AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 25, 1999
REGISTRATION NO.
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
COMMUNICATION TELESYSTEMS INTERNATIONAL
(Exact name of registrant as specified in its charter)
CALIFORNIA 4813 33-0466205
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
9999 WILLOW CREEK ROAD, SAN DIEGO, CALIFORNIA 92131 (800) 500-8972
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
ROGER B. ABBOTT
Chief Executive Officer
Communication TeleSystems International d/b/a
WORLDxCHANGE Communications
9999 Willow Creek Road
San Diego, California 92131
(800) 500-8972
(Name, address including zip code, and telephone number,
including area code, of agent for service)
------------------------
COPIES TO:
DAVID A. KRINSKY, ESQ. DOUGLAS L. GETTER, ESQ.
O'Melveny & Myers LLP Dewey Ballantine LLP
610 Newport Center Drive, Suite 1700 1301 Avenue of the Americas
Newport Beach, California 92660-6429 New York, NY 10019-6092
(949) 760-9600 (212) 259-8000
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
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If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
------------------------
CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM
TITLE OF EACH CLASS AGGREGATE AMOUNT OF
OF SECURITIES TO BE OFFERING REGISTRATION
REGISTERED PRICE(1)(2) FEE
Common Stock, no par value per share.................................................... $82,000,000 $22,796
(1) Includes shares subject to the underwriters' over-allotment option.
(2) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(o).
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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- --------------------------------------------------------------------------------
SUBJECT TO COMPLETION, DATED AUGUST 25, 1999
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PROSPECTUS
SHARES
WORLDxCHANGE COMMUNICATIONS
COMMON STOCK
------------------
This is an initial public offering of shares of common stock of
Communication TeleSystems International d/b/a WORLDxCHANGE Communications. No
public market currently exists for our common stock. We anticipate that the
initial public offering price will be between $ and $ per share.
------------------------
PRICE $ PER SHARE
------------------------
We have applied to list our common stock on the Nasdaq National Market.
NASDAQ NATIONAL MARKET SYMBOL--CALL
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 11.
PER SHARE TOTAL
----------- --------------
Public offering price............................................. $ $
Underwriting discount............................................. $ $
Proceeds, before expenses, to WORLDxCHANGE........................ $ $
Roger Abbott, our chief executive officer and a director, and Edward Soren,
our executive vice president and a director, have granted to the underwriters an
option to purchase up to an aggregate of additional shares to cover
over-allotments, if any.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
GERARD KLAUER MATTISON & CO., INC.
Prospectus dated , 1999
----------------------
TABLE OF CONTENTS
----------------------
PAGE
---------
Prospectus Summary......................................................................................... 3
Risk Factors............................................................................................... 11
Acquisition of Minority Interests in Subsidiaries.......................................................... 22
Use of Proceeds............................................................................................ 22
Dividend Policy............................................................................................ 22
Capitalization............................................................................................. 23
Dilution................................................................................................... 24
Selected Consolidated Financial Data....................................................................... 25
Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 27
Business................................................................................................... 39
Management................................................................................................. 82
Principal Shareholders..................................................................................... 90
Certain Relationships and Related Transactions............................................................. 92
Certain Indebtedness....................................................................................... 95
Description of Capital Stock............................................................................... 96
Shares Eligible for Future Sale............................................................................ 99
Underwriting............................................................................................... 101
Legal Matters.............................................................................................. 102
Experts.................................................................................................... 102
Additional Information..................................................................................... 103
Index to Consolidated Financial Statements................................................................. F-1
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING OUR COMPANY AND THE COMMON STOCK BEING SOLD IN THIS
OFFERING AND OUR FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN
THIS PROSPECTUS.
WORLDxCHANGE
We are a leading global telecommunications company that specializes in
providing high-quality, low-cost domestic and international telecommunications
services. We have established retail and wholesale operations in North America,
Europe and the Pacific Rim. Our global facilities include 40 switches located in
major metropolitan areas in 12 countries. Our network has been designed to give
us the ability to simultaneously carry voice and data. We connect our switches
with an extensive network of owned and leased undersea and land-based fiber
optic cables. Our revenues have grown from $184 million in fiscal 1996 to $332
million in fiscal 1997 to $399 million in fiscal 1998. According to the 1999
edition of Telegeography, in 1997 we were the 39th largest telecommunications
carrier of international minutes in the world and the fourth largest of the
non-monopoly or non-former monopoly carriers behind MCI WorldCom, Sprint and
Pacific Gateway Exchange.
We currently serve more than 750,000 residential and commercial retail
customers each month. Our services currently include international and domestic
long distance telephone service, post-paid and pre-paid calling card services,
operator services, Internet access and e-commerce services. We market these
services through direct mail, independent agents, direct sales and media
advertising. By the end of 1999, we intend to offer high-speed data networking
services through digital subscriber line, or DSL, technology to our customers in
North America, with service to European and Australian customers to follow.
We currently have established operations in the United States, Australia,
Canada, The Netherlands, New Zealand and the United Kingdom and have recently
obtained, or expect shortly to obtain, interconnection for our operations in
Belgium, Chile, France, Germany, Guatemala and Sweden, after which we plan to
expand our marketing efforts in these countries. We plan to establish operations
in El Salvador, Italy, Japan, Spain and Switzerland within the next 15 months.
We also plan to begin the installation and integration of Asynchronous Transfer
Mode, or ATM, switches across our global network to allow for the seamless
transport of voice, data and video.
OUR COMPETITIVE STRENGTHS
We believe we have positioned ourselves to compete successfully in the
domestic and international marketplace and have the following competitive
strengths:
ESTABLISHED GLOBAL COMMUNICATIONS NETWORK
We have established a worldwide telecommunications network that enables us
to carry calling traffic on a high-quality, cost-effective basis. This network
includes:
- 40 switches in 12 countries;
- ownership interests in 14 undersea cable systems, and long-term capacity
agreements, which are commonly referred to as "IRUs", in an additional 11
undersea cable systems, comprising in total over 340 E-1 circuits;
- IRUs in more than 25 million DS-0 miles of on-land fiber optic cable
capacity in the United States;
- seven satellite earth stations at locations in the United States and
abroad.
3
In addition, we have interconnection agreements in Australia, Belgium,
Canada, Chile, France, Germany, Guatemala, The Netherlands, New Zealand and the
United Kingdom.
WE HAVE A SEASONED MANAGEMENT TEAM WITH SIGNIFICANT OWNERSHIP
We have assembled a seasoned and aggressive management team. This team
includes our chairman, Walt Anderson, who founded Esprit Telecommunications, Mid
Atlantic Telecom, and Telco Communications and oversaw their growth until they
were acquired. Tom Cirrito, a director of our company, also founded several long
distance telecommunications carriers, including Telco Communications and Long
Distance Wholesale Club. Chris Bantoft, our president and a director, is a
former senior executive who was based in Europe with ACC Corp., an international
carrier that was recently acquired by AT&T. These individuals complement the
skills of our company's founder and chief executive officer, Roger Abbott, as
well as of our other senior executives, who have experience in management,
multinational sales and marketing, network operations and engineering, finance
and regulatory matters. Through corporate affiliates, Mr. Anderson and Mr.
Cirrito recently purchased a total of $120 million of our equity securities.
INNOVATIVE AND DIVERSE MARKETING STRATEGY
We use a variety of marketing channels to reach our customers. These
channels include direct mail, multilevel marketing, independent sales agents,
direct sales and media advertising. In October 1998, we introduced our
innovative "xPectations ML" multilevel marketing program. This program allows
participating representatives to earn commissions based on revenues we collect
from new pre-subscribed and dial-around long distance customers, as well as
Internet access and prepaid calling card customers that they sign up. In
addition, these representatives earn commissions based on revenues we collect
from customers signed up by other representatives that they recruit to the
program. We also use the Internet to provide on-line commission information and
accounting, call details, pre-approved advertising, marketing information and
alerts, chat rooms and on-line trouble reporting for program representatives. We
also provide program representatives with a Web site, which we host. This allows
our representatives to use a professionally designed Web site to market our
services while allowing us to retain control over the advertising content. We
have recruited more than 7,000 representatives into the xPectations ML program
since its introduction.
ADVANCED OPERATIONAL SYSTEMS
We have developed proprietary software and information systems that allow us
to manage our business using real-time information. We believe we are one of the
few companies with systems that provide management with daily network cost
information on a route-by-route basis, which enables us to calculate our
variable gross margins by type of service on a daily basis throughout the world.
We believe these analytical tools allow us to quickly identify new market growth
and cost-saving opportunities, as well as to manage our business effectively.
HIGH-QUALITY CUSTOMER CARE
We have developed an advanced customer care platform that enables us to
communicate with our customers over a variety of media, including the Internet.
We have engineered and designed call centers that incorporate access to our
customer information with real-time information dissemination and
trouble-shooting. The proprietary billing system that we use in our foreign
markets provides significant competitive advantages, such as integration with
our switching systems to provide instant account set-up and other benefits,
adaptability for pre-paid and post-paid calling card services, compatibility
with every currency and flexibility to implement appropriate rate and discount
plans as competitive conditions warrant.
4
OUR STRATEGY
Our objective is to position ourselves as a leading total solution provider
of high-quality, low cost communications services, including voice, data and
Internet protocol services. Our strategy for achieving this objective consists
of the following key elements:
EXPAND OUR NETWORK AND ENTER KEY NEW MARKETS
Within the next 15 months, we intend to initiate operations in five
additional countries. We recently began developing our European network
consisting of fiber optic lines to be constructed by us in selected cities,
long-term IRUs in dark fiber and in operational capacity owned by other
carriers, and leased capacity. We expect to decrease our transmission costs by
increasing the use of our network. It costs us less to carry calls over our
network than to do so over other carriers' networks, since our owned
transmission capacity entails fixed costs regardless of the volume of traffic
carried. In contrast, we pay per-minute charges to transmit calls over other
carriers' networks.
INTEGRATE BROADBAND CAPABILITIES INTO OUR NETWORK
We intend to expand the technological capability of our network. We plan to
incorporate into our network DSL multiplexing equipment for the end-user as well
as our central switching offices, which will enable us to provide high-speed,
local data network services. We also intend to install ATM switches in key
switching locations within our network, which will enable us to provide
integrated voice, data and video communications services.
EMPHASIZE OUR HIGHER MARGIN RETAIL BUSINESS
We intend to concentrate our future growth in the retail market segment
while continuing to sell excess network capacity to other carriers and wholesale
customers. We believe that the retail segment offers several advantages,
including:
- higher margins;
- higher barriers to entry because of the significant investments required
to develop sales, marketing and customer support;
- greater opportunities to bundle local, data and other value-added
services, such as DSL Internet access and e-commerce services;
- greater opportunities to increase name recognition and build brand
loyalty; and
- reduced concentration on large wholesale customers who have higher credit
and cancellation risks.
EXPAND OUR MARKETING PROGRAMS IN EXISTING AND NEW MARKETS
We believe that we have developed a cost-effective and successful marketing
platform. We believe that we can increase our retail sales by expanding our
marketing programs in existing markets and aggressively implementing them in new
foreign markets. We intend to emphasize our Internet, e-commerce and multi-level
marketing activities. For example, we intend to expand our recently introduced
"xPectations ML" multi-level marketing program both in the United States and
overseas.
EXPAND OUR INTERNET AND e-COMMERCE SERVICE OFFERINGS
We recently began offering Internet access services in several of the
countries in which we operate and intend to offer these services in other
markets in the near future. Our planned installation of DSL equipment on our
network will enable us to provide customers with continuously connected,
high-speed
5
Internet access. We provide an Internet-based billing and customer care platform
that allows our customers to sign up for our services and make changes to the
services they select, view their call data, generate customized billing reports,
and make billing and service inquiries. We also recently introduced our
e-commerce program in the United States by developing a user-friendly Web site
for the sale and recharge of prepaid calling cards. We intend to offer this
program in other markets, as well as to expand the range of our products and
services offered through the Internet.
PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES
To date we have achieved all of our growth internally. Although we intend to
continue to emphasize internal growth, we also plan to pursue strategic
acquisitions and alliances. We will seek to acquire or partner with
complementary companies that:
- will provide us with access to attractive new geographic markets;
- have an established customer base or marketing channels;
- have a complementary network; or
- have innovative telecommunications services or technologies.
LOCATION
Our principal executive offices are located at 9999 Willow Creek Road, San
Diego, California 92131. Our telephone number is (800) 576-7775. Our Web site
address is www.worldxchange.com. The information found on our Web site is not a
part of this prospectus.
6
THE OFFERING
Common stock offered by
WORLDxCHANGE................... shares
Common stock to be outstanding
after the offering............. shares(1)
Over-allotment option........... shares(2)
Use of proceeds................. We will receive net proceeds from the offering of
approximately $ million. We intend to use the net
proceeds to expand our sales and marketing activities,
expand our network, repay a portion of our indebtedness,
fund working capital and for general corporate purposes.
Dividend policy................. We do not, for the foreseeable future, intend to pay
dividends on our common stock. We plan to retain earnings,
if any, to pay dividends on our Series A Convertible
Preferred Stock, for use in the operation of our business
and to fund future growth. In addition, our credit
facility currently restricts the payment of dividends.
Risk factors.................... For a discussion of certain risks relating to our company,
its business and an investment in our common stock, see
"Risk Factors."
Proposed Nasdaq National Market
symbol......................... CALL
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(1) Based on the number of shares outstanding as of August 16, 1999. Includes
1,554,763 shares to be issued by us in connection with our planned
acquisition of minority interests in certain subsidiaries. See "Acquisition
of Minority Interests in Subsidiaries." Excludes:
- 7,000,000 shares of common stock reserved under our stock option plans, of
which 2,479,626 shares of common stock at a weighted average exercise
price of $ per share are covered by outstanding options;
- 1,194,095 shares of common stock issuable upon the exercise of options
granted by us outside of our stock option plans, with a weighted average
exercise price of $ per share;
- a total of shares of common stock issuable upon the exercise of
warrants outstanding or to be outstanding as of the closing of this
offering at a weighted average exercise price of $ per share; and
- 2,727,270 shares of common stock issuable upon the conversion of 30,000
shares of our Series A Convertible Preferred Stock.
See "Capitalization," "Management--1999 Stock Option Plan/Stock Issuance
Plan," "Description of Capital Stock--Preferred Stock--Series A Convertible
Preferred Stock" and "Underwriting."
(2) In the event the over-allotment option is exercised, Roger Abbott, our chief
executive officer and a director, and Edward Soren, our executive vice
president and a director, will sell a portion of their shares of our common
stock to cover the over-allotment option.
------------------------
OUR COMPANY'S LOGO AND CERTAIN TITLES AND LOGOS OF OUR COMPANY'S SERVICES
MENTIONED IN THIS PROSPECTUS ARE OUR COMPANY'S TRADEMARKS. EACH TRADEMARK, TRADE
NAME OR SERVICE MARK OF ANY OTHER COMPANY APPEARING IN THIS PROSPECTUS BELONGS
TO ITS HOLDER.
7
EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES:
- NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION;
- THE ISSUANCE OF A TOTAL OF 1,554,763 SHARES OF COMMON STOCK IN CONNECTION
WITH OUR PLANNED ACQUISITION OF MINORITY INTERESTS IN CERTAIN
SUBSIDIARIES; AND
- NO CONVERSION OF THE SERIES A CONVERTIBLE PREFERRED STOCK INTO OUR COMMON
STOCK.
SEE "ACQUISITION OF MINORITY INTERESTS IN SUBSIDIARIES" AND "DESCRIPTION OF
CAPITAL STOCK--PREFERRED STOCK--SERIES A CONVERTIBLE PREFERRED STOCK."
------------------------
This prospectus includes statistical data including Federal Communications
Commission and International Telecommunications Union data concerning the
telecommunications industry that we obtained from industry publications. These
publications generally indicate that they have obtained information from sources
that they believe are reliable, but that they do not guarantee the accuracy and
completeness of the information. Although we believe that these industry
publications are reliable, we have not independently verified their data. We
also have not sought the consent of any of these publications to refer to their
data in this prospectus.
8
SUMMARY CONSOLIDATED FINANCIAL DATA
The following table summarizes our financial data. The data presented in
this table are derived from the "Selected Consolidated Financial Data" and the
consolidated financial statements and notes which are included elsewhere in this
prospectus. You should read those sections for a further explanation of the
financial data summarized here.
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------------------------ -------------------------------
PRO FORMA PRO FORMA
--------- ---------
1996 1997 1998 1998(1) 1998 1999 1999(1)
--------- --------- --------- --------- --------- --------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues.......................... $ 183.9 $ 331.7 $ 398.9 $ 398.9 $ 301.0 $ 304.3 $ 304.3
Cost of services.................. 127.9 235.0 287.3 287.3 207.2 238.6 238.6
--------- --------- --------- --------- --------- --------- ---------
Gross profit...................... 56.0 96.7 111.6 111.6 93.8 65.7 65.7
Selling, general and
administrative.................. 64.5 113.5 115.0 115.0 81.2 88.4 88.4
Depreciation and amortization..... 7.0 8.7 12.3 12.9 8.9 12.4 12.8
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss)........... (15.5) (25.5) (15.7) (16.3) 3.7 (35.1) (35.5)
Interest expense.................. 5.7 8.7 11.9 11.9 8.6 12.5 12.5
Other expense, net................ 0.6 3.4 1.4 1.4 0.2 0.2 0.2
Minority interest................. (0.2) (0.5) (1.5) -- (1.1) (1.8) --
--------- --------- --------- --------- --------- --------- ---------
Net loss.......................... $ (21.6) $ (37.1) $ (27.5) $ (29.6) $ (4.0) $ (46.0) $ (48.2)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Basic and diluted net loss per
share........................... $ (0.78) $ (1.34) $ (0.99) $ (1.01) $ (0.15) $ (1.41) $ (1.41)
Shares used to compute basic and
diluted net loss per share...... 27.572 27.734 27.760 29.315 27.734 32.696 34.251
OTHER DATA:
EBITDA(2)......................... $ (8.5) $ (16.8) $ (3.4) $ (3.4) $ 12.6 $ (22.7) $ (22.7)
Net cash provided by (used in)
operating activities............ 7.6 (7.2) (31.7) (31.7) (28.0) (4.5) (4.5)
Capital expenditures.............. 8.7 19.4 22.4 22.4 14.2 57.8 57.8
GEOGRAPHIC DATA:
Revenues:
North America................... $ 171.4 $ 291.7 $ 321.8 $ 321.8 $ 244.9 $ 238.0 $ 238.0
Pacific Rim..................... 7.5 24.4 58.4 58.4 43.5 43.0 43.0
Europe.......................... 5.0 15.6 18.7 18.7 12.6 23.3 23.3
--------- --------- --------- --------- --------- --------- ---------
Total......................... $ 183.9 $ 331.7 $ 398.9 $ 398.9 $ 301.0 $ 304.3 $ 304.3
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
(FOOTNOTES ON NEXT PAGE)
9
AS OF JUNE 30, 1999
-------------------------------------
PRO FORMA
PRO AS
ACTUAL FORMA(3) ADJUSTED(4)
--------- ----------- -------------
BALANCE SHEET DATA:
Cash and cash equivalents.................................... $ 38.2 $ 68.2 $
Intangible assets............................................ 2.1 13.7 13.7
Total assets................................................. 199.7 241.3
Current portion of long-term debt and capital lease
obligations................................................ 17.0 17.0
Long-term debt and capital lease obligations, net of current
portion.................................................... 112.4 112.4
Minority interest............................................ 5.5 -- --
Total shareholders' equity (deficit)......................... (64.2) (17.1)
- ------------------------
(1) The pro forma Statement of Operations Data gives effect to:
- the amortization of a portion of the newly created intangible assets
resulting from the planned acquisition of minority interests in certain
subsidiaries. See "Acquisition of Minority Interests in Subsidiaries." The
amortization was based upon an estimated useful life of 20 years.
- the removal of losses previously allocated to the minority interest
holders in certain subsidiaries.
(2) EBITDA represents operating income (loss) plus depreciation and amortization
expense.
(3) The pro forma Balance Sheet Data give effect to:
- the issuance of 1,554,763 shares of common stock by us for the planned
acquisition of minority interests in certain subsidiaries, generating the
following adjustments:
-- the creation of an intangible asset in the amount of $11.6 million,
representing the excess value of the stock issued over the minority
interest recorded in the financial statements; and
-- the elimination of the minority interest in these subsidiaries.
- the planned issuance of 30,000 shares of our Series A Convertible
Preferred Stock at a price of $1,000 per share convertible into 2,727,270
shares of common stock.
(4) The pro forma as adjusted data gives effect to the pro forma adjustments
noted above and to this offering.
10
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN
INVESTMENT DECISION. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE HARMED. IN SUCH CASE, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF
YOUR INVESTMENT.
THE CHALLENGES INHERENT IN GROWING OUR BUSINESS ARE DIFFICULT AND SUCCESS IS
UNCERTAIN
We have aggressive growth plans, particularly in Europe and other foreign
markets in which we have no or limited operating experience. We expect that the
return to our shareholders will depend greatly on our ability to grow our
business. To successfully implement our growth plans, we will need to:
- successfully implement our marketing strategies;
- continue the development, expansion and integration of our network,
including the planned construction of our own European fiber optic
network;
- successfully manage the strain on our financial and management resources
should we continue to grow;
- obtain satisfactory and cost-effective ownership interests and lease
rights from, and establish interconnection arrangements with, competitors
that own transmission lines (in certain cases, intra-national transmission
lines may be available only from dominant local carriers);
- hire, retain and motivate highly productive sales personnel and
independent sales representatives;
- continue to expand and develop our billing and information systems,
switching systems, and technical support, customer service and other
back-office capacity;
- enhance and expand our service features and offerings;
- continue to attract and hire experienced corporate professionals; and
- recognize and capitalize on opportunities in foreign markets.
If we are unable to successfully manage any one or more of the above
challenges, our business could be harmed and the price of our common stock could
be depressed.
WE WILL FACE CHALLENGES AND RISKS IN EXPANDING AND OPERATING OUR NETWORK
Our success is dependent, in part, on our ability to continue to expand our
network and to keep the network functioning properly and reliably. We intend to
install DSL and ATM equipment across our network. We also plan to continue
developing a European network and to install switching equipment in selected
cities in El Salvador, Italy, Japan, Spain and Switzerland over the next 15
months. As we expand our network, we will face increasing challenges, including:
- managing the construction of new fiber optic cable routes in a
cost-effective manner, including obtaining required rights-of-way and
construction licenses and timely completing the construction within our
budget;
- managing the acquisition and integration of DSL and ATM equipment into our
network in a cost-effective manner;
- increasing network traffic volume; and
- selling capacity on our network.
If we experience construction delays, we will not be able to begin carrying
increased traffic over our own network as planned, which will impair our ability
to improve our gross margins. Furthermore, our ability to sell IRUs or capacity
to other carriers would be adversely affected by construction delays. See
"Business--The WORLDxCHANGE Network--European Network--Network Expansion."
The telecommunications industry is experiencing significant technological
change. In order to remain competitive, we believe it will be
11
necessary for us to acquire and incorporate new and emerging technologies into
our network in the future. Integrating such new technologies into our system
could increase the risk of system failure and result in further strain on our
network. Moreover, there is no assurance that we will be able to afford any new
technology that becomes available in the future. See "--The Costs of Expanding
Our Business Will Be Significant; We Will Need Additional Capital to Complete
the Build-out of Our European Network" and "--We Have a Limited Operating
History and May Not Be Successful in Implementing Our Business Plan; We Have Had
Historical Losses and Expect to Have Future Losses." Further, integration of
such new and emerging technological changes into our network may create
regulatory consequences that we cannot, at this time, anticipate.
We face risks in operating our network that are beyond our control. These
risks include:
- the risk that our network hardware and/or software will be damaged as a
result of fire or natural disasters, such as earthquakes;
- the risk of power losses;
- the risk of general transmission failures caused by cable cuts, switch
failures and other factors; and
- the risk that new technology could make our network obsolete or
non-competitive.
From time to time in the past we have experienced network failures or
disruptions. We attempt to minimize customer inconvenience in the event of a
network disruption by routing traffic to other circuits and switches that may be
owned by other carriers. Such re-routing increases our transmission costs and
may not always be possible. If our operations are significantly interrupted by
any network failure, our business could be harmed and the price of our common
stock could be depressed.
WE WILL FACE CHALLENGES AND RISKS IN IMPLEMENTING OUR DSL STRATEGY
The implementation of our strategy of becoming a DSL service provider will
entail significant challenges and risks. Historically, we have derived a
substantial portion of our revenue from customers who are not obligated to
purchase any minimum volume of service and who do not need to make any up-front
cash investment to use our service. In contrast, our DSL customers will need to
pre-subscribe to this service at a fixed monthly rate and will be required to
pay up-front installation and other fees and costs, which could total several
hundred dollars or more. There can be no assurance that we will be successful in
attracting our existing or prospective customers to make the financial
commitment associated with DSL service. In addition, we do not have experience
in marketing or implementing DSL service, and there can be no assurance that we
will be successful in doing so.
WE OPERATE INTERNATIONALLY AND AS SUCH FACE ADDITIONAL RISKS
We are subject to risks inherent in conducting business internationally,
which could require us to modify our operations in international markets, harm
our international business and depress the price of our common stock. For the
years ended September 30, 1996, 1997 and 1998, international revenue, including
Canada, represented 8%, 13% and 20% of our total revenues, respectively. Revenue
from our international operations continues to increase as a percentage of total
revenue. Risks relating to conducting business internationally include:
- unexpected changes in regulatory requirements, tariffs, customs, duties
and other trade barriers;
- difficulties in staffing and managing foreign operations;
- political risks;
- technology export and import restrictions or prohibitions;
- delays from customs brokers or government agencies;
- seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world; and
12
- potentially adverse tax consequences resulting from operating in multiple
jurisdictions with different tax laws.
A substantial portion of our revenues are denominated in non-U.S.
currencies. We expect that an increasing percentage of our revenues will be
denominated in non-U.S. currencies, while a disproportionate portion of our
expenses, including interest and principal on our indebtedness, will continue to
be denominated in U.S. dollars. We currently do not use foreign exchange
contracts to hedge our foreign currency exposure and therefore we are exposed to
fluctuations in the rate of exchange between foreign currencies and the U.S.
dollar. If these fluctuations are or become significant, our business could be
harmed and the price of our common stock could be depressed.
WE REQUIRE LOCAL CONNECTIVITY, WHICH IS OFTEN DIFFICULT TO OBTAIN, IN ORDER TO
COMPETE COST-EFFECTIVELY IN OUR OVERSEAS MARKETS
Monopolies or former monopolies own the only line to substantially all of
the telephones in nearly all of the overseas markets in which we operate.
Therefore, we need to interconnect with these dominant local carriers in order
to cost effectively provide service in the geographic markets where we operate.
In order to achieve local connectivity with the dominant local carrier in a
particular geographic market, we must:
- negotiate and execute an interconnection agreement with the dominant local
carrier; and
- implement the interconnection agreement by ordering lines from the
dominant local carrier and conducting required interconnection testing in
order to satisfy the dominant local carrier that we have properly tied our
network into its network.
Interconnection availability and rates are determined on a
country-by-country basis. If these rates were to increase, our margins could
shrink. In continental Europe, the dominant local carriers, which are our
primary competitors, have only recently begun providing interconnection to other
carriers and in many cases have delayed doing so.
Interconnection agreements with the dominant local carriers typically
facilitate our ability to obtain more favorable access and termination rates for
the origination and termination of traffic and other benefits, such as the
ability to offer customers abbreviated dialing. Because of these advantages,
interconnection with the dominant local carrier is effectively a prerequisite to
offering cost-effective services to customers in local markets. We cannot be
certain that we will be able to maintain any of our interconnections, obtain
additional interconnection in cities where we currently operate, which would
increase our ability to handle larger traffic volumes or additional types of
traffic or services, or obtain interconnection in additional cities, in each
case on acceptable terms, on a timely basis or at all. If we are unable to
obtain or maintain interconnection on commercially acceptable terms,
particularly in key markets, our business could be harmed and the price of our
common stock could be depressed.
THE COSTS OF EXPANDING OUR BUSINESS WILL BE SIGNIFICANT; WE WILL NEED ADDITIONAL
CAPITAL TO COMPLETE THE BUILD-OUT OF OUR EUROPEAN NETWORK
During the next 12 months, we plan to spend approximately $140 million for
capital expenditures, including the planned development of our fiber optic
network in Europe and acquisition of DSL, ATM and other network equipment. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation--Liquidity and Capital Resources," "Business--The WORLDxCHANGE
Network-- Development of Broadband Network Capabilities" and "Business--The
WORLDxCHANGE Network--European Network--Network Expansion." Our actual capital
expenditures may be significantly higher than we currently anticipate,
particularly if we perceive opportunities to acquire additional transmission
capacity on attractive terms.
We also expect to incur substantially greater sales and customer care
expenses as we increase
13
our customer base. We plan to expand our existing marketing programs and to hire
additional internal sales personnel. These initiatives will be costly and may
negatively affect our operating results.
We will need to finance our expansion costs and capital expenditures through
capital lease and vendor financing and by issuing additional debt or equity
securities. The issuance of debt would increase our interest expenses and could
be accompanied by additional restrictive covenants. The issuance of equity would
dilute our shareholders' ownership interests in our company. There can be no
assurance that we will be able to obtain additional financing on favorable terms
or at all. If we are unsuccessful in obtaining additional financing, we would be
forced to delay or curtail our planned network expansion and would not be able
to take advantage of the expected benefits of having our own European fiber
optic network.
WE HAVE MANY COMPETITORS WHO ENJOY SIGNIFICANT COMPETITIVE ADVANTAGES OVER US
The markets for our services are extremely competitive, and we expect
competition to continue to intensify. We believe that competition in our
overseas markets will become as intense as competition in the United States.
Our larger competitors include AT&T, MCI WorldCom, Sprint, Telstra, KPN
Telecom, British Telecom, Deutsche Telekom, France Telecom and Belgacom. All of
these competitors, and many other competitors, have larger networks than we do
and control a greater portion of their transmission lines, which gives these
competitors significant cost advantages over us. Many of our competitors
currently offer customers additional services that we do not provide as part of
an integrated package of services. In addition, many of our competitors,
including the dominant local carriers in many of our markets, have long-standing
relationships with our target customers and the regulators in local markets, and
many already have universal name recognition.
We also expect to face new competition from the Regional Bell Operating
Companies (RBOCs), the principal U.S. local telephone companies, for long
distance and Internet access services, such as DSL service, to their customers
in the RBOCs' "in region" service areas in the United States. RBOCs would have
significant competitive advantages, including substantial name recognition and
established customer relationships. RBOCs will have a cost advantage over us and
other competitors, since they are established local carriers.
Providers using new or different technologies and/or transmission methods
may also compete with us. These competitors include Internet service providers,
cable television companies, wireless telephone companies, satellite owners and
resellers, electric and other utilities, railways, microwave carriers and large
end users that have private networks. Technological advances may enable one or
more of them to provide competitive services on attractive terms.
WE ARE SUBJECT TO SIGNIFICANT REGULATORY RESTRICTIONS
The jurisdictions in which we operate impose varying degrees and kinds of
regulation on us. We cannot assure you that future regulatory, judicial and
legislative changes will not harm our business or that domestic or international
regulators or third parties will not raise material issues with respect to our
compliance with applicable regulations.
In the United States, the following federal and state regulatory matters
affect our business:
- Our ability to terminate international long distance calls for other
carriers and to have our international long distance calls terminated by
other carriers is subject to regulation;
- We operate under tariffs providing for the rates, terms and conditions
applicable to our services. The requirement that we file tariffs could be
subject to modification or elimination, in which case we would have to
secure contractual arrangements with each of our customers. Such a change
could hinder our ability to collect our accounts receivable, increase our
overall bad debt losses and collection expenses
14
and increase our exposure to damage claims;
- We are required to make universal service fund and other contributions on
both the federal and state levels and to pay compensation to the owners of
payphones, the amount and timing of which are subject to change;
- We are required to pay access charges to local telephone companies to
originate and terminate most interexchange or long distance calls, which
account for a significant portion of our costs and are subject to change.
See "Business-- Regulation";
- We are subject to federal and state regulations prohibiting carriers from
changing a customer's service without the customer's permission. As a
result of its finding that we had violated these regulations during
periods prior to March 1996, the California Public Utilities Commission
revoked our license to provide intrastate telecommunications services in
California and imposed a substantial fine on us. See "Business-- Legal
Proceedings";
- We are subject to consumer protection and marketing regulations, including
regulations concerning the use of customer proprietary network information
in cross-marketing efforts; and
- We are subject to regulations relating to the provision of Internet
access. See "Business--Regulation--United States-- Internet Regulation".
- We are subject to state and federal interpretations of the
Telecommunications Act of 1996 applicable to inter-carrier compensation
for Internet-bound traffic, which are currently in a state of flux. See
"Business Regulation--United States-- FCC Domestic Interstate Regulation."
In Europe, the following regulatory matters affect our business:
- European Union (EU) directives have mandated competition;
- EU directives must be implemented on a national level, and such national
legislation is variable and subject to delay;
- EU directives impose requirements relating to data protection and customer
privacy; and
- We are subject to regulations concerning temporary license and/or
interconnection matters.
In the Pacific Rim, our business is affected by the following regulatory
matters:
- We are subject to various Australian state and federal laws, including
consumer protection and competition legislation and legislation that
regulates the provision of and access to telephony services and
infrastructure;
- We are required to pay interconnection charges to carriers to originate
and terminate calls in Australia;
- Our Australian operations may develop in a manner that would require us to
obtain a carrier license. The acquisition of a carrier license would
result in increased regulatory obligations, including the obligation to
pay universal service fees.
- Potential changes to the Commerce Act 1986 in New Zealand that could
restrict trade practices that have the effect of reducing competition in
the telecommunications market.
In Canada, the following regulatory matters affect our business:
- The new requirement that international carriers and resellers be licensed
by the Canadian Radio-television and Telecommunications Commission (CRTC);
- CRTC license requirements relating to such matters as anti-competitive
conduct and consumer safeguards;
- The CRTC regime of contribution charges (which are similar to access
charges in the United States) with its associated traffic reporting
requirements; and
15
- Canadian government regulations restricting foreign ownership and control
of facilities-based carriers operating in Canada.
See "Business--Regulation" for a discussion of these and certain other
regulatory risks and considerations relevant to our business.
INTERNATIONAL CALLING PRICES ARE DECLINING
We compete for customers based primarily on price. Prevailing prices for
international long distance services are declining worldwide. These price
declines are due to a number of factors, including increased competition,
particularly from the dominant local carriers and other carriers with
substantial transmission networks and significant resulting cost advantages, and
the erosion of the traditional pricing system for international long distance
services. See "Business--The WORLDxCHANGE Network-- Costs of Call Origination,
Transmission and Termination." We have no control over the prices set by our
competitors, and when our competitors reduce their prices, we generally reduce
our prices. Many dominant local carriers that had long enjoyed monopoly or
near-monopoly pricing are substantially reducing their retail prices to protect
market share and discourage competition. See "Business-- Competition." If
calling prices continue to drop and are not offset by a substantial increase in
our calling traffic or charges for additional services, or a decrease in our
costs, we will experience shrinking revenues and gross margins, which will harm
our business and depress the price of our common stock.
IF OUR INFORMATION SYSTEMS WERE TO FAIL, OUR ABILITY TO BILL OUR CUSTOMERS AND
MANAGE OUR OPERATIONS COULD BE HARMED
We rely heavily on our information systems to record and process large
amounts of data quickly and accurately and to bill our customers. If our
customer base continues to increase, we may need to make investments in new and
upgraded information systems. We may encounter difficulties in integrating any
revised or upgraded hardware, software and equipment technology that our
suppliers may develop or use. Our business could be harmed and the price of our
common stock could be depressed if we encounter delays or cost-overruns or
suffer adverse consequences in implementing these systems. We have previously
experienced problems with certain of our information systems. Should we
experience additional problems with our billing and information systems in the
future, our business could be harmed and our results of operations could be
depressed. See "Business--The WORLDxCHANGE Network--Network Hardware and
Software."
WE FACE YEAR 2000 TECHNOLOGY RISKS
Year 2000 issues could harm our business and depress the price of our common
stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-- Year 2000 Computer Issues" for a discussion of these
risks.
WE HAVE A LIMITED OPERATING HISTORY AND MAY NOT BE SUCCESSFUL IN IMPLEMENTING
OUR BUSINESS PLAN; WE HAVE HAD HISTORICAL LOSSES AND EXPECT TO HAVE FUTURE
LOSSES
We have a limited operating history. Although we were founded in 1991, we
conducted only minimal business before 1993, and we have only been providing
most of our current services in most of our current markets since 1996 or later.
We have recently introduced or intend to introduce new services and features,
including enhanced services such as Internet access services and e-commerce
services and high-speed data access, which we have not historically offered to
any significant extent. As a result of our limited operating history and
experience, it will be difficult to accurately predict our revenues or results
of operations. This may result in one or more future quarters where our
financial results may fall below the expectations of analysts and investors,
which could cause the price of our common stock to be depressed.
Although we have achieved substantial revenue growth, we have experienced
net losses for each fiscal year since our inception. For the nine months ended
June 30, 1999, we had a net loss of $46.0 million, negative EBITDA of $22.7
million, and net cash used in operating
16
activities was $4.5 million. In addition, as of June 30, 1999, we had total
consolidated indebtedness of $129.4 million. We expect to have net losses
through at least fiscal 2002 and cannot be certain that we will ever have
profits or be able to repay principal and interest on money that we have
borrowed. Our failure to achieve profitability could depress the price of our
common stock.
WE ARE SUBJECT TO CERTAIN RESTRICTIONS UNDER OUR DEBT OBLIGATIONS
The legal documents governing our credit facility contain financial
covenants, as well as restrictive covenants that impose limitations on our
ability and the ability of certain of our subsidiaries to:
- incur additional debt or guarantee debt;
- pay dividends and make other distributions;
- create liens on our property and that of certain of our subsidiaries;
- enter into transactions out of the ordinary course of business;
- prepay outstanding indebtedness;
- enter into transactions resulting in a change of control of our company;
- make capital expenditures or advances to our foreign subsidiaries beyond
specified limits; and
- make certain investments.
These restrictions could prevent us from taking actions that may prove to be
beneficial to shareholders or to our business. In addition, we are required to
use 35% of the net proceeds of this and any future common stock offerings to
repay our junior debt obligations. See "Certain Indebtedness."
WE FACE RISKS RELATING TO CARRIER AND OTHER WHOLESALE CUSTOMERS
Our sales of transmission capacity to other carriers accounted for 45% of
our consolidated net revenues for the nine months ended June 30, 1999, as
compared to 42% for the fiscal year ended September 30, 1998. Carrier customers
generally are extremely price sensitive. They often move their traffic from
carrier to carrier based solely on small price changes, which may occur daily.
As a result, margins from carrier revenues are usually very small. Moreover, we
believe that carrier customers, particularly our smaller carrier customers, pose
a higher credit risk on average than that posed by our retail customers as a
whole. We have established credit criteria to address this risk, and we maintain
an allowance for doubtful accounts receivable. However, we cannot be certain
that these measures will adequately protect us against our credit risks.
IF WE ARE UNABLE TO OBTAIN OR IF WE INACCURATELY ESTIMATE REQUIRED TRANSMISSION
CAPACITY, OUR COSTS WILL INCREASE AND OUR COMPETITIVE POSITION WILL BE HARMED
Nearly all of our communications are carried on transmission lines. Our
practice to date has been either to purchase ownership interests or IRUs in
transmission lines or to lease the transmission capacity of another carrier or
consortium of carriers, or to lease transmission capacity on a short-term basis.
When we negotiate purchase and lease arrangements, we must estimate the future
supply and demand for transmission capacity, as well as our customer calling
patterns and traffic levels. We could suffer competitive disadvantages if we
base our acquisitions of transmission capacity on inaccurate projections.
In many of our markets outside of the United States, dominant local carriers
are the only significant providers of transmission facilities. In these
countries, carriers with a monopoly or near-monopoly position may provide lease
transmission capacity at artificially high rates. In some areas, dominant local
carriers may not be required by law to provide us with transmission capacity at
all. Even when dominant local carriers are required by law to provide
transmission capacity to other carriers, we and other private carriers have
often experienced substantial delays in negotiating leases or other transmission
arrangements. If we were unable to obtain sufficient transmission capacity, we
would be forced to attempt to use the networks of other carriers at increased
cost (if available at all), which would harm our
17
business and depress the price of our common stock.
WE OBTAIN MOST OF OUR NETWORK EQUIPMENT FROM ONE SUPPLIER
We purchase a significant portion of our switching equipment from Siemens
AG. Siemens also provides a substantial portion of our technical support for
this equipment. In addition, Siemens may from time to time introduce software
and hardware upgrades, which increase the efficiency and/or features of our
switching equipment. These upgrades frequently can be purchased only directly
from Siemens. We cannot be certain that, as we expand our network, we will be
able to acquire the necessary Siemens equipment or compatible equipment. If we
are unable to do so on a timely basis or at a reasonable price or at all, we may
experience delays, operational problems or increased expenses, any of which
could harm our business and the price of our common stock. See "Business--The
WORLDxCHANGE Network-- Network Hardware and Software."
IF WE LOSE THE SERVICES OF OUR KEY PERSONNEL, OUR OPERATIONS COULD BE HARMED
Our success is substantially dependent upon the continued services of the
key members of our management. We are highly dependent upon Roger Abbott, our
chief executive officer and a director, and Christopher Bantoft, our president
and a director. In addition, Walt Anderson, the chairman of our board of
directors, has made important contributions to the strategic direction of our
company and has facilitated recent access to outside capital. If we were to lose
the services of Mr. Abbott, Mr. Bantoft, Mr. Anderson or any of the other
members of our senior management team, our business could be harmed and the
price of our common stock could be depressed.
We are also highly dependent upon the efforts and contributions of our other
key managerial and highly skilled employees. These employees are in great
demand. We cannot be certain that we will be able to retain them or that we will
be able to attract, integrate or retain these kinds of employees in the future.
Our inability to do so could harm our business and depress the price of our
common stock.
WE RELY ON THIRD PARTY SELLERS
We expect to sell an increasing portion of our services through indirect
distribution channels, including independent sales representatives, distributors
and, to a lesser extent, resellers. We do not have control over these third
party sellers or their agents and employees. Therefore, we cannot be certain
that they will perform well for us or that their interests will be aligned with
ours. In addition, we could lose the services of our third party sellers at any
time and without notice. For example, our competitors may attract our third
party sellers with financial and other incentives to leave us and go to work for
our competitors. If our third party sellers fail to perform well or terminate
their business relationships with us, our business could be harmed and the price
of our common stock could be depressed.
In addition, recent European Union regulations pertaining to commercial
agents provide sales agents with far greater protection than under prior
legislation. These recent regulations could require us to pay significant
termination payments to our third party sellers in the event we have any
disputes with them.
WE MAY HAVE TROUBLE MAINTAINING OUR CUSTOMER BASE
We derive a substantial portion of our revenues from customers who are not
obligated to purchase any minimum volume of service and may discontinue our
service, without penalty, at any time. We believe that most of our customers
perceive telecommunications providers to be relatively fungible and are
therefore highly price sensitive. In addition to price competition, we also
compete for our customers based on technological advances, marketing programs,
billing functions and quality of service. As a result, we face a relatively high
customer turnover rate. This, in turn, makes us vulnerable to significant
fluctuations in the timing and amount of our revenues. If we lose a significant
portion of our customers and are unable to replace them with other customers,
our business
18
would be harmed and the price of our common stock would be depressed.
OUR PRINCIPAL SHAREHOLDERS COULD HAVE SIGNIFICANT INFLUENCE OVER OUR AFFAIRS
When this offering is complete, our executive officers and directors,
members of their immediate families and affiliated entities will control, in the
aggregate, approximately % of our outstanding common stock. As a result,
these shareholders will have majority control of our company, the ability to
approve certain fundamental corporate transactions and to elect a majority of
the members of our board of directors. The exercise of these powers may present
conflicts of interest between these shareholders and the other owners of our
capital stock. In addition, the fact that the ownership of our capital stock is
concentrated in the hands of a few shareholders may have the effect of delaying,
deferring or preventing a change of control of our company, even if such
transaction may otherwise be desirable to the shareholders generally. Such
concentration of ownership could also prevent the other shareholders from
removing incumbent management even if factors warrant such removal. See
"Principal Shareholders."
In addition, upon completion of the issuance of our Series A Convertible
Preferred Stock, a corporate affiliate of our chairman of the board will own all
outstanding shares of this stock. Until the conversion of this stock, this
affiliate will have an effective veto right over certain merger and other
fundamental corporate transactions under California law. See "-- Description of
Capital Stock--Preferred Stock-- Series A Convertible Preferred Stock."
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS
We may pursue selected acquisitions, some of which could be material. Our
ability to engage in acquisitions will depend on our ability to identify
attractive acquisition candidates and, if necessary, obtain financing on
satisfactory terms, which cannot be assured. We face the following challenges in
undertaking acquisitions:
- potential distraction to management;
- integrating the network and operations of acquired businesses into our
own;
- integrating the acquired business's financial, computer and other systems
into our own;
- unanticipated liabilities or contingencies from the acquired company; and
- reduced earnings or increased losses due to increased goodwill
amortization, increased interest costs and costs related to integration.
We could use our common stock to pay for acquisitions, which would dilute
our shareholders' ownership interests in our company. If we are unsuccessful in
addressing the challenges arising out of acquisitions, our business could be
harmed and the price of our common stock could be depressed.
WE HAVE ADOPTED ANTI-TAKEOVER MEASURES THAT COULD DISCOURAGE TAKEOVER ATTEMPTS
AND COULD LIMIT THE OPPORTUNITY FOR OUR SHAREHOLDERS TO RECEIVE A PREMIUM FOR
THEIR SHARES
Certain provisions in our articles of incorporation and bylaws may
discourage, delay or prevent an acquisition of our company at a premium price.
These provisions:
- authorize the issuance of "blank check" preferred stock;
- provide for a classified board of directors;
- prohibit cumulative voting in the election of directors;
- require a super-majority shareholder vote to effect certain amendments to
our articles of incorporation and bylaws;
- limit the persons who may call special meetings of shareholders; and
- establish advance notice requirements for nominations for election to our
board of directors or for proposing matters that can be acted on by
shareholders at shareholder meetings.
As a result of these provisions, our management could attempt to utilize
these provisions to discourage or reject unsolicited bids to acquire us,
including bids that may propose the payment to our shareholders of a premium
over the then current market price of
19
their shares. In addition, we may adopt a shareholder rights plan after the
completion of this offering. This plan would cause substantial dilution to any
person or group that attempts to acquire our company on terms not approved in
advance by our board of directors. See "Description of Capital
Stock--Anti-Takeover Provisions."
Certain provisions of the California General Corporation Law, our
shareholder rights plan and some of our employment agreements may delay, deter
or prevent someone from acquiring us in a transaction that would provide our
shareholders with a premium over the market price for our shares of common
stock. In addition, the Federal Communications Commission and certain state
public service commissions require prior approval of transfers of control.
Our credit facility also prohibits us from entering into a change of control
transaction without the prior consent of our lender. See "Certain Indebtedness."
THERE HAS NOT BEEN A PUBLIC MARKET FOR OUR COMMON STOCK; OUR STOCK PRICE MAY BE
VOLATILE
There has not been a market for our common stock, and there can be no
assurance that a public market for our common stock will develop or be sustained
after this offering. A number of factors, many of which we cannot control, may
cause our stock price to fluctuate significantly, including:
- variations in operating results;
- changes in financial estimates by securities analysts;
- changes in market valuations of telecommunications companies;
- announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
- our ability or inability to implement our expansion plans;
- an adverse decision by a regulatory agency in one of our primary markets;
- increases or decreases in reported holdings by insiders or mutual funds;
- the hiring or departure of key personnel;
- future sales of common stock; and
- general stock market price and volume fluctuations.
A SIGNIFICANT PORTION OF OUR TOTAL OUTSTANDING SHARES ARE RESTRICTED FROM
IMMEDIATE RESALE BUT MAY BE SOLD INTO THE MARKET IN THE NEAR FUTURE. THIS
COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DROP SIGNIFICANTLY, EVEN
IF OUR BUSINESS IS DOING WELL.
After this offering, and giving effect to the conversion of the Series A
Convertible Preferred Stock into a total of 2,727,270 shares of common stock, we
will have outstanding shares of common stock. This includes the
shares we are selling in this offering which may be resold in the public market
immediately. The remaining %, or 39,693,141 shares, of our total outstanding
shares as of August 16, 1999 will become available for resale in the public
market as shown in the chart below.
As restrictions on resale end, the market price could drop significantly if
the holders of these restricted shares sell them or are perceived by the market
as intending to sell them.
NUMBER OF SHARES / % OF DATE OF AVAILABILITY FOR
TOTAL OUTSTANDING RESALE INTO PUBLIC MARKET
5,262,175 / % IMMEDIATELY AFTER THE DATE
OF THIS PROSPECTUS UNDER
RULE 144(K)
235,749 / % 90 DAYS AFTER THE DATE OF
THIS PROSPECTUS UNDER RULE
144 OR RULE 701
27,185,914 / % 181 DAYS AFTER THE DATE OF
THIS PROSPECTUS UPON
EXPIRATION OF AN AGREEMENT
THESE SHAREHOLDERS HAVE
WITH THE UNDERWRITERS.
HOWEVER, THE UNDERWRITERS
CAN WAIVE THIS RESTRICTION
AND ALLOW THESE
SHAREHOLDERS TO SELL THEIR
SHARES AT ANY TIME UNDER
RULE 144.
7,009,303 / % BETWEEN 181 DAYS AND 365
DAYS AFTER THE DATE OF
THIS PROSPECTUS DUE TO THE
REQUIREMENTS OF THE
FEDERAL SECURITIES LAWS.
20
Immediately after this offering, we intend to file registration statements
under the Securities Act covering 7,659,721 shares of the common stock reserved
for issuance upon exercise of options granted under our stock option plans or
outside of these plans or to be granted under the 1999 Stock Option/Stock
Issuance Plan. The registration statements are expected to be filed and become
effective as soon as practicable after the closing of this offering.
Accordingly, shares registered under the registration statements will, subject
to Rule 144 volume limitations applicable to affiliates, be available for sale
in the open market beginning on the date the registration statements covering
these shares becomes effective.
OUR QUARTERLY RESULTS ARE SUBJECT TO FLUCTUATION
Our quarterly operating results are difficult to forecast with any degree of
accuracy as they are subject to significant fluctuations resulting from a number
of factors. Fluctuations in our results make it harder to identify and
understand trends in our business and may lead to volatility in our stock price.
Given our past fluctuations in quarterly results, we believe that period to
period comparisons of our operating results are not necessarily meaningful and
should not be relied upon as indications of future performance.
OUR RESULTS CAN MATERIALLY DIFFER FROM THOSE FORECAST OR EXPRESSED IN THE
FORWARD LOOKING STATEMENTS CONTAINED IN THIS PROSPECTUS
This prospectus contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "could," "may," "will," "should," "except," "plan,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue," the
negative of such terms or other comparable terminology. These statements are
only predictions and are not guarantees of future performance. Actual events or
results may differ materially. In evaluating these statements, you should
specifically consider various factors, including the risks described above and
in other parts of this prospectus. These factors may cause our actual results to
differ materially from those expressed or reflected in any forward-looking
statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy or completeness of the forward-looking
statements after the date of this prospectus to conform them to actual results
or to changes in our expectations.
21
ACQUISITION OF MINORITY INTERESTS IN SUBSIDIARIES
On August 24, 1999 we agreed to issue 1,450,000 shares of our common stock
to the TVG Asian Communications Fund in exchange for its 40% interest in our
Australian operating subsidiary. This transaction will close upon the receipt of
required regulatory approvals in Australia. In addition, on August 10, 1999, we
issued 104,763 shares of our common stock to Richard A. D. Vincent, a former
executive officer of our Australian operating subsidiary, in exchange for
1,000,000 shares of common stock of our subsidiary, WxL International-Australia,
Inc., which holds a majority equity interest in our Australian operating
subsidiary.
USE OF PROCEEDS
The net proceeds to be received by us from the offering are estimated to be
approximately $ million after deducting discounts, commissions and estimated
offering expenses payable by us. We intend to use the net proceeds from the
offering as follows:
- $ million to repay a portion of our subordinated indebtedness, which,
after giving effect to this payment, will be due and payable on November
30, 2002; and
- the remainder of the proceeds for network expansion and equipment
purchases, other capital expenditures, sales and marketing, as well as to
fund working capital and for general corporate purposes.
While we currently intend to use the net proceeds of the offering in the
manner described above, the actual allocation of funds among these uses will
depend on future developments in or affecting our business, the competitive
environment in which we operate, and the emergence of future opportunities.
Pending use of the net proceeds as described above, the net proceeds will be
invested in investment grade, short-term marketable securities.
DIVIDEND POLICY
We have not declared or paid any cash dividends or distributions on our
common stock since our inception. We anticipate that, for the foreseeable
future, all earnings will be used to pay dividends on our Series A Convertible
Preferred Stock or retained for use in our business, and no cash dividends will
be paid on our common stock. See "Description of Capital Stock--Preferred
Stock--Series A Convertible Preferred Stock." Any payment of cash dividends in
the future on our common stock will be dependent upon our financial condition,
results of operations, current and anticipated cash requirements, plans for
expansions, the ability of our subsidiaries to pay dividends or otherwise make
cash payments or advances to us and restrictions, if any, under any future debt
obligations, as well as other factors that our board of directors deems
relevant. Our credit facility restricts our ability to pay cash dividends,
including on our common stock and Series A Convertible Preferred Stock. In
addition, under the terms of our Series A Convertible Preferred Stock, we are
not permitted to pay any dividends on our common stock unless we have paid all
required dividends on our Series A Convertible Preferred Stock.
22
CAPITALIZATION
The following table sets forth our unaudited cash and cash equivalents,
short-term debt and capitalization as of June 30, 1999, (i) on an actual basis,
(ii) on a pro forma basis giving effect to our issuance of 1,554,763 shares of
common stock in connection with the planned acquisition of minority interests in
certain subsidiaries, at a deemed fair value of approximately $17 million (see
"Acquisition of Minority Interests in Subsidiaries"), and the planned issuance
of 30,000 shares of Series A Convertible Preferred Stock, convertible into
2,727,270 shares of common stock, for proceeds of $30 million, and (iii) on a
pro forma as adjusted basis for the sale of the common stock offered hereby, at
an assumed initial public offering price of $ per share on a pro forma basis,
and the application of the net proceeds as described in "Use of Proceeds." The
table should be read in conjunction with the Consolidated Financial Statements
and notes thereto, which are included elsewhere herein.
AS OF JUNE 30, 1999
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -----------
(IN MILLIONS)
Cash and cash equivalents...................................................... $ 38.2 $ 68.2 $
--------- ----------- -----------
--------- ----------- -----------
Short-term debt:
Current portion of long-term debt and subordinated debentures.............. $ 8.9 $ 8.9 $ 8.9
Current portion of capital lease obligations............................... 8.1 8.1 8.1
--------- ----------- -----------
Total short-term debt.................................................... $ 17.0 $ 17.0 $ 17.0
--------- ----------- -----------
--------- ----------- -----------
Long-term debt, net of current portion:
Long-term debt............................................................. $ 22.4 $ 22.4 $
Notes...................................................................... 64.0 64.0
Capital lease obligations.................................................. 26.0 26.0
--------- ----------- -----------
Total long-term debt..................................................... 112.4 112.4
Minority interest.............................................................. 5.5 -- --
Shareholders' equity (deficit):
Preferred stock no par value; 10,000,000 shares authorized;
Series A Convertible Preferred Stock no par value; zero shares
outstanding, actual; 30,000 shares issued and outstanding, pro forma;
30,000 shares issued and outstanding, pro forma as adjusted............ -- 30.0 30.0
Common stock no par value; 100,000,000 shares authorized; 35,411,108 shares
issued and outstanding, actual; 36,965,871 shares issued and outstanding,
pro forma(1); shares issued and outstanding, pro forma as
adjusted(1).............................................................. 81.6 98.7
Notes receivable from shareholders......................................... (1.1) (1.1) (1.1)
Accumulated other comprehensive income..................................... (2.3) (2.3) (2.3)
Accumulated deficit........................................................ (142.4) (142.4) (142.4)
--------- ----------- -----------
Total shareholders' equity (deficit)..................................... (64.2) (17.1)
--------- ----------- -----------
Total capitalization................................................... $ 53.7 $ 95.3 $
--------- ----------- -----------
--------- ----------- -----------
- --------------------------
(1) Excludes:
- 7,000,000 shares of common stock reserved under our stock option plans, of
which 2,479,626 shares of common stock at a weighted average exercise
price of $ per share are covered by outstanding options as of
August 16, 1999;
- 1,194,095 shares of common stock issuable upon the exercise of options
granted by us outside of our stock option plans, with a weighted average
exercise price of $ per share as of August 16, 1999; and
- a total of shares of common stock issuable upon the exercise of
warrants outstanding or to be outstanding following the closing of this
offering at a weighted average exercise price of $ per share.
23
DILUTION
The difference between the public offering price per share of the common
stock and our net tangible book value per share after the offering constitutes
the dilution to investors in the offering. Net tangible book value per share is
determined by dividing our net tangible book value (tangible assets less total
liabilities) by the applicable number of shares of common stock. At June 30,
1999, the pro forma net tangible book value (deficit) of our common stock was
$(60.8) million, or $(1.64) per share of common stock based on a total of
36,965,871 shares outstanding. After giving effect to the sale of the
shares of common stock offered hereby, at the initial public offering price per
share of $ , and the application of the net proceeds from such sale, our pro
forma net tangible book value attributable to our common stock at June 30, 1999
would have been $ million or $ per share, representing an immediate
increase in pro forma net tangible book value of $ per share to existing
shareholders and an immediate dilution of $ per share to new investors.
The following table illustrates the foregoing information with respect to
dilution to new investors on a per share basis:
Assumed initial public offering price per share................................... $
Pro forma net tangible book value (deficit) per share before the offering....... $ (1.64 (1)
Increase in net tangible book value per share attributable to new investors.....
---------
Pro forma net tangible book value per share after the offering..................
---------
Dilution per share to new investors............................................... $
---------
---------
- --------------------------
(1) Pro forma net tangible book value gives effect to the issuance of a total of
1,554,763 shares of our common stock in connection with our planned
acquisition of minority interests in certain subsidiaries. See "Acquisition
of Minority Interests in Subsidiaries." Pro forma net tangible book value
per share of common stock is computed by reducing pro forma total assets of
$211.3 million at June 30, 1999 by $13.7 million (the amount of pro forma
intangible assets), subtracting total pro forma liabilities of $258.4
million, and then dividing by 36,965,871 (the pro forma number of shares
outstanding at June 30, 1999 after giving effect to the issuance of
1,554,763 shares in connection with our planned acquisition of minority
interests in certain subsidiaries as described under "Acquisition of
Minority Interests in Subsidiaries"). Pro forma net tangible book value
excludes the effect of the planned issuance of 30,000 shares of Series A
Convertible Preferred Stock for $30 million, which are convertible into
2,727,270 shares of common stock.
The following table sets forth, with respect to existing shareholders and
new investors, a comparison of the number of shares of common stock acquired
from us, the percentage ownership of such shares, the total consideration paid,
the percentage of total consideration paid and the average price per share paid.
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- --------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- -------------- ----------- -----------
Existing shareholders................................ 39,693,144 % $ 131,794,692 % $ 3.32
New investors........................................ % % $
------------ ----- -------------- -----
Total............................................ 100.0% $ 100.0%
------------ ----- -------------- -----
------------ ----- -------------- -----
The foregoing table assumes:
- no exercise of outstanding options to purchase 3,673,721 shares of common
stock at a weighted average exercise price of $ per share as of August
16, 1999;
- no exercise of warrants to purchase a total of shares of common
stock at a weighted average exercise price of $ per share;
- the issuance of a total of 1,554,763 shares of common stock in connection
with our planned acquisition of minority interests in certain
subsidiaries. See "Acquisition of Minority Interests in Subsidiaries"; and
- the conversion of the 30,000 shares of Series A Convertible Preferred
Stock into 2,727,270 shares of common stock.
To the extent that any outstanding options or warrants are exercised, there may
be further dilution to new investors. See "Capitalization" and
"Management--Stock Option Plans."
24
SELECTED CONSOLIDATED FINANCIAL DATA
In the table below, we provide you with selected consolidated financial data
of WORLDxCHANGE. The selected consolidated financial data as of September 30,
1997 and 1998 and for each of the three years in the period ended September 30,
1998 are derived from our audited consolidated financial statements included
elsewhere in this prospectus. The selected consolidated financial data as of
September 30, 1994, 1995 and 1996 and for the years ended September 30, 1994 and
1995 are derived from our audited consolidated financial statements that are not
contained herein. The selected consolidated financial data as of June 30, 1999
and for the nine-month periods ended June 30, 1998 and 1999 are derived from our
unaudited consolidated financial statements included elsewhere in this
prospectus, which, in the opinion of management, include all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
such information. Operating results for the nine months ended June 30, 1999 are
not necessarily indicative of the results that are expected for fiscal 1999.
When you read this selected consolidated financial data, it is important that
you also read the section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements and the related notes thereto included elsewhere in this prospectus.
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
---------------------------------------------------------------- --------------------
PRO FORMA
---------
1994 1995 1996 1997 1998 1998(1) 1998 1999
--------- --------- --------- --------- --------- --------- --------- ---------
(IN MILLIONS)
STATEMENT OF OPERATIONS DATA:
Revenues............................ $ 39.3 $ 101.7 $ 183.9 $ 331.7 $ 398.9 $ 398.9 $ 301.0 $ 304.3
Cost of services.................... 20.9 64.5 127.9 235.0 287.3 287.3 207.2 238.6
--------- --------- --------- --------- --------- --------- --------- ---------
Gross profit........................ 18.4 37.2 56.0 96.7 111.6 111.6 93.8 65.7
Selling, general & administrative... 16.6 38.6 64.5 113.5 115.0 115.0 81.2 88.4
Depreciation and amortization....... 0.9 3.1 7.0 8.7 12.3 12.9 8.9 12.4
--------- --------- --------- --------- --------- --------- --------- ---------
Operating income (loss)............. 0.9 (4.5) (15.5) (25.5) (15.7) (16.3) 3.7 (35.1)
Interest expense.................... 0.9 3.3 5.7 8.7 11.9 11.9 8.6 12.5
Other expense, net.................. (0.3) (0.2) 0.6 3.4 1.4 1.4 0.2 0.2
Minority interest................... -- (0.2) (0.2) (0.5) (1.5) -- (1.1) (1.8)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss)................... $ 0.3 $ (7.4) $ (21.6) $ (37.1) $ (27.5) $ (29.6) $ (4.0) $ (46.0)
Basic and diluted net income (loss)
per share......................... $ 0.01 $ (0.27) $ (0.78) $ (1.34) $ (0.99) $ (1.01) $ (0.15) $ (1.41)
Shares used to compute basic and
diluted net income (loss) per
share............................. 27.398 27.572 27.572 27.734 27.760 29.315 27.734 32.696
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
OTHER DATA:
EBITDA(2)........................... $ 1.8 $ 1.4 $ (8.5) $ (16.8) $ (3.4) $ (3.4) $ 12.6 $ (22.7)
Net cash provided by (used in)
operating activities.............. 0.3 2.6 7.6 (7.2) (31.7) (31.7) (28.0) (4.5)
Capital expenditures................ 5.8 24.3 8.7 19.4 22.4 22.4 14.2 57.8
GEOGRAPHIC DATA:
Net revenues:
North America..................... $ 39.3 $ 100.9 $ 171.4 $ 291.7 $ 321.8 $ 321.8 $ 244.9 $ 238.0
Pacific Rim....................... -- 0.3 7.5 24.4 58.4 58.4 43.5 43.0
Europe............................ -- 0.5 5.0 15.6 18.7 18.7 12.6 23.3
--------- --------- --------- --------- --------- --------- --------- ---------
Total........................... $ 39.3 $ 101.7 $ 183.9 $ 331.7 $ 398.9 $ 398.9 $ 301.0 $ 304.3
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
PRO FORMA
---------
1999(1)
---------
STATEMENT OF OPERATIONS DATA:
Revenues............................ $ 304.3
Cost of services.................... 238.6
---------
Gross profit........................ 65.7
Selling, general & administrative... 88.4
Depreciation and amortization....... 12.8
---------
Operating income (loss)............. (35.5)
Interest expense.................... 12.5
Other expense, net.................. 0.2
Minority interest................... --
---------
Net income (loss)................... $ (48.2)
Basic and diluted net income (loss)
per share......................... $ (1.41)
Shares used to compute basic and
diluted net income (loss) per
share............................. 34.251
---------
---------
OTHER DATA:
EBITDA(2)........................... $ (22.7)
Net cash provided by (used in)
operating activities.............. (4.5)
Capital expenditures................ 57.8
GEOGRAPHIC DATA:
Net revenues:
North America..................... $ 238.0
Pacific Rim....................... 43.0
Europe............................ 23.3
---------
Total........................... $ 304.3
---------
---------
(FOOTNOTES ON NEXT PAGE)
25
AS OF
JUNE 30,
1999
AS OF SEPTEMBER 30, ----------------------
----------------------------------------------------- PRO
1994 1995 1996 1997 1998 ACTUAL FORMA(3)
--------- --------- --------- --------- --------- --------- -----------
(IN MILLIONS)
BALANCE SHEET DATA:
Cash and cash equivalents......................... $ 0.2 $ 1.4 $ 3.4 $ 4.3 $ 20.9 $ 38.2 $ 68.2
Working capital (deficit)......................... (4.5) (15.1) (35.4) (50.4) (37.0) (41.8) (11.8)
Total assets...................................... 16.8 55.2 62.8 103.7 120.1 199.7 241.3
Short-term debt and capital lease obligations..... 2.7 13.5 15.7 9.5 20.3 17.0 17.0
Long-term debt, net of current portion............ 4.5 24.9 24.7 49.2 99.3 112.4 112.4
Minority interest................................. -- -- 0.3 8.8 7.3 5.5 --
Total shareholders' deficit....................... (1.1) (8.6) (32.0) (68.9) (89.6) (64.2) (17.1)
- --------------------------
(1) The pro forma Statement of Operations Data give effect to:
- the amortization of a portion of the newly created intangible assets
resulting from the planned acquisition of minority interests in certain
subsidiaries. See "Acquisition of Minority Interests in Subsidiaries." The
amortization was based upon an estimated useful life of 20 years; and
- the removal of losses previously allocated to the minority interest
holders in certain subsidiaries.
(2) EBITDA represents operating income (loss) plus depreciation and amortization
expense. We have included information concerning EBITDA herein because such
information is commonly used in the telecommunications industry as one
measure of an issuer's operating performance and historical ability to
service debt. EBITDA is not determined in accordance with generally accepted
accounting principles, is not indicative of cash provided by operating
activities, is not necessarily comparable to similarly titled measures of
other companies, should not be used as a measure of operating income and
cash flows from operations as determined under generally accepted accounting
principles and should not be considered in isolation or as an alternative
to, or to be more meaningful than, measures of performance determined in
accordance with generally accepted accounting principles.
(3) The pro forma Balance Sheet Data give effect to:
- the issuance of 1,554,763 shares of common stock by us for the planned
acquisition of minority interests in certain subsidiaries, generating the
following adjustments:
-- the creation of an intangible asset in the amount of $11.6 million,
representing the excess value of the stock issued over the minority
interest recorded in the financial statements; and
-- the elimination of the minority interest in these subsidiaries.
- the planned issuance of 30,000 shares of our Series A Convertible
Preferred Stock at a price of $1,000 per share convertible into 2,727,270
shares of common stock.
26
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL
STATEMENTS, THE NOTES THERETO AND THE OTHER FINANCIAL DATA INCLUDED ELSEWHERE IN
THIS PROSPECTUS. IN ADDITION TO HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION
AND OTHER PARTS OF THIS PROSPECTUS CONTAIN FORWARD-LOOKING INFORMATION THAT
INVOLVES RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED BY FORWARD-LOOKING INFORMATION DUE TO FACTORS DISCUSSED
UNDER "RISK FACTORS," "BUSINESS" AND ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
GENERAL
We are a leading global telecommunications company that specializes in
providing high-quality, low-cost domestic and international telecommunications
services. We have established retail and wholesale operations in North America,
Europe and the Pacific Rim. Our global facilities include 40 switches located in
major metropolitan areas in 12 countries. Our network has been designed to give
us the ability to simultaneously carry voice and data. We connect our switches
with a network of owned and leased undersea and land-based fiber optic cables.
Our revenues have grown from $184 million in fiscal 1996 to $332 million in
fiscal 1997 to $399 million in fiscal 1998.
REVENUES
We obtain our revenues from providing international and domestic
telecommunication services to retail and wholesale customers on four continents.
Our retail revenues are derived from usage generated by residential and
commercial customers. Our wholesale revenues are comprised of revenues generated
from sales to other U.S. and foreign telecommunications carriers and resellers.
Revenues are derived mainly from the number of minutes (or fractions
thereof) used by our customers and billed by WORLDxCHANGE and are recognized
upon completion of the calls, as well as, to a lesser extent, from certain
recurring and non-recurring fees that are recognized when services are provided.
Prices for long distance calls have decreased substantially in many of the
markets that we serve due to increased competition and to cost reductions
associated with technological advancements. As a consequence, we have
experienced and expect to continue to experience declining revenues per minute
in these markets. We expect that increased minute volumes will more than offset
the impact on our revenue from declining revenues per minute.
We have experienced substantial growth with revenues increasing from $183.9
million in fiscal 1996 to $398.9 million in fiscal 1998. Our recent growth shows
revenue increasing in each of the first three quarters of fiscal 1999: from
$89.9 million in the first quarter to $100.8 million in the second quarter to
$113.6 million in the third quarter.
Our total retail revenues have grown significantly, from $69.2 million in
fiscal 1996 to $191.7 million in fiscal 1998. Our foreign retail revenues have
increased from $10.7 million in fiscal 1996 to $68.1 million in fiscal 1998. We
have achieved our retail growth primarily through the use of direct mail
marketing campaigns in Europe, the U.S. and Australia, as well as through agent
sales. We have achieved substantial revenue growth despite the fact that we have
historically been hampered by cash constraints and at times during these periods
have had to curtail spending on sales and marketing programs. We believe that
our direct mail and other marketing programs will become increasingly effective
as we obtain the cash resources required to consistently fund them.
27
The following table reflects percentages of total revenue from our North
American and non-North American operations and by type of customer for fiscal
1996, 1997, and 1998 and the nine months ended June 30, 1998 and 1999:
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
Retail:
North America........................................................ 32% 34% 31% 32% 31%
Outside North America................................................ 6 8 17 17 18
--------- --------- --------- --------- ---------
Total Retail..................................................... 38 42 48 49 49
Carrier:
North America........................................................ 48 46 40 38 41
Outside North America................................................ 1 3 2 2 4
--------- --------- --------- --------- ---------
Total Carrier.................................................... 49 49 42 40 45
Operator Services.................................................... 13 9 10 11 6
--------- --------- --------- --------- ---------
Total Revenues................................................... 100% 100% 100% 100% 100%
As we implement our growth strategy, we expect our operations outside North
America, particularly in Europe, to contribute an increasingly larger percentage
of our revenues. In addition, we expect carrier revenue to become a smaller
percentage of total revenue as our marketing efforts continue to focus on retail
customers. Carrier customers are generally more price-sensitive and revenues
from carriers generally generate lower gross margins than revenues from retail
customers. Although we continue to sell and market our operator services, we
have reduced the level of marketing associated with this business and do not
anticipate these revenues to grow.
COST OF SERVICES
Cost of services is our largest expense and consists of both variable and
fixed costs. Variable costs include costs associated with the origination and
termination of calls. Virtually all calls we carry must be originated and
terminated by a local carrier. Variable costs also include the cost of
transmitting calls using the long distance facilities of other carriers, which
we use if we cannot carry the traffic over our own network. These local and long
distance carriers charge on a per minute basis. Our fixed costs consist of
leased point-to-point cable capacity, which typically requires fixed monthly
payments regardless of usage. Because the cost of leased lines is fixed,
transmitting a greater portion of our traffic over the leased lines reduces our
incremental marginal transmission costs. Accordingly, once certain volume levels
are reached, leased line capacity can be more cost-effective than capacity
acquired from other long distance carriers.
Capitalized costs associated with our ownership interests in cables, known
as "MIUs", and long-term rights of use in cables or other facilities, known as
"IRUs", are expensed in depreciation and amortization and are therefore not
accounted for as part of cost of services. To the extent our expanded use of
MIUs or IRUs reduces our utilization of leased lines and the facilities of other
long distance carriers, we believe the increase in depreciation expense
associated with the MIUs or IRUs will be fully offset by a decrease in our
variable and fixed cost of services.
We intend to continue to reduce our dependence on transmission arrangements
with other carriers by increasing the percentage of our traffic carried on our
network. We plan to expand the geographic scope and capacity of our network. Our
strategy is to bring our network as close to the end user as possible, reducing
the need to use other carriers' networks. We believe that control of network
28
infrastructure is critical to enhancing our position as a high-quality, low-cost
provider of communications services and will enable us to better manage service
offerings.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Our selling, general and administrative expenses consist of commissions paid
to our independent agents and direct sales force, advertising and promotional
costs, direct mail expenses, employee compensation, occupancy, insurance,
professional fees, bad debt expense, expenses relating to customer service
operations and the costs related to maintaining and supporting our systems. As
we start operations in new countries, we incur significant start-up costs
associated with establishing a supporting infrastructure, particularly for
hiring and training of personnel, leasing office space and paying various fees
in conjunction with our business. As we increase our sales and marketing efforts
and commence operations in new countries, we expect that our sales and marketing
expenses will increase.
DEPRECIATION AND AMORTIZATION EXPENSES
Depreciation and amortization expenses consist of depreciation of all fixed
assets and computer equipment, as well as amortization of the fixed costs
associated with our:
- owned and leased switching platforms, which have been capitalized and are
being amortized over their estimated useful lives or the term of the
lease, which is typically five to seven years; and
- MIU or IRU interests in international undersea and on-land fiber-optic
cable systems, which are being amortized over their estimated useful
lives, which is typically 20 years.
Following the offering, as we expand our network, we expect depreciation and
amortization expenses to increase significantly.
INTEREST EXPENSE
Interest expense principally consists of interest payable on our revolving
credit agreement, subordinated notes, notes payable and capital leases.
Following the offering, as we incur additional indebtedness to expand our
network, we expect interest expense to increase.
INCOME TAXES
As of September 30, 1998, we had net operating loss carryforwards available
for federal, state, and foreign tax purposes of approximately $43.0 million,
$29.9 million and $26.5 million, respectively. The federal net operating loss
carryforwards will begin expiring in 2007 and the state net operating loss
carryforwards will expire from 1999 through 2003, unless previously utilized.
The Canadian and Netherlands net operating loss carryforwards, in the amounts of
$4.7 million and $700,000, respectively, will begin expiring in 2002. Our other
foreign net operating loss carryforwards carry forward indefinitely. The
realization of future domestic benefits from net operating loss carryforwards
may be limited under Section 382 of the Internal Revenue Code if certain
cumulative changes occur in our equity ownership. We have not recognized any
income tax benefit in our historical financial statements because we believe the
realization of the deferred tax asset is uncertain. See Note 7 to Consolidated
Financial Statements.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly results of
operations data for each of the three quarters in the nine month period ended
June 30, 1999. In our opinion, this information has been prepared substantially
on the same basis as the audited financial statements appearing elsewhere in
this prospectus, and all necessary adjustments, consisting only of normal
recurring adjustments, have been
29
included in the amounts stated below to present fairly the unaudited quarterly
results of operations data.
THREE MONTHS ENDED
-------------------------------------
DECEMBER 31, MARCH 31, JUNE 30,
1998 1999 1999
------------- ----------- ---------
(IN MILLIONS)
STATEMENT OF OPERATIONS DATA:
Revenues..................................................................... $ 89.9 $100.8 $113.6
Cost of services............................................................. 70.4 79.4 88.8
------ ----------- ---------
Gross profit................................................................. 19.5 21.4 24.8
Selling general and administrative........................................... 27.9 29.2 31.3
Depreciation and amortization................................................ 3.6 4.1 4.7
------ ----------- ---------
Operating loss............................................................... (12.0 ) (11.9 ) (11.2)
Interest expense............................................................. 4.3 3.8 4.3
Other expense, net........................................................... 0.1 -- 0.1
Minority interest............................................................ (0.6 ) (0.5 ) (0.7)
------ ----------- ---------
Net loss..................................................................... ($ 15.8 ) ($15.2 ) ($14.9)
------ ----------- ---------
------ ----------- ---------
REVENUES. Our revenues increased in each of the first three quarters of
fiscal 1999, primarily due to increased revenues in North America and Europe. In
October 1998, we initiated a multilevel marketing program in North America to
augment our direct mail marketing efforts and provide an added retail sales
distribution channel. We also expanded our sales and marketing efforts for our
calling card products. In Europe, revenues have grown due to increased marketing
expenditures on direct mail campaigns and direct sales. These increases have
been offset in part by planned decreases in our operator services revenues.
COST OF SERVICES. Cost of services has increased proportionately with
increased revenues, keeping gross margin percentages relatively constant during
the three quarters. In April 1999 we began using on-land fiber optic cable
capacity in the United States, allowing us to reduce our leased network capacity
and improve our North American gross margins. In Europe margins have declined
over the quarters as we have increased our leased network facilities to provide
us with the capacity needed for our expected future growth. We expect our
European gross margins to improve as we more fully utilize this capacity. Gross
margins in the Pacific Rim have remained relatively constant.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative spending levels increased due to increased sales and marketing
spending and the continued expansion of our European infrastructure. In spite of
increased sales and marketing spending during the quarters, selling, general and
administrative expenses as a percentage of revenues continued to improve each
quarter. This improvement has been due to the implementation in our North
American operations of a cost reduction program to streamline general and
administrative expenses.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expense increased during the quarters as we made $57.8 million in capitalized
purchases during this period to expand the geographic scope and available
capacity of our network.
INTEREST EXPENSE. Interest expense fluctuated commensurate with the level
of quarterly indebtedness. The decline in interest expense in the second quarter
from the first quarter was due to a reduction in our notes payable of $8.5
million. The increase of interest expense in the third quarter from the second
quarter was due to an increase in our indebtedness associated with the purchase
of our on-land fiber optic cable capacity in the United States.
30
RESULTS OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 1999 COMPARED TO NINE MONTHS ENDED JUNE 30, 1998
REVENUES. Total revenues increased by 1.1% to $304.3 million in the first
nine months of fiscal 1999 from $301.0 million for the first nine months of
fiscal 1998. The increase in revenues was primarily associated with an increase
in European retail revenues, which was partially offset by a decrease in retail
and operator services revenues in North America.
In North America, revenues decreased by 2.8% to $238.0 million for the first
nine months of fiscal 1999 from $244.9 million for the first nine months of
fiscal 1998. The decrease was primarily attributable to a decline in revenues
from operator services of 46.4% from $33.0 million for the first nine months of
fiscal 1998 to $17.7 million for the same period of fiscal 1999. The decline in
operator services revenues was due to our strategic decision to reduce marketing
efforts in the operator services market. The decrease was also attributable to a
decline in retail revenues. These revenues declined 3.0% from $96.7 million for
the first nine months of fiscal 1998 to $93.8 million for the first nine months
of fiscal 1999. Our retail revenues declined due to cash constraints experienced
during the last half of fiscal 1998, which caused us to curtail our direct mail
and other marketing programs, which had a negative impact on fiscal 1999
revenues. Our North American carrier revenues increased 9.8% to $126.5 million
for the first nine months of fiscal 1999 from $115.2 million for the first nine
months of fiscal 1998.
In the Pacific Rim, revenues decreased by 1.1%, to $43.0 million for the
first nine months of fiscal 1999 from $43.5 million for the first nine months of
fiscal 1998. This decline, which followed strong growth in each of the prior two
fiscal years, was primarily attributable to the loss of our largest reseller
customer, which accounted for approximately 23% of this region's fiscal 1998
revenues. This reseller's business was purchased by a competitor and the traffic
began to migrate off our network in October 1998. A substantial portion of the
reduction in revenues attributable to the reseller was offset by increased
retail revenue generated through direct mail and agent sales. Currently, none of
our customers accounts for more than five percent of this region's revenues.
In Europe, revenues increased by 84.9% for the first nine months of fiscal
1999 to $23.3 million from $12.6 million for the same period of fiscal 1998,
primarily due to increases in retail revenues. Retail revenues increased due to
geographic expansion in the region and increased direct mail campaigns in the
region. We believe Europe will continue to provide us with an opportunity for
revenue growth due to the expanding deregulation of the European
telecommunications market, the recent achievement of interconnection in existing
markets, and our plans to enter additional European countries.
COST OF SERVICES. Cost of services increased by 15.1% to $238.6 million for
the first nine months of fiscal 1999 from $207.2 million for the same nine
months in fiscal 1998 and, as a percentage of revenue, increased to 78.4% from
68.8%. Cost of services as a percentage of revenue increased primarily as a
result of decreasing margins associated with carrier revenues. Carrier revenues
as a percentage of total revenues increased for the first nine months of fiscal
1999 compared to the same period of fiscal 1998. These revenues have lower gross
margins than the gross margins from retail and operator services revenues. Cost
of services as a percentage of revenues increased in North America from 72.8%
for the first nine months of fiscal 1998 to 83.3% for the same period of fiscal
1999. Cost of services as a percentage of revenues decreased in the Pacific Rim
from 77.7% for the first nine months of fiscal 1998 to 73.9% for the same period
of fiscal 1999. Cost of services as a percentage of revenues increased in Europe
from 74.4% for the first nine months of fiscal 1998 to 78.3% for the same period
of fiscal 1999. This increase was due to additional costs associated with the
expansion of our European network infrastructure in anticipation of future
growth in our customer base.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 8.9% to $88.4 million for the first nine
months of fiscal 1999 from $81.2 million for the
31
same period in fiscal 1998 and, as a percentage of revenues, increased from
27.0% to 29.1%. The increase was primarily due to increased spending in Europe
and the Pacific Rim, offset in part by reduced general and administrative
spending in North America. These expenses in Europe increased from $6.9 million
for the first nine months of fiscal 1998 to $13.8 million for the first nine
months of fiscal 1999. This increase was due to increased sales, operations and
back office infrastructure to support sales growth and the expansion into new
markets in Europe. Selling, general and administrative expenses in the Pacific
Rim increased by 14.0% to $16.3 million for the first nine months of fiscal 1999
from $14.3 million for the same period of fiscal 1998. This increase was due to
growth in the supporting infrastructure and increased staffing levels in
customer service in our Pacific Rim markets. Selling, general and administrative
expenses in North America decreased to $57.5 million for the first nine months
of fiscal 1999 from $59.4 million for the same period of fiscal 1998. The
decline in these expenses in North America was due to our efforts to streamline
our North American operations and reduce overall spending costs. We expect
selling, general and administrative expenses to continue to grow as revenues
increase and as we continue to expand into new markets and build infrastructure.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses increased by 39.6% to $12.4 million for the first nine months of fiscal
1999 from $8.9 million in the first nine months of fiscal 1998. The increase in
depreciation and amortization was due to the continued build-out of our network
and supporting infrastructure.
INTEREST EXPENSE. Interest expense increased by 44.2% to $12.4 million for
the first nine months of fiscal 1999 from $8.6 million in the first nine months
of fiscal 1998. The increase was primarily due to interest associated with the
subordinated promissory notes issued between May and August of 1998.
FISCAL 1998 AS COMPARED TO FISCAL 1997
REVENUES. Total revenues for fiscal 1998 increased by 20.3% to $398.9
million from $331.7 million for fiscal 1997. Growth in revenues during 1998 was
attributable primarily to an increase in traffic volume, offset in part by a
decline in average carrier prices. Total revenues for fiscal 1998 were also
negatively impacted by our inability to bill for certain calls during the period
due to technical difficulties with a newly installed switch.
In North America, our revenues for fiscal 1998 increased by 10.3% to $321.8
million, primarily as a result of substantial increases in sales of residential
and operator services. Revenues from residential customers increased by 13.5% to
$116.1 million for fiscal 1998 from $102.3 million for fiscal 1997. The increase
in residential revenues was due to increased promotional spending in late fiscal
1997, which stimulated growth in the first half of fiscal 1998. Revenues from
operator services increased by 51.7% to $40.5 million for fiscal 1998 from $26.7
million for fiscal 1997. Revenues from carrier and commercial customers were
relatively stable.
In the Pacific Rim, revenues increased by 139.3% to $58.4 million for fiscal
1998 from $24.4 million for fiscal 1997, reflecting significant increases in the
usage of our services by residential and commercial customers.
In Europe, revenues increased by 19.9% to $18.7 million for fiscal 1998 from
$15.6 million for fiscal 1997, reflecting significant increases in the usage of
our services by residential and commercial customers.
COST OF SERVICES. Cost of services increased by 22.2% to $287.3 million for
fiscal 1998 from $235.0 million for fiscal 1997 and, as a percentage of
revenues, increased to 72.0% for fiscal 1998 from 70.9% for fiscal 1997. Cost of
services increased as a percentage of revenues as a result of lower margins
associated with carrier revenues. Although our carrier costs decreased during
fiscal 1998 due to competitive pricing pressures, we were unable to maintain the
gross margins we experienced in 1997. In addition, during the fourth quarter of
fiscal 1998, we experienced technical problems with a newly installed switch.
The problems included the failure of the switch to record billing information
for
32
certain calls. As a result, we were unable to bill for all of our calls. This
resulted in our incurring costs for calls with no corresponding revenues, which
reduced overall gross margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. In fiscal 1998, selling,
general and administrative expenses increased by 1.4% to $114.9 million from
$113.5 million for fiscal 1997 and, as a percentage of revenue, decreased to
28.8% for fiscal 1998 from 34.2% for fiscal 1997. A significant portion of the
increase in spending was directly related to the increase in revenues, as
marketing and sales expenses increased due to increases in commissions,
marketing, and other related expenses. Selling, general and administrative
expenses, as a percentage of revenue, declined due to efficiencies gained as our
revenues increased.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses increased by 41.4% to $12.3 million for fiscal 1998 from $8.7 million
for fiscal 1997. This increase was due to the expansion of our network and
capital deployed as we entered new markets.
INTEREST EXPENSE. Interest expense increased by 36.8% to $11.9 million in
fiscal 1998 from $8.7 million in fiscal 1997. The increase in interest was due
to the increase in the level of debt and capital lease obligations we incurred
in order to fund our network expansion.
FISCAL 1997 COMPARED TO FISCAL 1996
REVENUES. Total revenues for fiscal 1997 increased by 80.4% to $331.7
million from $183.9 million for fiscal 1996. Growth in revenues during fiscal
1997 was attributable primarily to an increase in traffic volume and was offset
in part by a decline in average prices.
In North America, revenues for fiscal 1997 increased by 70.1% to $291.6
million from $171.4 million for fiscal 1996, primarily as a result of
substantial increases in sales of international long distance services. Revenues
from carrier customers for fiscal 1997 increased by 73.0% to $153.3 million from
$88.6 million for fiscal 1996, while revenues from retail customers for fiscal
1997 increased by 91.1% to $111.6 million from $58.4 million for fiscal 1996.
Revenues from operator services increased 9.0% to $26.7 million for fiscal 1997
from $24.5 million for fiscal 1996.
In the Pacific Rim, revenues in fiscal 1997 increased by 225.3% to $24.4
million from $7.5 million in fiscal 1996. Revenues from retail customers
increased to $21.8 million in fiscal 1997 from $7.5 million in fiscal 1996. We
commenced operations in the Asia Pacific region by entering the Australian
market in 1995.
In Europe, revenues increased by 212.0% for fiscal 1997 to $15.6 million
from $5.0 million for fiscal 1996. This increase was primarily attributable to
increased sales to carrier customers, which grew from $1.7 million for fiscal
1996 to $9.4 million for fiscal 1997. Revenues from retail customers increased
from $3.3 million for fiscal 1996 to $6.2 million for fiscal 1997 due to the
establishment of operations in additional European markets and increased
business in existing markets during fiscal 1997. We commenced operations in
Europe by entering the U.K. market in 1995.
COST OF SERVICES. Cost of services increased by 83.9% to $235.0 million for
fiscal 1997 from $127.8 million for fiscal 1996 and, as a percentage of
revenues, increased to 70.9% for fiscal 1997 from 69.5% for fiscal 1996. Cost of
services as a percentage of revenue increased primarily due to higher
transmission costs. Transmission costs increased as we invested in new
transmission capacity, as part of our growth strategy, which capacity was not
fully utilized. In addition, because certain of our lowest-cost suppliers of
switched transmission would not furnish us with sufficient capacity due to our
slow payment history during fiscal 1997, we were forced to obtain switched
transmission capacity on more expensive terms.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. In fiscal 1997, selling,
general and administrative expenses increased by 75.7% to $113.5 million from
$64.6 million for fiscal 1996 and, as a percentage
33
of revenue, decreased to 34.2% for fiscal 1997 from 35.1% for fiscal 1996. A
significant portion of the percentage decrease was directly related to increased
efficiencies as a result of the revenue growth.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses increased by 24.3% to $8.7 million for fiscal 1997 from $7.0 million
for fiscal 1996. The increase in depreciation and amortization was due to the
expansion of our network and capital deployed as we entered new markets.
INTEREST EXPENSE. Interest expense increased by 50.0% to $8.7 million for
fiscal 1997 from $5.8 million for fiscal 1996. The increase in interest was due
to the increase in the level of debt and capital lease obligations we incurred.
The level of debt and capital lease obligations increased in conjunction with
network expansion and the expansion of our operations into new markets.
OTHER INCOME/EXPENSE. Other expenses increased to $3.4 million for fiscal
1997 from approximately $600,000 for fiscal 1996 as we increased our accruals
and reserves for certain domestic and international taxes other than income
taxes.
LIQUIDITY AND CAPITAL RESOURCES
As a consequence of the rapid expansion of our business and our historical
capital constraints, we have incurred cumulative net losses from inception in
1991 through June 30, 1999. These losses and associated negative cash flows
resulted primarily from start-up costs, marketing expenses and capital
expenditures required to build and deploy our network. Following the offering,
we expect to continue to significantly expand our operations, to continue
building our worldwide network and to increase our customer base and marketing
operations. We have utilized cash provided from financing activities to fund
losses and capital expenditures. The sources of this cash have primarily been
private placement equity offerings, the issuance of subordinated debt, capital
lease and vendor financing and our revolving credit facility.
For the first nine months of fiscal 1999, cash used in operating activities
was $4.5 million, primarily composed of a net loss of $46.0 million, offset by
an increase in operating working capital and non-cash charges relating to the
provision for bad debt and depreciation and amortization. Cash used for
investing activities, primarily capital expenditures, totaled $25.1 million in
the first nine months of fiscal 1999. Cash provided by financing activities
amounted to $46.9 million, primarily consisting of the receipt of $70.0 million
in private placement equity offerings, offset by repayments of certain
subordinated debt. As of June 30, 1999, we had $38.2 million in cash.
As of September 30, 1998, we had approximately $20.9 million in cash. Our
net cash used in operating activities was $31.7 million in fiscal 1998,
primarily caused by a net loss of $27.5 million, a decrease in operating working
capital of $28.0 million, and $27.5 million of non-cash charges consisting of
the provision for bad debts and depreciation and amortization. Cash used for
investing activities totaled $12.0 million in fiscal 1998, which was for capital
expenditures. The capital expenditures primarily consisted of purchases
associated with the expansion of our network, computers, and general equipment.
Net cash provided by financing activities totaled $60.5 million for fiscal 1998,
which consisted of $55.2 million in proceeds from the issuance of subordinated
debt, $10.0 million from a private placement equity offering, a $0.7 million
increase in our revolving credit facility, offset by $5.3 million in the
repayment of debt and capital lease obligations. Net cash used in operating
activities for fiscal 1997 was $7.2 million, and net cash provided by operating
activities for fiscal 1996 was $7.6 million. Net cash used in investing
activities, principally capital expenditures, was $10.9 million and $3.1 million
for fiscal 1997 and 1996, respectively. We financed these capital expenditures
primarily with long-term debt. Net cash provided by financing activities for
fiscal 1997 was $18.8 million, and net cash used in financing activities for
fiscal 1996 was $2.3 million.
In October 1997, the California Public Utilities Commission issued its final
order which imposed a $19.6 million fine against us, $2.0 million of which was
charged against earnings in fiscal 1997 and was
34
paid in April 1998 and the remainder of which is suspended by the CPUC subject
to our refraining from committing any violations of statutes or CPUC directives.
See "Business--Legal Proceedings."
Capital expenditures, including assets acquired by incurring capital lease
obligations, for fiscal 1996, 1997 and 1998 totaled $8.7 million, $19.4 million,
and $22.4 million, respectively. We expect to continue to make significant
capital expenditures during fiscal 1999 and fiscal 2000, including the purchase
of telecommunications equipment such as digital subscriber line and Asynchronous
Transfer Mode equipment, additional interests in undersea cables, investments in
U.S. and European fiber optic networks and network management systems. We also
intend to enhance our network infrastructure, including by making further
improvements to our billing systems and management information systems. Total
estimated capital expenditures for fiscal 1999 are $67.0 million, of which $57.8
million had been spent as of June 30, 1999. Total estimated capital expenditures
for fiscal 2000 are $142.0 million. Included in the fiscal 2000 estimate is
approximately $113.0 million for our planned buildout of our U.S. and European
networks and interests in undersea cables. These capital expenditures will
increase the geographic scope of our operations. We expect that the
implementation of our network expansion plans will reduce the cost of
transmission on a per minute basis as traffic volumes increase on our network.
In order to finance the planned network expansion in fiscal 2000 we intend to
use a portion of the proceeds of this offering, together with capital lease and
vendor financing and the issuance of additional debt and/or equity securities.
We cannot assure you that we will be able to obtain such financing or raise
additional capital on acceptable terms or at all. If we are not successful in
obtaining this additional financing, we would be forced to delay or curtail our
planned network expansion. See "Risk Factors--We Are Subject to Certain
Restrictions Under Our Debt Obligations," "Risk Factors-- The Costs of Expanding
Our Business Will Be Significant; We Will Need Additional Capital to Complete
the Build-out of Our European Network" and "Use of Proceeds."
We have utilized capital lease and vendor financing to assist in financing
the building of our network, systems and infrastructure. As of June 30, 1999,
the balance of capital lease financing obligations totaled $34.0 million,
primarily relating to the lease of our switching platforms in North America. In
addition, as of June 30, 1999 we had $22.5 million in obligations owed to
vendors.
In March 1997, we entered into our revolving credit facility, which consists
of an accounts receivable-based revolving credit facility and a term loan. The
credit facility allows us to borrow up to a maximum of $35.0 million, subject to
certain restrictions and borrowing base limitations. The available borrowing
base under the revolving credit agreement is determined as a specified
percentage of eligible accounts receivable. The balance outstanding on the
revolving credit agreement is reduced by the application of payments received on
collections of accounts receivable. The accounts receivable revolving credit
facility had an outstanding balance of approximately $22.4 million at June 30,
1999, which approximates the maximum available pursuant to the borrowing base
limitations. This facility bears interest at the prime rate plus 2.75%, is
repaid through collections of accounts receivable, and matures in October 2000.
The term loan, which at June 30, 1999 had an outstanding balance of
approximately $4.1 million, bears interest at the prime rate plus 6.75%,
requires monthly reductions of principal of $300,000 plus interest, and matures
in October 2000. As of June 30, 1999 we were in compliance with the restrictive
covenants under the credit facility. Our obligations under the credit facility
are secured by a first position in substantially all of our property.
In fiscal 1997, we sold a 40% interest in WorldxChange Pty. Ltd., our
Australian operating subsidiary, to an affiliate of the Asian Infrastructure
Fund. The proceeds of approximately $9.0 million from this sale were used to
finance working capital requirements and the expansion of this operating
subsidiary. We have recently agreed to repurchase the 40% interest in
WorldxChange Pty. Ltd. See "Acquisition of Minority Interest in Subsidiaries."
From May through August 1998, we issued and sold subordinated promissory
notes in the aggregate principal amount of $55.0 million. These notes bear
interest at the rate of 12.5% per annum, provide for quarterly payments of
interest only and mature on November 30, 2000. These notes provide
35
the lender the right to require us to use 35% of the net proceeds from any
private placement or public offering of our common stock, including this
offering, to repay the notes. The balance of these notes at June 30, 1999 was
$45.2 million.
In September 1998, we sold 788,127 shares of our common stock in a private
placement at a price of $12.69 per share for total proceeds of $10.0 million. In
December 1998, we sold 871,087 shares of our common stock in a private placement
at a price of $11.48 per share for total proceeds of $10.0 million. In March
1999, we sold 3,000,000 shares of our common stock in a private placement at a
price of $10.00 per share for total proceeds of $30.0 million. In June 1999, we
sold 2,727,270 shares of our common stock in a private placement at a price of
$11.00 per share for total proceeds of $30.0 million. The offerings raised a
total of $80 million. The proceeds from these private placements were used for
network expansion, to pay for direct mail campaigns and other marketing
activities, to repay subordinated debentures, and to prepay a portion of our
subordinated promissory notes and for other corporate purposes.
In August 1999, we entered into an agreement to sell 30,000 shares of our
Series A Convertible Preferred Stock in a private placement for total proceeds
of $30.0 million. These shares are convertible into 2,727,270 shares of our
common stock. Prior to the conversion of these shares, we are obligated to pay
the holder of these shares an annual dividend equal to 4% of the face amount of
these shares.
We entered into two agreements during the nine month period ended June 30,
1999 for the acquisition of capacity on land-based fiber optic cable systems for
a total price of $45.0 million. The vendors have agreed to finance 90% of the
commitment at 12% interest, with monthly principal and interest payments over a
five year amortization period. As of June 30, 1999, we had acquired
approximately $16.0 million, leaving $29.0 million to be ordered by November
1999.
We believe that we will be able to satisfy our operating cash requirements
for at least the next 12 months from a combination of cash on hand, the proceeds
of this offering, availability under our vendor financing arrangements, and our
secured credit facility. In order to complete our planned network expansion, we
must raise additional capital through the issuance of debt and/or equity
securities. If we are not successful in obtaining this additional financing, we
would be forced to delay or curtail our planned network expansion in order to
satisfy our operating cash requirements.
MARKET RISK
The carrying value of cash and cash equivalents approximates fair value due
to the short-term, highly liquid nature of the cash equivalents, which have
maturities of three months or less. Interest rate fluctuations would not have a
significant effect on the fair market value of cash equivalents held by us.
At June 30, 1999 we had outstanding debt, excluding capital lease
obligations, in the amount of $95.4 million, of which $68.9 million is fixed
interest debt. The remaining $26.5 million carries adjustable interest rates at
the prime rate plus 2.75%. A one percent change in the interest rate would
change interest payments by approximately $22,100 per month.
FOREIGN CURRENCY EXPOSURE
While an increasing amount of our revenues will be denominated in non-U.S.
currencies, a disproportionate portion of our expenditures, including interest,
will be denominated in U.S. dollars. In addition, the assets and liabilities of
our non-U.S. subsidiaries are generally denominated in local currencies.
Accordingly, we may be subject to significant foreign currency exchange risks.
In addition, we may in the future acquire interests in entities that operate in
countries where the expatriation or conversion of currency is restricted. We
currently do not hedge against foreign currency exchange risks, but may in the
future. Because of the number of currencies involved, our constantly changing
foreign currency exposure and the fact that all foreign currencies do not
fluctuate in the same manner against
36
the U.S. dollar, we cannot quantify the effect of exchange rate fluctuations on
our future financial condition or results of operations.
EURO CONVERSION
On January 1, 1999, several member countries of the European Union
established fixed conversion rates and adopted the euro as their new common
legal currency. Since that date, the euro has traded on currency exchanges,
although the legacy currencies will remain legal tender in the participating
countries for a transition period between January 1, 1999 and January 1, 2002.
During the transition period, parties can elect to pay for goods and services
and transact business using either the euro or a legacy currency. Between
January 1, 2002 and July 1, 2002, the participating countries will introduce
euro currency coins and withdraw all legacy currencies.
The euro conversion may affect cross-border competition by creating
cross-border price transparency. We are assessing our pricing and marketing
strategy in order to insure that it remains competitive in a broader European
market. In addition, we are reviewing whether certain existing contracts will
need to be modified. Our currency risks and risk management for operations in
participating countries may be reduced as the legacy currencies now trade at a
fixed exchange rate against the euro. We will continue to evaluate issues
involving introduction of the euro. However, based on current information and
assessments, we do not expect that the euro conversion will have a material
adverse effect on our results of operations or financial condition.
SEASONALITY
Our European and Australian operations experience seasonality during the
summer seasons of those regions, which results in decreased customer calling
volumes.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This standard is effective for fiscal years beginning after December 15,
1997. SFAS 130 requires that all components of comprehensive income, including
net income, be reported in the financial statements in the period in which they
are recognized. Comprehensive income is defined as the change in equity during a
period from transactions and other events and circumstances from non-owner
sources. Net income and other comprehensive income, including foreign currency
translation adjustments, and unrealized gains and losses on investments, shall
be reported, net of their related tax effect, to arrive at comprehensive income.
We have adopted this standard in our financial statements.
Also, in June 1997, the Financial Accounting Standards Board issued SFAS No.
131 (SFAS 131), Segment Information. This standard is effective for fiscal years
beginning after December 15, 1997. SFAS 131 amends the requirements for public
enterprises to report financial and descriptive information about its reportable
operating segments. Operating segments, as defined by SFAS 131, are components
of an enterprise for which financial information is available and evaluated
regularly by a company in deciding how to allocate resources and in assessing
performance. The financial information is required to be reported on the basis
that is used internally for evaluating the segment performance. We have adopted
this standard in our financial statements.
YEAR 2000 COMPUTER ISSUES
The Year 2000 problem is the result of computer programs, microprocessors
and embedded date reliant systems using two digits rather than four to define
the applicable year. If not corrected, these programs and systems may recognize
a date using "00" as the year 1900 rather than the year 2000. This could cause
systems to fail, lock up or generate erroneous results.
37
In mid-1998, we commenced an assessment of our internal systems to determine
whether they were Year 2000 compliant. The fundamental ability of our network to
carry calling traffic has been tested for Year 2000 compliance and has passed.
We are currently in the process of remediating our remaining systems and
functions for Year 2000 compliance. We expect this process to be completed by
September 30, 1999.
Our remaining Year 2000 preparedness efforts have principally focused on the
implementation of a Year 2000 compliant billing software package for our North
American operations. This process involves replacing our existing North American
billing software, which is not Year 2000 compliant, with a compliant version
from the same vendor and then customizing the new version to integrate it into
our billing platform. We have scheduled a series of tests, which will be
internally conducted, supervised and reviewed, for mid-September 1999 to assess
the new North American billing software and all other systems and functions. The
billing systems used in our overseas operations have all been previously tested
and found to be Year 2000 compliant.
In addition to our remediation efforts, we have established contingency
plans in the event that any of our systems or functions were to fail as a result
of the Year 2000 problem. We have arranged to have the employees who were
involved in our Year 2000 preparedness efforts on-site or available on short
notice to augment our normal trouble-shooting team. These employees, on a
rotating basis, will provide 24-hour availability of Year 2000 expertise should
unforeseen problems arise. There can be no assurance that our contingency plans
will allow us to avoid delays, disruptions and losses in our operations if our
systems are not successfully remediated. If any of our systems were to fail as a
result of the Year 2000 problem or for any other reason, our business could be
harmed and the price of our common stock could be depressed.
We have budgeted a total of approximately $4.25 million, representing
approximately 50% of our total information technology budget for fiscal 1999,
for Year 2000 preparedness efforts. Of this amount:
- approximately $1 million is budgeted for detection of Year 2000 problems;
and
- approximately $3.25 million is budgeted for remediation, internal testing
and verification of Year 2000 preparedness.
As of August 1, 1999, approximately 30 of the 65 full-time employees in our
information technology department were fully engaged in Year 2000 preparedness
activities. Staffing will increase beginning in the month of August to nearly 40
full-time employees and contractors to complete the integration, testing and
remediation of any new problems found during the course of testing.
We are in the process of communicating with key carriers and other vendors
and suppliers upon which our operation and infrastructure are dependent to
determine the extent to which we are vulnerable to a failure resulting from the
inability of these parties to correct their own Year 2000 issues. We have taken
steps to ensure that services and products provided to us by these parties are
Year 2000 compliant. Although there can be no assurance that the carriers and
vendors with whom we do business, or the products or services they provide, are
Year 2000 compliant, we are working with each one to understand their Year 2000
preparedness levels. Also, we will be reviewing any Year 2000 contingency plans
of these vendors and carriers. Should these services be disrupted, and depending
upon the extent and duration of any such disruptions, our business and common
stock price could be adversely affected.
We are also vulnerable to disruptions in the economy generally resulting
from Year 2000 problems. We could be subject to litigation resulting from
disruptions in our services. Any such litigation could harm our business and
depress the price of our common stock.
38
BUSINESS
OUR COMPANY
We are a leading global telecommunications company that specializes in
providing high-quality, low-cost domestic and international telecommunications
services. We have established retail and wholesale operations in North America,
Europe and the Pacific Rim. Our global facilities include 40 switches located in
major metropolitan areas in 12 countries. Our network has been designed to give
us the ability to simultaneously carry voice and data. We connect our switches
with an extensive network of owned and leased undersea and land-based fiber
optic cables. Our revenues have grown from $184 million in fiscal 1996 to $332
million in fiscal 1997 to $399 million in fiscal 1998. According to the 1999
edition of Telegeography, in 1997 we were the 39(th) largest telecommunications
carrier of international minutes in the world and the fourth largest of the
non-monopoly or non-former monopoly carriers behind MCI WorldCom, Sprint and
Pacific Gateway Exchange.
We currently serve more than 750,000 residential and commercial retail
customers each month. Our services currently include international and domestic
long distance telephone service, post-paid and pre-paid calling card services,
operator services, Internet access and e-commerce services. We market these
services through direct mail, independent agents, direct sales and media
advertising. By the end of 1999, we intend to offer high-speed data networking
services through DSL technology to our customers in North America, with service
to European and Australian customers to follow.
We currently have established operations in the United States, Australia,
Canada, The Netherlands, New Zealand and the United Kingdom and have recently
obtained, or expect shortly to obtain, interconnection for our operations in
Belgium, Chile, France, Germany, Guatemala and Sweden, after which we plan to
expand our marketing efforts in these countries. We plan to establish operations
in El Salvador, Italy, Japan, Spain and Switzerland within the next 15 months.
We also plan to begin the installation and integration of ATM switches across
our global network to allow for the seamless transport of voice, data and video.
We entered the U.S. market during 1992 and quickly recognized the
opportunities presented by the international long distance market both in the
United States and abroad. Our strategy is to continue to expand our global
network to enhance our ability to provide high-quality, low-cost
telecommunications services to our growing customer base. In the United States,
we target customers with international long distance usage. In foreign markets,
our strategy is to establish operations in key metropolitan areas early in the
deregulation process to position ourselves to accelerate our growth after
obtaining connection to the networks of the dominant carriers in those markets.
Using this strategy, we have increased our international revenues from $44.5
million for fiscal 1997 to $84.5 million for fiscal 1998. We believe there are
significant opportunities for continued growth in overseas markets.
INDUSTRY OVERVIEW
The industry is being shaped by the following trends:
- deregulation and privatization of telecommunications markets worldwide;
- diversification of services through technological innovations;
- globalization of major carriers through market expansion;
- consolidation and strategic alliances;
- greater consumer demand;
- increases in international business travel; and
- privatization of national carriers, growth of computerized transmission of
voice and data information.
39
These trends have sharply increased the use of, and reliance upon,
telecommunications services throughout the world. We believe that despite these
trends, a high percentage of international businesses and residential consumers
continue to be subject to high prices and poor quality of service in comparison
to the United States. Demand for improved service and lower prices have spurred
deregulation and created opportunities for private industry to compete in
previously closed or restricted sectors of the international market. Increased
competition, in turn, has spurred a broadening of products and services, and new
technologies have contributed to improved quality and increased transmission
capacity and speed.
Measured in minutes, international long distance switched telecommunications
grew at an average annual rate exceeding 14% between 1989 and 1997, making it
one of the fastest-growing segments of the long distance industry. International
Telecommunications Union forecasts project continued growth in this segment at a
compound annual rate of approximately 12% to 18% from 1997 to 2001. Based on
this forecast, worldwide international long distance traffic is projected to
increase from approximately 81.8 billion minutes in 1997 to between
approximately 128.7 billion and 158.6 billion minutes by the year 2001. We
believe that the last decade of industry growth as well as the projected future
industry growth are based on a combination of:
- regulatory liberalization of the telecommunications industry;
- privatization of the dominant local carriers;
- the opening of geographic markets to foreign competition;
- substantial investment in the telecommunications infrastructure;
- greater consumer access to international long distance services
attributable in part to the increase in the number of households with
telephones; and
- technological advances.
Regulatory liberalization and technological advances have also broadened the
range of telecommunications and information services that are now available to
consumers. In addition to traditional person-to-person long distance calling,
telecommunications and other companies now provide such services as voicemail,
faxmail and electronic mail, as well as itemized billing, telephone debit and
calling cards, and intranet and Internet services, some of which are not
regulated at this time. This greater variety of services, combined with
generally declining prices, has contributed to the increase in the volume of
long distance traffic.
International long distance calling prices have historically been determined
by international settlement rates, which are the rates that a carrier (often a
dominant local carrier) charges to terminate an international call in its home
country. Historically, national monopolies set these rates at arbitrary,
artificially high levels that enabled many carriers to enjoy high gross margins
on international calls. Intensifying competition in many countries has caused
international settlement rates to decline for the last several years. In
addition, a greater percentage of calls is being placed outside the
international settlement rate system altogether, resulting in further price
declines. Moreover, practices such as "refile" (where traffic originating from a
particular country is rerouted through another country with a lower settlement
rate), off settlement rate terminations (where a local carrier agrees to
terminate an international call at rates below the settlement rates) and transit
(where a carrier agrees to terminate another carrier's traffic to a particular
country at a negotiated price other than the settlement rate) are becoming
increasingly common. We believe that all of these factors, combined with
advances in technology, are leading to the end of the international settlement
rate system.
Regulatory initiatives are also mandating reductions in settlement rates. We
expect that many countries will implement lower settlement rates over the next
several years. Prices may decline further as a result of recent FCC decisions
modifying the Commission's regulatory requirements for the provision of
international services. See "--Regulation--United States--FCC International
Regulation."
40
THE U.S. MARKET
The U.S. domestic long distance companies had approximately $105 billion in
revenue in 1998. While AT&T, MCI WorldCom and Sprint accounted for the
overwhelming share of that revenue, there are literally hundreds of competitors.
The U.S. market is among the most competitive and deregulated in the world.
Carriers compete on the basis of price, quality of service, customer service,
and the ability to provide value-added services. The Regional Bell Operating
Companies are currently precluded from providing long distance service in their
local exchange operating territories, but it is expected that the first
instances of such authority will be granted soon, paving the way for the entry
of additional major competitors.
The U.S. international long distance telecommunications market accounted for
approximately 33% of worldwide long distance traffic originations in 1997. The
profitability of the U.S. international long distance market is determined
principally by the spread between settlement rates, which are the rates paid to
other carriers to terminate an international call, and billed revenues.
Settlement rates have been declining due to increased competition resulting from
regulatory liberalization and political pressure arising from increased global
trade. The costs of leased capacity have also declined as technological
advances, investments in the telecommunications infrastructure and regulatory
liberalization have increased the availability of transmission lines. We believe
that settlement rates and costs for leased capacity will continue to decline,
although we cannot be certain of this. See "Risk Factors--International Calling
Prices Are Declining."
THE EUROPEAN MARKET
The European international long distance telecommunications market accounted
for approximately 43% of worldwide long distance traffic originations in 1997. A
fully liberalized single market for continental European telecommunications is
expected to arise. Already deregulation is stimulating competition. As of August
1, 1998, there were more than 400 facilities-based carriers competing to provide
international service in Europe.
As alternative wholesale networks are constructed in continental Europe, it
is becoming less expensive to operate a retail long distance business there.
Since such projects have been announced or completed, the costs associated with
the operation of European long distance facilities has begun to decline rapidly.
For example, over a period of less than one year, the cost of an E-1 circuit,
which is a European unit of measure representing the capacity to carry 30 calls
simultaneously, from London to Stockholm has declined from approximately $21,000
to approximately $12,000 per month. We believe that these cost declines will
continue to outpace declines in prices for long distance services because:
- dominant local carriers in markets for retail national and international
long distance services are reluctant to reduce prices; and
- enhanced services and generally lower prices should increase the demand
for long distance services.
However, there can be no assurance in this regard. See "Risk Factors--We Have
Many Competitors Who Enjoy Significant Competitive Advantages Over Us" and "Risk
Factors--International Calling Prices Are Declining."
PACIFIC RIM MARKET
Led by Australia and New Zealand, the telecommunications industries in the
countries of the Pacific Rim are becoming increasingly liberalized. Australia
and New Zealand have for some time allowed full facilities-based competition.
Each of these countries also actively fosters competition by establishing
regulatory bodies empowered to monitor and curtail anti-competitive practices
and promulgating rules and regulations intended to promote competition.
41
The pace of regulatory liberalization in the Pacific Rim is accelerating,
with recent liberalization developments occurring in Japan, Guam, Hong Kong,
Malaysia, the Philippines and other Pacific Rim countries. Several of these
markets generate significant long distance traffic. We believe that a number of
these markets potentially offer attractive growth opportunities. However, we
cannot assure you that the pace of liberalization will continue at its current
rate or at all in these countries, or that these markets will ultimately become
open to full or significant competition.
THE LATIN AMERICAN MARKET
During the last few years, several Latin American countries have taken
preliminary steps to liberalize the regulation of their telecommunications
markets. The markets of Chile, the Dominican Republic, El Salvador, Guatemala
and Mexico are among the most liberalized. Several other countries have also
partially or totally privatized their dominant local carriers, including
Argentina, Mexico, Peru and Venezuela. Some of the more significant developments
in the liberalization of the Latin American international long distance market
include:
- Telmex, the dominant local carrier in Mexico, was recently privatized and,
since 1997 has been required to interconnect with the networks of
competing carriers;
- Venezuela approved the provision of value-added services and has announced
plans to implement full regulatory liberalization by January 1, 2000; and
- Brazil is in the process of privatizing its dominant local carrier, has
established an independent regulator, and is opening its
telecommunications market to competition.
OUR COMPETITIVE STRENGTHS
We believe we have positioned ourselves to compete successfully in the
domestic and international marketplace and have the following competitive
strengths:
ESTABLISHED GLOBAL COMMUNICATIONS NETWORK
We have established a worldwide telecommunications network that enables us
to carry calling traffic on a high-quality, cost-effective basis. This network
includes:
- 40 switches in 12 countries;
- ownership interests in 14 undersea cable systems, and IRUs in an
additional 11 undersea cable systems, comprising in total over 340 E-1
circuits;
- IRUs in more than 25 million DS-0 miles of on-land fiber optic cable
capacity in the United States;
- seven satellite earth stations at locations in the United States and
abroad.
In addition, we have interconnection agreements in Australia, Belgium,
Canada, Chile, France, Germany, Guatemala, The Netherlands, New Zealand and the
United Kingdom.
WE HAVE A SEASONED MANAGEMENT TEAM WITH SIGNIFICANT OWNERSHIP
We have assembled a seasoned and aggressive management team. This team
includes our chairman, Walt Anderson, who founded Esprit Telecommunications, Mid
Atlantic Telecom and Telco Communications and oversaw their growth until they
were acquired. Tom Cirrito, a director of our company, also founded several long
distance telecommunications carriers, including Telco Communications and the
Long Distance Wholesale Club. Chris Bantoft, our president and a director, is a
former senior executive who was based in Europe with ACC, an international
carrier that was recently acquired by AT&T. These individuals complement the
skills of our company's founder and chief executive officer, Roger Abbott, as
well as of our other senior executives, who have experience in
42
management, multinational sales and marketing, network operations and
engineering, finance and regulatory matters. Through corporate affiliates, Mr.
Anderson and Mr. Cirrito recently purchased a total of $120 million of our
equity securities.
INNOVATIVE AND DIVERSE MARKETING STRATEGY
We use a variety of marketing channels to reach our customers. These
channels include direct mail, multilevel marketing, independent sales agents,
direct sales and media advertising. In October 1998, we introduced our
innovative "xPectations ML" multilevel marketing program. This allows
participating representatives to earn commissions based on revenues we collect
from new pre-subscribed and dial-around long distance customers, as well as
Internet access and prepaid calling card customers that they sign up. In
addition, these representatives earn commissions based on revenues we collect
from customers signed up by other representatives that they recruit to the
program. We also use the Internet to provide on-line commission information and
accounting, call details, pre-approved advertising, marketing information and
alerts, chat rooms and on-line trouble reporting for program representatives. We
also provide program representatives with a Web site, which we host. This allows
our representatives to use a professionally designed Web site to market our
services while allowing us to retain control over the advertising content. We
have recruited more than 7,000 representatives into this program since its
introduction.
ADVANCED OPERATIONAL SYSTEMS
We have developed proprietary software and information systems that allow us
to manage our business using real-time information. We believe we are one of the
few companies with systems that provide management with daily network cost
information on a route-by-route basis, which enables us to calculate our
variable gross margins by type of service on a daily basis throughout the world.
We believe these analytical tools allow us to quickly identify new market growth
and cost-saving opportunities, as well as to manage our business effectively.
HIGH-QUALITY CUSTOMER CARE
We have developed an advanced customer care platform that enables us to
communicate with our customers over a variety of media, including the Internet.
We have engineered and designed call centers that incorporate access to our
customer information with real-time information dissemination and
trouble-shooting. The proprietary billing system that we use in our foreign
markets provides significant competitive advantages, such as integration with
our switching systems to provide instant account set-up and other benefits,
adaptability for pre-paid and post-paid calling card services, compatibility
with every currency, and flexibility to implement appropriate rate and discount
plans as competitive conditions warrant.
OUR STRATEGY
Our objective is to position ourselves as a leading total solution provider
of high-quality, low-cost communications services, including voice, data and
Internet protocol services. Our strategy for achieving this objective consists
of the following key elements:
EXPAND OUR NETWORK AND ENTER KEY NEW MARKETS
Within the next 15 months, we intend to initiate operations in five
additional countries. We recently began developing our European network
consisting of fiber optic lines to be constructed by us in selected cities,
long-term IRUs in dark fiber and in operational capacity owned by other
carriers, and leased capacity. We expect to decrease our transmission costs by
increasing the use of our network. It costs us less to carry calls over our
network than to do so over other carriers' networks, since our
43
owned transmission capacity entails fixed costs regardless of the volume of
traffic carried. In contrast, we pay per-minute charges to transmit calls over
other carriers' networks.
INTEGRATE BROADBAND CAPABILITIES INTO OUR NETWORK
We intend to expand the technological capability of our network. We plan to
incorporate into our network high-speed DSL multiplexing equipment for the
end-user as well as our central switching offices, which will enable us to
provide high-speed, local data network services. We also intend to install ATM
switches in key switching locations within our network, which will enable us to
provide integrated voice, data and video communications services.
EMPHASIZE OUR HIGHER MARGIN RETAIL BUSINESS
We intend to concentrate our future growth in the retail market segment
while continuing to sell excess network capacity to other carriers and wholesale
customers. We believe that the retail segment offers several advantages,
including:
- higher margins;
- higher barriers to entry because of the significant investments required
to develop sales, marketing and customer support;
- greater opportunities to bundle local, data and other value-added
services, such as DSL Internet access and e-commerce services;
- greater opportunities to increase name recognition and build brand
loyalty; and
- reduced concentration on large wholesale customers who have higher credit
and cancellation risks.
EXPAND OUR MARKETING PROGRAMS IN EXISTING AND NEW MARKETS
We believe that we have developed a cost-effective and successful marketing
platform. We believe that we can increase our retail sales by expanding our
marketing programs in existing markets and aggressively implementing them in new
foreign markets. We intend to emphasize our Internet, e-commerce and multi-level
marketing activities. For example, we intend to expand our recently introduced
"xPectations ML" multi-level marketing program both in the United States and
overseas.
EXPAND OUR INTERNET AND E-COMMERCE SERVICE OFFERINGS
We recently began offering Internet access services in several of the
countries in which we operate and intend to offer these services in other
markets in the near future. Our planned installation of DSL equipment on our
network will enable us to provide customers with continuously connected,
high-speed Internet access. We provide an Internet-based billing and customer
care platform that allows our customers to sign up for our services and make
changes to the services they select, view their call data, generate customized
billing reports, and make billing and service inquiries. We also recently
introduced our e-commerce program in the United States by developing a
user-friendly Web site for the sale and recharge of prepaid calling cards. We
intend to offer this program in other markets, as well as to expand the range of
products and services offered through the Internet.
PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES
To date we have achieved all of our growth internally. Although we intend to
continue to emphasize internal growth, we also plan to pursue strategic
acquisitions and alliances. We will seek to acquire or partner with
complementary companies that:
- will provide us with access to attractive new geographic markets;
44
- have an established customer base or marketing channels;
- have a complementary network; or
- have innovative telecommunications services or technologies.
SERVICES
We provide a variety of retail telecommunication and information services,
including international and domestic long distance telephone service, post-paid
and pre-paid calling card services, operator services, Internet access and
e-commerce services, to our residential and commercial customers. We also
provide wholesale and resale services to our carrier customers. Our services are
discussed below.
RETAIL SERVICES
We offer international and domestic long distance telephone service,
post-paid and pre-paid calling card services, and Internet access services in
all of our primary geographic markets, including the United States, Australia,
Belgium, Canada, France, Germany, The Netherlands, New Zealand and the United
Kingdom. We also offer e-commerce services in the United States, Australia and
Canada. Each of these services is described in more detail below.
INTERNATIONAL AND DOMESTIC LONG DISTANCE TELEPHONE SERVICE. International
and domestic long distance telephone service is accessed from a customer's
billing location, such as the home or office. In North America, Germany and New
Zealand, customers who have pre-subscribed our service may access the
WORLDxCHANGE network by dialing "1+". U.S. customers who have not pre-subscribed
our service may access our network by dialing a seven-digit code. Most of our
U.S. residential customers use the dial around method. In other countries, our
customers generally must dial a three- to seven-digit access code. We expect to
add a pre-subscription option for these customers as that service becomes
available to us. Our international and domestic long distance telephone service
generally enables customers to call to any destination.
CALLING CARD SERVICES. We sell post-paid and pre-paid calling card services
in most of the countries in which we operate. In these countries, customers
access our calling card service by dialing a national toll free number or a
local access number. Our services can be accessed from outside a customer's home
country through an international or national toll free number or a local access
number.
INTERNET ACCESS SERVICES. We introduced our Internet access service, known
as "wxc.net", in June 1999. We plan to increase the number of markets in which
we offer our Internet access services. Our customers access our Internet service
by dialing a local or toll-free number. We offer this service to retail
customers for a fixed monthly price, which we believe is discounted from the
prices charged by the major Internet access providers. We believe offering
Internet access will increase usage of our services, generate additional revenue
and help us attract and retain customers.
e-COMMERCE SERVICES. We believe it will be important for us to capitalize
on the growing popularity of the Internet. We have implemented several
e-commerce services and expect to introduce additional Internet services in the
near future. For example, in July 1999, we introduced "Virtual PIN," a program
under which our customers are able to purchase and recharge prepaid calling
cards exclusively through our Web site, which may be accessed at
www.worldxchange.com. We also offer our North American customers the "iPlan"
billing option, under which they can receive a discount by having their bills
rendered over the Internet instead of by paper invoice. Other features allow our
customers, via the Internet, to sign up for our services and make changes to the
services they select, view their call data, generate customized billing reports,
and make billing and service inquiries. We intend to offer Internet-accessed
pre-paid calling cards and paperless "iPlan" billing in additional markets in
the near future.
45
Our e-commerce strategy also includes our "xPectations ML" multi-level
marketing program. Under this program, independent representatives can obtain
their own Web site, which we host. This allows the representatives to use a
professionally-designed Web site to market our services to potential customers
and the xPectations ML program to prospective new representatives while allowing
us to retain control over the advertising content on the site.
We believe that e-commerce represents a significant growth opportunity for
us. We believe that these services will appeal to a desirable segment of the
population that is:
- technologically proficient;
- makes a significant number of long distance calls; and
- represents a broad geographic base.
E-commerce services also generally have lower associated sales and marketing,
billing and customer service costs.
OTHER RETAIL SERVICES. We also provide the other retail services described
below. These services currently account for a relatively small portion of our
revenues. We currently intend to continue providing these services as ancillary
offerings.
- TOLL-FREE SERVICE. We provide domestic toll-free service to customers in
most of the countries where we operate. Our toll-free customers also may
obtain an enhanced feature known as "follow me" service, under which
toll-free calls are automatically forwarded to alternate numbers until
answered.
- DIRECTORY ASSISTANCE. We provide our U.S. and Canadian long distance
customers with nationwide directory assistance service 24 hours a day.
- DEDICATED ACCESS SERVICE. This service provides customers with a
dedicated, leased transmission line that connects the customer's business
directly to our network. This service is marketed to high-volume customers
in the United States and can be used for voice, data, video and Internet
access.
- OPERATOR SERVICES. In the United States, we offer 24-hour operator service
to customers that have pre-selected our service. We also offer alternative
operator services predominately for U.S. bound calls originating from
hospitality locations in Latin American countries. We process collect,
third-party, person-to-person and calling card calls and generally share a
percentage of call revenues with the location owner and/or the agent or
agents procuring such locations.
WHOLESALE SERVICES
CARRIER SERVICES. We sell long distance transmission capacity to carriers
through our direct sales force in the United States, Australia, Belgium, Canada,
The Netherlands, New Zealand and the United Kingdom. These customers, which
include some of the largest carriers in the world, may purchase capacity from us
to carry traffic where they do not have their own routes of if they require
additional or reserve capacity. These carrier customers use our transmission
capacity to provide service to their customers.
By selling transmission capacity to carrier customers where all or a portion
of the traffic is transmitted over a route or routes on which we have unused
capacity, we can generate additional revenues without incurring significant
marginal costs. In addition, by selling carriers capacity purchased from
third-party vendors, we increase the amount of transmission capacity that we
purchase overall, which may allow us to obtain volume discounts on our purchases
of transmission capacity from these third-party vendors. This in turn may allow
us to generate higher margins and/or offer better pricing on our retail
services. See "Risk Factors--We Face Risks Relating to Carrier and Other
Wholesale Customers."
46
OTHER WHOLESALE SERVICES. We sell transmission capacity to customers that
offer their own branded products and services such as private label calling
cards. In addition, we also sell transmission capacity to resellers for
subsequent sale of long distance services to their customers. We intend to
increase the amount of capacity that we sell to resale customers in overseas
markets, since this channel typically generates higher margins than wholesale
carrier sales. See "Risk Factors--We Face Risks Relating to Carrier and Other
Wholesale Customers."
THE WORLDxCHANGE NETWORK
As of June 30, 1999, our network consisted of:
- 40 switches in 12 countries;
- IRUs in more than 25 million DS-0 miles of on-land fiber optic cable
capacity in the United States;
- seven satellite earth stations at locations in the United States and
abroad; and
- an international transmission network consisting of direct ownership
interests and IRUs, comprising over 340 E-1 circuits, including rights on
the following undersea cables:
SERVICE STATUS OR
PLANNED CALENDAR
QUARTER SERVICE MIU/ TOTAL E1
UNDERSEA CABLE DATE IRU CAPACITY
- ------------------------------------------------------ ------------------- --------- -----------
Americas-I............................................ In Service MIU 1
APCN.................................................. In Service IRU 2
Atlantic Crossing..................................... In Service IRU 126
Cantat 3.............................................. In Service MIU 2
Canus 1............................................... In Service IRU 2
Columbus II........................................... In Service MIU 1
F.L.A.G............................................... In Service IRU 7
Guam-Philippines...................................... In Service MIU 3
HAW-5................................................. In Service IRU 1
Jasuraus.............................................. In Service IRU 2
PacRim East........................................... In Service MIU 9
Pan American.......................................... In Service MIU 10
PTAT.................................................. In Service IRU 1
Taino-Caribe.......................................... In Service IRU 1
Tasman 2.............................................. In Service IRU 3
TAT-12/TAT-13......................................... In Service MIU 5
TPC-5................................................. In Service MIU 4
UK-Belgium 6.......................................... In Service IRU 3
UK-Germany 6.......................................... In Service MIU 42
UK-Japan.............................................. In Service MIU 3
UK-Netherlands 12..................................... In Service IRU 1
China-US.............................................. Q1 2000 MIU 2
Columbus-III.......................................... Q4 1999 MIU 11
Maya 1................................................ Q2 2000 MIU 9
Southern Cross........................................ Q1 2000 MIU 89
In addition, we have interconnection arrangements in Australia, Belgium,
Canada, Chile, France, Germany, Guatemala, The Netherlands, New Zealand and the
United Kingdom. On the inside cover of this prospectus there is a graphic
illustration of our network. We intend to continue to make substantial
investments in network infrastructure, particularly investments in ATM and DSL
equipment and in a
47
fiber optic cable network in Europe. See "--Development of Broadband Network
Capabilities" and "--European Network--Network Expansion."
COSTS OF CALL ORIGINATION, TRANSMISSION AND TERMINATION
The major components of our costs include the cost of origination,
transmission and termination. We believe that our ability to control these costs
will be an important factor in our overall financial performance.
ORIGINATION AND TERMINATION. In general, we pay a per-minute fee to
originate and terminate calls. We can reduce the costs of our U.S. calls by
having direct interconnection with the applicable local telephone companies,
which allows us to carry a larger portion of each call on our network. We can
reduce these costs outside North America by interconnecting with the dominant
local carriers. In addition, these interconnections allow us to provide network
access through abbreviated dialing and to transport calls on our network
originating in a greater number of cities. We can also achieve higher
transmission quality and improved reliability through direct interconnection.
TRANSMISSION. In Europe we have begun developing a network consisting of
fiber optic lines to be constructed by us in selected cities, long-term IRUs in
dark fiber and in operational capacity owned by other carriers, and leased
capacity. We currently use a combination of direct ownership interests in
undersea cables, IRUs in on-land and undersea cables, leased lines and
arrangements with other carriers to manage our transmission costs. We usually
try to acquire ownership interests in undersea cables and/or IRUs that connect
network cities with substantial calling traffic between them. However, we have
used leased lines in regions where IRUs are either too expensive or if we
believe IRU prices will decline, or where IRUs are not available. For example,
in continental Europe, we have used leased lines and intend to construct our
network and obtain IRUs. See "--Our Strategy--Expand Our Network and Enter Key
New Markets" and "--European Network--Network Expansion." We are able to reduce
our incremental transmission costs by transmitting a greater percentage of calls
over these owned facilities, IRUs and leased lines because they involve only an
initial capital outlay or a fixed monthly payment. Once we have generated enough
traffic to cover the costs of IRUs and leased lines, there is no significant
marginal cost to us for carrying additional calls over these IRUs and leased
lines. In some cases, we use compression or multiplexing equipment to further
increase the capacity of our IRUs.
OTHER. In addition to the cost of origination, transmission and
termination, the other costs of our network relate primarily to switching
equipment, compression equipment, our Internet protocol overlay and
facility/network management and related software.
NETWORK OPERATIONS
NORTH AMERICA. We monitor and maintain the North American portion of our
network from a centralized network operations center in San Diego, which
operates 24 hours a day. By centralizing the North American network monitoring
function, we are able to monitor the network more effectively and on a more
cost-efficient basis.
OVERSEAS OPERATIONS. Currently, each of our foreign operating subsidiaries
monitors their own domestic switching and network infrastructure. In our San
Diego network operation center we monitor the intercontinental and intercountry
portion of our network. Our proprietary switch, which we refer to as the TCIB
2000, has sophisticated alarm capabilities that facilitate the monitoring
process. We are in the process of centralizing the management of our overseas
network on a company-wide basis through our network operation center in San
Diego. As part of the centralization process, we are modifying our existing TCIB
2000 software to allow it to be integrated with the other network alarm and
monitoring software that we use. Each of our foreign operating subsidiaries will
continue to monitor their domestic portion of our overseas network as we
gradually centralize the monitoring function to our network operation center.
48
INFORMATION SYSTEMS. Our information systems are one of our key assets. The
systems we have developed provide us with vital "real time" operating
information and statistics. Specifically, these systems provide the following
information:
- customer usage, broken down by country and by time period within country,
in order to track sales and enable management to respond to any loss of
traffic from particular customers;
- country usage, detailed by vendor or customer, which assists management
with route and network planning;
- vendor rates, through an audit report that allows management to determine
which vendors have the lowest rates for a particular market for a given
time period;
- vendor usage by minute, enabling management to confirm and audit vendor
invoices and calculate the value of minutes purchased from our vendors and
to determine operating margins;
- reports that are used to identify routes that are generating negative
variable margins as well as to highlight routes experiencing substantial
surplus usage;
- regional reporting, broken down by originating and terminating areas,
which facilitates RBOC access charge audits; and
- daily variable network cost information on a route-by-route basis, which
enables us to monitor our gross margins by product line on a daily basis
throughout the world.
We use our information systems to monitor carrier traffic volumes and
patterns and price schedules. These systems allow us to respond in real time to
changes in these traffic volumes, patterns and prices and assist us in effecting
least-cost routing. We have installed a wide area network linking all of our
switch sites in North America, which coordinates the use of our systems. In
addition, we operate and maintain a sophisticated intranet in the United States,
which has automated most of our operations reporting functions. These systems
allow us to assess and resolve quickly many customer billing and collection
problems; monitor and determine production by and compensation or commissions
owed to agents, sales representatives and distributors; and determine proper
pricing for our services.
TCIB 2000 FEATURE PLATFORM. The TCIB 2000 feature platform is an integrated
suite of services that includes switching, billing and customer care. These
services can be and are integrated with other platforms like the Siemens EWSD
switch. The TCIB 2000 system has been designed to be integrated into the
operations of each of our current and planned international operating
subsidiaries. Due to its relatively low cost and ease of installation, the TCIB
2000 system enables us to initiate service in new locations quickly and
efficiently. We expect that the TCIB 2000 system will facilitate integration and
central oversight of our foreign operating subsidiaries. See "Risk Factors--If
Our Information Systems Were to Fail, Our Ability to Bill Customers and Manage
Our Operations Could Be Harmed."
DEVELOPMENT OF BROADBAND NETWORK CAPABILITIES
We intend to expand the technological capability of our network to enable us
to provide our customers with a fully integrated, total solution communications
package. These efforts will focus principally on two technologies: digital
subscriber line (DSL) technology and Asynchronous Transfer Mode (ATM)
technology. These technologies, and our plans to acquire and integrate them into
our network, are discussed below.
DSL TECHNOLOGY. DSL technology enables data transport over telephone lines
at speeds many times faster than common dial-up modems. This technology works by
encoding information in a digital format, which allows for dramatically faster
and more efficient transmission of data over telephone lines. DSL technology
facilitates a number of applications, including Internet access, intranets,
extranets, telecommuting, e-commerce, e-mail, video conferencing and multimedia.
Collectively, these applications represent the fastest-growing segment of the
telecommunications industry.
49
DSL technology requires equipment that is installed at the end-user's
location and at our central switching offices. At the end-user's location, DSL
modems are connected with the end-user's computer, local area network or
enterprise router. These connections will also require on-site wiring into the
telephone lines leading into the end-user's location. We expect to use outside
contractors to install end-user DSL modems. In our central switching offices, we
plan to install DSL multiplexing equipment, which compresses data received via
the end-user's DSL modem for transmission over our network. Over approximately
the next 12 months, we plan to spend approximately $5 million to acquire central
office multiplexing equipment, which will be installed in our largest
metropolitan market areas. We will acquire DSL modems, which currently range in
price from approximately $300 to $2,000 per unit, as end-user demand warrants. A
significant portion of the build-out of our DSL network will be directly related
to the demand of paying subscribers, which will result in a success-based
deployment of capital.
ATM TECHNOLOGY. ATM technology enables the integrated and simultaneous
transport of voice, data and video over the same transmission lines. This
technology works by bundling the otherwise disparate signals of voice, data and
video transmissions into packets, which are then sent simultaneously through
communications circuits in an efficient manner. The result to our customers will
be seamless transmission of their diverse communications using a single point of
connection. During the next 12 months, we plan to spend approximately $5 million
to acquire approximately 40 ATM switches, which we plan to install in various
locations across our global network.
NORTH AMERICAN NETWORK
We have switches in each of the 12 cities listed below that are connected
with a fiber optic backbone.
Chicago Miami Seattle
Dallas Montreal Toronto
Honolulu New York Vancouver
Los Angeles Ottawa Washington D.C.
Through our interconnection with the local telephone companies, we are able
to connect with approximately 85% of the U.S. market.
We connect or are in the process of connecting the North American portion of
our network with other regions of the world through our direct ownership
interests or IRUs on the Americas-I, Atlantic Crossing, Canus 1, China-US,
Columbus II, HAW-5, Southern Cross, Taino-Caribe and TPC-5 undersea cables.
U.S. NETWORK. Prior to March 1999, we leased approximately 17.5 million
route miles of fiber optic transmission capacity, representing most of our U.S.
transmission capacity, from MCI WorldCom. As those leases expired, we converted
them to long-term IRU arrangements covering the same capacity. The new IRU
arrangements significantly reduced our monthly cost associated with this
capacity. The IRU arrangements also allow us to add additional capacity in the
future.
In February 1999, we entered into a five-year lease with Level 3
Communications covering approximately 19.4 million route miles of fiber optic
transmission capacity. This lease is convertible into a 15-year IRU on the same
capacity at the end of the lease. We are obligated under this lease-IRU
arrangement to order all of the capacity by November 11, 1999.
We also currently have leased transmission capacity in the United States
from other carriers. We intend to replace most of this leased capacity with
capacity obtained under the IRU arrangements described above. This will further
reduce our domestic transmission costs.
EUROPEAN NETWORK
We have six TCIB 2000 switches in continental Europe and the United Kingdom.
We intend to install 23 additional TCIB 2000 switches in those European
countries where we presently operate, as
50
well as in new European markets within the next 12 months. In addition, as our
call traffic increases, we may replace the TCIB 2000 switches with the higher
capacity Siemens EWSD switches in certain major cities, such as London and
Frankfurt. The table below lists the location of each of our existing switches
in Europe, the locations and the calendar quarter in which we expect to commence
operation of switches that we plan to install over the next 18 months, whether
we are interconnected in at least one location in the specified country, and, if
we are not currently so interconnected, the calendar quarter in which we expect
to obtain interconnection to the dominant local carrier in at least one location
in that country. There can be no assurance that we will achieve interconnection
or become operational in any location by the indicated date or at all.
EXPECTED DATE OF EXPECTED DATE OF
LOCATION OPERATION INTERCONNECTION
- ------------------------------------------------------- ------------------------- ------------------------------
BELGIUM................................................ Interconnected
Brussels............................................. Operational
Antwerp.............................................. Q1 2000
FRANCE................................................. Interconnected
Paris................................................ Operational
Bordeaux............................................. Q2 2000
Lille................................................ Q2 2000
Lyons................................................ Q2 2000
Marseilles........................................... Q3 2000
Toulouse............................................. Q3 2000
GERMANY................................................ Interconnected
Frankfurt............................................ Operational
Berlin............................................... Q1 2000
Bonn................................................. Q2 2000
Cologne.............................................. Q1 2000
Dusseldorf........................................... Q1 2000
Hamburg.............................................. Q2 2000
Mannheim............................................. Q2 2000
Munich............................................... Q1 2000
Stuttgart............................................ Q3 2000
ITALY.................................................. Q4 2000
Milan................................................ Q4 2000
Rome................................................. Q4 2000
THE NETHERLANDS........................................ Interconnected
Amsterdam............................................ Operational
Zoetermeer........................................... Q1 2000
SPAIN Q4 2000
Barcelona............................................ Q4 2000
Madrid............................................... Q4 2000
SWEDEN................................................. Q3 2000
Stockholm............................................ Operational
SWITZERLAND............................................ Q2 2000
Geneva............................................... Q2 2000
Zurich............................................... Q2 2000
UNITED KINGDOM......................................... Interconnected
London............................................... Operational
Glasgow.............................................. Q3 2000
Manchester........................................... Q1 2000
We connect the European portion of our network with other regions of the
world through direct ownership interests or IRUs on the Atlantic Crossing,
Cantat 3, Columbus-II, F.L.A.G., PTAT,
51
TAT-12/TAT-13, UK-Belgium 6, UK-Germany 6 and UK-Netherlands 12 undersea cables.
As part of our expansion strategy, we intend to acquire additional IRUs,
including in continental Europe. See "--The WORLDxCHANGE Network--European
Network--Network Expansion."
By having interconnection, we are able to offer domestic long distance
service, provide network access through abbreviated dialing and reduce our costs
for the origination and termination of calls. As we enter additional countries
in continental Europe, we will aggressively seek to enter and implement direct
interconnection agreements with the dominant local carriers.
NETWORK EXPANSION. We have begun developing a network consisting of fiber
optic lines to be constructed by us in selected cities, long-term IRUs in dark
fiber and in operational capacity owned by other carriers, and leased capacity.
We currently plan to develop an 1,800 route mile fiber optic cable network
within approximately the next two years. We intend to obtain IRUs or enter into
other long term capacity agreements for dark fiber where existing capacity of
other carriers is available at attractive prices. Where existing capacity of
other carriers is not available or too expensive, we intend to construct our own
fiber optic cable systems. We expect to construct fiber optic lines that will
account for approximately 20% of the capacity to be provided by our planned
European network expansion.
The process of constructing fiber optic cable systems includes purchasing
the raw fiber optic cable and hiring an engineering firm to design and a
construction firm to dig the necessary trenches and lay and connect the fiber
optic cable. We have budgeted approximately $160,000 per mile of construction.
We intend to complete our European network expansion in two primary phases.
In the first phase, we intend to build or acquire capacity in Amsterdam,
Antwerp, Brussels, Dusseldorf, Frankfurt, London, Paris and Strasbourg. Once we
have completed this portion of our expansion, we intend to branch out from each
of these major cities to four or five other significant cities in the same
country by building or acquiring capacity. Once we complete our planned network
expansion, we expect to be able to reduce our overall transmission costs in our
European markets. Currently, we anticipate the total cost of developing this
network will be approximately $150 million.
PACIFIC RIM NETWORK
We have a total of nine TCIB 2000 switches in Australia. We recently
installed a Siemens EWSD switch in Sydney, Australia. Within the next 12 months,
we plan to replace four TCIB 2000 switches in Australia with higher capacity
Siemens EWSD switches. See "--Network Hardware and Software-- Overseas
Operations." These planned switch upgrades will coincide with the upgrade of our
interconnection with the Australian carrier, Telstra. We are currently
interconnected with Telstra through their National Connect program, and we
intend to migrate to Telstra's National Access interconnection program during
the fourth calendar quarter of 1999. National Access interconnection will reduce
our access costs and allow customers to pre-subscribe to our service. In
addition, in New Zealand, we are planning to install a calling card platform in
Auckland in the near future. The table below lists the location of each of our
existing switches in the Pacific Rim, the locations and the calendar quarter in
which we expect to commence operation of switches that we plan to install over
the next 18 months, whether we are interconnected in at least one location in
the specified country, and, if we are not currently so interconnected, the
calendar quarter in which we expect to obtain interconnection to the dominant
local carrier in at least one location in that country. There can be no
52
assurance that we will achieve interconnection or become operational in any
location by the indicated date or at all.
EXPECTED DATE OF EXPECTED DATE OF
LOCATION OPERATION INTERCONNECTION
- ------------------------------------------------------- ------------------------- ------------------------------
AUSTRALIA.............................................. Interconnected
Adelaide............................................. Operational
Brisbane............................................. Operational
Canberra............................................. Operational
Cairns............................................... Operational
Gold Coast........................................... Operational
Melbourne............................................ Operational
Penrith.............................................. Operational
Perth................................................ Operational
Sydney............................................... Operational
GUAM................................................... Interconnected
Agana................................................ Q4 2000
JAPAN.................................................. Q4 2000
Osaka................................................ Q4 2000
Tokyo................................................ Q4 2000
NEW ZEALAND............................................ Interconnected
Auckland............................................. Operational
Christchurch......................................... Q3 2000
Wellington........................................... Q3 2000
We connect or are in the process of connecting the Asia Pacific portion of
our network with other regions of the world through direct ownership interests
or IRUs on the APCN, Jasuraus, China-U.S., F.L.A.G., Guam-Philippines, PacRim
East, Southern Cross, Tasman 2, TPC-5 and US-Japan undersea cables.
LATIN AMERICA NETWORK
We have a TCIB 2000 switch in Guatemala City, Guatemala and Santiago, Chile.
We intend to install an additional TCIB 2000 switch in El Salvador within the
next 12 months. The table below lists the location of each of our existing
switches or points of presence in Latin America, the locations and the calendar
quarter in which we expect to commence operation of switches that we plan to
install over the next 18 months, whether we are interconnected in at least one
location in the specified country, and, if we are not so currently
interconnected, the calendar quarter in which we expect to obtain
interconnection to the dominant local carrier in at least one location in that
country. There can be no assurance that we will achieve interconnection or
become operational in any location by the indicated date or at all.
EXPECTED DATE OF EXPECTED DATE OF
LOCATION OPERATION INTERCONNECTION
- ------------------------------------------------------- ------------------------- ------------------------------
CHILE.................................................. Interconnected
Santiago............................................. Operational
EL SALVADOR............................................ Q3 2000
San Salvador......................................... Q3 2000
GUATEMALA.............................................. Interconnected
Guatemala City....................................... Operational
PUERTO RICO............................................ Interconnected
San Juan............................................. Operational
53
We connect the Latin American portion of our network through a direct
ownership interest in the Maya-1 and the Pan American undersea cables.
NETWORK ACCESS AND CALL ROUTING
NETWORK ACCESS. Our network can be accessed through a variety of methods,
depending upon the service and the location from which the customer is calling.
These methods are as follows:
- EQUAL ACCESS. Equal access, also known as pre-selection or non-code
access, enables a long distance customer to access our network from the
customer's premises by dialing typically a single or double digit number
and then the number that the customer is calling. Using the equal access
method, a customer can avoid dialing a specific prefix access code by
pre-selecting our company as its long distance carrier, since the dominant
local carrier's switching system already is programmed to direct long
distance calls from the customer's telephone to our nearest switch.
Currently, most of our customers in the U.S., Canada, Germany, Guatemala
and New Zealand can pre-select us as their long distance carriers. Our
customers in Australia will be able to pre-select us as their long
distance carrier when we interconnect through Telstra's National Access
program.
- CODE DIALING. In our European and Pacific Rim markets, as well as in the
United States, long distance customers can use code dialing, which is also
referred to as dial-around calling, to access our network. To use code
dialing, customers dial a carrier access code of typically three to seven
digits, and then the number the customer is calling.
- LOCAL DIAL-UP ACCESS. In certain continental European cities where we
have a switch, customers can access our international and domestic long
distance service and, in some cases, prepaid card service, by dialing a
local telephone number. Local dial-up access reduces our transmission
costs for these calls because it shifts the cost of accessing our switch
to the customer, which enables us to increase our margins and/or reduce
our retail prices on these calls. We also offer local dial-up access for
our prepaid calling card customers in certain U.S. cities.
- INTERNATIONAL TOLL-FREE ACCESS. This access method allows customers to
access our operator or card-based services from over 80 countries by
dialing an international toll-free number. This access method is
predominantly used by customers who are traveling outside of their home
country.
- NATIONAL TOLL-FREE ACCESS. This access method allows customers to access
our network by dialing a national toll-free number. This access method is
available to our customers in most of the countries in which we operate.
- DEDICATED ACCESS. Carrier customers and high volume end-users can be
connected to our switch by a dedicated leased line. Dedicated access lines
offer several advantages, including simplified dialing, faster call setup
times and lower access costs if a sufficient volume of calls is
transmitted over the leased line. This service can be used for voice,
data, video and the Internet over a single leased line.
CALL ROUTING. We route calls to their destination through one or more of
our switches. If a call originates in a network city with a switch, the caller
generally will dial into the network over local lines. These calls will then be
routed to our switch by the local service provider, which is generally a local
exchange carrier in the U.S. and a dominant local carrier in Europe. If a call
originates in a city where we only have a point of presence, which acts solely
as a collection point for calls, it will be originated using one of the access
methods described above and sent to the point of presence. The call is then
transmitted from the point of presence to one of our switches on an owned or
leased line on our network. Callers originating calls in cities where we do not
have a switch or point of presence generally
54
will dial into our network using national or international toll-free access,
which costs us more than code dialing, equal access or local dial-up access. We
use "least cost" routing techniques to determine whether the call should be
transferred directly to the public switched telephone network or routed to
another one of our switches over an owned or leased line and then transferred to
the public switched telephone network for termination. See "--Network Hardware
and Software--Least Cost Routing."
NETWORK HARDWARE AND SOFTWARE
NORTH AMERICA. We use Siemens DC0-CS and EWSD switches throughout our North
American network. These switches give us the ability to handle large,
simultaneous call volumes, provide high quality service to customers and
seamlessly interconnect with local operators.
We have installed the Siemens EWSD switch at our Dallas, Los Angeles and New
York switch sites. Our Siemens EWSD switches have 21,000 ports and are
expandable to up to 60,000 ports, while the Siemens DC0-CS switch has 5,000
ports. A Siemens EWSD switch with 21,000 ports can simultaneously handle 21,000
calls. We may replace DC0-CS switches as we approach our capacity limits on
those switches.
During the fourth quarter of 1998, we experienced technical problems with
the new Siemens EWSD switch that we installed in New York. The problems included
the failure of the switch to record billing information for certain calls. We
worked with Siemens to fix the problems and have implemented new procedures to
detect any similar problems that may arise with our Siemens EWSD switches in the
future. Siemens has agreed to provide us with additional future lease financing
for third-party equipment, free software and deferred lease payments on most of
our EWSD and DC0-CS switches in the United States. While we believe that the
EWSD switch is now functioning reliably, there can be no assurance that we will
not experience additional problems with the EWSD or other switching equipment in
the future. See "Risk Factors--If Our Information Systems Were to Fail, Our
Ability to Bill Our Customers and Manage Our Operations Could Be Harmed."
OVERSEAS OPERATIONS. We use our proprietary TCIB 2000 switching equipment
in our markets outside of North America. The TCIB 2000 is a personal
computer-based, integrated telephony hardware and software platform designed by
us that combines standard switching functions with customer care and billing
functions. Because the TCIB 2000 is less expensive than other commercially
available switches, we install this switch in new markets to minimize our
initial network investment. Our strategy is to replace the TCIB 2000 switches
with greater-capacity switches as our customer base grows in major metropolitan
markets. For example, we are in the process of replacing our TCIB 2000 switch in
Sydney with a Siemens EWSD switch.
Unlike the TCIB 2000 switches that perform billing functions on the same
platform, the Siemens EWSD switches rely on separate billing software.
Therefore, when we replace the TCIB 2000 switches, we will have to make changes
to our billing software to accommodate the new switches. We are currently
working on changes to our TCIB 2000 billing software to support the Siemens EWSD
switches. However, these changes present risks to us, and there can be no
assurance that we will be able to integrate new switches into our billing
systems cost-effectively or at all.
LEAST COST ROUTING. We use a combination of network hardware and software
to route a call over the most cost-efficient route available at the time the
call is placed. Prices for various destinations fluctuate daily. Our least cost
routing software enables us to continually revise our routing tables, including
accounting for fluctuations in currency exchange rates, as the cost of certain
routes change. We have a dedicated group of employees based in San Diego that
are largely responsible for monitoring the routing of calls and seeking to
minimize our transmission costs. In addition to the monitoring performed by our
San Diego-based team, some of the monitoring is performed in each of the
countries in which we operate.
55
INTERNET NETWORK
We provide Internet access from our network. Internet customers dial an
access number, which connects the customer over our network to our Ascend
Communications MAX/TNT random access server in Los Angeles. The random access
server interfaces with our IBM authentication server in our San Diego office.
The authentication server uses IBM Sentinel software to verify the customer's
account number and password. Once the authentication server verifies the
customer's account information, the random access server sends the call to our
Cisco Series 7206 router for connection to the Internet backbone. We use Navais
software to monitor the integrity of our Internet network from our San Diego
network operations center.
We are in the process of expanding our Internet network to add back-up
random access servers, additional data lines to the network's backbone nodes and
high-speed DSL equipment. Additionally, we plan to add additional routers and
servers into our network as necessitated by demand for our Internet access
service.
TERMINATION ARRANGEMENTS
We attempt to maximize our alternatives for terminating our calling traffic
by utilizing a number of routing alternatives. These alternatives include resale
arrangements, operating agreements and other attractive termination
arrangements. By diversifying our termination alternatives, we believe that we
are able to take advantage of attractive arrangements as they may become
available, which helps us to control our termination costs.
Resale arrangements provide us with multiple options to route traffic
through our switches in various destination countries. These arrangements
generally involve terminating traffic through a third party's correspondent
relationships or through the third party itself. Resale arrangements allow us to
leverage another carrier's network to terminate our customers' calls. For
example, we currently do not have operations in Afghanistan. If one of our
customers wishes to place a call to Afghanistan, we can pass the call on to a
third party carrier by purchasing some of the excess capacity of that carrier's
network. The carrier would then terminate the call in Afghanistan either through
a correspondent relationship that it has with a carrier with facilities in
Afghanistan or directly through its own local facilities.
During a typical month, we may purchase capacity from approximately 80
vendors. We pay per-minute charges to use much of this capacity, which subjects
us to potential price increases. In addition, since we generally obtain this
capacity on a short-term basis, we may experience service cancellations. Our
vendor contracts provide that rates are subject to change after notice periods
varying from one to 30 days. The pricing of termination services depends on such
factors as the volume of call traffic and the time of day. Our sophisticated
information systems and reports allow us to track price changes on a real-time
basis, which helps us to achieve least-cost routing and greater overall
efficiency. See "--The WORLDxCHANGE Network--Network Operations--Information
Systems" and "Risk Factors--If Our Information Systems Were to Fail, Our Ability
to Bill Our Customers and Manage Our Operations Could Be Harmed." In addition,
in each of the countries in which we operate, we have or intend to have within
the next 18 months, interconnection agreements with the dominant local carrier
or carriers for termination of our traffic within that country.
The FCC or foreign regulatory agencies may assert that certain of our call
termination practices do not comply with current international settlement rules
and policies, such as current international simple resale rules. We could face
sanctions, including forfeitures, if the Federal Communications Commission were
to find that certain of our termination arrangements violate FCC rules. See
"--Regulation-- United States--FCC International Regulation."
56
SALES AND MARKETING
We use a variety of marketing channels to reach a wide range of customers.
These channels include direct mail, independent sales agents, multilevel
marketing, a direct sales force, affinity groups, the Internet and media
advertising. This multi-faceted approach allows us to customize our marketing
for specific geographic markets and services. We believe that our multichannel
marketing approach will help accelerate our growth.
UNITED STATES
We use several channels to market our services to U.S. customers, including
direct mail, our recently introduced "xPectations ML" multi-level marketing
program, direct sales and other channels such as affinity programs, the Internet
and media advertising. These channels are described below.
DIRECT MAIL. Our direct mail marketing programs have proved to be an
effective marketing channel. We have developed a number of different direct mail
programs, each tailored to appeal to a particular market segment. We use direct
mail principally to market our dial-around services to residential and
commercial customers. We completed mailings of approximately 75.6 million pieces
in fiscal 1997 and 59.8 million pieces in fiscal 1998. We intend to expand our
use of this marketing channel in the United States.
MULTILEVEL MARKETING. In October 1998, we introduced our xPectations ML
multi-level marketing program in the United States. This program involves the
marketing by our independent representatives of our pre-selected and dial-around
long distance service, as well as our Internet access and prepaid calling card
services, to potential customers. These representatives also seek to recruit
additional xPectations ML representatives who will in turn market our services
to their contacts. Program representatives earn commissions based on revenues we
collect from new customers that they sign up, as well as based on revenues we
collect from customers signed up by other representatives that they recruit to
the program. To recruit xPectations ML representatives ourselves, we conduct
seminars and use media advertising. We have recruited more than 7,000
representatives into the xPectations ML program since its introduction.
We have also harnessed the power of the Internet to enhance the xPectations
ML program. xPectations ML representatives can obtain their own Web site, which
we host. This allows them to use a professionally-designed Web site to market
the xPectations ML program to their contacts while allowing us to retain control
over the advertising content on the site. We are also considering expanding the
range of products and services to be offered over the xPectations ML Web sites
to include non-telecommunications-related items such as personal computers.
DIRECT SALES. We employ an internal sales force in the United States that
consisted of approximately 38 people as of June 30, 1999. This direct sales
force primarily markets our prepaid calling cards to residential and commercial
customers. They also sell our excess transmission capacity to carrier and other
wholesale customers. We use the direct sales approach for these services because
they are more complex and usually have a longer sales cycle.
OTHER CHANNELS. We also use affinity programs, the Internet and media
advertising to market our services in the United States. Under our affinity
programs we partner with other companies and organizations to introduce and sell
our products. Our Internet marketing strategy includes our recent introduction
of several e-commerce services, such as the "Virtual PIN" program under which
our customers are able to purchase and recharge prepaid calling cards
exclusively through our Web site, which may be accessed at www.worldxchange.com.
As part of our growth strategy, we intend to expand our direct mailing,
xPectations ML and Internet marketing programs into additional overseas markets.
57
EUROPE
Our marketing activities vary from country to country and are distilled from
our successful marketing programs used throughout the world. For example, we are
beginning the process of implementing our xPectations ML program in Europe, and
we have commenced direct mailing campaigns modeled after our U.S. direct mail
programs.
Our marketing activities vary by the kind of service we are selling and the
kind of customer we are targeting within a particular country. For example, in
the United Kingdom, we market our residential long distance services through
affinity programs and direct mail programs. We use direct sales to generate
commercial long distance, resale and carrier and other wholesale business in the
United Kingdom, and independent agents to market our calling card services
there. We plan to substantially increase our direct mail activities in the
United Kingdom within the next 12 months. In The Netherlands we use direct mail,
affinity programs, direct sales and independent agents to market our residential
and our commercial long distance services. We also use direct sales, independent
agents and limited media advertising to market other services in The
Netherlands, including our resale and carrier services.
In Belgium, we rely on direct mail and independent agents to market our
residential long distance services. We have two employees dedicated to making
direct sales of our long distance service to commercial customers in Belgium, as
well as sales of excess capacity to carrier and other wholesale customers there.
We have three employees who market our calling card services in Belgium. In
addition, our independent agents also market our long distance services to
Belgian commercial customers.
We are in the process of establishing a sales and marketing infrastructure
and customer base in France and Germany as we increase our operating capacity in
those countries. In France, we are promoting our residential long distance
service, which currently requires our customers to dial a seven-digit access
number, through independent agents and, to a lesser extent, the distribution of
flyers to apartment complexes and other residential locations. We use direct
sales to market our calling card services and direct sales and independent
agents to market our commercial long distance services, which require the use of
a four-digit access code, in France. We are marketing our calling card services
in Germany primarily through independent agents and, to a lesser extent, through
affinity programs. We plan to conduct direct mailing campaigns in both France
and Germany in the near future.
THE PACIFIC RIM
Our marketing strategy in Australia and New Zealand uses direct mailing,
independent agents, affinity programs and media advertising to reach potential
residential long distance customers. We rely on direct sales and independent
agents to market our long distance service to commercial customers and direct
sales to reach calling card and carrier and other wholesale customers.
BROADBAND MARKETING STRATEGY
Once we are able to offer DSL services to end-users, we plan to market these
services through many of our marketing channels, with an emphasis on agent
sales.
WORLDWIDE OPERATIONS
U.S. HEADQUARTERS OPERATIONS
Our senior management directs our operations and those of our foreign
operating subsidiaries and develops and oversees the implementation of our
overall business strategy from our San Diego headquarters. These functions
include managing the growth of our operations and assessing potential new
markets and acquisition, joint venture and strategic alliance opportunities. Our
headquarters
58
personnel currently perform centralized financial services for all of our
foreign operating subsidiaries, including financial planning and analysis and
cost control. Our San Diego-based senior management also coordinate the
acquisition of additional transmission capacity, either leased or purchased,
based on the growth of traffic volumes in each market and helps arrange
financing and vendor discounts on behalf of our foreign operating subsidiaries.
In addition, our headquarters personnel perform worldwide treasury functions for
our foreign operating subsidiaries, including managing cash flows between our
foreign operating subsidiaries for the transmission of traffic between them as
well as the allocation of working capital. We plan to maintain our decentralized
billing system that allows each foreign operating subsidiary to provide its own
billing using the TCIB 2000 billing system.
Our headquarters personnel manage the expansion of our network, which
includes determining whether to acquire additional capacity for existing
operations and integrating foreign operating subsidiaries into our network.
Headquarters personnel also coordinate least-cost traffic routing over our
network, which involves the programming of our switches to transport
international calls over the route which is most likely to result in the
lowest-cost transmission without sacrificing quality. Headquarters personnel
also provide our foreign operating subsidiaries with consolidated least-cost
routing information to allow them to benefit from each other's low cost
structure.
NON-U.S. OPERATIONS
Each of our foreign operating subsidiaries is a limited liability company.
The table below provides the operational status for each subsidiary, the status
of that subsidiary's operating licenses or other required authorizations, and
our direct or indirect percentage ownership in the operating subsidiary located
in each listed country. Following the table is a more detailed description of
the operations of our operating subsidiaries in certain of the markets outside
of the United States. The percentage ownership listed for the Australian
operating subsidiary gives effect to our planned acquisition of minority
interests in certain subsidiaries. See "Acquisition of Minority Interests in
Subsidiaries." Percentages are rounded to the nearest one percent.
EXPECTED STATUS OF EFFECTIVE
CALENDAR QUARTER LICENSE/ OWNERSHIP
COUNTRY OF OPERATION AUTHORIZATION PERCENTAGE
- -------------------------------------------------------- ---------------- ------------------- -------------
Australia............................................... Operational 1 98%
Belgium................................................. Operational 1 100
Canada.................................................. Operational 1 100
Chile................................................... Operational 1 100
France.................................................. Operational 1 99
Germany................................................. Operational 1 100
Guam.................................................... Operational 1 100
Guatemala............................................... Operational 1 99
The Netherlands......................................... Operational 1 100
New Zealand............................................. Operational 1 100
Sweden.................................................. Operational 1 100
United Kingdom.......................................... Operational 1 100
El Salvador............................................. Q3 2000 1 100
Italy................................................... Q4 2000 2 99
Japan................................................... Q4 2000 2 100
Spain................................................... Q4 2000 2 99
Switzerland............................................. Q2 2000 2 100
- ------------------------
KEY FOR LICENSE/AUTHORIZATION STATUS:
1) Existing license or other authorization for provision of switched voice and
data over the public switched telephone network.
2) Application for license to provide switched voice and data over the public
switched telephone network not yet filed.
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AUSTRALIAN OPERATIONS
The Australian market originated 1.5 billion minutes of international
telecommunications traffic in 1997. Our operating subsidiary in Australia
commenced operations in January 1995. As of June 30, 1999, our Australian
operating subsidiary employed 159 people.
Our Australian operating subsidiary provides local service and international
and domestic long distance service to residential and commercial customers and
sells excess transmission capacity to other carrier customers. Calling card
services are also provided. Current commercial customers in Australia include
multinational corporations, large national companies, as well as small and
medium-sized businesses.
Currently, we are interconnected with the Australian carrier, Telstra,
through its National Connect program. Under this program, our customers must
dial a four-digit code to access our network. However, during the first quarter
of fiscal 2000, we expect to migrate to Telstra's National Access
interconnection program, which will allow our customers to pre-select our
service and eliminate the need for our customers to dial access codes.
BELGIAN OPERATIONS
The Belgian market originated 1.3 billion minutes of international
telecommunications traffic in 1997. Our operating subsidiary in Belgium
commenced operations in March 1997. As of June 30, 1999, our Belgian operating
subsidiary employed 44 people.
Our Belgian operating subsidiary provides domestic and international long
distance and calling card services to residential and commercial customers. It
also sells excess transmission capacity to other telecommunications carriers.
Our Belgian operating subsidiary signed a provisional interconnection
agreement with Belgacom in May 1998 and a definitive interconnection agreement
in December 1998, which was superseded by a new definitive agreement with
Belgacom signed by our Belgian operating subsidiary in June 1999. Our Belgian
operating subsidiary interconnected its first lines with Belgacom's network in
December 1998. Currently, our Belgian interconnection requires long distance
customers to dial a four-digit code to access our network. However, we
anticipate that customers will be able to pre-select our service within
approximately the next 12 months, which will eliminate the need for access
codes.
DUTCH OPERATIONS
The Dutch market originated 1.5 billion minutes of international
telecommunications traffic in 1997. Our operating subsidiary in The Netherlands
commenced operations in October 1996 and is an indirect wholly-owned subsidiary
of our company. As of June 30, 1999, our Dutch operating subsidiary employed 50
people.
Our Dutch operating subsidiary provides local service and domestic and
international long distance service to residential and commercial customers and
call shops. Commercial customers include small and medium-sized businesses. Our
Dutch operating subsidiary also has reseller, carrier and other wholesale
customers.
Our Dutch operating subsidiary has an interconnection agreement with KPN
Telecom, the dominant local carrier in The Netherlands. Currently, this
interconnection requires long distance customers to dial a four-digit code to
access our network. However, we anticipate that customers will be able to
pre-select our service within approximately the next 12 months, which will
eliminate the need for access codes.
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FRENCH OPERATIONS
The French market originated 3.5 billion minutes of international
telecommunications traffic in 1997. Our operating subsidiary in France commenced
operations in October 1995. As of June 30, 1999, our French operating subsidiary
employed 15 people.
Our French operating subsidiary provides local service, domestic and
international long distance and calling card services to residential and
commercial customers. It also sells excess transmission capacity to other
telecommunications carriers.
Our French operating subsidiary signed an interconnection agreement with
France Telecom in May 1999 and interconnected its first lines with that dominant
local carrier's network in July 1999. Currently, this interconnection requires
long distance customers to dial a four-digit code to access our network.
However, we anticipate that customers will be able to pre-select our service
within approximately the next 12 months, which will eliminate the need for
access codes.
GERMAN OPERATIONS
The German market originated 5.3 billion minutes of international
telecommunications in 1997. Our operating subsidiary in Germany commenced
operations in October 1995. As of June 30, 1999, our German operating subsidiary
employed 12 people.
Our German operating subsidiary provides local service, domestic and
international long distance and calling card services to residential and
commercial customers. It also sells excess transmission capacity to other
telecommunications carriers.
Our German operating subsidiary signed an interconnection agreement with
Deutsche Telekom during the fourth quarter of 1998, which expired and was
subsequently replaced with a new interconnection agreement in June 1999, and
interconnected its first lines with that dominant local carrier's network in
July 1999. Currently, this interconnection requires long distance customers to
dial a six-digit code to access our network. However, we anticipate that
customers will be able to pre-select our service within approximately the next
12 months, which will eliminate the need for access codes.
NEW ZEALAND OPERATIONS
The New Zealand market originated 407 million minutes of international
telecommunications traffic in 1997. Our operating subsidiary in New Zealand
commenced operations in October 1996. As of June 30, 1999, our New Zealand
operating subsidiary employed 36 people.
Our New Zealand operating subsidiary provides domestic and international
long distance services to residential and commercial customers, as well as
toll-free services. Additionally, we expect that our New Zealand operating
subsidiary will begin offering Internet access and calling card services in New
Zealand within approximately the next six months.
Our New Zealand operating subsidiary is interconnected with the networks of
the two largest local carriers in New Zealand, New Zealand Telecom and Clear
Communications. Under this interconnection, our customers are able to access our
network either through pre-subscription or by dialing a four-digit access code.
U.K. OPERATIONS
The U.K. market originated 6.6 billion minutes of international
telecommunications traffic in 1997. Our operating subsidiary in the United
Kingdom, WORLDxCHANGE Communications Ltd., is an indirect wholly-owned
subsidiary of our company and began generating revenues in May 1995. As of June
30, 1999, our U.K. operating subsidiary employed 53 people.
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Our U.K. operating subsidiary provides local service and domestic and
international long distance service to residential and commercial customers and
other carriers in the United Kingdom, as well as calling card services. Current
commercial customers include small and medium-sized businesses.
Our U.K. operating subsidiary has an interconnection agreement with British
Telecom. This interconnection requires customers to dial a four-digit code to
access our network. However, we anticipate that customers will be able to
pre-subscribe to our service within approximately the next 12 months, which will
eliminate the need for access codes.
CUSTOMER CARE
We are committed to providing our customers with high-quality customer care
and believe that we have developed the infrastructure necessary to serve both
our existing customer base and accommodate substantial growth. We have a
24-hour-a-day customer care department located in our San Diego headquarters,
which, at June 30, 1999, had 130 full-time equivalent customer care
representatives. Additionally, each of our foreign operating subsidiaries
maintains an extended-hours customer care department. At all of our customer
care facilities, our representatives handle both service and billing inquiries.
In addition, our call centers all have representatives who are multilingual. We
also provide our North American customers with automated customer care through
the Internet.
COMPETITION
The international telecommunications industry is and will continue to be
highly competitive. Regulatory changes, technological advances and actions taken
by the dominant local carriers and other large industry participants continue to
shape our competitive environment. Prices for long distance calls have decreased
substantially over the last few years in most of our markets and we anticipate
further substantial price declines. Our larger competitors generally have lower
per call transmission costs than we have. They own more transmission capacity,
have more favorable interconnection rates and obtain larger volume discounts
from suppliers. Carriers are able to substantially reduce their variable
transmission costs by having their own international networks, which enable them
to offer lower retail and wholesale prices.
In addition to risks associated with price competition, we face risks and
challenges inherent in entering new markets. In certain markets, we will not be
able to offer all of the services that certain of our competitors provide due to
regulatory limitations applicable to us in such markets. Moreover, even in
markets where we may be able to provide a range of services comparable to that
provided by our competitors, many of our potential customers will not be
familiar with us and may be reluctant to entrust their telecommunications
services needs to an unfamiliar provider.
If any of our competitors were to devote substantial additional resources to
the provision of international long distance voice telecommunications services
to our target customer base, our business would be materially adversely
affected. In addition, certain of our competitors may provide discounts in one
market to gain an advantage in another market or with a particular customer. We
may not have the financial ability to offer competitive discounts and may lose
customers as a consequence. This price competition would harm our business and
depress the price of our common stock. See "Risk Factors-- We Have Many
Competitors Who Enjoy Significant Competitive Advantages Over Us."
WORLD TRADE ORGANIZATION INITIATIVES
Under the World Trade Organization Basic Telecommunications Services
Agreement ("WTO Agreement"), which went into effect on February 9, 1998, 69
countries have agreed to permit varying degrees of competition from foreign
carriers over different timeframes. As a result of the WTO Agreement,
competition is expected to increase in telecommunications markets in countries
representing more than 90% of the global telecommunications market.
62
Implementation of the WTO Agreement in foreign countries is expected to
create additional competitive opportunities in international and foreign markets
for multinational telecommunications businesses such as ours. Although many
countries have agreed to make certain changes to open and ensure fair
competition in their respective markets, there can be no assurance that
countries will honor their commitments in a timely manner, if at all. In
addition, since the regulatory frameworks are not yet well established in all
countries, specific foreign regulatory requirements that we will face in
carrying out our business plan are not yet known. While the WTO Agreement may
allow us to access new markets or to provide additional services, it also may
subject us to greater competitive pressures in these markets, which could cause
us to lose customers and/or reduce the rates that we are able to charge. At the
same time, the WTO Agreement has created expanded opportunities for foreign
carriers to compete with us in the U.S. telecommunications market. See
"--Competition--United States."
UNITED STATES
The United States telecommunications marketplace is among the most
competitive and deregulated in the world. Competition in the U.S. market is
based primarily upon pricing, customer service, network quality and the ability
to provide value added services.
With respect to all of our services other than Internet access services, we
compete with major carriers such as AT&T, MCI WorldCom and Sprint, as well as
other national and regional long distance carriers and resellers, many of whom
are able to provide services at costs that are lower than our current costs.
These competitors are, or may in the future, be able to provide bundled packages
of telecommunications products, including local and long distance services and
data services and prepaid services, in direct competition with the products
offered or to be offered by us, and may be capable of offering these products
sooner and at lower prices than us.
In addition, as a result of the 1996 Telecommunications Act, the RBOCs can
compete with us in the long distance telecommunications industry, both outside
of their service area and, upon satisfaction of certain conditions, within their
service area. RBOCs can now enter an "out-of-region" long distance market
immediately upon the receipt of any state or federal regulatory approvals
otherwise applicable in the provision of long distance service. In order to
enter the "in region" long distance market in a given state, a RBOC must satisfy
certain procedural and substantive requirements, including obtaining FCC
approval based upon a number of statutorily prescribed requirements. Any RBOC
that receives such authority must provide in-region long distance service
through a separate affiliate. No RBOC is authorized to provided in-region long
distance services in any state at this time, but some are likely to be so
authorized soon. When an RBOC-affiliate is so authorized, it is likely to have a
substantial advantage for long distance calls, because it typically will be
paying access charges to its affiliate when it originates or terminates a call
in-region. There can be no guarantee that such RBOC entry will be delayed and
will not harm our business when it occurs.
The WTO Agreement has resulted in additional competitors entering the U.S.
telecommunications market. To implement the WTO Agreement, in November 1997 the
FCC adopted its "Foreign Participation Order," which created streamlined
procedures for processing market entry applications from foreign carriers and
established a presumption that such applications will be granted. The FCC's
streamlined processing procedures and presumptions of entry have made it
substantially easier for foreign carriers to enter the market and compete in the
United States. We cannot assure you that this increased competition will not
harm our business.
We also expect increasing competition from Internet protocol-based ("IP
Telephony") service providers. Some of our current competitors are already
offering voice telecommunication services using Internet protocols at
substantially reduced prices. Methods are also becoming available to allow
customers of ISPs to conduct near real-time voice communications over their
Internet connections ("Computer-to-Computer Internet Telephony"). As the
technology matures in this area, transmission
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quality will improve and the competitive pressure against us will increase as a
result. Furthermore, the FCC, to date, has determined not to subject either type
of these telephony services to FCC regulation as telecommunications services.
There can be no guarantee when, or even if, the FCC will subject either IP
Telephony or Computer-to-Computer Internet Telephony to regulation. Accordingly,
ISPs and providers of IP Telephony are, today, not subject to universal service
contributions, access charge requirements, or traditional common carrier
regulation.
Under the Telecommunications Act of 1996, RBOCs were granted new rights to
provide certain TV services. Interexchange carriers were permitted to construct
their own local facilities and/or resell local services. State laws no longer
can require providers of cable television services to obtain a franchise before
offering telecomunications services. In addition, under the Telecommunications
Act of 1996 all utility holding companies are permitted to diversify into
telecommunications services. All of these are sources of potential increased
competition. We also expect to face increasing competition from wireless
telecommunications providers in the future.
With respect to our Internet access service, in addition to competing with
other carriers, we also compete with Internet service providers such as American
Online, Prodigy, Earthlink and MindSpring. Many of these competitors are able to
devote greater financial, technological and marketing resources than us to the
Internet access business. If any of these competitors were to focus their
resources on providing Internet access service to our target customers, our
Internet access business could be harmed.
CANADA
The Canadian telecommunications market is highly competitive and is
dominated by a few established carriers whose marketing and pricing decisions
have a significant impact on the other industry participants, including us. Our
principal facilities-based competitors include Bell Canada, Bell Nexxia, BCT.
TELUS, AT&T Canada, and Sprint Canada. We also compete with Primus, which
recently acquired the residential long-distance customer base of AT&T Canada,
and with ACC TelEnterprises which, until its recent merger with AT&T Canada, was
one of the largest resellers in Canada. In addition, we are competing with
alternative telecommunications providers such as cable companies, including
Rogers Communications, Shaw Cable and cellular and personal communications
service providers, including Microcell Solutions, Bell Mobility, Rogers Cantel
and Clearnet.
EUROPE
In Europe, our competitors include:
- the dominant local carriers,
- certain large alliances such as Global One, consisting of Sprint, Deutsche
Telekom and France Telecom, and AT&T's alliance with both British Telecom
and Japan Telecom,
- emerging multinational carriers such as Destia, Primus Telecommunications
Group, Viatel, RSL Communications, Global Telesystems Group and Colt
Telecommunications;
- companies offering resold international telecommunications services; and
- other companies with business plans similar in varying degrees to us,
including emerging public telephone operators who are constructing their
own networks and wireless network operators.
BELGIUM. Our principal competitor is the dominant local carrier, Belgacom.
We also compete with the Belgian affiliates of some of the mega-carriers such as
Global One, local resellers and other international carriers with Belgian
operations such as RSL Communications and Viatel.
FRANCE. Our principal competitor is the dominant local carrier, France
Telecom. We also compete with international carriers who have obtained
interconnection with France Telecom including companies
64
such as MCI Worldcom, Colt, Siris, Cegetel and Bouygues. These competitors are
also in the process of constructing fiber networks in major metropolitan areas,
which, when completed will allow these companies to offer telecommunications
services at lower prices than we currently can. In addition, we compete with
resellers such as Omnicom. As deregulation continues, we expect that alternative
networks will become available to route and terminate call traffic.
GERMANY. Our principal competitor is the dominant local carrier, Deutsche
Telekom. We also compete with newly licensed operators who are constructing
their own facilities-based networks, such as Arcor, O.telo and VIAG Interkom. In
addition, we compete with resellers such as MCI Worldcom.
THE NETHERLANDS. Our principal competitor is the dominant local carrier,
KPN Telecom. Our other major competitors in The Netherlands are MCI WorldCom and
mega-carriers such as Global One. We are also competing with companies such as
MCI WorldCom, who are constructing facilities-based networks and have been
licensed as public telephone operators. As deregulation continues, we expect
that alternative networks currently under construction will become available to
route and terminate call traffic.
THE UNITED KINGDOM. Competition is intense in the relatively deregulated
United Kingdom market. Our principal competitors include the dominant local
carrier, British Telecom, and Cable and Wireless Communications. We are also
competing with emerging licensed public telephone operators, who are
constructing their own facilities-based networks, such as Energis. In addition
we compete with resellers such as MCI WorldCom and Global One.
THE PACIFIC RIM
AUSTRALIA. In Australia, our principal competitors are Telstra Corporation
Limited and Optus Communications Pty. Limited. In addition, our Australian
competitors include carriers and carriage service providers such as Spectrum
Network Systems Limited, Axicorp Pty. Limited, Call Australia Pty. Limited,
Primus and AAPT Pty. Limited.
NEW ZEALAND. In New Zealand, our principal competitors are the two largest
local carriers, Telecom New Zealand and Clear Communications. In addition, our
New Zealand competitors include switch-based and switchless resellers such as
Telstra and Pacific Gateway Exchange. There are a number of competitors in the
toll-call telecommunications market. New Zealand is a comparatively deregulated
market, and competition there is expected to intensify.
LATIN AMERICA
GUATEMALA. In Guatemala, our principal competitor is the dominant local
carrier, Telgua.
CHILE. In Chile, our competitors include Entel Chile, CTC-Mundo and
Chilesat.
REGULATION
We are subject to varying degrees of regulation in the jurisdictions in
which we provide services. This regulation--both domestically and
internationally--is changing rapidly. The laws and regulations applicable to our
business differ significantly from market to market. There can be no assurance
that future regulatory, judicial and legislative changes will not harm us or
that domestic or international regulators or third parties will not raise
material issues with respect to our compliance or noncompliance with applicable
regulations.
Below is a description of the regulatory framework in certain jurisdictions
in which we provide our services.
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UNITED STATES
As a provider of telecommunications services, we must comply with a number
of statutes and regulations in the United States. These include the
Communications Act of 1934, as amended by the 1996 Telecommunications Act (the
"1934 Act"), the FCC regulations thereunder, as well as the applicable laws and
regulations of the various states administered by the relevant state public
service commissions. The FCC exercises jurisdiction over all facilities and
services of telecommunications common carriers to the extent those facilities
are used to provide, originate or terminate interstate or international
communications. State public utility and service commissions retain jurisdiction
over the Company's facilities and services to the extent they are used to
originate or terminate intrastate communications. Local governments may require
the Company to obtain licenses or franchises permitting access to or use of
public rights-of-way to install and operate its networks.
There has been a general trend toward deregulation of the telecommunications
industry at both the federal and state level. Because this trend facilitates
market entry and competition by multiple providers, it has both created
opportunities and presented challenges for us. For example, it has given AT&T,
the largest international and domestic long distance carrier in the United
States, increased pricing and market entry flexibility that has permitted it to
compete more effectively with smaller carriers, such as us. In addition, the
1996 Telecommunications Act has opened the U.S. market to increased competition
from RBOCs. It is difficult to predict the future impact of regulatory, judicial
and legislative changes in the United States. There can be no assurance that
these changes will not materially affect our business and the price of our
common stock.
We are currently regulated as a non-dominant telecommunications carrier by
the FCC with respect to our international and domestic interstate long distance
services. Historically, the FCC has generally not closely regulated the charges,
practices or classifications of non-dominant carriers. However, it has the
authority to do so, including the power to impose more stringent regulatory
requirements on us, to change our regulatory classification, to impose monetary
forfeitures, to hear complaints for alleged violations of the 1934 Act or FCC
regulations, and to revoke our authority. We do not believe, however, that in
the increasingly deregulated U.S. market, the FCC is likely to take such actions
(apart from resolving complaints filed by third parties) but we cannot guarantee
this. There can be no assurance were the FCC to take such actions, that such
actions would not materially affect our business and the price of our stock.
We are required to obtain prior FCC and, in certain jurisdictions, state
regulatory approval before engaging in transactions that would result in a
change of control of our company, including transfers of control resulting from
corporate reorganizations and assignments of regulatory authorizations. The need
to obtain these approvals may delay, prevent or hinder a change in control of
our company. Effective May 19, 1999, new FCC rules went into effect under which
the FCC will forbear from reviewing pro forma assignments and transfers of
control of international telecommunications service authorizations. Instead, the
FCC requires only post-consummation notifications of pro forma assignments.
Although we intend to comply with such notification requirements, we do not
believe that we would incur any material penalties for failing to notify the FCC
of a pro forma change of control where required. We cannot be certain that this
would be the case.
FCC DOMESTIC INTERSTATE REGULATION. The FCC considers us a non-dominant
domestic interstate carrier. As a result, we are subject to minimal FCC
regulation. Although we are not required to obtain FCC authority to expand our
domestic interstate operations, we currently are required to maintain, and do
maintain, a domestic interstate tariff on file with the FCC. Pursuant to the
1934 Act, we are subject to the general requirement that our charges and
regulations for communications services must be "just and reasonable" and that
we may not make any "unjust or unreasonable discrimination" in our charges or
regulations.The FCC presumes the tariffs of non-dominant carriers to be lawful
and does not carefully review such tariffs before permitting them to take
effect. However, the FCC could investigate
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our tariffs in response to any public complaint or upon its own motion. Any such
FCC investigation could result in an FCC order to revise our tariffs or
prescribing revised tariffs. The FCC has jurisdiction to act upon complaints
from third parties against any common carrier for failure of the carrier to
comply with its statutory obligations and to award damages for such violations.
The FCC ruled in late 1996 that interexchange carriers do not have to file
their tariffs for domestic interstate interexchange services. In August 1997,
the FCC affirmed its decision eliminating the requirement that non-dominant
carriers file tariffs for domestic interstate long distance services. However,
since February 13, 1997, the FCC's detariffing orders have been stayed by the
U.S. Court of Appeals for the D.C. Circuit pending judicial review. Those
appeals remain pending.
We also are subject to a variety of miscellaneous regulations that, for
instance, govern the documentation and verifications necessary to change a
consumer's long distance carrier and require the filing of periodic reports.
On February 1, 1996, the U.S. Congress enacted comprehensive
telecommunications reform legislation, which the President signed into law as
the Telecommunications Act of 1996 on February 8, 1996 (the "1996 Act"). The
1996 Act requires all local exchange carriers:
- not to prohibit or unduly restrict resale of their services;
- to provide number portability;
- to provide dialing parity and nondiscriminatory access to telephone
numbers, operators services, directory assistance and directory listings;
- to afford access to poles, ducts, conduits and rights-of-way; and
- to establish reciprocal compensation arrangements for the transport and
termination of local telecommunications traffic.
The 1996 Act also permits the RBOCs to enter an "out-of-region" long
distance market immediately upon the receipt of any state and/or federal
regulatory approvals otherwise applicable in the provision of long distance
service. The provisions also permit an RBOC to enter the long distance market in
its local exchange operating territory (on a state-by-state basis) by satisfying
certain procedural and substantive requirements, including by showing that
facilities-based competition is present in its market, that it has entered into
interconnection agreements which satisfy a 14-point "checklist" of competitive
requirements and that its entry into the "in-region" long distance market is in
the public interest.
A number of RBOCs have made initial applications for the approvals necessary
to enter their "in-region" long distance markets. To date, all such applications
the FCC has acted upon have been denied on the basis that the RBOC has not
satisfied the list of competitive requirements. However, over the past year,
there have been extensive discussions among the state public service
commissions, the FCC and RBOCs in order to develop a definitive understanding of
these requirements and the specific criteria to measure their satisfaction. In
certain states, such as New York and Texas, RBOC efforts to obtain in-region,
long distance authority through such discussions may lead to one or more
successful RBOC "in-region" applications in the near future. See "Risk
Factors--We Have Many Competitors Who Enjoy Significant Competitive Advantages
Over Us." We cannot predict whether such entry would have a material adverse
effect on our business.
Our operations may also be affected by a number of other provisions of the
1996 Act. However, it is difficult at this time to accurately assess what these
effects will be. On August 1, 1996, the FCC adopted an Interconnection Order
implementing the requirements that incumbent local exchange carriers make
available to new entrants, such as us, interconnection and unbundled network
elements, and offer retail local services for resale at wholesale rates.
Although portions of the FCC's order were
67
temporarily overturned by a reviewing court, the U.S. Supreme Court recently
upheld most of the challenged rules, finding that the FCC has jurisdiction to
establish rules to promote competition for competitive local exchange services.
Several incumbent local exchange carriers are pursuing substantive appeals
before the U. S. Court of Appeals for the Eighth Circuit of the FCC rules the
Supreme Court upheld on jurisdictional grounds only. Incumbent local exchange
carriers have argued, for example, that the FCC's pricing method ignores their
historic costs and underestimates the actual costs of providing interconnection
and unbundled access. The Eighth Circuit did not reach that issue when it first
reviewed the FCC's Interconnection Orders, and the Supreme Court noted that only
the jurisdictional issue was before it.
The Supreme Court also held that the FCC's analysis leading to the creation
of its minimum list of seven mandatory incumbent local exchange carrier
unbundled network elements was inadequate. The Court ruled that the FCC failed
to consider whether access to proprietary network elements was "necessary," or
whether lack of access to any such element would "impair" the ability of
competitive local exchange carriers to offer telecommunications services. The
Court vacated the relevant rule and remanded the matter to the FCC either to
modify the rule or justify it, subject to further court review. The Supreme
Court's action also provides an opportunity for incumbent local exchange
carriers to argue before the FCC that the FCC should refrain from requiring
incumbent local exchange carriers to provide access to at least some network
elements on the ground that they do not satisfy the 1996 Act's "necessary" and
"impair" standards. The FCC has a proceeding underway to determine whether its
list of seven mandatory network elements should be reduced, expanded or
otherwise revised. We are unable to predict what the outcome of these decisions
related to network elements and their pricing or any resulting litigation will
be or when these matters will be resolved. We cannot guarantee that the outcome
will not materially affect our business.
Certain other aspects of the FCC's Interconnection Orders were vacated by
the Eighth Circuit and were not appealed to the Supreme Court; thus, they remain
vacated. These include FCC rules that had directed incumbent local exchange
carriers to combine network elements requested by competitors whether or not
those elements had previously been combined ("the new combinations rule"), and a
provision requiring incumbent local exchange carriers to provide interconnection
superior in quality to that provided by the incumbent local exchange carriers to
themselves, when requested to do so by competitors. The Court's action vacating
these rules may have an adverse impact on our business.
On August 6, 1998, the FCC took certain actions regarding the deployment of
advanced communications services. "Advanced communications services" are
wireline, broadband telecommunications services, such as services that rely on
digital subscriber line technology, commonly referred to as xDSL, and
packet-switched technology. The FCC issued a Memorandum Opinion and Order and a
Notice of Proposed Rulemaking that (i) clarified its views on the applicability
of existing statutory requirements in Sections 251 and 271 to advanced services,
and (ii) sought comment on a wide variety of issues associated with the
provision of advanced services by wireline carriers. Generally, the FCC
clarified that the Section 251(c) interconnection, unbundling and resale
obligations of incumbent local exchange carriers extend to their provision of
advanced communications services. The FCC also denied requests by several of the
incumbent local exchange carriers to forbear from imposing Section 251
obligations as then applied to advanced services. The FCC also proposed measures
to promote the deployment of advanced communications services by both incumbent
local exchange carriers and competitive local exchange carriers. Among the
proposals that generally were favorable to competitive local exchange carriers
are those for expanded physical collocation rights and strengthened rights to
order unbundled network elements required to provide advanced communications
services. However, the FCC also tentatively interpreted the 1996 Act as
permitting incumbent local exchange carriers to deploy advanced communications
services through separate affiliates that would not be regulated as incumbent
local exchange carriers. Thus, such separate affiliates of incumbent local
exchange carriers, if permitted, would not be subject to Section 251 and 252
unbundling and resale
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obligations. On March 18, 1999, the FCC adopted a First Report and Order in
these proceedings requiring incumbent local exchange carriers to make available
to requesting competitive local exchange carriers shared cage and cageless
collocation arrangements. The FCC also ruled that incumbent local exchange
carriers must permit competitive local exchange carriers to collocate equipment
used for interconnection and/or access to unbundled network elements even if
equipment includes certain switching or enhanced services functions. The FCC
also adopted rules designed to limit incumbent local exchange carriers' ability
to deny competitive local exchange carriers' ability to deploy transmission
hardware by purporting that the equipment will cause electrical interference
with other wires, and it proposed rules making these requirements more specific.
We cannot predict the final outcome of these proceedings or any appeals that
might ensue, and the effect such outcome may have on our business.
US WEST has sought judicial review before the U.S. Court of Appeals for the
D.C. Circuit of the FCC's decision that the Section 251(c) obligations apply to
advanced services. Pending before the Court are the FCC's voluntary motion to
remand for further explanation of its Order and U.S. WEST's motion to vacate the
decision pending such remand. Petitions for reconsideration of other aspects of
the FCC's advanced services decision remain pending before the agency. We cannot
predict the outcome of these proceedings or their effect on our business.
The FCC also has revised the universal service subsidy regime pursuant to
the 1996 Act. Beginning January 1, 1998, we and other interstate carriers and
other entities became obligated to make FCC-mandated contributions to universal
service funds. These funds help pay for telecommunications services in high cost
areas and to low-income customers, as well as for telecommunications and certain
other services to eligible schools, libraries and rural health care providers.
The amount of our required contributions is based on our end user revenues. We
make contributions to the high cost and low income fund based on our interstate
and international gross end-user telecommunications revenues. We make
contributions to the schools and libraries and rural health care fund based on
our intrastate, interstate and international gross end-user telecommunications
revenues. The FCC sets contribution factors quarterly, and we and other carriers
are billed monthly. The FCC orders implementing the universal service
contribution obligation were reviewed by the U.S. Court of Appeals for the Fifth
Circuit and, on July 30, 1998, were generally upheld. The Court did reverse
certain aspects of the FCC's rules, though, including the assessment of
contributions on interstate revenues, limits on certain state rules concerning
disconnection of local service and the incumbent carriers' recovery of its
contributions through access charges. There can be no assurance as to how these
rulings will be implemented or enforced or what effect the orders will have on
the industry generally or on us specifically. Contribution factors for the third
quarter of 1999 are: (i) 2.94% for the high cost, insular and low income funds
(interstate and international revenues); and (ii) 0.99% for the schools,
libraries and rural health care funds (intrastate, interstate and international
revenues). Although we are unable to predict future contribution factors or the
annual cost to us of the contributions, there is no reason of which we are aware
that would cause the factors in the short run to change materially from today's
levels.
The Universal Service Fund could be used to enable the incumbent local
exchange carriers to reduce prices that they charge to certain customers,
putting additional competitive pressure on us. However, we also are eligible to
qualify as a recipient of universal service support if we elect to provide
facilities-based service to areas designated for universal service support. We
presently are unable to predict the potential impact of these universal service
funding reforms, but they could have a significant impact on our future
operations. Significant portions of the FCC's universal service orders have been
appealed and are under review by the U.S. Court of Appeals for the Fifth Circuit
or are the subject of further proceedings by the FCC. We cannot predict the
outcome of these proceedings or the effect of these proceedings on our business.
In 1991, the FCC replaced traditional rate of return regulation for large
incumbent local exchange carriers with price caps, under which incumbent local
exchange carriers can only raise prices for certain
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interstate services by a small percentage each year. In addition, there are
constraints on the pricing of incumbent local exchange carriers services that
are competitive with those of competitive local exchange carriers. However, the
FCC has taken several actions, and is considering additional such steps, that
grant incumbent local exchange carriers pricing flexibility in areas of
concentrated population or where they face potential competition from
competitive local exchange carriers or competitive access providers. Changes in
local exchange carrier access charge rates for origination and termination of
calls over local exchange carrier facilities will affect our costs of providing
long distance services. Over the past few years, the FCC has granted incumbent
local exchange carriers significant flexibility in pricing their interstate
special and switched access services. Under this pricing scheme, incumbent local
exchange carriers may establish pricing zones based on access traffic density
and charge different prices for each zone. We anticipate that this pricing
flexibility will result in incumbent local exchange carriers lowering their
prices in high traffic density areas, the probable area of competition with us.
We also anticipate that the FCC will grant incumbent local exchange carriers
increasing pricing flexibility as the number of potential competitors increases.
On May 7, 1997, the FCC took action to reform the current interstate access
charge system. The FCC adopted an order that makes various reforms to the
existing rate structure for interstate access that are designed to move access
charges, over time, to more economically efficient rate levels and structures.
On October 5, 1998, the FCC released a public notice inviting comment on
proposals to accelerate reductions in incumbent local exchange carrier access
charges and grant the incumbent local exchange carriers increased flexibility
when setting prices in response to competition. In an order released on the same
day, the Commission deferred a scheduled increase in monthly presubscribed
interexchange carrier charges, which are commonly referred to as "PICCs," from
January 1, 1999, to July 1, 1999, explaining that on the latter date it expected
concurrent proceedings to have a significant downward effect on incumbent local
exchange carrier access charges. The July 1, 1999 changes have taken effect as
scheduled, with the PICCs increasing but overall access charges decreasing. The
PICCs are currently scheduled to continue to increase yearly until they reach
certain limits. The recent incumbent local exchange carrier annual access charge
revisions are intended to reflect implementation of a revised mechanism for
determining universal service high cost support for non-rural carriers, and
incumbent local exchange carrier price caps were adjusted downward on the basis
of a productivity improvement factor and lower inflation. The FCC is currently
considering several incumbent local exchange carriers petitions for waiver of
access charge rules which would further enable them to negotiate certain access
charge arrangements on an individual case basis. This series of decisions and
proceedings is likely ultimately to reduce the prices of incumbent local
exchange carriers access services with which we compete and could therefore have
a significant impact on our operations, expenses, pricing and revenue. We
currently intend to pass on to our customers the costs of both the PICC and our
universal service fund contributions. However, we cannot be certain that we will
not be prohibited from doing so, or that we will not lose customers if we do so.
We expect further revisions to the FCC's access charge rules. The FCC
already has indicated that it will promulgate additional rules in the near
future that may afford certain LECs increased flexibility. Recently, the FCC
issued an order clarifying the definition of a "primary line." Under the FCC's
order, a primary residential line is defined as "one residential line provided
by a price cap LEC per service location." The FCC did not change its definition
of a single line business subscriber line for purposes of its price cap rule.
This kind of line is still defined as a line for which the subscriber pays a
rate that is not described as a residential rate in the local exchange service
tariff and does not obtain more than one such line from a particular telephone
company.
Costs may also change based on changes in our agreements with various
carriers for the termination, origination and exchange of traffic. These
carriers may seek to change their arrangements with us as a result of changes to
their similar agreements with other carriers or local exchange carriers. Any
change in any of these agreements, whether by operation of law or otherwise, may
affect our costs or could disrupt our ability to terminate, originate or
exchange traffic, which could harm us.
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Interexchange carriers are required under the 1996 Telecommunications Act to
compensate the owners of payphones that are used by calling card customers to
originate a telephone call. Under the FCC's original compensation scheme,
beginning October 7, 1997, all carriers were required to compensate payphone
owners at a rate of 35 cents per call. On July 1, 1997, the United States Court
of Appeals for the District of Columbia Circuit ("D.C. Circuit") reversed in
part the FCC's payphone orders. The court ruled that the rate of 35 cents per
call was arbitrary and capricious and remanded the case to the FCC for further
proceedings. The FCC subsequently ruled that, for the period from October 7,
1997 through October 7, 1999, interexchange carriers are required to compensate
payphone owners at a per call rate of 28.4 cents for all payphone calls. The
Court remanded this order to the FCC on May 15, 1998, ruling that the 28.4 cents
rate was arbitrary and capricious, but not vacating it. On February 4, 1999, the
FCC lowered the payphone compensation rate to 24 cents, effective to October,
1997. However, the FCC has stated there will be no refunds until the FCC
determines what payphone compensation interexchange carriers must pay for the
"interim period" between November 1996 and October 1997. Because any refunds to
which interexchange carriers are entitled will be offset by payment obligations
for the "interim period" the timing and amount of any refund is uncertain. MCI
WorldCom, Sprint, the RBOCs and the American Public Communications Council have
filed Petitions for Review of this latest order with the D.C. Circuit. In
addition, a coalition including the RBOCs, SNET and GTE have filed a Petition
for Clarification with the FCC. This petition requests the FCC to clarify which
long distance carriers are responsible for payment of per-call compensation and
urges that the obligation be placed on the entity identified by the Carrier
Identification Code (CIC) used to route the call from the local exchange
network. We cannot predict the outcome of these proceedings or whether we will
have payment obligations for the "interim period" that exceed any refund to
which we are entitled, or any other effect on our business.
As a result of many factors, many payphone service providers have made
compensation claims against long distance carriers, including against us. We
have paid or accrued all payphone compensation we believe is due under the most
recent payphone compensation scheme but cannot provide any assurances as to the
outcome of these proceedings or their effect on our business.
The FCC also regulates the marketing of telephone services and the changing
of a customer's primary long distance carrier. The FCC has recently imposed
severe penalties on a number of carriers for "slamming." See "--Legal
Proceedings." Under an order recently issued by the FCC, carriers such as us are
required to take certain additional steps to prevent slamming. We expect the FCC
to continue to reexamine its slamming rules and cannot predict the outcome of
such reexamination, which may lead to additional or modified obligations imposed
upon us.
FCC INTERNATIONAL REGULATION We are regulated as a non-dominant carrier in
our provision of international service. As an international carrier, we are
required to obtain an appropriate certificate of public convenience and
necessity from the FCC pursuant to Section 214 of the 1934 Act before providing
international service. We also must comply with tariff, reporting, and fee
requirements that are the same as or similar to the tariff, reporting, and fee
requirements applicable to our U.S. domestic business. We are also required to
comply with the FCC's international service policies. Certain of these policies
may limit our ability to provide our services in the most economical manner.
We are subject to the FCC's "International Settlements Policy" governing
traffic exchange and settlement between U.S. and foreign carriers. The
International Settlements Policy establishes the parameters by which U.S.
carriers and their foreign correspondents settle international revenues to
recover the cost of terminating each other's traffic over their respective
networks under the international accounting rate system. Under the international
accounting rate system, a U.S. facilities-based carrier is permitted to
negotiate an "accounting rate" with the corresponding foreign carrier for
handling each minute of international telephone service. The amount of payment
is determined by applying a "settlement rate" (generally one-half of the
negotiated accounting rate) to net billed minutes for a particular month. Unless
we receive a waiver, the FCC could find that certain terms of our
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foreign carrier agreements or our actions to terminate international traffic do
not comply with the International Settlement Policy. While the FCC generally has
not imposed penalties in this area, it could take action against a carrier
violating the International Settlement Policy, including issuing a cease and
desist order, revoking Section 214 authorizations, or imposing fines. Recently,
the FCC approved sweeping reform of its International Settlement Policy. This
reform will eliminate the International Settlement Policy for arrangements with
foreign carriers lacking market power (i.e., less than 50% market share in the
relevant destination market) and for arrangements with all foreign carriers on
liberalized routes (i.e., those routes where the settlement rate to terminate
U.S. calls is at least 25 percent below the FCC's relevant benchmark rate set
for that country). Although these rules should afford us additional flexibility,
they may also increase competition on certain routes.
We are also subject to the FCC's rules regarding "international simple
resale" or "ISR." ISR is the provision of switched services over "private" lines
interconnected on one or both ends to the public network. U.S. carriers are
allowed to engage in ISR on any route where the U.S. carrier exchanges switched
traffic with a foreign carrier that lacks market power. In addition, U.S.
carriers are permitted to engage in ISR with any foreign carrier, regardless of
market power, on any route for which the FCC has authorized the provision of
ISR. The FCC will allow ISR between the U.S. and a WTO member country for which
it has not previously authorized such service upon a demonstration that (1)
settlement rates for at least 50 percent of the settled U.S.-billed traffic
between the U.S. and the proposed destination country are at or below the
benchmark settlement rate adopted by the FCC, or (2) where such destination
country affords resale opportunities "equivalent" to those available under U.S.
law. The FCC will allow ISR between the U.S. and a non-WTO member country not
previously authorized to provide such service if both conditions summarized
above are satisfied. As of July 21, 1999, the FCC has authorized ISR to the
following countries: Australia, Austria, Belgium, Canada, Denmark, Finland,
France, Germany, Hong Kong, Iceland, Ireland, Israel, Italy, Japan, Luxembourg,
The Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland, and the United
Kingdom. The FCC could find that certain of our actions regarding the
termination of traffic do not comply with the ISR requirements. Although the FCC
generally has not issued penalties in this area, it could take action against a
carrier violating the ISR requirements, including issuing a cease and desist
order, revoking Section 214 authorizations, or imposing fines.
We are also subject to the FCC's rules on "special concessions." A special
concession is an exclusive arrangement involving certain services, facilities,
or functions on the foreign end of a U.S. international route that are necessary
for the provision of basic telecommunications services where the arrangement is
not offered to similarly situated U.S. licensed carriers. The FCC's rule on
special concessions prohibits us from accepting, directly or indirectly, any
special concession from a foreign carrier with respect to any U.S. international
route where the foreign carrier possesses sufficient market power on the foreign
end of the route to affect competition adversely in the U.S. market. The FCC's
rules on special concessions could limit our flexibility in making arrangements
with some foreign carriers for termination of international traffic.
STATE REGULATION. We are authorized, where necessary, either pursuant to
certification, the fulfillment of tariff requirements or notification
requirements, to provide long distance services in 41 states.
We believe that, as the degree of intrastate competition increases, some
states are likely to offer incumbent local exchange carriers increasing pricing
flexibility. This pricing flexibility may present incumbent local exchange
carriers with an opportunity to subsidize services that compete with our
services with revenues generated from less competitive services, thereby
allowing incumbent local exchange carriers to offer services competing with ours
at prices below the cost of providing the service. We cannot predict the extent
to which this may occur or its impact on our business.
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We are subject to various reporting and other requirements in a number of
states. State commissions regulate access charges and other pricing for
telecommunications services. In addition, a number of state public service
commissions regulate the marketing of telephone services and require customer
authorizations for changes of a customers' primary long distance carrier.
Several states also require (and others are considering requiring) universal
service fund contributions. States also generally have the right to impose
sanctions on a carrier or to condition, modify, cancel, terminate or revoke
authorization to provide telecommunications services for failure to comply with
state law and/or rules, regulations and policies of the state regulatory
authorities. There can be no assurance that the states will not modify their
regulations so as to have an adverse impact on our business.
INTERNET REGULATION. In the United States, Internet service providers are
generally considered "enhanced service providers" and therefore are not subject
to U.S. federal and state regulations governing common carriers. Accordingly, we
are currently exempt from tariffing, certification and rate regulation with
respect to our provision of Internet access services. However, other
requirements may apply to our provision of Internet services, including
regulations relating to disclosure of confidential communications, copyright and
excise tax matters. We may become subject to material additional regulations in
the future that apply to our Internet access business and adversely affect it.
Internet service providers such as us are subject to potential criminal
liability under the provisions of the Communications Decency Act of 1996 (CDA)
that govern the use of interstate telecommunications networks,
telecommunications devices, or interactive computer services, to transmit
obscene or indecent communications. In an April 1999 decision, the Supreme Court
upheld provisions of the CDA that impose criminal liability on:
- any person who knowingly uses a telecommunications device to send an
obscene or indecent communication with intent to annoy another person; or
- any entity who knowingly permits any telecommunications facility under his
control to be used for such purposes.
Entities solely providing access to facilities not under their control are
exempted from liability, as are providers that take good faith, reasonable,
effective and appropriate actions to restrict access by minors to the prohibited
communications. The U.S. Supreme Court struck down, on constitutional grounds,
provisions of the CDA that imposed criminal liability on:
- any person who knowingly uses a telecommunications device to send an
obscene or indecent communication to a recipient under 18 years of age,
and
- any person who knowingly uses an interactive computer service to send to a
specific person under 18 years of age, or to display in a manner available
to a person under 18 years of age, communications that, in context, depict
or describe, in terms patently offensive as measured by contemporary
community standards, sexual or excretory activities or organs.
It is not known how the provisions of the CDA will be enforced or
interpreted in the future. It is possible that these provisions will chill the
development of Internet content or otherwise adversely affect Internet access
providers such as us. In addition, we cannot be certain that we will not be
required to modify our Internet access operations to comply with the CDA.
As an Internet service provider, we have been granted statutory immunity
from liability for the transmission of, or provision of access to, information
created or originated by others over our network. Internet service providers are
exempt from criminal prosecution under the Children's Online Protection Act of
1998 ("COPA") with respect to the commercial use of their networks by others to
make available to minors material that is obscene, pornographic or harmful to
minors. Section 230 of the CDA immunizes an Internet service provider from
potential civil liability in connection with the dissemination of information
originated or created by a third party that is transmitted or made
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available on the Internet service provider's network. Federal court decisions in
1997 and 1998 have held that Section 230 of the CDA grants an Internet service
provider immunity from civil liability with respect to the transmission of, or
provision of access to, defamatory materials created by others. Notwithstanding
these statutory and court precedents granting limitations on Internet service
provider liability, we cannot predict whether our operations may be adversely
affected in the future by the negligent or criminal acts or communications of
others in the use of our network.
The FCC initiated a Notice of Inquiry in December 1996 seeking public
comment on whether to impose regulations or surcharges on, among other entities,
providers of Internet access. In addition, the FCC indicated in a Report to
Congress in April 1998 that it will reexamine its policy of not requiring
Internet service providers to make mandatory universal service fund
contributions when they provide their own transmission facilities and engage in
data transport over those facilities to provide an information service. The FCC
also strongly hinted in this Report that, although the matter was not before it,
it would find voice telephony over Internet protocol services to be
telecommunications services, making such services, as opposed to
computer-to-computer Internet Telephony, subject to universal service
obligations, access charges, and other common carrier obligations. U S WEST has
filed a complaint before the FCC seeking such a ruling, which remains pending.
We are unable to predict the outcome of the FCC's review and proceedings
regarding the regulation of Internet related services and IP Telephony.
Furthermore, we cannot predict whether we will face additional regulations,
requirements or charges in connection with our Internet access service and what
the impact on our business will be.
Over 30 states have found that, through existing interconnection agreements,
local exchange carriers are eligible to receive compensation from incumbent
local exchange carriers or competitive local exchange carriers for traffic that
originates on the other carrier's network and is delivered to an Internet
service provider in the same local calling area. Although subject to differing
interpretations, as many as three states have found to the contrary. The FCC
found in February 1999 that such Internet-bound traffic is jurisdictionally
interstate. The FCC tentatively concluded that some intercarrier compensation is
due for the exchange of such traffic, but has not yet decided the direction or
amount of such compensation that is due. These issues are pending before the
agency, and a decision is expected in the next few months. In the interim, state
commissions remain free to resolve issues concerning the propriety of such
compensation under current interconnection arrangements or for new agreements.
We cannot predict the outcome of such state or federal proceedings or their
effect upon our business.
NETWORK MARKETING REGULATION. Our network marketing system is subject to
extensive government regulation. For example, we are subject to state regulation
of marketing practices and federal and state regulation of the offer and sale of
business franchises, business opportunities and securities. In addition, various
regulatory authorities monitor direct selling activities, including those of our
company. There is also the risk that the Internal Revenue Service and/or any
state taxing authority could classify our independent representatives as
employees rather than independent contractors. If such a determination were made
by any one or more taxing authorities, we could be subject to penalties and
interest for taxes not withheld and/or required to withhold such taxes in the
future, and we could be required to pay unemployment insurance. In addition, any
adverse determination in one jurisdiction with respect to these matters could
influence the decisions of authorities in other jurisdictions. Any or all of
these factors could adversely affect the way we do business and could hurt our
ability to attract potential independent representatives. While network
marketing regulations are complex and vary from jurisdiction to jurisdiction, we
believe we are in compliance with currently applicable regulations. However, no
assurance can be given that one or more jurisdictions will not assert future
violations against us in the future or that, if such assertions are made, that
they will not harm our business or depress the price of our common stock.
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PATENT RIGHTS RELATING TO PREPAID SERVICES. Certain prepaid card providers
have been subject to claims that their provision of prepaid services infringes
the patent rights of other parties. To date, we have not received any such
claims. However, no assurance can be given that such claims will not be asserted
against us in the future. And while we do not believe that our provision of
prepaid services infringes any third party patent rights, we cannot be certain
that we would prevail if a claim were asserted by a third party. If we were
unable to continue providing our prepaid card services as we do now, our
business could be harmed and the price of our common stock could be depressed.
EUROPEAN UNION REGULATION
The European Union (EU), formerly the European Communities, consists of the
following EU member states: Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and
the United Kingdom. The telecommunications industry in the EU is governed by
regulations and directives issued at a supra-national level by the EU
authorities (the EU Commission, the EU Council of Ministers and Parliament)
which generally require further implementation in each member state through
domestic legislation. The EU has adopted pan-European policies aimed at
facilitating an open and competitive telecommunications market.
With a number of exceptions, the EU ordered all special or exclusive rights
that restrict the provision of telecommunications services in EU countries to be
abolished, effective January 1, 1998. The EU adopted specific directives
implementing this policy, including the Open Network Provision (ONP) Framework
Directive, ONP Leased Lines Directive, the Revised Voice Telephony Directive,
the ONP Adaptation of Full Competition Amending Directive, the Services
Directive, the Interconnection Directive, and the Licensing Directive. The
Licensing Directive sets out framework rules for the procedures associated with
granting national authorizations for the provision of telecommunications
services and for the establishment or operation of any infrastructure for the
provision of telecommunications services. It requires EU member states to rely
as much as possible on "general authorizations," which do not require an
explicit decision from the regulatory agency, and to require "individual
licenses," only for public voice telephony and in other limited circumstances
such as where the licensee requires access to scarce resources. The EU also has
mandated carrier pre-selection and number portability on or before January 1,
2000. Carrier pre-selection will enable our customers to access our network over
the fixed public telephone network of operations without dialing an access code,
by "pre-selecting" our company as their long distance carrier.
Implementation of the EU directives has varied among the EU member states.
Some EU member states were granted derogation from the January 1, 1998
liberalization date as follows: Luxembourg (July 1, 1998), Spain (December 1,
1998), Ireland (January 1, 2000), Portugal (January 1, 2000), and Greece
(January 1, 2002), but actual liberalization in some of these countries has
already been achieved or will be achieved, prior to the deadlines in question.
Even those EU member states that have already fully implemented the EU licensing
framework vary in their requirements that we obtain approvals and are expected
to continue to so vary. See "Risk Factors--We Are Subject to Significant
Regulatory Restrictions."
UNITED KINGDOM. The Telecommunications Act of 1984 (U.K. Act) establishes
the licensing and regulatory framework for telecommunications activities in the
United Kingdom. Pursuant to the U.K. Act, the Secretary of State for Trade and
the Department of Trade and Industry (DTI) is responsible for granting licenses
and for overseeing telecommunications policy, while the Director General of the
Office of Telecommunications (OFTEL) is responsible, among other things, for
enforcing the terms of such licenses. Applications for licenses are generally
approved by the DTI provided that the DTI determines that the applicant has a
reasonable business plan and the necessary financial resources to provide the
proposed services and there are no overriding considerations against grant of
the application. Applications for frequency assignment are processed and acted
upon separately by the Radiocommunications Agency.
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Since 1992, the British Government has permitted competition in the
provision of international voice service over leased lines interconnected with
the PSTN on certain specified routes. In December 1996, the British Government
introduced the International Facilities License (IFL) which authorizes holders
to provide international telecommunications services over their own
international infrastructure and/or through ownership interest in international
undersea cables.
We have all of the required licenses to provide international services in
the United Kingdom. We provide certain services in the United Kingdom under
registrable class licenses. In addition, through our U.K. subsidiary,
WorldxChange Communications Ltd., we have an International Simple Voice Resale
License (the ISVR), under which we are authorized to resell international voice
services. WorldxChange Communications Ltd. is also able to interconnect with,
and lease capacity at wholesale rates from, British Telecom and other public
telecommunications operators by virtue of this license. We also hold an IFL
license which authorizes us to provide international telecommunication services
over our own international infrastructure.
Our customers in the United Kingdom are not yet able to pre-select us as
their long distance carrier. Consequently, they have to dial a four-digit access
code to use our service. EU directives have mandated equal access in the United
Kingdom by January 1, 2000. However, OFTEL is seeking to defer the
implementation of carrier pre-selection in the United Kingdom until a later
date.
BELGIUM. In December 1997, the Belgian Federal Parliament enacted a new
Telecommunications Law establishing January 1, 1998 as the date for full
liberalization of the Belgian telecommunications market, including voice
telephony. Under this law, separate licenses are required to operate public
telecommunications networks, provide leased lines and supply voice telephony
services. Despite liberalization under the new Telecommunications Law, Belgium's
regulatory framework remains partly incomplete because measures required by EU
Directives--in particular, those pertaining to systems and licensing--have yet
to be implemented. As a result, authorizations continue to be granted under a
provisional licensing regime.
As a provider of voice telephony services in Belgium, we are required to
have a voice telephony license. We recently obtained this license from the
Belgium Minister for Telecommunications. Our license expires in January 2014. We
have interconnection in Belgium through an agreement with Belgacom.
Our customers may not yet pre-select us as their long distance carrier.
Therefore, they must dial a four-digit access code to use our service. Belgian
regulatory authorities have not yet introduced the regulations setting forth the
criteria that private carriers must satisfy to offer pre-selection to their
customers. However, Belgacom has submitted to Belgian regulators a proposal for
allowing carriers such as us to establish pre-selection for their customers. We
expect to be able to begin offering pre-selection to our Belgian customers
within approximately the next 12 months, although no assurance can be given in
this regard.
FRANCE. Licensed private service providers have been authorized to provide
domestic and international long distance voice telephony services in France
since January 1, 1998. The establishment and operation of a public
telecommunications network and the provision of voice telephony are subject to
separate individual licenses, which are granted by the Minister charged with
oversight of telecommunications upon recommendation of France's independent
regulatory authority, the Authorite de Regulation des Telecommunications (ART).
Carriers that desire to own and control transmission infrastructure in
France need an infrastructure license (License L33-1) from the ART. A license
34-1 is required to provide voice telephony only. Our French subsidiary,
WorldxChange Communications, S.A., obtained its voice telephony license during
the third quarter of 1998. This license enables us to provide all of our current
services in France.
We lease our transmission lines in France and are therefore not required to
have an infrastructure license. However, we are also unable to take advantage of
lower access charges available through France Telecom to carriers with their own
infrastructure.
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Currently, our customers may not pre-select our service and must dial a
four-digit access code to use our service. Seven carriers that have agreed to
interconnect on a national basis to the French public switched telephone network
in a substantial number of markets have been granted single digit access for
their customers.
GERMANY. The German Telecommunications Act of July 25, 1996 (the German
Telecommunications Act) liberalized all telecommunications activities, but
postponed effective liberalization of voice telephony until January 1, 1998. The
German Telecommunications Act has been complemented by several Ordinances. The
most significant Ordinances concern license fees, rate regulation,
interconnection, universal service fees, frequencies and consumer protection.
Under the German regulatory scheme, a license is required for the operation
of transmission lines. There are three infrastructure license classes: mobile
telecommunications (license class 1); satellite (license class 2); and
telecommunications services for the general public (license class 3). The
provision of "voice telephone service," which includes services involving
switching in Germany over a privately owned telecommunications network, requires
a license Class 4. We received a license Class 4 during the second quarter of
fiscal 1998.
The German Telecommunications Act and the Network Access Ordinance require
public telecommunications network operators to offer interconnection at the
request of other network interconnection operators. This requires Deutsche
Telekom to allow other providers interconnection to its telecommunications
networks. During the fourth quarter of 1998, we entered into an interconnection
agreement with Deutsche Telekom, which expired at the end of February 1999. In
June 1999, we entered into a new interconnection agreement with Deutsche
Telekom.
THE NETHERLANDS. The Dutch Telecommunications Act of 1998 (Dutch Telecom
Act), which became effective December 15, 1998, provides the existing regulatory
framework for the provision of telecommunications services in the Netherlands.
The new regime closely parallels the EU Licensing Directive, requiring
individual licenses only for the use of spectrum. All other services, including
the installation and provision of public telecommunications networks, leased
lines and broadcasting networks, may be provided pursuant to registration. Our
Dutch operating subsidiary became licensed and registered in The Netherlands
during the first quarter of fiscal 1997.
SWEDEN. Sweden's telecommunications market has been deregulated since July
1, 1993. The Post and Telestryrelsen (PTS) was created to issue licenses and
monitor compliance with telecommunications regulations. The agency is also
responsible for number planning and spectrum allocation.
The regulatory regime is quite liberal according to international standards,
and, for the most part, appears to be in compliance with the EU Licensing
Directive. Only a few important telecommunications services are regulated. A
declaration (notification) is required for companies wishing to provide, over a
publicly available network, fixed telephony, mobile services, any other
telecommunications service which requires allocation of capacity from a
numbering plan for telephony, and network capacity (including leasing lines).
Companies may commence operations immediately upon filing the declaration with
the PTS. Our Swedish operating subsidiary filed its declaration with the PTS in
March 1998.
An individual license is required only where a service provider maintains a
significant presence in the market. The PTS will issue a determination of
whether a license is required upon application. Licenses generally are granted
except where the applicant clearly is not capable of pursuing the activity on a
permanent basis and with adequate capacity and quality. All operator licenses
within a specific category are subject to the same conditions, regardless of
whether the operator is or is not from an EU member state.
Uncertainty in the Swedish market could be created by the fact that a
carrier's unregulated operations may expand and at some point require an
individual license. However, operators may request an advance ruling as to
whether an individual license is required, which generally takes up to six
weeks.
77
AUSTRALIA
The provision of telecommunications services in Australia is principally
regulated by the Telecommunications Act of 1997 and the Trade Practices Act of
1974.
The Telecommunications Act regulates the use of telecommunications
facilities to provide telecommunications carriage and content services. The
Australian Communications Authority (ACA) is responsible for administering the
Telecommunications Act, including licensing telecommunications carriers,
ensuring compliance with carrier license conditions and carriage service
provider rules and monitoring industry participants' performance and service
quality.
There are three principal classes of telecommunications operators under the
Telecommunications Act:
- Carriers -- which own the infrastructure used to provide carriage services
to the public;
- Carriage service providers -- which use infrastructure owned by carriers
to offer carriage service to the public; and
- Content service providers -- which use carriage services supplied by a
carriage service provider to supply content services to the public.
A carrier license is required to own most types of transmission
infrastructure that are used for the provision of telecommunications services to
the public, including cable networks that connect distinct places in Australia,
mobile telephony networks, certain fixed radiocommunications transmitters and
satellites. A carrier license is not required to own infrastructure such as
switches, operational support systems, and databases.
We operate in Australia through our subsidiary, WorldxChange Pty. Limited,
which is a carriage service provider.
The Trade Practices Act of 1974 governs restrictive trade practices and
consumer protection in Australia. In addition, the Trade Practices Act provides
a mechanism for carriers and carriage service providers to gain access to each
other's services and some facilities. The Trade Practices Act is administered by
the Australia Competition and Consumer Commission (ACCC). The ACCC may declare a
carriage service (Declared Service) if the ACCC considers that the declaration
of the service would promote the long-term interests of end-users. A carrier or
carriage service provider must comply with certain standard access obligations
in supplying Declared Services.
The regulatory regime provided by the Trade Practices Act encourages access
providers and access seekers to reach commercial agreements on the supply of
Declared Services. If an agreement can not be reached, the ACCC has the power to
arbitrate. If an access provider has not given an access undertaking, the ACCC
has full discretion to determine the terms and conditions of access that it
considers reasonable.
In addition to the Telecommunications Act and the Trade Practices Act,
WorldxChange Pty. Limited is required to comply with various other federal,
state and local government legislation, regulations, codes, statements of policy
and court decisions affecting telecommunications providers.
NEW ZEALAND
The Telecommunications Act of 1987 opened the New Zealand telecommunications
market to competition effective April 1, 1989. Although the New Zealand
telecommunications market is comparatively deregulated, like other New Zealand
businesses, we are subject to the Commerce Act 1986, which prohibits restrictive
trade practices that have the purpose or effect of substantially lessening
competition. The New Zealand government is currently reviewing the Commerce Act,
which may be amended to make these provisions more stringent.
The Commerce Act also prohibits any person who has a dominant position in a
market from using that position for the purpose of restricting the entry of
others into any market, preventing or deterring others from engaging in
competitive conduct in any market or eliminating others from any market.
78
The Consumer Guarantees Act 1993 implies certain guarantees in respect of
the supply of goods or services to consumers and provides consumers with
remedies against suppliers and manufacturers of such goods and services in
respect of any failure to comply with such guarantees.
The Telecommunications (International Services) Regulations 1994 apply to
all persons who establish, operate and maintain facilities in New Zealand for
the purpose of providing to other persons in New Zealand, leased circuits that
are connected both with public networks in New Zealand and with public networks
in the territory of the operator that is provided with such leased circuits or
public switched telecommunications services to or from territories outside New
Zealand. Any person to whom the regulations apply must apply to the Secretary of
Commerce to become a registered operator. Registered operators must comply with
certain conditions. Our operating subsidiary is a registered operator under
these regulations.
Like all businesses in New Zealand, we are also subject to the Fair Trading
Act 1986 which prohibits misleading and deceptive conduct, making false
representations and unfair trade practices.
Under the Overseas Investment Regulations 1995, certain proposals by our
operating subsidiary, WorldxChange Limited, to acquire securities in a New
Zealand entity, to acquire the assets of a New Zealand business or to acquire
certain land in New Zealand require the consent of the Minister of Finance,
acting through the Overseas Investment Commission, and also the Minister of
Lands, in relation to proposals to acquire certain land. This is because our
operating subsidiary is an "overseas person" for the purposes of such
legislation. No consent is required if the value of the transaction is below
NZ$10 million.
CANADA
The domestic long distance market in Canada has been open to resale
competition since 1990 and to facilities-based competition since 1992.
Foreign-owned resellers competing in the Canadian domestic long-distance market
are neither regulated nor subject to any foreign ownership restrictions or
licensing requirements.
Under the WTO Agreement, Canada agreed to end Teleglobe Canada's
long-standing monopoly on the provision of Canada--overseas transmission
facilities and services effective on October 1, 1998. An international telecom
service provider licensing regime was introduced by the Canadian Radio-
television and Telecommunications Commission effective on January 1, 1999,
applicable to Canadian and foreign carriers and resellers alike. We obtained a
license authorizing us to provide international long distance services in Canada
in the first quarter of 1999, and we are subject to licensing conditions
regarding anti-competition conduct, traffic reporting and payment of
contribution charges (which are similar to access charges in the United States).
CHILE
The Chilean telecommunications sector has been opened to competition since
1992. There are no restrictions on foreign ownership of telecommunications
service providers. All telecommunications service providers must obtain a
concession or license from the Ministry of Transport and Telecommunications.
Our Chilean subsidiary, WorldxChange Communications, S.A. has obtained an
Intermediate Telecommunications Service Concession from the Ministry of
Transport and Telecommunications. We have installed a switch in Santiago and
have entered into a signal transport agreement with ENTEL. We have obtained
interconnection for our operations in Chile.
GUATEMALA
The telecommunications sector in Guatemala has been opened to competition
since 1996 with the enactment of the Telecommunications Law. As a result, all
telecommunications services previously reserved to the state-owned monopoly
provider, EMPRESA GUATEMALTECA DE TELECOMMUNICACIONES (TELGUA), are now fully
open to competition and local, long distance (national and international), and
value-added services may be provided by new operators using their own facilities
or by reselling the
79
facilities of other carriers. All providers must register with the
SUPERINTENDENCIA DE TELECOMMUNICACIONES (SIT).
Our Guatemalan subsidiary, WorldxChange Communications, S.A., has registered
with the SIT as a commercial operator of a telecommunications network. We have
installed a switch in Guatemala City and have entered into an interconnection
agreement with TELGUA. In addition, we are currently requesting registration
with the SIT as a user of satellite facilities and as an operator of an
international gateway.
EL SALVADOR
All aspects of the telecommunications sector in El Salvador -- including
local, domestic and international long distance, and value-added services --
have been fully open to competition since 1997. The state-owned telephone
company, ANTEL (currently CTE Antel Telecom), was also privatized. Licensing
procedures for facilities-based and resale carriers are not burdensome.
Interconnection is mandated and Salvadorian law designates a list of essential
network facilities that must be offered to all telecommunications carriers on a
non-discriminatory basis. El Salvador imposes no foreign ownership restrictions
on telecommunications providers.
Our Salvadoran subsidiary, WorldxChange Communications, S.A. de C.V., has
obtained access code number 151 and has been registered as a telecommunications
provider with the SUPERINTENDENCIA GENERAL DE TELECOMUNICACIONES (SIGET). We
have started negotiating an interconnection agreement with CTE Antel Telecom,
but the negotiations have been delayed due to the incumbent's lack of capacity
for new entrants. If an interconnection agreement cannot be reached with CTE
Antel Telecom, an alternative will be to negotiate an agreement WITH TELEFONICA
EL SALVADOR, S.A. DE C.V., one of the largest competitive operators in the
country. We currently have no operations in El Salvador, but we anticipate that
we will begin operations in El Salvador as soon as we finalize our
interconnection negotiations.
EMPLOYEES
As of June 30, 1999, we employed 917 people, including officers,
administrative and sales personnel. We consider our relationship with our
employees to be good.
PROPERTIES
Our principal offices are located at 9999 Willow Creek Road, San Diego,
California, where we occupy approximately 36,100 square feet under a lease that
expires on August 31, 2002. The lease provides for annual lease payments of
$398,000, subject to annual adjustment.
We also maintain a 24,300 square-foot office at 9775 Businesspark Avenue,
San Diego, California, which houses our human resources, technical and certain
other corporate functions. The lease expires on July 31, 2002 and provides for
annual lease payments of $253,812.
We lease all of the facilities in which our switches are installed. These
leases are generally multi-year leases and provide for aggregate annual lease
payments of approximately $536,000, subject to annual adjustment.
In addition, our foreign operating subsidiaries lease facilities for their
respective corporate offices and switch sites. The aggregate annual lease
payments for these leases total approximately $1.9 million, subject to annual
adjustment.
LEGAL PROCEEDINGS
In May 1997, the California Public Utilities Commission issued an order
revoking our authority to provide intrastate calling service in California and
imposing certain other fines and penalties, including, among other things, a
$19.6 million fine, against us based on the CPUC's finding that we had violated
California laws and regulations requiring us to obtain prior consumer
authorization before switching consumers' long distance carriers. We have paid
$2.0 million of the $19.6 million fine, with the balance suspended so long as we
are not found to have committed any future violations of statutes or CPUC
80
directives. Under the CPUC's order, the sanctions and fines are binding on any
successor to us, unless otherwise ordered by the CPUC, which could materially
adversely affect our marketability. We have implemented a number of policies and
procedures designed to help reduce the likelihood of future allegations of the
kind leading to the CPUC's order. However, there can be no assurance that
additional allegations of wrongdoing will not be brought against us in the
future or that, if such allegations are made, that they would not result in
substantial expense and/or liability to us. For example, if such allegations
were to be made in California and we were found to have violated statutes or any
CPUC directives, we would be subject to paying the $17.6 million portion of the
CPUC fine that is currently suspended, as well as potentially other fines and
penalties, which could be substantial. If we were required to pay the suspended
portion of the CPUC fine and/or any such additional fines or penalties, our
business would be harmed and the price of our common stock would be depressed.
In September 1995, the California Attorney General notified us that it was
investigating alleged violations by us of certain consumer protection laws. We
commenced negotiations for a settlement with the California Attorney General,
but these negotiations were terminated in 1997 in connection with the CPUC
proceedings described above without any settlement agreement. It is possible
that the California Attorney General could reopen its investigation of us or
commence a lawsuit against us based on the same or new or additional allegations
of wrongdoing by us. If such investigation were to be reopened or such lawsuit
were to be commenced, we would be forced to respond and defend ourselves, which
could result in significant expense and diversion of our management's time and
resources. In addition, we could incur significant liability pursuant to a
settlement or adverse judicial ruling in connection with any such proceedings.
We were also notified in September 1995 by the attorneys general of five
other states that they were investigating alleged violations by us of certain
consumer protection laws. We settled these allegations by paying an aggregate
amount of $475,000 and, without admitting liability, consenting to civil
injunctions.
We are a party, from time to time, to certain legal and administrative
proceedings, claims and inquiries that arise in the ordinary course of our
business, as well as to certain other litigation, some of which proceedings,
claims and inquiries involve claims for substantial amounts of damages. Although
the ultimate outcome of these proceedings, claims and inquiries is uncertain, we
do not believe that any of these proceedings, claims or inquiries will
materially harm our business.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Our board of directors is divided into two classes. See "Description of
Capital Stock-- Anti-Takeover Effects." Each of our directors serves a two year
term and one class is elected each year by our shareholders, commencing at the
annual shareholders' meeting in 2000. Directors hold office until their terms
expire and their successors are elected and qualified. The terms of the current
directors will expire as follows: Messrs. Angeloff, Bantoft and Laxalt, in 2000;
and Messrs. Abbott, Anderson, Cerrito and Soren, in 2001. The following table
sets forth the name, age and position of our directors and executive officers.
NAME AGE POSITION WITH WORLDXCHANGE
- ---------------------------------------------- --- ------------------------------------------------------------
Walt Anderson................................. 45 Chairman of the Board
Roger B. Abbott............................... 41 Chief Executive Officer and Director
Christopher Bantoft........................... 52 President, Chief Operating Officer and Director
Edward S. Soren............................... 56 Executive Vice President and Director
Patrick M. Aelvoet............................ 36 Senior Vice President and Chief Financial Officer
Barbara H. Jamaleddin......................... 53 Senior Vice President of Network Operations
Eric G. Lipoff................................ 45 Senior Vice President, Secretary and General Counsel
William Moskowitz............................. 36 Senior Vice President of Information Systems
Dann V. Angeloff.............................. 63 Director
Tom Cirrito................................... 51 Director
Paul Laxalt................................... 77 Director
WALT ANDERSON has served as chairman of our board of directors since March
1999. Since 1992, Mr. Anderson has been the financial advisor to Gold & Appel
Transfer, S.A., a venture capital company which owns substantial positions in
several public and private telecommunications companies, including WORLDxCHANGE.
Pursuant to a power of attorney, Mr. Anderson has sole investment power over the
shares of our common stock owned by Gold & Appel Transfer, S.A. Mr. Anderson has
been president and chairman of Entree International Ltd. (financial consulting
services) from July 1997 to the present; chairman of Teleport UK Ltd. (satellite
communications) from January 1995 to the present; chairman of US WATS (telecom
services) since May 1997; and chairman and chief executive officer of Esprit
Telecom Group plc. (telecom services) from 1990 to December 1998. Mr. Anderson
is also a director of American Technology Labs (network equipment), Asia Access
Telecommunications (telecom services), Net-Tel Holdings (telecom services) and
Total-Tel USA Communications, Inc. (telecom services).
ROGER B. ABBOTT is a co-founder of WORLDxCHANGE and has served as our chief
executive officer since January 1997 and as a director since May 1, 1998. From
May 1991 to December 1996, Mr. Abbott served as our chief operating officer. Mr.
Abbott was a co-founder of, and served as a director of and held various
executive positions with, Walker & Wellington, an investment/commodities
company, from 1986 to 1992.
CHRISTOPHER BANTOFT has served as our president and chief operating officer
and a director since May 1998. From December 1997 to April 1998, Mr. Bantoft
served as executive vice president of ACC Corp., an international
telecommunications company. From October 1996 to April 1998, he served as
president of ACC Telecom Europe, a subsidiary of ACC Corp. Mr. Bantoft served as
the managing director of ACC Telecom United Kingdom, a subsidiary of ACC Corp.,
from January 1994 to December 1997. From October 1991 to December 1993, Mr.
Bantoft served as managing director of Alcatel Business Systems.
82
EDWARD S. SOREN is a co-founder of WORLDxCHANGE, has served as a director
since our inception in May 1991 and as our executive vice president since March
1999. From March 1998 to March 1999, Mr. Soren served as chairman of our board
of directors. From our inception until February 1998, Mr. Soren served as our
president. From 1988 to 1992, Mr. Soren held various executive positions with
Walker & Wellington, an investment/commodities company. From June 1987 to July
1988, Mr. Soren served as president of First Philadelphia Trading Corporation, a
precious metals firm. From September 1980 to July 1983, Mr. Soren served as
director of sales for Monex International, Ltd., one of the largest independent
precious metals firms in the United States.
PATRICK M. AELVOET has served as a senior vice president and our chief
financial officer since May 1999. From March 1998 to April 1999, Mr. Aelvoet
served as our vice president and chief accounting officer. From March 1993 to
March 1998, Mr. Aelvoet served in various capacities at USLD Communications
Corp., most recently as vice president and corporate controller. Prior to
joining USLD Communications Corp. in 1993, Mr. Aelvoet was a senior manager at
KPMG Peat Marwick LLP.
BARBARA H. JAMALEDDIN has served as our senior vice president of network
operations since March 1998. From February 1997 to February 1998, Ms. Jamaleddin
served as our vice president of network support and customer service. From
December 1995 to February 1997, she served as a director of our network control
center. From April 1992 to December 1995, Ms. Jamaleddin acted as the director
of multimedia and strategic services for Sprint. From February 1988 to April
1992, Ms. Jamaleddin served as the director of the national operations control
center for Sprint.
ERIC G. LIPOFF has served as our general counsel since January 1997 and as a
senior vice president and our general counsel since March 1998. Since October
1998, Mr. Lipoff has also served as our secretary. From 1985 to 1996, Mr. Lipoff
was a partner in the law firm of Raring & Lipoff where he specialized in
telecommunications law and investment and business litigation. From our
inception in May 1991 to December 1996, Raring & Lipoff served as our regulatory
counsel. From 1982 to 1985, Mr. Lipoff served as director of compliance for the
Monex group of companies, which included a broker-dealer and futures commission
merchant. Mr. Lipoff previously practiced law with several southern California
law firms.
WILLIAM MOSKOWITZ has served as our senior vice president of management
information systems since June 1999. From June 1996 to June 1999, Mr. Moskowitz
was a director and chief engineer of software development for Xerox corporation.
From June 1995 to June 1996, Mr. Moskowitz served as a senior manager in the
user support and software development department of MCI Telecommunications. Mr.
Moskowitz also served as a software development manager for MCI
Telecommunications from September 1991 to June 1995.
DANN V. ANGELOFF has served as a director since May 1998. Mr. Angeloff
founded the Angeloff Company, a corporate financial advisory firm, in 1976 and
has served as its president since such date. Mr. Angeloff serves as a director
of AremisSoft Corporation, Balboa Capital Corporation, Compensation Resource
Group, Nicholas-Applegate Growth Equity Fund, Public Storage, Inc., Ready Pac
Produce, Inc., Royce Medical Company and topjobs.net plc. He is a former trustee
of the University of Southern California and is a university counselor.
TOM CIRRITO has served as a director since April 1999. Mr. Cirrito is a
general partner of Atocha, L.P., a Texas limited partnership which owns
substantial interests in several public and private telecommunications
companies, including WORLDxCHANGE. He has also served from June 1998 to the
present as chairman of the board of Digital Commerce Corporation, a provider of
commercial and government e-commerce solutions, and from January 1999 to the
present as a director of Paradigm 4 Corporation, a provider of wireless data
solutions. He served from June 1993 until May 1996 as director and president,
consumer division, of Telco Communications Group, and from May 1993 to April
1996 as president and chief executive officer of Long Distance Wholesale Club, a
company that he co-founded.
83
PAUL LAXALT has served as a director since May 1998. Sen. Laxalt founded the
Paul Laxalt Group, a governmental relations firm, in 1990. From 1974 to 1986,
Sen. Laxalt served as a U.S. Senator. Sen. Laxalt served as the Governor of
Nevada from 1967 to 1971 and as Lieutenant Governor of Nevada from 1963 to 1967.
BOARD COMPOSITION
Our board of directors is currently set at seven directors and is divided
into two classes. See "Description of Capital Stock--Anti-Takeover Effects."
Each of our directors serves a two year term and one class is elected each year
by our shareholders, commencing at the annual shareholders' meeting in 2000.
Directors hold office until their terms expire and their successors are elected
and qualified. The terms of the current directors will expire as follows:
Messrs. Angeloff, Bantoft and Laxalt, in 2000; and Messrs. Abbott, Anderson,
Cerrito and Soren, in 2001.
COMMITTEES OF OUR BOARD OF DIRECTORS
The standing committees of our board of directors consist of an audit
committee and a compensation committee. Ad hoc committees of members of our
board of directors may be convened periodically to address specific matters
affecting our company.
AUDIT COMMITTEE
Our audit committee meets periodically with representatives of our auditors,
Ernst & Young LLP, to make inquiries regarding the manner in which their
respective responsibilities are being discharged in relation to each audit of
our financial statements. Our audit committee recommends to our board of
directors the annual appointment of our auditors, with whom the audit committee
reviews the scope of audit and non-audit assignments and related fees, our
accounting principles and the adequacy of our internal controls. Our audit
committee currently is composed of Mr. Angeloff (chairman) and Sen. Laxalt.
COMPENSATION COMMITTEE
Our compensation committee reviews the salaries, bonuses and share ownership
awards for our officers. Our compensation committee currently is composed of
Sen. Laxalt (chairman) and Mr. Angeloff.
DIRECTOR COMPENSATION
Mr. Angeloff and Sen. Laxalt each receive a $20,000 annual retainer, plus
$1,000 for each board or committee meeting they attend in person and $500 for
each such meeting attended by telephone. In addition, the chairman of our audit
committee receives an $8,000 annual retainer, and the chairman of our
compensation committee receives a $4,000 annual retainer. We will also reimburse
our directors for their travel and other expenses incurred in connection with
attending meetings of our board of directors and committees thereof.
In May 1998, we granted each of Mr. Angeloff and Sen. Laxalt options to
purchase 25,000 shares of our common stock, which are fully vested. In January
1999, we granted each of Mr. Angeloff and Sen. Laxalt additional options to
purchase 20,000 shares of our common stock. These options vest at the rate of
one-twelfth per month so long as the optionees continue to serve as directors of
our company. All of the options were granted under our 1996 Stock Option
Plan/Stock Issuance Plan, expire on the 10th anniversary of the date of grant
and have an exercise price of $10.00 per share.
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EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information with respect to
compensation earned by our chief executive officer and the named executive
officers other than the chief executive officer during fiscal 1998.
LONG TERM
COMPENSATION
-------------
AWARDS
-------------
ANNUAL COMPENSATION SECURITIES
-------------------------- UNDERLYING
SALARY($) BONUS($) OPTIONS(#)
------------ ------------ -------------
Roger B. Abbott(1)..................................................... $ 581,391 $ 1,150,009 --
Chief Executive Officer
Edward S. Soren(1)..................................................... 465,104 919,991 --
Executive Vice President
Eric G. Lipoff......................................................... 1,126,919 -- --
Senior Vice President, Secretary and General Counsel
Rosalind Abbott(2)..................................................... 232,559 460,009 --
Ralph Brandifino(3).................................................... 312,000 -- --
- ------------------------
(1) Effective as of October 1, 1998, Messrs. Abbott and Soren agreed to reduce
their total annual compensation for each of the next three years to a
maximum of $600,000 and $200,000, respectively.
(2) Rosalind Abbott, Roger Abbott's spouse, resigned as our secretary and as a
director effective as of October 1, 1998.
(3) Ralph Brandifino resigned as our chief financial officer effective as of May
1999.
FISCAL YEAR-END OPTION VALUES
None of the named executive officers exercised any options during fiscal
1998. The following table sets forth certain information with respect to the
value of the options as of September 30, 1998 held by our named executive
officers.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS(#) FISCAL YEAR END($)(1)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------------------ ------------- ------------- ------------- -------------
Eric G. Lipoff........................................ 138,900 111,120 $ 694,500 $ 555,600
Ralph Brandifino(2)................................... 29,530 64,970 88,590 194,910
- ------------------------
(1) Represents the difference between the estimated fair market value of $10.00
per share as of September 30, 1998 and the exercise prices of the options,
in each case multiplied by the applicable number of shares underlying the
options. The exercise price of all of Mr. Lipoff's options is $5.00 per
share. The exercise price of all of Mr. Brandifino's options were $7.00 per
share.
(2) Mr. Brandifino resigned as our chief financial officer in May 1999. In
connection with his resignation, Mr. Brandifino exercised options to
purchase a total of 50,374 shares of common
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stock, representing all of his vested options to date. Options to purchase
94,126 shares of common stock were cancelled.
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
EMPLOYMENT AGREEMENTS
Mr. Abbott has an employment agreement that provides for a salary of $50,000
per month. Under this agreement, we may terminate Mr. Abbott's employment
without cause, as that term is defined in the agreement, upon 90 days' prior
written notice to Mr. Abbott. If Mr. Abbott is terminated other than for cause
or due to death or disability, Mr. Abbott will be entitled to receive a lump sum
cash payment equal to the amount Mr. Abbott would have earned from the date of
termination through July 31, 2002 plus the cost for Mr. Abbott to obtain the
medical, dental, disability and life insurance plans in effect prior to his
termination.
Mr. Bantoft has an employment agreement providing for a salary of $29,167
per month. Mr. Bantoft is also entitled under the agreement to earn up to
$50,000 in additional compensation during each year of his employment, based
upon our achievement of financial performance levels. Mr. Bantoft received a
living allowance of $3,000 per month for the first six months of his employment
with us. In May 1998, we granted Mr. Bantoft options to purchase 400,000 shares
of common stock under our 1996 Stock Option Plan/Stock Issuance Plan. A total of
125,000 of these options are vested, and the remainder vest at the rate of
25,000 shares per quarter. The options expire on the 10th anniversary of the
date of grant and have an exercise price of $10.00 per share.
Mr. Soren has an employment agreement that may be terminated at any time by
us or by Mr. Soren for any reason. The agreement provides that Mr. Soren's
salary may be changed at any time upon 10 days' prior written notice to Mr.
Soren. Mr. Soren's current salary is $16,666 per month.
Mr. Lipoff has an employment agreement that provides for a salary of $83,333
per month and expires on December 31, 1999. Pursuant to the agreement, we cannot
terminate Mr. Lipoff's employment without cause prior to January 1, 2000. Mr.
Lipoff is also entitled under this agreement to a payment upon a change of
control of our company, generally including a merger or consolidation, or a
complete liquidation of our company. The amount of this payment is equal to the
lesser of 5% of the total consideration received by our shareholders in the
change of control transaction or .7% of the combined gross monthly revenues of
our company and WxL Communications Ltd. in the last full month prior to the
month in which the change of control transaction occurs, multiplied by the
number of months prior to and including December 1999 that the change of control
transaction occurs. Mr. Lipoff is also entitled to a payment if certain of our
assets are sold or if we terminate his employment after this offering. Pursuant
to the agreement, we cannot terminate Mr. Lipoff's employment without cause
prior to January 1, 2001, unless Mr. Lipoff's employment is terminated within 30
days after a change of control transaction, as defined above, or the closing of
this offering.
STOCK OPTION PLANS
1999 STOCK OPTION PLAN/STOCK ISSUANCE PLAN
In July 1999, we adopted the Communication TeleSystems International 1999
Stock Option Plan/ Stock Issuance Plan to provide an additional means to
attract, motivate, reward and retain key personnel. The plan gives the
administrator the authority to grant different types of stock and cash incentive
awards and to select participants. While only stock options are contemplated at
this time, the other forms of awards that may be granted give us flexibility to
structure future incentives. Our employees, officers, directors, and
consultants, and those of our subsidiaries, may be selected to receive awards
under the plan. The following summary is qualified by reference to the complete
plan, which has been filed as an exhibit to the registration statement of which
this prospectus is a part.
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SHARE LIMITS. A maximum of 4,000,000 shares of our common stock may be
issued under the plan, or approximately % of our outstanding shares after
giving effect to the public offering. The aggregate number of shares subject to
stock options and stock appreciation rights granted under the plan to any one
person in a calendar year can not exceed 600,000 shares. The aggregate number of
shares subject to all awards granted under the plan to any one person in a
calendar year can not exceed 600,000 shares. Performance-based awards payable
solely in cash that are granted under the plan to any one person in a calendar
year can not provide for payment of more than $1,000,000.
Each share limit and award under the plan is subject to adjustment for
certain changes in our capital structure, reorganizations and other
extraordinary events. Shares subject to awards that are not paid or exercised
before they expire or are terminated are available for future grants under the
plan.
AWARDS. Awards under the plan may be in the form of nonqualified stock
options, incentive stock options, stock appreciation rights, limited stock
appreciation rights (these are stock appreciation rights limited to specific
events, such as in a change in control or other special circumstances),
restricted stock, performance shares, stock units, stock bonuses, or cash
bonuses based on performance. Awards may be granted individually or in
combination with other awards. Any cash bonuses and certain types of stock-based
performance awards under the plan will depend upon the extent to which
performance goals set by the administrator are met during the performance
period.
Awards under the plan generally will be nontransferable, subject to such
exceptions (such as a transfer to a family member or to a trust) as may be
authorized by the administrator.
Nonqualified stock options and other awards may be granted at prices below
the fair market value of the common stock on the date of grant. Restricted stock
awards can be issued for nominal or the minimum lawful consideration. Incentive
stock options must have an exercise price that is at least equal to the fair
market value of the common stock (110% of fair market value of the common stock
for holders of 10% of our common stock) on the date of grant. These and other
awards may also be issued solely or in part for services.
ADMINISTRATION. The plan will be administered by our board of directors or
a committee of directors appointed by the board. Currently, our board has
delegated general administrative authority over the plan to the compensation
committee.
The administrator of the plan has broad authority to:
- designate recipients of awards;
- determine or modify, subject to any required consent, the terms and
provisions of awards, including the price, vesting provisions, terms of
exercise and expiration dates;
- approve the form of award agreements;
- determine specific objectives and performance criteria with respect to
performance awards;
- construe and interpret the plan; and
- reprice, accelerate and extend the exercisability or term, and establish
the events of termination or reversion of outstanding awards.
CHANGE IN CONTROL. Upon a change in control event, the administrator may
provide that each option and stock appreciation right will become immediately
exercisable, restricted stock will immediately vest free of restrictions, and
the number of shares, cash or other property covered by each performance award
will be issued to the holder of the award. Generally speaking, a change in
control event will be triggered under the plan:
- upon dissolution or liquidation;
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- upon the sale of all or substantially all of our assets to an entity that
is not an affiliate;
- in connection with certain mergers or consolidations of our company into
or with another entity where our shareholders before the transaction own
less than 50% of the surviving entity; or
- if a change in ownership of more than 50% of our outstanding common stock
occurs.
The administrator of the plan may also provide for alternative settlements
(including cash payments) of awards, the assumption or substitution of awards,
or other adjustments of awards, in connection with a change in control or other
reorganization of our company.
PLAN AMENDMENT, TERMINATION AND TERM. Our board of directors may amend,
suspend or discontinue the plan at any time, but no such action will affect any
outstanding award in any manner materially adverse to a participant without the
consent of the participant. Plan amendments will generally not be submitted to
shareholders for their approval unless such approval is required by applicable
law.
The plan will remain in existence as to all outstanding awards until such
awards are exercised or terminated. The maximum term of options, stock
appreciation rights and other rights to acquire common stock under the plan is
10 years after the initial date of award, subject to provisions for further
deferred payment in certain circumstances. No award can be granted after July
29, 2009.
PAYMENT FOR SHARES. The exercise price of options or other awards may
generally be paid in cash or, subject to certain restrictions, shares of our
common stock or a note satisfying the requirements of the plan. Subject to any
applicable limits, we may finance or offset shares to cover any minimum
withholding taxes due in connection with an award.
FEDERAL TAX CONSEQUENCES. The current federal income tax consequences of
awards authorized under the plan follow certain basic patterns. Generally,
awards under the plan that are includable in the income of the recipient at the
time of exercise, vesting or payment (such as nonqualified stock options, stock
appreciation rights, restricted stock and performance awards), are deductible by
us, and awards that are not required to be included in the income of the
recipient (such as incentive stock options) are not deductible by us.
Generally speaking, Section 162(m) of the Internal Revenue Code provides
that a public company may not deduct compensation (except for certain
compensation that is commission or performance-based) paid to its chief
executive officer or to any of its four other highest compensated officers to
the extent that the compensation paid to such person exceeds $1,000,000 in a tax
year. The regulations exclude from these limits compensation that is paid
pursuant to a plan in effect prior to the time that a company is publicly held.
We expect that compensation paid under the plan will not be subject to Section
162(m) in reliance on this transition rule, as long as such compensation is paid
(or stock options, stock appreciation rights, and/or restricted stock awards are
granted) before the earlier of a material amendment to the plan or the annual
shareholders meeting in the year 2003.
In addition, we may not be able to deduct certain compensation attributable
to the acceleration of payment and/or vesting of awards in connection with a
change in control event should that compensation exceed certain threshold limits
under Section 280G of the Internal Revenue Code.
NON-EXCLUSIVE PLAN. The 1999 Stock Option Plan/Stock Issuance Plan is not
exclusive. Our board of directors (or its delegate), under California law, may
grant stock and performance incentives or other compensation, in stock or cash,
under other plans or authority.
CERTAIN SPECIFIC AWARDS. As of August 16, 1999, options to purchase 14,000
shares of our common stock had been granted under the 1999 Stock Option
Plan/Stock Issuance Plan, and 3,986,000 shares reserved under the plan remain
available for grant purposes.
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THE 1996 PLAN
We also maintain the Communication TeleSystems International 1996 Stock
Option Plan/Stock Issuance Plan. As of August 16, 1999, approximately 2,465,626
shares are covered by currently outstanding options granted under the 1996 plan.
These options were granted for 10-year terms and at exercise prices between
$5.00 and $11.00 per share. Our board of directors or a committee appointed by
the board has the authority to administer such options, and the vesting of such
options may be accelerated in connection with a change in control event on terms
similar to those described above with respect to the 1999 plan. Future awards
will be granted under the 1999 plan and we do not intend to grant new awards
under the 1996 plan.
OTHER MATTERS
In 1981, Mr. Abbott, then 23, was charged and in 1983 subsequently convicted
in California of conspiracy to traffic narcotics.
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of our common stock as of June 30, 1999 by the following persons both
immediately prior to and immediately after giving effect to the offering:
- each person who is known by us to own beneficially 5% or more of the
outstanding shares of our common stock;
- each of our directors;
- each of our officers named in the executive compensation table above; and
- all of our directors and executive officers as a group.
Except as indicated in the footnotes to the table, the persons named in the
table have sole voting and investment power with respect to all shares of our
common stock shown as beneficially owned by them, subject to community property
laws where applicable, and are located at our principal offices at 9999 Willow
Creek Road, San Diego, California 92131.
Shares of common stock subject to options or warrants exercisable, or
securities convertible, within 60 days of June 30, 1999 are deemed outstanding
for the purpose of computing the percentage ownership of the person holding
those options, warrants or securities, but are not deemed outstanding for
computing the percentage ownership of any other person.
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING AFTER OFFERING
---------------------- ----------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT(1) NUMBER PERCENT(1)
- -------------------------------------------------- --------- ----------- --------- -----------
Roger B. Abbott(2)(3)............................. 15,214,857 41.2% 15,214,857 %
Edward S. Soren(3)................................ 7,331,812 19.8% 7,331,812 %
Gold & Appel Transfer, S.A.(4).................... 4,525,043 12.2% 4,525,043 %
Atocha, L.P.(5)................................... 3,833,672 10.4% 3,833,672 %
Eric G. Lipoff(6)................................. 243,095 * 243,095 *
Christopher Bantoft(7)............................ 125,000 * 125,000 *
Ralph Brandifino.................................. 50,374 * 50,374 *
Dann V. Angeloff(7)............................... 36,667 * 36,667 *
Paul Laxalt(7).................................... 36,667 * 36,667 *
All directors and executive officers as a group
(11 persons)(2)(3)(4)(5)(6)(7).................. 30,385,082 81.2% 30,385,082 %
- ------------------------
* Less than 1%.
(1) Percentage calculation is based upon 36,965,871 shares outstanding (
shares following the offering). The outstanding shares totals give effect to
our issuance of a total of 1,554,763 shares of our common stock in
connection with our acquisition of minority interests in certain
subsidiaries. See "Acquisition of Minority Interests in Subsidiaries."
(2) All shares, other than (i) 1,000,000 shares as to which Mr. Abbott, our
chief executive officer and a director, has sole voting power pursuant to a
voting trust agreement with Mr. Soren (see note 3 below), (ii) 81,176 shares
that are held directly by Mr. Abbott, and (iii) 81,176 shares that are held
directly by Mr. Abbott's spouse, Rosalind Abbott, are jointly held by Mr.
Abbott and Ms. Abbott as community property. Mr. Abbott and Ms. Abbott have
granted the underwriters an option to purchase up to shares of their
common stock pursuant to the underwriters' over-allotment option. Assuming
such option is exercised in full, Mr. Abbott will beneficially own
shares, or approximately %, of our common stock upon consummation of the
offering.
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(3) Includes 1,000,000 shares of common stock as to which Mr. Abbott has sole
voting power and Mr. Soren has sole investment power pursuant to the terms
of a voting trust agreement between Mr. Abbott and Mr. Soren. Mr. Soren has
granted the underwriters an option to purchase up to shares of his
common stock pursuant to the underwriters' over-allotment option. Assuming
such option is exercised in full, Mr. Soren will beneficially own
shares, or approximately %, of our common stock upon consummation of the
offering.
(4) Includes 20,000 shares issuable upon the exercise of a warrant held by Gold
& Appel Transfer, S.A. Under a power of attorney from Gold & Appel Transfer,
S.A., Walt Anderson, the chairman of our board of directors, has sole
investment power over these shares and as a result may be deemed to be the
beneficial owner of such shares. Mr. Anderson, however, disclaims beneficial
ownership of these shares. Does not include a total of 2,727,270 shares of
common stock issuable upon conversion of the Series A Convertible Preferred
Stock held by Gold & Appel Transfer, S.A. If such shares of Series A
Convertible Preferred Stock were to be fully converted, Gold & Appel
Transfer, S.A. will beneficially own 7,252,313 shares, or approximately
%, of our common stock upon consummation of the offering. The address for
each of Gold & Appel Transfer, S.A. and Walt Anderson is c/o Gold & Appel
Transfer, S.A., Omar Hodge Building, Wickhams Cay, Road Town, Tortula,
British Virgin Islands.
(5) Tom Cirrito, one of our directors, is a general partner of Atocha, L.P., and
as a result may be deemed to have beneficial ownership of these shares. The
address for each of Atocha, L.P. and Tom Cirrito is c/o Atocha, L.P., 6429
Georgetown Pike, McLean, Virginia 22101.
(6) Includes a total of 215,295 shares issuable pursuant to options that were
exercisable as of June 30, 1999 or within 60 days of such date.
(7) Represents shares issuable pursuant to options that were exercisable as of
June 30, 1999 or within 60 days of that date.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH FORMER CORPORATE AFFILIATES
During the periods indicated below, we engaged in the transactions described
below with corporate affiliates. We believe that all of these transactions were
on terms at least as favorable to us as would be available from independent
third parties. We have acquired the entities described below or otherwise
terminated the transactions with these former corporate affiliates. As the
mergers with CTS Telcom, Inc. and WORLDxCHANGE Ltd. were mergers with entities
under common control, our historical consolidated financial statements include
the operations of CTS Telcom, Inc. and WORLDxCHANGE Ltd. since their respective
inceptions. The transactions described below as they relate to CTS Telcom, Inc.
and WORLDxCHANGE Limited are netted out in our consolidated financial
statements.
CTS TELCOM, INC.
Effective December 1, 1998, CTS Telcom Holdings, Inc., a Delaware
corporation and our wholly owned subsidiary, acquired for no consideration, all
of the outstanding capital stock of CTS Telcom, Inc., a Florida corporation,
from Edward Soren, a director and our executive vice president, and Rosalind
Abbott, a former officer and director of our company. As a result of this
transaction, CTS Telcom, Inc. is now a wholly-owned subsidiary of our company.
Prior to December 1, 1998, Mr. Soren owned 38% and Ms. Abbott owned 62% of
the outstanding capital stock of CTS Telcom, Inc. CTS Telcom, Inc. provided
intrastate and domestic and international long distance services to consumers in
Florida. Prior to December 1, 1998, CTS Telcom, Inc. arranged for the
termination of a portion of our calling traffic and performed certain billing
and collection services for us, for which we were billed as follows:
- $2,003,000 during fiscal 1996;
- $4,277,000 during fiscal 1997;
- $3,168,000 during fiscal 1998; and
- $566,000 during the first two months of fiscal 1999.
We also provided certain billing, collection, accounting and administrative
services and arranged for the termination of call traffic for CTS Telcom, Inc.
We billed CTS Telcom, Inc. for these services as follows:
- $9,949,000 during fiscal 1996;
- $10,729,000 during fiscal 1997;
- $11,372,000 during fiscal 1998; and
- $1,423,000 during the first two months of fiscal 1999.
WORLDxCHANGE LIMITED
Effective December 31, 1998, WxL International-New Zealand, Inc., a Delaware
corporation and our wholly-owned subsidiary, acquired all of the outstanding
capital stock of WORLDxCHANGE Limited, a New Zealand corporation, in exchange
for the issuance of 81,176 shares of our common stock to each of Roger Abbott
and Rosalind Abbott, 80,898 shares to Edward Soren, 27,800 shares to Eric Lipoff
(our senior vice president, secretary and general counsel) and 6,950 shares to
Richard Vincent (one of our employees). As a result of this transaction,
WORLDxCHANGE Limited is now an indirect wholly-owned subsidiary of our company.
Prior to December 31, 1998, Mr. Abbott and Ms. Abbott owned approximately
55%, Mr. Soren owned approximately 29%, and Mr. Lipoff owned approximately 10%
of WORLDxCHANGE Limited.
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WORLDxCHANGE Limited arranged for the termination of a portion of our calling
traffic through capacity purchased by WORLDxCHANGE Limited from, among other
sources, certain corporations that are wholly-owned by Raeline Scott, the
fiancee of Mr. Soren. In connection with these arrangements, we were billed as
follows:
- $4,529,000 during fiscal 1996;
- $15,745,000 during fiscal 1997;
- $17,394,000 during fiscal 1998; and
- $2,669,000 during the first three months of fiscal 1999.
We also arranged for the termination of call traffic for WORLDxCHANGE
Limited and billed WORLDxCHANGE Limited as follows:
- $0 during fiscal 1996;
- $85,000 during fiscal 1997;
- $1,115,000 during fiscal 1998; and
- $311,000 during the first three months of fiscal 1999.
WORLDxCHANGE DE MEXICO S.A. DE C.V.
Holly Mead, one of our former employees and the sister of Roger Abbott, and
her husband collectively owned 100% of WORLDxCHANGE de Mexico S.A. de C.V., a
corporation organized under Mexican law. We incurred commission expense of
approximately $507,000 during fiscal 1997 to agents and third parties based upon
contracts between WORLDxCHANGE de Mexico and these agents. These commissions
were paid as a result of operator service traffic delivered to us pursuant to
contracts between WORLDxCHANGE de Mexico and these agents. We did not incur any
commission expense in fiscal 1996 or fiscal 1998. As of March 23, 1998,
WORLDxCHANGE de Mexico assigned all rights and interests in these agent
contracts to us for no consideration, and we are not conducting any further
business with WORLDxCHANGE de Mexico.
TRANSACTIONS WITH CERTAIN SHAREHOLDERS
ATOCHA, L.P.
On September 30, 1998, Atocha, L.P., a limited partnership in which Tom
Cirrito, one of our directors, is a general partner, purchased:
- 553,115 shares of our common stock from Roger Abbott and Rosalind Abbott
for $6,666,667; and
- 276,557 shares of our common stock from Edward Soren for $3,333,333.
On March 22, 1999, we issued 3,000,000 shares of common stock to Atocha,
L.P. for $30,000,000.
GOLD & APPEL TRANSFER, S.A.
On September 30, 1998, we issued 788,127 shares of common stock to Gold &
Appel Transfer, S.A. for $10,000,000. Walt Anderson, the chairman of our board
of directors, has sole investment power over the shares of our common stock
owned by Gold & Appel Transfer, S.A. pursuant to a power of attorney. Effective
December 22, 1998, we issued an additional 871,087 shares of our common stock to
Gold & Appel Transfer, S.A. for $10,000,000. As an inducement to Gold & Appel
Transfer, S.A. to complete the acquisition of the additional 871,087 shares
prior to the scheduled closing of that acquisition, we issued Gold & Appel
Transfer, S.A. a warrant to purchase up to an additional 20,000 shares of our
common stock. See "Description of Capital Stock--Preferred Stock--Warrants."
93
On June 25, 1999, we issued 2,727,270 shares of common stock to Gold & Appel
Transfer, S.A. for $30,000,000. Pursuant to a power of attorney, Walt Anderson,
the chairman of our board of directors, has sole investment power over the
shares of our common stock owned by Gold & Appel Transfer, S.A.
On August 16, 1999, we entered into an agreement to issue 30,000 shares of
our Series A Convertible Preferred Stock to Gold & Appel Transfer, S.A. for
$30,000,000. Each share of Series A Convertible Preferred Stock is convertible
into 90.9091 shares of our common stock provided in the Certificate of
Determination relating to such shares of Series A Convertible Preferred Stock.
See "--Description of Capital Stock--Preferred Stock--Series A Convertible
Preferred Stock."
SEVERANCE AGREEMENT WITH HOLLY MEAD
Holly Mead resigned as a vice president effective July 31, 1998. In
connection with her resignation, we entered into a severance agreement with Ms.
Mead under which Ms. Mead will receive a total of $574,750 in severance benefits
over a period of 18 months from the effective date of her resignation. Under the
severance agreement, all options granted to Ms. Mead that were not vested were
terminated. Ms. Mead exercised all of the options granted to her that had
vested. Ms. Mead paid the exercise price for these options through a
full-recourse promissory note in favor of WORLDxCHANGE in the aggregate
principal amount of $309,000. The note accrues interest at a rate of 12% per
annum and is due and payable on September 30, 2001.
PAYMENTS TO THE PAUL LAXALT GROUP
Since the third quarter of fiscal 1997, we have utilized the services of the
Paul Laxalt Group, a governmental relations firm of which Sen. Laxalt, one of
our directors, is the founding member. We paid the Paul Laxalt Group a total of
$130,000 in fiscal 1997 and $78,000 in fiscal 1998 for these services. We have
not utilized these services in fiscal 1999.
PAYMENTS TO RARING & LIPOFF
From our inception in May 1991 to December 1996, Raring & Lipoff, a law firm
in which Eric Lipoff, our senior vice president, secretary and general counsel,
was formerly a partner, served as our regulatory counsel. We paid Raring &
Lipoff a total of approximately $617,000 in fiscal 1996 and $224,000 in fiscal
1997 for services provided by Raring & Lipoff to us prior to Mr. Lipoff joining
our company on January 1, 1997.
CERTAIN INDEBTEDNESS OF MANAGEMENT
From time to time since the fourth quarter of fiscal 1994, Roger Abbott and
Rosalind Abbott have jointly borrowed various amounts from us. Since October 1,
1995, the largest aggregate amount outstanding on these loans was $231,907.
These loans bore interest at the rate of 8% per annum and were repaid on
September 30, 1998.
Edward Soren has also borrowed various amounts from us from time to time
since the fourth quarter of 1994. Since October 1, 1995, the largest aggregate
amount outstanding on these loans was $142,723. These loans bore interest at the
rate of 8% per annum and were repaid on September 30, 1998.
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CERTAIN INDEBTEDNESS
OUR CREDIT FACILITY
In March 1997, we and certain of our subsidiaries entered into a credit
facility with Foothill Capital Corporation. Our credit facility extends through
October 31, 2000, until which time we can borrow up to a maximum of $35 million,
subject to borrowing base limitations. Our credit facility consists of a
revolving credit agreement and a term loan and is guaranteed by three of our
shareholders. The available borrowing base under the revolving credit agreement
is determined as a specified percentage of eligible accounts receivable. The
balance outstanding on the revolving credit agreement is reduced by the amount
of payments received on collections of accounts receivable. As of June 30, 1999,
the aggregate amount outstanding under our credit facility was $26.5 million.
Loans under our credit facility accrue interest at an interest rate equal to
prime (8.5% at June 30, 1999) plus a margin of 2.75% on the revolving credit
portion and a margin of 6.75% on the term loan, provided that each of the
interest rates must at all times be at least 8.00%. Our obligations under the
credit facility are secured by a first position in substantially all of our
property.
Our credit facility prohibits us, with some exceptions, from:
- incurring additional debt or guaranteeing additional debt;
- creating or incurring liens on our property and that of certain of our
subsidiaries;
- entering into transactions out of the ordinary course of business;
- making any distribution, declaring or paying any dividend or making any
redemption of capital stock, directly or indirectly;
- entering into transactions resulting in a change of control of our
company;
- making capital expenditures or advances to our foreign subsidiaries beyond
specified limits;
- making certain investments; and
- permitting our tangible net worth to fall below specified levels.
THE TEL-SAVE NOTES
From May 1998 through August 1998, we obtained financing from Tel-Save
Holdings, Inc., in the aggregate amount of $56.2 million. The Tel-Save debt
bears interest at the rate of 12.50% per annum, requires quarterly payments of
interest only and matures on November 30, 2000. Tel-Save Holdings, Inc. has the
right to require us to use an amount equal to 35% of the net proceeds from any
sale of our common stock to prepay the Tel-Save debt. In connection with various
sales of our common stock to Gold & Appel Transfer, S.A. and Atocha, L.P., we
reduced the principal on the Tel-Save debt by a total of $11 million.
The term of the Tel-Save debt will be extended by one year if we make
additional aggregate principal payments of at least $12.25 million, and by two
years if we make additional aggregate payments of principal of at least $21
million. Tel-Save Holdings, Inc. has assigned all of its interest in the
Tel-Save debt to a third party.
As of June 30, 1999, the aggregate amount outstanding under the Tel-Save
debt was $45.2 million. Our obligations under the Tel-Save debt are secured by
(i) a junior lien on substantially all of our assets, and (ii) a pledge by three
of our shareholders of certain of their shares of our common stock.
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DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 100,000,000 shares of common stock,
no par value, and 10,000,000 shares of preferred stock, no par value, which can
be issued in one or more series. Immediately following completion of this
offering and assuming no exercise of outstanding stock options, an aggregate of
shares of our common stock will be issued and outstanding and 30,000
shares of our Series A Convertible Preferred Stock will be issued and
outstanding. As of June 30, 1999, our common stock was held of record by 90
persons and, when issued, our Series A Convertible Preferred Stock will be held
by one holder of record.
COMMON STOCK
Holders of our common stock are entitled to one vote per share on all
matters submitted to a vote of shareholders. Subject to the rights of the
holders of any outstanding preferred stock, holders of our common stock are
entitled to receive ratably any dividends that may be legally declared by our
board of directors and, in the event of liquidation, dissolution or winding up
of our company, to share ratably in all assets remaining after payment of
liabilities. Holders of our common stock have no preemptive, subscription,
redemption or conversion rights. All of our outstanding shares of common stock
are, and all shares of our common stock to be outstanding upon completion of
this offering will be, fully paid and nonassessable.
PREFERRED STOCK
Our board of directors has the authority to issue up to 10,000,000 shares of
preferred stock in one or more series and to fix the powers, designations,
preferences and relative, participating, optional or other rights thereof,
including dividend rights, conversion rights, voting rights, redemption terms,
liquidation preferences and the number of shares constituting each such series,
without any further vote or action by our shareholders. The issuance of
preferred stock could adversely affect the rights of holders of common stock.
The issuance of preferred stock in certain circumstances may have the effect of
delaying, deterring or preventing a change in control of our company, may
discourage bids for our common stock at a premium over the market price of our
common stock and may adversely affect the market price of, and the voting and
other rights of the holders of, our common stock.
SERIES A CONVERTIBLE PREFERRED STOCK
DIVIDENDS. The holders of shares of Series A Convertible Preferred Stock
are entitled to receive, when, as and if declared by our board of directors,
annual dividends equal to $40 per share. If we fail to make a dividend payment,
we are required to pay an additional dividend of 4% per annum on the unpaid
amount.
CONVERTIBILITY. Each share of Series A Convertible Preferred Stock is
convertible into 90.9091 shares of our common stock as described below. The
conversion rate is subject to certain antidilution adjustments that may be
triggered if we:
- effect any stock splits or reverse stock splits of common stock;
- reclassify our common stock into any other security or securities of our
company; or
- make or issue a dividend or other distribution with respect to our common
stock that is payable in securities, properties (other than cash) or
rights of our company other than our common stock.
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AUTOMATIC CONVERSION. Each share of Series A Convertible Preferred Stock
will be automatically converted into shares of our common stock at the
conversion rate specified above on the first date on or by which:
- we have completed a registered public offering of our securities;
- at least six months have elapsed since we have completed a registered
public offering of our securities; and
- there is no pending registered public offering by us of our securities.
VOTING RIGHTS. Except as provided by law holders of Series A Convertible
Preferred Stock will not have any voting rights. Under California law, holders
of the Series A Convertible Preferred Stock will have an effective veto right
over certain mergers and like transactions involving us. Upon conversion of any
shares of Series A Convertible Preferred Stock into shares of common stock the
holders of such converted shares will have the voting rights applicable to the
shares of common stock into which such shares are converted.
LIQUIDATION PREFERENCE. If we are voluntarily or involuntarily liquidated
or dissolved or our affairs wound up, holders of our Series A Convertible
Preferred Stock will be entitled to receive out of our assets available for
distribution to shareholders an amount equal to $1,000 per share, plus any
accrued and unpaid dividends on such shares, before any distribution is made to
the holders of our common stock.
WARRANTS
We have issued to Gold & Appel Transfer, S.A. a warrant to purchase 20,000
shares of our common stock at an exercise price of $12.05 per share. This
warrant became exercisable upon issuance and will remain exercisable until
December 15, 2001. We will also issue to Gerard Klauer Mattison & Co., Inc. upon
the closing of this offering a warrant to purchase shares of our common stock
at an exercise price of $ per share. This warrant will become exercisable
beginning on the second anniversary of the closing date of this offering and
will expire five years from the closing date of the offering. In the event of a
change of control of our company, the warrant will become immediately
exercisable. Under the terms of this warrant, a change of control is deemed to
occur if more than 50% of our common stock is transferred to persons or entities
other than our principal shareholders as of the date of issuance of the warrant,
or their affiliates. We have granted to Gerard Klauer Mattison & Co., Inc.
registration rights with respect to the shares underlying their warrant. See
"--Registration Rights."
ANTI-TAKEOVER PROVISIONS
The provisions of our articles of incorporation and bylaws summarized below
may have the effect of delaying, deterring or preventing a change in control of
our company, may discourage bids for our common stock at a premium over the
market price of our common stock and may adversely affect the market price of,
and the voting and other rights of the holders of, our common stock.
Our articles of incorporation authorize issuance of up to 10,000,000 shares
of preferred stock, with such characteristics that may tend to discourage a
merger, tender offer or proxy contest, as described in "--Preferred Stock"
above. Our bylaws also limit the ability of shareholders to raise certain
matters at a meeting of shareholders without giving advance notice. In addition,
so long as we are a "listed corporation" as defined in Section 301.5(d) of the
California Corporations Code:
- cumulative voting will be eliminated;
97
- as long as the size of our board of directors is at least six but less
than nine directors, our board of directors will be divided into two
classes of directors with each class serving staggered two-year terms;
- and, if the number of directors is increased to nine or more, our board of
directors will be divided into three classes serving staggered three-year
terms.
Our articles of incorporation also provide that the provisions in our
articles of incorporation relating to the classification of our board of
directors and the prohibition on cumulative voting cannot be amended without the
approval of shareholders representing at least 66 2/3% of our outstanding common
stock.
REGISTRATION RIGHTS
We have granted registration rights with respect to our common stock as
described below:
- We have granted substantially similar piggyback and demand registration
rights to each of Gold & Appel Transfer, S.A., Atocha, L.P., TVG Asian
Communications Fund, Gerard Klauer Mattison & Co., Inc. and Roger Abbott.
The holders of these rights may in their discretion require us to include
their shares of our common stock in future registration statements filed
by us. In addition, the holders of these rights may require us to file a
registration statement with respect to the resale of these shares one time
beginning two years after the date of the applicable registration rights
agreements. These registration rights cover a total of 23,881,013 shares
of our common stock held by these shareholders and an additional
shares issuable upon exercise of the warrant to be issued to Gerard Klauer
Mattison & Co., Inc. in connection with this offering.
- We have also granted demand registration rights to Gold & Appel Transfer,
S.A. with respect to a total of 2,727,270 shares of our common stock
issuable upon the conversion of the 30,000 shares of our Series A
Convertible Preferred Stock sold to Gold & Appel Transfer, S.A. in August
1999. These rights are substantially similar to the registration rights
granted to Gold & Appel Transfer, S.A. as described above.
The piggyback registration rights described above terminate when the holder
of the registration rights is able to resell the underlying shares of common
stock under Rule 144 of the Securities Act within a six month period.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar of our common stock is U.S. Stock Transfer
Corporation.
REPORTS TO SHAREHOLDERS
We will furnish our shareholders with annual reports containing financial
statements audited by our independent accountants and quarterly reports for the
first three quarters of each year containing unaudited financial statements.
98
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock, and
we cannot assure you that a significant public market for our common stock will
develop or be sustained after this offering.
Upon completion of this offering, we will have outstanding shares of
common stock, assuming no exercise of outstanding options and warrants and
assuming our issuance of a total of 1,554,763 shares of our common stock in
connection with the planned acquisition of minority interests in certain
subsidiaries and the issuance of 2,727,270 shares of our common stock upon the
conversion of our Series A Convertible Preferred Stock. See "Acquisition of
Minority Interests in Subsidiaries" and "Description of Capital Stock--Preferred
Stock--Series A Convertible Preferred Stock." Of these shares, all of the shares
sold in this offering will be freely tradable without restriction under the
Securities Act unless purchased by our affiliates.
The remaining 39,693,144 shares of our common stock held (or to be held) by
existing shareholders are, or will be upon issuance, restricted securities.
Restricted securities may be sold in the public market only if registered or if
they qualify for an exemption from registration described below under Rules 144,
144(k) or 701 promulgated under the Securities Act.
As a result of the lock-up agreements and the provisions of Rules 144,
144(k) and 701 described below, these restricted shares will be available for
sale in the public market as follows:
- 5,262,175 shares will have been held long enough to be sold under Rule
144(k) immediately after this offering and will not be subject to a
lock-up agreement;
- an additional 235,749 shares will have been held long enough to be sold
under Rule 144 or Rule 701 beginning 90 days after the date of this
prospectus and will not be subject to a lock-up agreement;
- an additional 27,185,914 shares will have been held long enough to be sold
under Rule 144 or Rule 701 beginning 181 days after the date of this
prospectus; and
- the remaining 7,009,306 outstanding shares may be sold under Rule 144 or
144(k) after they have been held for the required time.
LOCK-UP AGREEMENTS
We and our directors, officers and certain shareholders have agreed that we
will not offer, sell, contract to sell, announce our intention to sell, pledge
or otherwise dispose of, directly or indirectly, any shares of our common stock
or securities convertible into or exchangeable or exercisable for any shares of
common stock, without the prior written consent of the representatives of the
underwriters for a period of 180 days after the date of this prospectus.
RULE 144
In general, under Rule 144, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- 1% of the number of shares of our common stock then outstanding, which
will equal approximately shares immediately after this offering,
assuming that the total outstanding shares will be increased by the
issuance of 2,727,270 shares of common stock upon conversion of the Series
A Convertible Preferred Stock; or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to the sale.
99
Sales under Rule 144 are also subject to manner-of-sale provisions and
notice requirements and to the availability of current public information about
us.
RULE 144(k)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144 discussed above.
RULE 701
In general, under Rule 701, any of our employees, consultants or advisors
who purchases or receives shares from us in connection with a compensatory stock
purchase plan or option plan or other written agreement will be eligible to
resell their shares beginning 90 days after the date of this prospectus.
Non-affiliates will be able to sell their shares subject only to the
manner-of-sale provisions of Rule 144. Affiliates will be able to sell their
shares without compliance with the holding period requirements of Rule 144.
REGISTRATION RIGHTS
Upon completion of this offering, the holders of a total of 23,881,013
shares of our common stock, a holder of a warrant exercisable into up to
shares of our common stock and the holder(s) of the 2,727,270 shares of our
common stock issuable upon the conversion of the 30,000 shares of our Series A
Convertible Preferred Stock will be entitled to rights with respect to the
registration of their shares under the Securities Act. See "Description of
Capital Stock--Registration Rights." Except for shares purchased by affiliates,
registration of their shares under the Securities Act would result in such
shares becoming freely tradable without restriction under the Securities Act
immediately upon the effectiveness of the registration.
STOCK OPTIONS
Immediately after this offering, we intend to file registration statements
under the Securities Act covering the shares of common stock reserved for
issuance upon the exercise of options granted or to be granted under our stock
option plans and upon the exercise of options which have been granted outside of
our stock option plans. The registration statement is expected to be filed and
become effective as soon as practicable after the closing of this offering.
Accordingly, shares registered under the registration statement will, subject to
Rule 144 volume limitations applicable to affiliates, be available for sale in
the open market beginning on the date the registration statement covering these
shares becomes effective.
We are unable to estimate the number of shares that may be sold in the
future by our existing shareholders. Sales of substantial amounts of our common
stock in the public market could adversely affect the prevailing market price
and our ability to raise equity capital in the future.
100
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Gerard Klauer Mattison & Co., Inc. and are acting as representatives,
have severally, but not jointly, agreed to purchase from us the following
respective number of shares of common stock:
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
Gerard Klauer Mattison & Co., Inc..........................................
............................................
-----------------
-----------------
-----------------
The underwriting agreement provides that the obligations of the underwriters
are subject to some conditions precedent, and that the underwriters will be
obligated to purchase all of the shares of common stock offered in this
prospectus, other than those shares covered by the over-allotment option
described below, if any are taken. The underwriting agreement provides that in
the event of a default by an underwriter, in some circumstances the purchase
commitments of non-defaulting underwriters may be increased.
The underwriters propose to offer the shares of common stock to the public
initially at the public offering price set forth on the cover page of this
prospectus and to some dealers at a price that represents a concession not in
excess of $ per share. After the initial offering of the shares of
common stock, the offering price and concession and discount to dealers may be
changed by the representatives of the underwriters.
Roger Abbott and Edward Soren have granted to the underwriters an option
exercisable by the representatives of the underwriters, expiring at the close of
business on the 45th day after the date of this prospectus, to purchase up to
additional shares of common stock at the offering price, less underwriting
discounts. This option may be exercised only to cover over-allotments in the
sale of the shares of common stock. To the extent that the option is exercised,
each underwriter will become obligated, subject to certain conditions, to
purchase a number of additional shares of the common stock proportionate to each
underwriter's initial amount reflected in the foregoing table.
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares of
common stock offered by them.
The following table summarizes the compensation we will pay:
TOTAL
------------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
----------- -------------- --------------
Underwriting discounts paid by us......................................
Our expenses in connection with this offering are estimated to be
approximately $ .
In connection with the offering, we have granted to Gerard Klauer Mattison &
Co., Inc. a warrant to purchase shares of common stock at an exercise
price equal to the greater of 1.44 times our annualized revenues based on the
last three months prior to the closing of this offering or 120% of the offering
price to the public. The warrant will become exercisable two years after the
offering and will
101
expire five years after the offering. The warrant will also have registration
rights with respect to the common stock issuable upon the exercise of the
warrant, exercisable by the holder beginning two years after the offering.
We, our directors, executive officers and some of our shareholders have
agreed that we will not offer, sell, contract to sell, announce our intention to
sell, pledge or otherwise dispose of, directly or indirectly, any shares of our
common stock or securities convertible into or exchangeable or exercisable for
any shares of common stock, without the prior written consent of the
representatives of the underwriters for a period of 180 days after the date of
this prospectus.
The representatives of the underwriters on behalf of the underwriters may
engage in over-allotment, stabilizing transactions, syndicate covering
transactions, penalty bids and "passive" market making in accordance with
Regulation M under the Securities Exchange Act of 1934. Over-allotment involves
syndicate sales in excess of the offering size, which creates a syndicate short
position. Stabilizing transactions permit bids to purchase the underlying
security so long as the stabilizing bids do not exceed a specified maximum.
Syndicate covering transactions involve purchases of the shares of common stock
in the open market after the distribution has been completed in order to cover
syndicate short positions. Penalty bids permit the representatives of the
underwriters to reclaim a selling concession from a syndicate member when the
shares of common stock originally sold by these syndicate members are purchased
in a syndicate covering transaction to cover syndicate short positions. In
"passive" market making, market makers in the securities offered hereby who are
underwriters or prospective underwriters may, subject to some limitations, make
bids for or purchases of such securities until the time, if any, at which a
stabilizing bid is made. These stabilizing transactions, syndicate covering
transactions and penalty bids may cause the price of the common stock to be
higher than it would otherwise be in the absence of these transactions. These
transactions may be effected on the Nasdaq National Market or otherwise and, if
commenced, may be discontinued at any time.
We have agreed to indemnify the underwriters against some liabilities,
including civil liabilities under the Securities Act.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock. The initial public offering price has been determined by negotiations
between us and the representatives of the underwriters. Among the factors
considered in determining the initial public offering price were estimates of
the business potential and prospects for us and our industry in general,
prevailing market and economic conditions, our revenues and earnings, market
valuations of other companies engaged in activities similar to us, the present
state of our business operations, our management and other factors deemed
relevant.
LEGAL MATTERS
O'Melveny & Myers LLP, Newport Beach, California, will pass upon the
validity of the shares of common stock offered by this prospectus. Dewey
Ballantine LLP, New York, New York, will pass upon certain legal matters for the
underwriters.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at September 30, 1997 and 1998, and for each of the three
years in the period ended September 30, 1998, as described in their report. We
have included our financial statements in our prospectus and in our registration
statement in reliance on Ernst & Young LLP's report, given on their authority as
experts in accounting and auditing.
102
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act, with respect to the common stock
offered by this prospectus. As permitted by the rules and regulations of the
SEC, this prospectus, which is part of the registration statement, omits certain
information exhibits, schedules and undertakings set forth in the registration
statement. For further information pertaining to us and the common stock offered
by this prospectus, reference is made to our registration statement and its
exhibits and schedules. Statements contained in this prospectus concerning the
contents of any contract or any other document to which this prospectus refers
are not necessarily complete, and in each instance, reference is made to the
copy of the contract or other document filed as an exhibit to the registration
statement, each such statement being qualified in all respects by such
reference. A copy of the registration statement may be inspected without charge
at the SEC's principal office at 450 Fifth Street, N.W., Washington, D.C. 20549,
and at the SEC's regional offices located at the Northwestern Atrium Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade
Center, 13th Floor, New York, New York 10048. Copies of all or any part of the
registration statement may be obtained from such offices upon the payment of the
fees prescribed by the SEC. In addition, registration statements and certain
other filings made with the SEC through its Electronic Data Gathering, Analysis
and Retrieval system, including our registration statement and all exhibits and
amendments to our registration statement, are publicly available through the
SEC's Web site at http://www.sec.gov.
As a result of this offering, we will become subject to the information and
reporting requirements of the Exchange Act and, in accordance therewith, will
file periodic reports, proxy statements and other information with the SEC. Upon
approval of our common stock for listing on the Nasdaq National Market, such
reports, proxy and information statements and other information may also be
inspected at the office of Nasdaq Operations, 1735 K Street, N.W., Washington,
D.C. 20006.
103
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors..................................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 1997 and 1998 and June 30, 1999
(unaudited)......................................................................... F-3
Consolidated Statements of Operations for each of the three years in the period ended
September 30, 1998 and the nine months ended June 30, 1998 and 1999 (unaudited)..... F-4
Consolidated Statements of Shareholders' Deficit and Comprehensive Income for each of
the three years in the period ended September 30, 1998 and the nine months ended
June 30, 1999 (unaudited)........................................................... F-5
Consolidated Statements of Cash Flows for each of the three years in the period ended
September 30, 1998 and the nine months ended June 30, 1998 and 1999 (unaudited)..... F-6
Notes to Consolidated Financial Statements............................................ F-7
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Communication Telesystems International d/b/a
WORLDxCHANGE Communications
We have audited the consolidated balance sheets of Communication Telesystems
International d/b/a WORLDxCHANGE Communications as of September 30, 1998 and
1997, and the related consolidated statements of operations, shareholders'
deficit and comprehensive income, 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 the financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Communication Telesystems International d/b/a WORLDxCHANGE Communications at
September 30, 1998 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended September 30,
1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
San Diego, California
August 2, 1999
F-2
WORLDxCHANGE COMMUNICATIONS
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
JUNE 30
SEPTEMBER 30 1999
---------------------- -----------
1997 1998
---------- ---------- (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................................. $ 4,326 $ 20,917 $ 38,197
Accounts receivable, net of allowance of $13,804 and $10,690 at September
30, 1997 and 1998, respectively and $8,825 at June 30, 1999
(unaudited)............................................................. 53,745 38,966 56,524
Receivables from related parties.......................................... 1,133 -- --
Prepaid expenses and other current assets................................. 2,531 3,825 6,924
---------- ---------- -----------
Total current assets.................................................. 61,735 63,708 101,645
Equipment and leasehold improvements, net................................... 38,437 49,697 92,155
Other assets.......................................................... 3,573 6,724 5,869
---------- ---------- -----------
Total assets.......................................................... $ 103,745 $ 120,129 $ 199,669
---------- ---------- -----------
---------- ---------- -----------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accrued network costs..................................................... $ 58,842 $ 49,796 $ 89,459
Accounts payable.......................................................... 16,384 14,144 17,415
Other accrued liabilities................................................. 21,114 15,377 17,040
Payable to related parties................................................ 3,406 468 --
Deferred revenue.......................................................... 2,961 686 2,511
Current portion of long-term debt and subordinated debentures............. 1,255 13,421 8,934
Current portion of capital lease obligations.............................. 8,201 6,851 8,071
---------- ---------- -----------
Total current liabilities............................................. 112,163 100,743 143,430
Long-term debt.............................................................. 26,010 75,287 86,421
Subordinated debentures..................................................... 6,297 1,182 --
Capital lease obligations................................................... 16,897 22,844 25,956
Other long-term liabilities................................................. 2,443 2,397 2,572
---------- ---------- -----------
Total liabilities..................................................... 163,810 202,453 258,379
Minority interest........................................................... 8,815 7,269 5,487
Shareholders' deficit:
Preferred Stock, no par value; authorized 100,000 shares: Series A
Cumulative Preferred Stock; Authorized shares--125, Issued and
outstanding--23 at September 30, 1997 and 1998 and zero at June 30, 1999
(unaudited)............................................................. 7 7 --
Common Stock, no par value;
Authorized shares--40,000,000, Issued and outstanding-- 27,734,000 at
September 30, 1997 and 28,576,552 at September 30, 1998 and 35,411,108
at June 30, 1999 (unaudited)............................................ 258 10,297 81,583
Notes receivable from shareholders........................................ -- -- (1,070)
Accumulated other comprehensive income.................................... (237) (3,529) (2,352)
Accumulated deficit....................................................... (68,908) (96,368) (142,358)
---------- ---------- -----------
Total shareholders' deficit........................................... (68,880) (89,593) (64,197)
---------- ---------- -----------
Total liabilities and shareholders' deficit........................... $ 103,745 $ 120,129 $ 199,669
---------- ---------- -----------
---------- ---------- -----------
See accompanying notes.
F-3
WORLDxCHANGE COMMUNICATIONS
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED
YEARS ENDED SEPTEMBER 30 JUNE 30
---------------------------------------- --------------------------
1996 1997 1998 1998 1999
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
Revenues................................... $ 183,861 $ 331,660 $ 398,867 $ 301,041 $ 304,324
Operating expenses:
Cost of services......................... 127,818 235,027 287,312 207,249 238,599
Selling, general and administrative...... 64,550 113,459 114,897 81,197 88,431
Depreciation and amortization............ 6,992 8,677 12,332 8,883 12,394
------------ ------------ ------------ ------------ ------------
Total operating expenses............. 199,360 357,163 414,541 297,329 339,424
Operating income (loss).................... (15,499) (25,503) (15,674) 3,712 (35,100)
Interest expense........................... 5,762 8,682 11,947 8,600 12,448
Other expense, net......................... 568 3,366 1,378 263 222
------------ ------------ ------------ ------------ ------------
Loss before minority interest.............. (21,829) (37,551) (28,999) (5,151) (47,770)
Minority interest.......................... 237 473 1,546 1,112 1,782
------------ ------------ ------------ ------------ ------------
Net loss................................... $ (21,592) $ (37,078) $ (27,453) $ (4,039) $ (45,988)
------------ ------------ ------------ ------------ ------------
Basic and diluted net loss per share....... $ (0.78) $ (1.34) $ (0.99) $ (0.15) $ (1.41)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Shares used to compute basic and diluted
net loss per share....................... 27,572,000 27,734,000 27,760,010 27,734,000 32,696,047
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
See accompanying notes.
F-4
WORLDxCHANGE COMMUNICATIONS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
SERIES A CUMULATIVE
NOTES
PREFERRED STOCK COMMON STOCK RECEIVABLE
------------------------ ---------------------- FROM
SHARES AMOUNT SHARES AMOUNT SHAREHOLDERS
----------- ----------- --------- ----------- -------------
Balance at September 30, 1995................................. 86 $ 38 27,572,000 $ 196 $ --
Repurchase of Series A Cumulative Preferred Stock........... (4) (2) -- -- --
Dividends on Series A Preferred Stock....................... -- -- -- -- --
Comprehensive loss:
Net loss.................................................. -- -- -- -- --
Foreign currency translation adjustment................... -- -- -- -- --
Total comprehensive loss....................................
--
----- --------- ----------- -------------
Balance at September 30, 1996................................. 82 36 27,572,000 196 --
Repurchase of Series A Cumulative Preferred Stock........... (59) (29) -- -- --
Dividends on Series A Cumulative Preferred Stock............ -- -- -- -- --
Exercise of options/warrants................................ -- -- 162,000 62 --
Comprehensive loss:
Net loss.................................................. -- -- -- -- --
Foreign currency translation adjustment................... -- -- -- -- --
Total comprehensive loss....................................
--
----- --------- ----------- -------------
Balance at September 30, 1997................................. 23 7 27,734,000 258 --
Dividends on Series A Preferred Stock....................... -- -- -- -- --
Issuance of Common Stock.................................... -- -- 788,127 10,000 --
Exercise of options/warrants................................ -- -- 54,425 39 --
Comprehensive loss:
Net loss.................................................. -- -- -- -- --
Foreign currency translation adjustment................... -- -- -- -- --
Total comprehensive loss....................................
--
----- --------- ----------- -------------
Balance at September 30, 1998................................. 23 7 28,576,552 10,297 --
Repurchase of Series A Cumulative Preferred Stock
(unaudited)............................................... (23) (7) -- -- --
Dividends on Series A Preferred Stock (unaudited)........... -- -- -- -- --
Issuance of Common Stock (unaudited)........................ -- -- 6,598,357 70,000 --
Exercise of options/warrants (unaudited).................... -- -- 236,199 1,286 --
Note receivable for sales of common stock (unaudited)....... -- -- -- -- (1,070)
Comprehensive income:
Net loss (unaudited)...................................... -- -- -- -- --
Foreign currency translation adjustment (unaudited)....... -- -- -- -- --
Total comprehensive loss (unaudited)........................
--
----- --------- ----------- -------------
Balance at June 30, 1999 (unaudited).......................... -- $ -- 35,411,108 $ 81,583 $ (1,070)
--
--
----- --------- ----------- -------------
----- --------- ----------- -------------
ACCUMULATED OTHER TOTAL
ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
DEFICIT INCOME DEFICIT
------------ ------------------- -------------
Balance at September 30, 1995................................. $ (10,200) $ (76) $ (10,042)
Repurchase of Series A Cumulative Preferred Stock........... -- -- (2)
Dividends on Series A Preferred Stock....................... (25) -- (25)
Comprehensive loss:
Net loss.................................................. (21,592) -- (21,592)
Foreign currency translation adjustment................... -- (358) (358)
-------------
Total comprehensive loss.................................... (21,950)
------------ ------- -------------
Balance at September 30, 1996................................. (31,817) (434) (32,019)
Repurchase of Series A Cumulative Preferred Stock........... -- -- (29)
Dividends on Series A Cumulative Preferred Stock............ (13) -- (13)
Exercise of options/warrants................................ -- -- 62
Comprehensive loss:
Net loss.................................................. (37,078) -- (37,078)
Foreign currency translation adjustment................... -- 197 197
-------------
Total comprehensive loss.................................... (36,881)
------------ ------- -------------
Balance at September 30, 1997................................. (68,908) (237) (68,880)
Dividends on Series A Preferred Stock....................... (7) -- (7)
Issuance of Common Stock.................................... -- -- 10,000
Exercise of options/warrants................................ -- -- 39
Comprehensive loss:
Net loss.................................................. (27,453) -- (27,453)
Foreign currency translation adjustment................... -- (3,292) (3,292)
-------------
Total comprehensive loss.................................... (30,745)
------------ ------- -------------
Balance at September 30, 1998................................. (96,368) (3,529) (89,593)
Repurchase of Series A Cumulative Preferred Stock
(unaudited)............................................... -- -- (7)
Dividends on Series A Preferred Stock (unaudited)........... (2) -- (2)
Issuance of Common Stock (unaudited)........................ -- -- 70,000
Exercise of options/warrants (unaudited).................... -- -- 1,286
Note receivable for sales of common stock (unaudited)....... -- -- (1,070)
Comprehensive income:
Net loss (unaudited)...................................... (45,988) -- (45,988)
Foreign currency translation adjustment (unaudited)....... -- 1,177 1,177
-------------
Total comprehensive loss (unaudited)........................ (44,811)
------------ ------- -------------
Balance at June 30, 1999 (unaudited).......................... $ (142,358) $ (2,352) $ (64,197)
------------ ------- -------------
------------ ------- -------------
See accompanying notes.
F-5
WORLDxCHANGE COMMUNICATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED NINE MONTHS ENDED
SEPTEMBER 30 JUNE 30
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
OPERATING ACTIVITIES
Net loss...................................................... $ (21,592) $ (37,078) $ (27,453) $ (4,039) $ (45,988)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Provision for bad debt...................................... 6,562 22,348 15,170 9,900 11,005
Depreciation and amortization............................... 6,992 8,677 12,332 8,883 12,394
Deferred revenue............................................ 5 2,714 (2,275) (2,387) 1,825
Impairment of long-lived assets............................. 1,430 659 -- -- --
Minority interest........................................... (237) (473) (1,546) (1,112) (1,782)
Changes in operating assets and liabilities:
Accounts receivable....................................... (18,167) (48,411) (391) (1,946) (26,214)
Receivables from related parties.......................... 634 1,317 (1,864) (283) (1,037)
Prepaid expenses and other assets......................... 3,302 (3,478) (5,551) (2,485) (2,536)
Accrued network costs..................................... 23,624 21,200 (12,255) (24,711) 39,966
Accounts payable.......................................... 1,512 12,136 (1,584) (1,672) 2,613
Other accrued liabilities................................. 3,578 13,183 (6,318) (8,098) 5,248
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating activities........... 7,643 (7,206) (31,735) (27,950) (4,506)
INVESTING ACTIVITIES
Acquisition of property and equipment......................... (3,124) (10,871) (11,990) (4,142) (25,125)
Proceeds from the sale of property and equipment.............. 111 -- -- -- --
--------- --------- --------- --------- ---------
Net cash used in investing activities......................... (3,013) (10,871) (11,990) (4,142) (25,125)
FINANCING ACTIVITIES
Proceeds from revolving credit agreement...................... -- 154,961 256,535 182,363 179,011
Repayments on revolving credit agreement...................... -- (128,598) (255,885) (184,029) (178,820)
Proceeds from issuance of long-term debt and
subordinated debentures..................................... 1,070 -- 55,152 41,002 --
Repayment of long-term debt, subordinated debentures,
loans payable and capital leases............................ (3,904) (16,602) (5,299) (5,192) (24,604)
Payment of dividends on Preferred Stock....................... (25) (11) (7) -- (2)
Proceeds from issuance of Common Stock........................ -- 62 10,039 -- 71,286
Repurchase of Preferred Stock................................. (2) (30) -- (1) (7)
Proceeds from issuance of subsidiary common stock to
minority holders............................................ 559 9,001 -- -- --
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing activities........... (2,302) 18,783 60,535 34,143 46,864
Effect of exchange rate changes on cash....................... (358) 197 (219) (107) 47
--------- --------- --------- --------- ---------
Net increase in cash.......................................... 1,970 903 16,591 1,944 17,280
Cash and cash equivalents at beginning of period.............. 1,453 3,423 4,326 4,326 20,917
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of period.................... $ 3,423 $ 4,326 $ 20,917 $ 6,270 $ 38,197
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest...................................................... $ 6,469 $ 7,176 $ 6,686 $ 4,723 $ 8,244
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Income taxes.................................................. $ 72 $ 102 $ 8 $ 1 $ 2
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
NON-CASH INVESTING AND FINANCING ACTIVITIES
Assets acquired by incurring capital lease obligations or
long-term debt.............................................. $ 5,596 $ 8,533 $ 10,421 $ 10,097 $ 32,638
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
See accompanying notes.
F-6
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
1. BUSINESS ACTIVITY
Communications TeleSystems International d/b/a WORLDxCHANGE Communications,
Inc. ("WORLDxCHANGE"), a California corporation, is a facilities-based
telecommunications carrier that provides international and domestic
long-distance service to retail and wholesale customers. Our retail base is
comprised of residential and commercial customers. Our wholesale base is
comprised of other U.S. and foreign telecommunications carriers and resellers.
We have established retail and wholesale operations in the United States, the
Pacific Rim, Canada, Europe and Latin America. WORLDxCHANGE also provides
operator, debit/calling card service, toll free, private line and other enhanced
services.
WORLDxCHANGE has established operations in the United Kingdom, Germany,
Belgium, The Netherlands, New Zealand, France and Canada through wholly owned
subsidiaries. WORLDxCHANGE has also established a subsidiary in Australia, in
which WORLDxCHANGE Communications initially had a 92% equity interest. During
the year ended September 30, 1997, WORLDxCHANGE sold an equity interest in its
Australian subsidiary which reduced WORLDxCHANGE's ownership interest to
approximately 55%. In August 1999, WORLDxCHANGE agreed to issue 1,554,763 shares
of its common stock for the shares held by certain minority shareholders of its
Australian subsidiary and a related holding company (see note 13). WORLDxCHANGE
has additional subsidiaries domiciled in various other countries; however, the
activity of these subsidiaries to date has not been significant.
The revenue from WORLDxCHANGE's international operations continues to
increase as a percentage of total revenue. As of the years ended September 30,
1996, 1997 and 1998 international revenue including Canada represented
approximately 8%, 13% and 20% of WORLDxCHANGE's total revenue, respectively.
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial statements have been prepared assuming that
WORLDxCHANGE will continue as a going concern. WORLDxCHANGE has experienced
recurring losses and has a deficiency in working capital and shareholders'
equity. WORLDxCHANGE's rapid growth and investments for additional anticipated
growth have required significant capital. Historically WORLDxCHANGE's capital
needs have been met primarily through a combination of a revolving credit
facility, debt, lease financing, cash flows from operations, the sale of stock
in its Australian subsidiary to minority shareholders and private placement
equity offerings. During the year ended September 30, 1998, WORLDxCHANGE raised
approximately $55 million from a private placement debt offering (Note 5) and
$10 million from a private placement equity offering closed on September 30,
1998. Management believes the additional $70 million in private placement
offerings received since September 30, 1998 (Note 8) and vendor committed
financing, along with the existing credit facility will be adequate to meet
WORLDxCHANGE's domestic and international capital requirements for the next
twelve months. Management also believes that WORLDxCHANGE's ability to raise
additional financing will enable the continuation of its global expansion.
However, without additional financing, WORLDxCHANGE will be required to delay,
reduce the scope of and/or
F-7
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
eliminate certain of its future expansion plans, and/or reduce its planned
expenditures on infrastructure and marketing activities.
CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
WORLDxCHANGE and its wholly and majority owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The accompanying financial statements at June 30, 1999 and for the nine
months ended June 30, 1998 and 1999 are unaudited but include all adjustments
(consisting of normal recurring accruals), which, in the opinion of management,
are necessary for a fair statement of the financial position and the operating
results and cash flows for the interim date and periods presented. Results for
the interim period ended June 30, 1999 are not necessarily indicative of results
for the entire year or future periods.
CASH EQUIVALENTS
WORLDxCHANGE considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
FOREIGN CURRENCY
The accounts of foreign subsidiaries consolidated herein have been
translated from their respective functional currencies into U.S. dollars at
appropriate exchange rates. Cumulative translation adjustments are included as a
separate component of shareholders' deficit. Exchange gains and losses from
foreign currency transactions are included in "Other (income) expense," in the
accompanying statements of operations.
CONCENTRATION OF CREDIT RISK
WORLDxCHANGE's customer base is comprised of several hundred carrier
customers and over 750,000 residential and commercial users of its direct dial
long distance telephone services, as well as hotels and other users of its
operator-assisted long distance telephone services. These customers are located
principally throughout the United States (U.S.), and to a much lesser extent in
the Pacific Rim, Europe, Latin America, and Canada. WORLDxCHANGE's U.S. revenues
from residential and smaller commercial users are billed and collected by local
exchange carriers (LECs). These LECs pass through to WORLDxCHANGE their
collection experience with customers billed under these billing agreements.
WORLDxCHANGE direct bills carrier and certain commercial customers in the U.S.
and direct bills all customers in its international markets. WORLDxCHANGE
performs credit evaluations of the financial condition of these direct bill
customers, and may require a deposit in certain circumstances. Estimated credit
losses are provided for in the financial statements at the same time the
F-8
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
corresponding revenue is recognized. No one customer accounted for more than 10%
of revenues for any period.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements, including equipment under capital
leases, are recorded at cost and are depreciated or amortized using the
straight-line method over the estimated useful lives of the assets (generally
two to seven years) or the term of the related lease (ranging from three to
seven years). Interests in international undersea and on-land fiber-optic cable
systems are amortized over their estimated useful lives, typically 20 years.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF ("SFAS
121"), companies are required to record impairment losses on long-lived assets
used in operations when events and circumstances indicate that the assets might
be impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. WORLDxCHANGE adopted
SFAS 121 at September 30, 1996, and its adoption resulted in a write-down of
$1.4 million to the pay telephone assets acquired from WintelCo in 1995. During
the year ended September 30, 1997, WORLDxCHANGE wrote-down the remaining
$659,000 associated with the pay telephone routes acquired from WintelCo. These
writedowns have been classified in selling, general and administrative expenses
in the Statement of Operations.
INSTALLATION COSTS
Installation costs consists of costs incurred by WORLDxCHANGE for the
expansion of its switching capacity and related network. These costs also
include dialer installation costs incurred upon establishing network services to
certain operator services customers. These costs are amortized using the
straight-line method over three years.
MINORITY INTEREST
Certain of WORLDxCHANGE's subsidiaries have sold stock to outside investors.
Income or losses from these operations are allocated to minority shareholders
based on ownership percentages, losses in excess of the amounts invested by the
minority shareholders are absorbed by WORLDxCHANGE. During 1997, WORLDxCHANGE's
Australian subsidiary sold $9.0 million of its stock to a minority shareholder.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("SFAS 123"), which was implemented by WORLDxCHANGE for the year
ending September 30, 1997. SFAS 123 allows companies to account for stock-based
compensation either under the new provisions of SFAS 123 or
F-9
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
under the provisions of Accounting Principles Board Opinion No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), but requires pro forma disclosure in
the footnotes to the financial statements as if the measurement provisions of
SFAS 123 had been adopted. WORLDxCHANGE has continued accounting for its
stock-based compensation in accordance with the provisions of APB 25.
REVENUE RECOGNITION
Revenue is recognized as long distance telecommunications services are
provided. Prepaid calling card revenue is reported net of selling discounts and
recorded when minutes are used. Deferred revenue relates to amounts received
from or billed to customers prior to WORLDxCHANGE providing telecommunications
services.
ADVERTISING
WORLDxCHANGE charges advertising costs to expense as the costs are incurred.
Total advertising expense was $9,391,000, $17,201,000 and $14,117,000 for the
years ended September 30, 1996, 1997 and 1998 and $8,677,000 and $13,898,000 for
the nine months ended June 30, 1998 and 1999, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NET LOSS PER SHARE
Basic and diluted net loss per share has been computed in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE,
using the weighted-average number of shares of common stock outstanding during
the period. Options, warrants, and preferred stock were not included in the
computation of diluted net loss per share because the effect would be
anti-dilutive.
NEW ACCOUNTING STANDARDS
Effective April 1, 1998, WORLDxCHANGE adopted SFAS No. 130, REPORTING
COMPREHENSIVE INCOME and SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. SFAS No. 130 requires that all components of
comprehensive income, including net income, be reported in the financial
statements in the period in which they are recognized. Comprehensive income is
defined as the change in equity during a period from transactions and other
events and circumstances from non-owner sources. Net income and other
comprehensive income, including unrealized gains and losses on investments and
foreign currency translation adjustments are reported, net of their related tax
effect, to arrive at comprehensive income. SFAS No. 131 amends the requirements
for public enterprises to report financial and descriptive information about its
reporting operating segments.
F-10
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Operating segments, as defined in SFAS No. 131, are components of an enterprise
for which separate financial information is available and is evaluated regularly
by the Company in deciding how to allocate resources and in assessing
performance. The financial information is required to be reported on the basis
that is used internally for evaluating the segment performance.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE DEVELOPED
OR OBTAINED FOR INTERNAL USE (SOP 98-1). This standard requires companies to
capitalize qualifying computer software costs which are incurred during the
application development stage and amortize them over the software's estimated
useful life. SOP 98-1 is effective for fiscal years beginning after December 15,
1998. The Company is currently evaluating the impact of SOP 98-1 on its
financial statements and related documents.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5 REPORTING ON THE COSTS OF START-UP ACTIVITIES (SOP
98-5). The standard requires companies to expense the costs of start-up
activities and organization costs as incurred. In general, SOP 98-5 is effective
for fiscal years beginning after December 15, 1998. The Company does not expect
the adoption of this standard to have a material effect on its financial
position or results of operations.
FAIR VALUES OF FINANCIAL INSTRUMENTS
WORLDxCHANGE believes that the carrying amounts of its cash, cash
equivalents, accounts receivable, accounts payable, accrued liabilities, and
notes payable approximate their fair market values due to their short-term
nature or variable interest rates.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the
current period presentation.
3. ACQUISITIONS
In December 1998, WORLDxCHANGE completed a business combination with CTS
Telecom, Inc. ("CTS") and WORLDxCHANGE Limited ("WxL"), affiliates under common
ownership and management control, both of which have been accounted for in a
manner similar to a pooling-of-interests. WORLDxCHANGE issued 278,000 shares in
connection with the acquisition of WxL. Because of these mergers, the Company
has reisssued its financial statements for the three years ended September 30,
1998. The accompanying retroactively pooled consolidated financial statements
are derived from the combined historical financial statements of CTS, WxL and
WORLDxCHANGE. All significant intercompany accounts and transactions have been
eliminated.
F-11
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
3. ACQUISITIONS (CONTINUED)
Net revenues and net loss for the three fiscal years preceding the merger by
entity are as follows (in thousands):
NET NET INCOME
REVENUES (LOSS)
---------- -----------
1996
WxC................................................................ $ 180,308 $ (15,441)
CTS Telecom........................................................ 15,505 (6,252)
WxL New Zealand.................................................... 4,523 101
Eliminations....................................................... (16,475) --
---------- -----------
Combined........................................................... $ 183,861 $ (21,592)
---------- -----------
---------- -----------
1997
WxC................................................................ $ 328,517 $ (35,349)
CTS Telecom........................................................ 17,884 (2,184)
WxL New Zealand.................................................... 18,342 455
Eliminations....................................................... (33,083) --
---------- -----------
Combined........................................................... $ 331,660 $ (37,078)
---------- -----------
---------- -----------
1998
WxC................................................................ $ 394,232 $ (24,932)
CTS Telecom........................................................ 16,343 (2,099)
WxL New Zealand.................................................... 21,204 (422)
Eliminations....................................................... (32,912) --
---------- -----------
Combined........................................................... $ 398,867 $ (27,453)
---------- -----------
---------- -----------
4. BALANCE SHEET INFORMATION
SALE OF ACCOUNTS RECEIVABLE WITH RECOURSE
WORLDxCHANGE sells certain receivables, subject to full recourse provisions,
to Zero Plus Dialing Incorporated (ZPDI), one of WORLDxCHANGE's providers of
billing and collection services. At September 30, 1997 and 1998 and June 30,
1999 the outstanding balance of such accounts for which WORLDxCHANGE is
contingently liable was approximately $4,374,000 and $4,019,000 and $1,548,000,
respectively.
F-12
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
4. BALANCE SHEET INFORMATION (CONTINUED)
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following (in
thousands):
SEPTEMBER 30,
--------------------
1997 1998
--------- --------- JUNE 30,
1999
-----------
(UNAUDITED)
Telecommunications equipment................................................... $ 42,961 $ 56,091 $ 106,345
Computer equipment and software................................................ 8,293 9,985 13,338
Office furniture, equipment and vehicles....................................... 6,895 9,335 9,622
Leasehold improvements......................................................... 616 1,614 2,750
Equipment in progress.......................................................... 78 4,932 4,311
--------- --------- -----------
58,843 81,957 136,366
Accumulated depreciation and amortization...................................... (20,406) (32,260) (44,211)
--------- --------- -----------
$ 38,437 $ 49,697 $ 92,155
--------- --------- -----------
--------- --------- -----------
OTHER ASSETS
Other assets consist of the following (in thousands):
SEPTEMBER 30,
--------------------
1997 1998
--------- --------- JUNE 30,
1999
-----------
(UNAUDITED)
Deposits......................................................................... $ 1,708 $ 3,417 $ 3,783
Debt issuance costs, net of accumulated amortization of $97 at September 30, 1998
and $1,168 at June 30, 1999.................................................... -- 3,307 2,086
Other............................................................................ 1,865 -- --
--------- --------- -----------
$ 3,573 $ 6,724 $ 5,869
--------- --------- -----------
--------- --------- -----------
ACCRUED LIABILITIES
Other accrued liabilities consist of the following (in thousands):
SEPTEMBER 30,
--------------------
1997 1998
--------- --------- JUNE 30,
1999
-----------
(UNAUDITED)
Accrued excise taxes........................................................... $ 7,107 $ 1,766 $ 5,170
Accrued commissions............................................................ 2,100 2,311 1,526
Accrued compensation and benefits.............................................. 3,340 3,384 2,842
Accrued settlements (Note 11).................................................. 4,254 2,059 1,945
Other.......................................................................... 4,313 5,857 5,557
--------- --------- -----------
$ 21,114 $ 15,377 $ 17,040
--------- --------- -----------
--------- --------- -----------
F-13
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
5. LONG-TERM DEBT AND SUBORDINATED DEBENTURES
Long-term debt consists of the following (in thousands):
SEPTEMBER 30,
--------------------
1997 1998
--------- --------- JUNE 30,
1999
-----------
(UNAUDITED)
Secured subordinated note with interest payable quarterly at 12.5%, balance due
November 2000................................................................ $ -- $ 55,000 $ 45,200
Loan and security agreement payable upon collections of accounts receivable
with interest payable monthly at prime rate plus 2.75% (11.25% at September
30, 1998, and 1997 and 10.5% at June 30, 1999) balance due October 2000...... 20,988 21,888 22,378
Note payable due May 2004, with principal and interest payments payable in
monthly installments of $322,632 at 12%...................................... -- -- 14,304
Note payable due March 2004, with principal and interest payments, payable in
monthly installments of $183,518 at 12%...................................... -- -- 7,840
Term loan due October 2000, with principal reductions of $300,000 due monthly
and interest payable monthly at prime plus 6.75% (15.25% at September 30,
1997 and 1998 and 14.50% at June 30, 1999)................................... 5,375 5,125 4,100
Secured subordinated note with interest payable quarterly at 10%, balance due
November 2000................................................................ -- 1,200 --
Secured and unsecured notes, with principal and interest payments payable in
quarterly installments, maturing at various dates through June 2000. Interest
rates ranging from 10% to 14.25%............................................. 407 429 351
--------- --------- -----------
26,770 83,642 94,173
Less current portion........................................................... (760) (8,355) (7,752)
--------- --------- -----------
$ 26,010 $ 75,287 $ 86,421
--------- --------- -----------
--------- --------- -----------
In March 1997, WORLDxCHANGE entered into a loan and security arrangement
with a financial institution for an initial term of three years wherein
WORLDxCHANGE can borrow up to a maximum of $35 million, subject to borrowing
base restrictions. The agreement consists of a revolving credit agreement and a
term loan. The available borrowing base under the revolving credit agreement is
determined as a specified percentage of eligible accounts receivable. The
balance outstanding on the revolving credit agreement is reduced by the
application of payments received on collections of accounts receivable. As of
September 30, 1998 $21,888,000 was outstanding under the revolving credit
agreement, which approximates the maximum available based upon the borrowing
base restrictions. The financial institution charges interest at prime plus a
margin of 2.75% on the revolving credit portion and a margin of 6.75% on the
term loan. The loan and security agreement requires compliance with certain
restrictive financial, operating and reporting covenants, including a
restriction on WORLDxCHANGE's ability to pay dividends to common shareholders.
As of September 30, 1998 and June 30, 1999, WORLDxCHANGE was in compliance
with these covenants, as amended and restructured in order to reflect the debt
and equity financings discussed
F-14
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
5. LONG-TERM DEBT AND SUBORDINATED DEBENTURES (CONTINUED)
below and in Note 8 and the acquisition of two affiliated companies subsequent
to year end discussed in Note 3.
The loan and security arrangement matures in October 2000. Further,
WORLDxCHANGE's obligations under this agreement are secured by a first position
in substantially all of its assets, excluding equipment where encumbrances
already exist.
From May through August 1998, WORLDxCHANGE issued and sold subordinated
promissory notes in the aggregate principal amounts of $55.0 million. These
notes bear interest at the rate of 12.5% per annum, provide for quarterly
payments of interest only and mature on November 30, 2000. These notes provide
the lender the right to require WORLDxCHANGE to use a portion of the net
proceeds from any private placement or public offering of WORLDxCHANGE's common
stock to repay the notes. As such, the outstanding balance at June 30, 1999 has
been reduced to $45,200,000.
In addition, WORLDxCHANGE also issued a promissory note in August 1998 in
the amount of $1.2 million representing accrued interest on the subordinated
promissory notes. This note bears interest at the rate of 10.0% per annum,
provides for quarterly payments of interest only and matures on November 30,
2000. In accordance with the terms of the note, this balance was repaid out of
the proceeds of the private placement equity offerings.
Subordinated debentures consist of the following (in thousands):
SEPTEMBER 30,
--------------------
1997 1998
--------- --------- JUNE 30,
1999
-----------
(UNAUDITED)
10% subordinated debentures maturing between December 31, 1998 and December 31,
1999.......................................................................... $ 1,222 $ 807 $ 704
15% subordinated debentures maturing between December 31, 1998 and December 31,
1999.......................................................................... 5,570 5,441 478
--------- --------- -----------
6,792 6,248 1,182
Less current portion............................................................ (495) (5,066) (1,182)
--------- --------- -----------
$ 6,297 $ 1,182 $ --
--------- --------- -----------
--------- --------- -----------
The subordinated debentures are subordinate to senior debt, as defined, and
are redeemable by WORLDxCHANGE at face value plus accrued interest.
Maturities of long-term debt and subordinated debentures as of September 30,
1998 are as follows (in thousands):
YEAR ENDING SEPTEMBER 30:
- -----------------------------------------------------------------------------------
1999............................................................................... $ 13,421
2000............................................................................... 22,617
2001............................................................................... 53,852
---------
Total.............................................................................. $ 89,890
---------
---------
F-15
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
6. COMMITMENTS AND CONTINGENCIES
LEASES
WORLDxCHANGE leases its primary operating facilities under noncancellable
operating leases which expire at various dates through March 2015. Certain of
these leases contain escalation clauses based on inflation or fixed amounts and
the leases generally require WORLDxCHANGE to pay utilities, insurance, taxes and
other operating expenses. Rental expense under such leases was $1,581,000,
$1,973,000 and $3,129,000 for the years ended September 30, 1996, 1997 and 1998,
respectively and $2,842,000 and $3,426,000 for the nine months ended June 30,
1998 and 1999, respectively.
WORLDxCHANGE leases its switches and certain other telecommunication and
computer equipment under capital leases, most of which contain bargain or fair
market value purchase options. At September 30, 1997 and 1998 and June 30, 1999,
assets acquired under these leases have an original cost of $34,311,000 and
$40,099,000 and $41,606,000, respectively, and accumulated amortization of
$14,796,000 and $18,515,000 and $21,164,000, respectively. The depreciation of
these assets is included with depreciation and amortization expense presented on
the consolidated statement of operations.
Future minimum payments for capital leases and noncancellable operating
leases with initial or remaining terms of one year or more as of September 30,
1998 are as follows (in thousands):
CAPITAL OPERATING
YEAR ENDING SEPTEMBER 30: LEASES LEASES
- -------------------------------------------------------------------------------------------- --------- -----------
1999........................................................................................ $ 10,325 $ 3,149
2000........................................................................................ 10,590 2,909
2001........................................................................................ 8,530 2,165
2002........................................................................................ 4,970 1,254
2003........................................................................................ 2,219 285
Thereafter.................................................................................. 134 589
--------- -----------
Total minimum lease payments................................................................ 36,768 $ 10,351
-----------
-----------
Less amount representing interest........................................................... (7,073)
---------
Present value of minimum lease payments..................................................... 29,695
Less current portion........................................................................ (6,851)
---------
Amounts due after one year.................................................................. $ 22,844
---------
---------
COMMITMENTS FOR UNDERSEA CABLE AND LAND-BASED FIBER OPTIC CABLE SYSTEMS
WORLDxCHANGE has entered into two agreements to increase its ownership of
undersea cables. These commitments will continue WORLDxCHANGE's further
expansion in international markets, and are expected to require incremental
capital expenditures of approximately $18.3 million. The first $10 million
installment was paid in December 1998 by WORLDxCHANGE with proceeds received
from the private placement equity offerings. On April 1, 1999, the remaining
$8.3 million was vendor financed at 12% interest, with monthly principal and
interest payments over a five year amortization period.
F-16
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
6. COMMITMENTS AND CONTINGENCIES (CONTINUED)
WORLDxCHANGE entered into two agreements during the nine month period ended
June 30, 1999 to acquire $45.0 million for capacity in land-based fiber optic
cable systems. The vendors have agreed to finance 90% of the commitment at 12%
interest, with monthly principal and interest payments over a five year
amortization period. At June 30, 1999, WORLDxCHANGE has purchased approximately
$16.0 million, leaving $29.0 million to be ordered by November 1999.
EMPLOYMENT AGREEMENT
Effective January 1, 1997, WORLDxCHANGE entered into an employment agreement
with an executive of WORLDxCHANGE whereby if certain transactions which result
in a change in ownership of at least 50% of the voting stock of WORLDxCHANGE or
a division of WORLDxCHANGE occur, or if WORLDxCHANGE or a division of
WORLDxCHANGE is sold, he is to receive additional compensation.
The compensation will be determined as the lesser of a) five percent of the
total consideration received from the sale of the assets; the value of the stock
outstanding after the sale of stock; or the value attributable to WORLDxCHANGE
in a merger as applicable or b) seven-tenths of one percent of the aggregate
monthly revenues of WORLDxCHANGE and WORLDxCHANGE Communications LTD. multiplied
by the number of months remaining until December 31, 1999.
7. INCOME TAXES
Income taxes are provided for in accordance with the provisions of FASB
Statement No. 109, ACCOUNTING FOR INCOME TAXES. Under this method, WORLDxCHANGE
recognizes deferred tax assets and liabilities for the expected future tax
effects of temporary differences between the carrying amounts and the tax bases
of assets and liabilities, as well as operating loss carryforwards.
The significant components of WORLDxCHANGE's deferred tax assets and
liabilities as of September 30, 1997 and 1998 are shown below (in thousands). At
September 30, 1998, a valuation allowance of $27,834,000 has been recorded as
realization of such net deferred assets is uncertain:
SEPTEMBER 30,
--------------------
1997 1998
--------- ---------
Deferred tax assets:
U.S. net operating loss carryforward.................. $ 6,557 $ 16,704
Foreign net operating loss carryforwards.............. 5,845 9,275
Accrued liabilities and reserves...................... 7,926 3,720
Other................................................. -- 336
--------- ---------
$ 20,328 $ 30,035
Deferred tax liabilities:
Depreciation and amortization......................... (2,281) (2,145)
Other................................................. (91) (56)
--------- ---------
Net deferred tax assets................................. 17,956 27,834
Deferred tax assets valuation allowance................. (17,956) (27,834)
--------- ---------
$ -- $ --
--------- ---------
--------- ---------
F-17
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
7. INCOME TAXES (CONTINUED)
At September 30, 1998, WORLDxCHANGE had net operating loss carryforwards
available for federal, state and foreign tax purposes of approximately
$43,000,000, $29,900,000 and $26,500,000, respectively. The federal tax loss
carryforwards will begin expiring in 2007, unless previously utilized. The state
tax loss carryforwards will begin expiring in 1999 through 2003, unless
previously utilized. The Canadian and Netherlands net operating loss
carryforwards in the amounts of $4,700,000 and $700,000, respectively, will
begin expiring in 2002. Other foreign loss carryforwards may be carried forward
indefinitely. The realization of future domestic benefits from net operating
loss carryforwards may be limited under Section 382 of the Internal Revenue Code
if certain cumulative changes occur in WORLDxCHANGE's ownership.
8. SHAREHOLDERS' DEFICIT
COMMON STOCK
In September 1998, WORLDxCHANGE completed a private placement for the
issuance of common stock. WORLDxCHANGE agreed to the issuance of 1,659,214
shares of common stock. WORLDxCHANGE issued 788,127 shares of common stock in
September 1998 for $10 million. The remaining 871,087 shares of common stock
were issued in December 1998 for another $10 million. The Company issued 3
million shares of common stock in March 1999 for proceeds at $30 million. In
June 1999, an additional 2,727,270 shares of common stock were issued for $30
million.
PREFERRED STOCK
Each share of Series A Cumulative Preferred Stock ("Preferred Stock") is
non-voting and is entitled to a $300 per share annual cumulative dividend,
payable monthly. Upon liquidation or dissolution of WORLDxCHANGE, each holder of
Preferred Stock shall be entitled to receive $500 per share (an aggregate of
$11,500 at September 30, 1998) plus any accrued but unpaid dividends.
STOCK OPTIONS
WORLDxCHANGE's 1996 Stock Option Plan provides for the granting of stock
options to purchase, and the issuance of, up to 3 million shares to employees,
non-exempt directors and consultants. Generally, options are granted at prices
at least equal to fair value of WORLDxCHANGE's common stock on the date of grant
as determined by WORLDxCHANGE's Board of Directors. In addition, certain
officers and directors have been granted stock options outside the Plan.
Pro forma information regarding net loss is required by Statement 123, and
has been determined as if WORLDxCHANGE had accounted for its employee stock
options under the fair value method of that statement. The fair value of these
options was estimated at the date of grant using the minimum value method and
the following weighted average assumptions for fiscal year 1996, 1997 and 1998,
respectively: risk free interest rate of 6.15%, 6.20% and 5.25%; expected option
life of seven years; and no annual dividends.
F-18
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
8. SHAREHOLDERS' DEFICIT (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period of such options. The
effects of applying SFAS 123 for pro forma disclosure purposes are not likely to
be representative of the effects on pro forma net income or loss in future years
because they do not take into consideration pro forma compensation expenses
related to grants made prior to fiscal 1996. WORLDxCHANGE's pro forma
information follows:
1996 1997 1998
--------- ----------- ---------
(IN THOUSANDS)
Pro forma net loss.......................... $ (21,611) $ (37,432) $ (28,176)
--------- ----------- ---------
--------- ----------- ---------
Pro forma basic and diluted net loss per
share..................................... $ (0.78) $ (1.36) $ (1.02)
--------- ----------- ---------
--------- ----------- ---------
A summary of WORLDxCHANGE's stock option activity, including those issued
outside of the plans and related information are as follows:
WEIGHTED-
SHARES NUMBER AVERAGE
AVAILABLE OF SHARES PRICE EXERCISE
FOR GRANT GRANTED PER SHARE PRICE
--------- --------- ------------ -------------
Balance as of September 30, 1995........... 1,740,000 1,260,000 $0.42-$0.67 $ 0.54
--------- --------- ------------ ------
Grants................................... (463,200) 463,200 $0.67-$5.00 4.04
Cancellations............................ 100,800 (100,800) $0.42-$0.67 0.43
--------- --------- ------------ ------
Balance as of September 30, 1996........... 1,377,600 1,622,400 $0.42-$5.00 $ 1.54
--------- --------- ------------ ------
Grants................................... (1,977,559) 1,977,559 $4.33-$7.00 4.94
Exercises................................ -- (90,000) $0.42 0.42
Cancellations............................ 1,312,525 (1,312,525) $4.33-$5.00 4.57
--------- --------- ------------ ------
Balance as of September 30, 1997........... 712,566 2,197,434 $0.42-$7.00 $ 2.84
--------- --------- ------------ ------
Additional shares reserved............... 1,008,166 -- -- --
Grants................................... (1,377,453) 1,377,453 $7.00-$10.00 9.67
Exercises................................ -- (54,425) $4.33-$5.00 0.72
Cancellations............................ 320,162 (320,162) $4.33-$5.00 5.49
--------- --------- ------------ ------
Balance as of September 30, 1998........... 663,441 3,200,300 $0.42-$10.00 $ 5.73
--------- --------- ------------ ------
Grants (unaudited)....................... (858,002) 858,002 $10.00-$11.00 10.10
Exercises (unaudited).................... -- (236,199) $0.67-$10.00 5.51
Cancellations (unaudited)................ 362,575 (362,575) $5.00-$10.00 8.91
--------- --------- ------------ ------
Balance at June 30, 1999 (unaudited)....... 168,014 3,459,528 $0.42-$11.00 $ 6.48
--------- --------- ------------ ------
--------- --------- ------------ ------
F-19
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
8. SHAREHOLDERS' DEFICIT (CONTINUED)
The following table summarizes significant ranges of outstanding and
exercisable options at June 30, 1999:
OUTSTANDING OPTIONS OPTIONS EXERCISABLE
-------------------------------- ------------------------
WEIGHED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF EXERCISE REMAINING LIFE EXERCISE EXERCISE
PRICES SHARES IN YEARS PRICE SHARES PRICE
- ------------------------------- --------- ----------------- ------------- --------- -------------
$0.42-$0.67.................... 944,075 3.81 $ 0.57 944,075 $ 0.57
$5.00-$9.00.................... 895,293 7.25 $ 6.25 490,964 $ 5.75
$10.00..................... 1,535,160 9.24 $ 10.00 356,688 $ 10.00
$11.00..................... 85,000 9.93 $ 11.00 -- $ --
--------- ----- ------ --------- ------
3,459,528 7.26 $ 6.48 1,791,727 $ 3.87
--------- ----- ------ --------- ------
--------- ----- ------ --------- ------
The weighted average fair value at date of grant for options granted during
1996, 1997, 1998 and the nine months ended June 30, 1999 were $0.53, $1.43,
$1.88 and $1.94 per share, respectively.
9. RELATED PARTY TRANSACTIONS
AFFILIATED LONG DISTANCE COMPANIES
In fiscal 1996, WORLDxCHANGE began utilizing long distance services from
four affiliated companies owned by a relative of WORLDxCHANGE's
officers/shareholders.
Billings by the four affiliates for long distance services provided to
WORLDxCHANGE were approximately $4,159,000, $12,607,000 and $5,409,000 for the
years ended September 30, 1996, 1997 and 1998, respectively and $3,658,000 and
$1,705,000 for the nine months ended June 30, 1998 and 1999, respectively.
WORLDxCHANGE had accounts payable to the four affiliates of $3,406,000 and
$468,000 at September 30, 1997 and 1998 and zero at June 30, 1999, respectively.
OFFICER/SHAREHOLDER NOTES RECEIVABLE AND ADVANCES
As of September 30, 1997, WORLDxCHANGE had made advances to its two major
shareholders which totaled $966,000 and are included in "receivables from
related parties" in the accompanying balance sheet. As of September 30, 1998,
the shareholder advances have been repaid to WORLDxCHANGE.
10. SAVINGS PLAN
On January 1, 1996, WORLDxCHANGE adopted a 401(k) Savings Plan covering
substantially all employees that have been employed for at least one year and
meet other age and eligibility requirements. Participants may elect to
contribute up to six percent of their compensation subject to limitations.
WORLDxCHANGE matches 25% of participant contributions. WORLDxCHANGE's matching
contribution totaled $30,989, $62,240 and $81,563 during the years ended
September 30, 1996,
F-20
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
10. SAVINGS PLAN (CONTINUED)
1997 and 1998 respectively and $61,137 and $73,764 for the nine months ended
June 30, 1998 and 1999, respectively.
11. LITIGATION AND REGULATION
WORLDxCHANGE is required under federal law and regulations to file tariffs
showing rates, terms and conditions affecting its services. WORLDxCHANGE has
filed interstate long distance tariffs with the FCC. The FCC has adopted an
order that, with certain exceptions, rescinds the requirement that carriers such
as WORLDxCHANGE maintain FCC tariffs and mandates that tariffs be withdrawn. The
FCC stayed its order pending judicial review. If tariffs are eliminated, it will
probably be necessary for WORLDxCHANGE to secure contractual agreements with its
customers providing for many of the terms of its existing tariffs. Absent
tariffs and contracts, WORLDxCHANGE believes that disputes could arise
concerning the respective rights of WORLDxCHANGE and its customers, which could
hinder WORLDxCHANGE's ability to collect its account receivable, increase
WORLDxCHANGE's overall bad debt losses and collection expenses, and increase
WORLDxCHANGE's exposure to unlimited damage claims. The FCC has not proposed to
change its requirements that tariffs for international services be filed, and
WORLDxCHANGE continues to file such tariffs.
The intrastate long distance operations of WORLDxCHANGE are also subject to
various state laws. The majority of states require certification or
registrations. WORLDxCHANGE has secured the ability to offer intra-state service
in forty-one states. Many states require tariff filing as well.
WORLDxCHANGE has been successful in obtaining all necessary regulatory
approvals to date, although revision of tariffs, authorities and approvals are
being made on a continuing basis and many such requests are pending at any one
time.
Some states may assess penalties on long distance service providers for
traffic sold prior to tariff approval. Such states may require refunds to be
made to customers. It is the opinion of management that such penalties and
refunds, if any, would not have a material adverse effect on the results of
operations, financial position or liquidity of WORLDxCHANGE.
In May 1997, the California Public Utilities Commission ("CPUC") issued an
order, which became effective in October 1997, revoking WORLDxCHANGE's
Certificate of Public Convenience and Necessity (the "CPCN") in California and
imposing certain other fines and penalties against WORLDxCHANGE based on the
CPUC's findings that WORLDxCHANGE violated California laws and regulations
requiring WORLDxCHANGE to obtain prior consumer authorization before switching
consumers' long distance carriers. As a result of the revocation for
WORLDxCHANGE's CPCN, WORLDxCHANGE cannot provide intrastate telecommunication
services in California. In addition, WORLDxCHANGE must, among other things, (i)
pay a $19.6 million fine to the state of California, $2 million of which has
been paid with the balance suspended so long as WORLDxCHANGE is not found to
have committed any future violations of California law or CPUC directives; (ii)
reimburse the CPUC for $100,000 in prosecution costs which has also been paid;
and (iii) pay approximately $1.9 million in reparations to consumers, of which
$927,200 remains payable at July 31, 1999.
WORLDxCHANGE may apply to the CPUC for reinstatement of the CPCN after
October 22, 2000, although there can be no assurance that such reinstatement
would be granted.
F-21
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
11. LITIGATION AND REGULATION (CONTINUED)
Under the CPUC's order, the suspension of WORLDxCHANGE's CPCN and the other
sanctions and fines imposed on WORLDxCHANGE are binding on any successor of
WORLDxCHANGE. The reparations noted above have been accrued by WORLDxCHANGE and
is included in other accrued liabilities in WORLDxCHANGE's balance sheet as of
September 30, 1998.
In addition, WORLDxCHANGE is subject to certain legal, regulatory and
administrative proceedings, claims and inquiries arising in the ordinary course
of business, some of which involve claims for substantial amounts of damages.
The ultimate outcome of such proceedings, claims or inquiries cannot be
predicted at this time. It is management's opinion, after consultation with its
legal counsel, that any such liability or possible restrictions placed on
WORLDxCHANGE's operations resulting from the ultimate resolution of such
proceedings, claims, and inquiries, beyond that provided, would not have a
material affect on WORLDxCHANGE's financial position or WORLDxCHANGE's future
results of operations or cash flows.
12. SEGMENT INFORMATION
In 1999, WORLDxCHANGE adopted FAS 131. The prior year's segment information
has been restated to present three reportable operating segments. WORLDxCHANGE's
segments are organized on the basis of geographic location and include North
America, Pacific Rim and Europe. None of WORLDxCHANGE's operating segments have
been aggregated.
WORLDxCHANGE evaluates performance and allocates resources based on profit
or loss from operations before interest expense, other income (loss) and
minority interest. The accounting policies of the reportable segments are the
same as those described in the basis of presentation and summary of significant
accounting policies. Intersegment sales and transfers between geographic regions
are accounted for at prices that approximate arm's length transactions. No
single customer accounted for 10% or more of revenues in fiscal 1998, 1997 or
1996, or for the nine months ended June 30, 1998 or 1999.
WORLDxCHANGE's regional segments earn revenue from direct-dial long distance
services as well as operator, debit/calling card, toll free, private line and
other enhanced services to residential customers, other telecommunications
carriers, and small to medium-sized businesses. Each of WORLDxCHANGE's
reportable regions represents a strategic business segment that functions in an
environment with common economic characteristics determined based on historical
and expected future performance.
The Company markets its products domestically and internationally, with its
principal international markets being Australia and Europe. The tables below
contain information about the geographical areas in which the Company operates
and represent information utilized by management to evaluate its operating
segments. Revenues are attributed to countries based on location in which the
sale originated. Long-lived assets are based on the country of domicile.
F-22
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
NORTH PACIFIC
AMERICA RIM EUROPE TOTALS
-------------- ------------- -------------- --------------
June 30, 1999, and for the nine months then ended
(in thousands)
Sales to unaffiliated customers................ $ 238,013 $ 42,975 $ 23,336 $ 304,324
Intersegment revenues.......................... 35,551 9,953 4,987 50,491
-------------- ------------- -------------- --------------
Segment revenues............................... 273,564 52,928 28,323 354,815
Depreciation and amortization.................. 9,823 1,298 1,273 12,394
Segment operating profit (loss)................ (22,405) (3,785) (8,910) (35,100)
Segment assets................................. 364,006 24,183 55,657 443,846
Expenditures for long-lived assets............. 15,765 1,742 7,618 25,125
Reconciliations:
NET LOSS
Total operating profit or loss for reportable
segments..................................... $ (35,100)
Interest expense............................... 12,448
Other income & expense......................... 222
Minority interest.............................. 1,782
--------------
Total consolidated net loss.................. $ (45,988)
--------------
--------------
ASSETS
Total assets for reportable segments........... $ 443,846
Elimination of intercompany receivables........ (244,177)
--------------
Total consolidated assets.................... $ 199,669
--------------
--------------
F-23
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
NORTH PACIFIC
AMERICA RIM EUROPE TOTALS
-------------- ------------- -------------- --------------
June 30, 1998, and for the nine months then ended
(in thousands)
Sales to unaffiliated customers................ $ 244,902 $ 43,540 $ 12,599 $ 301,041
Intersegment revenues.......................... 32,618 16,164 9,522 58,304
-------------- ------------- -------------- --------------
Segment revenues............................... 277,520 59,704 22,121 359,345
Depreciation and amortization.................. 7,093 1,111 679 8,883
Segment operating profit (loss)................ 8,688 (2,109) (2,529) 4,050
Segment assets................................. 159,603 23,425 18,771 201,799
Expenditures for long-lived assets............. 4,142 -- -- 4,142
Reconciliations:
NET LOSS
Total operating profit or loss for reportable
segments..................................... $ 4,050
Interest expense............................... 8,600
Other income & expense......................... 263
Minority interest.............................. 1,112
Eliminations of operating income............... (338)
--------------
Total consolidated net loss.................. $ (4,039)
--------------
--------------
ASSETS
Total assets for reportable segments........... $ 201,799
Elimination of intercompany receivables........ (99,504)
--------------
Total consolidated assets.................... $ 102,295
--------------
--------------
F-24
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
NORTH PACIFIC
AMERICA RIM EUROPE TOTALS
----------- ---------- ------------ -----------
September 30, 1998, and for the twelve
months then ended (in thousands)
Sales to unaffiliated customers..... $ 321,763 $ 58,382 $ 18,722 $ 398,867
Intersegment revenues............... 44,650 22,605 7,576 74,831
----------- ---------- ------------ -----------
Segment revenues.................... 366,413 80,987 26,298 473,698
Depreciation and amortization....... 9,988 1,484 860 12,332
Segment operating profit (loss)..... (5,547) (3,041) (7,086) (15,674)
Segment assets...................... 176,678 19,883 28,705 225,266
Expenditures for long-lived
assets............................ 11,790 200 -- 11,990
Reconciliations:
NET LOSS
Total operating profit or loss for
reportable segments............... $ (15,674)
Interest expense.................... 11,947
Other income & expense.............. 1,378
Minority interest................... 1,546
------------
Total consolidated net loss....... $ (27,453)
------------
------------
ASSETS
Total assets for reportable
segments.......................... $ 225,266
Elimination of intercompany
receivables....................... (105,137)
------------
Total consolidated assets......... $ 120,129
------------
------------
F-25
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
NORTH PACIFIC
AMERICA RIM EUROPE TOTALS
-------------- ------------- -------------- --------------
September 30, 1997, and for the twelve months
then ended (in thousands)
Sales to unaffiliated customers................ $ 291,633 $ 24,437 $ 15,590 $ 331,660
Intersegment revenues.......................... 39,326 19,333 2,712 61,371
-------------- ------------- -------------- --------------
Segment revenues............................... 330,959 43,770 18,302 393,031
Depreciation and amortization.................. 7,474 548 655 8,677
Segment operating profit (loss)................ (23,439) 2,433 (4,497) (25,503)
Other significant noncash item:
Write down of impaired long-lived assets..... 659 -- -- 659
Segment assets................................. 136,355 17,796 17,583 171,734
Expenditures for long-lived assets............. 8,691 2,180 -- 10,871
Reconciliations:
NET LOSS
Total operating profit or loss for reportable
segments..................................... $ (25,503)
Interest expense............................... 8,682
Other income & expense......................... 3,366
Minority interest.............................. 473
--------------
Total consolidated net loss.................. $ (37,078)
--------------
--------------
ASSETS
Total assets for reportable segments........... $ 171,734
Elimination of intercompany receivables........ (67,989)
--------------
Total consolidated assets.................... $ 103,745
--------------
--------------
F-26
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
NORTH PACIFIC
AMERICA RIM EUROPE TOTALS
-------------- ------------- -------------- --------------
September 30, 1996, and for the twelve months
then ended (in thousands):
Sales to unaffiliated customers................ $ 171,446 $ 7,455 $ 4,960 $ 183,861
Intersegment revenues.......................... 19,561 4,845 329 24,735
-------------- ------------- -------------- --------------
Segment revenues............................... 191,007 12,300 5,289 208,596
Depreciation and amortization.................. 6,122 373 497 6,992
Segment operating profit (loss)................ (9,745) (2,328) (3,426) (15,499)
Other significant noncash item:
Write down of impaired long-lived assets..... 1,430 -- -- 1,430
Segment assets................................. 83,938 5,423 4,621 93,982
Expenditures for long-lived assets............. 3,124 -- -- 3,124
Reconciliations:
NET LOSS
Total operating profit or loss for reportable
segments..................................... $ (15,499)
Interest expense............................... 5,762
Other income & expense......................... 568
Minority interest.............................. 237
--------------
Total consolidated net loss.................. $ (21,592)
--------------
--------------
ASSETS
Total assets for reportable segments........... $ 93,982
Elimination of intercompany receivables........ (31,217)
--------------
Total consolidated assets.................... $ 62,765
--------------
--------------
F-27
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
12. SEGMENT INFORMATION (CONTINUED)
The following table summarizes revenue by region and by type of customer for
the years ended September 30, 1996, 1997 and 1998, and for the nine months ended
June 30, 1998 and 1999:
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(IN MILLIONS)
REVENUE BY REGIONS:
United States.................................................... $ 169.5 $ 287.4 $ 318.1 $ 242.1 $ 233.5
North America (other)............................................ 1.9 4.3 3.7 2.8 4.5
--------- --------- --------- --------- ---------
North America total.............................................. 171.4 291.7 321.8 244.9 238.0
Pacific Rim...................................................... 7.5 24.4 58.4 43.5 43.0
Europe........................................................... 5.0 15.6 18.7 12.6 23.3
--------- --------- --------- --------- ---------
Total.......................................................... $ 183.9 $ 331.7 $ 398.9 $ 301.0 $ 304.3
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
REVENUE BY CUSTOMERS:
Carrier.......................................................... $ 90.2 $ 163.3 $ 166.1 $ 120.4 $ 138.1
Residential...................................................... 52.9 116.9 161.1 124.6 125.5
Operator Services................................................ 24.5 28.7 41.1 33.0 17.7
Commercial....................................................... 16.3 22.8 30.6 23.0 23.0
--------- --------- --------- --------- ---------
Total.......................................................... $ 183.9 $ 331.7 $ 398.9 $ 301.0 $ 304.3
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
13. SUBSEQUENT EVENTS (UNAUDITED)
By August 4, 1999, WORLDxCHANGE repaid all amounts outstanding relating to
the 10% and 15% subordinated debentures.
In August 1999, WORLDxCHANGE agreed to issue 1,554,763 shares of its common
stock in exchange for minority interests held in certain of its subsidiaries.
WORLDxCHANGE will account for the acquisition as a purchase, with a deemed value
of approximately $17 million, and as such will record an intangible asset of
approximately $11.6 million, representing the excess value of the stock issued
over the minority interest recorded in the financial statements. WORLDxCHANGE
will amortize the intangible asset over its estimated useful life of 20 years.
In August 1999, WORLDxCHANGE's shareholders approved the restatement of
WORLDxCHANGE's articles of incorporation to increase the authorized common stock
to 100,000,000 shares and the authorized preferred stock to 10,000,000 shares.
The unissued preferred stock is "blank check preferred" which can be created and
issued by the board of directors without shareholder approval, with rights
senior to those of common stock.
On August 16, 1999, WORLDxCHANGE entered into an agreement to issue 30,000
shares of Series A Convertible Preferred Stock for $30,000,000. The holders of
the Series A Convertible Preferred Stock are entitled to receive an annual 4
percent cumulative cash dividend of $40 per share.
F-28
WORLDxCHANGE COMMUNICATIONS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO SEPTEMBER 30, 1998 AND PERTAINING TO JUNE 30, 1999
AND FOR
THE NINE MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
13. SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)
The holders of the Series A Convertible Preferred Stock are entitled to certain
antidilution rights and have liquidation rights senior to those of common
shareholders.
Each share of Series A Convertible Preferred Stock is convertible into
90.9091 shares of common stock. The stock is convertible at the option of the
holder six months after issuance provided WORLDxCHANGE has not completed a
public offering and no such offering is pending. The stock is automatically
convertible: (i) six months from a completed registered public offering,
provided there has been no other registered public offering during the course of
the six months and no registered public offering is pending, or (ii) in the
event there is no registered public offering, two years from the date of
issuance, provided there is no registered public offering pending.
F-29
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of common stock and
seeking offers to buy shares of common stock only in jurisdictions where offers
and sales are permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of the common stock. In this
prospectus, "WORLDxCHANGE," "we," "us" and "our" refer to Communication
TeleSystems International, which operates under the name "WORLDxCHANGE
Communications", and its subsidiaries, unless the context indicates otherwise.
Until , 1999, which is 25 days after the commencement of the
offering, all dealers that effect transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
SHARES
[LOGO]
WORLDxCHANGE
COMMUNICATIONS
COMMON STOCK
------------
PROSPECTUS
, 1999
---------------
GERARD KLAUER MATTISON & CO., INC.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by us in connection with the
sale of the common stock being registered. All amounts are estimates except the
SEC registration fee, the NASD filing fees and the Nasdaq National Market
listing fee.
SEC Registration fee............................................ $ 22,796
NASD fee........................................................ $ 8,700
Nasdaq National Market listing fee.............................. $ 95,000
Printing and engraving expenses................................. $ 250,000
Legal fees and expenses......................................... $ 650,000
Accounting fees and expenses.................................... $ 350,000
Blue sky fees and expenses...................................... $ 15,000
Transfer agent fees............................................. $ 5,000
Miscellaneous fees and expenses................................. $ 78,344
---------
Total......................................................... $1,474,840
---------
---------
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 317 of the California General Corporation Law (the "CGCL") provides
for the indemnification of directors, officers and "agents" (as defined in
Section 317 of the CGCL) under certain circumstances. Subject to certain
limitations, Section 204(a)(11) of the CGCL permits corporations incorporated in
California to provide for indemnification of directors, officers and agents for
breach of their duty to the corporation and its shareholders in excess of that
expressly permitted by Section 317 of the CGCL. Under our articles of
incorporation and bylaws, we have the power to indemnify any person who was or
is a party or is threatened to be made a party to any proceeding by reason of
the fact that such person is or was one of our officers, directors or agents,
against expenses, judgments, fines, settlements and other amounts, actually and
reasonably incurred in connection with such proceeding if the person acted in
good faith, reasonably believing the acts to be in our best interest and having
no reason to believe the conduct to be unlawful.
We have entered into indemnification agreements with our directors and
officers. These agreements provide for the indemnification by us of our officers
and directors against all costs and expenses, judgments and fines and other
amounts actually and reasonably incurred in connection with proceedings in which
our officers or directors are or become involved as a party or otherwise by any
of their actions or inactions while acting as a director or officer, all to the
full extent permitted by federal and California law. The agreements also require
us to advance to indemnified officers and directors, prior to the final
disposition of any proceedings for which our officers and directors are entitled
to indemnification and promptly upon our receipt of supporting documentation
therefor, expenses relating to such proceedings. We are also required under the
agreements to obtain and maintain in full force and effect directors' and
officers' liability insurance in reasonable amounts from reputable insurers.
Section 317 of the CGCL permits us to obtain such insurance, and we intend to do
so.
The above discussion of our articles of incorporation, bylaws and
indemnification agreements and of Sections 204(a)(11) and 317 of the CGCL is not
intended to be exhaustive and is respectively qualified in its entirety by such
articles of incorporation, bylaws, indemnification agreements and statutes.
II-1
In addition, the Underwriting Agreement filed as Exhibit 1.1 to this
registration statement provides for indemnification by the underwriters of us
and our officers and directors, and by us of the underwriters, for certain
liabilities arising under the Securities Act or otherwise.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
We have issued and sold the following unregistered securities during the
last three years:
- In November 1996, we issued 30,000 shares of our common stock, and in July
1998, we issued 6,000 shares of our common stock, to a former employee in
connection with the exercise of options issued by us to the former
employee outside of our 1996 Stock Option/Stock Issuance Plan. The
issuance of these shares was exempt from registration under the Securities
Act pursuant to Section 4(2) thereunder.
- From December 1996, the date of the first issuance of options under our
1996 Stock Option Plan, through August 16, 1999, we granted stock options
to purchase an aggregate of 3,336,030 shares of common stock, with
exercise prices ranging from $5.00 to $11.00 per share, to employees,
consultants and directors pursuant to our 1996 Stock Option/Stock Issuance
Plan. Of these options, options to purchase an aggregate of 222,799 shares
of common stock have been exercised, options to purchase an aggregate of
710,305 shares have vested and are outstanding, options to purchase an
aggregate of 665,105 shares of common stock have been cancelled and
options to purchase 1,737,821 shares of common stock have not yet vested
and remain outstanding. The grants of the above options were exempt from
registration in reliance on Section 2(3) of the Securities Act as
transactions by an issuer not involving the sale of a security. The
issuances of the shares of our common stock pursuant to the exercise of
our options were exempt from registration under the Securities Act
pursuant to Section 4(2) thereunder.
- In January 1997, we issued an option to purchase 250,020 shares of common
stock at an exercise price of $5.00 per share to one employee. This option
was issued outside of the 1996 Stock Option Plan. The issuance of this
option was exempt from registration under the Securities Act in reliance
upon Section 2(3) of the Securities Act.
- On September 30, 1998, we issued 788,127 shares of common stock to Gold &
Appel Transfer, S.A., for $10,000,000 pursuant to a Stock Purchase
Agreement, dated September 30, 1998 by and among WORLDxCHANGE, Gold &
Appel, Roger Abbott, Rosalind Abbott and Edward Soren. Effective December
22, 1998, we issued an additional 871,087 shares of our common stock to
Gold & Appel for $10,000,000. As an inducement to Gold & Appel to complete
the acquisition of the additional 871,087 shares prior to the scheduled
closing of the acquisition, we issued Gold & Appel a warrant to purchase
up to an additional 20,000 shares of common stock at an exercise price of
$12.05 per share. The issuances of the common stock and the warrant to
Gold & Appel were exempt from registration under the Securities Act
pursuant to Section 4(2) thereunder.
- In January 1999, we issued 13,825 shares of our common stock to one of our
employees in connection with the exercise of options issued by us to the
employee outside of our 1996 Stock Option/Stock Issuance Plan. The
issuance of these shares was exempt from registration under the Securities
Act pursuant to Section 4(2) thereunder.
- On February 1, 1999, we issued an aggregate of 278,000 shares of common
stock to five current or former employees, pursuant to the acquisition by
WxL New Zealand-International, Inc. (our wholly-owned subsidiary) of all
of the outstanding equity interests in WORLDxCHANGE Limited, a New Zealand
corporation. These issuances of common stock were exempt from registration
under the Securities Act pursuant to Section 4(2) thereunder.
II-2
- On March 22, 1999, we issued 3,000,000 shares of common stock to Atocha,
L.P. for $30,000,000 pursuant to a Stock Purchase Agreement dated February
3, 1999 between WORLDxCHANGE and Atocha. The issuance of common stock to
Atocha was exempt from registration under the Securities Act pursuant to
Section 4(2) thereunder.
- On June 25, 1999, we issued 2,727,270 shares of common stock to Gold &
Appel for $30,000,000 pursuant to a Stock Purchase Agreement dated May 10,
1999 between WORLDxCHANGE and Gold & Appel. The issuance of common stock
to Gold & Appel was exempt from registration under the Securities Act
pursuant to Section 4(2) thereunder.
- On August 10, 1999, we entered into a Subscription Agreement with Richard
A. D. Vincent, a former executive officer of our Australian operating
subsidiary, under which we issued 104,763 shares of our common stock to
Mr. Vincent in exchange for 1,000,000 shares of the common stock of our
subsidiary,WxL International-Australia, Inc. Our issuance of these shares
to Mr. Vincent was exempt from registration under Section 4(2) of the
Securities Act.
- On August 16, 1999, we entered into an agreement to issue 30,000 shares of
Series A Convertible Preferred Stock to Gold & Appel for $30,000,000. The
issuance of these shares to Gold & Appel will be exempt from registration
under the Securities Act pursuant to Section 4(2) thereunder.
- On August 24, 1999, we entered into a Stock Purchase Agreement with The
TVG Asian Communications Fund, under which we have agreed to issue a total
of 1,450,000 shares of our common stock to The TVG Asian Communications
Fund in exchange for the 40% interest in our Australian operating
subsidiary, WORLDxCHANGE Pty. Ltd., held by The TVG Asian Communications
Fund. Under the agreement, we and The TVG Asian Communications Fund are
obligated to close this transaction upon the receipt of required
regulatory approval in Australia. Our issuance of shares to The TVG Asian
Communications Fund will be exempt from registration under Section 4(2) of
the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
The following Exhibits are attached hereto and incorporated herein by
reference.
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
1.1 Underwriting Agreement, dated , by and among Communication
TeleSystems International and Gerard Klauer Mattison & Co., Inc.*
2.1 Stock Purchase Agreement, dated August 24, 1999, among WORLDxCHANGE
B.V.B.A., The TVG Asian Communications Fund, Communication TeleSystems
International, WORLDxCHANGE Pty. Ltd., Warna Gerakan Sdn Bhd and the other
parties named therein
2.2 Stock Purchase Agreement, dated November 30, 1998, among CTS Telcom
Holdings, Inc., CTS Telcom, Inc., Rosalind R. Abbott and Edward S. Soren
2.3 Stock Purchase Agreement, dated December 31, 1998, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications, WxL
International-New Zealand, Inc., WORLDxCHANGE Limited, Roger B. Abbott,
Rosalind R. Abbott, Edward S. Soren, Eric G. Lipoff and Richard Vincent.
3.1 Amended and Restated Articles of Incorporation of Communication
TeleSystems International
II-3
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
3.2 Certificate of Determination of Preferences of Series A Convertible Stock
3.3 Amended and Restated Bylaws of Communication TeleSystems International
4.1 Specimen Common Stock Certificate*
5.1 Opinion of O'Melveny & Myers LLP*
9.1 Voting Trust Agreement, dated March 1, 1998, by and between Edward S.
Soren and Roger B. Abbott
10.1 Stock Purchase Agreement, dated September 29, 1998, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications, Gold & Appel
Transfer S.A., Roger B. Abbott, Rosalind Abbott and Edward S. Soren.
10.2 Stock Purchase Agreement, dated September 29, 1998, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications, Atocha L.P.,
Roger B. Abbott, Rosalind Abbott and Edward S. Soren.
10.3 Registration Rights Agreement, dated September 29, 1998, among
Communication TeleSystems International d/b/a WORLDxCHANGE Communications,
Gold & Appel Transfer S.A. and Atocha L.P.
10.4 Stock Purchase Agreement, dated February 3, 1999, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications and Atocha
L.P.
10.5 Registration Rights Agreement, dated February 3, 1999, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications and Atocha
L.P.
10.6 Stock Purchase Agreement, dated May 10, 1999, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications and Gold &
Appel Transfer S.A.
10.7 Registration Rights Agreement, dated May 10, 1999, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications and Gold &
Appel Transfer S.A.
10.8 Subordinated Promissory Note, dated August 25, 1998, made by Communication
TeleSystems International d/b/a WORLDxCHANGE Communications in favor of
Gerard Klauer Mattison & Co., Inc. in the principal amount of $20,000,000.
10.9 Subordinated Promissory Note, dated August 25, 1998, made by Communication
TeleSystems International d/b/a WORLDxCHANGE Communications in favor of
Gerard Klauer Mattison & Co., Inc. in the principal amount of $20,000,000.
10.10 Subordinated Promissory Note, dated August 25, 1998, made by Communication
TeleSystems International d/b/a WORLDxCHANGE Communications in favor of
Gerard Klauer Mattison & Co., Inc. in the principal amount of $15,000,000.
10.11 Subordinated Promissory Note, dated August 25, 1998, made by Communication
TeleSystems International d/b/a WORLDxCHANGE Communications in favor of
Tel-Save Holdings, Inc. in the principal amount of $1,200,000.
10.12 Agreement, dated March 15, 1999, among Communication TeleSystems
International d/b/a WORLDxCHANGE Communications, Tel-Save.com, Inc.,
Tel-Save, Inc., Mark Pavol, as Trustee of that certain D&K Grantor
Retained Annuity Trust dated June 15, 1998, Roger B. Abbott and Rosalind
Abbott, and Edward Soren
II-4
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
10.13 Agreement, dated June 28, 1999, among Communication TeleSystems
International d/b/a WORLDxCHANGE Communications, Mark Pavol, as Trustee of
that certain D&K Grantor Retained Annuity Trust dated June 15, 1998, Roger
B. Abbott and Rosalind Abbott, and Edward Soren
10.14 Security Agreement, dated August 25, 1998, between Communication
TeleSystems International d/b/a WORLDxCHANGE Communications and Gerard
Klauer Mattison & Co., Inc.
10.15 Assignment made by Gerard Klauer Mattison & Co., Inc. in favor of Tel-Save
Holdings, Inc.
10.16 Loan and Security Agreement, dated March 11, 1997, among Communication
TeleSystems International d/b/a WORLDxCHANGE Communications, WXL
Communications, Ltd., CTS Telcom, Inc. and Foothill Capital Corporation.
10.16.1 Amendment Number One, dated December 31, 1997, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WXL Communications, Ltd., CTS Telcom, Inc. and Foothill
Capital Corporation
10.16.2 Amendment Number Two, dated February 20, 1998, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WXL Communications, Ltd., CTS Telcom, Inc. and Foothill
Capital Corporation
10.16.3 Amendment Number Three, dated April 27, 1998, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WXL Communications, Ltd., CTS Telcom, Inc. and Foothill
Capital Corporation
10.16.4 Amendment Number Four, dated August 25, 1998, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WXL Communications, Ltd., CTS Telcom, Inc. and Foothill
Capital Corporation
10.16.5 Amendment Number Five, dated December 29, 1998, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WXL Communications, Ltd., CTS Telcom, Inc. and Foothill
Capital Corporation
10.16.6 Amendment Number Six, dated March 15, 1999, to Loan and Security Agreement
among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WorldxChange Communications, Inc., CTS Telcom Holdings,
Inc., CTS Telcom, Inc. and Foothill Capital Corporation
10.16.7 Amendment Number Seven, dated June 16, 1999, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WorldxChange Communications, Inc., CTS Telcom Holdings,
Inc., CTS Telcom, Inc. and Foothill Capital Corporation
10.16.8 Amendment Number Eight, dated August 24, 1999, to Loan and Security
Agreement among Communication TeleSystems International d/b/a WORLDxCHANGE
Communications, WorldxChange Communications, Inc., CTS Telcom Holdings,
Inc., CTS Telcom, Inc. and Foothill Capital Corporation
10.17 TPC-5 Cable Network Construction and Maintenance Agreement, dated October
29, 1992, among the Parties listed on Schedule A thereto, as amended
II-5
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
10.17.1 TPC-5 Cable Network Amendatory Agreement No. 1, dated May 16, 1995, to the
Construction and Maintenance Agreement, dated October 29, 1992, among CTS
and the other Parties listed on Schedule A thereto
10.18 Tasman 2 Cable System Indefeasible Right of Use Agreement, dated April 1,
1997, between WORLDxCHANGE (New Zealand) Limited and WorldxChange Pty Ltd.
10.19 Tasman 2 Cable System Construction and Maintenance Agreement Revision No.
1, dated December 5, 1990, among the Parties identified in Schedule A
thereto
10.19.1 Sixth Supplementary Agreement, dated December 3, 1996, to the Tasman 2
Cable System Construction and Maintenance Agreement Revision No. 1, dated
December 5, 1990, among the Parties identified in Schedule A thereto
10.20 PacRimEast Cable System Construction and Maintenance Agreement, dated
December 5, 1990, as amended, among Communication TeleSystems
International d/b/a WORLDxCHANGE Communications and the other Parties
identified on Schedule A attached thereto
10.20.1 Third Supplementary Agreement, dated October 31, 1995, to the PacRimEast
Cable System Construction and Maintenance Agreement, dated December 5,
1990, as amended by the First Supplementary Agreement, dated October 8,
1992 and the Second Supplementary Agreement, dated October 19, 1993, among
Communication TeleSystems International d/b/a WORLDxCHANGE Communications
and the other Parties identified on Schedule A attached thereto
10.21 Indefeasible Right of Use Agreement and Financing Agreement, dated October
5, 1998 between Teleglobe USA Inc. and Communication TeleSystems
International d/b/a WORLDxCHANGE Communications
10.21.1 Side Letter, dated October 12, 1998, between Communication TeleSystems
International
d/b/a WORLDxCHANGE Communications and Teleglobe USA, Inc., regarding the
Indefeasible Right of Use Agreement and Financing Agreement, dated October
5, 1998
10.22 Southern Cross Cable Network Capacity Use Agreement, dated May 1998
between Southern Cross Cables Limited and Communication TeleSystems
International d/b/a WORLDxCHANGE Communications
10.23 Taino-Carib Cable System Indefeasible Right of User Agreement, dated
October 26, 1995, among AT&T Corp., Transoceanic Communications,
Incorporated and Communication TeleSystems International d/b/a
WORLDxCHANGE Communications
10.24 HAW-5 Cable System Indefeasible Right of User Agreement, dated March 9,
1995, between AT&T Corp. and Communication TeleSystems International d/b/a
WORLDxCHANGE Communications
10.25 Warrant to Purchase Common Stock, dated December 31, 1998, by and between
Communication TeleSystems International d/b/a WORLDxCHANGE Communications
and Gold & Appel Transfer S.A.
10.26 Capacity Lease and IRU Agreement, dated February 11, 1999, by and between
Level 3 Communications, LLC, a Delaware limited liability company, and
Communication Telesystems International, d/b/a WORLDxCHANGE Communications
(1)
II-6
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
10.27 Capacity Lease Agreement, dated March 26, 1999, by and between
Communication Telesystems International d/b/a WORLDxCHANGE Communications
and Worldcom Network Services, Inc.(1)
10.28 Termination and Severance Agreement, dated July 24, 1998, between
Communication Telesystems International d/b/a WORLDxCHANGE Communications
and Holly Mead
10.29 Termination and Severance Agreement, dated May 11, 1999, by and between
Communication Telesystems International d/b/a WORLDxCHANGE Communications
and Ralph Brandifino
10.30 Letter Agreement, dated April 7, 1999, by and among Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Siemens
Information and Communications Networks, Inc.
10.31 Registration Rights Agreement, dated July 29, 1999, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Rosalind
and Roger Abbott
10.32 Form of Indemnification Agreement, dated July 29, 1999, between
Communication Telesystems International d/b/a WORLDxCHANGE Communications
and each of the individuals identified on Schedule A thereto
10.33 Communication TeleSystems International 1999 Stock Option / Stock Issuance
Plan
10.34 Communication TeleSystems International 1996 Stock Option / Stock Issuance
Plan
10.35 Employment Agreement, dated August 1, 1999, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Roger B.
Abbott
10.36 Employment Agreement, dated April 23, 1998, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Chris
Bantoft
10.37 Employment Agreement, dated December 16, 1993, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Edward S.
Soren
10.38 Amended and Restated Employment Agreement, dated June 1, 1999, between
Communication Telesystems International d/b/a WORLDxCHANGE Communications
and Patrick Aelvoet
10.39 Employment Agreement, dated November 10, 1995, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Barbara H.
Jamaleddin
10.40 Employment Agreement, dated October 1, 1996, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and Eric G.
Lipoff
10.41 Employment Agreement, dated April 28, 1999, between Communication
Telesystems International d/b/a WORLDxCHANGE Communications and William
Moskowitz
10.42 Lease Agreement, dated October 4, 1993, between Telecommunications Finance
Group and Communication Telesystems International d/b/a WORLDxCHANGE
Communications
10.43 Lease Agreement, dated June 2, 1992, between Telecommunications Finance
Group and Communication Telesystems International d/b/a WORLDxCHANGE
Communications
10.44 Lease Agreement, dated February 23, 1993, between Telecommunications
Finance Group and Communication Telesystems International d/b/a
WORLDxCHANGE Communications
II-7
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
10.45 Lease Agreement, dated February 20, 1995, between Telecommunications
Finance Group and Communication Telesystems International d/b/a
WORLDxCHANGE Communications
10.46 Lease Agreement, dated March 8, 1995, between Telecommunications Finance
Group and Communication Telesystems International d/b/a WORLDxCHANGE
Communications
10.47 Lease relating to 611 Wilshire Boulevard, Suite 601, Los Angeles,
California, 90017, dated September 17, 1997, between Downtown Properties,
L.L.C. and Communication Telesystems International d/b/a WORLDxCHANGE
Communications
10.48 Lease relating to Levels 3 and 4, 1 Elizabeth Place, North Sydney,
Australia, dated July 14, 1997, between Nesova Pty. Limited and
WORLDxCHANGE Pty. Limited
10.49 Univision Center Office Lease Agreement relating to 2323 Bryan Street,
15th Floor, Dallas, Texas 75201, dated May 30, 1998, between Beverly Hills
Center LLC and Communication Telesystems International d/b/a WORLDxCHANGE
Communications
10.50 Agreement of Lease relating to 60 Hudson Street, 15th Floor, New York, New
York, dated January 1995, between Hudson Telegraph Associates and
Communication Telesystems International d/b/a WORLDxCHANGE Communications
10.51 Underlease relating to Suite 9.02 Exchange Tower, One Harbor Exchange
Square, London E14 9GB, dated December 12, 1994, by and between Globe
Trust Limited and WORLDxCHANGE Communications Limited
10.51.1 Deed of Variation, relating to Suite 9.02 Exchange Tower, One Harbor
Exchange Square, London E14 9GB, dated June 23, 1997, between Dockways
Limited and WORLDxCHANGE Communications Limited
10.52 Sub-Underlease, relating to Suite 9.03 Exchange Tower, One Harbor Exchange
Square, London E14 9GB, dated June 23, 1997, between Dockways Limited and
WORLDxCHANGE Communications Limited
10.53 Lease relating to 9775 Business Park, San Diego, California, dated June
23, 1997, between Burnham Pacific Properties, Inc. and Communication
Telesystems International d/b/a WORLDxCHANGE Communications
10.54 Lease relating to 9999 Willow Creek Road, San Diego, California, dated
June 1, 1997, between Currie/Samuelson Development Group LP and
Communication TeleSystems, International d/b/a WORLDxCHANGE Communications
10.55 Registration Rights Agreement, dated August 24, 1999, between
Communication TeleSystems International d/b/a WORLDxCHANGE Communications
and the TVG Asian Communications Fund
10.56 Warrant to Purchase Common Stock, dated , 1999, by and between
Communication TeleSystems International d/b/a WORLDxCHANGE Communications
and Gerard Klauer Mattison & Co., Inc.*
10.57 Registration Rights Agreement, dated August , 1999, between
Communication TeleSystems International d/b/a WORLDxCHANGE Communications
and Gerard Klauer Mattison & Co., Inc.*
10.58 Stock Purchase Agreement, dated August 16, 1999, between Communications
TeleSystems International d/b/a WORLDxCHANGE Communications and Gold &
Appel Transfer S.A.
II-8
EXHIBIT
NO. DESCRIPTION
- ------ --------------------------------------------------------------------------
10.59 Registration Rights Agreement, dated August 16, 1999, between
Communications TeleSystems International d/b/a WORLDxCHANGE Communications
and Gold & Appel Transfer S.A.
10.60 Voting Agreement, dated August 16, 1999, between Communications
TeleSystems International d/b/a WORLDxCHANGE Communications and Gold &
Appel Transfer S.A.
21.1 Subsidiaries of the Company.
23.1 Consent of O'Melveny & Myers LLP (contained in Exhibit 5.1)*
23.2 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (included in the signature pages to the Registration
Statement)
27.1 Financial Data Schedule
- ------------------------
(1) Confidential treatment has been requested for a portion of this Exhibit
* To be filed by amendment
(b) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
All other 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.
II-9
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated August 2, 1999 in the Registration Statement on Form
S-1 and related Prospectus to be filed on or about August 25, 1999 of
Communication Telesystems International d/b/a WORLDxCHANGE Communications for
the registration of its common stock.
Our audits also included the financial statement schedule of Communication
Telesystems International d/b/a WORLDxCHANGE Communications for the three years
ended September 30, 1998 listed in Item 16(b). This schedule is the
responsibility of Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein.
/s/ ERNST & YOUNG LLP
San Diego, California
August 20, 1999
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SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
WORLDxCHANGE COMMUNICATIONS
COL. C
----------------------------------
COL. B COL. E
------------ ADDITIONS ----------------
COL. A BALANCE AT ---------------------------------- COL. D BALANCE AT END
- ------------------------------------- BEGINNING OF CHARGED TO COSTS CHARGED TO OTHER ------------- OF
DESCRIPTION YEAR AND EXPENSES ACCOUNTS DEDUCTIONS(1) YEAR
- ------------------------------------- ------------ ---------------- ---------------- ------------- ----------------
(IN THOUSANDS)
YEAR ENDED SEPTEMBER 30, 1998:
Reserves and allowances deducted
from asset accounts
Allowance for uncollectible
accounts....................... $ 9,808 $ 15,170 -- $ (16,524) $ 8,454
Allowance for credits and billing
adjustments.................... 3,996 6,098 -- (7,858) 2,236
YEAR ENDED SEPTEMBER 30, 1997:
Reserves and allowances deducted
from asset accounts
Allowance for uncollectible
accounts....................... $ 2,915 22,348 -- $ (15,455) $ 9,808
Allowance for credits and billing
adjustments.................... -- 10,260 -- (6,264) 3,996
YEAR ENDED SEPTEMBER 30, 1996:
Reserves and allowances deducted
from asset accounts
Allowance for uncollectible
accounts....................... $ 501 $ 6,562 -- $ (4,148) $ 2,915
Allowance for credits and billing
adjustments.................... -- -- -- -- --
- ------------------------
(1) Uncollectible accounts written off, net of recoveries.
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ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the Company pursuant
to the provisions referenced in Item 14 of this Registration Statement or
otherwise, the Company has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act, and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Company of expenses incurred or paid by a director, officer, or controlling
person of the Company in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered hereunder, the Company will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
The Company hereby undertakes that:
(1) For purposes of determining any liability under the Act, the information
omitted from the form of prospectus filed as part of this Registration Statement
in reliance upon Rule 430A and contained in a form of prospectus filed by the
Company pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be
deemed to be part of this Registration Statement as of the time it was declared
effective.
(2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
The Company hereby undertakes to provide to the underwriters at the Closing,
as specified in the Underwriting Agreement, certificates in such denomination
and registered in such names as required by the underwriters to permit prompt
delivery to each purchaser.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on this 25th day of August, 1999.
COMMUNICATION TELESYSTEMS INTERNATIONAL D/B/A
WORLDxCHANGE Communications
By: /s/ ROGER B. ABBOTT
------------------------------------------
Roger B. Abbott
CHIEF EXECUTIVE OFFICER
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Edward S. Soren and Roger B. Abbott, and each of
them, his true and lawful attorneys-in-fact and agents, each with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments, including post-effective
amendments, to this Registration Statement, and any registration statement
relating to the offering covered by this Registration Statement and filed
pursuant to Rule 462(b) under the Securities Act of 1933, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done, as fully to all intents
and purposes as he might or could do in person, hereby ratifying and confirming
all that each of said attorneys-in-fact and agents or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed below by the following persons in the capacities and
on the dates indicated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ WALT ANDERSON
- ------------------------------ Chairman of the Board August 25, 1999
Walt Anderson
/s/ ROGER B. ABBOTT Chief Executive Officer
- ------------------------------ (Principal Executive August 25, 1999
Roger B. Abbott Officer) and Director
/s/ CHRISTOPHER BANTOFT President and Chief
- ------------------------------ Operating Officer and August 25, 1999
Christopher Bantoft Director
/s/ PATRICK AELVOET Chief Financial Officer
- ------------------------------ (Principal Financial and August 25, 1999
Patrick Aelvoet Accounting Officer)
/s/ EDWARD S. SOREN
- ------------------------------ Executive Vice President August 25, 1999
Edward S. Soren and Director
/s/ TOM CIRRITO
- ------------------------------ Director August 25, 1999
Tom Cirrito
/s/ DANN V. ANGELOFF
- ------------------------------ Director August 25, 1999
Dann V. Angeloff
/s/ PAUL LAXALT
- ------------------------------ Director August 25, 1999
Paul Laxalt
II-13