, FL (Switch Location).................................. 3,578 November 2008
London, U.K. (Switch Location)............................... 888 December 2001
London, U.K. (Sales Office).................................. 3,839 January 2003
London, U.K. (Switch Location)............................... 400 October 1999
Amsterdam, The Netherlands (Switch Location)................. 1,161 May 2003
Amsterdam, The Netherlands (Sales Office).................... 3,379 December 2001
Copenhagen, Denmark (Sales & Switch Location)................ 6,104 August 2002
Malmo, Sweden (Sales Office)................................. 9,218 December 1999
Malmo, Sweden (Switch Location).............................. 8,448 October 1998
Malmo, Sweden (Sales Office and Switch Location)............. 18,458 November 2003
Brussels, Belgium (Sales Office and Switch Location)......... 10,253 March 2005
Milan, Italy (Sales Office and Switch Location).............. 6,297 July 2004
Paris, France (Sales Office and Switch Location)............. 5,438 January 2007
Frankfurt, Germany (Switch Location)......................... 2,798 January 2003
Frankfurt, Germany (Sales Office)............................ 2,956 February 2001
Oslo, Norway (Switch Location)............................... 42 May 1999
Vienna, Austria (Sales Office and Switch Location)........... 9,775 July 2008
Helsinki, Finland (Sales Office and Switch Location)......... 3,769 October 2001
Sornaisten, Finland (Switch Location)........................ 1,130 June 2002
Madrid, Spain (Sales Office and Switch Location)............. 9,979 August 2003
Geneva, Switzerland (Sales Office)........................... 2,428 June 2002
Zurich, Switzerland (Sales Office and Switch Location)....... 7,603 June 2008
ITEM 3. LEGAL PROCEEDINGS
The Company makes routine filings and is a party to customary regulatory
proceedings with the FCC relating to its operations. The Company is not a party
to any lawsuit or proceeding which, in the opinion of management, is likely to
have a material adverse effect on the Company's business, financial condition
and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the quarter ended
September 30, 1998.
18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The authorized capital stock of the Company consists of 300,000 shares of
common stock, par value $.01 per share ("Common Stock"). As of September 30,
1998, there were 225,741 shares of Common Stock issued and outstanding. There
is no established public trading market for the Common Stock. All of the Common
Stock is owned by AIT and FCI Management Group, a Pennsylvania general
partnership ("FMG").
Holders of shares of Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders and are entitled to receive such
dividends as the Company's Board of Directors may declare in its discretion out
of funds legally available therefor. In the event of a liquidation, dissolution
or winding up of the Company, the holders of shares of Common Stock are entitled
to a distribution of any remaining assets of the Company. Holders of shares of
Common Stock have no cumulative voting or preemptive rights. All outstanding
shares of Common Stock are fully paid and nonassessable.
STOCKHOLDERS AGREEMENT
Pursuant to the Stockholders Agreement, FMG and AIT agreed to certain rights
and restrictions with respect to the shares of Common Stock they hold, including
the following:
Transfer Restrictions. The parties agreed that no shares of Common Stock may
be issued by the Company or sold, exchanged, pledged, encumbered, given,
bequeathed or otherwise disposed of by AIT or FMG unless and until the proposed
transferee agrees to be bound by the provisions of the Stockholders Agreement.
Designation of Directors by AIT and FMG. The parties agreed that the Board of
Directors will be comprised of seven persons, five of whom will be designated by
AIT and two of whom will be designated by FMG.
Board Approval of Significant Actions. The parties agreed that certain
actions may not be taken by officers of the Company without the prior approval
of the Board of Directors. Such actions include: (a) issuance or sale of any
securities of the Company other than securities issued pursuant to the 1997
Stock Option Plan No. 1, the 1997 Stock Option Plan No. 2 and the Phantom Stock
Plan; (b) sale, lease or transfer of a material portion of the assets of the
Company or transfer of any material governmental permit or license relating to
the business of the Company; (c) adoption of budgets, modification of any
approved budgets or expenditure of funds in excess of then-current budgets; (d)
guarantee indebtedness, extension of credit, incurrence of certain types of
indebtedness or the pledge of any assets of the Company; (e) certain of
management personnel decisions, including paying annual compensation to an
employee in excess of $100,000 or paying a bonus to an employee; (f) execution
of a contract obligating the Company for amounts in excess of $500,000; (g)
modification of any employee benefit plan; or (h) certain transactions with
affiliates of the Company.
19
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements of FCI included elsewhere in this Form 10-K.
Period From
Period from January 1, 1995 to
May 5, 1995 June 30, 1995
Fiscal Year Ended September 30, to September 30, Tele8--
1998 1997 1996 1995 Predecessor(1)
--------------------------------------------------------------------------
(Dollars in thousands)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues......................................... $184,246 $ 70,187 $11,891 $ 547 $ 367
Loss before income taxes......................... (57,946) (14,031) (9,662) (1,725) (1,341)
Income tax benefit (2)........................... 11,351 -- -- -- --
Net loss......................................... (46,595) (14,031) (9,662) (1,725) (1,341)
CONSOLIDATED BALANCE SHEET DATA:
Property and equipment........................... 115,748 20,244 10,144 2,661 N/A
Total assets..................................... 378,884 44,017 21,008 5,664 N/A
Total long-term obligations (including
current portion) (3)............................. 308,938 22,589 9,795 1,906 N/A
(1) Data for periods prior to January 1, 1995 have not been presented because
amounts were insignificant and not meaningful. Cumulative revenue and losses
from inception through December 31, 1994 were $35,758 and $287,564,
respectively, and both total assets and liabilities at December 31, 1994
were $2.6 million.
(2) The Company became a taxable entity in January 1998. Net loss is not
comparable for periods prior to September 30, 1998 when the Company was not
subject to income taxes.
(3) The Company completed an offering of $300 million of Senior Notes in January
1998 and used some of the proceeds to pay off debt borrowed from equipment
financiers.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
FCI is a rapidly growing multinational carrier focused on providing
international wholesale telecommunications services to other carriers worldwide.
As a facilities-based carrier, the Company seeks primarily to provide service
over its facilities and international transmission capacity owned or leased on a
fixed-cost basis ("on-net"). The Company believes that it is better able to
control the quality and the termination costs of on-net traffic and that
increasing the proportion of on-net traffic significantly improves the Company's
gross margins. For the three months ended September 30, 1998, 36.7% of the
Company's wholesale international traffic was terminated on-net and 63.3% was
terminated by other long distance carriers pursuant to resale and operating
agreements between the Company and such carriers ("off-net"). The Company plans
to continue to expand its facilities to increase the percentage of on-net
traffic.
The Company provides its services over a carrier-grade international network
consisting of international gateway switches, transmission capacity owned or
leased on a fixed-cost basis and various multinational termination agreements
and resale arrangements with other long distance providers. FCI began generating
revenue in July 1995 through it's acquisition of FCI-Sweden, formerly Tele8.
Since that time the Company has installed or acquired 11 additional
international gateway switches within the United States (New York, New Jersey,
Los Angeles and Miami) and Europe (United Kingdom, The Netherlands, Germany,
Finland, Denmark, France and Norway).
The Company's strategy is to invest in network facilities as it expands its
customer base, allowing it to enhance service quality and increase gross margins
on particular routes. However, this approach also causes the Company's gross
margins to fluctuate with changes in network utilization due to the Company's
fixed-cost investment in its network. The Company intends to expand its
international presence during Fiscal 1999 by installing five additional switches
in Switzerland, Austria, Belgium, Spain and Italy. The Company believes that
expansion into these additional markets will provide the Company with an
opportunity to increase its traffic volume.
20
Currently, the Company's revenues are generated through the sale of
international long distance services on a wholesale basis to telecommunications
carriers and through the sale of domestic and international long distance
services on a retail basis in Sweden, Denmark and Finland. The Company records
revenues from the sale of telecommunications services at the time of customer
usage. The Company earns revenue based on the number of minutes it bills to and
collects from its customers. The Company's agreements with its wholesale
customers are short-term in duration and are subject to significant traffic
variability. The rates charged to customers are subject to change from time to
time, generally requiring seven days' notice to the customer. However, the
Company is beginning to offer longer-term, fixed-price arrangements to select
customers who historically have generated large volumes of traffic, specifically
on routes where the Company provides on-net service.
The Company believes its services are competitively priced in each country in
which the Company offers its services. Prices for wholesale and retail
telecommunications services in many of the Company's markets have declined in
recent years as a result of deregulation and increased competition. The Company
believes that worldwide deregulation and increased competition are likely to
continue to reduce the Company's wholesale and retail revenues per billed minute
of use. The Company believes, however, that any decrease in wholesale and retail
revenues per minute will be at least partially offset by an increase in billed
minutes by the Company's wholesale and retail customers, and by a decreased cost
per billed minute.
The Company currently has operating agreements with established long distance
providers in Belgium, Chile, Denmark, the Dominican Republic, Estonia, Finland,
Germany, Hungary, Iceland, Italy, Nicaragua, Norway, Poland, Portugal, Slovenia,
the U.S., the U.K. and Venezuela, and is in the process of negotiating
additional operating agreements with carriers in other countries. Under its
operating agreements, FCI typically agrees to send traffic to its foreign
partners who agree to send a proportionate amount of return traffic via the
Company's network at negotiated rates. The Company and its foreign partners
typically settle the amounts owed to each other in cash on a net basis,
subsequent to the receipt of return traffic. FCI records the amount due to each
foreign partner as an expense in the period during which the Company's traffic
is delivered. FCI recognizes revenue on return traffic in the period in which it
is received. For the fiscal year ended September 30, 1998 the Company received
29.5 million minutes of return traffic, which accounted for 1.3% of the
Company's consolidated revenues.
In addition, the Company currently has interconnection agreements with
established long distance providers in Denmark, Finland, the Netherlands,
Norway, Sweden, Switzerland, the U.S. and the U.K. and is in the process of
negotiating additional interconnection agreements with carriers in France,
Germany, Italy, Belgium, Austria and Spain. Under its interconnection
agreements, FCI typically terminates in-bound traffic to the foreign carrier
through designated interconnection points at negotiated rates. The
interconnection agreement also provides the Company with a domestic access code,
which can be used to originate traffic within the country. The foreign carrier
as part of the interconnection agreement delivers originated traffic to the
Company's international gateway switch.
The Company has made since its inception, and expects to continue to make,
significant investments to expand its network. Increased capital expenditures in
the future can be expected to affect the Company's operating results due to
increased depreciation charges and interest expense in connection with
borrowings to fund such expenditures.
21
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data and related percentage of revenues:
Fiscal Year Ended September 30,
-----------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------
$ % $ % $ %
-----------------------------------------------------------------
Revenues....................................... $184,246 100.0% $ 70,187 100.0% $11,891 100.0%
Cost of revenues............................... 178,952 97.1 65,718 93.6 12,742 107.2
-------- ------ -------- ------ ------- ------
Gross (deficit) margin......................... 5,294 2.9 4,469 6.4 (851) (7.2)
-------- ------ -------- ------ ------- ------
Operating Expenses:
Selling, general and administrative
(including related party)................ 34,347 18.6 13,511 19.3 7,582 63.8
Stock-based compensation expense........... 6,017 3.3 -- -- -- --
Depreciation and amortization.............. 8,816 4.8 2,318 3.3 1,143 9.6
-------- ------ -------- ------ ------- ------
Total operating expenses.............. 49,180 26.7 15,829 22.6 8,725 73.4
-------- ------ -------- ------ ------- ------
Operating loss................................. (43,886) (23.8) (11,360) (16.2) (9,576) (80.6)
-------- ------ -------- ------ ------- ------
Other income (expense):
Interest expense (including related party). (22,612) (12.3) (1,336) (1.9) (312) (2.6)
Interest income............................ 8,152 4.4 -- -- -- --
Gain on settlement agreement............... 791 0.5 -- -- -- --
Foreign exchange (loss) gain............... (391) (0.2) (1,335) (1.9) 226 1.9
-------- ------ -------- ------ ------- ------
Total other income (expense).......... (14,060) (7.6) (2,671) (3.8) (86) (0.7)
-------- ------ -------- ------ ------- ------
Loss before income taxes....................... (57,946) (31.4) (14,031) (20.0) (9,662) (81.3)
Income tax benefit............................. 11,351 6.1 -- -- -- --
-------- ------ -------- ------ ------- ------
Net loss....................................... $(46,595) (25.3)% $(14,031) (20.0)% $(9,662) (81.3)%
======== ====== ======== ====== ======= ======
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998, AS COMPARED TO THE FISCAL YEAR
ENDED SEPTEMBER 30, 1997
Revenues increased by $114.1 million to $184.2 million for the fiscal year
ended September 30, 1998, from $70.2 million for the fiscal year ended September
30, 1997. The growth in revenue resulted primarily from an increase in billed
customer minutes of use resulting from an increase in wholesale customers in the
U.S. and Europe and an increase in retail customers in Sweden, Denmark and
Finland, as well as usage increases from existing wholesale customers.
Offsetting the growth in revenue during this period was a decrease in the price
per billed minute to $0.225 for the fiscal year ended September 30, 1998, from
$0.278 for the fiscal year ended September 30, 1997, as a result of increased
on-net traffic and competition. For the fiscal year ended September 30, 1998,
U.S. revenues totaled $116.4 million or 63.2% of the Company's consolidated
revenues and European revenues totaled $67.8 million, or 36.8% of consolidated
revenues. Billed minutes of use increased by 568.1 million, to 820.3 million
minutes of use for the fiscal year ended September 30, 1998, from 252.3 million
minutes of use for the fiscal year ended September 30, 1997.
Wholesale customers increased by 86 or 162.3%, to 139 wholesale customers at
September 30, 1998, from 53 at September 30, 1997. As of September 30, 1998
retail customers in Sweden, Denmark and Finland total approximately 43,300.
Cost of revenues increased by $113.3 million, to $179.0 million for the fiscal
year ended September 30, 1998, from $65.7 million for the fiscal year ended
September 30, 1997. As a percentage of revenues, cost of revenues increased to
97.1% for the fiscal year ended September 30, 1998, from 93.6% for the fiscal
year ended September 30, 1997, primarily as a result of increased fixed costs
associated with expanding inter-switch fiber capacity within the U.S. and
Europe. Cost of revenues as a percentage of revenues is expected to decrease as
a result of improved efficiencies of network fiber facilities due to higher
traffic volumes as well as from an anticipated increases in the percentage of
on-net traffic.
Gross margin increased by $825,000 to $5.3 million for the fiscal year ended
September 30, 1998, from $4.5 million for the fiscal year ended September 30,
1997. As a percentage of revenues, gross margin decreased to 2.9% for the fiscal
year ended September 30, 1998, from 6.4% for the fiscal year ended September 30,
1997.
Selling, general and administrative expenses increased by $26.9 million to
$40.4 million for the fiscal year ended September 30, 1998, from $13.5 million
for the fiscal year ended September 30, 1997, primarily as a result of
22
the Company's increased sales, an increase in customer service, billing,
collections and accounting staff required to support revenue growth, and
approximately $6.0 million of expenses related to stock-based compensation
arrangements. As a percentage of revenues, selling, general and administrative
expenses increased to 21.9% for the fiscal year ended September 30, 1998, from
19.3% for the fiscal year ended September 30, 1997. Bad debt expense was $3.8
million, or 2.0% of revenues for the fiscal year ended September 30, 1998
compared with $1.3 million, or 1.8% of revenues for the fiscal year ended
September 30, 1997, as a result of increased revenue and new customers. Although
selling, general and administrative expenses are expected to increase on an
absolute basis in order to support expansion of the Company's operations, the
Company expects that selling, general and administrative expenses as a
percentage of revenues will decrease over time.
Depreciation and amortization increased by $6.5 million to $8.8 million for
the fiscal year ended September 30, 1998, from $2.3 million for the fiscal year
ended September 30, 1997, primarily due to increased capital expenditures
incurred in connection with the deployment and expansion of the Company's
network.
Interest expense increased by $21.3 million to $22.6 million for the fiscal
year ended September 30, 1998, from $1.3 million for the fiscal year ended
September 30, 1997, primarily due to the offering of the Senior Notes.
Interest income for the fiscal year ended September 30, 1998, was $8.2 million
and related principally to interest on proceeds from the Senior Notes offering,
which were invested in marketable securities and cash and cash equivalents.
Foreign exchange loss decreased by $944,000 to $391,000 for the fiscal year
ended September 30, 1998, from $1.3 million for the fiscal year ended September
30, 1997.
Income tax benefit of $11.4 million was recorded for the fiscal year ended
September 30, 1998 related mainly to a tax benefit of $12.1 million utilized by
AHI, a $393,000 tax charge related to the change in tax status as a result of
the reorganization on December 22, 1997 and approximately $302,000 tax charge
for taxes in Finland.
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997, AS COMPARED TO THE FISCAL YEAR
ENDED SEPTEMBER 30, 1996
Revenues increased by $58.3 million to $70.2 million in the fiscal year ended
September 30, 1997, from $11.9 million in the fiscal year ended September 30,
1996. The growth in revenue resulted primarily from an increase in billed
customer minutes of use resulting from an increased number of wholesale
customers in the U.S., the U.K. and Scandinavia and an increased number of
retail customers in Sweden, as well as usage increases from existing wholesale
customers. Offsetting the growth in revenue during this period was a decrease in
the price per billed minute of 3.5%, to $0.278 for the fiscal year ended
September 30, 1997 from $0.288 for the fiscal year ended September 30, 1996, as
a result of increased competition. In the fiscal year ended September 30, 1997,
U.S. revenues totaled $53.7 million, or 76.5% of the Company's consolidated
revenues, Swedish revenues totaled $15.5 million, or 22.1% of consolidated
revenues and U.K. revenues totaled $1.0 million, or 1.4% of consolidated
revenues.
Wholesale customers increased by 36, or 211.8%, to 53 wholesale customers at
September 30, 1997, from 17 at September 30, 1996. Retail customers in Sweden
increased by 10,750, to 12,365 retail customers at September 30, 1997, from
1,615 at September 30, 1996. Billed minutes of use increased by 211.0 million,
to 252.3 million minutes of use in the fiscal year ended September 30, 1997,
from 41.3 million minutes of use in the fiscal year ended September 30, 1996.
Cost of revenues increased by $53.0 million, to $65.7 million in the fiscal
year ended September 30, 1997, from $12.7 million in the fiscal year ended
September 30, 1996. As a percentage of revenues, cost of revenues declined to
93.6% in the fiscal year ended September 30, 1997, from 107.2% in the fiscal
year ended September 30, 1996, primarily as a result of increased minutes of use
on the Company's network, improved efficiencies of network facilities due to
higher traffic volumes and reductions in rates charged by the Company's carrier
suppliers. Cost of revenues as a percentage of revenues is expected to continue
to decrease as a result of higher traffic volumes, which are expected to result
in volume discounts for off-net traffic, as well as from an anticipated increase
in the percentage of on-net traffic.
23
Gross margin increased to $4.5 million in the fiscal year ended September 30,
1997, from ($851,000) in the fiscal year ended September 30, 1996. As a
percentage of revenues, gross margin increased to 6.4% in the fiscal year ended
September 30, 1997, from (7.2%) in the fiscal year ended September 30, 1996.
Selling, general and administrative expenses increased by $5.9 million to
$13.5 million in the fiscal year ended September 30, 1997, from $7.6 million in
the fiscal year ended September 30, 1996, primarily as a result of the Company's
increased sales, and an increase in customer service, billing, collections and
accounting staff required to support revenue growth. Staff levels grew by 30, or
47.6%, to 93 employees at September 30, 1997, from 63 employees at September 30,
1996. As a percentage of revenues, selling, general and administrative expenses
decreased to 19.3% in the fiscal year ended September 30, 1997, from 63.8% in
the fiscal year ended September 30, 1996, as a result of improved efficiencies.
Bad debt expense was $1.3 million for the fiscal year ended September 30, 1997,
or 1.8% of revenues.
Depreciation and amortization expenses increased by $1.2 million to $2.3
million in the fiscal year ended September 30, 1997, from $1.1 million in the
fiscal year ended September 30, 1996, primarily due to increased capital
expenditures incurred in connection with the deployment and expansion of the
Company's network.
Interest expense, net increased by $1.0 million to $1.3 million in the fiscal
year ended September 30, 1997, from $312,000 in the fiscal year ended September
30, 1996, primarily due to increased levels of vendor financing and loans from
AIT.
Foreign exchange gain (loss) decreased by $1.5 million to ($1.3) million in
the fiscal year ended September 30, 1997, from $226,000 in the fiscal year ended
September 30, 1996.
Income taxes were $0 for both years, as all net operating losses from foreign
subsidiaries were fully reserved.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating losses and negative cash flows
as a result of the development and operation of its network, including the
acquisition and maintenance of switches and fiber optic capacity. The Company
has financed its growth primarily through equity, a credit facility provided by
AIT, credit facilities with two equipment vendors, capital lease financing and
the proceeds from the $300 million offering of Senior Notes.
Net cash provided by (used in) operating activities was $(36.1) million for
the fiscal year ended September 30, 1998 due principally to a net loss of $46.6
million offset in part by depreciation and amortization expense of $8.8 million.
Net cash provided by (used in) investing activities was $(184.7) million for
the fiscal year ended September 30, 1998. Net cash utilized by investing
activities in this period resulted from an increase in capital expenditures to
expand the Company's network, acquisition of FCI-Finland and the purchase of
marketable securities.
Net cash provided by (used in) financing activities was $285.2 million for the
fiscal year ended September 30, 1998. Net cash provided by financing activities
for the fiscal year ended September 30, 1998 resulted from the $13.8 million
equity investment by AIT and the issuance of $300 million of Senior Notes
partially offset by payments on existing long-term debt and capital leases.
Non-cash financing activities for the fiscal year ended September 30, 1998
resulted from the financing of network equipment provided by NTFC Capital Corp.
("NTFC") and Ericsson I.F.S., and financing of fiber circuits provided by
Teleglobe Cantat-3 Inc. and Telecom A/S (collectively "Globesystems").
The Company's business strategy contemplates aggregate capital expenditures of
approximately $100 million through September 30, 1999. Such capital expenditures
are expected to be used primarily for international gateway switches, PoPs,
transmission equipment, undersea and international fiber circuits for new and
existing routes and other support systems. In May 1998, the Company entered
into a Memorandum of Understanding with Qwest. The agreement provides Qwest
with international direct dial termination service to various destinations and
provides the Company an IRU for domestic and international fiber optic capacity.
The IRU is for twenty-five years, for which
24
the Company has agreed to pay $24 million over a three-year period. Deliveries
of the capacity under this agreement are expected by March 31, 1999.
In addition, the Company has entered into two agreements that provide the
Company with IRU's for international fiber optic capacity for Europe and the
Pacific Rim. Deliveries of the capacity under the agreements are expected prior
to November 1999. The IRU's are for ten to fifteen years, for which the
Company has agreed to pay approximately $41.6 million through September 30,
2002, of which $2.5 million has already been paid as a deposit and an additional
$24.1 million is expected to be paid in the fiscal year ended September 30,
1999.
Subsequent to September 30, 1998, the Company agreed to acquire additional
capacity in Europe and Scandinavia for $8.6 million. Deliveries and payment of
the capacity under these agreements are expected by September 30, 1999. During
Fiscal 1999, the Company also plans to install five additional switches in
Switzerland, Austria, Spain, Belgium and Italy.
On December 22, 1997, the Company received the equity investment from AIT,
which consisted of a contribution of cash and the cancellation of indebtedness.
Following the recapitalization, AIT owned approximately 84.0% of the outstanding
shares of common stock of the Company.
On January 28, 1998, FCI issued $300 million in aggregate principal amount of
Senior Notes. Interest on the Senior Notes is payable semiannually in arrears on
January 15 and July 15 of each year, commencing on July 15, 1998. The Senior
Notes are redeemable at the option of FCI, in whole or in part at any time on or
after January 15, 2003, at specified redemption prices plus accrued and unpaid
interest and Liquidated Damages (as defined in the Indenture), if any, thereon
to the date of redemption. In addition, at any time prior to January 15, 2001,
FCI may redeem from time to time up to 35.0% of the originally issued aggregate
principal amount of the Senior Notes at the specified redemption prices plus
accrued interest and Liquidated Damages, if any, to the date of redemption with
the Net Cash Proceeds (as defined in the Indenture) of one or more Public Equity
Offerings (as defined in the Indenture); provided that at least 65.0% of the
originally issued aggregate principal amount of the Senior Notes remains
outstanding after such redemption. In the event of a Change in Control (as
defined in the Indenture), each holder of the Senior Notes has the right to
require FCI to purchase all or any of such holder's Senior Notes at a purchase
price in cash equal to 101% of the aggregate principal amount thereof, plus
accrued and paid interest and Liquidated Damages, if any, to the date of
purchase.
FCI used approximately $86.5 million of the proceeds from the offering of the
Senior Notes to purchase a portfolio of Pledged Securities (as defined in the
Indenture) consisting of U.S. Government Obligations (as defined in the
Indenture), which are pledged as security and restricted for the first six
scheduled interest payments on the Senior Notes. During July 1998, approximately
$14.5 million of those Pledged Securities were used to pay the first schedule
interest payment. In addition, approximately $16.9 million of existing
indebtedness was paid off with the proceeds from the offering of the Senior
Notes.
In June 1998, 100% of the Senior Notes were exchanged for registered Senior
Notes pursuant to an exchange offer registration statement. The registered
Senior Notes have the same terms and conditions as the unregistered Senior
Notes, other than restrictions of transferability.
The Company continuously reviews opportunities to further its business
strategy through strategic alliances with, investments in, or acquisitions of
companies that are complementary to the Company's operations. The Company may
finance such alliances, investments or acquisitions with cash flow from
operations or through additional bank debt, vendor financing or one or more
public offerings or private placements of securities.
The Company believes that the net proceeds from the offering of the Senior
Notes, together with cash provided by operating activities and vendor financing,
will provide the Company with sufficient capital to fund planned capital
expenditures and anticipated losses and to make interest payments on the Senior
Notes through at least September 30, 1999. There can be no assurance, however,
that the Company will achieve or, if achieved, will sustain profitability or
positive cash flow from operating activities in the future.
In June 1997 the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which (i) establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and
25
losses) in a full set of general-purpose financial statements, and (ii) requires
an enterprise to report a total for comprehensive income in condensed financial
statements of interim periods. The statement is effective for fiscal years
beginning after December 15, 1997. In June 1997 the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. The statement is effective for
fiscal years beginning after December 15, 1997. In June 1998, the FASB issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which establishes accounting and reporting standards for derivative instruments
and for hedging activities. It requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
measuring those instruments at fair value, with the potential effect on
operations dependent upon certain conditions being met. The statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
The implementation of such standards is not expected to have a material impact
on the Company's financial position or results of operations, except for SFAS
No. 133, for which the Company has not determined the impact on the Company's
financial position or results of operations.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs having been written
using two digits rather than four to define the applicable year, resulting in
date-sensitive software having the potential, among other things, to recognize
a date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities, which could have
material adverse operational and financial consequences. Currently, the Company
believes that a disruption in the operation of its networks, billing system and
financial and accounting systems and/or an inability to access interconnections
with other telecommunications carriers, are the major risks associated with the
inability of systems and software to process Year 2000 data correctly. If the
systems of other companies on whose services the Company depends, including AHI,
or with whom the Company's systems interface are not Year 2000 compliant, there
could be a material adverse effect on the Company's business, financial
condition and results of operation.
STATE OF READINESS
FCI, in conjunction with AHI, formed a task team in February 1998. The task
team's program comprises three phases: (i) assessment of Year 2000 compliance of
FCI's equipment, software and systems, (ii) a detailed inventory of these items
and (iii) building and implementing a workplan, which includes assessing the
cost in dollars and the necessary the manpower, upgrading or replacing the item,
and scheduling the date of compliance. The Company has completed the first two
phases and expects the majority of phase three to be completed by June 30, 1999
with remaining items completed by September 30, 1999. Included in the task
team's assessment is a review of the Year 2000 compliance efforts of FCI's key
suppliers. Below is a more detailed breakdown of our efforts to date:
INTERNAL ISSUES
Network elements--The Company's main concern is the switching equipment and
peripherals, and other vendor components that are time sensitive. The Company
is upgrading all of its networks with the compliant software and expects to have
this completed by the end of December 1998, except for one switch in Finland,
for which the vendor is currently producing a Year 2000 compliance plan. In
addition, the Company expects to complete the software upgrade for its Passport
equipment by the end of December 1998. Passport equipment allows the Company to
compress the traffic, which allows more traffic to be carried over a single
fiber optic cable. With regards to the transmission equipment, the Company's
equipment is currently Year 2000 "Friendly", which means the manufacturer has
represented that the releases will not experience any service-affecting issues
upon rollover into the new millennium. Some problems could be experienced, which
the Company expects can be resolved with workarounds. There can be no
assurance that such workarounds will be successful. The Company expects Year
2000 compliant software releases to be released and installed by the end of
September 1999; however, the development and release of such software is not
within the control of the Company.
Billing System and the Accounting System--The Company's billing system was
developed by AHI's programmers and operates on the AS400. The Company believes
that the billing system and the AS400 are Year 2000 compliant. However, the
production of accurate and timely customer invoices depends upon the generation
of accurate and timely underlying data by the Company's switches; while the
switch manufacturers have represented that these switches are Year 2000
compliant, there can be no assurance that such billing problems will not occur.
The Company is in the process of converting its accounting system. The
manufacturer has represented that this system is Year 2000 compliant and its
implementation is expected to be completed by June 30, 1999.
26
Information Systems--The Company's upgrade of its information systems is in
progress. All of the Company's hardware equipment, including the equipment it
relies upon at AHI, is Year 2000 compliant. With regards to software, three
main softwares are not Year 2000 compliant. Two of them have free patches that
can be downloaded and the third will be upgraded to the latest version. The
Company has approximately 150 workstations and laptops that will need these
software upgrades. Each upgrade is expected to take approximately 20 to 30
minutes and will be performed by the Company's MIS team. The cost is expected
to be immaterial.
THIRD PARTY ISSUES
Vendor Issues--In general, FCI's product vendors have made available either
Year 2000 compliant versions of their offerings or new compliant products as
replacements of discontinued offerings. In most cases, representations herein as
to the degree of compliance of the product in question are based on vendor-
provided information, which remains subject to FCI's testing and verification
activities. The Company is in the process of requesting information from
utilities and similar service providers.
Customer Issues--FCI's customers are interested in the progress of FCI's Year
2000 efforts, and FCI anticipates increased demand for information, including
detailed testing data and company-specific responses. When requested by
customers, the Company provides Year 2000 compliance information. At this time,
the Company has not performed an analysis of its potential liability to
customers in the event of Year 2000 related problems.
Interconnecting Carriers--FCI's network operations interconnect with domestic
and international networks of other carriers. If one of these interconnecting
carriers should fail or suffer adverse effect from a Year 2000 problem, our
customers could experience impairment of services. In addition, since many of
these interconnecting carriers are also our customers, a Year 2000 problem by
one of these customers could lead to a loss of revenue, due to its inability to
send traffic on our network. The Company is in the process of sending
correspondence to its major interconnecting carriers to determine the status
of their Year 2000 compliance review.
COSTS
Although total costs to implement the plan cannot be precisely estimated, the
Company had not incurred costs to date in excess of those normally associated
with business planning and implementation. The Company anticipates that
future costs will not be material, in as much as the Company began to acquire
products after the Year 2000 issue was identified and manufacturers had begun
to remediate the problem. However, there can be no assurance that material
costs will not be incurred. The Company cannot estimate the future cost
related to the interoperability of third party products. These costs will be
expensed as incurred, unless new systems are purchased that should be
capitalized in accordance with generally accepted accounting principles.
RISKS
The failure to correct a material Year 2000 problem could cause an
interruption or failure of certain of our normal business functions or
operations, which could have a material adverse effect on the Company's
business, financial condition and results of operation. Due to the uncertainty
inherent in other Year 2000 issues that are ultimately beyond our control,
including, for example, the Year 2000 readiness of our suppliers, customers and
interconnecting carriers, we are unable to determine at this time the likelihood
of a material impact on the Company's business, financial condition and results
of operation, due to such Year 2000 issues. However, based upon risk assessment
work conducted thus far, the Company believes that the most reasonably likely
worst case scenario of the failure by the Company, its suppliers or other
telecommunications carriers with which the Company interconnects to resolve Year
2000 issues would be an inability by the Company to (i) provide
telecommunications services to the Company's customers, (ii) route and deliver
telephone calls originating from or terminating with other telecommunications
carriers, and (iii) timely and accurately bill its customers. In addition to
lost earnings, these failures could result in loss of customers due to service
interruptions and billing errors, substantial claims by customers and increased
expenses associated with Year 2000 litigation, stabilization of operations and
executing mitigation and contingency plans. While the Company believes that it
is taking appropriate measures to mitigate these risks, there can be no
assurance that such measures will be successful.
CONTINGENCY PLAN
At this time, the Company does not have a contingency plan, but is in the
process of developing a plan. This plan is expected to be completed by June 30,
1999.
Item 7A: Quantitative and Qualitative Disclosures about Market Risk
Although the Company's reporting currency is the U.S. dollar, the Company
expects to derive an increasing percentage of its revenues from international
operations. Accordingly, changes in currency exchange rates may have a
significant effect on the Company's results of operations. For example, the
accounting rate under operating agreements is often defined in monetary units
other than U.S. dollars, such as "special drawing rights" or "SDRs." To the
extent that the U.S. dollar declines relative to units such as SDRs, the dollar
equivalent accounting rate would increase. In addition, as the Company expands
into foreign markets, its exposure to foreign currency rate fluctuations is
expected to increase. Although the Company does not currently engage in exchange
rate hedging strategies, it may choose to limit such exposure by purchasing
forward foreign exchange contracts or other similar hedging strategies. The
Company's board of directors (the "Board of Directors") periodically reviews and
approves the overall interest rate and foreign exchange risk management policy
and transaction authority limits. Specific
27
hedging contracts, if any, will be subject to approval by certain specified
officers of FCI acting within the Board of Directors' overall policies and
limits. The Company intends to limit its hedging activities to the extent of its
foreign currency exposure. There can be no assurance that any currency hedging
strategy would be successful in avoiding currency exchange-related losses.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements, together with related notes
and the report of Deloitte & Touche LLP, the Company's independent accountants,
are set forth on the pages indicated in Item 14.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For purposes of this item, unless the context otherwise requires, (i) references
to offices held by certain individuals with the Company prior to December 1997
reflect officer positions held by those individuals with FaciliCom
International, L.L.C. ("FCI LLC") prior to the recapitalization and (ii)
references to directorships held by certain individuals with the Company prior
to December 1997 reflect positions held by those individuals as members of the
management committee of FCI LLC prior to the recapitalization.
OFFICERS AND DIRECTORS
The officers and directors of the Company, and their ages as of September 30,
1998, are as follows:
Name Age POSITION
---- ----- --------
Walter J. Burmeister......... 59 Chief Executive Officer, President, Director
Anand Kumar.................. 55 Executive Vice President--Business Development
Jeffrey J. Guzy.............. 47 Executive Vice President--Marketing, Sales &
Product Development
Juan Carlos Valls............ 44 Executive Vice President--Business Development
Christopher S. King.......... 37 Vice President--Finance and Administration, Chief Financial Officer
Donald Dodd.................. 65 Managing Director--Operations & Engineering
Kirby J. Campbell............ 51 Treasurer, Vice President, Director
Dru A. Sedwick............... 34 Secretary, Vice President, Director
Bryan Cipoletti.............. 38 Director
Robert L. Reed............... 47 Director
Jay L. Sedwick............... 63 Director
William C. Stewart........... 58 Director
WALTER J. BURMEISTER is a co-founder of the Company and has served as its
Chief Executive Officer, President, and as a Director of the Company since its
inception in May 1995. Prior to co-founding the Company, Mr. Burmeister founded
Telecommunications Management Group, Inc. ("TMG"), a telecommunications
consulting firm, and has served as its Chairman from 1992 to present. Prior to
founding TMG, Mr. Burmeister served as Vice President and Chief Financial
Officer of Bell Atlantic International from 1989 to 1992. In these positions,
Mr. Burmeister was responsible for overseeing business development in Central
and South America, the Middle East and Africa, as well as managing that
company's financial affairs. During his 31 years with Bell Atlantic, Mr.
Burmeister served as Vice President of Bell of Pennsylvania and Diamond State
Telephone sales organization and headed the C&P Telephone Operations Staff. Mr.
Burmeister has served as a director of Skysat Communications Network Corp. since
1992.
28
ANAND KUMAR is a co-founder of the Company and has served as its Executive
Vice President--Business Development since its inception in May 1995. Prior to
co-founding the Company, Mr. Kumar founded and served as President of
Communications Strategy Group, a technology consulting firm, from 1980 to 1996.
Mr. Kumar was founder and, from 1986 to 1992, President of Washington
International Teleport ("WIT"), a privately held transport facility with more
than 25 earth stations. Prior to founding WIT, Mr. Kumar served in various
positions with GTE and AT&T.
JEFFREY J. GUZY is a co-founder of the Company and has served as its Executive
Vice President-- Marketing, Sales of Product Development since its inception in
May 1995. Prior to co-founding the Company, Mr. Guzy served as Vice President of
Business Development at Interferometrics from 1993 to 1995, a scientific
organization dedicated to low earth orbit satellite technology. Mr. Guzy served
as Director of Information Services at Bell Atlantic from 1991 to 1993. Before
joining Bell Atlantic, Mr. Guzy served as Marketing Director at Sprint
International from 1989 to 1991 and as a Vice President at Overseas
Telecommunications Inc., an international private line carrier, from 1983 to
1989.
JUAN CARLOS VALLS has served as the Company's Executive Vice President--
Business Development since January 1998. Prior to joining the Company, Mr. Valls
co-founded TMG and has served as its President from 1992 to present. Prior to
founding TMG, Mr. Valls served as Director of Business Development for Bell
Atlantic International and held various positions with Bell Atlantic.
CHRISTOPHER S. KING has served as the Company's Vice President--Finance and
Administration and Chief Financial Officer since July 1996. Prior to joining the
Company, Mr. King was employed by Bell Atlantic from 1987 to 1996 where he
served in a variety of management positions in corporate finance, business
planning, marketing and new product development. In his last position at Bell
Atlantic, Mr. King served as Director of Public Calling Services and Director of
Video Services. Before joining Bell Atlantic, Mr. King served as Assistant
Comptroller for Creative Technologies Incorporated, a manufacturer of graphic
arts and video presentation products.
DONALD DODD has served as the Company's Managing Director--Operations and
Engineering since April 1996. Prior to joining the Company, Mr. Dodd served as
Senior Director of Marketing from 1994 to 1996 at Tekelec Incorporated, an
equipment manufacturer. From 1992 to 1994, Mr. Dodd served as a consultant with
TMG. Prior to that time, Mr. Dodd held a number of positions with Bell Atlantic
and Northern Telecom, where he was General Manager of Operations for the eastern
region from 1984 to 1992.
KIRBY J. CAMPBELL has served as a Vice President, Treasurer and as Director of
the Company since its inception in May 1995. Mr. Campbell has served since June
1997 as Chief Executive Officer of Armstrong Holdings, Inc., the Company's
indirect majority stockholder and previously served as Executive Vice President
of Armstrong Holdings, Inc. Mr. Campbell also holds various executive and board
positions with Armstrong's affiliated companies.
DRU A. SEDWICK has served as Vice President, Secretary and as a Director of
the Company since its inception in May 1995. Mr. Sedwick has served since June
1997 as President of Armstrong Holdings, Inc., the Company's indirect majority
stockholder, and previously served as Senior Vice President of Armstrong
Holdings, Inc. Mr. Sedwick also holds various executive and board positions with
Armstrong's affiliated companies.
BRYAN CIPOLETTI has served as a Director of the Company since September 1997.
Mr. Cipoletti has served as Vice President of Finance of Armstrong Holdings
Inc., the Company's indirect majority stockholder, since 1993. Mr. Cipoletti
also holds various executive and board positions with Armstrong's affiliated
companies.
ROBERT L. REED has served as a Director of the Company since its inception in
May 1995. In 1987, Mr. Reed founded EPIC Capital Corp., an investment banking
firm that specializes in the privately-held business market, and has served as
its Chairman since that time.
JAY L. SEDWICK has served as a Director of the Company since its inception in
May 1995. Since 1992, Mr. Sedwick has served as the Chairman of the Board of
Armstrong Holdings, Inc., the Company's indirect majority stockholder. Mr.
Sedwick also serves as Chairman of many of Armstrong's affiliated companies and
has served as a director of North Pittsburgh Systems, Inc. since 1980.
29
WILLIAM C. STEWART has served as a Director of the Company since September
1997. Mr. Stewart has served as President and Chief Executive Officer of
Armstrong Utilities, Inc., an affiliate of the Company's majority stockholder,
since June 1997 and previously served as Executive Vice President and Chief
Operating Officer of Armstrong Utilities, Inc. Mr. Stewart also holds various
executive and board positions for Armstrong's affiliated companies.
Members of the Company's Board of Directors hold office for the term for which
they are elected. Currently, each director has been elected to serve until the
next annual stockholders meeting or until his death, resignation or removal.
Officers of the Company serve at the discretion of the Board of Directors.
Jay L. Sedwick is a brother-in-law of William C. Stewart. Jay L. Sedwick is
the father of Dru A. Sedwick. There are no other family relationships among any
of the directors and executive officers of the Company.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain summary information concerning
compensation for services in all capacities awarded to, earned by or paid to,
the Company's Chief Executive Officer and each of the four other most highly
compensated executive officers of the Company, whose aggregate cash and cash
equivalent compensation exceeded $100,000 (collectively, the "Named Officers"),
with respect to the fiscal year ended September 30, 1998.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION AWARDS
-----------------------------------
SECURITIES
ANNUAL COMPENSATION RESTRICTED UNDERLYING
FISCAL -------------------------- STOCK AWARDS OPTIONS/SARS
NAME OF INDIVIDUAL AND PRINCIPAL POSITION YEAR Salary ($) Bonus ($) ($)(1) (#)
- ----------------------------------------- -------- -------------- --------- ---------------- -------------
Walter J. Burmeister................................ 1998 $ 187,500 $54,000 -- 2,502
Chief Executive Officer, President 1997 $191,857 (2) 54,000 $949,981 (3)(7) --
Anand Kumar......................................... 1998 147,000 19,698 -- 1,330
Executive Vice President--Business Development 1997 139,539 52,628 237,495 (4)(7) --
Jeffrey J. Guzy...................................... 1998 133,700 39,300 -- 1,045
Executive Vice President--Marketing, 1997 100,154 66,845 189,996 (5)(7) --
Sales & Product Development
Christopher S. King.................................. 1998 120,000 33,319 -- 570
Vice President--Finance and Administration, 1997 96,962 41,836 90,060 (6)(7) --
Chief Financial Officer
Juan Carlos Valls/(8)/............................... 1998 110,250 23,520 -- --
Executive Vice President--Business Development 1997 N/A N/A N/A N/A
___________
(1) For accounting purposes, the Company recognizes expense under the Phantom
Stock Plan over the employee's respective service period. The fair market
value of the phantom units granted pursuant to FCI LLC's Amended and
Restated Performance Unit Plan (the "Performance Unit Plan") and Phantom
Shares granted pursuant to the Phantom Stock Plan was determined, in each
case at the time of grant, by the Board of Directors. The fair market value
for Phantom Shares granted for the fiscal year ended September 30, 1997, and
the value of Phantom Shares at that date, was based on a value of $500 per
share, as determined by the Board of Directors. The Board's determination of
such fair market value was based primarily on the Company's operating
results for the quarter ended September 30, 1997, using a multiple of
revenues for such quarter that the Board believed to be consistent with
companies whose business and financial position were similar to those of the
Company. This valuation was further supported by a valuation that was
determined by arms'-length negotiation between the Company and an
unaffiliated third party in connection with a proposed private equity
investment by such party in November 1997. The transaction was not
consummated for reasons unrelated to the valuation of the Company. Effective
March 31, 1998, the Phantom Shares previously granted were converted to
options under the Company's 1998 Stock Option Plan, as defined below.
(2) Mr. Burmeister owns 50% of the equity interests in TMG, an international
telecommunications consulting company which provides consulting services to
the Company. For the fiscal year ended September 30, 1998 and 1997, the
Company paid fees totaling $60,000 and $85,097 to TMG. Mr. Burmeister's
salary for the fiscal year ended September 30, 1998 and 1997, includes
$30,000 and $42,549, reflecting Mr. Burmeister's 50% interest in such fees.
30
(3) Represents the fair market value of 190,000 phantom units granted pursuant
to the Performance Unit Plan in the fiscal year ended September 30, 1997, at
an exercise price of $.01 per phantom unit, which units were exchanged for
1,900 Phantom Shares under the Phantom Stock Plan. All 1,900 Phantom Shares
vested immediately. No prior grants of Phantom Shares were received by him.
(4) Represents the fair market value of 47,500 phantom units granted pursuant to
the Performance Unit Plan in the fiscal year ended September 30, 1997 at an
exercise price of $.01 per phantom unit, which units were exchanged for 475
Phantom Shares under the Phantom Stock Plan. Of the 475 Phantom Shares
granted in the fiscal year ended September 30, 1997, 50% vest one year after
the date of grant and the remaining 50% vest two years after the date of
grant. Together with prior grants of Phantom Shares received by him, Mr.
Kumar's aggregate holdings are 1,330 Phantom Shares with an aggregate dollar
value of $664,987, of which 617.5 Phantom Shares had vested as of September
30, 1997.
(5) Represents the fair market value of 38,000 phantom units granted pursuant to
the Performance Unit Plan in the fiscal year ended September 30, 1997 at an
exercise price of $.01 per phantom unit, which units were exchanged for 380
Phantom Shares under the Phantom Stock Plan. Of the 380 Phantom Shares
granted in the fiscal year ended September 30, 1997, 50% vest one year after
the date of grant and the remaining 50% vest two years after the date of
grant. Together with prior grants of Phantom Shares received by him, Mr.
Guzy's aggregate holdings are 1,045 Phantom Shares with an aggregate dollar
value of $522,489, of which 475 Phantom Shares had vested as of September
30, 1998.
(6) Represents the fair market value of 38,000 phantom units granted pursuant to
the Performance Unit Plan in the fiscal year ended September 30, 1997 at an
exercise price of $2.63 per phantom unit, which units were exchanged for 380
Phantom Shares under the Phantom Stock Plan. Of the 380 Phantom Shares
granted in the fiscal year ended September 30, 1997, 50% vest one year after
the date of grant and the remaining 50% vest two years after the date of
grant. Together with prior grants of Phantom Shares received by him, Mr.
King's aggregate holdings are 570 Phantom Shares with an aggregate dollar
value of $135,090, of which 190 Phantom Shares had vested as of September
30, 1997.
(7) No dividends will be paid on the Phantom Shares.
(8) Mr. Valls was hired on January 1, 1998. The compensation set forth
reflects the amounts earned from such date until September 30, 1998.
STOCK OPTIONS
The following table sets forth certain information regarding options for the
purchase of Common Stock that were awarded to the Named Officers with respect to
the fiscal year ended September 30, 1998.
OPTION GRANTS IN FISCAL YEAR ENDED SEPTEMBER 30, 1998
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS/SARs EXERCISE
UNDERLYING GRANTED TO OF BASE GRANT DATE
OPTIONS/SARs EMPLOYEES IN PRICE EXPIRATION PRESENT
NAME OF INDIVIDUAL AND PRINCIPAL POSITION GRANTED (#) FISCAL YEAR ($/SH) DATE VALUE ($)
- ------------------------------------------------- -------------- --------------- ---------- ---------- -------------
Walter J. Burmeister............................... 2,502 30.8% 1.00 3/31/08 $1,601,280
Chief Executive Officer, President
Anand Kumar........................................ 1,330 16.4 1.00 3/31/08 851,200
Executive Vice President--Business Development
Jeffrey J. Guzy.................................... 1,045 12.9 1.00 3/31/08 668,800
Executive Vice President--Marketing,
Sales & Product Development
Christopher S. King................................ 570 7.0 263.00 3/31/08 241,110
Vice President--Finance and Administration,
Chief Financial Officer
Juan Carlos Valls.................................. -- -- -- -- --
Executive Vice President--Business Development
31
The following table sets forth certain information concerning the number and
value of unexercised options at fiscal year end. There were no options
exercised by any of the Named Officers during the fiscal year ended September
30, 1998.
FISCAL YEAR END OPTION VALUES
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN
UNEXERCISED OPTIONS THE MONEY OPTIONS
AT FISCAL YEAR END AT FISCAL YEAR
(EXERCISABLE/ END (EXERCISABLE/
NAME OF INDIVIDUAL AND PRINCIPAL POSITION UNEXERCISABLE) (#) UNEXERCISABLE) ($)
- ----------------------------------------- ------------------- ------------------
Walter J. Burmeister............................... 2,502/0 $2,374,398/0
Chief Executive Officer, President
Anand Kumar........................................ 1,093/237 1,037,257/224,913
Executive Vice President--Business Development
Jeffrey J. Guzy.................................... 855/190 811,395/180,310
Executive Vice President--Marketing,
Sales & Product Development
Christopher S. King................................ 380/190 261,060/130,530
Vice President--Finance and Administration,
Chief Financial Officer
Juan Carlos Valls.................................. -- --
Executive Vice President--Business Development
MANAGEMENT RELATIONSHIP WITH ARMSTRONG
Kirby J. Campbell and Dru A. Sedwick devote approximately 10% of their working
time to activities related to the Company. Other than the Company, Armstrong
owns several businesses, including six independent local telephone companies.
These local telephone companies provide primarily local exchange services and
long distance access to residential and business customers in defined service
areas. The activities of these independent local telephone companies are neither
competitive with, nor complementary to, the activities of the Company. The
Company believes that this avoids any potential conflicts of interest.
MANAGEMENT RELATIONSHIP WITH TELECOMMUNICATIONS MANAGEMENT GROUP
TMG, co-founded by Messrs. Burmeister and Valls, provides international
telecommunications consulting services. TMG has provided consulting services to
the Company since the Company's inception in May 1995, principally with respect
to business development opportunities in Latin America. Since the Company's
inception, Mr. Burmeister has devoted less than 5% of his working time to
performing services for TMG. Prior to January 1, 1998, at which time he was
hired as an executive officer of the Company, Mr. Valls devoted all of his
working time to performing services for TMG. Since January 1, 1998, Mr. Valls
has devoted less than 5% of his working time to performing services for TMG. To
avoid possible conflicts of interest, TMG has refused several requests from
competitors of the Company to provide consulting services for such competitors.
The majority of TMG's revenues are generated from providing consulting services
to governmental entities in Latin America and the Middle East as well as to non-
governmental organizations worldwide. Although Messrs. Burmeister and Valls
could be subject to conflicts of interest in the future, TMG intends to continue
to decline requests for consulting services from the Company's direct
competitors. See "Certain Relationships and Related Transactions."
32
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
FCI's Board of Directors had a compensation committee in the fiscal year ended
September 30, 1998 comprising Messrs. Campbell, Reed and Dru Sedwick. Messrs.
Campbell and Dru Sedwick are executive officers of the Company. The compensation
committee is responsible for reviewing executive officer compensation matters,
including Mr. Burmeister's compensation. Other than members of the compensation
committee, no other directors, officers or employees of the Company performed
functions equivalent to those discharged by a compensation committee during
fiscal year 1998. Messrs. Campbell, Reed and Dru Sedwick received options to
purchase a total of 2,041 shares of the Company's Common Stock in the fiscal
year ended September 30, 1998. During fiscal year 1998, Messrs. Campbell, Dru
Sedwick, Jay Sedwick, Cipoletti and Stewart, directors of the Company, served on
the board of directors and as executive officers of various Armstrong entities.
DIRECTOR COMPENSATION
Members of the Company's Board of Directors do not receive any cash
compensation for their participation at meetings of the Board of Directors or
any committee thereof. Directors are not currently reimbursed for out-of-pocket
expenses incurred in connection with their attendance at meetings of the Board
of Directors or any committee thereof. During the fiscal year ended September
30, 1998, options to purchase a total of 2,743 shares of the Company's Common
Stock were granted to members of the Company's Board of Directors, excluding Mr.
Burmeister. All of such options vest immediately, have an exercise price of
$1.00 per share and expire on March 31, 2008.
PHANTOM STOCK PLAN
The Board of Directors adopted the Phantom Stock Plan on December 22, 1997.
The Phantom Stock Plan provides for the grant of phantom stock rights ("Phantom
Shares") to certain directors, officers and key employees of the Company and its
subsidiaries. Each Phantom Share entitles the holder thereof (the "participant")
to receive a cash payment upon the occurrence of (i) the retirement of the
participant from the Company or a subsidiary if the participant is over 65 years
old and has been continuously employed by the Company or a subsidiary for not
fewer than ten years, (ii) the Company's written agreement that the termination
of the participant's employment with the Company or a subsidiary will not result
in such forfeiture or (iii) the death or total disability of the participant
(the "Triggering Event") equal to the excess of the fair market value of the
Phantom Share (as determined in good faith by the Board of Directors) less the
value assigned to that Phantom Share on the date the Phantom Share is granted.
The total number of Phantom Shares which may be granted pursuant to the Phantom
Stock Plan is 6,175, subject to adjustments for stock splits and stock
dividends. The plan is administered by persons who have been designated by the
Board of Directors to serve as administrator (the "administrator"). The
administrator is charged with determining, among other things, the eligibility
of directors, officers and employees to receive Phantom Shares under the plan,
how many Phantom Shares will be granted to directors, officers and employees,
and the rules, regulations and procedures in connection with the operation of
the plan.
In determining the eligibility of a director, officer or employee to receive
Phantom Shares, the administrator will consider the position and
responsibilities of such director, officer or employee, the nature and value to
the Company or a subsidiary of his or her services and accomplishments, his or
her present and potential contribution to the success of the Company or its
subsidiaries and such other factors as the administrator may deem relevant.
Phantom Shares that have not vested may be forfeited upon the termination of
the participant's employment for a reason other than a Triggering Event. In
addition, the Board of Directors may terminate all rights in Phantom Shares held
by a participant, whether or not they have vested, if the participant (i)
actively competes with the Company or a subsidiary, (ii) is terminated from the
Company or a subsidiary for the commission of any crime, (iii) is terminated
from the Company or a subsidiary for cause or (iv) is terminated from the
Company or a subsidiary for gross negligence or willful misconduct.
Phantom Shares granted under the Phantom Stock Plan may not be transferred by
a participant other than by operation of a will or by the laws of descent and
distribution. Phantom Shares will immediately vest upon the occurrence of
certain events, including a merger or consolidation in which the Company is not
the surviving entity, the acquisition of 50% or more of the combined voting
power of the Company (other than by AIT or FMG) or a
33
transaction requiring stockholder approval involving the disposition of all or
substantially all of the Company's assets.
STOCK OPTION PLANS
1998 Stock Option Plan
The Board of Directors adopted the FaciliCom International, Inc. 1998 Stock
Option Plan ( the "1998 Stock Option Plan") on March 31, 1998. The 1998 Stock
Option Plan provides for the grant of options to purchase shares of the
Company's non-voting common stock to certain directors, officers, key employees
and advisors of the Company and its subsidiaries. The purpose of the 1998 Stock
Option Plan is to promote the growth and profitability of the Company by
enabling it to attract and retain the best available personnel for positions of
substantial responsibility, to provide directors, officers, key employees and
advisors with an opportunity for investment in the Company's non-voting common
stock and to give them an additional incentive to increase their efforts on
behalf of the Company. The aggregate number of shares of Common Stock as to
which options may be granted pursuant to the 1998 Stock Option Plan is 22,574,
subject to adjustments for stock splits and stock dividends, and no option may
be granted under the plan after March 31, 2008. The plan is administered by
persons who have been designated by the Board of Directors to serve as
administrator, consisting of one or more, but no more than three, members of the
Board of Directors. The administrator is charged with, among other things,
granting options and determining the purchase price of the shares of common
stock covered by each option, determining the term of each option, determining
the persons to whom (and the times at which) options are granted, and
determining the number of shares of common stock to be covered by each option,
interpreting the plan, determining the rules, regulations and procedures in
connection with the operation of the plan, and determining the provisions of
stock option agreements. In determining the eligibility of a director, officer
or employee to receive options, the administrator will consider the position and
responsibilities of such director, officer or employee, the nature and value to
the Company or a subsidiary of his or her services and accomplishments, his or
her present and potential contribution to the success of the Company or its
subsidiaries and such other factors as the administrator may deem relevant.
The exercise price for options is determined by the administrator in its
discretion. The exercise price for options may be paid in full in cash, or in an
combination of cash and installment payments, and/or in shares of common stock.
Options immediately vest upon the occurrence of certain events, including a
merger or consolidation in which the Company is not the surviving entity, the
acquisition of 50% or more of the combined voting power of the Company (other
than by AIT or FMG) or a transaction requiring stockholder approval involving
the disposition of all or substantially all of the Company's assets. Options
granted under the 1998 Stock Option Plan may not be transferred by an optionee
other than by operation of a will or by the laws of descent and distribution.
If the employment or status as an optionee director or officer terminates for
any reason other than voluntary termination with the consent of the Company or
subsidiary, retirement under any retirement plan of the Company or subsidiary,
death or involuntary termination without cause, the rights of the optionee under
any option shall terminate at the time of such termination. In addition, the
administrator may terminate all rights in options held by an optionee, whether
or not they have vested, if the optionee actively competes with the Company or
subsidiary.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of the Company's common stock as of December 15, 1998, by (i) each
person known by the Company to beneficially own five percent or more of any
class of the Company's capital stock, (ii) each director of the Company, (iii)
each executive officer of the Company that is a Named Officer and (iv) all
directors and executive officers of the Company as a group. All
34
information with respect to beneficial ownership has been furnished to the
Company by the respective shareholders of the Company.
NUMBER OF SHARES
OF PERCENT AS OF
COMMON STOCK DECEMBER 15,
BENEFICIAL OWNER BENEFICIALLY OWNED 1998
- -------------------------------------------------------------- ------------------ -------------
Armstrong International Telecommunications, Inc./(1)/......... 189,641 84.0%
Jay L. Sedwick/(2)/........................................... 189,641 84.0
Walter J. Burmeister/(3)/..................................... 38,602 16.9
Juan Carlos Valls/(4)/........................................ 36,100 16.0
Robert L. Reed/(5)/........................................... 36,401 16.1
Anand Kumar/(6)/.............................................. 1,093 *
Jeffrey J. Guzy/(7)/.......................................... 855 *
Christopher S. King/(8)/...................................... 380 *
Donald Dodd/(9)/.............................................. 33 *
Kirby J. Campbell/(10)/....................................... 950 *
Bryan Cipoletti/(11)/......................................... 33 *
Dru A. Sedwick/(12)/.......................................... 790 *
William C. Stewart............................................ -- --
All directors and executive officers as a group (12 persons).. 232,678 100.0%
- --------------
* Represents beneficial ownership of less than 1% of the outstanding shares of
common stock.
(1) The address for Armstrong International Telecommunications, Inc. is One
Armstrong Place, Butler, PA 16001.
(2) Represents shares of common stock owned by AIT, a wholly owned subsidiary
of Armstrong. Mr. J. Sedwick, a director of the Company, is the Chairman of
the Board of, and controls, Armstrong. The address for Mr. J. Sedwick is
One Armstrong Place, Butler, PA 16001.
(3) Represents 36,100 shares of common stock owned beneficially by Mr.
Burmeister through FMG, in which Mr. Burmeister has a 33.3% ownership
interest, and 2,502 shares of common stock issuable upon the exercise of
stock options currently exercisable within 60 days of December 15, 1998.
Mr. Burmeister shares with Messrs. Valls and Reed voting and investment
control with respect to 36,100 shares of common stock owned by FMG. The
address for Mr. Burmeister is c/o FaciliCom International, 1401 New York
Avenue, NW, Washington, D.C. 20005.
(4) Represents 36,100 shares of common stock owned beneficially by Mr. Valls
through FMG, in which Mr. Valls has a 33.3% ownership interest. The address
for Mr. Valls is c/o FaciliCom International, 1401 New York Avenue, NW,
Washington, D.C. 20005. Mr. Valls shares with Messrs. Burmeister and Reed
voting and investment control with respect to 36,100 shares of common stock
owned by FMG.
(5) Represents 36,100 shares of common stock owned beneficially by Mr. Reed
through FMG, in which Mr. Reed has a 33.3% ownership interest, and 301
shares of common stock issuable upon the exercise of stock options
currently exercisable within 60 days of December 15, 1998.. The address for
Mr. Reed is c/o FaciliCom International, 1401 New York Avenue, NW,
Washington, D.C. 20005. Mr. Reed shares with Messrs. Burmeister and Valls
voting and investment control with respect to 36,100 shares of common stock
owned by FMG.
(6) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. Kumar is c/o FaciliCom International, 1401 New York Avenue,
NW, Washington, D.C. 20005.
(7) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. Guzy is c/o FaciliCom International, 1401 New York Avenue,
NW, Washington, D.C. 20005.
(8) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. King is c/o FaciliCom International, 1401 New York Avenue,
NW, Washington, D.C. 20005.
(9) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. Dodd is c/o FaciliCom International, 1401 New York Avenue,
NW, Washington, D.C. 20005.
(10) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. Campbell is One Armstrong Place, Butler, PA 16001.
(11) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. Cipoletti is One Armstrong Place, Butler, PA 16001.
(12) Represents shares of common stock issuable upon the exercise of stock
options currently exercisable within 60 days of December 15, 1998. The
address for Mr. D. Sedwick is One Armstrong Place, Butler, PA 16001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RELATIONSHIP WITH ARMSTRONG
FCI LLC, the Company's predecessor, was formed as a Delaware limited liability
company in May 1995 by AIT and FMG, with AIT and FMG contributing $180,000 and
$60,000, respectively, in exchange for ownership interests of 75.0% and 25.0% in
the Company, respectively. In July 1995, FCI LLC acquired 66.5% of FCI-Sweden,
an established competitive carrier based in Sweden. In October 1997, FCI LLC
acquired additional equity from a minority stockholder in FCI-Sweden, thereby
increasing its total ownership interest in FCI-Sweden to approximately 98.9%.
35
As the Company's majority stockholder, AIT has supplied substantially all of
the Company's equity capital. In September 1996, AIT provided FCI LLC with the
Additional Capital in the amount of $10.2 million for working capital purposes.
As a result of the Additional Capital, AIT was entitled to a guaranteed return
through September 30, 1997 for the use of the Additional Capital, pursuant to
the terms of FCI LLC's limited liability company agreement. In November 1996,
AIT provided FCI LLC the Convertible Debenture in the form of a $5.0 million
convertible line of credit and a guaranteed $10.0 million letter of credit
facility for the benefit of FCI LLC.
In September 1997, AIT increased its equity ownership in the Company from
75.0% to 81.0% by converting into permanent equity (1) the Convertible Debenture
(which, together with accrued interest, totaled $5.4 million) and (2) capital
contributions of $10.9 million (representing the $10.2 million furnished by AIT
in September 1996 plus a guaranteed return of $724,000 related thereto). Also in
September 1997, AIT established a bridge loan for the benefit of the Company,
pursuant to which AIT advanced funds to the Company for working capital purposes
at a rate equal to the prime rate plus 1.0% per annum.
In November 1997, the Company's stockholders, AIT and FMG, formed FaciliCom
International, Inc. On December 22, 1997, as a result of the Reorganization, FCI
LLC became a wholly owned subsidiary of the Company. Also, on December 22, 1997,
AIT made the Equity Investment of $20.0 million by making a cash contribution of
$13.7 million and a noncash contribution of $6.3 million in the form of
cancellation of amounts outstanding under the bridge loan, thereby increasing
AIT's equity ownership in the Company from 81.0% to 84.0%.
On March 31, 1998, the Company granted options to purchase 3,401 shares of
non-voting common stock to non-employee directors and advisors of the Company
who are related to the non-employee directors. The options were granted at an
exercise price of $1.00, and as a result, the Company recognized compensation
cost of $2,112,640 during the year ended September 30, 1998.
MIS Services Agreement. The Company has a contract with Armstrong pursuant to
which Armstrong provides billing and MIS support services, including, but not
limited to, call collection, processing, rating and reporting for the Company
and its subsidiaries. Armstrong also provides the Company with access to
experienced MIS professionals and programmers on an as-needed basis. The costs
for such services are as follows: (i) professional services are billed at a rate
of $65 per hour, (ii) call detail record (CDR) processing including data center
management, operations and hardware services billed at a rate per minute of use
dependent upon call volumes, (iii) AS/400 disk storage services are billed at a
rate of $25 per gigabyte, (iv) software applications and direct hardware
purchased by the Company are billed at actual cost and (v) telecommunications
facilities are billed based on actual facilities used by the Company. Armstrong
has reserved the right to increase the cost of its services upon thirty days'
written notice. During the fiscal years ended September 30, 1998, 1997 and 1996,
the Company paid $1.5 million, $431,000 and $0, respectively, to Armstrong for
MIS services provided under this agreement. Armstrong provides similar services
to other telecommunications companies with which it is affiliated. The Company
believes that the terms of its MIS Services Agreement with Armstrong are
competitive with those offered by other providers of MIS services. The agreement
expires on September 30, 2002.
Financial Accounting Services Agreement. The Company also has entered into an
agreement with Armstrong whereby Armstrong provides to the Company certain
financial accounting services, such as payroll, accounts payable, general ledger
services and income tax return preparation services. The costs for these
services are as follows: (i) payroll processing is billed at $2.75 per check,
(ii) accounts payable processing is billed at $2.75 per check, (iii) income tax
return preparation is billed at $75 per hour and (iv) paralegal services are
billed at $40 per hour. Armstrong has reserved the right to increase the cost of
its services upon thirty days' written notice. During the fiscal years ended
September 30, 1998, 1997 and 1996, the Company paid $30,000, $8,000 and $7,000,
respectively, to Armstrong for financial accounting services provided under this
agreement. The agreement may be terminated by the Company or Armstrong upon 180
days' notice to the other party. Armstrong provides similar services to other
telecommunications companies with which it is affiliated. The Company believes
that the terms of its Financial Accounting Services Agreement with Armstrong are
competitive with those offered by other providers of financial accounting
services in the industry. The agreement expires on June 30, 2002.
In December 1997, the Company and Armstrong entered into a tax sharing
agreement to define the method by which the federal income tax liability will be
allocated between the Company and Armstrong and the manner in
36
which such allocated tax liability will be paid. To date, the Company has not
made any payment to under the tax sharing agreement.
Management Relationship with Telecommunications Management Group. Messrs.
Burmeister and Valls are the co-founders, sole shareholders and directors of
TMG. TMG is an international telecommunications consulting company. During 1997,
the Company utilized the consulting services of TMG principally for exploring
business development opportunities in Latin America. Since the Company's
inception in May 1995, Mr. Burmeister has devoted less than 5% of his working
time to performing services for TMG. Prior to January 1, 1998, at which time he
was hired as an executive officer of the Company, Mr. Valls devoted all of his
working time to performing services for TMG. Since January 1, 1998, Mr. Valls
has devoted less than 5% of his working time to performing services for TMG.
Since becoming employees of the Company, neither Mr. Burmeister nor Mr. Valls
has provided any of the services provided by TMG to the Company. Pursuant to its
arrangements with TMG, the Company paid TMG fees of $60,000, $85,000 and $58,000
in the fiscal year ended September 30, 1998, 1997 and 1996, respectively. The
Company believes that the fees paid to TMG for the services rendered are
competitive with those charged for comparable services by other companies in the
industry.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
Page
1. Financial Statements
Independent Auditors' Report................................................................... F-2
Consolidated Balance Sheets as of September 30, 1998 and 1997.................................. F-3
Consolidated Statements of Operations for the three years ended September 30, 1998............. F-5
Consolidated Statements of Capital Accounts for the three years ended September 30, 1998....... F-6
Consolidated Statements of Cash Flows for the three years ended September 30, 1998............. F-7
Notes to Consolidated Financial Statements..................................................... F-9
2. Financial Statement Schedules
All schedules have been omitted because they are not applicable, not
required, or the required information is included in the Consolidated
Financial Statements or the Notes thereto.
3. Exhibits
See Index to Exhibits. The Exhibits listed in the accompanying Index
to Exhibits are filed herewith or incorporated by reference as part of
this report.
(b) Reports on Form 8-K:
None
(c) Exhibits
See (a) above
(d) Financial Statement Schedules
See (a) above
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FACILICOM INTERNATIONAL, INC.
Dated: December 28, 1998 By: /s/
--------------------------------------
Walter J. Burmeister
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons in the capacities
and on the dates indicated:
/s/ Walter J. Burmeister Chief Executive Officer, President and Director
- -------------------------------------------- (Principal Executive Officer)
Walter J. Burmeister
/s/ Christopher S. King Vice President--Finance and Administration, Chief
- -------------------------------------------- Financial Officer (Principal Financial Officer
Christopher S. King and Principal Accounting Officer)
/s/ Kirby J. Campbell Treasurer, Vice President and Director
- --------------------------------------------
Kirby J. Campbell
/s/ Dru A. Sedwick Secretary, Vice President and Director
- --------------------------------------------
Dru A. Sedwick
/s/ Bryan Cipoletti Director
- --------------------------------------------
Bryan Cipoletti
/s/ Robert Reed Director
- --------------------------------------------
Robert Reed
/s/ Jay Sedwick Director
- --------------------------------------------
Jay Sedwick
/s/ William Stewart Director
- --------------------------------------------
William Stewart
38
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FACILICOM INTERNATIONAL, INC.
Page
------
Independent Auditors' Report F-2
Consolidated Balance Sheets at September 30, 1998 and 1997............................................ F-3
Consolidated Statements of Operations for the three years ended September 30, 1998.................... F-5
Consolidated Statements of Capital Accounts for the three years ended September 30, 1998.............. F-6
Consolidated Statements of Cash Flows for the three years ended September 30, 1998.................... F-7
Notes to Consolidated Financial Statements............................................................ F-9
1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
FACILICOM INTERNATIONAL, INC.:
We have audited the accompanying consolidated balance sheets of FaciliCom
International, Inc. and subsidiaries (formerly FaciliCom International, LLC)
(the "Company") as of September 30, 1998 and 1997, and the related consolidated
statements of operations, capital accounts and cash flows for each of the three
years in the period ended September 30, 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, such consolidated financial statements present fairly, in all
material respects, the financial position of FaciliCom International, Inc. and
subsidiaries as of September 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1998 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
December 9, 1998
2
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
September 30,
1998 1997
-------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................ $ 68,129 $ 1,016
Accounts receivable--net of $4,620 and $161 at
September 1998 and 1997.................................. 59,915 19,485
Marketable securities ($31,394 restricted)................ 70,092 --
Prepaid expenses and other current assets................. 6,060 1,737
-------- -------
Total current assets...................................... 204,196 22,238
-------- -------
PROPERTY AND EQUIPMENT:
Transmission and communications equipment................. 97,849 16,593
Transmission and communications
equipment--leased........................................ 17,162 5,419
Furniture, fixtures and other............................. 11,154 1,266
-------- -------
126,165 23,278
Less accumulated depreciation and amortization............ (10,417) (3,034)
-------- -------
Net property and equipment................................ 115,748 20,244
-------- -------
OTHER ASSETS:
Intangible assets, net of accumulated amortization of
$1,673 and $583 at September 30, 1998 and 1997............ 5,630 1,535
Debt issue costs, net of accumulated amortization of $744
at September 30, 1998..................................... 9,696 --
Advance to affiliate...................................... 490 --
Marketable securities-restricted.......................... 43,124 --
-------- -------
Total other assets........................................ 58,940 1,535
-------- -------
TOTAL ASSETS............................................... $378,884 $44,017
======== =======
See notes to consolidated financial statements.
F-3
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
September 30,
1998 1997
-------- --------
LIABILITIES AND CAPITAL ACCOUNTS
CURRENT LIABILITIES:
Accounts payable.................................... $ 63,802 $ 24,205
Accounts payable--transmission equipment .......... 24,668 --
Accounts payable--related party..................... 332 389
Accrued interest.................................... 7,109 331
Other current obligations........................... 12,610 5,924
Capital lease obligations due within one year....... 3,407 573
Long-term debt due within one year.................. 394 1,043
-------- --------
Total current liabilities......................... 112,322 32,465
-------- --------
OTHER LIABILITIES:
Capital lease obligations........................... 4,791 1,723
Long-term debt...................................... 300,346 13,000
Loans from owners................................... -- 6,250
-------- --------
Total other liabilities.......................... 305,137 20,973
-------- --------
COMMITMENTS AND CONTINGENCIES
CAPITAL ACCOUNTS:
Common stock, $.01 par value--300,000 shares
authorized; 225,741 issued and
outstanding at September 30, 1998.................. 2 --
Additional paid-in capital.......................... 36,534 --
Class A initial capital............................. -- 180
Class B initial capital............................. -- 60
Excess capital contributions--Class A............... -- 16,296
Stock-based compensation............................ 6,305 --
Holding gain on marketable securities............... 24 --
Foreign currency translation adjustments............ 3,450 684
Accumulated deficit................................. (84,890) (26,641)
-------- --------
Total capital accounts........................... (38,575) (9,421)
-------- --------
TOTAL LIABILITIES AND CAPITAL ACCOUNTS................ $378,884 $ 44,017
======== ========
See notes to consolidated financial statements.
F-4
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
Years Ended September 30,
------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
Revenues............................... $184,246 $ 70,187 $11,891
Cost of revenues....................... 178,952 65,718 12,742
-------- -------- -------
Gross margin (deficit)................. 5,294 4,469 (851)
-------- -------- -------
Operating Expenses:
Selling, general and administrative 32,797 13,072 7,575
Stock-based compensation expense... 6,017 -- --
Related party expense.............. 1,550 439 7
Depreciation and amortization...... 8,816 2,318 1,143
-------- -------- -------
Total operating expenses...... 49,180 15,829 8,725
-------- -------- -------
Operating loss......................... (43,886) (11,360) (9,576)
-------- -------- -------
Other income (expense):
Interest expense-related party..... (195) (462) (26)
Interest expense................... (22,417) (874) (286)
Interest income.................... 8,152 -- --
Gain on settlement agreement....... 791 -- --
Foreign exchange (loss) gain....... (391) (1,335) 226
-------- -------- -------
Total other income (expense).. (14,060) (2,671) (86)
-------- -------- -------
Loss before income taxes............... (57,946) (14,031) (9,662)
Income tax benefit..................... 11,351 -- --
-------- -------- -------
Net loss............................... $(46,595) $(14,031) $(9,662)
======== ======== =======
See notes to consolidated financial statements.
F-5
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITAL ACCOUNTS
(IN THOUSANDS)
COMMON STOCK ADDITIONAL CLASS A CLASS B EXCESS CAPITAL
--------------- PAID-IN INITIAL INITIAL CONTRIBUTIONS-- STOCK-BASED
SHARES AMOUNT CAPITAL CAPITAL CAPITAL CLASS A COMPENSATION
------ ------ -------- -------- ----------- ---------------- -------------
BALANCE, SEPTEMBER 30, 1995............... -- $ -- $ -- $ 180 $ 60 $ 2,594 $ --
Net loss.............................. -- -- -- -- -- -- --
Contributions......................... -- -- -- -- -- 7,083 --
Guaranteed return..................... -- -- -- -- -- -- --
Contribution to excess capital--
guaranteed return................... -- -- -- -- -- 499 --
Foreign currency translation
adjustments......................... -- -- -- -- -- -- --
------ ------ -------- ------- ---------- --------- -------
BALANCE, SEPTEMBER 30, 1996............... -- -- -- 180 60 10,176 --
Net loss.............................. -- -- -- -- -- -- --
Converted loans from owners........... -- -- -- -- -- 5,396 --
Guaranteed return..................... -- -- -- -- -- -- --
Contribution to excess capital--
guaranteed return.................... -- -- -- -- -- 724 --
Foreign currency translation
adjustments......................... -- -- -- -- -- -- --
------ ------ -------- ------- -------- --------- -------
BALANCE, SEPTEMBER 30, 1997................ -- -- -- 180 60 16,296 --
Net loss............................... -- -- -- -- -- -- --
Contributions.......................... -- -- -- -- -- 13,750 --
Converted loans from owners............ -- -- -- -- -- 6,250 --
Reorganization......................... 226 2 36,534 (180) (60) (36,296) --
Utilization of tax benefit of the
Company's operating loss by AHI...... -- -- -- -- -- -- --
Stock options granted.................. -- -- -- -- -- -- 5,706
Phantom unit exchange.................. -- -- -- -- -- -- 599
Holding gain on marketable securities.. -- -- -- -- -- -- --
Foreign currency translation
adjustments......................... -- -- -- -- -- -- --
----- ------ -------- ------- ---------- --------- -------
BALANCE, SEPTEMBER 30, 1998................ 266 $2 $36,534 $ -- $ -- $ -- $ 6,305
====== ====== ======== ======= ========== ========= ========
HOLDING FOREIGN
LOSS ON CURRENCY TOTAL
MARKETABLE TRANSLATION ACCUMULATED CAPITAL
SECURITIES ADJUSTMENTS DEFICIT ACCOUNTS
----------- ------------ ------------- ------------
BALANCE, SEPTEMBER 30, 1995............... $ -- $ -- $ (1,725) $ 1,109
Net loss.............................. -- -- (9,662) (9,662)
Contributions......................... -- -- -- 7,083
Guaranteed return..................... -- -- (499) (499)
Contribution to excess capital--
guaranteed return................... -- -- -- 499
Foreign currency translation
adjustments......................... -- (245) -- (245)
------ -------- -------- --------
BALANCE, SEPTEMBER 30, 1996............... -- (245) (11,886) (1,715)
Net loss.............................. -- -- (14,031) (14,031)
Converted loans from owners........... -- -- -- 5,396
Guaranteed return..................... -- -- (724) (724)
Contribution to excess capital--
guaranteed return.................... -- -- -- 724
Foreign currency translation
adjustments......................... -- 929 -- 929
------ -------- -------- --------
BALANCE, SEPTEMBER 30, 1997................ -- 684 (26,641) (9,421)
Net loss............................... -- -- (46,595) (46,595)
Contributions.......................... -- -- -- 13,750
Converted loans from owners............ -- -- -- 6,250
Reorganization......................... -- -- -- --
Utilization of tax benefit of the
Company's operating loss by AHI...... -- -- (11,654) (11,654)
Stock options granted.................. -- -- -- 5,706
Phantom unit exchange.................. -- -- -- 599
Holding gain on marketable securities.. 24 -- -- 24
Foreign currency translation
adjustments......................... -- 2,766 -- 2,766
----- ------- -------- --------
BALANCE, SEPTEMBER 30, 1998................ $ 24 $ 3,450 $(84,890) $(38,575)
===== ======= ======== ========
See notes to consolidated financial statements.
F-6
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Years Ended September 30,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Cash flows from operating activities:
Net loss....................................................... $ (46,595) $(14,031) $(9,662)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.................................. 8,816 2,318 1,143
Non-cash stock-based compensation.............................. 6,017 -- --
Income tax benefit............................................. (11,654) -- --
Amortization of bond discount.................................. 237 -- --
Loss on disposal of property and equipment..................... -- 130 --
Changes in operating assets and liabilities:
Accounts receivable............................................ (40,107) (14,260) (4,356)
Prepaid expenses and other current assets...................... (3,792) (810) (770)
Accounts payable and other current liabilities................. 51,510 17,903 8,731
Accounts payable--related party................................ (57) 389 --
Advance to affiliate........................................... (490) (2,018) (499)
--------- -------- -------
Net cash used in operating activities (36,115) (8,361) (5,413)
--------- -------- -------
Cash flows from investing activities:
Purchase of investments in subsidiaries........................ (4,652) -- --
Purchase of investments in available-for-sale securities....... (77,820) -- --
Maturities of available-for-sale securities.................... 30,582 -- --
Sales of available-for-sale securities......................... 7,046 -- --
Purchase of investments in held-to-maturity securities......... (87,683) -- --
Maturities of held-to-maturity securities...................... 14,446 -- --
Purchases of property and equipment............................ (66,487) (1,897) (2,004)
Other.......................................................... (124) 233 930
--------- -------- -------
Net cash used in investing activities.......................... (184,692) (1,664) (1,074)
--------- -------- -------
Cash flows from financing activities:
Advances from owners........................................... -- 9,726 2,029
Excess capital contributions................................... 13,750 -- 7,083
Proceeds from debt issuance.................................... 300,000 -- --
Payments of long-term debt and capital leases.................. (18,156) (1,812) (540)
Payment of debt issuance costs................................. (10,440) -- --
--------- -------- -------
Net cash provided by financing activities...................... 285,154 7,914 8,572
--------- -------- -------
Effect of exchange rate changes on cash 2,766 929 4
--------- -------- -------
Increase (decrease) in cash and cash equivalents 67,113 (1,182) 408
Cash and cash equivalents, beginning of period 1,016 2,198 2,198
--------- -------- -------
Cash and cash equivalents, end of period $ 68,129 $ 1,016 $ 2,606
========= ======== =======
Supplemental cash flow information:
Interest paid.................................................. $ 15,834 $ 747 $ 201
========= ======== =======
(Footnotes on following page)
See notes to consolidated financial statements.
F-7
- --------
NONCASH TRANSACTIONS:
(a) For the fiscal year ended September 30, 1998, the majority owner converted
$6,250 of loans into capital and a $162 receivable was forgiven as part of
the purchase of minority interest which reduced prepaid expenses and other
current assets and increased goodwill.
(b) FCI received $480 in FCI-Sweden convertible debentures during the year ended
September 30, 1997 to satisfy an advance to affiliate, which reduced advance
to affiliate and advances from owners.
(c) During the year ended September 30, 1997, the majority owner converted
$5,396 of loans and accrued interest into capital.
(d) FCI received property and equipment under capital leases and financing
agreements, which increased property and equipment and long-term obligations
$10,755, $10,385 and $6,400 in the fiscal years ended September 30, 1998,
1997 and 1996, respectively. In addition, for the fiscal year ended
September 30, 1998, FCI received equipment which increased property and
equipment and accounts payable transmission equipment by $24,668 (of which
$15,331 was not yet placed in service as of September 30, 1998).
(e) FCI recognized a tax benefit of $11,654 for the fiscal year ended September
30, 1998. In accordance with the tax sharing agreement with AHI entered into
on December 22, 1997, FCI recorded a dividend to AHI for the amount of the
benefit to be realized by AHI (See Note 5 to the financial statements).
F-8
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
Organization--FaciliCom International, LLC ("FCI, LLC") is a Delaware limited
liability company that was formed on May 5, 1995 to engage in various
international telecommunications businesses. On December 22, 1997, the owners of
FCI, LLC entered into an Investment and Shareholders Agreement ("Agreement").
Under the Agreement, the owners of FCI, LLC transferred all of their respective
units in FCI, LLC and FCI (GP), LLC, a Delaware limited liability company, to
FaciliCom International, Inc. ("FCI"), a Delaware corporation, and additionally
Armstrong International Telecommunications, Inc. ("AIT") contributed $20,000,000
(in cash and assignment of indebtedness) to FCI, all in exchange for 225,741
shares of FCI's common stock. FCI was incorporated on November 20, 1997, and has
300,000 authorized shares of common stock. Since the reorganization was a
combination of entities under common control, it was accounted for by combining
the historical accounts of FCI, LLC, FCI (GP), LLC and FCI in a manner similar
to a pooling of interests. FCI is authorized by the Federal Communications
Commission (the "FCC") to provide global facilities-based services as well as
switched international services through resale of the services and facilities of
other international carriers. In addition, FCI has worldwide authorization for
private line resale of noninterconnected private line services and authorization
to resell interconnected private lines for switched services to Canada, the
United Kingdom, Sweden, and New Zealand. FCI, LLC was and FCI is a majority-
owned subsidiary of AIT, which is a wholly owned subsidiary of Armstrong
Holdings, Inc. ("Armstrong" or "AHI").
On July 21, 1995, FCI acquired 66.5% of the outstanding capital stock of both
Nordiska Tele8 AB ("Tele8" or "FCI-Sweden") and FGC, Inc. ("FGC"), entities
related through common ownership. Subsequently, FCI acquired up to 99% of FCI-
Sweden and sold all of its interest in FGC. The additional interest in FCI-
Sweden was the result of three separate transactions (see Note 8). On March 14,
1997, $1,600,000 of FCI-Sweden convertible debentures were converted into 7,400
shares of FCI-Sweden common stock, on May 15, 1997, FCI paid $3,600,000 for
14,400 shares of FCI-Sweden common stock and on October 23, 1997, FCI paid
$750,000 for substantially all of the minority interest outstanding and recorded
$750,000 of goodwill. Also, on October 23, 1997, FCI sold all of its interest in
FGC for $100 and recorded a loss of approximately $79,000 on the transaction.
FCI-Sweden is a corporation organized under the laws of Sweden to provide
national and international telecommunications services. These acquisitions were
accounted for as purchase transactions with the purchase price being allocated
to the assets and liabilities acquired based on their fair values as of the date
of acquisition. The excess of the purchase price over the fair value of the net
assets acquired was recorded as goodwill and is being amortized over five years.
The following summarizes the allocation of the original 1995 purchase price to
the major categories of assets acquired and liabilities assumed (in thousands):
Current assets............................................... $ 343
Property and equipment....................................... 1,760
Excess of cost over net assets of businesses acquired........ 1,715
Other intangibles............................................ 32
------
3,850
Less liabilities assumed..................................... 3,010
------
Cash paid.................................................... $ 840
======
On April 27, 1998, the Company entered into an agreement to purchase 100% of the
issued and outstanding capital stock of Oy Teleykkanen AB ("Tele 1" or "FCI-
Finland"), a corporation formed under the laws of Finland, for $4.0 million in
cash. FCI Finland is a Finnish provider of local and long distance international
telecommunication services and has a carrier agreement to exchange customer
traffic with Telecom Finland, the dominant carrier in Finland. This acquisition
was accounted for using the purchase method of accounting. The excess of the
purchase price over the fair value of the net assets acquired was recorded as
goodwill and is being amortized over five years. The results of operations for
Tele 1 were included in consolidated results of operations since the date of
acquisition.
F-9
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following summarizes the allocation of the purchase price to the major
categories of assets acquired and liabilities assumed (in thousands):
Current assets............................................... $1,017
Property and equipment....................................... 976
Excess of cost over net assets of businesses acquired........ 3,911
Other assets................................................. 126
------
6,030
Less liabilities assumed..................................... 1,966
------
Cash paid.................................................... $4,064
======
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Basis of Presentation--The accompanying consolidated financial statements
include the accounts of FCI and its majority owned and wholly owned
subsidiaries (together, the "Company"). All intercompany transactions and
balances have been eliminated in consolidation. Because losses applicable to
the minority interest exceeded the minority interest in the equity capital
and the minority stockholder was not obligated to provide additional funding
with respect to the losses incurred, such losses were recorded by the Company
prior to the purchase of the minority interest.
b. Cash and cash equivalents--The Company considers its investments with an
original maturity of three months or less to be cash equivalents. Cash
equivalents are stated at cost plus accrued interest and are highly liquid
debt instruments of the U.S. government and commercial corporations and money
market funds.
c. Property and Equipment--Property and equipment is stated at cost.
Depreciation is provided for financial reporting purposes using the straight-
line method. Depreciation expense includes the amortization of capital
leases. The estimated useful lives of property and equipment are as follows:
Transmission and communications equipment................. 5 to 25 years
Transmission and communications equipment--leased......... 5 to 25 years
Furniture, fixtures and other............................. 5 to 7 years
The Company capitalizes the costs of software and software upgrades purchased
for use in its transmission and communications equipment. The Company
expenses the costs of software purchased for internal use. Maintenance and
repairs are expensed as incurred. Replacements and betterments are
capitalized.
Depreciation expense for the fiscal years ended September 30, 1998, 1997 and
1996 was $7,383,000, $2,053,000 and $863,000.
The Company periodically evaluates its long-lived assets to confirm that the
carrying values have not been impaired using the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 121.
d. Intangible Assets--Intangible assets, consisting primarily of goodwill, are
amortized using the straight-line method over the following useful lives:
Organization costs................ 5 years
Licenses.......................... 5 years
Goodwill.......................... 5 years
The Company periodically evaluates its intangible assets to confirm that the
carrying values have not been impaired using the provisions of SFAS No. 121.
e. Income Taxes--FCI, LLC is a limited liability company and is not subject to
income tax, while Facilicom International, Inc., incorporated on November 20,
1997 as a Delaware corporation is subject to income taxes.
F-10
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company accounts for income taxes under the liability method in
accordance with the provisions set forth in SFAS No. 109, "Accounting for
Income Taxes," whereby deferred income taxes reflect the net tax effect of
temporary differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax
purposes. In assessing realization of deferred tax assets, the Company uses
judgment in considering the relative impact of negative and positive
evidence. The weight given to the potential effect of negative and positive
evidence is commensurate with the extent to which it can be objectively
verified. Based on the weight of evidence, both negative and positive,
including the lack of historical earnings, if it is more likely than not that
some portion or all of a deferred tax asset will not be realized, a valuation
allowance is established.
f. Initial and Excess Capital Contributions--Excess capital contributions were
the amounts of capital an owner had contributed in excess of the owner's
initial capital commitment. The owners were credited with a guaranteed return
through September 30, 1997 for the use of their capital, and profits and
losses were allocated, in accordance with the provisions in the FCI LLC
Limited Liability Company Agreement ("LLC Agreement").
The guaranteed return was calculated as simple interest at a rate per annum
equal to the lowest rate of interest available to AIT or any of its
affiliates from time-to-time under any of their respective existing credit
facilities. Upon liquidation of FCI LLC, allocations of annual net profits
are allocated first to the Class A and Class B owners to the extent required
to adjust capital accounts, then to the extent of cumulative net losses
previously allocated in accordance with certain capital contribution
priorities set forth in the LLC Agreement and thereafter 75% to Class A and
25% to Class B owners. Allocations of annual net losses are allocated to the
extent of cumulative net profits previously allocated and then to the extent
of owner's capital contributions and thereafter to the Class A owner. Net
losses allocated to the Class B owner may not cause such owner's account to
result in a deficit. The Company may make distributions after first paying
any unpaid guaranteed return and then in accordance with the owner's
respective capital contributions and thereafter 75% to the Class A owner and
25% to the Class B owner. Upon dissolution, the LLC Agreement provides for
liquidation of FCI LLC's assets and any distribution to owners will be in
accordance with the balance of their respective capital accounts. Following
distribution of assets, owners having a capital account with a deficit
balance shall be required to restore the account. The LLC Agreement provides
that FCI LLC shall terminate on December 31, 2025. In consideration of all
capital contributions made through September 30, 1997, the Class A and Class
B owners owned 15,390,000 and 3,610,000 membership interests in FCI LLC,
respectively, representing 81% and 19%, respectively, of such interests.
g. Foreign Currency Translation--For non-U.S. subsidiaries, the functional
currency is the local currency. Assets and liabilities of those operations
are translated into U.S. dollars using year-end exchange rates; income and
expenses are translated using the average exchange rates for the reporting
period. Translation adjustments are reported as a separate component of
capital accounts. Exchange losses and gains resulting from foreign currency
transactions are included in the results of operations based upon the
provisions of SFAS No. 52, "Foreign Currency Translation."
h. 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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
i. Revenue Recognition--The Company records revenues from the sale of
telecommunications services at the time of customer usage based upon minutes
of traffic processed at contractual fees. The Company has entered into, and
continues to enter into, operating agreements with telecommunications
carriers in several foreign countries under which international long distance
traffic is both delivered and received. Under these agreements, the foreign
carriers are contractually obligated to adhere to the policy of the FCC,
whereby traffic from the foreign country is routed to U.S. based
international carriers, such as the Company, in the same proportion as
traffic carried into the country. Mutually exchanged traffic between the
Company and foreign carriers is settled through a formal settlement policy at
an agreed upon rate which allows for the offsetting of receivables and
payables with the same carrier (settlement on a net basis). Although the
Company can reasonably estimate the revenue it will receive under the FCC's
proportional share policy, there is no guarantee
F-11
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
that the Company will receive return traffic and the Company is unable to
determine what impact changes in future settlement rates will have on net
payments made and revenue received. Accordingly, the Company does not record
this revenue until the service is provided and the minutes of traffic are
processed. The Company recognizes revenues from prepaid calling cards when
earned.
j. Cost of Revenue--Cost of revenue includes network costs which consist of
access, transport and termination costs. Such costs are recognized when
incurred in connection with the provision of telecommunication services,
including costs incurred under operating agreements.
k. Stock-Based Compensation--The Company accounts for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion (APBO") No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. Accordingly, compensation cost is measured as the
excess, if any, of the market price of the Company's stock at the date of
grant (determined by a valuation report) over the amount an employee must pay
to acquire the stock.
l. Financial Instruments--The Company has financial instruments, which include
cash and cash equivalents, marketable securities and long-term debt
obligations. The carrying values of these instruments in the balance sheets,
except for certain marketable securities and 10- 1/2% Senior Notes due 2008
(the "Notes") (see Note 4), approximated their fair market value. See Note 16
for disclosure of fair market value for marketable securities. The estimated
fair value of the Company's Notes at September 30, 1998 was $261.0 million
and was estimated using quoted market prices.
The fair values of the instruments were based upon quoted market prices of
the same or similar instruments or on the rate available to the Company for
instruments of similar maturities.
m. Fiber Optic Cable Arrangements--The Company obtains capacity on certain fiber
optic cables under three types of arrangements. The Indefeasible Right of Use
("IRU") basis provides the Company the right to use a fiber optic cable, with
most of the rights and duties of ownership, but without the right to control
or manage the facility and without any right to salvage or duty to dispose of
the cable at the end of its useful life. Because of this lack of control and
an IRU term approximates the estimated economic life of the asset, the
Company accounts for such leases as leased transmission and communications
equipment and as capital leases. The Minimum Assignable Ownership Units
("MAOU") basis provides the Company an ownership interest in the fiber optic
cable with certain rights to control and to manage the facility. Because of
the ownership features, the Company records these fiber optic cables as owned
transmission and communications equipment and as long-term debt. The Carrier
Lease Agreement basis involves a shorter term agreement which provides the
Company the right to use capacity on a cable but without any rights and
duties of ownership. The Company accounts for such leases as operating
leases.
n. Impact of Recently Issued Accounting Standards--In June 1997 the FASB issued
SFAS No. 130, "Reporting Comprehensive Income," which (i) establishes
standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains, and losses) in a full set of general-
purpose financial statements, and (ii) requires an enterprise to report a
total for comprehensive income in condensed financial statements of interim
periods. The statement is effective for fiscal years beginning after December
15, 1997. In June 1997 the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which establishes
standards for the way that public business enterprises report information
about operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. The statement is effective
for fiscal years beginning after December 15, 1997. In June 1998, the FASB
issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measuring those instruments at fair
value, with the potential effect on operations dependent upon certain
conditions being met. The statement is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. The implementation of such
standards is not expected to have a material impact on the Company's
financial position or results of operations, except for
F-12
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SFAS No. 133, for which the Company has not determined the impact on the
Company's financial position or results of operations.
o. Reclassifications--Certain amounts in the September 30, 1997 and 1996
consolidated financial statements have been reclassified to conform with the
presentation of the September 30, 1998 consolidated financial statements.
3. OPERATING DEFICIT AND MANAGEMENT'S PLANS
The Company had a net loss of approximately $46.6 million for the year ended
September 30, 1998. On January 28, 1998, the Company issued $300 million
aggregate principal amount of the Notes. The Company believes that the net
proceeds from the offering of the Notes, together with cash provided by
operating activities and vendor financing, will provide the Company with
sufficient capital to fund planned capital expenditures and anticipated losses
and to make interest payments on the Notes through at least September 30, 1999.
4. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-Term Debt--During 1997, FCI entered into an Equipment Loan and Security
Agreement with NTFC Capital Corporation ("NTFC") to finance up to $5,000,000 for
the purchase of transmission and communications equipment. Interest was payable
quarterly and was calculated based upon the London Interbank Offering Rate
("LIBOR") plus 4%. Quarterly principal payments were to commence on June 30,
1999. The loan was collateralized by the related equipment purchased under such
agreement. The Company used a portion of the proceeds from the offering of Notes
to pay off the indebtedness under the Equipment Loan and Security Agreement and
the agreement was terminated.
During 1995, FCI entered into an equipment financing agreement with Ericsson
I.F.S. to purchase certain equipment. The original agreement was amended and
restated on December 30, 1996, to increase the borrowing limit to $7,000,000 and
certain terms were further revised on June 12, 1997 and November 21, 1997.
Interest was calculated based upon LIBOR plus 4%. Quarterly principal payments
were to commence on June 30, 1998. The loan was collateralized by the related
equipment purchased under the financing agreement. The Company used a portion of
the proceeds from the offering of Notes to pay off the indebtedness under the
equipment financing agreement and the agreement was terminated.
On January 28, 1998, FCI issued $300 million aggregate principal amount of Notes
bearing interest at 10- 1/2% due 2008 pursuant to an Indenture (the "Offering").
The Notes are unsecured obligations of FCI and interest on the Notes is payable
semiannually in arrears on January 15 and July 15 of each year, commencing on
July 15, 1998.
The Notes are redeemable at the option of FCI, in whole or in part at any time
on or after January 15, 2003, at specified redemption prices plus accrued and
unpaid interest. In addition, at any time prior to January 15, 2001, FCI, may
redeem from time to time up to 35% of the originally issued aggregate principal
amount of the Notes at the specified redemption prices with the net cash
proceeds (as defined in the Indenture) of one or more public equity offerings.
In the event of a change in control of ownership of FCI, Inc., each holder of
the Notes has the right to require FCI, to purchase all or any of such holder's
Notes at a purchase price in cash equal to 101% of the aggregate principal
amount.
FCI used approximately $86.5 million of the proceeds from the Offering to
purchase investments consisting of U.S. Government Obligations, which are
pledged as security and restricted for the first six scheduled interest payments
on the Notes (see Note 16).
The Notes require maintenance of certain financial and nonfinancial covenants,
including limitations on additional indebtedness, restricted payments including
dividends, transactions with affiliates, liens and asset sales.
F-13
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Long-term debt at September 30, 1998 and 1997 consists of the following:
INTEREST RATE 1998 1997
----------------- ------------- -------------
Indenture notes, due 2008................................ 10.5% $300,000 $ --
NTFC debt................................................ LIBOR+4% -- 7,116
Ericsson debt............................................ LIBOR+4% -- 5,094
Cable capacity debt, due 2001............................ LIBOR+4.5% 740 1,134
Other.................................................... Various -- 699
-------- -------
Sub-total............................................ 300,740 14,043
Less: Current portion of long-term debt.................. (394) (1,043)
-------- -------
$300,346 $13,000
======== =======
The LIBOR rate was 5.3% and 5.8% on September 30, 1998 and 1997, respectively.
Capital Leases--The Company leases certain fiber optic cables under agreements
permitting the use of the cables over periods up to 25 years with payment
requirements over periods not exceeding five years. Payments are made quarterly
and interest is calculated at LIBOR plus 4% to 4.5%.
Future minimum payments on long-term debt and capital lease obligations at
September 30, 1998 are as follows (in thousands):
LONG-TERM CAPITAL
DEBT LEASES
----------- -----------
1999....................................................................... $ 394 $4,195
2000....................................................................... 346 4,065
2001....................................................................... -- 650
2002....................................................................... -- 221
2003....................................................................... -- --
Thereafter................................................................. 300,000 --
-------- ------
Total future minimum payments.............................................. $300,740 9,131
========
Less: Amount representing interest (using September 30, 1998 LIBOR rate)... (933)
------
$8,198
======
5. INCOME TAXES
At September 30, 1998, the Company has approximately $2.6 million of cumulative
net operating losses ("NOLs") to offset future U.S. federal taxable income and
approximately $25.3 million of NOLs to offset future foreign taxable income for
those subsidiaries taxed in foreign jurisdictions. The U.S. NOLs expire in
fifteen years, while the foreign NOLs do not expire. A valuation allowance was
established for the deferred assets related to the NOLs at September 30, 1998.
Deferred tax assets of approximately $3,130,000 at September 30, 1997 were
related to the NOL carryforwards of foreign subsidiaries taxed in foreign
jurisdictions totaling approximately $11,100,000. A valuation allowance was
established for the amount of deferred tax assets at September 30, 1997.
On December 22, 1997, the Company adopted a tax sharing agreement with AHI,
whereby the Company is obligated to file a consolidated federal income tax
return with AHI and subsidiaries. Under the Agreement, FCI is obligated to pay,
with certain exceptions, its share of the consolidated tax liability to AHI and
FCI will not be paid by AHI for tax benefits realized in the consolidated tax
return. At December 31, 1997, FCI had approximately $1,018,000 of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and amounts used for income tax purposes that amounted to
approximately $393,000 and was recorded as a deferred tax liability and deferred
income tax expense for the change in tax status for the year ended September 30,
1998.
F-14
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
From December 23, 1997 through September 30, 1998, the period after the change
in tax status, FCI recorded a tax benefit of $12.1 million based upon the
Company's losses expected to be utilized by AHI. The net benefit recorded was
passed through to AHI.
The components of loss before income taxes for the periods ended September 30,
1998, 1997 and 1996 are as follows (in thousands):
1998 1997 1996
-------- ------- ------
Domestic...................... $43,432 $ 6,978 $3,009
Foreign....................... 14,514 7,053 6,653
------- ------- ------
Total........................ $57,946 $14,031 $9,662
======= ======= ======
The components of the income tax provision for the years ended September 30,
1997 and 1996 are as follows (in thousands):
1997 1996
----------- -----------
Deferred tax asset-foreign NOLs......... $ 2,010 $ 1,120
Valuation allowance..................... (2,010) (1,120)
------- -------
$ -- $ --
======= =======
A reconciliation of the total tax benefit with the amount computed by applying
the statutory federal income tax rate to the loss before taxes for the year
ended September 30, 1998 is as follows (in thousands):
1998
--------
Loss applying statutory rate............... $19,700
Permanent differences...................... (3,693)
Foreign country taxes...................... (302)
Change in tax status....................... (393)
State taxes................................ 226
Valuation allowance........................ (4,187)
-------
Income tax benefit......................... $11,351
=======
There are no pro forma income tax amounts presented giving effect to the change
in tax status for the statements of operations presented as the Company would
have been a stand alone taxpaying entity and a valuation allowance would have
been established for any net deferred tax benefit related to net operating
losses.
The components of deferred tax assets and liabilities at September 30, 1998 and
1997 are as follows (in thousands):
1998 1997
-------- ---------
Deferred tax asset-foreign NOLs............ $ 7,718 $ --
Deferred tax asset-domestic NOLs........... 1,065 3,130
Property and equipment..................... 600 --
Stock-based compensation................... 2,522 --
Valuation allowance........................ (11,905) (3,130)
-------- ---------
$ -- $ --
========= =========
6. OPERATING LEASES
The Company leases office facilities and certain fiber optic cables and
switching facilities under noncancelable operating leases. Rental expense for
the fiscal years ended September 30, 1998, 1997, and 1996 was $21.9 million,
$4.7 million and $1.4 million, respectively, of which $19.2 million, $3.8
million and $1.1 million relates to fiber optic cable leases, which are
generally for less than one year.
F-15
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum lease payments under noncancelable operating leases as of
September 30, 1998 are as follows (in thousands):
1999........................................... $ 3,864
2000........................................... 3,733
2001........................................... 3,599
2002........................................... 3,247
2003........................................... 2,955
Thereafter..................................... 13,659
-------
Total.......................................... 31,057
Less: Subleases................................ (1,087)
-------
$29,970
=======
7. BORROWINGS FROM OWNERS
At September 30, 1996, the Company had outstanding interest-bearing working
capital advances from Armstrong totaling $1,549,000. On November 1, 1996, FCI
entered into a Convertible Line of Credit Agreement with Armstrong. The
outstanding advances were converted into borrowings under the line of credit
agreement. Under such agreement, FCI had a $15,000,000 credit facility of which
$5,000,000 was available in cash and $10,000,000 was available for letter of
credit needs. Armstrong had the right, at any time on or before October 31,
1999, to convert the entire principal amount of the cash loan into a maximum of
3.1% of additional ownership and convert the letter of credit balance
outstanding into a maximum additional 4.44% ownership. In 1997, Armstrong
converted the outstanding balance of $5,396,000 under the cash portion of the
agreement into an ownership interest.
At September 30, 1997, FCI had $10,000,000 for letter of credit needs of which
it had outstanding letters of credit of $6,136,000 under the Convertible Line of
Credit Agreement.
In 1997, FCI entered into a Bridge Loan Agreement with Armstrong in which FCI
could borrow up to $10,000,000. Interest was calculated based upon prime plus
1%. The prime rate was 8.5% at September 30, 1997. The loan was due on October
1, 1998. The outstanding balance at September 30, 1997 was $6,250,000. During
the year ended September 30, 1998, Armstrong converted the outstanding balance
of $6,250,000 into an ownership interest (see Note 1).
Additionally, as of September 30, 1996, FCI-Sweden had outstanding convertible
debentures in the amount of $480,000 to a minority stockholder of both FCI-
Sweden and FGC (the "Minority Stockholder"). Such convertible debentures accrued
interest at LIBOR plus 4%. Interest was payable annually on September 30, with
the full principal amount due on September 30, 2003. In December 1996, these
convertible debentures were assigned to FCI (see Note 8).
FCI's total interest expense under the above borrowings was $195,000, $462,000
and $26,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
8. OTHER RELATED PARTY TRANSACTIONS
As of September 30, 1996, FCI had an outstanding advance to the Minority
Stockholder of $499,000.
As of September 30, 1996, FCI and the Minority Stockholder held $1,120,000 and
$480,000, respectively, of FCI-Sweden debentures totaling $1,600,000 which
earned interest at LIBOR plus 4%. The holder of the debentures had the right to
convert the outstanding principal balance into FCI-Sweden common stock at a
predetermined price ranging from $200 to $250 per share.
On December 23, 1996, the Minority Stockholder assigned its right, title and
interest in the FCI-Sweden convertible debentures to FCI to satisfy the
outstanding advance due to FCI from the Minority Stockholder. On March 14, 1997,
FCI converted all of its FCI-Sweden convertible debentures into 7,400 shares of
FCI-Sweden common stock. On
F-16
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
May 15, 1997, FCI-Sweden issued 14,400 additional shares of common stock to FCI
for consideration of $3,600,000. Such transactions increased FCI's ownership in
FCI-Sweden to 89.6%.
In March 1996, Tele8 Kontakt, a subsidiary of FCI at that time, was awarded a
license agreement from the Swedish government for certain rights relating to
communications systems and technology. During October 1996, FCI distributed its
rights under such license agreement to its owners.
FCI has contracted with AHI, since its inception, for the performance of certain
services by AHI for FCI, including but not limited to financial accounting,
professional and billing services. In May 1998, an agreement was entered into
for such services. The agreement expires on September 30, 2002. Expenses
related to such contracted services of approximately $1.6 million, $439,000 and
$7,000 are included in the statements of operations for the years ended
September 30, 1998, 1997 and 1996, respectively.
The terms of the agreements include professional services billed at hourly
rates, check processing at an amount per check and data center services based on
usage and disk storage space. The Company believes that the terms of the
agreements are competitive with similar services offered in the industry.
As of September 30, 1998 an affiliate of AHI had issued letters of credits on
behalf of the Company totaling $9.4 million.
9. BENEFIT PLANS
Foreign Operations--Various foreign subsidiaries contribute to their respective
government pension funds, social insurance, medical insurance and unemployment
charters for their employees. The total contribution was $1.3 million, $781,000
and $563,000 for the years ended September 30, 1998, 1997 and 1996,
respectively.
401(k)--Employees of FCI may participate in a salary reduction (401(k) plan
administered by AHI. All contributions represent employee salary reductions.
10. CONCENTRATION OF RISK
Financial instruments that potentially subject the Company to concentration of
credit risk are accounts receivable. Four of the Company's customers accounted
for approximately 13.0% and 31.0% of gross accounts receivable as of September
30, 1998 and 1997, respectively. The Company performs on-going credit
evaluations of its customers and in certain circumstances requires collateral to
support customer receivables. However, many of the Company's customers,
including these four, are suppliers to whom the Company has accounts payable
that mitigate this risk.
In addition, the Company is dependent upon certain suppliers for the provision
of telecommunication services to its customers. The Company has not experienced,
and does not expect, any disruption of such services.
Approximately 24% and 41% of the Company's revenues for the years ended
September 30, 1997 and 1996, respectively, were derived from two customers each
with percentages in excess of 10%. No one customer represented 10% or more of
the Company's revenues for the year ended September 30, 1998.
11. COMMITMENTS
Equipment--At September 30, 1998, the Company had outstanding commitments to
purchase certain switching equipment for approximately $15 million.
In May 1998, the Company entered into a Memorandum of Understanding ("MOU") with
Qwest. The MOU incorporates agreements to provide Qwest with international
direct dial termination service to various destinations and provides the Company
an indefeasible right of use ("IRU") for domestic and international fiber optic
capacity. Deliveries of capacity under the IRU are expected by March 1999. The
IRU is for twenty-five years, for which the Company has agreed to pay $24
million over a three-year period, which includes a $4.8 million payment on the
F-17
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Ready For Service date, as defined in the agreement. In addition, during the
three-year period, Qwest has the right of first refusal pursuant to additional
capacity purchases made by the Company.
The Company has also entered into two agreements that provide the Company with
IRU's for international fiber optic capacity for Europe and the Pacific Rim.
Deliveries of the capacity under the agreements are expected prior to November
1999. The IRU's are for ten to fifteen years, for which the Company has agreed
to pay approximately $41.6 million through September 30, 2002, of which $2.5
million has already been paid as a deposit and an additional $24.1 million is
expected to be paid in the fiscal year ended September 30, 1999.
Subsequent to September 30, 1998, the Company agreed to acquire additional
capacity in Europe and Scandinavia for $8.6 million. Deliveries and payment of
the capacity under these agreements are expected by September 30, 1999.
12. CONTINGENCIES AND LITIGATION
The Company is involved in various claims and possible actions arising in the
normal course of its business. Although the ultimate outcome of these claims
cannot be ascertained at this time, it is the opinion of the Company's
management, based on its knowledge of the facts and advice of counsel, that the
resolution of such claims and actions will not have a material adverse effect on
the Company's financial condition or results of operations.
In August 1997, the Company entered into a settlement agreement relating to
litigation arising from a certain 1996 FCI-Sweden international telephone
services agreement and related billing, collection and factoring agreements with
third parties. For the fiscal year ended September 30, 1996, selling, general
and administrative expenses includes approximately $708,000 of losses relating
to the settlement of which $500,000 represents a reserve on advances, paid at
the time of the settlement agreement, on behalf of the telephone service
company. Under the settlement agreement all of the above amounts were paid to
fully satisfy any amounts which may be owing from the Company and the telephone
services company to a company under a factoring agreement. At the date of
settlement, the management of the Company believed the amounts advanced to the
telephone services company were uncollectible. The settlement agreement also
provides for the factoring company to assign to the Company any and all
receivable claims the factoring company may have against the billing and
collection agent ("Agent"). The Company filed a complaint against the Agent for
breach of contract and related claims pursuant to an agreement between the
Company and the Agent. The Agent placed in escrow the sum of $1,431,324. On May
8, 1998, the balance of the escrow account was distributed among various
entities. The Company received $791,000.
13. STOCK-BASED COMPENSATION
Through December 22, 1997, certain employees and directors were eligible to
participate in a Performance Unit Plan established by the Company, under which a
maximum of 1,254,000 units could have been granted. A unit is a right to receive
a cash payment equal to the excess of the fair market value of a unit on its
maturity date over the initial value of a unit. Fair market value of a unit as
determined by the management committee of the Company. At September 30, 1997 and
1996, 484,500 and 152,000 units had been granted, respectively. Participants
vested in their units over a period not to exceed two years and were entitled to
receive cash compensation equivalent to the value of the units at the time a
participant retires provided the participant had 10 years of continuous service
or, if earlier, upon the occurrence of certain events, including a change in
control of the Company. The Company accrued to expense over the participant's
service vesting period (10 years) amounts based on the value of the unit at year
end. Amounts charged to expense for this plan for the year ended September 30,
1997 was $288,000. No amounts were expensed in prior years.
On December 22, 1997, the Board of Directors adopted the 1997 Phantom Stock
Rights Plan (the "Phantom Stock Plan"). The Phantom Stock Plan provided for the
granting of phantom stock rights ("Phantom Shares") to certain directors,
officers and key employees of the Company and its subsidiaries. The total number
of Phantom Shares eligible for grant pursuant to the Phantom Stock Plan was
6,175, subject to adjustments for stock splits and stock dividends.
F-18
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
All of the units granted under the Company's Performance Unit Plan were
exchanged for equivalent phantom rights with equivalent terms under the new
phantom rights plan. Accordingly, 4,845 Phantom Shares had been granted of which
3,182 had vested. All of the provisions of the Phantom Stock Plan including
vesting, forfeiture and cash settlement mirror the provisions of the Company's
Performance Unit Plan.
On March 31, 1998, the Board of Directors adopted the FaciliCom International,
Inc. 1998 Stock Option Plan (the "1998 Stock Option Plan"). By resolution of the
Board of Directors on March 31, 1998, the Company's Certificate of Incorporation
was amended to create 25,000 shares of a non-voting class of common stock. At
September 30, 1998, the Company has 300,000 authorized shares, of which 275,000
are a voting class of common stock.
The 1998 Stock Option Plan provides for the grant of options to purchase shares
of the Company's non-voting common stock to certain directors, officers, key
employees and advisors of the Company. The aggregate number of options that may
be granted under the 1998 Stock Option Plan is 22,574 and no option may be
granted after March 31, 2008. No option is exercisable within the first six
months of grant and options expire after ten years.
Also on March 31, 1998, all of the Phantom Shares previously granted to
employees of the Company under the Company's Phantom Stock Plan were converted
to options under the 1998 Stock Option Plan, and the Company granted additional
options to purchase 6,448 shares of non-voting common stock to employees,
directors and advisors under the 1998 Stock Option Plan. The exchange of
employees' Phantom Shares for options resulted in additional compensation cost
for the incremental value of the new option amortized over the vesting period of
the option that is shorter than the service period of the Phantom Shares. Total
unrecognized compensation cost approximated $1,672,375 at time of conversion.
A summary of the stock option activity at September 30, 1998 is as follows:
OPTION SHARES OPTION SHARES OPTION SHARES OPTION SHARES
(EXERCISE PRICE (EXERCISE PRICE (EXERCISE PRICE (EXERCISE PRICE
$1) $263) $500) $1,000)
----------------- ------------------ ------------------ -------------------
Options granted March 31, 1998...... 9,918 670 705 --
Options granted June 1, 1998........ -- -- 30 --
Options granted July 1, 1998........ -- -- -- 200
----- --- --- ---
Options outstanding at September 30,
1998.............................. 9,918 670 735 200
===== === === ===
Options exercisable at September 30,
1998.............................. 9,490 380 -- --
===== === === ===
All of the options outstanding at September 30, 1998 have a 10-year life and an
option price range from $1.00 to $1,000 per option share. The options vest over
a period up to 5 years and at September 30, 1998 there were 8,826 options
granted that vested immediately. The Company recognized compensation cost of
$5,706,000 as of September 30, 1998 relating to options granted and recognized
compensation cost of $311,592 for the year ended September 30, 1998 relating to
the Company's Phantom Stock plan. For the year ended September 30, 1998
compensation cost includes $2,112,640 for 3,401 options with an exercise price
of $1.00 granted to certain non-employee directors and advisors related to
certain directors of the Company.
The fair value of options granted at September 30, 1998 was as follows:
OPTION FAIR
VALUE
OPTION SHARES AT DATE OF
EXERCISE PRICE GRANT
------------------- -----------
$ 1............. $640
$ 263............. $423
$ 500............. $306
$1,000............. $135
The fair value of the option grant is estimated on the date of grant using the
Black-Scholes option pricing model. The assumptions used in the Black-Scholes
model are: dividend yield 0%, volatility 30%, risk free interest rate of 6%,
assumed forfeiture rate of 0% and an expected life of 3 to 5 years.
F-19
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
If the Company would have recorded compensation cost for the Company's stock
option plan consistent with the fair value-based method of accounting prescribed
under SFAS No. 123 it would have had an immaterial effect on the net loss of the
Company for the fiscal year ended September 30, 1998.
On October 1, 1998, the Company granted options to purchase 1,702 shares at
exercise prices ranging from $1 to $950. The options vest over 1 to 5 years and
are exercisable for 10 years. Approximately $589,000 of compensation expense
will be recorded for the options.
14. VALUATION AND QUALIFYING ACCOUNTS
Activity in the Company's allowance accounts for the periods ended September 30,
1998, 1997 and 1996 were as follows (in thousands):
DOUBTFUL ACCOUNTS
-----------------------------------------------------------------------------------
ADDITIONS
-----------------
BALANCE AT BALANCE AT
BEGINNING OF CHARGED TO CHARGED TO END OF
PERIOD COSTS AND EXPENSE OTHER ACCOUNTS DEDUCTIONS PERIOD
----------------- ----------------- -------------- ---------- ------------
1996...... $ -- $ -- $ -- $ -- $ --
1997...... $ -- $1,263 $ -- $(1,102) $ 161
1998...... $ 161 $3,771 $745 $ (57) $4,620
DEFERRED TAX ASSET VALUATION
-----------------------------------------------------------------
BALANCE AT BALANCE AT
BEGINNING OF CHARGED TO END OF
PERIOD COSTS AND EXPENSE DEDUCTIONS PERIOD
----------------- ----------------- ---------- ------------
1996........ $ -- $ 1,120 $ -- $ 1,120
1997........ $ 1,120 $ 2,010 $ -- $ 3,130
1998........ $ 3,130 $ 8,221 $ -- $11,351
15. GEOGRAPHIC DATA
The Company operates as a provider of international long-distance
telecommunications services. The Company is a multinational company operating in
many countries including the United States, the United Kingdom, Sweden, Denmark,
France, Germany and The Netherlands. Sales between geographic areas represent
the providing of services through carrying and ultimately termination of
customer traffic originated in the other geographic area and are accounted for
based on established sales prices. In computing operating loss for foreign
operations, no allocations of certain general corporate expenses have been made.
Summary information with respect to the Company's geographic operations is as
follows:
YEARS ENDED SEPTEMBER 30,
-----------------------------------------
1998 1997 1996
------------ ------------ -----------
NET REVENUE
North America............ $ 142,126 $ 56,315 $ 8,363
Europe................... 112,392 24,187 7,347
Eliminations............. (70,272) (10,315) (3,819)
--------- -------- -------
Total................ $ 184,246 $ 70,187 $11,891
========= ======== =======
OPERATING LOSS
North America............ $ (29,553) $ (6,337) $(2,936)
Europe................... (14,333) (5,023) (6,640)
--------- -------- -------
Total................ $ (43,886) $(11,360) $(9,576)
========= ======== =======
ASSETS
North America............ $ 488,649 $ 25,035 $ 9,431
Europe................... 150,992 21,824 13,042
Eliminations . (260,757) (2,842) (1,465)
--------- -------- -------
Total................ $ 378,884 $ 44,017 $21,008
========= ======== =======
F-20
FACILICOM INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. MARKETABLE SECURITIES
In accordance with SFAS 115, the Company's debt securities are considered either
held-to-maturity or available-for-sale. Held-to-maturity securities represent
those securities that the Company has both the positive intent and the ability
to hold to maturity, and are carried at amortized cost. This classification
includes those securities purchased and pledged for payment of interest on the
Notes. Available-for-sale securities represent those securities that do not meet
that classification of held-to-maturity, are not actively traded and are carried
at fair value. Unrealized gains and losses on these securities are excluded from
earnings and are reported as a separate component of capital accounts until
realized.
The amortized cost and estimated fair value of the marketable securities are as
follows:
SEPTEMBER 30, 1998
------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAIN LOSS VALUE
------------ ------------ ------------ ---------
Held-to-Maturity (IN THOUSANDS)
U.S. Government Securities -------------
Maturing in 1 year or less.............. $ 31,394 $ 79 $ -- $ 31,473
Maturing between 1 and 3 years.......... 43,124 546 -- 43,670
-------- ---- ------------ --------
Total held-to-maturity....................... 74,518 625 -- 75,143
-------- ---- ------------ --------
Available-for-sale
Commercial paper........................ 6,887 -- -- 6,887
Government backed securities............ 31,787 24 -- 31,811
-------- ---- ------------ --------
Total available-for-sale..................... 38,674 24 -- 38,698
-------- ---- ------------ --------
Total marketable securities.................. $113,192 $649 $ -- $113,841
======== ==== ------------ ========
AS REPORTED SEPTEMBER 30, 1998 (IN THOUSANDS):
- -----------------------------------------------------
Current Assets:
Held-to-maturity (at amortized cost)................ $31,394
Available-for-sale (at fair value).................. 38,698
-------
Total current assets..................................... $70,092
=======
Noncurrent Assets:
Held-to-maturity (at amortized cost)................ $43,124
=======
Capital Accounts:
Holding gain on marketable securities............... $ 24
=======
F-21
Index to Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ---------- ------------------------------------------------------------------------------------------------------
3.1 Certificate of Incorporation of FaciliCom International, Inc. (1)
3.2 Certificate of Amendment of Incorporation of FaciliCom International, Inc. (1)
3.3 By-laws of FaciliCom International, Inc. (1)
4.1 Indenture between the Company and State Street Bank and Trust Company dated January 28, 1998 (1)
4.2 Form of Common Stock Certificate of FaciliCom International, Inc. (1)
10.1 Registration Rights Agreement between the Company, Lehman Brothers, Inc. and BT Alex. Brown
Incorporated dated January 28, 1998 (1)
10.2 FaciliCom International, Inc., 1997 Stock Option Plan No. 1 (1)
10.3 FaciliCom International, Inc., 1997 Stock Option Plan No. 2 (1)
10.4 FaciliCom International, Inc., 1997 Phantom Stock Rights Plan (1)
10.5 International Telecommunications Services Agreement between Fonetel Global Communications AB and
Telecom Finland International dated December 15, 1994 (1)
10.6 Service Agreements between Fonetel Global Communications AB and Nordnet OY dated January 26, 1995 (1)
10.7 Services Agreements between Fonetel Global Communications AB and Belgacom SA dated February 15, 1995
(1)
10.8 Services Agreement between Telenor Carrier Services A/S and Nordiska Tele8 AB dated November 14, 1995
(1)
10.9 Operating Agreement between Nordiska Tele8 AB and Portugal Telecom dated February 1, 1996 (1)
10.10 Operating Agreement between Deutsche Telekom AG and Tele8 Sweden dated May 28, 1996 (1)
10.11 Operating Agreement between Nordiska Tele8 AB and Eesti Telefon dated August 12, 1996 (1)
10.12 Memorandum of Understanding between Telekon Sloveniga and Nordiska Tele8 AB dated October 30, 1996 (1)
10.13 Services Agreement between Telecom Italia SpA and Nordiska Tele8 AB dated January 16, 1997 (1)
10.14 Agreement to Operate International Telecommunications between CANTV and FaciliCom International and
Between FaciliCom International L.L.C. and Compania Anonima Nacional de Telefonos de Venezuela dated
June 2, 1997 (1)
10.15 International Telecommunications Service Agreement between MATAV Rt--Hungary and Nordiska Tele8
AB--Sweden (1)
10.16 Agreement on Joint Traffic between TeleDanmark Als and Nordiska Tele8 dated December 18, 1997 (1)
10.17 Interconnect Agreement between Telia AB and Nordiska Tele8 AB (1)
10.18 Services Agreement between Armstrong Holdings, Inc. and FaciliCom International, L.L.C. (1)
10.19 FaciliCom International, Inc. 1998 Stock Option Plan (1)
10.20 Billing and MIS Services Agreement between Armstrong Holdings, Inc. and FaciliCom International,
L.L.C. dated July 1, 1997 (1)
10.21 Stock Purchase Agreement dated April 27, 1998 between FaciliCom International, L.L.C. and Oy
Teleykkonen AB (1)
12.1* Schedule of Earnings to Fixed Charges
21.1* Subsidiaries of Registrant
27.1* Financial Data Schedule
* Filed herewith.
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4 (File No. 333-48371), as amended.