<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 4, 1997
REGISTRATION NO. 333-33117
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
ECONOPHONE, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
NEW YORK 4813 11-3132722
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>
45 BROADWAY
NEW YORK, NEW YORK 10006
(212) 444-6991
(Address, including zip code, and telephone number, including
area code, of Registrant's principal executive offices)
ALAN L. LEVY
PRESIDENT, CHIEF FINANCIAL OFFICER AND CHIEF OPERATING OFFICER
45 BROADWAY
NEW YORK, NEW YORK 10006
(212) 444-6991
(Name, address, including zip code, and telephone number
including area code, of agent for service)
------------------------
PLEASE SEND COPIES OF ALL COMMUNICATIONS TO:
ANDRE WEISS, ESQ.
SCHULTE ROTH & ZABEL LLP
900 THIRD AVENUE
NEW YORK, NEW YORK 10022
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO THE PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
------------------------
If the only securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, please check the following box: / /
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THE 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.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
ECONOPHONE, INC.
CROSS REFERENCE SHEET TO FORM S-4
PURSUANT TO ITEM 501(B) OF REGULATION S-K
<TABLE>
<CAPTION>
FORM S-4 NUMBER AND CAPTION LOCATION IN PROSPECTUS
- ---------------------------------------------------------------- -----------------------------------------------------
<C> <S> <C>
1. Forepart of the Registration Statement and Outside
Front Cover Page of Prospectus..................... Forepart of the Registration Statement; Outside Front
Cover Page of Prospectus
2. Inside Front and Outside Back Cover Pages of
Prospectus......................................... Inside Front and Outside Back Cover Pages of
Prospectus; Table of Contents
3. Risk Factors, Ratio of Earnings to Fixed Charges and
Other Information.................................. Prospectus Summary; Risk Factors; Summary Selected
Consolidated Financial Data
4. Terms of the Transaction............................. Prospectus Summary; Risk Factors; The Exchange Offer;
Description of the Exchange Notes; Certain Federal
Income Tax Considerations
5. Pro Forma Financial Information...................... Prospectus Summary; Capitalization; Summary Selected
Consolidated Financial Data
6. Material Contracts with the Company Being Acquired... *
7. Additional Information Required for Reoffering by
Persons and Parties Deemed to be Underwriters...... *
8. Interests of Named Experts and Counsel............... *
9. Disclosure of Commission Position on Indemnification
for Securities Act Liabilities..................... Management
10. Information with Respect to S-3 Registrants.......... *
11. Incorporation of Certain Information by Reference.... *
12. Information with Respect to S-2 or S-3 Registrants... *
13. Incorporation of Certain Information by Reference.... *
14. Information with Respect to Registrants other than
S-3 or S-2 Registrants............................. Cover Page of Registration Statement; Available
Information; Prospectus Summary; Risk Factors; Use
of Proceeds; Capitalization; Selected Consolidated
Financial Data: Management's Discussion and
Analysis of Financial Condition and Results of
Operations; Business; Management; Description of
the Exchange Notes; Financial Statements
15. Information with Respect to S-3 Companies............ *
16. Information with Respect to S-2 or S-3 Companies..... *
17. Information with Respect to Companies other than S-2
or S-3 Companies................................... *
18. Information if Proxies, Consents or Authorizations
are to be Solicited................................ *
19. Information if Proxies, Consents or Authorizations
are not to be Solicited or in an Exchange Offer.... Management; Certain Transactions; Description of
Certain Indebtedness; Principal Stockholders;
Financial Statements
</TABLE>
- ------------------------
* Item is omitted because answer is negative or the item is inapplicable.
<PAGE>
ECONOPHONE, INC.
OFFER TO EXCHANGE $155,000,000 OF NEW
13 1/2% SENIOR NOTES DUE 2007
FOR $155,000,000 OF ANY AND ALL OUTSTANDING
13 1/2% SENIOR NOTES DUE 2007
Econophone, Inc., a New York corporation ("Econophone" or the "Company"),
hereby offers to exchange (the "Exchange Offer"), upon the terms and conditions
set forth in this Prospectus (the "Prospectus") and the accompanying Letter of
Transmittal (the "Letter of Transmittal"), up to $155,000,000 in aggregate
principal amount of its 13 1/2% Senior Notes due 2007 (the "Exchange Notes") for
a like principal amount of its 13 1/2% Senior Notes due 2007 (the "Original
Notes" and, together with the Exchange Notes, the "Notes").
The terms of the Exchange Notes are identical in all material respects
(including principal amount, interest rate and maturity) to the terms of the
Original Notes for which they may be exchanged pursuant to the Exchange Offer,
except that the Exchange Notes will generally be freely transferable by holders
thereof (each, a "Holder" and, collectively, the "Holders"), (except as provided
herein), and are not subject to any covenant of the Company regarding
registration. The Exchange Notes will be issued under the indenture governing
the Original Notes. For a description of the principal terms of the Exchange
Notes, see "Description of the Exchange Notes."
Interest on the Exchange Notes will be payable semi-annually on January 15
and July 15 of each year, commencing January 15, 1998. The Notes will be
redeemable at the option of the Company, in whole or in part, at any time on or
after July 15, 2002, at the redemption prices set forth herein, plus accrued and
unpaid interest if any, thereon to the date of redemption. In addition, at any
time prior to July 15, 2000, the Company may, in its discretion, redeem up to
35% of the original principal amount of the Notes at a redemption price equal to
113.50% of the principal amount thereof, plus accrued and unpaid interest, if
any, thereon to the date of redemption, with the net proceeds of one or more
Public Equity Offerings (as defined); provided that (1) at least $100.00 million
in principal amount of the Notes remains outstanding after each such redemption
and (2) each such redemption occurs within 180 days of the related Public Equity
Offering. The Exchange Notes will not be subject to any mandatory sinking fund.
In the event of a Change of Control (as defined), each holder of the Notes will
have the right to require the Company to purchase all or any part of such
Holder's Notes at a purchase price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid interest, if any, thereon to
the date of purchase. See "Description of the Exchange Notes" and
"Capitalization."
The Original Notes were issued and sold on July 1, 1997, in a transaction
(the "Offering") not registered under the Securities Act of 1933, as amended
(the "Securities Act"), in reliance upon the exemptions provided in Section 4(2)
of the Securities Act and Rule 144A and Regulation S under the Securities Act.
Accordingly, the Original Notes may not be reoffered, resold or otherwise
pledged, hypothecated or transferred unless so registered or unless an
applicable exemption from the registration
(COVER PAGE CONTINUED)
------------------------
SEE "RISK FACTORS," COMMENCING ON PAGE 14, FOR A DESCRIPTION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PARTICIPANTS IN THE EXCHANGE OFFER.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is November 4, 1997.
<PAGE>
(COVER PAGE CONTINUED)
requirements of the Securities Act is available. The Exchange Notes are being
offered hereunder in order to satisfy certain of the obligations of the Company
under a registration rights agreement relating to the Original Notes. See "The
Exchange Offer--Purpose of the Exchange Offer." The Company is making the
Exchange Offer in reliance upon an interpretation by the staff of the Securities
and Exchange Commission (the "Commission") set forth in a series of no-action
letters issued to third parties, although the Company has not sought, and does
not intend to seek, its own no-action letter and there can be no assurance that
the staff of the Commission would make a similar determination with respect to
the Exchange Offer. Based upon the Commission's interpretations, the Company
believes that the Exchange Notes issued pursuant to the Exchange Offer in
exchange for Original Notes may be offered for resale, resold and otherwise
transferred by Holders thereof (other than any Holder that is (i) an "affiliate"
of the Company within the meaning of Rule 405 under the Securities Act (an
"Affiliate"), (ii) a broker-dealer who acquired Original Notes directly from the
Company or (iii) a broker-dealer who acquired Original Notes as a result of
market making or other trading activities) without compliance with the
registration and prospectus delivery provisions of the Securities Act provided
that such Exchange Notes are acquired in the ordinary course of such Holders'
business and such Holders are not engaged in, and do not intend to engage in,
and have no arrangement or understanding with any person to participate in, a
distribution of such Exchange Notes. Any Holder that cannot rely upon such
interpretations must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction. See "The Exchange Offer--Procedures Applicable to All Holders."
Each broker-dealer who receives Exchange Notes pursuant to the Exchange
Offer in exchange for Original Notes acquired for its own account as a result of
market-making activities or other trading activities may be a statutory
underwriter and must acknowledge that it will deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of such
Exchange Notes. The Letter of Transmittal that is filed as an exhibit to the
Registration Statement of which this Prospectus is a part states that by so
acknowledging and by delivering a prospectus, a broker-dealer will not be deemed
to admit that it is an "underwriter" within the meaning of the Securities Act.
Broker-dealers who acquired Original Notes as a result of market making or other
trading activities may use this Prospectus, as supplemented or amended, in
connection with resales of the Exchange Notes.
The Original Notes are designated for trading in the Private Offerings,
Resales and Trading through Automated Linkages ("PORTAL") market. The Exchange
Notes constitute a new issue of securities for which there is no established
trading market. Any Original Notes not tendered and accepted in the Exchange
Offer will remain outstanding. To the extent Original Notes are tendered and
accepted in the Exchange Offer, a Holder's ability to sell untendered, and
tendered but unaccepted, Original Notes could be adversely affected. Following
consummation of the Exchange Offer, the Holders of Original Notes will continue
to be subject to the existing restrictions on transfer thereof and the Company
will have no further obligations to such Holders to provide for the registration
under the Securities Act of the Original Notes. Morgan Stanley & Co.
Incorporated ("Morgan Stanley") has advised the Company that it currently
intends to make a market in the Exchange Notes; however, it is not obligated to
do so and any market making activity may be discontinued at any time without
notice. Therefore, no assurance can be given that an active trading market will
develop or as to the liquidity of the trading market for either the Original
Notes or the Exchange Notes.
The Exchange Offer is not conditioned upon any minimum aggregate principal
amount of Original Notes being tendered for exchange but is otherwise subject to
customary conditions. The Exchange Offer will expire at 5:00 p.m., New York City
time, on December 5, 1997, unless extended by the Company to such other date and
time as the Company, in its sole discretion, may determine (the "Expiration
Date"). The date of acceptance for exchange of the Original Notes (the "Exchange
Date") will be the first business day following the Expiration Date. Original
Notes tendered pursuant to the Exchange Offer may be withdrawn at any time prior
to the Expiration Date; otherwise such tenders are irrevocable. There will be no
cash proceeds to the Company from the Exchange Offer.
This Prospectus, as it may be amended or supplemented from time to time, may
be used by a broker-dealer in connection with resales of Exchange Notes received
for Original Notes where such Original Notes were acquired for its own account
as a result of market-making activities or other trading activities. The Company
will make copies of this Prospectus available to any broker-dealer for use in
connection with any such resale.
2
<PAGE>
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (the "Registration Statement") under the Securities Act with respect to the
Exchange Notes being offered by this Prospectus. This Prospectus does not
contain all of the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain portions of which have been omitted
pursuant to the rules and regulations of the Commission. Statements made in this
Prospectus as to any contract, agreement or other document are summaries of the
material terms of such contracts, agreements or other documents and are not
necessarily complete. With respect to each such contract, agreement or other
document filed as an exhibit to the Registration Statement, reference is made to
the exhibit for a more complete description of the matter involved, and each
such statement is qualified in its entirety by such reference.
The Company is not currently subject to the informational requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Upon
completion of the Exchange Offer, the Company will file periodic reports and
other information with the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549. The Company is required by the terms of the Indenture, dated as of
July 1, 1997 (the "Indenture"), between the Company and The Bank of New York, as
trustee (the "Trustee"), under which the Original Notes were issued and under
which the Exchange Notes are to be issued, at all times from and after January
15, 1998, whether or not the Company is then required to file reports with the
Commission, so long as any of the Notes are outstanding, to furnish, to the
Trustee and each Holder, or supply to the Trustee for forwarding to each such
Holder, without cost to such Holder, such reports and other information as it
would be required to file with the Commission by Sections 13(a) or 15(d) under
the Exchange Act if it were subject thereto. In addition, at all times prior to
the registration of the Original Notes, the Company has agreed to furnish to any
Holder of Notes, and prospective investors upon their request, the information
required to be delivered pursuant to Rule 144A under the Securities Act.
Reports and other information filed by the Company with the Commission, and
the Registration Statement and the exhibits and schedules thereto, may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and will also be available for inspection and copying at the regional
offices of the Commission at 7 World Trade Center, 13th Floor, New York, New
York 10048 and at Northwestern Atrium Center, 500 West Madison Street (suite
1400), Chicago, Illinois 60661. Copies of such materials may also be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. Also, the Company will file such
reports and other information with the Commission pursuant to the Commission's
EDGAR system. The Commission maintains a Web site that contains reports and
other information regarding registrants that file electronically with the
Commission pursuant to the EDGAR system. The address of the Commission's Web
site is http://www.sec.gov.
3
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS APPEARING ELSEWHERE IN THIS PROSPECTUS. AS
USED HEREIN, THE TERMS "COMPANY" AND "ECONOPHONE" REFER TO ECONOPHONE, INC. AND
ITS SUBSIDIARIES, UNLESS THE CONTEXT OTHERWISE REQUIRES. STATEMENTS CONTAINED IN
THIS PROSPECTUS REGARDING ECONOPHONE'S EXPECTATIONS WITH RESPECT TO FUTURE
OPERATIONS AND OTHER MATTERS, WHICH CAN BE IDENTIFIED BY USE OF FORWARD-LOOKING
TERMINOLOGY, SUCH AS "MAY," "WILL," "EXPECT," "ANTICIPATE," "ESTIMATE" OR
"CONTINUE" OR THE NEGATIVE THEREOF OR VARIATIONS THEREON OR COMPARABLE
TERMINOLOGY, ARE FORWARD-LOOKING STATEMENTS. SEE "RISK FACTORS" FOR CAUTIONARY
STATEMENTS IDENTIFYING IMPORTANT FACTORS WITH RESPECT TO SUCH FORWARD-LOOKING
STATEMENTS, INCLUDING IMPORTANT RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM RESULTS REFERRED TO IN THE FORWARD-LOOKING
STATEMENTS. INDUSTRY DATA USED THROUGHOUT THIS PROSPECTUS WAS OBTAINED FROM
INDUSTRY PUBLICATIONS AND HAS NOT BEEN INDEPENDENTLY VERIFIED BY ECONOPHONE. SEE
"GLOSSARY" FOR A DESCRIPTION OF CERTAIN TERMS THAT MAY BE HELPFUL FOR
UNDERSTANDING CERTAIN TECHNICAL MATTERS DISCUSSED IN THIS PROSPECTUS.
THE EXCHANGE OFFER
Econophone completed on July 1, 1997 the Offering of 155,000 units (each a
"Unit"), each Unit consisting of one 13 1/2% Senior Note due 2007 of Econophone
and one warrant (each a "Warrant") to purchase 8.167 shares of common stock of
Econophone (the "Common Stock"). The Units were sold for an aggregate purchase
price of $155.0 million.
Econophone entered into a Notes Registration Rights Agreement with Morgan
Stanley (the "Placement Agent") in connection with the Offering in which it
agreed, among other things, to deliver to Holders this Prospectus and to
complete the Exchange Offer on or prior to January 15, 1998. Holders are
entitled to exchange in the Exchange Offer their Original Notes for Exchange
Notes with substantially identical terms. If the Exchange Offer is not completed
on or prior to January 15, 1998, interest (in addition to interest otherwise due
on the Notes) will accrue at a rate of .5% per annum, payable in cash
semiannually in arrears. See the discussion under the heading "Summary of Terms
of the Exchange Notes" and "Description of the Exchange Notes" for further
information regarding the Exchange Notes.
Econophone believes that Exchange Notes issued in the Exchange Offer may be
resold by Holders without compliance with the registration and prospectus
delivery provisions of the Securities Act, subject to certain conditions.
Holders should read the discussion under the headings "Summary of the Exchange
Offer" and "The Exchange Offer" for further information regarding the Exchange
Offer and resales of Exchange Notes.
THE COMPANY
Econophone is a switch-based provider of long distance telecommunications
services in certain major U.S. and western European markets. Econophone's
customer base consists primarily of small- and medium-sized businesses,
residential customers and other telecommunications carriers, with a focus on
customers with significant international calling needs. In the United States and
the United Kingdom, Econophone provides principally international and domestic
long distance, calling card, prepaid and carrier services. In western Europe,
Econophone provides principally international long distance, calling card and
prepaid services.
Through internal growth, Econophone's consolidated revenues have increased
from $3.5 million in 1993 to $45.1 million in 1996. Consolidated revenues for
the first six months of 1997 were $30.4 million. During that time, the United
States, western Europe and the United Kingdom accounted for 62%, 24% and 14% of
Econophone's consolidated revenues, respectively. Econophone's strategy is to
expand into new geographic markets in western Europe and the United States, with
a focus on large markets that generate substantial international calling
traffic, add customers in its existing markets and deliver an expanded portfolio
of features and services to its customers. Over time, Econophone expects its
European markets to contribute an increasingly larger percentage of its
revenues.
4
<PAGE>
International telecommunications is one of the fastest growing segments of
the long distance industry, having experienced a compounded growth in total
minutes of 14% per annum from 1989 to 1995. The European international long
distance market is the largest in the world, with approximately 26 billion
minutes or 43% of international calling volume originating in Europe in 1995.
The continental European state-owned telecommunications organizations (the
"PTOs") generally have had monopolies on providing telephone services from their
respective countries, making the cost of international telephone calls from
continental Europe much higher than comparable calls initiated from the United
States or the United Kingdom. Furthermore, customers in many continental
European markets generally have not been able to obtain from their PTO
value-added features that are readily available in the United States, such as
itemized billing, speed dial, redial and voice mail. Regulatory liberalization,
together with significant advances in technology that have decreased the cost of
providing services and allowed the provision of sophisticated value-added
features, is facilitating competition with European PTOs by emerging
telecommunications service providers.
Econophone has rapidly increased its network infrastructure over the past
twelve months, and is continuing to expand significantly its European network.
The location and dates of installation and commercial operation of Econophone's
switches, nodes and points of presence are as follows:
<TABLE>
<CAPTION>
NETWORK INSTALLATION COMMERCIAL
MARKET ELEMENT DATE OPERATION DATE
- ------------------ ------------------ ------------- -----------------
New York Switch 3Q93 3Q93
<S> <C> <C> <C>
- ------------------------------------------------------------------------
London Switch Partition 4Q95 4Q95
Point of
Baltimore Presence 4Q96 1Q97
Hamburg Node 4Q96 1Q97
Point of
New Jersey Presence 4Q96 1Q97
Point of
Philadelphia Presence 4Q96 1Q97
Point of
Washington, D.C. Presence 4Q96 1Q97
- ------------------------------------------------------------------------
Antwerp Node 1Q97 1Q97
- ------------------------------------------------------------------------
Brussels Switch 1Q97 1Q97
- ------------------------------------------------------------------------
Point of
Connecticut Presence 1Q97 1Q97
- ------------------------------------------------------------------------
London Switch 1Q97 2Q97
- ------------------------------------------------------------------------
Paris Switch 1Q97 1Q97
Amsterdam* Node 4Q97 4Q97
Athens* Node 4Q97 4Q97
Berlin* Node 4Q97 4Q97
Zurich* Node 4Q97 4Q97
</TABLE>
-------------------------------------
* Planned network expansion.
Econophone's network elements are interconnected by a combination of owned
indefeasible rights of use ("IRUs") and leased lines. In 1998, Econophone
intends to further expand its network to additional markets in western Europe
and the United States, as market and regulatory conditions warrant.
Econophone also is in the process of expanding its sales and marketing
activities. Econophone primarily sells its services through independent sales
representatives, who until recently had not been supported or supplemented by a
significant internal sales force. In many of its markets, Econophone's strategy
has been to retain independent sales representatives to market its services in
order to rapidly generate revenues and create local brand awareness. Econophone
recently has established and is expanding its internal sales forces in its
European network cities, which include Antwerp, Brussels, Hamburg, London and
Paris. In the United States, during 1997, Econophone has hired senior sales
personnel and sales managers for Baltimore, Connecticut, New Jersey and New
York. Going forward, Econophone's internal sales forces generally will
concentrate on sales to small- and medium-sized businesses and to other
carriers, while supporting local independent sales representatives, and
independent sales representatives will concentrate on residential sales.
In 1996, Econophone changed its distribution strategy in the United Kingdom.
In order to achieve greater strategic and operating flexibility in the United
Kingdom, Econophone terminated its U.K. sales and marketing joint venture in the
second quarter of 1996 and established a new operation, Telco Global
5
<PAGE>
Communications Ltd. ("Telco"). Telco concentrates on residential sales,
primarily through independent sales representatives.
Econophone believes that its principal competitive strengths are its carrier
grade network and internally developed supporting software, both of which enable
it to provide greater reliability and services and features not offered by many
of its competitors, its emphasis on technological innovation and its low cost
structure, which enables it to offer competitive pricing. In addition, in
continental Europe, Econophone believes that it provides more responsive
customer service than the PTOs and that it responds more quickly to new business
opportunities than the PTOs and other large competitors. Econophone also
believes that its relatively early entry as an alternative telecommunications
provider into continental European markets and the experience of certain members
of its management team in those markets provide it with a competitive advantage
over less experienced emerging competitors.
Econophone's successful implementation of its strategy will require the
continued expansion and development of its network in Europe and the United
States, as well as the continued expansion and development of related
back-office capacity, including billing systems, and the hiring and retention of
highly productive internal sales personnel and independent sales agents.
Execution of Econophone's expansion plans is subject to a variety of risks,
including, but not limited to, operating and technical problems, regulatory
uncertainties and competition, and there can be no assurance that Econophone
will be able to successfully implement such plans. Econophone has had, and
expects to continue to have, as hereinafter discussed, operating losses, net
losses, deficiencies of earnings to fixed charges, negative EBITDA and negative
cash flow. Econophone had a net loss of $7.8 million for the six months ended
June 30, 1997 and, on a pro forma basis, assuming that the Offering had been
consummated on January 1, 1997, a net loss of $18.9 million. Econophone had a
deficiency of earnings to fixed charges of $6.4 million ($17.5 million on a pro
forma basis) and negative EBITDA of $6.4 million for the six months ended June
30, 1997. Net cash used in operating activities for such six month period was
$7.7 million. Econophone expects to have operating losses, net losses and a
deficiency of earnings to fixed charges for at least the next several years and
negative EBITDA and negative cash flow from operations until at least 1999. See
"Risk Factors" for a discussion of certain risks associated with Econophone's
business and "Selected Financial Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements
contained herein for further information concerning Econophone's historical
financial performance.
On November 1, 1996, Princes Gate Investors II, L.P. and certain of its
affiliates (collectively, "Princes Gate") purchased 140,000 shares of Series A
Redeemable Convertible Preferred Stock, par value $.01 per share, of Econophone
("Series A Preferred Stock") for $14.0 million, less certain fees. Princes Gate
is an affiliate of Morgan Stanley, the Placement Agent in the Offering. The
Series A Preferred Stock is convertible into shares of Common Stock representing
approximately 14.6% of the Common Stock of Econophone on an as converted basis
(determined as of October 1, 1997 without giving effect to the issuance or
exercise of the Warrants or any options issued by Econophone). On April 24,
1997, Econophone entered into a Note Purchase Agreement (the "Note Purchase
Agreement") with Morgan Stanley Group Inc., an affiliate of Morgan Stanley
("Morgan Stanley Group"), pursuant to which Morgan Stanley Group agreed to
purchase from Econophone up to $15.0 million of First Secured Increasing Rate
Notes due April 24, 1998 (the "Bridge Notes"). Econophone sold a total of $7.0
million of Bridge Notes to Morgan Stanley Group and, upon consummation of the
Offering, all of the outstanding Bridge Notes were redeemed and all accrued
interest thereon was paid. At such time, the facility represented by the Note
Purchase Agreement was terminated. Prior to the Offering and the investments by
Princes Gate and Morgan Stanley Group, Econophone's growth had been funded
primarily through founders' capital, internally generated funds and equipment
financings.
Econophone's principal executive offices are located at 45 Broadway, New
York, New York 10006. Its main telephone number is (212) 444-6991.
6
<PAGE>
SUMMARY OF THE EXCHANGE OFFER
<TABLE>
<S> <C>
Registration Rights
Agreement............. Holders are entitled to exchange the Original Notes for Notes
registered under the Securities Act with substantially identical
terms. The Exchange Offer is intended to satisfy these rights.
After the Exchange Offer is complete, Holders will no longer be
entitled to any exchange or registration rights with respect to
the Original Notes.
The Exchange Offer...... The Company is offering to exchange $1,000 principal amount of
Exchange Notes that have been registered under the Securities Act
for each $1,000 principal amount of the Original Notes. In order
to be exchanged, an outstanding note must be properly tendered
and accepted. All outstanding notes that are validly tendered and
not validly withdrawn will be exchanged.
As of this date, there are $155.0 million principal amount of the
Original Notes outstanding.
The Company will issue registered Exchange Notes on or promptly
after the expiration of the Exchange Offer. Each of the Original
Notes was originally issued as part of a Unit consisting of one
Original Note and a Warrant to purchase 8.167 shares of the
Common Stock of the Company. These Warrants will be separately
traded on the commencement of the Exchange Offer and the Company
is not offering to exchange them.
Resales................. Except as indicated herein, the Company believes that the
Exchange Notes may be offered for resale, resold and otherwise
transferred by Holders without compliance with the registration
and prospectus delivery provisions of the Securities Act,
provided that:
(i) the Exchange Notes are being acquired in the ordinary
course of a Holder's business;
(ii) a Holder is not participating, does not intend to
participate, and has no arrangement or understanding with any
person to participate, in the distribution of the Exchange
Notes; and
(iii) a Holder is not an "affiliate" of the Company.
If the Company's belief is inaccurate and a Holder transfers any
Exchange Note without delivering a prospectus meeting the
requirements of the Securities Act or without an exemption from
such requirements, such Holder may incur liability under the
Securities Act. The Company does not assume or indemnify Holders
against such liability.
Each broker-dealer that is issued Exchange Notes for its own
account in exchange for Original Notes which were acquired by
such broker-dealer as a result of market-making or other trading
activities must acknowledge that it will deliver a Prospectus
meeting the requirements of the Securities Act in connection with
any resale of the notes issued in the Exchange Offer. A
broker-dealer may use this Prospectus for an offer to resell,
resale or other retransfer of the Exchange Notes.
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
Expiration Date......... The Exchange Offer will expire at 5:00 p.m., New York City time,
December 5, 1997, unless the Company decides to extend the
Expiration Date.
Conditions to the
Exchange Offer........ The Exchange Offer is not subject to any condition other than
that the Exchange Offer not violate applicable law or any
applicable interpretation of the Staff of the Commission.
Procedures for Tendering
Outstanding Notes held
in the Form of Book-
Entry Interests....... The Original Notes were issued as global securities without
interest coupons. The Original Notes were deposited with The Bank
of New York, as book-entry depositary, when they were issued. The
Bank of New York issued a certificateless depositary interest in
each Original Note, which represents a 100% interest in the
Original Note, to The Depository Trust Company ("DTC").
Beneficial interests in the Original Notes, which are held by
direct or indirect participants in DTC through the
certificateless depositary interests (the "Book-Entry
Interests"), are shown on, and transfers of such Original Notes
can be made only through, records maintained in book-entry form
by DTC (with respect to its participants) and its participants.
Holders of Original Notes held in the form of a Book-Entry
Interest who wish to tender their Book-Entry Interest for
exchange pursuant to the Exchange Offer must transmit to The Bank
of New York, as exchange agent (the "Exchange Agent"), on or
prior to the Expiration Date:
(i) either:
(a) a properly completed and duly executed Letter of
Transmittal, which accompanies this Prospectus, or a facsimile
of the Letter of Transmittal, including all other documents
required by the Letter of Transmittal, to the Exchange Agent at
the address set forth on the cover page of the Letter of
Transmittal; or
(b) a computer-generated message transmitted by means of DTC's
Automated Tender Offer Program system and received by the
Exchange Agent and forming a part of a confirmation of
book-entry transfer in which such Holder acknowledges and
agrees to be bound by the terms of the Letter of Transmittal;
and (ii) either:
(a) a timely confirmation of book-entry transfer of such
Holder's Original Notes into the Exchange Agent's account at
DTC, pursuant to the procedure for book-entry transfers
described in this Prospectus under the heading "The Exchange
Offer--Book-Entry Transfer," received by the Exchange Agent on
or prior to the Expiration Date; or
(b) the documents necessary for compliance with the guaranteed
delivery procedures described below.
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
Procedures for Tendering
Definitive Registered
Notes................. Subject to certain conditions, a holder of Book-Entry Interests
in the Original Notes is entitled to receive, in exchange for its
Book-Entry Interests, registered Original Notes which are in
equal principal amounts to its Book-Entry Interests. However, as
of this date, no registered Original Notes are issued and
outstanding. If a Holder acquires registered Original Notes prior
to the Expiration Date, such Holder must tender its registered
Original Notes in accordance with the procedures described in
this Prospectus under the heading "The Exchange Offer--Procedures
for Tendering Definitive Registered Notes."
Special Procedures for
Beneficial Owners..... A beneficial owner of Book-Entry Interests whose name does not
appear on a security position listing of DTC as the holder of
such Book-Entry Interests or a beneficial owner of registered
Original Notes that are registered in the name of a broker,
dealer, commercial bank, trust company or other nominee that
wishes to tender such Book-Entry Interests or registered Original
Notes in the Exchange Offer should contact such person in whose
name its Book-Entry Interests or registered Original Notes are
registered promptly and instruct such person to tender on its
behalf.
Guaranteed Delivery
Procedures............ If Holders wish to tender their Original Notes and time will not
permit the required documents to reach the Exchange Agent by the
Expiration Date, or the procedure for book-entry transfer cannot
be completed on time or certificates for registered Original
Notes cannot be delivered on time, such Holders may tender their
Original Notes pursuant to the procedures described in this
Prospectus under the heading "The Exchange Offer-- Guaranteed
Delivery Procedures."
Withdrawal Rights....... Holders may withdraw the tender of their Notes at any time prior
to 5:00 p.m. New York City time on December 5, 1997.
Certain U.S. Federal
Income Tax
Consequences.......... The exchange of Original Notes will not be a taxable exchange for
United States federal income tax purposes. Holders will not
recognize any taxable gain or loss or any interest income as a
result of such exchange.
Use of Proceeds......... The Company will not receive any proceeds from the issuance of
the Exchange Notes pursuant to the Exchange Offer. The Company
will pay all expenses incident to the Exchange Offer.
Exchange Agent.......... The Bank of New York is serving as Exchange Agent in connection
with the Exchange Offer.
</TABLE>
9
<PAGE>
SUMMARY OF TERMS OF THE EXCHANGE NOTES
The form and terms of the notes to be issued in the Exchange Offer are the
same as the form and terms of the Original Notes, except that the Exchange Notes
will be registered under the Securities Act and, therefore, will not bear
legends restricting their transfer and generally will not be entitled to
registration under the Securities Act. The Exchange Notes will evidence the same
debt as the Original Notes and both the Original Notes and the Exchange Notes
are governed by the same Indenture.
<TABLE>
<S> <C>
Aggregate Amount........ $155.0 million principal amount of 13 1/2% Senior Notes due 2007
of Econophone.
Maturity................ July 15, 2007.
Yield and Interest...... Interest on the Notes will be payable in cash at a rate of
13 1/2% per annum, semi-annually in arrears on each January 15
and July 15, commencing January 15, 1998. In addition to stated
interest, for U.S. federal income tax purposes, purchasers of the
Notes will be required to include amounts attributable to
original issue discount in their gross income in advance of
receipt of the cash payment to which such income is attributable.
See "Certain Federal Income Tax Considerations."
Security................ Econophone has used approximately $57.4 million of the net
proceeds from the issuance of the Original Notes to purchase a
portfolio of securities, consisting of U.S. government securities
(the "Pledged Securities"), that has been pledged as security for
the payment of the first six scheduled interest payments due on
the Notes. Proceeds from the Pledged Securities will be used by
Econophone to make the first six scheduled interest payments on
the Notes. See "Description of the Exchange Notes--Security." The
Pledged Securities are being held by the Trustee (as defined
herein) under the Pledge Agreement (as defined herein) pending
disbursement.
Optional Redemption..... On or after July 15, 2002, the Notes will be redeemable, at the
option of Econophone, in whole or in part, at any time or from
time to time, at the redemption prices set forth herein, plus
accrued and unpaid interest, if any, to the date of redemption.
In addition, prior to July 15, 2000, up to 35% of the aggregate
principal amount of the Notes may be redeemed with the proceeds
of Public Equity Offerings (as defined herein). See "Description
of the Exchange Notes--Optional Redemption."
Change of Control....... Upon a Change of Control (as defined herein), Econophone is
required to make an offer to purchase the Notes at a purchase
price equal to 101% of the aggregate principal amount thereof,
plus accrued interest, if any. There can be no assurance that
Econophone will have sufficient funds available at the time of a
Change of Control to fund any repurchase of Notes required by the
foregoing covenant. See "Description of the Exchange Notes--
Repurchase of Notes upon a Change of Control."
Ranking................. The Notes are unsecured, unsubordinated indebtedness of
Econophone, rank PARI PASSU in right of payment with all existing
and future unsubordinated indebtedness of Econophone, and are
senior in right of payment to all existing and future
subordinated indebtedness of Econophone. As of September 30,
1997, excluding the Notes, Econophone had $5.3 million of
indebtedness outstanding, all of which was senior
</TABLE>
10
<PAGE>
<TABLE>
<S> <C>
indebtedness and $5.0 million of which was secured. The Notes are
effectively subordinated to such secured indebtedness to the
extent of the security interests relating thereto.
Certain Covenants....... The Indenture contains certain covenants, which, among other
things and subject to certain exceptions, restrict the ability of
Econophone and its Restricted Subsidiaries to incur additional
indebtedness, make restricted payments, create restrictions on
the ability of Restricted Subsidiaries to make payments to
Econophone, issue capital stock of Restricted Subsidiaries, issue
guarantees, enter into transactions with stockholders and affili-
ates, create liens, engage in sale-leaseback transactions, sell
assets and, with respect to Econophone, consolidate, merge or
sell all or substantially all of its assets. See "Description of
the Exchange Notes--Covenants."
Original Issue
Discount.............. The Exchange Notes should be treated as a continuation of the
Original Notes for federal income tax purposes. The Original
Notes were issued with original issue discount. For federal
income tax purposes, holders of the Notes will be required to
include the amount of original issue discount in income in
advance of receipt of cash to which the income is attributable.
See "Certain Federal Income Tax Considerations."
</TABLE>
11
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
THE FOLLOWING SUMMARY CONSOLIDATED FINANCIAL DATA (EXCEPT FOR CERTAIN DATA
UNDER OTHER DATA AND DATA UNDER REGIONAL DATA) FOR THE YEARS ENDED DECEMBER 31,
1994, 1995 AND 1996 WAS DERIVED FROM THE AUDITED CONSOLIDATED FINANCIAL
STATEMENTS OF ECONOPHONE. THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF
ECONOPHONE AS OF DECEMBER 31, 1995 AND 1996 AND FOR EACH OF THE THREE YEARS IN
THE PERIOD ENDED DECEMBER 31, 1996, TOGETHER WITH THE NOTES THERETO AND THE
RELATED REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT ACCOUNTANTS, ARE INCLUDED
ELSEWHERE IN THIS PROSPECTUS. THE SUMMARY CONSOLIDATED FINANCIAL DATA FOR THE
YEARS ENDED DECEMBER 31, 1992 AND 1993 IS DERIVED FROM UNAUDITED FINANCIAL
STATEMENTS OF ECONOPHONE, WHICH, IN THE OPINION OF MANAGEMENT, INCLUDE ALL
ADJUSTMENTS NECESSARY FOR A FAIR PRESENTATION OF THE FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF ECONOPHONE FOR SUCH PERIODS. THE FOLLOWING SUMMARY
FINANCIAL INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997 WAS
DERIVED FROM THE UNAUDITED INTERIM FINANCIAL STATEMENTS OF ECONOPHONE AND
REFLECTS ALL ADJUSTMENTS (CONSISTING OF NORMAL RECURRING ADJUSTMENTS) WHICH ARE,
IN THE OPINION OF MANAGEMENT, NECESSARY FOR A FAIR PRESENTATION OF THE
CONSOLIDATED FINANCIAL INFORMATION FOR THOSE PERIODS. THE INFORMATION CONTAINED
BELOW SHOULD BE READ IN CONJUNCTION WITH "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND THE FINANCIAL STATEMENTS
OF ECONOPHONE AND THE NOTES RELATED THERETO INCLUDED ELSEWHERE IN THIS
PROSPECTUS.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
--------------------------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1992(1) 1993(1) 1994 1995 1996 1996 1997
----------- ----------- --------- --------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS, EXCEPT NET INCOME (LOSS) PER SHARE,
REVENUE PER MINUTE AND RATIO OF EARNINGS TO FIXED CHARGES)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 3,268 $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 22,992 $ 30,446
Cost of services............................ 2,659 2,761 5,540 19,735 35,369 16,333 24,012
Selling, general and administrative
expense................................... 474 497 2,013 7,087 16,834 9,805 12,896
Depreciation and amortization............... 12 51 168 389 1,049 383 1,069
----------- ----------- --------- --------- --------- --------- ---------
Income (loss) from operations............... 123 219 802 279 (8,149) (3,529) (7,531)
Other income (expense)...................... -- 6 100 (10) 133 11 58
Interest expense, net....................... -- (19) (103) (148) (296) (78) (285)
Provision (benefit) for taxes............... 2 -- 73 -- -- -- --
----------- ----------- --------- --------- --------- --------- ---------
Net income (loss)........................... $ 121 $ 206 $ 726 $ 121 $ (8,312) $ (3,596) $ (7,758)
----------- ----------- --------- --------- --------- --------- ---------
----------- ----------- --------- --------- --------- --------- ---------
Net income (loss) per share(3).............. $ .01 $ .01 $ .04 $ .01 $ (.42) $ (.18) $ (.39)
OTHER DATA:
Capital expenditures(4)..................... $ 118 $ 605 $ 906 $ 1,677 $ 4,670 $ 2,152 $ 5,758
EBITDA(5)................................... 135 276 1,070 658 (6,967) (3,135) (6,404)
Dividends declared.......................... -- -- -- 449 508 226 879
Net cash (used in) provided by operating
activities(6)............................. -- (190) 474 2,037 (6,006) 60 (7,698)
Revenue per minute.......................... .70 .57 .43 .56 .29
Minutes..................................... 12,196 47,859 104,566 40,869 104,615
Ratio of earnings to fixed charges(7)....... 2.5x 8.6x 7.2x 1.5x -- -- --
Deficiency of earnings available to cover
fixed charges............................. -- -- -- -- $ (7,507) $ (3,476) $ (6,395)
REGIONAL DATA:
Revenues
United States............................. $ 2,728 $ 8,292 $ 18,185 $ 6,876 $ 18,896
United Kingdom............................ 3,143 14,173 15,477 10,910 4,201
Continental Europe........................ 2,652 5,025 11,441 5,206 7,349
Minutes
United States............................. 5,707 23,411 68,247 20,744 87,747
United Kingdom............................ 4,532 20,592 27,968 16,390 10,136
Continental Europe........................ 1,957 3,856 8,351 3,735 6,732
<CAPTION>
<S> <C>
AS ADJUSTED
1997(2)
--------------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 30,446
Cost of services............................ 24,012
Selling, general and administrative
expense................................... 12,896
Depreciation and amortization............... 1,414
--------------
Income (loss) from operations............... (7,876)
Other income (expense)...................... 58
Interest expense, net....................... (11,028)
Provision (benefit) for taxes............... --
--------------
Net income (loss)........................... $ (18,846)
--------------
--------------
Net income (loss) per share(3).............. $ (.94)
OTHER DATA:
Capital expenditures(4).....................
EBITDA(5)...................................
Dividends declared..........................
Net cash (used in) provided by operating
activities(6).............................
Revenue per minute..........................
Minutes.....................................
Ratio of earnings to fixed charges(7)....... --
Deficiency of earnings available to cover
fixed charges............................. $ (17,483)
REGIONAL DATA:
Revenues
United States.............................
United Kingdom............................
Continental Europe........................
Minutes
United States.............................
United Kingdom............................
Continental Europe........................
</TABLE>
12
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<TABLE>
<CAPTION>
AT JUNE
AT DECEMBER 31, 1996 30, 1997
----------------------------------------------------- ---------
1992 1993 1994 1995 1996 ACTUAL
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents..................................... $ 12 $ 120 $ 86 $ 106 $ 6,272 $ 632
Current assets................................................ 519 852 2,588 7,616 14,729 15,063
Restricted cash............................................... -- -- -- -- -- --
Total assets.................................................. 609 1,541 4,034 10,508 22,755 28,224
Current portion of borrowings................................. 420 510 480 558 3,020 8,300
Long-term borrowings, less current portion.................... -- 39 639 719 2,263 4,799
Redeemable Convertible Preferred Stock........................ -- -- -- -- 13,358 14,282
Total stockholders' equity (deficit).......................... 118 708 1,088 710 (8,124) (16,817)
<CAPTION>
AS ADJUSTED(2)
--------------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................................... $ 90,295
Current assets................................................ 123,872
Restricted cash............................................... 57,437
Total assets.................................................. 182,224
Current portion of borrowings................................. 7,300
Long-term borrowings, less current portion.................... 154,199
Redeemable Convertible Preferred Stock........................ 14,282
Total stockholders' equity (deficit).......................... (11,217)
</TABLE>
- ------------------------
(1) Regional revenue data and minute data for 1992 and 1993 are not available.
(2) The as adjusted data gives effect to (i) the issuance of the Units and the
accrual and accretion of interest associated with the Notes, (ii) the
amortization of the deferred financing costs associated with the Offering,
(iii) the repayment of approximately $.6 million owed to IDT Corporation
("IDT") and (iv) the repayment of certain equipment financings totaling
approximately $.4 million in the aggregate, as if such events had occurred
on January 1, 1997 (for statement of operations purposes) and June 30, 1997
(for balance sheet purposes). See "Use of Proceeds." As adjusted data does
not give effect to any interest income on the proceeds of the Units.
(3) Net income (loss) per share is computed using the weighted average number of
shares outstanding during the period.
(4) Capital expenditures include assets acquired through capital lease financing
and other debt.
(5) EBITDA represents net income (loss) plus interest expense, income tax
expense, and depreciation and amortization expense. Econophone has 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 more meaningful than,
measures of performance determined in accordance with generally accepted
accounting principles.
(6) Net cash (used in) provided by operations for the year ended December 31,
1992 is not available.
(7) Earnings available to cover fixed charges consist of earnings (losses)
before income taxes. Fixed charges consist of interest on debt, the interest
component of rent expense (deemed to be one-third of the total) and
dividends accrued on preferred stock.
13
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE EXCHANGE NOTES INVOLVES A HIGH DEGREE OF RISK. THE
FOLLOWING RISK FACTORS, TOGETHER WITH THE OTHER INFORMATION CONTAINED IN THIS
PROSPECTUS, SHOULD BE CONSIDERED CAREFULLY BEFORE PURCHASING THE EXCHANGE NOTES.
THE TERM "NOTE" OR "NOTES" INCLUDES THE ORIGINAL NOTES AND THE EXCHANGE NOTES.
LIMITED OPERATING HISTORY
Econophone commenced operations in 1989, and prior to 1994 engaged only in
limited operations, and, therefore, has a limited operating history upon which
potential investors may base an evaluation of its performance. Econophone's
principal operations have been in the United Kingdom (principally in the London
area), the United States (principally in the New York area) and Belgium
(principally in the Antwerp area). Econophone began providing services in its
other continental European and U.S. markets only in 1996 and 1997 and, to date,
its business activities in such markets have been limited. See
"Business--Services."
Econophone intends to significantly expand its operations in its current
markets and to enter into a number of markets where it currently does not have
operations. In many of its existing and future markets, Econophone also plans to
offer services that have been provided in the past to a large extent only by
PTOs. Furthermore, in certain of such markets, Econophone also intends to
utilize access and transmission methods with respect to which it has limited
operating experience. Econophone's prospects must, therefore, be considered in
light of the risks, expenses, problems and delays inherent in substantially
expanding a business and in establishing a new business in additional markets in
an evolving industry. See "--Implementation of Expansion Plans," "--Need for
Local Connectivity," "--Dependence on Third Party Sales Organizations,"
"--Competition," "--Risks Associated with Rapid Growth," "--Risks Associated
with Rapidly Changing Industry; Significant Price Declines," "--Dependence on
Effective Information Systems," "--Dependence Upon Key Personnel; Integration of
Management," "--Dependence on Equipment Supplier" and "Business--Services."
HIGH LEVERAGE, FUTURE LOSSES, DEFICIENCY OF EARNINGS TO FIXED CHARGES AND
NEGATIVE CASH FLOW
At June 30, 1997, on an as adjusted basis after giving effect to the
Offering, Econophone would have had total consolidated indebtedness of
approximately $161.5 million and negative stockholders' equity of approximately
$11.2 million. Econophone anticipates that it will incur additional
indebtedness, primarily in connection with equipment financings. Econophone had
a net loss of $8.3 million and $7.8 million for the year ended December 31, 1996
and for the six months ended June 30, 1997, respectively. On a pro forma basis,
assuming the Offering had been consummated on January 1, 1997, Econophone would
have had a net loss of $18.8 million for the six months ended June 30, 1997,
and, assuming the Offering had been consummated on January 1, 1996, Econophone
would have had a net loss of $30.4 million for 1996. In addition, for the six
months ended June 30, 1997, Econophone's deficiency of earnings to fixed charges
was $6.4 million and, for the year ended December 31, 1996, the deficiency was
$7.5 million. Econophone also had negative EBITDA of $5.0 million and $6.4
million for the year ended December 31, 1996 and for the six months ended June
30, 1997, respectively. Furthermore, Econophone had net cash used in operating
activities of $6.0 million and $7.7 million for the year ended December 31, 1996
and the six months ended June 30, 1997, respectively. Econophone expects to have
operating losses, net losses and a deficiency of earnings to fixed charges for
at least the next several years and negative EBITDA and negative cash flow from
operations until at least 1999. See "Capitalization" and "Selected Consolidated
Financial Data."
The ability of Econophone to meet its debt service obligations will depend
upon its future performance, which, in turn, is subject to Econophone's
successful implementation of its strategy, as well as to financial, competitive,
business, regulatory, technical and other factors, substantially all of which
are beyond Econophone's control. There can be no assurance that Econophone will
ever operate at profitable levels, have positive EBITDA or eliminate its
deficiency of earnings to fixed charges. If Econophone is unable to generate
cash flow from operations that, together with its restricted cash, is sufficient
to meet its debt service requirements, it may be required to refinance all or a
portion of its indebtedness. There can be
14
<PAGE>
no assurance that any such refinancing would be possible on terms that would be
acceptable to Econophone, if at all. If such refinancing were not possible or if
additional financing were not available, Econophone could be forced to default
on its obligations with respect to the Notes.
The Indenture contains certain restrictive covenants. Such restrictions
affect, and in many respects significantly limit, among other things, the
ability of Econophone to incur indebtedness, make prepayments of subordinated
indebtedness, pay dividends, make investments, engage in transactions with
stockholders and affiliates, issue capital stock of restricted subsidiaries,
create liens, sell assets and engage in mergers and consolidations. See
"Description of the Exchange Notes--Covenants." The terms of Econophone's Series
A Preferred Stock and the Amended and Restated Equipment Loan and Security
Agreement between Econophone and NTFC Capital Corporation ("NTFC") (as amended,
the "NTFC Agreement") also place restrictions on the ability of Econophone to
incur indebtedness and to engage in certain other transactions. These
restrictions, in combination with Econophone's high leverage, could limit the
ability of Econophone to effect financings or other corporate activities.
Furthermore, the high level of Econophone's indebtedness could restrict its
flexibility in responding to changing business and economic conditions, its
ability to take advantage of business opportunities and its ability to pay
principal and interest on the Notes. See "Description of Certain
Indebtedness--NTFC Vendor Financing" and "Certain Transactions-- Investment by
Princes Gate--Series A Preferred Stock."
The level of Econophone's indebtedness could have important consequences to
holders of the Notes, including the following: (i) the debt service requirements
of other indebtedness could make it more difficult for Econophone to make
payments on the Notes (other than the first six scheduled interest payments),
(ii) the ability of Econophone to obtain any necessary financing in the future
for working capital, capital expenditures, debt service requirements or other
purposes may be limited; (iii) a substantial portion of Econophone's future cash
flow from operations, if any, may be dedicated to the payment of principal and
interest on its indebtedness and other obligations and might not be available
for Econophone's business; (iv) Econophone's level of indebtedness could limit
its flexibility in planning for, or reacting to changes in, its business; (v)
Econophone will be more highly leveraged than certain of its competitors, which
may place it at a competitive disadvantage; and (vi) Econophone's high degree of
indebtedness could make it more vulnerable in the event of a downturn in its
business. Econophone's high level of indebtedness may have a material adverse
effect on its ability to pay principal and interest on the Notes. See "Selected
Consolidated Financial Data" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
IMPLEMENTATION OF EXPANSION PLANS
Econophone's successful implementation of its strategy will require the
continued expansion and development of its network in Europe and the United
States, as well as the continued expansion and development of related
back-office capacity, including billing systems, and the hiring and retention of
highly productive internal sales personnel and independent sales agents.
Execution of Econophone's expansion plans is subject to a variety of risks,
including, but not limited to, operating and technical problems, regulatory
uncertainties and competition, and there can be no assurance that Econophone
will be able to successfully implement such plans.
As Econophone expands its network, it will incur significant fixed costs,
relating principally to switching equipment costs, IRUs and leased lines and
network management costs. The installation and expansion of Econophone's network
has entailed and will continue to entail considerable expenses in advance of
anticipated revenues and may cause substantial fluctuations in Econophone's
operating results. Econophone will use its network primarily to originate, but
not terminate, calls. Therefore, the economic benefits of Econophone's network
primarily will be limited to originating calls where Econophone has a switch,
node or point of presence. There can be no assurance that Econophone will be
able to expand its network successfully or that Econophone will generate traffic
volumes sufficient to enjoy significant economies of scale, which Econophone
believes are critical to the overall success of its strategy. Failure by
15
<PAGE>
Econophone to implement its expansion plans would have a material adverse effect
on Econophone's financial condition and results of operations and its ability to
pay principal of and interest on the Notes.
COMPETITION
The provision of telecommunications services is extremely competitive and
will become increasingly so as the regulatory barriers to entry into
telecommunications markets are reduced or eliminated. Econophone believes that
its non-US markets will experience increased competition and will begin to
resemble the competitive landscape in the United States, in part as a result of
regulatory initiatives.
Competition for customers is primarily on the basis of price and, to a
lesser extent, on the type and quality of services offered and customer service.
Econophone has no control over the prices set by its competitors. Econophone has
a large number of competitors which may use their substantial financial
resources to cause severe price competition in the markets in which Econophone
operates, which would require Econophone to reduce its prices in order to remain
competitive. For example, Sprint recently announced a program offering $.10 per
minute rates on certain calls to the United Kingdom. Econophone has focused on
users that make these calls. In the United Kingdom, the Office of
Telecommunications ("Oftel"), the U.K. telecommunications regulatory authority,
is expected to continue to require British Telecom to reduce its retail prices.
In the United States, the Federal Communications Commission (the "FCC"), the
U.S. telecommunications regulatory authority, also has proposed rules (which may
or may not be adopted in their proposed form or in a revised form) which are
designed to bring downward pressure on international telephone rates. The FCC is
proposing to require U.S. international facilities-based carriers to pay lower
settlement rates to correspondent foreign carriers that deliver calls in foreign
jurisdictions. Any resulting savings to the U.S. facilities-based carriers might
be passed along to their customers in the form of reduced rates for
international calls. Corresponding price reductions by Econophone could reduce
Econophone's revenue and margins, which could have a material adverse effect on
Econophone's business, financial condition and results of operations and its
ability to pay interest on and principal of the Notes. Econophone has
experienced, and expects to continue to experience, declining revenue per
billable minute in all of its markets, in part as a result of increasing
worldwide competition within the telecommunications industry. Econophone also
experiences customer attrition, or "churn," as a result of the highly
competitive nature of its markets and expects current levels of churn to
continue or increase.
Econophone's success will depend upon its ability to compete with a variety
of other telecommunications providers in each of its markets. In Europe,
Econophone's competitors include (i) PTOs, (ii) alliances such as AT&T's
alliance with Unisource (itself a joint venture among Telecom Netherlands, Telia
AB and Swiss Telecom PTT), known as "Uniworld," and the corresponding alliance
with WorldPartners, MCI's alliance with British Telecom, known as "Concert," and
Sprint's alliance with Deutsche Telekom and France Telecom, known as "Global
One," (iii) companies offering resold international telecommunications services,
such as Esprit Telecom, Viatel and RSL Communications, and (iv) other companies
with business plans similar in varying degrees to Econophone's, including
emerging public telephone operators who are constructing their own networks.
Unisource recently announced that its venture partners would contribute their
international facilities and personnel to a newly formed company, and some
commentators have speculated that AT&T might do the same. The resulting company
is likely to be a substantially more formidable competitor. In addition,
Econophone anticipates that numerous new competitors will enter the European
telecommunications market.
Because all of Econophone's current and intended European markets (other
than the United Kingdom, which already has a substantially liberalized
telecommunications market) still are in the process of liberalizing the
provision of telephone services, customers in most of these markets are not
accustomed to obtaining services from competitors to PTOs and may be reluctant
to use new providers, such as Econophone. In particular, Econophone's target
customers, small- and medium-sized businesses and residential users with
significant international calling needs, may be reluctant to entrust their
telecommunications needs to new operators that are believed to be unproven. In
addition, in continental Europe, certain of Econophone's competitors (including
the PTOs) provide potential customers with a
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broader range of services than Econophone currently offers or can offer due to
regulatory restrictions. PTOs also generally have certain competitive advantages
over Econophone and other providers due to their control of local
inter-connectivity, their extensive ownership of facilities, their ability to
delay or prevent equal access to lines and the reluctance of some regulators to
adopt policies and grant regulatory approvals that will result in increased
competition for the local PTO. If the PTO in any jurisdiction uses its
competitive advantages to their fullest extent, Econophone's operations in such
jurisdiction would be adversely affected.
In the United States, Econophone's competitors include AT&T, MCI, Sprint and
numerous other carriers for domestic and international long distance calls.
Congress has substantially amended the Communications Act of 1934 (the "1934
Act") by enacting the Telecommunications Act of 1996 (the "1996 Act"), making
the regional Bell operating companies (the "RBOCs") eligible, subject to FCC
approval, to offer domestic long distance and international telecommunications
services in their "in region" service areas, where they control essential
facilities such as local lines connecting to the premises of customers. The use
of these facilities is necessary at reasonable and non-discriminatory rates, and
on reasonable and nondiscriminatory conditions, to enable new market entrants,
including long distance carriers, to compete effectively with the RBOCs and
other carriers. The RBOCs have the incentive to overcharge for the use of their
essential facilities for the dual purposes of retarding competition from new
local market entrants and cross-subsidizing their proposed new long distance
services. The RBOCs also may offer domestic long distance and international
services outside of their service areas, or "out-of-region" services. In
addition, the FCC is now permitting foreign telecommunications entities to enter
the U.S. international telecommunications market, including dominant foreign
entities whose home markets are conducive to competition. The FCC also has
substantially reduced the regulatory constraints on AT&T, Econophone's largest
competitor, by declaring AT&T to be "non-dominant," first in the domestic long
distance market and more recently in the international market, thus, granting
AT&T more pricing and service flexibility and permitting it to compete more
effectively with smaller inter-exchange carriers such as Econophone.
The World Trade Organization (the "WTO") recently concluded an agreement,
known as the WTO Basic Telecommunications Service Agreement (the "WTO
Agreement"), which would open the telecommunications markets of the signatory
countries to foreign carriers on varying dates beginning January 1, 1998. The
WTO Agreement is subject to legislative ratification in many of the 70 signatory
countries. Pursuant to the WTO Agreement, U.S. companies would have foreign
market access for local, long distance and international services, either on a
facilities basis or through resale of existing network capacity. U.S. companies
also would be permitted to acquire, establish or hold a significant stake in
telecommunications companies around the world. Conversely, foreign companies
would be permitted to enter the domestic U.S. telecommunications market and
acquire ownership interests in U.S. service providers. Although the WTO
Agreement may open additional markets to Econophone or broaden the permissible
services that Econophone can provide in certain markets, the WTO Agreement also
may subject Econophone to greater competitive pressures in its markets, with the
risk of losing customers to other carriers and reductions in Econophone's rates.
In addition, there are pending major consolidations in the
telecommunications industry which could result in even more powerful competitors
to Econophone in its major markets. For example, the acquisition of MCI by
British Telecom, if consummated, could adversely impact Econophone in the market
for calling between the United Kingdom and the United States and the creation of
a new company with the international facilities of the Unisource partners could
result in downward pressure on prices without a corresponding reduction in
transmission costs. In addition, the recent merger between Bell Atlantic and
NYNEX and the acquisition of MCI by WorldCom, Inc. or GTE, if consummated, may
result in increased price competition.
Econophone also may experience competition in one or more of its markets
from competitors utilizing new or alternative technologies and/or transmission
methods, including cable television companies, wireless telephone companies,
satellite owners and resellers, Internet service providers, electric and other
utilities, railways, microwave carriers and large end users that have private
networks.
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Many of Econophone's competitors are significantly larger, have
substantially greater financial, technical and marketing resources and larger
networks than Econophone, control transmission lines and have long-standing
relationships with Econophone's target customers. If any of Econophone's
competitors were to devote additional resources to the provision of
international and/or domestic long distance voice telecommunication services to
Econophone's target customer base, there could be a material adverse effect on
Econophone's ability to pay principal of and interest on the Notes.
Each of the markets in which Econophone offers or intends to offer its
services will present unique competitive factors. There can be no assurance that
Econophone will be able to effectively compete in any given market and the
success of Econophone's strategy in any one market is not necessarily indicative
of its ability to succeed in any other market. See "Business--Competition."
DEPENDENCE ON THIRD PARTY SALES ORGANIZATIONS
Econophone historically has sold substantially all, and intends to continue
selling a substantial percentage of, its services through indirect channels of
distribution, consisting of independent sales agents and resellers. For the six
months ended June 30, 1997, 50% of Econophone's revenues were attributable to
independent sales agents. Substantially all of Econophone's U.S. calling card
sales are attributable to VoiceNet (which constituted 26% of Econophone's
revenues during the six months ended June 30, 1997), a reseller that sells
Econophone's calling card services to end users. VoiceNet's relationship with
Econophone is non-exclusive and can be terminated at will by either party.
Although Econophone believes that it offers its independent sales agents and
resellers sufficient incentives to market and sell its services, Econophone does
not have direct control over such persons and there can be no assurance that
they will perform in a satisfactory manner. Econophone has, in the past,
experienced disputes with certain of its independent sales agents. In connection
with its change in distribution strategy, in the United Kingdom, Econophone
entered into a settlement agreement with Europhone International ("EI"), its
former partner in its U.K. sales and marketing joint venture. Pursuant to the
terms of the settlement, among other things, EI retained all of the rights in
the customer list of the joint venture, which included approximately 21,700
names, and Econophone agreed not to solicit sales from such customers, subject
to certain permitted exceptions. For 1996, Econophone's joint venture with EI
and sales of carrier services to EI contributed 32% of Econophone's consolidated
revenues and 91% of its U.K. originated revenues. See "-- Dependence on Carrier
and Other Principal Customers," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business--Sales and
Marketing."
Econophone believes that its relationships with its current independent
sales agents and resellers are good. However, there can be no assurance that
Econophone will not in the future experience material disputes with any such
person or that Econophone and/or any such person will not decide to terminate
their business relationship. Such disputes or terminations could adversely
affect the number of customers obtained and/or retained by Econophone, which
could have a material adverse effect on Econophone's ability to pay principal of
and interest on the Notes.
DEPENDENCE ON CARRIER AND OTHER PRINCIPAL CUSTOMERS
Revenues derived from carrier customers accounted for 25% of Econophone's
revenues during 1996 and 20% during the first six months of 1997, and revenues
derived from VoiceNet accounted for 26% of Econophone's revenues during the
first six months of 1997. Such revenues are produced by a limited number of
carrier customers. Accordingly, the loss of revenue from one or more carrier
customers could have a material adverse effect upon Econophone's business and
its ability to pay interest on and principal of the Notes.
From June through November 1996, following the changing of its U.K.
distribution strategy, Econophone provided carrier services to EI. This
relationship was terminated as a result of disputes between Econophone and EI
following payment delinquencies by EI. In connection with such termination,
Econophone extended the payment period for receivables from EI and agreed not to
solicit sales from former customers of Econophone's joint venture with EI,
subject to certain permitted exceptions. EI
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accounted for 21% of Econophone's revenues during the time it was a carrier
customer and such carrier sales and revenues attributable to the U.K. sales and
marketing joint venture between EI and Econophone accounted for 91% of U.K. and
32% of consolidated revenues for 1996. In the United States, Econophone's five
largest carrier customers accounted in the aggregate for 25% of U.S. revenues
and 10% of consolidated revenues in 1996 and 20% of U.S. revenues and 13% of
consolidated revenues during the first six months of 1997. In addition,
VoiceNet, a reseller that sells Econophone's calling card services to end users,
accounted for 42% of U.S. revenues and 26% of consolidated revenues during the
first six months of 1997. VoiceNet's relationship with Econophone is
non-exclusive and can be terminated at will by either party. See "--Dependence
on Third Party Sales Organizations" "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business--Sales and
Marketing."
Carrier customers are extremely price sensitive, generate very low margin
business and frequently choose to move their business based solely on small
price changes. In addition, smaller carrier customers generally are perceived in
the telecommunications industry as presenting a higher risk of payment
delinquency or non-payment than other customers. While Econophone believes that
its credit criteria enables it to reduce its exposure to the higher payment
risks generally associated with carrier customers, no assurance can be given
that such criteria will afford adequate protection against such risks.
RISKS ASSOCIATED WITH RAPIDLY CHANGING INDUSTRY; SIGNIFICANT PRICE DECLINES
The international telecommunications industry is changing rapidly due to,
among other things, regulatory liberalization, upon which much of Econophone's
planned growth in continental Europe is predicated, privatization of PTOs, the
expansion of telecommunications infrastructure and the globalization of the
world's economies. The telecommunications industry also is in a period of rapid
technological evolution, marked by the introduction of new product and service
offerings and increased satellite and fiber optic cable transmission capacity
for services similar to those provided by Econophone, including utilization of
the Internet for voice and data communications. See "--Competition."
There can be no assurance that one or more of the foregoing factors will not
vary unpredictably, which could have a material adverse effect on Econophone and
its ability to pay principal of and interest on the Notes. There also can be no
assurance, even if such factors turn out as anticipated by Econophone, that
Econophone will be able to implement its strategy or that its strategy will be
successful in the rapidly evolving telecommunications market. In addition, there
can be no assurance that Econophone will be able to compete effectively or
adjust its contemplated plan of development to meet changing market conditions.
Furthermore, Econophone is unable to predict which of the many possible future
service offerings will be important to establish and maintain a competitive
position or what expenditures will be required to develop and provide such
services. Econophone's profitability will depend, in part, on its ability to
anticipate and adapt to rapid technological changes occurring in the
telecommunications industry and on its ability to offer, on a timely basis,
services that satisfy evolving industry standards. The failure by Econophone to
respond to new technologies on a timely basis, penetrate new markets in a timely
manner in response to changing market conditions or customer requirements or
achieve a significant degree of market acceptance of new or enhanced services
could have a material adverse effect on Econophone's business, financial
condition and results of operations and its ability to pay interest on and
principal of the Notes.
Prices for international long distance calls historically have been
determined by international settlement rates. Because these rates historically
have been negotiated between national telephone monopolies, they have been
artificially high and have allowed carriers to enjoy artificially high gross
margins on international calls. However, many observers believe that, given the
negligible marginal cost to a facilities-based carrier of carrying an
international call and given the emergence of competition in many countries
(particularly in western Europe, where Econophone's principal target markets are
located), the international settlement rate system is in the process of
collapsing. This has begun to be reflected in international rates, particularly
the rates charged for calls between countries where competition exists. For
example, Sprint recently reduced its rates on certain calls between the United
States and the United
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Kingdom to $.10 per minute. This represents a steep decline from rates charged
for such calls as recently as several years ago and Econophone expects rates on
international calls, particularly between the United States and the United
Kingdom, to continue to decline significantly. Furthermore, the FCC has proposed
rules designed to bring downward pressure on international telephone rates that
would require U.S. international facilities-based carriers to pay lower
settlement rates to their correspondent foreign carriers. Industry observers
predict that, early in the next decade, telephone charges will no longer be
based on the distance a call is carried. As a consequence, Econophone would
experience a substantial reduction in its margins on international calls, which,
absent a substantial increase in billable minutes of traffic carried or charges
for additional services, would have a material adverse effect on Econophone's
ability to pay principal of and interest on the Notes.
RISKS ASSOCIATED WITH RAPID GROWTH
Econophone has experienced rapid growth. Econophone's revenues were $3.5
million for 1993, and increased to $8.5 million, $27.5 million and $45.1 million
for 1994, 1995 and 1996, respectively. Revenues during the first six months of
1997 were $30.4 million.
Econophone's strategy contemplates continued growth primarily through
further expansion of its existing operations and the establishment of new
operations. Econophone's ability to manage its anticipated future growth will
depend on its ability to evaluate new markets, secure, retain and motivate
independent sales agents and its internal sales forces, monitor operations,
control costs, maintain effective quality controls, provide customer service,
obtain satisfactory and cost-effective lease rights from, and interconnection
with, competitors that own transmission lines (in many cases, intra-national
transmission lines may be available only from the PTO), and significantly expand
its internal management, technical, accounting and customer billing systems.
Econophone's rapid growth has placed, and its planned future growth will
continue to place, a significant and increasing strain on its financial,
management and operational resources. There can be no assurance that
Econophone's financial, management and operational systems and infrastructure
will be adequate to maintain and effectively monitor future growth or that
Econophone will be able to successfully attract, train and manage additional
employees and/or independent sales agents. The failure to continue to upgrade
Econophone's financial, management and operational control systems and
infrastructure or the occurrence of unexpected expansion difficulties could have
a material adverse effect on Econophone's ability to pay principal of and
interest on the Notes. See "--Dependence on Effective Information Systems" and
"--Dependence on Key Personnel; Integration of Management."
SUBSTANTIAL CAPITAL REQUIREMENTS
Econophone will require substantial capital expenditures significantly in
excess of historical levels to implement its business strategy. Econophone has
used and will continue to use a portion of the net proceeds of the Offering to
meet its capital expenditure requirements. See "Use of Proceeds." The net
proceeds from the Offering are expected to be sufficient to fund Econophone's
planned expansion of its operations and operating losses until such time as
Econophone begins to generate operating income; however, this is a
forward-looking statement and there can be no assurance in this regard. Actual
capital expenditures and operating income may vary significantly from
Econophone's estimates depending on a number of factors, including the pace,
extent and cost of network expansion, sales levels, competitive pressures and
regulatory actions. If Econophone's plans or assumptions change, its assumptions
prove to be inaccurate, it experiences unanticipated costs or competitive
pressures, the net proceeds from the Offering prove to be insufficient or it
consummates acquisitions, Econophone may be required to seek additional capital.
Econophone may seek to raise additional equity or debt capital from public or
private sources. There can be no assurance that Econophone will be able to raise
such capital on satisfactory terms or at all. Furthermore, the restrictive
covenants contained in the Indenture and the NTFC Agreement, and the terms of
the Series A Preferred Stock, limit Econophone's ability to incur additional
indebtedness. If Econophone raises additional funds through the incurrence of
indebtedness, Econophone may become
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subject to additional or more restrictive covenants. In the event that
Econophone is unable to obtain such additional capital or is unable to obtain
such additional capital on acceptable terms, Econophone may be required to
reduce the scope of its expansion, which could materially adversely affect
Econophone's ability to pay principal of and interest on the Notes.
RISKS ASSOCIATED WITH IMPOSITION OF VAT
A value added tax ("VAT") is a tax charged on goods and services that is
designed to be borne by the ultimate end user of the goods or services. The rate
of VAT varies among European Union ("EU") member states but typically is between
15% and 20% of the cost of the goods or services. Pursuant to the Sixth VAT
Directive adopted in 1977 (the "VAT Directive"), providers of telecommunications
services in the EU are liable for VAT in the EU member state where the provider
of the services is "established." The provider, in turn, charges VAT to its
customers at the rate prevailing in the provider's state of establishment. Under
VAT rules, most businesses are permitted to offset the VAT charged to them with
the VAT that they charge to their customers. Residential customers and certain
categories of businesses to which Econophone does not market its services,
however, cannot offset VAT and, therefore, bear the cost of the tax. As a
result, in countries where it has not been an established provider, Econophone
has had a competitive price advantage over competitors who are required to
charge VAT to residential customers, including the PTOs. "Establishment" has
been determined under national law and, in most of the EU member states where it
has engaged in business, Econophone has not until recently been required to
charge VAT.
In March 1997, the Council of the European Union issued derogations to the
VAT Directive (the "VAT Derogation") that, as of January 1, 1997, permitted
individual EU member states to amend their laws so as to treat
telecommunications services as being provided where the customer is located
rather than where the telecommunications provider is established. In the case of
sales by a telecommunications provider to residential customers, the VAT
Derogation permits EU member states to require all providers to collect and
remit VAT. With effect between January 1, 1997 and July 1, 1997, all EU member
states have adopted rules that subject all telecommunications services provided
to residential customers in such states to VAT.
There can be no assurance that, in order to remain competitive, Econophone
will not need to reduce prices in the future in one or more EU markets in order
to offset VAT that it is required to charge. Any such reduction could have a
material adverse effect on Econophone's business, financial condition and
results of operations and its ability to pay interest on and principal of the
Notes. See "Business-- Regulation."
DEVALUATION AND CURRENCY RISKS
A substantial portion of Econophone's revenues and expenses are denominated
in non-U.S. currencies, consisting principally of the British pound, Belgian
franc and the French franc. Furthermore, Econophone's business strategy
contemplates that, although an increasing portion of its revenues and expenses
will be denominated in non-U.S. currencies, a disproportionate portion of
Econophone's expenses, including interest and principal on the Notes, will be
denominated in dollars. Except in respect of its operations in the United
Kingdom, Econophone has not hedged against foreign currency exchange transaction
risks. Because of the number of currencies involved, Econophone's constantly
changing currency exposure and the fact that all foreign currencies do not
fluctuate in the same manner against the dollar, Econophone cannot quantify the
effect of exchange rate fluctuations on its future financial condition or
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."
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REGULATORY RESTRICTIONS
National and local laws and regulations governing the provision of
telecommunications services differ significantly among the countries in which
Econophone currently operates and intends to operate. The interpretation and
enforcement of such laws and regulations varies and could limit Econophone's
ability to provide certain telecommunications services in certain markets. There
can be no assurance that future regulatory, judicial and legislative changes
will not have a material adverse effect on Econophone, that domestic or
international regulators or third parties will not raise material issues with
regard to Econophone's compliance or noncompliance with applicable laws and
regulations or that other regulatory activities will not have a material adverse
effect on Econophone. See "Business--Regulation."
A substantial portion of Econophone's strategy is based upon the expected
regulatory liberalization of certain EU markets on January 1, 1998 based on
current EC directives. In anticipation of such liberalization, Econophone is
establishing operations and making capital expenditures in certain EU countries.
Although liberalization is a legal obligation required by EC directives, a
substantial portion of the more detailed EU regulatory framework to apply in the
liberalized environment after January 1, 1998, including further directives,
still requires adoption by the Council of the European Communities. Certain EU
member states have been granted a derogation from liberalizing their
telecommunication markets on January 1, 1998. Ireland and Portugal have been
granted a derogation until January 1, 2000. Spain has requested a derogation
entitling it to delay liberalization until November 30, 1998. Luxembourg and
Greece have requested derogations entitling them to delay full liberalization
until January 1, 2000 and January 1, 2003, respectively. There can be no
assurance that each EU member state will proceed with the expected
liberalization on schedule, if at all, or that the trend towards liberalization
will not be stopped or reversed. Accordingly, Econophone faces the risk that it
will establish operations and make capital expenditures in a given country in
anticipation of regulatory liberalization which does not subsequently occur.
The national governments of EU member states must pass legislation to
liberalize the markets within their countries to give effect to EC directives.
This applies not only to the liberalization requirements set out in EC
directives that already have been adopted, but also requirements to be contained
in those directives which still remain to be adopted by the Council of the
European Communities. Econophone's provision of services in Europe may be
materially adversely affected if any EU member state imposes greater
restrictions on non-EU international services than on international services
within the EU. Some EU member states have inconsistently and, in some instances,
unclearly implemented EC telecommunications directives, which could limit,
constrain or otherwise adversely affect Econophone's ability to provide certain
services. Furthermore, national governments may not necessarily pass legislation
enacting an EC directive in the form required, if at all, or may pass such
legislation only after a significant delay. Even if a national legislature
enacts appropriate regulations within the time frame established by the European
Union, there may be significant resistance to the implementation of such
legislation from PTOs, regulators, trade unions and other sources. For example,
in the United Kingdom, Mercury resorted to legal action against the Post Office
Engineering Union because the union refused to connect customers to Mercury's
switches. In France, the telecommunications union has stated its objection to
the current move towards liberalization. In Italy, the government has, in the
past, failed to adopt requisite legislation liberalizing its telecommunications
markets on a timely basis. These and other potential obstacles to liberalization
could have a material adverse effect on Econophone's operations by preventing
Econophone from expanding its operations as currently intended, as well as a
material adverse effect on Econophone's ability to pay interest on and principal
of the Notes.
In the United States, Econophone's authority to engage in the resale of
international private lines to provide international telephone service is
pursuant to an authorization (the "Section 214 Private Line Authorization")
granted under Section 214 of the 1934 Act. Certain rules of the FCC prohibit
Econophone from (i) transmitting calls routed over leased lines between New York
and London onward over a leased
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line to continental Europe (other than to a country which the FCC deems to be
"equivalent," which currently is only Sweden) or (ii) transmitting calls from
continental European countries (other than those deemed to be equivalent) over
leased lines to London and then onward over a leased line between London and New
York. FCC restrictions thus may materially limit the optimal and most profitable
use of Econophone's leased lines between New York and London and result in
increased transmission costs on certain calls, which Econophone may not be able
to pass on to its customers.
In the United States, the FCC and relevant state public service commissions
("PSCs") have the authority to regulate interstate and intrastate telephone
rates, respectively, ownership of transmission facilities and the terms and
conditions under which certain of Econophone's services are provided. Federal
and state regulations and regulatory trends have had, and in the future are
likely to have, both positive and negative effects on Econophone and its ability
to compete. The recent trend in both Federal and state regulation of
telecommunications service providers has been in the direction of reduced
regulation. In general, neither the FCC nor the relevant state PSCs currently
regulate Econophone's domestic long distance rates or profit levels, although
either or both may do so in the future. There can be no assurance that changes
in current or future Federal or state regulations or future judicial changes
would not have a material adverse effect on Econophone. See
"Business--Regulation."
In order to provide their services, inter-exchange carriers, including
Econophone, must generally purchase "access" from local exchange carriers
("LECs") to originate calls from and terminate calls in the local exchange
telephone networks. In the United States, access charges generally are regulated
by the FCC and the relevant state PSCs. Under the terms of the AT&T Divestiture
Decree, a court order entered in 1982 which, among other things, required AT&T
to divest its 22 wholly-owned RBOCs from its long distance division (the "AT&T
Divestiture Decree"), the RBOCs were required to price the "local transport"
portion of such access charges on an "equal price per unit of traffic" basis.
The FCC has adopted, subject to reconsideration, a change in the access charge
structure, which reduces per minute access charges, but applies additional per
line charges for business users. This change in access charge structure may
disproportionately disadvantage smaller carriers such as Econophone. Under
alternative access charge rate structures proposed to the FCC, LECs would be
permitted to allow volume discounts in the pricing of access charges. If these
rate structures are adopted, access charges for AT&T and other large
inter-exchange carriers would decrease and access charges for small
inter-exchange carriers would increase. While the outcome of these proceedings
is uncertain, should the FCC adopt permanent access charge rules along the lines
of the proposed structures, Econophone would be at a cost disadvantage with
regard to access charges in comparison to AT&T and other large inter-exchange
carrier competitors. The FCC also has, subject to reconsideration, announced
that it will impose charges on inter-exchange carriers, including Econophone, to
support subsidies for telecommunications services for schools, libraries, rural
health care centers and low income persons. Econophone does not expect these
charges to be material to Econophone, although there can be no assurance that
this will be the case.
The FCC requires long distance carriers to pay access charges to payphone
providers for calls made from payphones to toll free numbers administered by
long distance carriers. The FCC had required the immediate payment of such
access charges by long distance carriers with toll revenues of $100 million or
more per annum. The FCC had also required, after October 7, 1997, all long
distance carriers, irrespective of their annual toll revenues, to pay to each
payphone operator $.35 for each access or toll free call made from the
operator's payphones unless the payphone operator and the long distance carrier
agree upon a different rate of compensation. The FCC payphone order was reversed
by an appellate court. This matter was remanded to the FCC by the court for
further consideration. The FCC may re-adopt the $.35 rate, or some different
rate, effective on October 7, or at some later date. Econophone's card-based
services in the United States are accessed by customers through a toll free
number, often from payphones. Econophone has marketed its services at a discount
to prices charged by larger carriers which recently have begun charging this
$.35 access charge. Irrespective of the effective date and the amount ultimately
adopted, when Econophone becomes subject to the access charge, there can be no
assurance that Econophone will
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be able to fully pass this cost on to its customers or that doing so will not
result in a loss of customers. Furthermore, larger carriers are likely to be
able to negotiate lower payphone access charges than Econophone, which could
result in such carriers offering lower pricing on card-based services in the
United States accessed from payphones than that offered by Econophone.
If Econophone's interpretation of applicable laws and regulations proves
incorrect, it could lose, or be unable to obtain, regulatory approvals necessary
to provide certain of its services or to use certain of its transmission
methods. Econophone also could have substantial monetary fines and penalties
imposed against it. In addition, Econophone's Section 214 Private Line
Authorization requires that services be provided in a manner consistent with the
laws and regulations of the countries in which Econophone operates. There can be
no assurance that Econophone has accurately interpreted or will accurately
interpret applicable laws and regulations in particular jurisdictions, or that
regulators or third parties will not raise material issues with regard to
Econophone's compliance with applicable laws or regulations.
If Econophone is unable to provide the services it is presently providing or
intends to provide or to use its existing or contemplated access or transmission
methods due to its inability to receive or retain formal or informal approvals
for such services or access or transmission methods, or for any other reason
related to regulatory compliance or the lack thereof, Econophone's business,
financial condition and results of operations would be materially and adversely
affected and the ability of Econophone to pay interest on and principal of the
Notes could be materially adversely affected. See "Business--Regulation."
NEED FOR LOCAL CONNECTIVITY
To originate and terminate calls, Econophone requires "local connectivity,"
which is the right to use the public switched telephone network (the "PSTN"). In
Europe, although Econophone has been successful to date in obtaining local
connectivity in each of its existing network cities, there can be no assurance
that Econophone will be able to maintain local connectivity, obtain additional
local connectivity in such cities to the extent necessary or desirable or obtain
local connectivity in additional cities, in each case either on acceptable terms
or at all. Econophone obtains its local connectivity in the United Kingdom from
British Telecom, the PTO in the United Kingdom and a principal competitor of
Econophone in the United Kingdom. In continental Europe, Econophone obtains its
local connectivity from PTOs which are, and are expected to continue to be,
among Econophone's primary competitors in continental Europe. In the United
States, Econophone obtains local connectivity from LECs, which also are
competitors of Econophone. Furthermore, in the United States, access and
termination costs charged by LECs to long distance providers constitute a
significant portion of the total cost of domestic long distance calls. There can
be no assurance that any of the foregoing competitors will make local
connectivity available to Econophone at commercially reasonable rates, on a
timely basis, or, in the case of Europe, at all. The availability and rates of
local connectivity are, and will continue to be, determined on a
country-by-country basis. The failure to obtain local connectivity on
commercially acceptable terms could have a material adverse effect on Econophone
and its ability to pay principal of and interest on the Notes.
DEPENDENCE ON LEASED LINES
Econophone does not own most of the telecommunications transmission lines
that it uses. The telephone calls made by Econophone's customers are and will
continue to be connected, at least in part, through transmission lines that
Econophone leases. Many of the lessors of such lines are competitors of
Econophone. In many countries, the only provider of transmission facilities is
the PTO. Accordingly, prior to full liberalization, there may be only one source
of intra-national transmission lines in these countries and Econophone may be
required to lease transmission capacity at artificially high rates from a
provider that occupies a monopoly or near monopoly position on the portion of a
call transmitted in that provider's country. Such rates may be too high to allow
Econophone to generate gross profit on international calls routed to an
Econophone switch or node by means of such intra-national lines. In addition,
PTOs will not necessarily be required by law to allow Econophone to lease
transmission lines. Even where applicable law
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requires PTOs to lease transmission lines to Econophone, delays may nevertheless
be encountered with
respect to the commencement of operations and extensive delays may occur with
respect to the negotiation of leases and interconnection agreements. In
addition, disputes may occur with respect to pricing terms and billing.
Econophone leases capacity for point-to-point circuits on a monthly or
longer-term fixed cost basis. Econophone is vulnerable to changes in its lease
arrangements, such as price increases and service cancellations. The negotiation
of lease agreements involves estimates regarding future supply and demand for
transmission capacity as well as estimates of the calling patterns and traffic
levels of Econophone's existing and future customers. Econophone's profitability
depends, in part, on its ability to obtain and utilize leased capacity on a
cost-effective basis. Depending upon the rate, Econophone could suffer
competitive disadvantages if it entered into leases with inappropriate durations
or leases based on per-minute charges for high volume routes (or leases with
fixed monthly rates for low volume routes), or if it failed to meet any minimum
volume requirements thereunder. Econophone also is vulnerable to service
interruptions and poor transmission quality from leased lines. The deterioration
or termination of Econophone's relationships with one or more of its carrier
vendors could have a material adverse effect upon Econophone's business,
financial condition and results of operations and its ability to pay interest on
and principal of the Notes.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
To complete its billing, Econophone must record and process large amounts of
data quickly and accurately. While Econophone believes its management
information systems currently are adequate, substantial investment therein will
be required to satisfy anticipated billing needs. Econophone has budgeted
approximately $2.0 million for the last two quarters of 1997 for enhancing
current, and purchasing and developing new network management and information
systems. Econophone believes that the successful implementation and integration
of these enhanced and new information systems is important to its continued
growth and its ability to monitor costs, bill customers and achieve operating
efficiencies, but there can be no assurance that Econophone will not encounter
delays or cost-overruns or suffer adverse consequences in implementing such
systems. In addition, as Econophone's information systems suppliers revise and
upgrade their hardware, software and equipment technology, there can be no
assurance that Econophone will not encounter difficulties in integrating such
new technology into its business or that the new systems will be appropriate for
Econophone's business. See "Business-- Information Technology."
DEPENDENCE ON KEY PERSONNEL; INTEGRATION OF MANAGEMENT
The success of Econophone is dependent, in large part, upon its key
management. The loss of services of any of the members of Econophone's senior
management team, particularly Alfred West, the Chief Executive Officer and
Chairman of the Board of Directors of Econophone and Alan L. Levy, the
President, Chief Operating Officer and Chief Financial Officer and a Director of
Econophone, could have a material adverse effect on Econophone and its ability
to successfully implement its business plan (including, without limitation, the
roll-out of its network infrastructure, its sales and marketing initiatives and
the expansion of its back-office capabilities) and to pay interest and principal
on the Notes. Messrs. West and Levy are parties to employment agreements with
Econophone, expiring on December 31, 1999 and July 31, 1999, respectively. Other
than Messrs. West and Levy, Econophone has not entered into employment
agreements with members of management. See "Management--Executive
Compensation--Employment Agreements and Arrangements." Econophone maintains "key
man" life insurance policies on Mr. West that provide for payment of $10.0
million to Econophone in the event of the death or long-term disability of Mr.
West. Under the terms of the Series A Preferred Stock, Econophone is required to
maintain such policy in full force and effect until November 1, 2000.
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Pursuant to the NTFC Agreement, Econophone may not cease to employ Alfred
West or suffer to exist any competition by Mr. West with the business now or
hereafter conducted by Econophone. Failure to comply with the foregoing
requirement would constitute a default under the NTFC Agreement, which, if not
cured, could require the prepayment of all amounts outstanding thereunder. In
addition, any holder of Series A Preferred Stock has the option to cause
Econophone to redeem its shares if Alfred West ceases to own voting securities
representing at least 25% of the total voting power of the outstanding voting
securities of Econophone or a person or group becomes the beneficial owner of
voting securities representing more voting power than the voting securities then
owned by Mr. West. See "Certain Transactions--Investment by Princes Gate" and
"Description of Certain Indebtedness--NTFC Vendor Financing."
Econophone has significantly increased the size of its management team since
the beginning of the fourth quarter of 1996. Econophone's management team has
limited experience in working together and any delays in the integration of new
members of Econophone's management team could result in delays in the
implementation of Econophone's strategy.
Econophone's success also will depend on its ability to attract, retain and
motivate additional qualified management, marketing, technical and sales
executives and other personnel who are in high demand and are often subject to
competing employment opportunities, including qualified independent sales
agents. The loss of the services of key personnel, or the inability to attract
additional qualified personnel, could have a material adverse effect on
Econophone's business, financial condition and results of operations. There can
be no assurance that Econophone will be successful in attracting, retaining and
motivating such personnel. Although members of management participate in
Econophone's incentive plan, other than Mr. Levy, their options do not provide
the right to acquire a significant portion of the equity of Econophone. See
"Management--Executive Compensation--1996 Flexible Incentive Plan."
DEPENDENCE ON EQUIPMENT SUPPLIER
Econophone purchases a significant portion of its switching equipment from
Northern Telecom. Certain of the switches acquired by Econophone from Northern
Telecom utilize new technologies. There can be no assurance that Econophone will
be able to integrate such switches into its network on a timely basis or at all,
or that such switches will provide satisfactory performance. There also can be
no assurance that Econophone will be able to acquire the switches that it will
require from Northern Telecom or from another manufacturer of compatible
equipment. Any inability of Econophone to acquire such switches on a timely
basis or at a similar price, or any failure by Econophone to successfully
integrate such switches into its network, could result in delays, operational
problems or increased expenses, which could have a material adverse effect on
Econophone's business, financial condition and results of operations and its
ability to pay principal and interest on the Notes. See "Business--Network
Infrastructure."
INABILITY TO REPAY NOTES UPON A CHANGE OF CONTROL
The Indenture provides that, upon the occurrence of a Change of Control
thereunder, Econophone must make an offer to purchase all of the Notes issued
and then outstanding at a purchase price equal to 101% of the principal amount
thereof plus accrued interest (if any) thereon to the Payment Date (as defined
in the Indenture). Under the NTFC Agreement, a change of control (as such term
is used in such agreement) occurring without the prior written consent of NTFC
would constitute a default thereunder, which would permit NTFC to accelerate
repayment of all amounts outstanding under the NTFC Agreement. In addition,
pursuant to the Certificate of Incorporation of Econophone, a change of control
(as such term is used therein) would, subject to approval by NTFC, permit
holders of the Series A Preferred, at their option, to require Econophone to
redeem all shares of Series A Preferred held by them. If an event were to occur
that would constitute a "change of control" pursuant to the NTFC Agreement
and/or the Certificate of Incorporation, prior to, or simultaneously with any
payment to the holders of the Notes in connection with a repurchase offer
resulting from a Change of Control pursuant to the Indenture,
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NTFC would be entitled to receive payment of all outstanding obligations under
the NTFC Agreement and the holders of the Series A Preferred would be entitled
to redemption of such securities. If a Change of Control were to occur, there
can be no assurance that Econophone would be able to satisfy its obligations
under the NTFC Agreement, the Certificate of Incorporation and the Notes. Such a
failure to purchase Notes tendered pursuant to such a repurchase offer would
constitute an Event of Default under the Indenture and the NTFC Agreement. See
"Description of the Exchange Notes--Repurchase of Notes Upon a Change of
Control", "Description of the Exchange Notes--Events of Default", "Certain
Transactions--Investment by Princes Gate" and "Description of Certain
Indebtedness--NTFC Vendor Financing."
CONTROL BY PRINCIPAL STOCKHOLDERS
Alfred West, the Chief Executive Officer of Econophone and Chairman of its
Board of Directors, Steven West, the brother of Alfred West and a member of the
Board of Directors of Econophone, and Gary Bondi, a member of the Board of
Directors of Econophone, own, in the aggregate, approximately 85.4% of the
outstanding shares of Common Stock (assuming conversion of the Series A
Preferred Stock at October 1, 1997, but not giving effect to the issuance or
exercise of the Warrants or any options issued by Econophone). Such stockholders
will have the ability to control the election of all members of Econophone's
Board of Directors, other than one director that is entitled to be elected by
the holders of the Series A Preferred Stock, the outcome of all matters
submitted to a vote of the holders of Common Stock and generally will be able to
direct the affairs of Econophone. The approval of the holders of a majority of
the shares of Series A Preferred Stock is required for Econophone to take
certain actions, including the sale of all or substantially all of the assets, a
merger, consolidation, recapitalization or liquidation of Econophone, the
declaration or payment of certain dividends, the acquisition or redemption of
any class of capital stock or an amendment to the certificate of incorporation
adversely affecting the rights, powers or preferences of the Series A Preferred
Stock. See "Certain Transactions--Investment by Princes Gate--Series A Preferred
Stock." The exercise of these powers may present conflicts of interest between
these individuals and the holders of the Notes. See "Principal Stockholders."
ORIGINAL ISSUE DISCOUNT CONSEQUENCES
The Exchange Notes should be treated as a continuation of the Original Notes
for federal income tax purposes. The Original Notes were treated as having been
issued at a discount for U.S. federal income tax purposes. Prospective investors
should consult their tax advisors about the application of federal income tax
law, as well as any applicable state, local or foreign tax laws. This Prospectus
contains no information regarding taxation other than under certain laws of the
United States.
If a bankruptcy case is commenced by or against Econophone under the United
States Bankruptcy Code, the claim of a holder of Notes may be limited to an
amount equal to the sum of the issue price as determined by the bankruptcy court
and that portion of the original issue discount which is deemed to accrue from
the issue date to the date of any such bankruptcy filing.
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CONSEQUENCES OF FAILURE TO EXCHANGE
The issuance of the Exchange Notes in exchange for the Original Notes
pursuant to the Exchange Offer will be made only after a timely receipt by the
Company of such Original Notes, a properly completed and duly executed Letter of
Transmittal and all other required documents. Therefore, holders of Original
Notes desiring to tender such Original Notes in exchange for Exchange Notes
should allow sufficient time to ensure timely delivery. The Company is under no
duty to give notification of defects or irregularities with respect to the
tenders of Original Notes for exchange.
Original Notes that are not validly tendered will, following the
consummation of the Exchange Offer, continue to be subject to the existing
restrictions upon transfer thereof and the Company will have no further
obligation to provide for the registration under the Securities Act of such
Original Notes. In addition, any holder of Original Notes who tenders in the
Exchange Offer for the purpose of participating in a distribution of the
Exchange Notes may be deemed to have received restricted securities and, if so,
will be required to comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale transaction. To
the extent that Original Notes are tendered in the Exchange Offer, the trading
market for untendered and tendered but unaccepted Original Notes could be
adversely affected. Each broker or dealer that receives Exchange Notes for its
own account in exchange for Original Notes where such Exchange Notes were
acquired by such broker or dealer as a result of market-making activities or
other trading activities must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. See "Plan of Distribution."
LACK OF PUBLIC MARKET
The Exchange Notes are a new issue of securities for which there is
currently no active trading market. The Company does not intend to list the
Exchange Notes on any national securities exchange or to seek approval for
quotation through any automated quotation system. Morgan Stanley has advised the
Company that it currently intends to make a market in the Exchange Notes;
however, it is not obligated to do so and any market making activity may be
discontinued at any time without notice. Therefore, there can be no assurance
that an active trading market for the Exchange Notes will develop or as to the
liquidity of or the trading market for the Exchange Notes. If a trading market
does not develop, Holders of the Exchange Notes may experience difficulty in
reselling the Exchange Notes or may be unable to sell them at all. If a market
for the Exchange Notes develops, any such market could cease to continue at any
time. If a trading market develops for the Exchange Notes, they may trade at a
discount from their initial offering price, depending upon prevailing interest
rates, the market for similar securities and other factors, including general
economic conditions and the financial condition, performance of and prospects
for the Company.
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THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
The Original Notes were initially issued and sold by Econophone on July 1,
1997 (the "Closing Date") to Morgan Stanley, the Placement Agent thereof,
pursuant to a Placement Agreement, dated June 26, 1997 (the "Placement
Agreement"). The Placement Agent subsequently resold the Original Notes to
qualified institutional buyers in reliance on Rule 144A under the Securities Act
and to non-U.S. persons pursuant to Regulation S under the Securities Act.
Pursuant to the Placement Agreement, Econophone and the Placement Agent entered
into a Notes Registration Rights Agreement on July 1, 1997 (the "Registration
Rights Agreement"). Pursuant to the Registration Rights Agreement, Econophone
agreed to use its best efforts to consummate the Exchange Offer on or prior to
January 15, 1998. A copy of the Registration Rights Agreement has been filed as
an exhibit to the Registration Statement of which this Prospectus is a part and
the description of the terms of the Registration Rights Agreement is qualified
in its entirety by reference thereto. The Registration Statement of which this
Prospectus is a part is intended to satisfy Econophone's obligations with
respect to the registration of Original Notes in accordance with the terms of
the Registration Rights Agreement and the Indenture.
Following the consummation of the Exchange Offer, holders of Original Notes
not validly tendered in the Exchange Offer and holders of Exchange Notes will
not have any further registration rights (other than certain registration rights
granted to Morgan Stanley, as hereinafter indicated). In addition, holders of
Original Notes will continue to be subject to certain restrictions on transfer.
Accordingly, the liquidity of the market for Original Notes could be adversely
affected. See "Risk Factors--Consequences of Failure to Exchange."
The Original Notes were issued in Units together with the Warrants. Upon the
effectiveness of the registration statement for the Exchange Notes, the Warrants
will be separately traded from the Original Notes and are not part of the
Exchange Offer.
TERMS OF THE EXCHANGE OFFER
Econophone intends the following terms to provide for the conduct of the
Exchange Offer in accordance with the provisions of the Registration Rights
Agreement, the Indenture, the applicable requirements of the Securities Act and
the rules and regulations of the Commission thereunder. Upon the terms and
subject to the conditions set forth in this Prospectus and in the accompanying
Letter of Transmittal, Econophone will accept any and all Original Notes validly
tendered and not withdrawn prior to 5:00 p.m., New York City time on December 5,
1997, or such later time and date to which the Exchange Offer is extended by
Econophone in its sole discretion, which time and date, as indicated herein or
as extended, is referred to herein as the "Expiration Date". Econophone will
issue $1,000 principal amount of Exchange Notes in exchange for each $1,000
principal amount of Original Notes accepted in the Exchange Offer. Holders may
tender some or all of their Original Notes pursuant to the Exchange Offer.
The form and terms of the Exchange Notes are the same as the form and terms
of the Original Notes except that (i) the Exchange Notes will have been
registered under the Securities Act and thus will not bear restrictive legends
restricting their transfer pursuant to the Securities Act and (ii) the Exchange
Notes will not be subject to any covenant regarding registration under the
Securities Act, including any such rights under the Registration Rights
Agreement or the Indenture, which rights, in any event, will terminate with
respect to the Original Notes upon consummation of the Exchange Offer. The
Exchange Notes will evidence the same debt as the Original Notes (which they
replace) and will be issued under, and be entitled to the benefits of, the
Indenture, which also authorized the issuance of the Original Notes, such that
both the Exchange Notes and the Original Notes will be treated as a single class
of debt securities under the Indenture.
As of the date of this Prospectus, $155.0 million in aggregate principal
amount of Original Notes was outstanding. There will be no fixed record date for
determining holders of the Original Notes entitled to participate in the
Exchange Offer.
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Econophone shall be deemed to have accepted validly tendered Original Notes
when, as and if Econophone has given oral or written notice thereof (oral notice
being promptly confirmed in writing) to The Bank of New York, as Exchange Agent.
The Exchange Agent will act as agent for the tendering holders of the Original
Notes for the purposes of receiving the Exchange Notes from Econophone.
Holders of Notes who tender Original Notes in the Exchange Offer will not be
required to pay brokerage commissions or fees or, subject to the instructions in
the Letter of Transmittal, transfer taxes with respect to the exchange of
Original Notes pursuant to the Exchange Offer. Econophone will pay all charges
and expenses, other than certain applicable taxes described below, in connection
with the Exchange Offer. See "--Fees and Expenses."
EXTENSION; AMENDMENTS
In order to extend the Exchange Offer, Econophone will notify the Exchange
Agent of any extension by oral or written notice (oral notice being promptly
confirmed in writing) and will make public announcement thereof, each prior to
9:00 a.m., New York City time, on the next business day after the previously
scheduled Expiration Date.
Econophone reserves the right, in its sole discretion, (i) to delay
accepting any Original Notes, (ii) to extend the Expiration Date, (iii) if any
of the conditions set forth below under "--Conditions of the Exchange Offer"
shall not have been satisfied, to terminate the Exchange Offer, or (iv) to amend
the terms of the Exchange Offer in any manner, by giving oral or written notice
(oral notice being promptly confirmed in writing) of such delay, extension,
termination or amendment to the Exchange Agent. Any such delay in acceptance,
extension, termination or amendment will be followed as promptly as practicable
by a public announcement thereof. If the Exchange Offer is amended in a manner
determined by Econophone to constitute a material change, Econophone will
promptly disclose such amendments by means of a prospectus supplement that will
be distributed to DTC and Econophone will extend the Exchange Offer for a period
of five to ten business days, depending upon the significance of the amendment
and the manner of disclosure to the registered holders, if the Exchange Offer
would otherwise expire during such five to ten business day period.
Without limiting the manner in which Econophone may choose to make a public
announcement of any delay, extension, termination or amendment of the Exchange
Offer, Econophone shall not have an obligation to publish, advertise or
otherwise communicate any such public announcement, other than by making a
timely release to an appropriate news agency.
PROCEDURES FOR TENDERING BOOK-ENTRY INTERESTS
The Original Notes (which for purposes of the Exchange Offer include
Book-Entry Interests and Original Notes in registered form ("Definitive
Registered Notes"), if any) were issued as global securities without interest
coupons (each, a "Global Note"). Concurrently with the issuance thereof, the
Global Notes were deposited with The Bank of New York, as Book-Entry Depositary
(the "Book-Entry Depositary"), which issued a certificateless depositary
interest (each, a "Depositary Interest") in each Global Note representing a 100%
interest therein to DTC. Book-Entry Interests, which are beneficial interests in
the Global Notes held by direct or indirect participants in DTC through the
Depositary Interests, are shown on, and transfers thereof are effected only
through, records maintained in book-entry form by DTC (with respect to its
participants) and its participants.
Each Holder (which for purposes of the Exchange Offer, includes any
participant in DTC whose name appears on a security position listing as a holder
of Book-Entry Interests) of Original Notes held in the form of Book-Entry
Interests who wishes to tender such Book-Entry Interests for exchange pursuant
to the Exchange Offer must transmit to the Exchange Agent on or prior to the
Expiration Date either (i) a properly completed and duly executed Letter of
Transmittal or a facsimile thereof, including all other documents required by
such Letter of Transmittal, to the Exchange Agent at the address set forth on
the cover page of the Letter of Transmittal or (ii) a computer-generated message
(an "Agent's Message"), transmitted by means of DTC's Automated Tender Offer
Program ("ATOP") system and received by the
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Exchange Agent and forming a part of a book-entry transfer (a "Book-Entry
Confirmation"), in which such Holder acknowledges and agrees to be bound by the
terms of the Letter of Transmittal. In addition, in order to deliver Original
Notes held in the form of Book-Entry Interests, (i) a timely Book-Entry
Confirmation of book-entry transfer of such Original Notes into the Exchange
Agent's account at DTC pursuant to the procedure for book-entry transfers
described below under "--Book-Entry Transfer" must be received by the Exchange
Agent prior to the Expiration Date or (ii) the Holder must comply with the
guaranteed delivery procedures described below.
The valid tender of an Original Note by a Holder that is not withdrawn prior
to the Expiration Date will constitute an agreement between such Holder and
Econophone in accordance with the terms and subject to the conditions set forth
hereunder and in the Letter of Transmittal.
DELIVERY OF BOOK-ENTRY INTERESTS MUST BE EFFECTED BY BOOK-ENTRY TRANSFER AS
DESCRIBED UNDER "--BOOK-ENTRY TRANSFER." THE METHOD OF DELIVERY OF THE LETTER OF
TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE
ELECTION AND RISK OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED
THAT HOLDERS USE AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL
CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE
AGENT BEFORE THE EXPIRATION DATE. NO LETTER OF TRANSMITTAL SHOULD BE SENT TO
ECONOPHONE.
PROCEDURES FOR TENDERING DEFINITIVE REGISTERED NOTES
Only registered holders of Definitive Registered Notes may tender such
Original Notes in the Exchange Offer. Each Holder of Definitive Registered Notes
who wishes to tender such Definitive Registered Notes for exchange pursuant to
the Exchange Offer must transmit to the Exchange Agent on or prior to the
Expiration Date a properly completed and duly executed Letter of Transmittal or
a facsimile thereof, including all other documents required by such Letter of
Transmittal, to the Exchange Agent at the address set forth below under
"--Exchange Agent." In addition, in order to deliver Definitive Registered Notes
(i) the certificates representing such Definitive Registered Notes must be
received by the Exchange Agent prior to the Expiration Date or (ii) the Holder
must comply with the guaranteed delivery procedures described below.
The valid tender by a Holder (not withdrawn prior to Expiration Date) will
constitute an agreement between such Holder and Econophone in accordance with
the terms and subject to the conditions set forth herein and in the Letter of
Transmittal.
THE METHOD OF DELIVERY OF THE DEFINITIVE REGISTERED NOTES AND THE LETTER OF
TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE
ELECTION AND RISK OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED
THAT HOLDERS USE AN OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT
TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE
EXPIRATION DATE. NO LETTER OF TRANSMITTAL OR CERTIFICATES FOR DEFINITIVE
REGISTERED NOTES SHOULD BE SENT TO ECONOPHONE. HOLDERS MAY REQUEST THEIR
RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES TO
EFFECT THE ABOVE TRANSACTION FOR SUCH HOLDERS.
PROCEDURES APPLICABLE TO ALL HOLDERS
Any beneficial owner of Book-Entry Interests whose name does not appear on a
security position listing of DTC as a holder of such Book-Entry Interests and
any beneficial owner of Definitive Registered Notes that are registered in the
name of a broker, dealer, commercial bank, trust company or other nominee and
who wishes to tender such Book-Entry Interests or Definitive Registered Notes in
the Exchange Offer should contact such person in whose name such Book-Entry
Interests or Definitive
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Registered Notes are registered promptly and instruct such Holder to tender on
such beneficial owner's behalf.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed unless the Original Notes surrendered for exchange
pursuant to the Letter of Transmittal or to which the notice of withdrawal
pertains are tendered (i) by a Holder of the Original Notes who has not
completed the box entitled "Special Issuance Instructions" on the Letter of
Transmittal or (ii) for the account of an Eligible Institution (as defined
below). In the event that signatures on a Letter of Transmittal or a notice of
withdrawal, as the case may be, are required to be guaranteed, such guarantees
must be by a firm which is a member of a registered national securities exchange
or a member of the National Association of Securities Dealers, Inc. or by a
commercial bank or trust company having an office or correspondent in the United
States (collectively, "Eligible Institutions").
If the Letter of Transmittal or notice of withdrawal is signed by a trustee,
executor, administrator, guardian, attorney-in-fact, officer of a corporation or
other person acting in a fiduciary or representative capacity, such person
should so indicate when signing and, unless waived by Econophone, proper
evidence satisfactory to Econophone of its authority to so act must be
submitted.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Original Notes will be
determined by Econophone in its sole discretion, which determination will be
final and binding. Econophone reserves the absolute right to reject any and all
Original Notes not properly tendered or any Original Notes Econophone's
acceptance of which would, in the opinion of counsel for Econophone, be
unlawful. Econophone also reserves the right to waive any defects,
irregularities or conditions of tender as to particular Original Notes.
Econophone's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of the Original Notes must be cured within such time as
Econophone shall determine. Although Econophone intends to notify holders of
defects or irregularities with respect to tenders of the Original Notes, none of
Econophone, the Exchange Agent or any other person shall incur any liability for
failure to give such notification. Tenders of the Original Notes will not be
deemed to have been made until any and all such defects or irregularities have
been cured or waived.
While Econophone has no present plan to acquire any Original Notes that are
not tendered in the Exchange Offer or to file a registration statement to permit
resales of any Original Notes that are not tendered in the Exchange Offer,
Econophone reserves the right in its sole discretion to purchase or make offers
for any Original Notes that remain outstanding subsequent to the Expiration Date
or, as set forth below under "--Conditions of the Exchange Offer," to terminate
the Exchange Offer and, to the extent permitted by applicable law, purchase
Original Notes in the open market, in privately negotiated transactions or
otherwise. The terms of any such purchases or offers could differ from the terms
of the Exchange Offer.
By transmitting an Agent's Message or executing a Letter of Transmittal,
each Holder will represent to Econophone and agree that, among other things, (i)
the Exchange Notes or interests therein to be acquired by such Holder and any
beneficial owners thereof (the "Beneficial Owner(s)") in the Exchange Offer are
being acquired by such Holder and any Beneficial Owner(s) in the ordinary course
of business of the Holder and any such Beneficial Owner(s), (ii) the Holder and
each Beneficial Owner are not participating, do not intend to participate and
have no arrangement or understanding with any person to participate in the
distribution of the Exchange Notes, (iii) the Holder and each Beneficial Owner
acknowledge and agree that any person who is a broker-dealer registered under
the Exchange Act or is participating in the Exchange Offer for the purpose of
distributing the Exchange Notes must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with a secondary
resale transaction of the Exchange Notes and any interest therein acquired by
such person and cannot rely on the position of the staff of the SEC set forth in
certain no-action letters (see "--Resales of the Exchange Notes"), (iv) the
Holder and each Beneficial Owner understands that a secondary resale transaction
described in clause (iii) above and any resales of the Exchange Notes and any
interest therein
32
<PAGE>
obtained by such Holder in exchange for the Original Notes originally acquired
by such Holder directly from Econophone should be covered by an effective
registration statement containing the selling security holder information
required by Items 507 and 508, as applicable, of Regulation S-K of the
Commission and (v) neither the Holder nor any Beneficial Owner(s) is an
"affiliate," as defined in Rule 405 promulgated under the Securities Act, of
Econophone. Each broker-dealer that receives Exchange Notes for its own account
in exchange for Original Notes must represent that the Original Notes tendered
in the Exchange Offer were acquired by such broker-dealer as a result of
market-making activities or other trading activities and must acknowledge that
it will deliver a prospectus meeting the requirements of the Securities Act in
connection with any resale of such Exchange Notes. By so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it is
an "underwriter" within the meaning of the Securities Act. This Prospectus, as
it may be amended or supplemented from time to time, may be used by a broker-
dealer in connection with the resales of Exchange Notes received in exchange for
Original Notes where Original Notes were acquired by such broker-dealer as a
result of market-making activities or other trading activities. Econophone has
indicated its intention to make this Prospectus (as it may be amended or
supplemented) available to any broker-dealer for use in connection with any such
resale for a period of 180 days after the last Exchange Date. See "Plan of
Distribution."
ACCEPTANCE OF ORIGINAL NOTES FOR EXCHANGE; DELIVERY OF EXCHANGE NOTES
Upon satisfaction or waiver of all of the conditions to the Exchange Offer,
Econophone will accept, promptly after the Expiration Date, all Original Notes
properly tendered and will issue the Exchange Notes promptly after acceptance of
the Original Notes. See "--Conditions of the Exchange Offer." For purposes of
the Exchange Offer, Econophone shall be deemed to have accepted properly
tendered Original Notes for exchange when, as and if Econophone has given oral
or written notice thereof (oral notice being promptly confirmed in writing) to
the Exchange Agent.
RETURN OF ORIGINAL NOTES
If any tendered Original Notes are not accepted for any reason set forth in
the terms and conditions of the Exchange Offer or if Original Notes are
withdrawn or are submitted for a greater principal amount than the Holders
thereof desire to exchange, then such unaccepted, withdrawn or non-exchanged
Original Notes will be returned without expense to the tendering Holder thereof.
Under such circumstances, Book-Entry Interests in Original Notes will be
credited to an account maintained with DTC as promptly as practicable.
BOOK-ENTRY TRANSFER
The Exchange Agent will establish an account with respect to the Book-Entry
Interests at DTC for purposes of the Exchange Offer promptly after the date of
this Prospectus. All deliveries of Book-Entry Interests must be made by
book-entry transfer to the account maintained by the Exchange Agent at DTC. Any
financial institution that is a participant in DTC's systems may make book-entry
delivery of Book-Entry Interests by causing DTC to transfer such Book-Entry
Interests into the Exchange Agent's account in accordance with DTC's ATOP
procedures for transfer. Holders of Book-Entry Interests who are unable to
deliver a Book-Entry Confirmation of the tender of their Book-Entry Interests
into the Exchange Agent's account at DTC or all other documents required by the
Letter of Transmittal to the Exchange Agent on or prior to the Expiration Date,
must tender their Book-Entry Interests according to the guaranteed delivery
procedures described below.
GUARANTEED DELIVERY PROCEDURES
If a Holder of Original Notes desires to tender such Original Notes and time
will not permit such Holder's required documents to reach the Exchange Agent, or
the procedure for book-entry transfer cannot be completed or the certificates
relating to Definitive Registered Notes cannot be delivered, in each case, on or
prior to the Expiration Date, a tender may be effected if (i) the tender is made
through an Eligible Institution, (ii) on or prior to the Expiration Date, the
Exchange Agent receives from such Eligible
33
<PAGE>
Institution (a) either a properly completed and duly executed Letter of
Transmittal (or a facsimile thereof) or a properly transmitted Agent's Message
and (b) a Notice of Guaranteed Delivery, substantially in the form provided by
Econophone (by facsimile transmission, mail or hand delivery), setting forth the
name and address of such Holder of Original Notes and the amount of Original
Notes tendered, stating that the tender is being made thereby and guaranteeing
that within five business days after the date of execution of the Notice of
Guaranteed Delivery, a Book-Entry Confirmation or the certificates relating to
the Definitive Registered Notes and all other documents required by the Letter
of Transmittal will be deposited by the Eligible Institution with the Exchange
Agent, and (iii) a Book-Entry Confirmation or the certificates relating to the
Definitive Registered Notes and all other documents required by the Letter of
Transmittal are received by the Exchange Agent within five business days after
the date of execution of the Notice of Guaranteed Delivery.
WITHDRAWAL OF TENDERS
A tender of Original Notes may be withdrawn any time prior to the Expiration
Date.
For a withdrawal to be effective, (i) a written notice must be received by
the Exchange Agent at the address set forth below under "--Exchange Agent" or
(ii) the appropriate procedures of DTC's ATOP system must be complied with. Any
such notice of withdrawal with respect to Book-Entry Interests must (i) specify
the name of the person having tendered the Original Notes to be withdrawn and
identify the Original Notes to be withdrawn (including the principal amount of
such Original Notes) and (ii) specify the name and number of the account at DTC
to be credited with the withdrawn Original Notes and otherwise comply with the
procedures of DTC. Any such notice of withdrawal with respect to Definitive
Registered Notes must (x) specify the name of the person having tendered the
Definitive Registered Notes to be withdrawn and (y) identify the Definitive
Registered Notes to be withdrawn (including the certificate number and principal
amount of Original Notes). Any such written withdrawal must be signed by the
Holder in the same manner as the original signature on the Letter of Transmittal
by which such Original Notes were tendered (including required signature
guarantees). All questions as to the validity, form and eligibility (including
time of receipt) of such notices will be determined by Econophone, in its sole
discretion and whose determination shall be final and binding on all parties.
Any Original Notes so withdrawn will be deemed not to have been validly tendered
for exchange for purposes of the Exchange Offer. Properly withdrawn Original
Notes may be retendered by following one of the procedures described above at
any time on or prior to the Expiration Date.
CONDITIONS OF THE EXCHANGE OFFER
Notwithstanding any other term of the Exchange Offer, Econophone shall not
be required to accept for exchange, or exchange Exchange Notes for, any Original
Notes, and may terminate the Exchange Offer as provided herein before the
acceptance of such Original Notes:
(a) if, in the sole judgment of Econophone, the Exchange Offer would
violate any law, statute, rule or regulation or an interpretation thereof of
the Commission staff; or
(b) with respect to all Book-Entry Interests tendered, if on the
Expiration Date, the Book-Entry Depositary does not present the Global Notes
to The Bank of New York, as Trustee.
If Econophone determines in its sole discretion that any of the conditions
are not satisfied, Econophone may (i) refuse to accept any Original Notes and
return all tendered Original Notes to the tendering Holders, (ii) extend the
Exchange Offer and retain all Original Notes tendered prior to the Expiration
Date, subject, however, to the rights of Holders to withdraw such Original Notes
(see "--Withdrawal of Tenders") or (iii) waive such unsatisfied conditions with
respect to the Exchange Offer and accept all validly tendered Original Notes
which have not been withdrawn. If such waiver constitutes a material change to
the Exchange Offer, Econophone will promptly disclose such waiver by means of a
prospectus supplement that will be distributed to the registered Holders and
Econophone will extend the Exchange Offer for a period of five to ten business
days, depending upon the significance of the waiver and
34
<PAGE>
the manner of disclosure to the registered holders, if the Exchange Offer would
otherwise expire during such five to ten business day period.
EXCHANGE AGENT
The Bank of New York has been appointed as Exchange Agent for the Exchange
Offer. Questions and requests for assistance, requests for additional copies of
this Prospectus or of the Letter of Transmittal and requests of or Notices of
Guaranteed Delivery should be directed to the Exchange Agent addressed as
follows:
BY REGISTERED OR CERTIFIED MAIL, BY OVERNIGHT COURIER OR BY HAND:
The Bank of New York
Reorganization Section
101 Barclay Street, Floor 7 East
New York, New York 10286
Attention: Shilpa Trivedi
or
BY FACSIMILE:
The Bank of New York
Attention: Shilpa Trivedi
Facsimile Number: (212) 815-6339
In addition, Letters of Transmittal and any other required documentation
should be sent to the Exchange Agent at the address set forth above, except
where facsimile transmission is specifically authorized (E.G., withdrawals and
Notices of Guaranteed Delivery). DELIVERY OF THE LETTER OF TRANSMITTAL TO AN
ADDRESS OTHER THAN AS SET FORTH ABOVE OR TRANSMISSION VIA FACSIMILE OTHER THAN
AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID DELIVERY.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by Econophone. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telecopy, telephone or in person by officers and regular
employees of Econophone and its affiliates.
Econophone has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptance of the Exchange Offer. Econophone, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
its reasonable out-of-pocket expenses in connection therewith.
Econophone will pay all transfer taxes, if any, applicable to the exchange
of the Original Notes pursuant to the Exchange Offer. If, however, a transfer
tax is imposed for any reason other than the exchange of the Original Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering holder. If satisfactory evidence of payment of such taxes or
exemption therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to the tendering holder.
CONSEQUENCES OF FAILURE TO EXCHANGE
Original Notes that are not exchanged for Exchange Notes pursuant to the
Exchange Offer will remain restricted securities within the meaning of Rule 144
of the Securities Act. Accordingly, such Original Notes may be resold only (i)
to Econophone or any subsidiary thereof, (ii) so long as the Original Notes are
eligible for resale pursuant to Rule 144A, to a person whom the seller
reasonably believes is a qualified institutional buyer within the meaning of
Rule 144A under the Securities Act, purchasing for its own account or for the
account of a qualified institutional buyer to whom notice is given that the
resale,
35
<PAGE>
pledge or other transfer is being made in reliance on Rule 144A, (iii) outside
the United States to non-U.S. persons in an offshore transaction in compliance
with Rule 904 under the Securities Act, (iv) pursuant to an exemption from
registration in accordance with Rule 144 (if available), (v) to an institutional
"accredited investor" that, prior to such transfer, furnishes to the Trustee a
signed letter containing certain representations and agreements relating to the
registration of transfer of the Original Notes and, if such transfer is in
respect of a principal amount of Original Notes at the time of transfer of less
than $250,000, an opinion of counsel acceptable to Econophone that such transfer
is in compliance with the Securities Act, and (vi) pursuant to an effective
registration statement under the Securities Act, in each case in accordance with
any applicable securities laws of any state of the United States and subject to
certain requirements of the Trustee being met. The liquidity of the Original
Notes could be adversely affected by the Exchange Offer. See "Risk
Factors--Consequences of Failure to Exchange." Following the consummation of the
Exchange Offer, holders of the Original Notes will have no further registration
rights under the Registration Rights Agreement (other than certain registration
rights granted to Morgan Stanley).
RESALES OF THE EXCHANGE NOTES
Based on an interpretation by the staff of the Commission set forth in
certain no-action letters issued to third parties, Econophone believes that the
Exchange Notes or interests therein issued pursuant to the Exchange Offer in
exchange for Original Notes or interests therein may be offered for resale,
resold and otherwise transferred by a Holder thereof (other than (i) a
broker-dealer who purchases such Exchange Notes directly from Econophone to
resell pursuant to Rule 144A or any other available exemption under the
Securities Act or (ii) a person that is an "affiliate" of Econophone within the
meaning of Rule 405 under the Securities Act), without compliance with the
registration and prospectus delivery requirements of the Securities Act,
PROVIDED that the Holder is acquiring the Exchange Notes in the ordinary course
of its business and not participating, and had no arrangement or understanding
with any person to participate, in the distribution of Exchange Notes. Each
broker-dealer that receives the Exchange Notes for its own account in exchange
for the Original Notes must represent that the Original Notes tendered in the
Exchange Offer were acquired by such broker-dealer as a result of market-making
activities or other trading activities and must acknowledge that it will deliver
a prospectus meeting the requirements of the Securities Act in connection with
any resale of such Exchange Notes. By so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This Prospectus, as it
may be amended or supplemented from time or time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Original
Notes where such Original Notes were acquired by such broker-dealer as a result
of market-making activities or other trading activities. Econophone has
indicated its intention to make this Prospectus (as it may be amended or
supplemented) available to any broker-dealer for use in connection with any such
resale for a period of 180 days after the last Exchange Date. See "Plan of
Distribution."
36
<PAGE>
USE OF PROCEEDS
The Exchange Offer is being effected to satisfy Econophone's obligations
under the Original Notes, the Indenture and the Registration Rights Agreement.
Econophone will not receive any cash proceeds from the Exchange Offer. In
consideration of issuing the Exchange Notes in the Exchange Offer, Econophone
will receive an equal principal amount of Original Notes. Original Notes that
are properly tendered in the Exchange Offer and not validly withdrawn will be
accepted, canceled and retired and cannot be reissued.
The net proceeds to Econophone from the Offering were approximately $148.1
million, after deducting commissions and other expenses paid by Econophone.
Approximately $57.4 million of the net proceeds were used to purchase the
Pledged Securities, which will be used to make the first six scheduled interest
payments on the Notes. In addition, approximately $7.2 million was used to
redeem the Bridge Notes and to pay all accrued interest thereon and
approximately $1.0 million is expected to be used to repay certain other
indebtedness in advance of its maturity date. Econophone also has used a portion
of the net proceeds for and plans to continue to use net proceeds for (i)
telecommunications equipment and IRUs, (ii) customer service, billing, financial
reporting and other management information systems, (iii) network management
systems, (iv) the expansion of Econophone's internal sales forces and (v)
operating losses. Proceeds from the Offering also may be used for future
investments, acquisitions or strategic alliances in companies that are
complementary to Econophone's current operations. Although Econophone currently
is evaluating certain potential investment opportunities, it does not have any
present commitments or agreements with respect to any such investment,
acquisition or strategic alliance.
Net proceeds from the Offering not immediately required for the purposes
described above are invested in short term, interest-bearing, investment grade
securities, subject to restrictions in the Indenture.
The Bridge Notes, which were redeemed in connection with the Offering, were
sold between April 24, 1997 and May 30, 1997 to Morgan Stanley Group, an
affiliate of Morgan Stanley. The net proceeds of such sales were used to fund
the purchase of equipment, other capital expenditures and operating losses.
Following the redemption of the Bridge Notes, Econophone was not entitled to
place any additional Bridge Notes under the Note Purchase Agreement and the
facility represented by the Note Purchase Agreement terminated. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Certain Transactions--Bridge
Funding by Morgan Stanley Group."
37
<PAGE>
CAPITALIZATION
The following table sets forth the cash and capitalization of Econophone at
June 30, 1997 and as adjusted to give effect to the Offering and to the
repayment of certain indebtedness, as described under "Use of Proceeds." This
information should be read in conjunction with the Financial Statements and the
notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AT JUNE 30, 1997
-----------------------
<S> <C> <C>
AS
ACTUAL ADJUSTED(1)
---------- -----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Cash, cash equivalents and restricted cash........................... $ 632 $ 147,732(2)
---------- -----------
---------- -----------
Short term borrowings, current portion of long-term debt, capital
lease obligations and notes payable-related parties................ $ 8,300 $ 7,300
Long-term debt and capital lease obligations:
Capital leases..................................................... 386 386
Notes offered hereby(4)............................................ -- 149,400
Other long-term debt(5)............................................ 4,413 4,413
---------- -----------
Total long-term debt and capital lease obligations............. 4,799 154,199
Redeemable Convertible Preferred Stock............................... 14,282 14,282
Stockholders' equity (deficit):
Common Stock, $.0001 par value, 29,250,000 shares authorized,
20,000,000 shares issued and outstanding(6)...................... 2 2
Non-Voting Common Stock, $.0001 par value, 500,000 shares
authorized, no shares issued and outstanding(6).................. -- --
Warrants(7)........................................................ -- 5,600
Additional paid-in capital......................................... 482 482
Cumulative translation adjustment.................................... (11) (11)
Accumulated deficit................................................ (17,290) (17,290)
---------- -----------
Total stockholders' equity (deficit)........................... (16,817) (11,217)
---------- -----------
Total capitalization....................................... $ 10,564 $ 164,564
---------- -----------
---------- -----------
</TABLE>
- ------------------------------
(1) The as adjusted data gives effect to (i) the issuance of the Units, (ii) the
repayment of approximately $.6 million owed to IDT and (iii) the repayment
of certain equipment financings totalling approximately $.4 million in the
aggregate, as if such events had occurred on June 30, 1997.
(2) At September 30, 1997, Econophone had cash, cash equivalents and restricted
cash totaling $132,320,602.
(3) Through December 31, 2002, the current long-term indebtedness of Econophone
matures as follows:
<TABLE>
<CAPTION>
YEAR OF MATURITY AMOUNT
- -------------------------------------------------------------------------------------- ---------
<S> <C>
1997.................................................................................. $ 704,713
1998.................................................................................. $1,124,890
1999.................................................................................. $1,009,407
2000.................................................................................. $ 981,335
2001.................................................................................. $ 592,655
2002.................................................................................. --
</TABLE>
(4) The annual interest requirement on the Notes is $20,925,000.
(5) As adjusted cash, cash equivalents and restricted cash includes actual cash
of $.6 million, plus the net proceeds of the Notes (approximately $148.1
million) less $1.0 million that will be used to retire indebtedness. See
"Use of Proceeds."
(6) Based on the number of shares outstanding on June 30, 1997. Does not include
(i) 2,626,500 shares of Common Stock issuable upon the exercise of options
to employees at a weighted average exercise price of $2.50, (ii) 3,420,701
shares of Common Stock issuable upon conversion of the Series A Preferred
Stock at August 1, 1997 or (iii) any of the shares of Common Stock issuable
upon exercise of the Warrants issued in connection with the Offering. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources," "Management--Executive
Compensation--1996 Flexible Incentive Plan" and "Certain
Transactions--Investment by Princes Gate."
(7) Represents the portion of the issue price for the Units attributable to the
fair value of the Warrants. Such amount has been recognized as a discount on
the Notes and will be amortized over the term of the Notes. Each Warrant may
be exercised for 8.167 shares of Common Stock at an exercise price of $.01
per share. The Warrants are exercisable for 1,265,885 shares of Common
Stock, in the aggregate. The fair value of the shares issuable upon exercise
of the Warrants was determined to be $4.43 per share based on an agreement
among Econophone and the Placement Agent in connection with the Offering.
Among the factors considered in making such determination were the history
of the prospects for the industry in which Econophone competes, an
assessment of Econophone's management, the present operations of Econophone,
the historical results of operations of Econophone and the trend of its
revenues and earnings, the prospects for future earnings of Econophone, the
general condition of the securities markets at the time of the Offering, and
the prices of similar securities of generally comparable companies. The
Warrants expire on June 30, 2007.
38
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data (except for certain data
under Other Data and data under Regional Data) for the years ended December 31,
1994, 1995 and 1996 was derived from the audited consolidated financial
statements of Econophone. The audited consolidated financial statements of
Econophone as of December 31, 1995 and 1996 and for each of the three years in
the period ended December 31, 1996, together with the notes thereto and the
related report of Arthur Andersen LLP, independent accountants, are included
elsewhere in this Prospectus. The selected consolidated financial data for the
years ended December 31, 1992 and 1993 is derived from unaudited financial
statements of Econophone, which, in the opinion of management, include all
adjustments necessary for a fair presentation of the financial condition and
results of operations of Econophone for such periods. The following selected
financial information for the six months ended June 30, 1996 and 1997 was
derived from the unaudited interim financial statements of Econophone and
reflects all adjustments (consisting of normal recurring adjustments) which are,
in the opinion of management, necessary for a fair presentation of the
consolidated financial information for those periods. The information contained
below should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Financial Statements
of Econophone and the notes related thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1992(1) 1993(1) 1994 1995 1996 1996 1997
------------- ----------- ----------- --------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS, EXCEPT NET INCOME (LOSS) PER SHARE,
REVENUE PER MINUTE AND RATIO OF EARNINGS TO FIXED CHARGES)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................... $ 3,268 $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 22,992 $ 30,446
Cost of services................. 2,659 2,761 5,540 19,735 35,369 16,333 24,012
Selling, general and
administrative expense......... 474 497 2,013 7,087 16,834 9,805 12,896
Depreciation and amortization.... 12 51 168 389 1,049 383 1,069
------ ----------- ----------- --------- --------- --------- ---------
Income (loss) from operations.... 123 219 802 279 (8,149) (3,529) (7,531)
Other income (expense)........... -- 6 100 (10) 133 11 58
Interest expense, net............ -- (19) (103) (148) (296) (78) (285)
Provision (benefit) for taxes.... 2 -- 73 -- -- -- --
------ ----------- ----------- --------- --------- --------- ---------
Net income (loss)................ $ 121 $ 206 $ 726 $ 121 $ (8,312) $ (3,596) $ (7,758)
------ ----------- ----------- --------- --------- --------- ---------
------ ----------- ----------- --------- --------- --------- ---------
Net income (loss) per share(3)... $ .01 $ .01 $ .04 $ .01 $ (.42) $ (.18) $ (.39)
OTHER DATA:
Capital expenditures(4).......... $ 118 $ 605 $ 906 $ 1,677 $ 4,670 $ 2,152 $ 5,758
EBITDA(5)........................ 135 276 1,070 658 (6,967) (3,135) (6,404)
Dividends declared............... -- -- -- 449 508 226 879
Net cash (used in) provided by
operating activities(6)........ -- (190) 474 2,037 (6,006) 60 (7,698)
Revenue per minute............... .70 .57 .43 .56 .29
Minutes.......................... 12,196 47,859 104,566 40,869 104,615
Ratio of earnings to fixed
charges(7)..................... 2.5x 8.6x 7.2x 1.5x -- -- --
Deficiency of earnings available
to cover fixed charges......... -- -- -- -- $ (7,507) $ (3,476) $ (6,395)
REGIONAL DATA:
Revenues
United States.................. $ 2,728 $ 8,292 $ 18,185 $ 6,876 $ 18,896
United Kingdom................. 3,143 14,173 15,477 10,910 4,201
Continental Europe............. 2,652 5,025 11,441 5,206 7,349
Minutes
United States.................. 5,707 23,411 68,247 20,744 87,747
United Kingdom................. 4,532 20,592 27,968 16,390 10,136
Continental Europe............. 1,957 3,856 8,351 3,735 6,732
<CAPTION>
<S> <C>
AS ADJUSTED
1997(2)
--------------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................... $ 30,446
Cost of services................. 24,012
Selling, general and
administrative expense......... 12,896
Depreciation and amortization.... 1,414
--------------
Income (loss) from operations.... (7,876)
Other income (expense)........... 58
Interest expense, net............ (11,028)
Provision (benefit) for taxes.... --
--------------
Net income (loss)................ $ (18,846)
--------------
--------------
Net income (loss) per share(3)... $ (.94)
OTHER DATA:
Capital expenditures(4)..........
EBITDA(5)........................
Dividends declared...............
Net cash (used in) provided by
operating activities(6)........
Revenue per minute...............
Minutes..........................
Ratio of earnings to fixed
charges(7)..................... --
Deficiency of earnings available
to cover fixed charges......... $ (17,483)
REGIONAL DATA:
Revenues
United States..................
United Kingdom.................
Continental Europe.............
Minutes
United States..................
United Kingdom.................
Continental Europe.............
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
AT JUNE
AT DECEMBER 31, 30, 1997
----------------------------------------------------- ---------
1992 1993 1994 1995 1996 ACTUAL
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents........................... $ 12 $ 120 $ 86 $ 106 $ 6,272 $ 632
Current assets...................................... 519 852 2,588 7,616 14,729 15,063
Restricted cash..................................... -- -- -- -- -- --
Total assets........................................ 609 1,541 4,034 10,508 22,755 28,224
Current portion of borrowings....................... 420 510 480 558 3,020 8,300
Long-term borrowings, less current portion.......... -- 39 639 719 2,263 4,799
Redeemable Convertible Preferred Stock.............. -- -- -- -- 13,358 14,282
Total stockholders' equity (deficit)................ 118 708 1,088 710 (8,124) (16,817)
<CAPTION>
AS ADJUSTED(2)
--------------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................... $ 90,295
Current assets...................................... 123,872
Restricted cash..................................... 57,437
Total assets........................................ 182,224
Current portion of borrowings....................... 7,300
Long-term borrowings, less current portion.......... 154,199
Redeemable Convertible Preferred Stock.............. 14,282
Total stockholders' equity (deficit)................ (11,217)
</TABLE>
- ------------------------
(1) Regional revenue data and minute data for 1992 and 1993 are not available.
(2) The as adjusted data gives effect to (i) the issuance of the Units and the
accrual and accretion of interest associated with the Notes, (ii) the
amortization of the deferred financing costs associated with the Offering,
(iii) the repayment of approximately $.6 million owed to IDT and (iv) the
repayment of certain equipment financings totaling approximately $.4 million
in the aggregate, as if such events had occurred on January 1, 1997 (for
statement of operations purposes) and June 30, 1997 (for balance sheet
purposes). See "Use of Proceeds." As adjusted data does not give effect to
any interest income on the proceeds of the Units.
(3) Net income (loss) per share is computed using the weighted average number of
shares outstanding during the period.
(4) Capital expenditures include assets acquired through capital lease financing
and other debt.
(5) EBITDA represents net income (loss) plus interest expense, income tax
expense and depreciation and amortization expense. Econophone has 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 more meaningful than,
measures of performance determined in accordance with generally accepted
accounting principles.
(6) Net cash provided by (used in) operations for the year ended December 31,
1992 is not available.
(7) Earnings available to cover fixed charges consist of earnings (losses)
before income taxes. Fixed charges consist of interest on debt, the interest
component of rent expense (deemed to be one-third of the total) and
dividends accrued on preferred stock.
40
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH ECONOPHONE'S
FINANCIAL STATEMENTS, THE NOTES THERETO AND THE OTHER FINANCIAL DATA INCLUDED
ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING DISCUSSION INCLUDES CERTAIN
FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION OF IMPORTANT FACTORS, INCLUDING,
BUT NOT LIMITED TO, CONTINUED DEVELOPMENT OF ECONOPHONE'S BUSINESS, ACTIONS OF
REGULATORY AUTHORITIES AND COMPETITORS, PRICE DECLINES AND OTHER FACTORS THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE FORWARD-LOOKING
STATEMENTS, SEE "RISK FACTORS."
OVERVIEW
REVENUES; PRICE DECLINES
Econophone derives its revenues from the provision of long distance
telecommunications services in certain major western European and U.S. markets.
In the United States and the United Kingdom, Econophone provides principally
international and domestic long distance, calling card, prepaid and carrier
services. In continental Europe, Econophone provides principally international
long distance, calling card and prepaid services. Econophone's services utilize
various access methods, including "1xxx," "1+," local dial-up, national toll
free and international toll free access. See "Business--Services" and
"Business--Network Infrastructure--Access Methods."
Econophone's revenues are derived from minutes of telecommunications traffic
carried. The following table shows the total revenue and billable minutes of use
attributable to Econophone's U.K., continental European and U.S. operations for
the years ended December 31, 1994, 1995 and 1996 and the six months ended June
30, 1996 and 1997. Over time, Econophone expects its European markets to
contribute an increasingly larger percentage of its revenues.
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- --------------------
<S> <C> <C> <C> <C> <C>
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
REVENUE
United States............................ $ 2,728 $ 8,292 $ 18,185 $ 6,876 $18,896
United Kingdom........................... 3,143 14,173 15,477 10,910 4,201
Continental Europe....................... 2,652 5,025 11,441 5,206 7,349
BILLABLE MINUTES OF USE
United States............................ 5,707 23,411 68,247 20,744 87,747
United Kingdom........................... 4,532 20,592 27,968 16,390 10,136
Continental Europe....................... 1,957 3,856 8,351 3,735 6,732
</TABLE>
Econophone generally prices its services at a discount to the primary
carrier (or carriers) in each of its target markets. Econophone has experienced
and expects to continue to experience declining revenue per minute in all of its
markets as a result of increased competition worldwide, although, due to
technological innovation and substantial available transmission capacity,
transmission costs in the telecommunications industry historically have declined
at a more rapid rate than prices. There can be no assurance that this cost trend
will continue. Industry observers predict that, early in the next decade,
telephone charges will no longer be based on the distance a call is carried. As
a consequence, Econophone would experience a substantial reduction in its
margins on international calls which, absent a significant increase in billable
minutes of traffic carried or charges for additional services, would have a
material adverse effect on Econophone's ability to pay principal of and interest
on the Notes. See "Risk Factors--Risks Associated with Rapidly Changing
Industry; Significant Price Declines" and "Business--Industry Overview."
41
<PAGE>
For prepaid cards, Econophone's revenues are reported net of selling
discounts and commissions and upon usage rather than sale.
Econophone's U.K. revenues were limited in 1996 and during the first six
months of 1997 due to a restructuring of Econophone's U.K. sales and marketing
arrangements resulting from a change in its distribution strategy. In September
1994, Econophone entered into a sales and marketing joint venture with EI in the
United Kingdom. EI engaged in sales and marketing, while Econophone provided
network support, billing and transmission services. Revenues attributable to
sales by the joint venture were included in Econophone's consolidated revenues
and customers of the joint venture were included as customers of Econophone.
After deducting transmission expenses and direct selling expenses incurred by
EI, Econophone was entitled to 50% of the net profits on sales by EI. In
connection with Econophone's change in U.K. distribution strategy, Econophone's
joint marketing arrangement with EI was modified on June 1, 1996, at which time
EI effectively became a carrier customer. This arrangement subsequently was
terminated during December 1996. Econophone's services now are sold in the
United Kingdom primarily through Telco, a majority-owned subsidiary of
Econophone. Telco began marketing efforts during the first quarter of 1997.
During the first six months of 1997, Econophone's U.K. revenues, which primarily
were generated by Telco, were $4.2 million. See "Business--Sales and Marketing."
Econophone has had a competitive advantage in certain EU markets where it
has not been required to charge VAT until recently. The European Union issued a
derogation from the VAT Directive in March 1997. As a result of this derogation,
EU member states, with effect from between January 1, 1997 and July 1, 1997,
began to require telecommunications providers "established" outside of the EU to
charge VAT on telecommunications services provided to EU customers, including
residential customers (who cannot offset the VAT charged to them). The foregoing
change in the VAT regulations may require Econophone to reduce the prices of its
services offered to residential customers in one or more of its EU markets in
order to remain competitive. See "Risk Factors--Risks Associated With Imposition
of VAT."
COST OF SERVICES
Econophone's cost of services is composed of the costs associated with
acquiring switched transmission and leased line capacity. Switched transmission
capacity is acquired on a per-minute basis (with volume discounts) and is,
therefore, a variable cost. Virtually all calls carried by Econophone must be
originated or terminated over another carrier's facilities. Termination and
origination charges on calls generally are paid by Econophone, although in
continental Europe origination charges on calls utilizing local dial-up access
are paid by Econophone's customers and do not constitute costs of Econophone.
Leased transmission capacity is acquired on a fixed cost basis, generally
involving monthly payments regardless of usage levels. Accordingly, once certain
volume levels are reached, leased line capacity is more cost effective than
switched transmission capacity. As Econophone's minutes of traffic carried have
grown, Econophone has obtained better pricing on switched transmission capacity
and from leased lines. The marginal cost of services also has decreased,
independent of volume discounts, due to greater usage of owned transmission
capacity, technological innovation and substantial available third-party
transmission capacity.
The cost of calls transmitted between Econophone's London and New York
switches consists of leased line and IRU costs. Leased line and IRU costs, the
latter of which are included in depreciation and amortization, involve only
fixed costs and no per minute charges and are, therefore, more cost-effective
means of transmitting traffic once certain volume levels are reached. Econophone
has, over time, reduced the average costs of transmitting the London to New York
portion of its calls by increasing its customer traffic. Econophone intends to
acquire the five half-circuits on PTAT-1 and the one on Cantat-3 that correspond
to its existing IRUs during the fourth quarter of 1997. As Econophone expands
its customer base, it will require additional transmission capacity. Its actual
infrastructure requirements will depend upon the capacity of the switches, nodes
and points of presence installed by Econophone and the extent to which it
utilizes compression technology to transmit calls. Based on current and
anticipated availability of
42
<PAGE>
switching and compression equipment and owned and leased transmission capacity,
Econophone believes that it will be able to meet its capacity requirements for
the foreseeable future, although there can be no assurance that this will be the
case. See "Business--Network Infrastructure--Transmission Capacity."
In the future, Econophone may be required to pay a $.35 access charge to
payphone operators for each call made using toll free access from a payphone in
the United States. There can be no assurance that Econophone will be able to
fully pass this cost on to its U.S. calling card and prepaid card customers or
that doing so will not result in a loss of customers. Furthermore, larger
carriers are likely to be able to negotiate lower payphone access charges than
Econophone, which could result in lower pricing on card-based services in the
United States accessed from payphones than that offered by Econophone. The FCC
also has, subject to reconsideration, announced that it will impose charges on
inter-exchange carriers, including Econophone, to support subsidies for
telecommunications services for schools, libraries, rural health care centers
and low income persons. Econophone does not expect these charges to be material
to Econophone, although there can be no assurance that this will be the case.
See "Risk Factors--Regulatory Restrictions."
SELLING EXPENSES
Econophone has historically sold its services primarily through independent
sales channels in both Europe and the United States. Selling expenses have,
therefore, primarily consisted of commissions paid to agents and EI. To a lesser
extent, Econophone also has incurred selling expenses arising out of advertising
and promotion costs and sales by Econophone employees and expenses related to
its customer service department.
In the fourth quarter of 1996, Econophone began to establish its internal
sales forces in Hamburg, London and Paris, and, in the first quarter of 1997,
Econophone began to establish its internal sales force in Brussels. Beginning in
the fourth quarter of 1996, Econophone also hired senior sales personnel in
continental Europe. The establishment and expansion by Econophone of its
internal sales forces and the hiring of senior sales personnel will increase
significantly its selling expenses due to costs associated with operating and
staffing sales offices. After an initial increase in these costs, Econophone
expects them to decline as a percentage of its continental European revenues
over time. Econophone will continue to utilize indirect channels of distribution
in its European network cities, although these channels will be managed by its
internal sales forces. See "Business--Sales and Marketing."
In the United States, during 1997, Econophone hired senior sales personnel
and sales managers for Baltimore, Connecticut, New Jersey and New York.
Econophone also intends to hire sales managers for other U.S. markets in which
it has or intends to establish a network presence. The addition of sales and
marketing personnel will result in an increase in U.S. selling expenses. After
an initial increase in advance of anticipated revenues, these costs are expected
to decline as a percentage of U.S. revenues over time. See "Business--Sales and
Marketing."
GENERAL AND ADMINISTRATIVE EXPENSES
During 1996, Econophone significantly increased the size of its management
team and established new sales offices in London, Paris, Brussels and Hamburg,
all of which resulted in an increase in general and administrative expenses.
Econophone intends to establish additional sales offices in all of its network
cities, which will further increase general and administrative expenses. General
and administrative expenses will increase substantially as Econophone applies a
portion of the proceeds from the Offering to expand its customer service,
billing, financial reporting and other management information systems and
network management systems and for organizational expenses related to entering
additional markets. Such expenses will be incurred in advance of anticipated
related revenues. After an initial increase in advance of anticipated revenues,
such expenses are expected to decline as a percentage of revenues over time.
43
<PAGE>
FOREIGN CURRENCY EXPOSURE
Econophone is exposed to fluctuations in foreign currencies relative to the
U.S. dollar because Econophone bills in local currency, while transmission costs
are largely incurred in U.S. dollars and interest expense on the Notes will be
in U.S. dollars. For the years ended 1994, 1995 and 1996 and the first six
months of 1997, approximately 66%, 60%, 40% and 37%, respectively, of
Econophone's revenues were billed in currencies other than the U.S. dollar,
consisting primarily of British pounds, Belgian francs and French francs. The
effect of these fluctuations on Econophone's margins for the six months ended
June 30, 1997 was $.5 million or 2.3% of gross margin. As Econophone expands its
operations, a higher percentage of revenues is expected to be billed in
currencies other than the U.S. dollar. Econophone from time to time uses foreign
exchange contracts relating to its receivables to hedge foreign currency
exposure and to control risks relating to currency fluctuations. Econophone does
not use derivative financial instruments for speculative purposes and, at
December 31, 1996 and August 31, 1997, Econophone had no open foreign currency
hedging positions. As Econophone's operations in Europe expand, it intends to
utilize hedging contracts to control risks relating to currency fluctuations.
See "Risk Factors--Devaluation and Currency Risks."
NEW ACCOUNTING PRONOUNCEMENTS
Subsequent to December 31, 1996, the Financial Accounting Standards Board
(the "FASB") issued SFAS No. 128, "Earnings Per Share." This statement
establishes standards for computing and presenting earnings per share ("EPS"),
replacing the presentation of currently required primary EPS with a presentation
of Basic EPS. For entities with complex capital structures, the statement
requires the dual presentation of Basic EPS and Diluted EPS on the face of the
statement of operations. Under this new standard, Basic EPS is computed based on
weighted average shares outstanding and excludes any potential dilution. Diluted
EPS reflects potential dilution from the exercise or conversion of securities
into common stock or from other contracts to issue common stock and is similar
to the currently-required fully diluted EPS. SFAS No. 128 is effective for
financial statements issued for periods ending after December 15, 1997,
including interim periods, and earlier application is not permitted. When
adopted, Econophone will be required to restate its EPS data for all prior
periods presented. The adoption of this statement is not expected to have a
material effect on Econophone's financial statements.
RESULTS OF OPERATIONS
The following table presents certain data concerning Econophone's results of
operations for the years ended December 31, 1994, 1995 and 1996 and for the six
months ended June 30, 1996 and 1997.
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- --------------------
<S> <C> <C> <C> <C> <C>
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues.............................................. $ 8,523 $ 27,490 $ 45,103 $ 22,992 $ 30,446
Cost of services...................................... 5,540 19,735 35,369 16,333 24,012
Selling expenses...................................... 549 3,934 7,821 6,101 3,979
General and administrative expenses................... 1,464 3,153 9,013 3,704 8,917
Depreciation and amortization......................... 168 389 1,049 383 1,069
Net income (loss)..................................... 726 121 (8,312) (3,596) (7,758)
</TABLE>
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
REVENUES. Total revenues for the six months ended June 30, 1997 increased
by 32% to $30.4 million on 104.6 million billable minutes of use from $23.0
million on 40.9 million billable minutes of use for the six months ended June
30, 1996. Growth in revenues during the six months ended June 30, 1997 primarily
44
<PAGE>
was attributable to additional minutes of use, particularly in the United
States, offset in part by a substantial decline in prices. At June 30, 1997,
Econophone had approximately 66,200 customer accounts compared to 35,200
customer accounts at June 30, 1996. The increase was primarily attributable to
sales by VoiceNet, which were $8.0 million for the six months ended June 30,
1997 and which accounted for approximately 45,800 customer accounts at June 30,
1997. VoiceNet's relationship with Econophone is non-exclusive and can be
terminated at will by either party.
In the United Kingdom, revenues decreased to $4.2 million from $10.9 million
as a result of the termination of Econophone's joint venture with EI, which had
accounted for all of the U.K. revenue in the first half of 1996, in connection
with Econophone's change in U.K. distribution strategy. This decrease partially
was offset by revenues of $2.6 million during the first half of 1997 from
international and domestic long distance and prepaid card services primarily
attributable to Telco, as well as from carrier services. Average U.K. revenue
per minute decreased from $.67 per minute during the six months ended June 30,
1996 to $.41 per minute during the six months ended June 30, 1997. This
reduction was attributable to price decreases resulting from increased price
competition, as well as lower prices being charged by Telco to its customers
than by Econophone to its joint venture with EI.
In continental Europe, revenues increased by 40% to $7.3 million from $5.2
million. This increase was attributable to an increase in prepaid card services,
primarily in France. Belgian revenues remained flat due to increased price
competition. As a result of the installation of a switch in Brussels and a node
in Antwerp during the first quarter of 1997, Econophone believes that it will be
able to more effectively compete in both of these markets. Average continental
European revenue per minute decreased from $1.39 per minute during the six
months ended June 30, 1996 to $1.09 per minute during the six months ended June
30, 1997. This decrease was due to Econophone's decision to price services more
aggressively to gain market share, in anticipation of its network coming on
line.
In the United States, revenues grew by 174% to $18.9 million from $6.9
million. This increase was due principally to calling card revenues attributable
to sales by VoiceNet, which were $8.0 million during the first half of 1997.
VoiceNet began reselling Econophone's calling card services to end users during
the second quarter of 1996. The remainder of the increase, $2.4 million,
resulted from increases in sales of carrier services, and, to a lesser extent,
international and domestic long distance and prepaid card services. Average U.S.
revenue per minute decreased to $.22 per minute during the six months ended June
30, 1997 from $.33 per minute during the six months ended June 30, 1996. This
reduction was due principally to a reduction in rates by Econophone in response
to increased competition, pricing reductions by larger carriers and sales of a
larger percentage of domestic long distance minutes, which are sold at lower
rates than international minutes.
During the first six months of 1997, Econophone experienced a customer
turnover or "churn" rate of approximately 5%. To date, Econophone's revenues and
margins have not been materially impacted by its "churn" rate.
COST OF SERVICES. Cost of services increased to $1.1 million for the six
months ended June 30, 1997 from $16.3 million for the six months ended June 30,
1996. As a percentage of revenues, cost of services increased to approximately
79% for the six months ended June 30, 1997 from approximately 71% for the six
months ended June 30, 1996. This trend was primarily due to a shift from higher
margin revenue attributable to EI to lower margin revenue attributable to Telco,
and, to a lesser extent, an increase in U.S. carrier traffic. Average cost per
minute for the six month period ended June 30, 1997 decreased to $.23 from $.40
for the six month period ended June 30, 1996.
SELLING EXPENSES. Selling expenses decreased to $4.0 million for the six
months ended June 30, 1997 from $6.1 million for the six months ended June 30,
1996, and, as a percentage of revenue, were 13% for the six months ended June
30, 1997 and 27% for the six months ended June 30, 1996. For the six months
ended June 30, 1997, selling expenses primarily consisted of $1.0 million in
expenses associated with Econophone's sales offices in London, Brussels, Hamburg
and Paris, which were opened after June 30,
45
<PAGE>
1996, commissions totalling $2.0 million paid to independent sales
representatives ($.1 million) and VoiceNet ($1.9 million), a reseller selling
Econophone's U.S. calling card services to end users, and expenses ($.5 million)
attributable to Econophone's customer service department, which has been
substantially enlarged since June 30, 1996. For the six months ended June 30,
1996, selling expenses primarily consisted of expenses related to EI and
commissions paid to independent sales agents.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $8.9 million for the six months ended June 30, 1997 from $3.7
million for the six months ended June 30, 1996, and, as a percentage of
revenues, increased to 29% for the six months ended June 30, 1997 from 16% for
the six months ended June 30, 1996. The increase in general and administrative
expenses of $2.4 million was attributable primarily to payroll costs of
additional management and staff in the areas of finance, network management and
information systems at Econophone's New York, New York, Brooklyn, New York and
College Station, Texas facilities.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $1.1 million for the six months ended June 30, 1997 from $.4
million for the six months ended June 30, 1996. This increase was substantially
due to the depreciation expense associated with upgrades in Econophone's switch
in New York and installation of multiplexing equipment in New York (totalling
$.7 million) and London ($.2 million) and the depreciation of IRUs and other
equipment ($.2 million).
BAD DEBT WRITE-OFFS. Econophone had bad debt write-offs of $.7 million for
the first six months of 1997, as compared to $.7 million for the first six
months of 1996.
INTEREST EXPENSE. Econophone had $285,000 of interest expense during the
first half of 1997, as compared to interest expense of $78,000 during the first
half of 1996. Interest expense will increase substantially as a result of the
Offering.
NET LOSS. Econophone had a net loss of $7.8 million during the first half
of 1997, compared to a net loss of $3.6 million during the first half of 1996.
Net loss will increase substantially over the near term as Econophone incurs
interest expense on the Notes and uses the proceeds of the Offering in advance
of anticipated related revenues.
1996 COMPARED TO 1995
REVENUES. Total revenues for 1996 increased by 64% to $45.1 million on
104.6 million billable minutes of use from $27.5 million on 47.9 million
billable minutes of use for 1995. Growth in revenues during 1996 was generated
primarily from an increase in minutes of traffic in existing markets, offset in
part by declining prices. At December 31, 1996, Econophone had approximately
24,700 customer accounts, compared to approximately 26,400 customer accounts at
December 31, 1995. The reduction in the number of customer accounts was
attributable to the termination of Econophone's relationship with EI discussed
below.
In the United Kingdom, revenues grew 9% to $15.5 million. Econophone's U.K.
revenues were limited in 1996 due to a restructuring of Econophone's U.K. sales
and marketing arrangements resulting from a change in its distribution strategy.
For the first five months of 1996, U.K. revenues increased substantially over
the corresponding period in 1995. On June 1, 1996, Econophone effectively
terminated its joint venture with EI, pursuant to which EI had the exclusive
right to sell Econophone's services in the United Kingdom. In exchange for
Econophone being granted the right to compete in the United Kingdom, Econophone
forgave a net receivable of $2.0 million and agreed to sell transmission to EI
at lower rates than transmission was sold to the joint venture, thereby
substantially reducing revenues on U.K. sales during the second half of 1996 as
compared to the corresponding period in 1995. Econophone ceased providing
transmission services to EI during November 1996 due to payment delinquencies by
EI and terminated its relationship with EI during December 1996. In connection
with the termination, EI agreed to pay Econophone $2.2 million on an agreed upon
payment schedule, substantially all of which has been
46
<PAGE>
paid. In addition, Econophone agreed not to solicit sales from customers of the
joint venture, subject to certain permitted exceptions. See "Risk
Factors--Dependence on Carrier and Other Principal Customers," and
"Business--Sales and Marketing."
During 1996, average U.K. revenue per minute was $.55, down from $.69 in
1995. This reduction was attributable to price decreases resulting from
increased price competition, as well as the modification of Econophone's
relationship with EI on June 1, 1996, which included a reduction in prices
charged to EI as compared to the prices charged to Econophone's joint venture
with EI.
In continental Europe, revenues increased by 128% to $11.4 million. This
increase was attributable primarily to growth in prepaid card services of $7.2
million due to full year sales and increased marketing and, to a lesser extent,
growth in calling card services of $4.2 million. Average continental European
revenue per minute was $1.37, up from $1.30 in 1995. This increase was
principally due to an increase in higher priced prepaid card traffic.
In the United States, Econophone's revenues grew 119% to $18.2 million,
primarily as a result of substantial increases in sales of international and
domestic long distance services of $7.8 million, prepaid card services of $2.6
million (which were introduced during the second half of 1995 and generated
minimal revenue during such year) and carrier services of $5.9 million, as well
as the introduction of calling card services of $1.9 million, which were sold
primarily through VoiceNet. Average U.S. revenue per minute was $.27 in 1996,
down from $.35 in 1995. This decrease was due principally to a reduction in
rates resulting from increased price competition attributable to pricing
reductions by larger carriers and sales of a larger percentage of domestic long
distance minutes, which are sold at lower rates than international minutes.
COST OF SERVICES. Cost of services increased to $35.4 million for 1996 from
$19.7 million for 1995 and, as a percentage of revenues, increased to 78% for
1996 from 72% for 1995. The increase as a percentage of revenues was primarily
due to the modification of Econophone's relationship with EI on June 1, 1996,
pursuant to which Econophone agreed to charge a lower transmission rate to EI,
thereby reducing margins on sales to EI. Average costs per minute for 1996
decreased to $.34 from $.41 for 1995. This decrease was attributable to volume
discounts resulting from the higher volume of traffic carried and general price
reductions on transmission capacity.
SELLING EXPENSES. Selling expenses increased to $7.8 million for 1996 from
$3.9 million for 1995, and, as a percentage of revenues, increased to 17% in
1996 from 14% in 1995. These expenses consisted primarily of expenses related to
EI and commissions paid to independent sales agents.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $9.0 million for 1996 from $3.2 million for 1995, and, as
percentage of revenues, increased to 20% in 1996 from 11% in 1995, respectively.
This increase was primarily due to increases in the size of Econophone's
customer service department and, starting in August 1996, a substantial increase
in Econophone's management and staff in the areas of finance, network management
and information systems at its New York, New York, Brooklyn, New York and
College Station, Texas facilities, and the establishment of sales offices in
London during the second quarter of 1996 and in Paris, Brussels and Hamburg
during the third quarter of 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $1.0 million for 1996 from $.4 million for 1995. This increase was
substantially due to the depreciation expense associated with upgrades in
Econophone's switch in New York and installation of multiplexing equipment in
New York and London.
BAD DEBT WRITE-OFFS. Econophone had bad debt write-offs of $.7 million
during 1996, compared to bad debt write-offs of $.2 million during 1995.
47
<PAGE>
1995 COMPARED TO 1994
REVENUES. Total revenues for 1995 increased to $27.5 million on 47.9
million billable minutes of use from $8.5 million on 12.2 million billable
minutes of use for 1994. Growth in revenues during 1995 was generated primarily
from an increase in minutes of traffic in existing markets and the introduction
of prepaid card services. At December 31, 1995, Econophone had approximately
26,400 customer accounts, compared to approximately 8,100 customer accounts at
December 31, 1994.
In the United Kingdom, revenues grew to $14.2 million from $3.1 million
primarily as a result of increased sales of calling card services by EI, which
began operations during September 1994, as well as the initiation of prepaid
card services by EI. During both 1995 and 1994, average U.K. revenue per minute
was $.69.
In continental Europe, revenues increased to $5.0 million from $2.7 million.
This increase was attributable to increases in calling card sales and the
introduction of prepaid card services, in each case primarily in Belgium. During
1995, average continental European revenue per minute was $1.30, down from $1.36
in 1994. This decrease was due to a permanent price reduction by Econophone in
Belgium in response to a large rate reduction by the local PTO.
In the United States, revenues grew to $8.3 million from $2.7 million. This
growth was attributable to substantial increases in sales of international and
domestic long distance services and carrier services. During 1995, average U.S.
revenue per minute was $.35, down from $.48 in 1994. This decrease was
principally due to increased carrier traffic which has lower revenue per minute
than other traffic.
COST OF SERVICES. Cost of services increased to $19.7 million for 1995 from
$5.5 million for 1994, and, as a percentage of revenues, increased to 72% for
1995 from 65% for 1994. This trend was primarily due to changes in geographic
and service revenue mix. Average cost per minute for 1995 decreased to $.41 from
$.45 for 1994.
SELLING EXPENSES. Selling expenses increased to $3.9 million for 1995 from
$.5 million for 1994 and, as a percentage of revenues, increased to 14% in 1995
from 6% in 1994. These expenses principally consisted of commissions paid to
independent sales representatives and EI and the increase was attributable to a
higher rate of commission paid on sales by EI than on other sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $3.2 million for 1995 from $1.5 million for 1994 and, as a
percentage of revenues, decreased to 11% from 17% for 1995 and 1994,
respectively. This decrease was due to significant growth in revenues during
1995.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $.4 million for 1995 from $.2 million for 1994. This increase was
due to the depreciation expense associated with upgrades in Econophone's New
York switch and multiplexing equipment and the depreciation of IRUs between New
York and London.
BAD DEBT WRITE-OFFS. Econophone had bad debt write-offs of $.2 million
during 1995, compared to bad debt write-offs of $.2 million in 1994.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, Econophone had approximately $75.0 million in cash
and cash equivalents, excluding the Pledged Securities but including unused net
proceeds of the Offering, which are invested in short term, interest-bearing,
investment grade securites. Econophone's net cash used by operating activities
was $7.7 million for the six months ended June 30, 1997, primarily due to a net
loss of $7.8 million and an increase in accounts receivable of $4.8 million,
offset by an increase in accounts payable of $4.9 million and depreciation and
amortization of $1.1 million. Cash used for investing in property and equipment
of $3.3 million for the six months ended June 30, 1997 was primarily
attributable to the
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implementation and expansion of Econophone's European network. Cash provided by
financing activities of $5.3 million was related to cash received from the sale
of the Bridge Notes of $7.0 million, and debt incurred to finance capital
expenditures of $.1 million offset by regular monthly payments totalling $.1
million and certain accelerated payments on existing debt totalling $1.7
million.
Econophone's net cash used by operating activities was $6.0 million for 1996
and net cash provided by operating activities was $2.0 million and $.5 million
for 1995 and 1994, respectively. Negative cash flow from operating activities in
1996 primarily was attributable to an operating loss of $6.4 million for such
year. Cash used for investing in property and equipment was $4.2 million, $1.2
million and $.7 million for 1996, 1995 and 1994, respectively. Such property and
equipment was primarily utilized in connection with the implementation and
expansion of Econophone's network. Cash provided by financing activities was
$16.4 million in 1996, primarily reflecting net cash proceeds of $13.1 million
from the sale of Series A Preferred Stock to Princes Gate, an affiliate of
Morgan Stanley, net borrowings of $3.6 million less shareholder distributions,
in order to pay income taxes with respect to the period in which Econophone was
a sub-Chapter S corporation, of $.2 million. Cash used in financing activities
was $.8 million in 1995, reflecting net debt repayments of $.3 million and
shareholder distributions, in order to pay income taxes with respect to the
period in which Econophone was a sub-Chapter S corporation, of $.5 million. Cash
provided by financing activities was $.3 million in 1994 and was attributable to
net borrowings.
Econophone expects capital expenditures during 1997 to be approximately
$14.0 million, of which $5.8 million was expended during the first half of 1997.
Capital expenditures for 1997 relate primarily to the further implementation and
expansion of Econophone's network, including the upgrade of Econophone's New
York switch and the purchase of switches or nodes for Amsterdam, Antwerp,
Athens, Berlin, Brussels, Hamburg, London, Paris and Zurich, the purchase of
additional transatlantic IRUs and the expansion of Econophone's back-office
capabilities, including its management information and network management
systems. Econophone intends to fund its capital expenditures for the foreseeable
future with the proceeds of the Offering and, to the extent available on
attractive terms, vendor financing. Econophone expects to continue to make
significant capital expenditures in future years as it continues to expand the
geographic scope of its services in Europe and the United States and to increase
its network capabilities and network infrastructure. Econophone's actual capital
expenditures and cash requirements will depend on numerous factors, including
the nature of future expansion, economic conditions, competition, regulatory
developments and the ability to incur debt and make capital expenditures under
the Indenture, the NTFC Agreement and the terms of the Series A Preferred Stock.
From its inception until November 1996, Econophone relied primarily on
founders' capital, equipment financing and internally generated funds to finance
its operations and growth. From November 1996 until the consummation of the
Offering, Econophone had three primary sources of funding: (i) Princes Gate;
(ii) NTFC; and (iii) the Note Purchase Agreement.
On November 1, 1996, Princes Gate purchased 140,000 shares of Series A
Preferred Stock for $14.0 million, less certain fees, resulting in net proceeds
to Econophone of $13.1 million. As of October 1, 1997, the shares of Series A
Preferred Stock purchased by Princes Gate were convertible into shares of Common
Stock representing approximately 14.6% of the Common Stock of Econophone on an
as converted basis (without giving effect to the issuance or exercise of the
Warrants or any options issued by Econophone). The proceeds of the issuance to
Princes Gate were used to fund the expansion of Econophone's network, the
implementation of its marketing strategy and operations generally, including
operating losses. See "Certain Transactions--Investment by Princes Gate" and
"Certain Transactions--Investment by Princes Gate--Series A Preferred Stock."
On May 28, 1996, Econophone entered into a credit facility with NTFC, which
was increased on March 27, 1997 pursuant to the NTFC Agreement, permitting
Econophone to borrow up to $5.0 million to purchase equipment and to pay certain
other related expenses. As of September 30, 1997, $4.8 million, some of which
has been repaid, has been drawn down under two tranches of the facility to
purchase
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equipment and to pay certain other related expenses. These tranches are to be
paid in 60 equal monthly installments and mature between July 1, 2001 and April
1, 2002 at an interest rate equal to the 90-day commercial paper rate plus 395
basis points, which will be adjusted quarterly. As of September 30, 1997, $4.1
million of indebtedness (including accrued intrest) was outstanding under the
NTFC Agreement at an interest rate of 5.63%. All of the equipment purchased
using borrowings from NTFC has been pledged to NTFC to secure such borrowings.
See "Description of Certain Indebtedness--NTFC Vendor Financing."
On April 24, 1997, Econophone entered into the Note Purchase Agreement with
Morgan Stanley Group, pursuant to which Morgan Stanley Group agreed to purchase
from Econophone up to $15,000,000 of Bridge Notes. At such time, Econophone paid
to Morgan Stanley Group a commitment fee of $225,000 and agreed to pay a further
fee of 2% of the principal amount of each issuance after the aggregate principal
amount of Bridge Notes issued exceeded $5.0 million. A total of $7.0 million of
Bridge Notes were issued under the Note Purchase Agreement. The net proceeds
from the Bridge Notes purchased by Econophone were $6.6 million and were used to
fund equipment and other capital expenditures and operations. Immediately
following the consummation of the Offering, all of the outstanding Bridge Notes
were redeemed and all accrued interest thereon was paid. Econophone is not
entitled to place any additional Bridge Notes under the Note Purchase Agreement
and the facility represented by the Note Purchase Agreement has terminated. See
"Certain Transactions--Bridge Funding by Morgan Stanley Group."
On July 1, 1997, Econophone consummated the Offering. In connection with the
Offering, Econophone issued $155.0 million in aggregate principal amount of
Original Notes and Warrants to purchase in the aggregate 1,265,885 shares of
Common Stock. The net proceeds of the Offering were approximately $148.1
million. Of this amount, approximately $57.4 million was used to purchase the
Pledged Securities, which will be used to make the first six scheduled interest
payments on the Notes. The net proceeds of the Offering are expected to be used
as set forth under "Use of Proceeds."
The net proceeds from the Offering are expected to fund Econophone's planned
expansion and operating losses until it generates positive cash flow; however,
this is a forward-looking statement and there can be no assurance in this
regard. The ability of Econophone to generate more than insignificant positive
cash flow, which is not expected to occur prior to 1999, and to meet its debt
service obligations will be subject to Econophone's successful implementation of
its operating strategy, as well as to financial, competitive, business,
regulatory and other factors beyond Econophone's control. If Econophone is
unable to generate cash flow from operations that, together with its restricted
cash, is sufficient to meet its debt service requirements, it may be required to
refinance all or a portion of its indebtedness or raise additional capital.
There can be no assurance that any such refinancing would be possible on terms
that would be acceptable to Econophone or that any additional financing could be
obtained. See "Risk Factors--High Leverage; Future Losses and Negative Cash
Flow."
See "Certain Indebtedness" for a description of certain other outstanding
indebtedness of Econophone. Econophone's scheduled principal and interest
payments in respect of such other indebtedness during the last six months of
1997 and during 1998 are $1.5 million and $1.9 million, respectively.
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BUSINESS
Econophone is a switch-based provider of long distance telecommunications
services in certain major U.S. and western European markets. Econophone's
customer base consists primarily of small- and medium-sized businesses,
residential customers and other telecommunications carriers, with a focus on
customers with significant international calling needs. In the United States and
the United Kingdom, Econophone provides principally international and domestic
long distance, calling card, prepaid and carrier services. In continental
Europe, Econophone provides principally international long distance, calling
card and prepaid services.
Econophone is a New York corporation. Econophone was originally formed in
1992 under the name of "Switchtel Communications Corp." In 1992 it changed its
name to "Econophone, Inc." Its principal executive offices are located at 45
Broadway, New York, New York 10006. Its main telephone number is (212) 444-6991.
INDUSTRY OVERVIEW
International telecommunications is one of the fastest growing segments of
the long distance industry, having experienced a compounded growth in total
minutes of 14% per annum from 1989 to 1995. Forecasts by the International
Telecommunications Union (the "ITU"), a worldwide telecommunications
organization under the auspices of the United Nations, project this growth to
continue at approximately 12% per annum through the year 2000. Based on this
estimate, worldwide international long distance traffic is projected to increase
from approximately 60 billion minutes in 1995 to over 100 billion minutes by the
year 2000. The market for these services is highly concentrated in more
developed countries, with approximately 43% and 26% of 1995 worldwide
international long distance traffic originating in Europe and the United States,
respectively.
The international telecommunications industry has been undergoing regulatory
liberalization generally, which has resulted in increased competition, lower
prices and increased demand for telecommunications services worldwide.
Liberalization has coincided with the construction of additional infrastructure
and technological innovation in the telecommunications industry. Fiber optic
cable, which has widely replaced wire lines for the transmission of the long
distance portion of calls, improvements in computer software and digital
compression technology have dramatically increased the capacity, speed and
flexibility of telephone lines and have substantially eliminated capacity
constraints as a technical barrier to entry for new international telephone
companies. Liberalization of the regulation of telecommunications services and
technological developments have also resulted in the broadening of service
offerings, including advanced and enhanced services such as voicemail, faxmail
and electronic mail, itemized billing, calling cards and intranet and Internet
services. Also as a result of these trends, the marginal transmission costs per
minute of an international call have decreased substantially and at a more rapid
rate than the decline in prices to customers.
CONTINENTAL EUROPEAN INTERNATIONAL LONG DISTANCE MARKET
The continental European international long distance market is the largest
in the world, generating approximately 22 billion minutes or 36% of
international calling volume originating in continental Europe in 1995. The
continental European PTOs generally have had monopolies on providing telephone
services from their respective countries, making the price of international
telephone calls from continental Europe much higher than comparable calls
initiated from the United States or the United Kingdom. Furthermore, customers
in many continental European markets have generally not been able to obtain
value-added features that are readily available in the United States, such as
touch tone dialing, voice mail and other enhanced services. Regulatory
liberalization, together with significant advances in technology that have
decreased the cost of providing services and allowed the provision of
sophisticated value-added features, is facilitating competition with European
PTOs by emerging telecommunications service providers.
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Econophone believes that the regulatory liberalization currently underway in
many countries in continental Europe could lead to market developments similar
to those that occurred in the United States and the United Kingdom upon
regulatory liberalization of long distance telecommunications services in those
countries. Regulatory liberalization in the United States and the United Kingdom
has resulted in an increase in call traffic and the emergence of multiple new
telecommunications service providers of varying sizes. In addition, significant
reductions in prices, particularly for domestic long distance calls, as well as
improvements in both the services offered and the level of overall
responsiveness to customers, have occurred. Although pricing has become
competitive in both the United States and the United Kingdom, marginal costs
have declined significantly. There can be no assurance, however, that the
continental European experience will mirror those in the United States or the
United Kingdom or that competitive and other factors will not adversely impact
profitability of companies in the industry.
UNITED KINGDOM LONG DISTANCE MARKET
Since 1991, the U.K. government has sought to encourage increased
competition in telecommunications services, including international
telecommunications services. The price of international calls made from the
United Kingdom has decreased significantly since 1991 due to increased
competition and the downward pressure exerted on British Telecom's prices by
Oftel. As a consequence of these actions, the United Kingdom now has a dynamic
telecommunications market, with over 150 public telecommunications operators
licensed to operate in the U.K. market.
The interconnection regime in the United Kingdom provides operators with the
ability to obtain cost based, non-discriminatory charges for interconnection
services. Oftel regulates the interconnection charges charged to other operators
by British Telecom and other PTOs. Oftel also has the power to intervene and
determine charges and other terms if an operator believes that it is not being
offered fair pricing. Oftel has stated that the category of companies that
qualify for interconnection services consist of those network operators that are
making a significant contribution to infrastructure competition by installing
transmission capacity or any international simple resale operator making a
significant contribution to competition in the international market. Econophone
believes it qualifies as one of the latter.
In August 1996, the U.K. government opened up to competition the provision
of international facilities-based services, which until then only British
Telecom and Mercury had been authorized to provide. Econophone was awarded an
international facilities based license (an "IFL") during the second quarter of
1997, which enables Econophone to provide international services over its own
international facilities. As a result of acquiring an IFL, Econophone intends to
acquire the six half-circuits on PTAT-1 and Cantat-3 that correspond to those
owned by Econophone during the fourth quarter of 1997. See "-- Network
Infrastructure--Transmission Capacity."
The United Kingdom is the favored hub for international traffic originating
in continental Europe due to the availability of relatively inexpensive
transmission capacity to and from the United Kingdom. This preference is
expected to continue as rates for international services are further reduced as
a result of additional competition.
UNITED STATES LONG DISTANCE MARKET
Approximately 15.9 billion minutes or 26% of global international calling
volume originated in the United States in 1995. According to estimates by the
FCC, the industry is large and has grown consistently, with aggregate
U.S.-originated international long distance telephone traffic rising from
approximately 6.8 billion minutes in 1989 to approximately 15.9 billion minutes
in 1995, a compound annual growth rate of approximately 15%. The growth of the
U.S.-originated international long distance market was initially attributable to
regulatory liberalization and the decrease in prices that accompanied the onset
of competition. Regulatory liberalization and the resulting competition also
have led to improvements in service offerings and customer service.
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The profitability of the U.S.-originated international long distance market
is principally driven by the difference between billed revenues and settlement
rates (i.e., the rates paid to other carriers to terminate an international
call). Increased competition arising from regulatory liberalization and pressure
arising from increased global trade have brought about reductions in settlement
rates and end-user prices, reducing termination costs for U.S. based carriers.
Based on FCC data for the period 1989 through 1995, per minute settlement
payments by U.S. based carriers to foreign PTOs fell 30%, from $.70 per minute
to $.49 per minute. However, over this same period, per minute international
billed revenues fell only 13%, from $1.02 in 1989 to $.89 in 1995. As a result,
gross profit per outbound international minute (before local access charges)
grew from $.32 in 1989 to $.40 in 1995, a 28% increase. Econophone believes that
international long distance will continue to provide substantial gross profit
per minute, although there can be no assurance in this regard and some industry
observers have predicted otherwise. See "Risk Factors-- Risks Associated with
Rapidly Changing Industry; Significant Price Declines."
Although Econophone focuses on the international telecommunications market,
it also provides domestic long distance services to many of its customers and,
as part of its strategy, is increasing its U.S. domestic long distance business.
Although the domestic market is much larger than the U.S.-originated
international long distance market, the profit per minute of use for
international traffic has generally been higher than for domestic traffic.
STRATEGY
Econophone's strategy is to expand into additional geographic markets in
western Europe and the United States, with a focus on markets that generate
substantial international calling traffic, add customers in its existing markets
and deliver an expanded portfolio of features and services to its customers.
Econophone intends to implement its strategy by continuing to expand its
network, broadening its sales and marketing efforts and developing and
introducing innovative services and features. Over time, Econophone expects its
European markets to contribute an increasing percentage of its revenues.
- EXPAND INTO NEW MARKETS. Econophone recently has installed switches in
Brussels, London and Paris and nodes in Antwerp and Hamburg and intends to
install nodes in Amsterdam, Athens, Berlin and Zurich during the remainder
of 1997. Each of these cities will be connected by leased line or IRU to
another Econophone network city. Econophone has or will establish internal
sales forces and retain independent sales representatives in each of these
cities. Econophone intends to enter additional markets in western Europe
and the United States as market and regulatory conditions warrant. See
"--The Econophone Network--European Expansion," "--The Econophone
Network--U.S. Expansion" and "--Regulation."
- ADD CUSTOMERS IN EXISTING MARKETS. To date, Econophone primarily has sold
its services through independent sales representatives, who have not been
supported or supplemented by a significant internal sales force. Since the
fourth quarter of 1996, Econophone has begun to establish internal sales
forces in its network cities, substantially increase its number of
independent sales representatives and hire senior sales personnel. Under
Econophone's marketing strategy, its internal sales forces generally
provide support to independent sales representatives and concentrate on
sales to small- and medium-sized businesses and to other carriers, while
independent sales representatives generally concentrate on residential
sales. Econophone's internal sales forces also make local advertising
decisions and enhance Econophone's local presence. Econophone believes
that local internal sales forces will substantially enhance market
acceptance of the Econophone brand and improve the performance of its
independent sales representatives. See "--Sales and Marketing."
- CONTINUE TO DEVELOP AND INTRODUCE INNOVATIVE SERVICES AND FEATURES.
Econophone's software development group designs value-added features and
integrates these features into Econophone's services and network. During
1997, Econophone plans to introduce voice mail, conference calling,
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the ability to access account information via the Internet and "E-Gram,"
an enhanced e-mail service. See "--Services--Value-added Features."
SERVICES
The following table summarizes Econophone's current service offerings by
principal geographic market:
<TABLE>
<CAPTION>
GEOGRAPHIC MARKET
-------------------------------------------------
<S> <C> <C> <C>
UNITED CONTINENTAL UNITED
KINGDOM EUROPE(1) STATES
--------------- ----------------- ------
International Long Distance.................................. x x x
Domestic Long Distance....................................... x x
Calling Card Services........................................ x x x
Prepaid Services............................................. x x x
Carrier Services............................................. x x
</TABLE>
- ------------------------
(1) Consists of selected cities in Belgium, France, Germany, Greece and The
Netherlands. Not all services listed are provided in all continental
European markets.
INTERNATIONAL AND DOMESTIC LONG DISTANCE SERVICE
"International and domestic long distance service" is service that is
accessed from the customer's billing location using "1xxx" access in the United
Kingdom, "1+" access in the United States or local dial-up access in continental
Europe. Econophone's international and domestic long distance service generally
enables customers to call to any destination. However, in continental Europe,
due to regulatory restrictions, to a lesser extent, Econophone also intends to
market this service as a virtual private network or "closed user group" service,
which provides customers with calling to a preprogrammed group of locations.
Virtual private network customers are able to access the local Econophone switch
or node and any destination in their preprogrammed calling group using
abbreviated dialing codes. See "--Network Infrastructure--Access Methods."
Econophone introduced international and domestic long distance service using
"lxxx" access in the United Kingdom in the third quarter of 1996, although it
did not begin aggressively marketing these services until 1997. These services
accounted for $100,000 (less than 1%) of Econophone's total revenues in 1996 and
$1.4 million or 5% of total revenues during the first six months of 1997,
although Econophone also generated U.K. revenues during the same periods from
international and domestic long distance calls using calling cards. In 1996,
international and domestic long distance service in the United States accounted
for $7.7 million or 17% of Econophone's revenues. During the first six months of
1997, these services accounted for $4.3 million or 14% of Econophone's revenues.
Econophone began offering international long distance service in continental
Europe at the end of the first quarter of 1997, and such services accounted for
less than $100,000 (less than 1%) of Econophone's total revenues during the
first six months of 1997.
UNITED KINGDOM. Econophone has provided international and domestic long
distance service in the London area since the third quarter of 1996. Since April
1997, Econophone has been able to provide this service on a U.K.-wide basis and
is in the process of introducing this service in selected additional U.K.
markets. Prior to that time, Econophone was able to provide U.K. international
and domestic long distance service only in London. See "--The Econophone
Network--European Expansion" and "--Network Infrastructure."
CONTINENTAL EUROPE. Econophone has offered international long distance
service to customers in Athens since 1996, to customers in Hamburg since
February 1997 and to customers in Antwerp, Brussels
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and Paris since March 1997. Econophone also intends to introduce international
long distance service in Amsterdam, Berlin and Zurich during 1997. Due to
regulatory restrictions, Econophone does not presently offer domestic long
distance service in continental Europe and, at present, Econophone cannot offer
intra-European international long distance service other than from its network
cities on a cost efficient basis. In addition, until January 1, 1998, in France,
applicable regulations prohibit Econophone and other private service providers
from providing unrestricted international long distance service utilizing local
dial-up access. However, prior to that time, Econophone may use its Paris switch
to collect virtual private network traffic. In France, Econophone also may
continue to provide card-based services utilizing international toll free
access. See "--Regulation--France."
UNITED STATES. Econophone has offered international and domestic long
distance service in the New York metropolitan area since March 1994 and began to
offer these services in Baltimore, Connecticut, New Jersey, Philadelphia and
Washington, D.C. during the first quarter of 1997. Econophone intends to
introduce these services in certain other geographic areas (primarily cities)
that generate substantial international long distance calling traffic. See
"--The Econophone Network--U.S. Expansion."
CALLING CARD SERVICES
In continental Europe, Econophone believes that a substantial portion of its
calling card customers use Econophone's service from their home or office as an
alternative to the PTO for international calls. In contrast, in the United
Kingdom and the United States, Econophone's calling cards are sold to customers
who use its calling card service for convenience when traveling. Over time, in
each of its continental European network cities, Econophone intends to migrate
its home- and office-based calling card customers to its international long
distance service. Its calling card service will continue to be offered in
continental Europe as a premium travel service.
Econophone's calling card customers are issued an identification or "PIN"
number that permits them to access Econophone's network. Econophone's calling
card services are sold in both Europe and the United States and can be used in
over 40 countries.
In the United Kingdom and the United States, Econophone's calling card
service is accessed by dialing a national toll free number. From other
countries, calling card customers access Econophone's services by dialing an
international toll free number.
Econophone offers calling card customers in the United Kingdom and the
United States competitive rates on calls to domestic and international
locations. In continental Europe, Econophone offers calling card customers
competitive rates on intercontinental card-based calls. Due to the high costs
resulting from international toll free access, which involves the transmission
of calls to Econophone's New York or London switch, and subsequent transmission
of calls back to continental Europe, Econophone is unable to offer competitive
rates on intra-European calls made by calling card customers. See "--The
Econophone Network."
In 1996, calling card service in the United Kingdom, continental Europe and
the United States accounted for $8.9 million, $4.2 million and $1.9 million, or
20%, 9% and 4%, of Econophone's revenues, respectively. During the first six
months of 1997, calling card service in the United Kingdom, continental Europe
and the United States accounted for $.3 million, $2.0 million and $8.0 million,
or 1%, 6% and 26%, of Econophone's revenues, respectively. Substantially all of
Econophone's U.S. calling card sales currently are attributable to VoiceNet, a
reseller of Econophone's calling card services. See "Risk Factors-- Dependence
on Carriers and Other Principal Customers."
PREPAID SERVICES
Econophone's prepaid card service is a pre-paid version of its calling card.
Econophone's prepaid card has similar features and is used in the same manner as
its calling card. Econophone's prepaid card
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generally can be used from the United Kingdom, the United States, Belgium,
Canada, Germany, France, Israel, The Netherlands, and Switzerland, although it
also sells prepaid cards that can be used only from the country in which they
are sold. Econophone believes that it is an early entrant into the market for
prepaid services in continental Europe.
In 1996, prepaid card services in the United Kingdom, continental Europe and
the United States accounted for $1.0 million, $7.2 million and $2.6 million, or
2%, 16% and 6%, of Econophone's revenues, respectively. During the first six
months of 1997, prepaid card services in the United Kingdom, continental Europe
and the United States accounted for $.9 million, $5.6 million and $1.7 million,
or 3%, 18% and 6%, of Econophone's revenues, respectively.
Econophone's software development group has developed a new prepaid service
called "Debit Phone," which currently is in testing and is expected to be
introduced by the end of 1997. Debit Phone will allow customers in the United
Kingdom and the United States to access Econophone's services from their homes
on a prepaid basis utilizing "1xxx" or "1+" access. When the customer makes a
domestic or international long distance call, Econophone's switch automatically
will recognize the customer's telephone number and deduct the cost of the call
from the customer's prepaid account balance. Debit Phone customers will be able
to replenish their balances on line by credit card or by purchasing vouchers.
Customers also will be able to access their balance by phone using voice
prompts. Econophone believes that this service will enable it to broaden its
addressable market by appealing to cost-conscious callers.
CARRIER SERVICES
In both the United Kingdom and the United States, Econophone resells
transmission capacity to carrier customers who use the transmission capacity to
service their end-user customers.
Carrier services are sold at substantially lower margins than Econophone's
other services. However, because carrier customers purchase transmission
capacity in bulk, these services allow Econophone to increase the amount of
transmission capacity that it purchases, enabling it to obtain volume discounts
on transmission capacity from its vendors and, therefore, generate higher
margins and/or offer better pricing on its other services. In addition, the sale
of transmission capacity on Econophone's IRUs and leased lines allows Econophone
to generate additional revenues on transmission lines operating at less than
full capacity without incurring significant marginal costs.
Carrier customers frequently change vendors based on small differences in
price and certain carrier customers have subjected and could in the future
subject Econophone to credit risks. Econophone ceased providing transmission
services to EI as a result of disputes following payment delinquencies by the
latter. Among other things, the parties agreed to restructure EI's payment
terms. Substantially all amounts due to Econophone by EI pursuant to the terms
of the restructing have been paid. See "Risk Factors-- Dependence on Carrier and
Other Principal Customers" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
In 1996, sales of transmission capacity to carrier customers in the United
Kingdom and the United States accounted for $5.5 million and $6.0 million, or
12% and 13%, of Econophone's revenues, respectively, or 25% of total revenues.
During the first six months of 1997, these sales in the United Kingdom and the
United States accounted for $1.2 million and $5.0 million, or 4% and 16%, of
Econophone's revenues, respectively, or 20% of total revenues.
In January 1997, Econophone entered into an agreement (the "UniqueAir
Agreement"), with UniqueAir Limited, one of the largest independent cellular
service providers in the United Kingdom. Pursuant to the UniqueAir Agreement,
Econophone will provide international transmission services for a portion of
UniqueAir's international calls. The interconnection between Econophone and
UniqueAir is in testing and Econophone has been providing transmission services
to UniqueAir since the third quarter of 1997. The UniqueAir Agreement also
contemplates that Econophone may provide international and
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domestic long distance and calling card service to UniqueAir's customers. The
UniqueAir Agreement is not exclusive and is terminable by either party on six
months' prior notice.
OTHER SERVICES
TOLL FREE SERVICE. Econophone provides domestic toll free service (i.e.,
"800" or "888" service) to customers in the United States and the United
Kingdom. This service is targeted at customers who have a substantial number of
incoming domestic long distance calls, such as mail order companies. Customers
of Econophone's toll free service are assigned a toll free number. Calls to the
toll free number are routed to an Econophone switch. From there, the call is
transmitted to the customer's location in the same manner as other calls routed
through the switch.
DEDICATED ACCESS SERVICE. Customers using this service lease a transmission
line that connects the customer's business directly to an Econophone switch or
node. By leasing a direct line, the customer avoids local access charges and can
reduce its cost of services. This service is marketed to high volume customers.
Econophone presently offers dedicated access service in the United States and
intends to introduce dedicated access service in the United Kingdom and in its
continental European network cities during 1997.
During 1996 and the first six months of 1997, sales of toll free and
dedicated access service accounted for an insignificant amount of Econophone's
revenues. In its markets other than Athens, where Econophone intends to
primarily offer dedicated access service, Econophone expects that revenues from
these services will represent a relatively small portion of its revenues.
VALUE-ADDED FEATURES
Econophone's software development group designs value-added features and
integrates these features into Econophone's services and network. Econophone
provides customers with value-added features such as speed dialing, redial and
multi-lingual voice prompts. In addition, Econophone's customers can obtain
detailed billing information, which is particularly important for business
users, including breakdowns of usage by account code and department. Customers
also are able to obtain pricing and certain other information via the Internet.
Callers in many European markets are not able to obtain these value-added
features from their PTO.
Econophone intends to continue to introduce new value-added features. For
example, during 1997, Econophone intends to introduce voicemail, conference
calling capability and the ability to access account information via the
Internet. Econophone believes that its emphasis on technological innovation and
quality is one of its principal competitive strengths.
In addition, during 1997, Econophone intends to introduce "E-Gram," an
enhanced e-mail service. E-Gram is expected to enable customers with Econophone
e-mail accounts to have a computer synthesized voice read them their e-mail.
E-Gram also is expected to enable customers to instruct the e-mail system to fax
them one or more pieces of e-mail, to save the e-mail for faxing at a later time
or to fax e-mail messages to third parties. Econophone believes that these
features will be particularly attractive to business travelers and will enhance
its ability to attract small- and medium-sized business customers. E-Gram is
being developed by E-Gram Corporation, 100% of the capital stock of which
currently is owned by Alfred West, the Chief Executive Officer and President of
Econophone. E-Gram will be licensed by Econophone on a non-exclusive basis from
E-Gram Corporation. Upon the commercialization of E-Gram Corporation's
technology, Mr. West has agreed to transfer 10% of the stock of E-Gram
corporation to Princes Gate. See "Certain Transactions--E-Gram."
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THE ECONOPHONE NETWORK
Econophone's network consists of (i) carrier grade Northern Telecom switches
in New York, London, Brussels and Paris, (ii) nodes in Antwerp and Hamburg,
(iii) points of presence in Baltimore, Connecticut, New Jersey, Philadelphia and
Washington, D.C., (iv) IRUs and leased trans-Atlantic telecommunications lines
and (v) leased lines in Europe and the United States. A key element in
Econophone's growth strategy is the continued build-out of its network in Europe
and the United States. As Econophone expands its network, it expects to be able
to provide service on an increasingly cost effective basis to a greater number
of customers. See "Risk Factors--Implementation of Expansion Plans" and
"Business--Strategy."
Econophone's network is designed to enable it to provide competitively
priced service from its network cities by reducing its total transmission costs
(i.e., the sum of its variable and fixed transmission costs) on calls
originating from these cities. Econophone's network enables it to reduce its
variable transmission costs because, among other things, (i) Econophone does not
incur any significant marginal costs for calls carried over its IRUs or leased
lines, (ii) calls routed by Econophone's switches can be delivered on a "least
cost" basis and (iii) in markets with switches, nodes or points of presence,
customers use local access instead of more expensive toll free access.
The fixed costs associated with Econophone's network relate principally to
switching equipment, leased lines and IRUs, rental charges, local connectivity
and facility/network management. Once sufficient traffic levels are attained,
Econophone's total costs of carrying calls are expected to decline as a
percentage of revenue, although there can be no assurance in this regard,
particularly given continuing signficant price reductions. See "Risk
Factors--Implementation of Expansion Plans," "Risk Factors--Competition" and
"Risk Factors--Risks Associated with Rapidly Changing Industry; Significant
Price Declines."
EUROPEAN EXPANSION
Econophone is expanding its network to include additional switches or nodes
in selected continental European cities. During the first quarter of 1997,
Econophone installed switches in Brussels and Paris that are connected to its
New York and London switches by leased line. Econophone also installed nodes in
Antwerp and Hamburg that are connected to the Brussels and London switches by
leased line. The node in Hamburg began collecting traffic during February 1997
and the switches in Brussels and Paris and the node in Antwerp begun collecting
traffic during March 1997. During the first quarter of 1997, Econophone
installed its own switch in London, which became operational during the second
quarter of 1997. Prior to that time, Econophone had leased a portion of Colt's
London switch. Nodes in Amsterdam, Athens, Berlin and Zurich also are expected
to be installed and become operational during 1997. The nodes in Amsterdam,
Athens and Zurich will be connected to Econophone's London switch by leased
line. The Berlin node will be connected to the Hamburg node by leased line.
Further European expansion plans provide for switches and nodes to be added in
additional cities. See "--Strategy."
In addition to increasing its addressable market, the expansion of
Econophone's network into continental Europe enables it to provide
intra-European international long distance service from continental European
cities with a switch or node on a cost-competitive basis. Prior to establishing
its network in continental Europe, Econophone was not able to transmit
intra-European international long distance calls on a cost-competitive basis
because of the high cost of transmitting those calls to its New York or London
switch using international toll free access and routing the calls back to
continental Europe over the PSTN. Calls that originate in cities with a switch
or node use less expensive local dial-up access instead of international toll
free access. Econophone's network does not enable it to competitively price
intra-European card-based calls, as these calls utilize international toll free
access rather than local dial-up access. However, in continental Europe,
Econophone's card based services are not marketed as discount services. Its
calling card service is marketed as a premium travel service and its prepaid
card service is marketed to users primarily calling destinations outside of
Europe. See "--Services--Calling Card Services" and "--Services--Prepaid
Services."
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U.S. EXPANSION
Econophone also intends to expand its network in the United States.
Econophone intends to install a carrier grade Northern Telecom DMS 250 switch in
Los Angeles that will enable Econophone to offer international and domestic long
distance service through "1+" access and carrier services in the Los Angeles
area. Econophone's switch in Los Angeles is expected to be installed and
operational by the end of the first quarter of 1998. Once this switch is
operational, Econophone intends to connect its Los Angeles and New York switches
by leased line, which will enable it to carry traffic between the New York and
Los Angeles areas (including traffic from Los Angeles to Europe) with lower
variable cost, which, upon attaining certain volume levels, should result in
lower total cost than at present. Econophone presently leases a portion of
another carrier's switch in Los Angeles, which its uses to offer carrier
services in the Los Angeles area.
Econophone intends to establish points of presence in certain other U.S.
markets that generate substantial international long distance calling traffic.
Econophone is able to offer international and domestic long distance service
through "1+" access in markets where its switches or points of presence are
located.
NETWORK INFRASTRUCTURE
NETWORK HARDWARE
Econophone's network employs carrier grade switches. In New York, Econophone
utilizes a Northern Telecom DMS 250/300 switch. In Brussels and Paris,
Econophone has installed Northern Telecom multi-media carrier grade switches. In
London, Econophone has installed a DMS 100 switch. Carrier grade switch
technology is primarily employed by large carriers and not by smaller
competitors. Certain advantages of Econophone's carrier grade network are
described below.
QUALITY AND RELIABILITY. Econophone believes that carrier grade switching
enables it to provide higher transmission quality and greater call completion
rates to its customers than are offered by carriers that use smaller, less
powerful switches.
INTERCONNECTION WITH PTOS. Carrier grade switches enable Econophone to
provide international and domestic long distance service utilizing "1xxx" access
in the United Kingdom. In addition, the interconnection to the PSTN of
Econophone's carrier grade switch in London during the second quarter of 1997
enables it to provide service on a U.K.-wide basis. See
"--Services--International and Domestic Long Distance Service--United Kingdom."
Many of Econophone's competitors in the United Kingdom do not utilize
carrier grade switches and, therefore, can provide access for residential or
office-based calling only through longer access numbers and codes (although
British Telecom is able to provide access without use of an access number or
code). Management believes that the comparative ease of use of Econophone's
home- and office-based service provides it with a competitive advantage over
U.K. service providers that do not utilize carrier grade switches.
TRANSMISSION SPEED AND EFFICIENCY. Econophone's switches have call
completion capabilities that reduce the time needed to connect calls, reduce
waiting times and allow for more efficient use of transmission capacity. In
addition, for calls transmitted over Econophone's IRUs between London and New
York (including calls originating in continental Europe), Econophone's network
utilizes "fast signaling" (also known as "SS7" or "CCS7"). Before a call is
completed, "fast signaling" notifies the originating switch if the number being
called is busy, in which case a busy signal will be sent back to the caller
without routing the call, freeing up transmission capacity for calls that can be
completed.
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ABILITY TO PROVIDE ENHANCED SERVICES. The carrier grade switching platforms
used by Econophone, in conjunction with other hardware and software, are capable
of supporting the enhanced services that Econophone currently offers, such as
prepaid card services, as well as other enhanced services that Econophone
intends to introduce, such as voicemail, conference calling and E-Gram.
Econophone's network primarily employs switch architecture that allows for
integration of voice and data onto a single platform.
HARDWARE INTEGRATION. Econophone believes that, by principally utilizing
the equipment of a single supplier, it is able to minimize difficulties
associated with integrating equipment from various sources and with differing
specifications, although this entails certain risks. See "Risk
Factors--Dependence on Equipment Supplier."
TRANSMISSION CAPACITY
Econophone utilizes IRUs and leased lines to transmit the on-network portion
of its calls. If the initial point of network access is a node or point of
presence, the call is then transmitted over a leased line to an Econophone
switch for routing to its destination. Once certain traffic levels are attained,
local dial-up access to the node or point of presence and transmission over a
leased line is a less expensive means of transmitting a call to an Econophone
switch than international toll free access. The reduced transmission costs
result because there is no significant marginal cost to Econophone for carrying
a call over facilities it owns or leases on a fixed cost basis. In order to
increase the capacity of its transmission lines, Econophone utilizes carrier
grade compression, or multiplexing, equipment.
Econophone presently owns five IRUs on the PTAT-1 transatlantic cable and
one IRU on the Cantat-3 transatlantic cable. Econophone's IRUs are half-circuits
(i.e., the portion of the circuit between North America and the mid-point in the
Atlantic Ocean). The corresponding half-circuits on PTAT-1 and Cantat-3 not
owned by Econophone are leased from Mercury. During the second quarter of 1997,
Econophone received an IFL in the United Kingdom, which authorizes it to provide
international telecommunications services over its own international
infrastructure. This license permits Econophone to purchase and operate
half-circuits originating in the United Kingdom. As a result of acquiring an
IFL, Econophone intends to acquire the five corresponding half-circuits on
PTAT-1 and the one on Cantat-3 during the fourth quarter of 1997. As part of its
expansion strategy, Econophone also intends to acquire additional IRUs,
including half-circuits originating in the United Kingdom between the United
Kingdom and selected continental European cities.
In addition to utilizing IRUs to carry traffic, Econophone utilizes leased
lines. Econophone's average aggregate monthly cost for its leased lines for the
nine months ended September 30, 1997 was approximately $290,000. These costs
will substantially increase as Econophone expands its network to the extent that
Econophone leases additional lines instead of purchasing them.
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Listed below are Econophone's IRUs and leased lines and the maximum number
of calls that can be carried at one time over each circuit. Other than
Econophone's half-circuits from New York to London, all of the lines listed
below are leased lines.
<TABLE>
<CAPTION>
SIMULTANEOUS
TRANSMISSION LINES CALLS(1)
- -------------------------------------------------------------------------------- -----------------
<S> <C>
London -- New York(2)........................................................... 600
New Brunswick, New Jersey -- New York........................................... 264
Newark -- New York.............................................................. 192
Brussels -- Antwerp............................................................. 120
Brussels -- New York............................................................ 120
Paris -- London................................................................. 120
Hamburg -- London............................................................... 60
Baltimore -- New York........................................................... 24
Los Angeles -- New York......................................................... 24
New Haven, Connecticut -- New York.............................................. 24
Philadelphia -- New York........................................................ 24
Washington, D.C. -- New York.................................................... 24
</TABLE>
--------------------------------------------
(1) Reflects transmission capacity after taking into account
compression or multiplexing equipment utilized by Econophone on
its intra-European lines and its lines between London and New
York.
(2) Consists of IRUs and the leased half-circuits that correspond
to the IRUs.
Econophone also purchases switched minutes from carriers on a per minute
basis. Such purchases are made on an as-needed basis and do not involve
significant minimum purchase requirements. Econophone's principal suppliers of
switched minutes of use are Sprint and Mercury, from whom it purchases
international toll free services.
As Econophone expands its customer base, it will require additional
transmission capacity. Its actual infrastructure requirements will depend upon
the capacity of the switches, nodes and points of presence installed by
Econophone and the extent to which it utilizes compression technology to
transmit calls. Based on current and anticipated availability of switching and
compression equipment and owned and leased transmission capacity, Econophone
believes that it will be able to meet its capacity requirements for the
foreseeable future, although there can be no assurance that this will be the
case.
NETWORK MANAGEMENT
Econophone's network is controlled from its New York and London switching
centers and its College Station, Texas facility. Centralized network management
enables Econophone to perform network monitoring and selected network
maintenance from these centers, rather than on-site. Econophone has budgeted
approximately $1.0 million to enhancing and developing its network management
systems during 1997, most of which will be spent during the last two quarters of
1997.
ACCESS METHODS
Econophone's services are accessed through a variety of methods, as
described below, depending upon the particular service and the location from
which the customer is calling.
"1XXX" ACCESS. "1xxx" access, or prefix dialing, enables a long distance
customer in the United Kingdom to access Econophone's network from the
customer's home or office by dialing "1" and Econophone's three digit access
code and then the number the customer is calling.
"1+" ACCESS. In the United States, "1+" access enables a long distance
customer to access Econophone's network from the customer's home or office by
dialing "1" and then the number that the
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customer is calling. The customer does not need to dial a special access number
or code. This access method is available where Econophone has a switch or point
of presence.
LOCAL DIAL-UP ACCESS. In cities in continental Europe where Econophone has
installed a switch or node, customers can access Econophone's international long
distance service by dialing a local telephone number. Local dial-up access
reduces transmission costs for Econophone on these calls because it reduces the
cost of accessing an Econophone switch. The reduction in transmission costs
enables Econophone to increase its margins and/or reduce its prices on these
calls, as well as to provide competitively-priced intra-European long distance
service. Until January 1, 1998, local dial-up access may be used in France only
to collect virtual private network traffic. See "--The Econophone Network" and
"--Regulation--France."
INTERNATIONAL TOLL FREE ACCESS. This access method is used to access
Econophone's card-based services outside of the United States and the United
Kingdom. Econophone's calling card customers in its continental European network
cities that use its calling card service for home- and office-based calls will
over time be provided with a local access number to use, subject to applicable
regulatory limitations, because local dial-up access allows Econophone to
provide its services at a substantially lower rate than international toll free
access. See "--Services--Calling Card Services."
NATIONAL TOLL FREE ACCESS. Customers who access Econophone's services in
this manner do so by dialing a national toll free number. This access method is
available to U.S. and U.K. customers who use Econophone's calling card and
prepaid card services.
DEDICATED ACCESS. Carrier customers and high volume end-users in the United
States are connected to Econophone's switch by dedicated leased line. In the
United Kingdom and continental Europe, Econophone intends to introduce dedicated
access during 1997. The advantages of dedicated access are simplified dialing,
faster call set-up times and potentially lower access costs (assuming a
sufficient volume of calls is transmitted over the leased line to generate
economies of scale).
CALL ROUTING
Calls are routed to their destination through one or more Econophone
switches. If the call originates in an Econophone network city with a switch,
the call generally will access the network using "1xxx," "1+" or local dial-up
access. A call originating in a city with a node or point of presence generally
will access the network in the same manner and then be routed to an Econophone
switch over leased line. If the call originates in a city where Econophone does
not have a switch, node or point of presence, the call generally accesses the
network using toll free access, which is substantially less cost efficient than
"1xxx," "1+" or local dial-up access. From an Econophone switch, "least cost
routing" techniques are used to determine whether the call should be transferred
directly to the PSTN or routed to another Econophone switch and then transferred
to the PSTN for termination. Econophone terminates, and will continue to
terminate, all of its traffic over the PSTN.
SALES AND MARKETING
Econophone's services are marketed primarily to small- and medium-sized
businesses and residential customers, with a focus on customers with significant
international calling needs. Econophone also sells transmission capacity to
carriers in the United States and the United Kingdom. As of June 30, 1997,
Econophone had 8,431, 2,866 and 54,868 customer accounts in the United Kingdom,
continental Europe and the United States, respectively, generating approximately
10.1 million, 6.7 million and 87.8 million minutes of calling traffic,
respectively, for the six months then ended.
In the United Kingdom, most of Econophone's sales are made through Telco,
its majority owned subsidiary that was established during the fourth quarter of
1996, although sales to carriers continue to be made directly by Econophone. As
of September 30, 1997, Econophone had retained 9,761 independent sales
representatives in the United Kingdom, primarily through master agents. A
substantial number of
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these sales representatives also sell products and services other than long
distance telephone service of other companies and have not yet begun to make
sales on behalf of Econophone. As of September 30, 1997, Telco also had 25
internal sales representatives. To date, Econophone's U.K. sales activities have
been limited primarily to the London area. However, since April 1997, Econophone
has been able to provide services on a U.K. wide basis and has begun to market
its services in additional U.K. cities. Prior to the establishment of Telco,
Econophone's services in the United Kingdom were marketed under a joint venture
between Econophone and EI. See "Risk Factors--Dependence on Third Party Sales
Organizations," "Risk Factors--Dependence on Carrier and Other Principal
Customers" and "Management's Discussion of Financial Condition and Results of
Operations."
As of September 30, 1997, Econophone had 15 internal sales representatives
and 60 independent sales representatives in continental Europe. Econophone's
internal sales representatives are based in Antwerp, Brussels, Hamburg and
Paris. In all four of these cities, Econophone is expanding its internal sales
forces and recruiting additional independent sales representatives. In addition,
during the fourth quarter of 1996, Econophone hired a Vice President of European
Sales and Marketing. Econophone's strategy to date in its continental European
markets generally has been initially to concentrate on sales of prepaid card
services since prepaid operations limit credit risk and do not require
substantial amounts of start-up capital. Thereafter, after establishing its
local sales and marketing infrastructure and gaining market acceptance,
Econophone has introduced calling card and other services. In each of its
markets, Econophone also has initially concentrated on sales in ethnic
communities and to expatriates since these market segments can be effectively
targeted with limited resources, enabling Econophone to rapidly generate
revenues and create brand awareness.
In the United States, Econophone's services are sold primarily in the New
York metropolitan area. Econophone is expanding its U.S. sales infrastructure
and focusing its marketing efforts on additional U.S. network cities. During the
first two quarters of 1997, Econophone hired sales managers for Baltimore,
Connecticut, New Jersey and New York. As of September 30, 1997, in the United
States, Econophone had 3 internal sales representatives and 237 independent
sales representatives. Substantially all of Econophone's U.S. calling card sales
are attributable to VoiceNet, a reseller that sells Econophone's calling card
services to end-users. See "Risk Factors--Dependence on Third Party Sales
Organizations."
Econophone's internal sales forces concentrate on sales to small-and
medium-sized businesses and to other carriers, while independent sales
representatives concentrate on residential sales. Econophone believes that local
internal sales forces will substantially enhance market acceptance of the
Econophone brand and improve the performance of its independent sales
representatives. Econophone's internal sales forces make local advertising
decisions and provide support for its independent sales representatives.
Internal sales forces also enable Econophone to more effectively focus marketing
efforts on target customer groups. In addition, Econophone believes that
internal sales forces have a higher sales completion rate to business users than
independent sales representatives due to the higher degree of technical
knowledge required to close sales to business users.
As Econophone expands into new network cities, it intends to establish
internal sales forces and recruit independent sales representatives in those
cities.
The terms on which Econophone retains independent sales representatives are
determined on a case-by-case basis and depend on a variety of factors, including
the geographic market, the services being sold by the representative and the
anticipated sales levels of the representative. Econophone's independent sales
representatives are retained on a commission-only basis, with commissions
generally ranging from 6% to 16% of sales. Relationships with independent sales
representatives generally are terminable at will by either party. In certain
cases, Econophone has engaged master sales representatives, who have then
engaged sub-representatives. In other cases, Econophone has engaged individual
independent sales representatives directly.
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INFORMATION TECHNOLOGY
Econophone believes that advanced, effective and flexible billing and
customer service information systems are vital for its operations and
anticipated growth. Econophone engages in design and integration of billing and
customer service information systems at its College Station, Texas and Brooklyn,
New York facilities, where it employs 19 systems engineers. Econophone's systems
engineers have designed direct debit, multi-currency and multi-language billing,
as well as other billing features. By developing systems internally, Econophone
believes that it is able to reduce development costs, improve quality control
and expedite systems development and integration. While Econophone believes that
its current billing and customer service information systems are adequate,
substantial investment will be required to maintain the adequacy of these
systems as Econophone expands its operations. Econophone has budgeted
approximately $2.0 million during the last two quarters of 1997 to enhancing
current and developing new customer service, billing, financial reporting and
other management information systems. In addition, during the second quarter of
1997, Econophone hired a Director of Management Information Systems. See
"Management--Directors, Executive Officers and Other Senior Management."
COMPETITION
The provision of telecommunications services is extremely competitive and
will become increasingly so as the regulatory barriers to entry into
telecommunications markets are increasingly reduced or eliminated. Competition
for customers is primarily on the basis of price and, to a lesser extent, on the
type and quality of services offered and customer service. The
telecommunications industry has relatively insignificant economic and
technological barriers to entry and numerous entities competing for the same
customer. Econophone has experienced, and expects to continue to experience,
declining revenue per billable minute in all of its markets in part as a result
of increasing worldwide competition within the telecommunications industry.
Econophone also experiences customer attrition, or "churn," as a result of the
highly competitive nature of its markets and expects current levels of churn to
continue or increase. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations."
In Europe, Econophone's competitors include (i) PTOs, (ii) alliances such as
AT&T's alliance with Unisource (itself a joint venture among Telecom
Netherlands, Telia AB and Swiss Telecom PTT), known as "Uniworld," and the
corresponding alliance with WorldPartners, MCI's alliance with British Telecom,
known as "Concert," and Sprint's alliance with Deutsche Telekom and France
Telecom, known as "Global One," (iii) companies offering resold international
telecommunications services, such as Esprit Telecom, Viatel and RSL
Communications, and (iv) other companies with business plans similar in varying
degrees to Econophone's, including emerging public telephone operators who are
constructing their own networks. Unisource recently announced that its venture
partners would contribute their international facilities and personnel to a
newly formed company, and some commentators have speculated that ATT might do
the same. The resulting company is likely to be a substantially more formidable
competitor. Econophone believes that its non-U.S. markets will experience
increased competition and begin to resemble the competitive landscape in the
United States. In addition, Econophone anticipates that numerous new competitors
will enter the European telecommunications market.
In the United States, Econophone's competitors include AT&T, MCI, Sprint and
other carriers for domestic and international long distance calls. As a result
of the 1996 Act, RBOCs are eligible, subject to FCC approval, to offer domestic
long distance and international telecommunications services in their "in region"
service areas, as well as outside of their service areas. In addition, the FCC
is now also permitting foreign telecommunications entities to enter the U.S.
international telecommunications market, including dominant foreign entities
whose home markets are conducive to competition. The FCC also has substantially
reduced the regulatory constraints on AT&T, Econophone's largest competitor, by
declaring AT&T to be "non-dominant," first, in the domestic long distance
market, and more recently in the
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international market; thus, granting AT&T more pricing and service flexibility
and permitting AT&T to compete more effectively with smaller inter-exchange
carriers, such as Econophone.
In addition, recently consummated and currently pending major consolidations
in the telecommunications industry could result in even more powerful
competitors to Econophone in its major markets. For example, the planned
acquisition of MCI by British Telecom, if consummated, could adversely impact
Econophone in the market for calling between the United Kingdom and the United
States and the merger between Bell Atlantic and NYNEX, the proposed acquisition
of MCI by Worldcom, Inc. or GTE and the creation of a new company with the
international facilities of the Unisource partners could result in downward
pressure on prices without a corresponding reduction in transmission costs.
Econophone also may experience competition in one or more of its markets
from competitors utilizing new or alternative technologies and/or transmission
methods including cable television companies, wireless telephone companies,
satellite owners and resellers, Internet service providers, electric and other
utilities, railways, microwave carriers and large end users that have private
networks.
As Econophone expands its geographic coverage, it will encounter additional
regional competitors and increased competition. Many of Econophone's competitors
are significantly larger, have substantially greater financial, technical and
marketing resources and larger networks than Econophone, control transmission
lines and have long-standing relationships with Econophone's target customers.
If any of Econophone's competitors were to devote additional resources to the
provision of international and/or domestic long distance voice telecommunication
services to Econophone's target customer base, there could be a material adverse
effect on Econophone's ability to pay principal of and interest on the Notes.
Each of the markets in which Econophone offers or intends to offer its
services will present unique competitive factors. There can be no assurance that
Econophone will be able to effectively compete in any given market and the
success of Econophone's strategy in any one market is not necessarily indicative
of its ability to succeed in any other market. See "Risk Factors--Competition."
REGULATION
A summary discussion of the regulatory frameworks in certain geographic
regions in which Econophone operates or has targeted for penetration is set
forth below. This discussion is intended to provide a general outline of the
more relevant regulations and current regulatory posture of the various
jurisdictions and is not intended as a comprehensive discussion of such
regulations or regulatory posture. There can be no assurance that future
regulatory, judicial and legislative changes will not have a material adverse
effect on Econophone, that domestic or international regulators or third parties
will not raise material issues with regard to Econophone's compliance or
noncompliance with applicable laws and regulations or that other regulatory
activities will not have a material adverse effect on Econophone. See "Risk
Factors--Regulatory Restrictions."
EUROPEAN UNION
Most EU member states (except for countries such as the United Kingdom,
Sweden and Finland, which are already substantially liberalized) are in the
initial stages of regulatory liberalization. Regulatory liberalization in these
countries may occur either because the EU member state decides to open up its
own market (e.g., the United Kingdom, Sweden and Finland) or because it is
directed to do so by the European Commission through one or more directives
issued thereby and/or because the member state may be required to do so in the
future by the Council of the European Communities. National governments must
pass legislation within their countries to give effect to EC directives. See
"Risk Factors--Regulatory Restrictions."
In 1990, the European Commission issued a Directive on Competition in the
Markets for Telecommunications Services (the "Services Directive") requiring
each EU member state to abolish its
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existing monopolies in the provision of all telecommunications services other
than voice telephony. The Services Directive did not require the liberalization
of telecommunications infrastructure, nor did it apply to telex, mobile
telephony, paging or satellite services. The effect of the Services Directive is
to direct EU member states to permit the competitive provision of all services
other than voice telephony, including value-added services and voice services
within closed user groups. However, as a consequence of inconsistent local
implementation of the Services Directive through the adoption of national
legislation, there are differing interpretations as to the definition of voice
telephony, which can be reserved to the PTOs, and permitted value-added and
closed user group services, which can be provided by competitors. The European
Commission generally has taken a narrow view of the definition of voice
telephony, declaring that voice services may not be reserved to the PTOs if (i)
dedicated customer access is used to provide the service, (ii) the service
confers new value-added benefits on users (such as alternative billing methods)
or (iii) calling is limited by a service provider to a group having legal,
economic or professional ties.
In March 1996, the Services Directive was amended by the adoption of the
Full Competition Directive, which required all EU member states, with the
exception of Greece, Ireland, Luxembourg, Portugal and Spain, (i) to allow those
operators which already have licenses to operate telecommunications
infrastructure for specific purposes (such as utility companies or railroad
companies authorized to operate telecommunications networks only for their own
purposes) to supply liberalized services over such "alternative infrastructure"
by July 1, 1996 and (ii) to fully liberalize the supply of all
telecommunications services and the provision of telecommunications
infrastructure by January 1, 1998. The Full Competition Directive encourages EU
member states to accelerate liberalization of voice telephony. Ireland and
Portugal have obtained a derogation from compliance with the Services Directive,
as amended by the Full Competition Directive, until January 1, 2000. Spain has
requested a derogation entitling it to delay compliance with the Services
Directive, as amended, until November 30, 1998 and Luxembourg and Greece each
have requested a derogation entitling it to delay compliance until January 1,
2000 and January 1, 2003, respectively.
The Full Competition Directive provides for the abolishment, as of January
1, 1998, of all special or exclusive rights that restrict the provision of
telecommunications services by companies established in the European Union
without regard to the destination or origin of the communications involved.
However, neither that directive nor the original Services Directive prevent EU
member states from maintaining restrictions on companies which are not
established in the European Union in order to ensure that EU companies are
afforded comparable and effective treatment in third countries. Thus, the United
Kingdom has in the past limited certain international services on routes to
countries that do not have open markets comparable to the U.K.'s liberalized
market. However, in 1994, the United Kingdom ruled that the United States (in
addition to certain other countries) provides an equivalent open market and
since that date has had no restrictions (subject to operators obtaining the
necessary license) on services provided over leased lines between the United
States and the United Kingdom. During August 1996, the United Kingdom
liberalized all international facilities-based services and international simple
resale services between the United Kingdom and other countries, subject to
operators meeting certain proportionate return conditions on routes that are not
considered to be competitive. The ability of EU member states to in the future
enact restrictions in respect of companies which are not established in the
European Union is expected to be limited to the extent that the WTO Agreement
enters into effect within the European Union.
In addition to the abolition of special and exclusive rights, the Council of
the European Communities has stated that it intends to adopt more detailed
regulatory measures in order to harmonize the rules applying in the liberalized
environment after January 1, 1998. In this respect, a directive relating to
licensing in general and a decision relating to the licensing of satellite PCS
services already have been adopted. However, additional directives are expected
to be adopted by the Council of the European Communities, although their final
content and timing of implementation cannot be predicted at this time.
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<PAGE>
Some EU member states, such as The Netherlands and Denmark, are implementing
liberalization in advance of the January 1, 1998 EC deadline, while, in other
member states, such as Germany and France, the majority of the national
legislation which will be required to meet the January 1, 1998 deadline already
has been adopted, together with legislation which anticipates the possible
future requirements of directives of the Council of the European Communities.
Each EU member state in which Econophone currently conducts its business has
a different regulatory regime and such differences are expected to continue
beyond January 1, 1998. The requirements for Econophone to obtain necessary
approvals vary considerably from country to country and are expected to continue
to so vary.
UNITED KINGDOM
The telecommunications services provided by Econophone in the United Kingdom
are subject to and affected by regulations introduced by Oftel. Since the
break-up of the U.K. telecommunications duopoly consisting of British Telecom
and Mercury in 1991, it has been the stated goal of Oftel to create a
competitive marketplace from which detailed regulation could eventually be
withdrawn.
In 1991, a "multi-operator" policy was established to introduce increased
competition in the market for telecommunication services and infrastructure.
Under the multi-operator policy, the U.K. Department of Trade and Industry (the
"DTI") will recommend the grant of a license to operate a telecommunications
network to any applicant that the DTI believes has a reasonable business plan
and where there are no other overriding considerations not to grant such
license. All public telecommunications operators and international simple
resellers operate under individual licenses granted by the Secretary of State
for Trade and Industry pursuant to the Telecommunications Act 1984. Currently,
most telecommunications systems with compatible equipment that are authorized to
be run under an individual license granted under this Act are permitted to
interconnect to British Telecom's network. Under the terms of British Telecom's
license, it is required to allow any such licensed operator to interconnect its
system to British Telecom's system, unless it is not reasonably practicable to
do so (e.g., due to incompatible equipment). Oftel has stated that the
categories of companies that qualify for interconnection services consist of
those network operators that are making significant contributions to
infrastructure competition by installing transmission capacity or international
simple resale operators making significant contributions to competition in their
respective international market. Econophone believes it qualifies as one of the
latter.
Since 1992, the U.K. government has permitted competition in the provision
of "any to any" international services over leased lines where calls originate
and terminate on the PSTN. Econophone, through a subsidiary, holds an
International Simple Resale ("ISR") license in the United Kingdom. An ISR
license entitles Econophone to resell international message, telephone and
private line services. Provided that Oftel is satisfied that the licensee is
making a significant contribution to competition in the market for international
telephony services, the ISR license also enables the licensee to interconnect
with, and lease capacity at wholesale rates from, British Telecom, Mercury and
other public telecommunications operators.
In the United Kingdom, there was until recently a duopoly on ownership of
international cable and satellite facilities vested with British Telecom and
Mercury. All other operators were required to buy leased capacity from British
Telecom or Mercury, rather than acquiring IRUs on existing cable routes. This
constraint was removed in December 1996 when the U.K. government began to issue
IFLs. An IFL authorizes its holder to provide international telecommunication
services over its own international infrastructure. There is no limit on the
number of these licenses that may be issued. Econophone was awarded an IFL
during the second quarter of 1997.
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WORLD TRADE ORGANIZATION INITIATIVES
The WTO recently concluded the WTO Agreement, which would open the
telecommunications markets of the signatory countries to entry by foreign
carriers on varying dates beginning January 1, 1998. The WTO Agreement will be
effective January 1, 1998, subject to legislative ratification in many of the 70
signatory countries. Pursuant to the WTO Agreement, U.S. companies would have
foreign market access for local, long distance and international services,
either on a facilities basis or through resale of existing network capacity.
U.S. companies also would be permitted to acquire, establish or hold a
significant stake in foreign telecommunications companies. Conversely, foreign
companies would be permitted to enter the domestic U.S. telecommunications
markets and acquire ownership interests in U.S. service providers. Although the
WTO Agreement might open additional markets to Econophone or broaden the
permissible services that Econophone now provides in certain markets, the WTO
Agreement also might subject Econophone to greater competitive pressures in its
existing markets, with the risk of customer diversions to competitive carriers
and reductions in Econophone's rates.
BELGIUM
Under the Belgian Law of March 21, 1991 and the Royal Decree of October 28,
1996, the provision of "telephone services" is reserved for the Belgian PTO.
"Telephone services" consist of real-time voice telephony involving switching in
Belgium. Services that do not constitute "telephone services" can be provided by
private service providers that are duly licensed. A subsidiary of Econophone has
been granted a license to provide certain non-reserved services. Pursuant to the
license, the subsidiary may, among other things, provide international service
utilizing international toll free access and local access, as well as card-based
services. Pursuant to the terms of its license, the subsidiary can transmit both
voice and data, and, thus, is able to offer voicemail, e-mail and facsimile
service.
FRANCE
Until recently, France had a single monopoly provider of telecommunications
services, France Telecom. As part of the EU-wide effort to liberalize the
telecommunications industry, the French legislature has taken steps to open its
national market to competition and to make France Telecom gradually subject to
the same rules as its competitors. As part of this process, the French
legislature adopted a law on July 26, 1996 which significantly modified the
French Postal and Telecommunications Code. At present, private service providers
may provide calling card services in France utilizing international toll free
access without a license. Private service providers may also offer data
transmission services to the general public without a license. In addition, no
license is required to provide telecommunications services through authorized
networks (i.e., networks that are licensed in France) to closed user groups,
such as "virtual private networks." In the case of data transmission services or
services offered to closed user groups, the private service provider may utilize
local dial-up access through an authorized network, engaging in switching in
France or routing of calls over leased lines to a second country for switching.
Beginning on January 1, 1998, licensed private service providers may offer
domestic and international long distance voice telephony services to the general
public in France. These services will be permitted to utilize local dial-up
access and may involve switching in France or routing of calls over leased lines
that are part of an authorized network to a second country for switching.
Econophone currently is preparing an application for a license to provide long
distance voice telephony services to the general public and intends to provide
such services utilizing local dial-up access on January 1, 1998 or as soon
thereafter as applicable requirements have been satisfied.
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GERMANY
In Germany, Econophone's activities are governed by the Telecommunications
Act of July 25, 1996 (the "German Telecommunications Act"). Under the German
Telecommunications Act, the provision of "voice telephone service" requires a
license. "Voice telephone service" is defined in the German Telecommunications
Act, in part, as "the commercial provision for the public of the direct
transport and switching of voice in real-time to and from the network
termination points of the public switched network." The provision of
telecommunications services that do not constitute "voice telephone services"
does not require a license. Under current regulatory practice, the provision by
Econophone of international long distance, calling card and prepaid card
services in Germany do not constitute "voice telephone services," and therefore
do not require a license, because Econophone does not switch the calls in
Germany, although Econophone was required to file a notification of the
commencement of services.
UNITED STATES
Econophone's U.S. operations are subject to extensive federal and state
regulation. Federal laws and FCC regulations apply to interstate
telecommunications (including international telecommunications that originate or
terminate in the United States), while particular state regulatory authorities
have jurisdiction over telecommunications originating and terminating within the
state.
FEDERAL. The FCC currently regulates Econophone as a non-dominant carrier
with respect to both its international and domestic long distance services. In
the domestic, as distinguished from the international sector, the FCC abstains
from closely regulating the services and charges of non-dominant carriers.
Nevertheless, the FCC acts upon complaints against such carriers for failure to
comply with statutory obligations or with the FCC's rules, regulations and
policies. The FCC also has the power to impose more stringent regulatory
requirements on Econophone and to change its regulatory classification. In the
current regulatory atmosphere, Econophone believes that the FCC is unlikely to
do so with respect to Econophone's international or domestic service offerings.
FCC policy and rules authorize (without the need to obtain specific service
authorizations) a non-dominant carrier to provide domestic interstate
telecommunications services, and generally to resell international private
leased lines connected to the PSTN in Canada, Sweden, the United Kingdom or New
Zealand. In the international sector, specific FCC authorizations, which
Econophone has acquired, are required for the resale of switched and private
line services of U.S. facilities-based carriers, and to provide
telecommunications services, both switched and private line, as a
facilities-based carrier by acquiring circuits or various undersea cables or
leasing satellite facilities. The FCC reserves the right to condition, modify or
revoke such domestic and international authority for violations of the 1934 Act
or the FCC's regulations, rules or policies promulgated thereunder. Although
Econophone believes the probability to be remote, a rescission by the FCC of
Econophone's domestic or international authority or a refusal by the FCC to
grant additional international authority would have a material adverse effect on
Econophone.
Econophone, as a non-dominant carrier, is required to file with the FCC
domestic and international tariffs containing charges and related practices,
regulations and classifications. The FCC presumes the tariffs of non-dominant
carriers to be lawful. Therefore, the FCC does not carefully review such
tariffs. The FCC could, however, investigate Econophone's tariffs, upon its own
motion or upon complaint by a member of the public. As a result of any such
investigation, the FCC could order Econophone to revise its tariffs, or the FCC
could prescribe revised tariffs.
Generally, authorizations held under Section 214 of the 1934 Act (such as
those held by Econophone) for international services are limited to providing
services or using facilities between the United States and countries specified
in the authorizations. Econophone holds all necessary Section 214 authorizations
for conducting its present business but may need additional authority in the
future. Additionally, carriers may not lease private lines between the United
States and an international point for the purpose of offering switched services
unless the FCC has first determined that the foreign country affords resale
opportunities
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<PAGE>
to U.S. carriers equivalent to those available under United States law. The FCC
has made such a determination with respect to Canada, Sweden, the United Kingdom
and New Zealand, and Econophone is authorized to resell international private
lines to these points interconnected to the PSTN for the provision of voice and
data services.
The FCC requires long distance carriers to pay access charges to payphone
providers for calls made from payphones to toll free numbers administered by
long distance carriers. The FCC had required the immediate payment of such
access charges by long distance carriers with toll revenues of $100 million or
more per annum. The FCC had also required, after October 7, 1997, all long
distance carriers, irrespective of their annual toll revenues, must pay to each
payphone operator $.35 for each access or toll free call made from the
operator's payphones unless the payphone operator and the long distance carrier
agree upon a different rate of compensation. The FCC payphone order was reversed
by an appellate court. The matter was remanded to the FCC by the court for
further consideration. The FCC may re-adopt the $.35 rate, or some different
rate, effective on October 7, 1997, or at some later date. Irrespective of the
effective date and the amount ultimately adopted by the FCC, there can be no
assurance that Econophone will be able to fully pass this cost on to its
customers or that doing so will not result in a loss of customers.
The FCC has issued an order designed to bring downward pressure on
international telephone rates. This order directs the U.S. international
facilities-based carriers to negotiate lower settlement rates paid to their
correspondent foreign carriers for international telephone calls. A transition
period is provided for these lower settlement rates of between one and five
years depending upon the country involved. Any resulting savings to the U.S.
facilities-based carriers might be passed along to their customers in the form
of reduced rates for international calls.
STATE. The intrastate long distance operations of Econophone are subject to
various state laws and regulations. Most states require Econophone to apply for
certification to provide intrastate telecommunications services, or to register
or be found exempt from regulation, before commencing intrastate services. Most
states also require Econophone to file and maintain detailed tariffs listing
their rates for intrastate service. Many states also impose various reporting
requirements and/or require prior approval for transfers of control of certified
carriers, assignment of carrier assets, including customer bases, carrier stock
offerings, incurrence by carriers of significant debt obligations and
acquisitions of telecommunications operations. Certificates of authority can
generally be conditioned, modified, cancelled, terminated or revoked by state
regulatory authorities for failure to comply with state law and/or rules,
regulations and policies of the state regulatory authorities. Fines and other
penalties also may be imposed for such violations.
Econophone provides interstate and international long distance service in
all or some portions of 50 states, for which Econophone has filed a tariff with
FCC. Econophone has received authority, pursuant to state regulations,
certifications, tariffs or notifications or on an unregulated basis, to provide
intrastate services in 49 states.
EMPLOYEES
As of September 30, 1997, Econophone had 330 full-time employees worldwide.
Of this total, 201 were based in the United States and 129 were based in Europe.
Econophone's U.S. employees are based principally in its offices in New York,
New York and Brooklyn, New York and in College Station, Texas. In Europe,
Econophone's employees are based principally in its offices in Antwerp,
Brussels, Hamburg, London and Paris.
Econophone has never experienced a work stoppage and its employees are not
represented by a labor union or a collective bargaining agreement. Econophone
considers its employee relations to be good.
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LITIGATION
Econophone is from time to time a party to litigation that arises in the
ordinary course of its business operations or otherwise. Econophone is not
presently a party to any litigation that it believes would have a material
adverse effect on its business or operations.
PROPERTIES
Econophone's executive offices and main operations center are located in New
York City, where Econophone leases approximately 18,000 square feet of space at
two facilities. Econophone also leases approximately 16,000 square feet of
office space in College Station, Texas, 10,500 square feet of office space in
Brooklyn, New York, approximately 2,400 square feet of office space in Los
Angeles, approximately 12,800 square feet in London, approximately 2,400 square
feet in Brussels and approximately 3,150 square feet in Paris, where it
maintains its European sales and marketing headquarters. Econophone maintains
smaller sales offices in Athens, Antwerp and Hamburg.
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MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT
The following table sets forth certain information with respect to the
directors, executive officers and other senior management of Econophone.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Alfred West.......................................... 36 Chief Executive Officer and Chairman of the Board of
Directors
Alan L. Levy......................................... 38 President, Chief Operating Officer, Chief Financial
Officer and Director
Patrick Attallah..................................... 31 Vice President of European Sales and Marketing
Paul E. Bilke........................................ 37 Director of Technology
Jeremy S. Kagan...................................... 32 Vice President of Service Systems
Charles D. Briggs.................................... 41 Vice President of Network Operations
Ira M. Riesenberg.................................... 36 Corporate Controller
Mark A. Schulz....................................... 37 Director of Management Information Systems
Gary S. Bondi........................................ 46 Director and Treasurer
Steven West.......................................... 47 Director
</TABLE>
Directors of Econophone each serve for a term of one year or until their
successors are elected. Holders of the Series A Preferred Stock are entitled to
elect one director. Officers of Econophone serve at the pleasure of the Board of
Directors, subject to any written arrangements with Econophone. See
"--Executive Compensation--Employment Agreements and Arrangements."
Set forth below is certain information with respect to the directors,
executive officers and other senior management of Econophone. In addition to the
Directors listed herein, the holders of the Series A Preferred Stock have the
right to vote as a separate class to elect one director. Hartley R. Rogers
served in such capacity until October 21, 1997, at which time he terminated his
employment with Princes Gate, the holder of the Series A Preferred Stock.
Princes Gate has reserved its right to designate a Director in the future.
ALFRED WEST, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD OF
DIRECTORS. Mr. West founded Econophone in 1989. Prior to founding Econophone,
Mr. West managed a family-owned textile trading company. Mr. West is the brother
of Steven West, a Director of Econophone.
ALAN L. LEVY, PRESIDENT, CHIEF OPERATING OFFICER, CHIEF FINANCIAL OFFICER
AND DIRECTOR. Mr. Levy has served as Econophone's Chief Operating Officer and
Chief Financial Officer since August 1996, as a Director since January 1997 and
as President since August 1997. From October 1993 to July 1996, Mr. Levy served
as Executive Vice President and Managing Director, Europe, as well as Chief
Financial Officer, of Viatel, where, among other things, Mr. Levy was
responsible for the implementation of Viatel's European strategy. From 1989 to
September 1993, Mr. Levy served as an Audit Manager for Edward Isaacs & Company,
an accounting firm. Mr. Levy is a Certified Public Accountant.
PATRICK ATTALLAH, VICE PRESIDENT OF EUROPEAN SALES AND MARKETING. Mr.
Attallah has served as Econophone's Vice President of European Sales and
Marketing since October 1996. From August 1995 to September 1996, Mr. Attallah
served as the General Manager-France and the South Europe Regional
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Director of VPN S.A., Viatel's French subsidiary. From October 1994 to July
1995, Mr. Attallah served as the Senior Account Manager in Paris for Tele Media
International, a division of Telecom Italia, the Italian PTO. From March 1989 to
September 1994, Mr. Attallah served in various sales management positions in
Paris, Milan and London for Sprint International, most recently as indirect
sales director in Paris.
PAUL E. BILKE, DIRECTOR OF TECHNOLOGY. Mr. Bilke has served as Econophone's
Director of Technology since November 1992. From February 1984 until November
1992, Mr. Bilke was an independent consultant. From December 1980 to January
1984, Mr. Bilke was director of software development at StarTel, Inc., a
regional facilities-based carrier in the southwestern United States. Mr. Bilke
is a principal of Bilke & Associates, an independent consulting firm with which
Econophone has entered into certain transactions. See "Certain
Transactions--Bilke & Associates."
JEREMY S. KAGAN, VICE PRESIDENT OF SERVICE SYSTEMS. Mr. Kagan has served as
Econophone's Vice President of Service Systems since October 1996. From January
1995 to October 1996, he worked at Andersen Consulting as Manager of the Network
Support Solutions Practice in its Communications Industry Group. From March 1987
to January 1995, Mr. Kagan worked at Bellcore as a Product Manager.
CHARLES D. BRIGGS, VICE PRESIDENT OF NETWORK OPERATIONS. Mr. Briggs joined
Econophone as Director of Network Operations in May 1997 and became Vice
President of Network Operations in August 1997. From October 1994 to May 1997,
Mr. Briggs was employed by Kallback/International Telecom LTC as Director of
Switched Services, in which capacity he was responsible for all
telecommunications network design, acquisition and implementation, including
management of Kallback's network control center. From November 1992 through
October 1994, Mr. Briggs was employed at Cypress Semiconductor as Test Lab
Manager. Prior to such time, Mr. Briggs held positions at Rep-Sac Corporation,
Leviton Telcom, and Interglobal Technical Services.
IRA M. RIESENBERG, CORPORATE CONTROLLER. Mr. Riesenberg has served as
Econophone's Corporate Controller since September 1996. From October 1995
through September 1996, Mr. Riesenberg was Director of Finance at Computron
Software, Inc., an international software development company. From April 1994
to September 1995, Mr. Riesenberg was the Assistant Controller at Computron, and
from April 1990 to March 1994 he served as Accounting Manager. Mr. Riesenberg is
a Certified Public Accountant and a member of the American Institute of
Certified Public Accountants.
MARK A. SCHULZ, DIRECTOR OF MANAGEMENT INFORMATION SERVICES. Mr. Schulz has
served as Econophone's Director of Management Information Services since October
1996. Prior to joining Econophone, Mr. Schulz spent fourteen years at Texas A&M
University, where he was responsible for developing and implementing a variety
of management information systems.
GARY S. BONDI, DIRECTOR AND TREASURER. Mr. Bondi has served as a Director
and the Treasurer of Econophone since 1993. Mr. Bondi is the President of Bondi,
Inc., a multinational trading firm specializing in non-ferrous metals that he
founded in 1987.
STEVEN WEST, DIRECTOR. Mr. West has served as a Director of Econophone
since 1993. Mr. West is a founding partner of SO Metals, Inc., a refiner and
reprocessor of precious metals in the New York/New Jersey metropolitan area that
was founded in 1982. Steven West is the brother of Alfred West, the President,
Chief Executive Officer and Chairman of the Board of Directors of Econophone.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Econophone does not have a compensation committee. Decisions with respect to
compensation matters that otherwise would be decided by a compensation committee
are made by the Board of Directors as a whole.
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All of the current members of the Board of Directors participated in
deliberations concerning executive officer compensation during 1996. Alfred West
and Alan L. Levy, who are members of the Board of Directors, receive
compensation as officers of Econophone. Hartley R. Rogers, who, effective as of
October 21, 1997, terminated his employment as a Managing Director of Morgan
Stanley and as the President of the General Partner of Princes Gate, was a
member of the Board of Directors until such time. Princes Gate has the power to
appoint a successor to Mr. Rogers on the Board of Directors. Princes Gate, which
is an affiliate of Morgan Stanley, owns 140,000 shares of Series A Preferred
Stock representing approximately 14.6% of the shares of Common Stock on an as
converted basis (without giving effect to the exercise of any options to
purchase Common Stock or the Warrants). Morgan Stanley Group, an affiliate of
Morgan Stanley, previously purchased $7.0 million of Bridge Notes from
Econophone, all of which have been redeemed. In addition, Morgan Stanley was the
Placement Agent in connection with the Offering. See "--Executive Compensation"
and "Certain Transactions."
EXECUTIVE COMPENSATION
At September 30, 1997, the chief executive officer and other four most
highly compensated executive officers of Econophone were Mr. West and Messrs.
Levy, Attallah, Bilke and Kagan. The following table summarizes all 1996 plan
and non-plan compensation awarded to, earned by or paid to Mr. West and Messrs.
Levy, Attallah and Bilke, who, at December 31, 1996, were Econophone's chief
executive officer and other executive officers whose total annual salary and
bonus exceeded $100,000, respectively (Messrs. West, Levy, Attallah, Bilke and
Kagan are referred to herein as the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
-------------------
NUMBER OF
ANNUAL COMPENSATION SECURITIES
------------------------ UNDERLYING OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION SALARY (1) BONUS GRANTED COMPENSATION
- ------------------------------------------------ ------------ ---------- ------------------- ---------------
<S> <C> <C> <C> <C>
Alfred West (2)................................. $ 326,280 $ 163,139 -- $ 5,171.13 (3)
President and Chief Executive Officer
Alan L. Levy (4)................................ 72,000 37,500 2,000,000 --
Chief Financial Officer and Chief Operating
Officer
Patrick Attallah (5)............................ 36,588 15,000 40,000 --
Vice President of European Sales and Marketing
Paul E. Bilke (6)............................... 76,154 -- 30,000 --
Director of Technology
Jeremy S. Kagan (7)............................. 57,884 30,000 30,000 --
</TABLE>
- ------------------------
(1) Does not include the value of certain personal benefits. The estimated value
of such personal benefits for each Named Executive Officer did not exceed
the lesser of $50,000 or 10% of the total annual salary and bonus paid to
the Named Executive Officer in 1996.
(2) See "--Employment Agreements and Arrangements" for a description of Mr.
West's Employment Agreement.
(3) Consists of premiums in respect of life insurance, of which Mr. West's
designee is the beneficiary, paid by Econophone.
(4) Mr. Levy joined Econophone on August 9, 1996. See "--Employment Agreements
and Arrangements" for a description of Mr. Levy's Employment Agreement.
(5) Mr. Attallah joined Econophone on October 4, 1996.
(6) Mr. Bilke joined Econophone on July 1, 1996.
(7) Mr. Kagan joined Econophone on October 11, 1996.
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1996 FLEXIBLE INCENTIVE PLAN
Econophone has adopted the Econophone, Inc. 1996 Flexible Stock Incentive
Plan, as amended (the "Incentive Plan"), which provides for the grant of
incentive stock options ("ISOs") to acquire shares of Common Stock to employees
of Econophone or any of its subsidiaries, the grant of non-qualified stock
options ("NQSOs") to acquire shares of Common Stock, the sale or grant of
Restricted Shares and Unrestricted Shares (each, as defined in the Incentive
Plan) and the grant of stock appreciation rights ("SARs") to employees,
directors and consultants. The Incentive Plan also provides for Tax Offset
Payments (as defined in the Incentive Plan) to employees. The Incentive Plan
provides for the award of up to a maximum of 3,000,000 shares of Common Stock
and is administered by the Board of Directors of Econophone. Econophone is
required to seek the approval of its stockholders to materially increase the
number of shares of Common Stock that may be issued under the Incentive Plan.
The Incentive Plan provides that, in the event of a merger, consolidation,
combination, exchange of shares, separation, spin-off, reorganization,
liquidation or other similar transaction, the Board of Directors of Econophone
may, in its sole discretion, accelerate the lapse of Restricted Periods (as
defined in the Incentive Plan) and other vesting periods and waiting periods and
extend exercise periods applicable to any awards made under the Incentive Plan,
except that, upon a Change of Control (as defined in the Incentive Plan), to the
extent that an employee has been employed by Econophone for the twelve month
period preceding the Change of Control, vesting of any options held by such
employee automatically will accelerate.
As of September 30, 1997, Econophone had issued options to purchase
2,626,500 shares of Common Stock under the Incentive Plan, 816,388 of which were
exercisable as of such date.
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The following table sets forth grants of options to purchase shares of
Common Stock of Econophone made during 1996 to each Named Executive Officer.
OPTION GRANTS IN 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------
% OF TOTAL POTENTIAL REALIZABLE VALUE
OPTIONS AT ASSUMED ANNUAL RATES OF
GRANTED TO STOCK PRICE APPRECIATION
NUMBER OF EMPLOYEES IN EXERCISE FOR OPTION TERM
SECURITIES FISCAL YEAR PRICE PER EXPIRATION --------------------------
NAME UNDERLYING OPTIONS 1996 SHARE($) DATE 5% ($) 10%($)
- ----------------------- ------------------ ------------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Alfred West............ -- -- -- -- -- --
Alan L. Levy........... 2,000,000 76.7% $ 2.50 08/01/2006 $ 3,144,473 $ 7,968,712
Patrick Attallah....... 40,000 1.5% 2.50 10/03/2006 62,889 159,376
Paul E. Bilke.......... 30,000 1.2% 2.50 10/31/2006 47,167 119,531
Jeremy S. Kagan........ 30,000 1.2% 2.50 10/31/2006 47,167 119,531
</TABLE>
The following table sets forth options exercised during 1996 and the fiscal
year-end value of unexercised options for each Named Executive Officer.
OPTION EXERCISES IN 1996 AND 1996 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1996 DECEMBER 31, 1996
SHARES ACQUIRED VALUE REALIZED ---------------------------- ------------------------------------
NAME ON EXERCISE (1) (1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------ ------------------- ---------------- ------------- ------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Alfred West....... -- -- -- -- -- --
Alan L. Levy...... -- -- 222,222 1,777,778 $ 0 $ 0
Patrick Attallah.. -- -- 2,222 37,778 0 0
Paul E. Bilke..... -- -- 0 30,000 0 0
Jeremy S. Kagan... -- -- 0 30,000 0 0
</TABLE>
- ------------------------
(1) No options were exercised during 1996.
EMPLOYMENT AGREEMENTS AND ARRANGEMENTS
Econophone has entered into an employment agreement with Alfred West (the
"West Employment Agreement"), effective as of January 1, 1997, pursuant to which
Mr. West serves as Chief Executive Officer and Chairman of the Board of
Directors of Econophone. The term of the West Employment Agreement extends until
December 31, 1999, subject to any earlier termination in accordance with the
terms thereof. Pursuant to the West Employment Agreement, Mr. West is entitled
to receive an annual base salary of not less than $330,000 for each year of the
employment term, subject to increases approved from time to time by the Board of
Directors of Econophone or the compensation committee thereof and automatic
increases each January 1 by the percentage increase in the consumer price index
in New York over the consumer price index published the preceding January. In
addition, Mr. West is eligible to participate in Econophone's incentive
compensation programs and to receive such annual bonus or other compensation,
including restricted stock or incentive stock options, as may be determined by
Econophone's Board of Directors. Pursuant to the West Employment Agreement, Mr.
West will be awarded an annual bonus of between 25% and 75% of his annual base
salary, subject to attainment of certain performance goals as determined by the
Board of Directors of Econophone or the compensation committee thereof. If
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Mr. West's employment is terminated prior to December 31, 1999 by Econophone
without just cause or by Mr. West with good reason (including upon a Change of
Control, as defined in the West Employment Agreement), he will be entitled to a
severance payment equal to up to his annual base salary for the greater of one
year or the remainder of the employment term, plus the continuation of his
benefits for up to the greater of two years after the date of termination and
the remainder of his employment term. The West Employment Agreement
automatically will be renewed for successive one year periods unless, at least
six months prior to the expiration of the employment term, either Mr. West or
Econophone shall notify the other that it does not wish to extend the term. If
Econophone does not offer to renew the West Employment Agreement, Mr. West will
be entitled to a severance payment equal to one year's base salary, plus a
continuation of his medical and other welfare benefits for one year.
In August 1996, Econophone entered into an employment agreement with Alan L.
Levy (as thereafter amended, the "Levy Employment Agreement") pursuant to which
Mr. Levy serves as Chief Financial Officer and Chief Operating Officer of
Econophone. Mr. Levy was promoted to President, Chief Operating Officer and
Chief Financial Officer in August 1997. The term of the Levy Employment
Agreement extends until July 31, 1999, subject to any earlier termination in
accordance with the terms thereof. Pursuant to the Levy Employment Agreement,
Mr. Levy is entitled to receive an annual base salary of $210,000 during each
year of the term thereof, subject to increases in the discretion of the Board of
Directors. In addition, Mr. Levy is eligible to participate in Econophone's
incentive compensation programs and to receive such annual bonus or other
compensation, including restricted stock or incentive stock options, as may be
determined by Econophone's Board of Directors. Pursuant to an incentive stock
option agreement dated October 31, 1996, Econophone granted Mr. Levy incentive
stock options to purchase 2,000,000 shares of Common Stock at an exercise price
of $2.50 per share. Mr. Levy is entitled to certain demand and piggyback
registration rights with respect to such shares. If Mr. Levy's employment is
terminated prior to July 31, 1999 by Econophone without just cause or if Mr.
Levy and Econophone do not enter into a new employment agreement prior to the
expiration of the Levy Employment Agreement, he will be entitled to a severance
payment equal to one year's base salary.
Messrs. Attallah, Bilke and Kagan do not have employment agreements with
Econophone. As of October 1, 1997, the annual compensation (exclusive of any
bonus) for Messrs. Attallah, Bilke and Kagan was $125,000, $150,000 and
$125,000, respectively.
LIMITATIONS ON OFFICERS' AND DIRECTORS' LIABILITY
Econophone's Certificate of Incorporation indemnifies its officers and
directors to the fullest extent permitted by the New York Business Corporation
Law (the "BCL"). The BCL permits a corporation to limit or eliminate an
officer's or a director's personal liability to the corporation or the holders
of its capital stock for breach of duty. This limitation is generally
unavailable for acts or omissions by an officer or director which were (i) in
bad faith, (ii) were the result of active and deliberate dishonesty and were
material to the cause of action so adjudicated or (iii) involved a financial
profit or other advantage to which such director was not legally entitled. The
Certificate of Incorporation and the BCL also prohibit limitations on officer or
director liability for acts or omissions which resulted in a violation of a
statute prohibiting certain dividend declarations, certain payments to
stockholders after dissolution and particular types of loans. The effect of
these provisions is to eliminate the rights of Econophone and its stockholders
(through stockholders' derivative suits on behalf of Econophone) to recover
monetary damages against an officer or director for breach of fiduciary duty as
an officer or director (including breaches resulting from grossly negligent
behavior), except in the situations described above.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors or officers of Econophone pursuant to the foreging
provisions, Econophone has been informed that, in the opinion of the Commission,
such indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable.
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CERTAIN TRANSACTIONS
INVESTMENT BY PRINCES GATE
On November 1, 1996, Princes Gate purchased 140,000 shares of Series A
Preferred Stock for a purchase price of $14.0 million, less $560,000 in fees. As
of October 1, 1997, the Series A Preferred Stock was convertible into
approximately 14.6% of the Common Stock on an as converted basis (without giving
effect to the exercise of the Warrants or any options issued by Econophone).
SERIES A PREFERRED STOCK
Certain of the terms of the Series A Preferred Stock issued to Princes Gate
are described below. As a result of the consummation of the Offering, Econophone
is permitted pursuant to the terms of the Series A Preferred Stock to amend its
Certificate of Incorporation so that the restrictions therein with respect to
limitations on dividends, indebtedness, restricted payments and transactions
with shareholders and affiliates are no more restrictive than the analogous
covenants contained in the Indenture.
RANKING. The Series A Preferred Stock is senior to all other capital stock
of Econophone, whether outstanding as of the date of issuance of the Series A
Preferred Stock or thereafter issued, as to dividend payments and distributions
upon liquidation, dissolution or the winding up of Econophone.
VOTING RIGHTS. In addition to such other vote, if any, as may be required
by New York law, the affirmative vote of the holders of at least a majority of
the outstanding shares of Series A Preferred Stock, voting together as a single
class, shall be necessary to: (i) declare or pay any dividends on, or redeem or
otherwise acquire any other class or series of capital stock of Econophone,
except to the extent provided for pursuant to the terms of any class or series
of capital stock approved by the affirmative vote of the holders of at least a
majority of the then outstanding shares of Series A Preferred Stock; (ii)
authorize an amendment to Econophone's Certificate of Incorporation decreasing
the liquidation preference of the Series A Preferred Stock or otherwise
adversely affecting the preferences, rights or powers of the Series A Preferred
Stock or the Series A Warrants (defined below); (iii) effect a voluntary
liquidation, dissolution or winding up of Econophone or the sale of all or
substantially all of its assets, or the merger, consolidation or
recapitalization of Econophone; or (iv) amend the Certificate of Incorporation
or bylaws in a manner or take any other action that would in any way impair,
limit or delay the ability of the holders of the Series A Preferred Stock to
exercise their voting rights, by written consent or at any meeting of
shareholders of Econophone.
BOARD REPRESENTATION. The holders of Series A Preferred Stock have the
right to vote as a separate class to elect one director. This right terminates
at such time as certain specified holders cease to hold at least 50% of the
outstanding shares of Series A Preferred Stock or Econophone consummates an
initial public offering of its Common Stock generating gross proceeds of at
least $25.0 million and registered with the Commission.
DIVIDENDS. The holders of Series A Preferred Stock were entitled to receive
a dividend payable at the rate of 12% per annum, which was cumulative and
compounded monthly. Dividends ceased to accrue and compound on the Series A
Preferred Stock upon the consummation of the Offering. Dividends will not be
paid on any shares of Series A Preferred Stock prior to any redemption or
liquidation (as described below) of such shares. Subject to certain exceptions,
no dividends or other distributions, and no redemption, purchase or other
acquisition for value, are allowed to be made with respect to any share of, or
right to acquire, any other class or series of Econophone's capital stock other
than the Series A Preferred Stock.
LIQUIDATION. Upon the liquidation, distribution of assets, dissolution or
winding up of Econophone, a holder of Series A Preferred Stock shall be entitled
to receive, prior to the holders of Common Stock, $100 per share plus all
accrued and unpaid dividends thereon.
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CONVERSION. At any time, any holder of Series A Preferred Stock may convert
all or any portion thereof into Common Stock of Econophone. As of October 1,
1997, the shares of Series A Preferred Stock outstanding were convertible into
3,420,701 shares of Common Stock. Notwithstanding the foregoing, until November
2, 1997, the holders of Series A Preferred Stock may only convert an aggregate
of 100,000 shares of Series A Preferred Stock. Econophone may convert any of the
shares of Series A Preferred Stock into Common Stock upon the closing of an
initial public offering of its Common Stock generating gross proceeds of at
least $25.0 million and registered with the Commission. The number of shares of
Common Stock that each share of Series A Preferred Stock is convertible into is
equal to the number of shares of Common Stock outstanding on November 1, 1996
(on a fully diluted basis), which was 22,564,000, multiplied by a fraction (i)
the numerator of which is equal to the stated value with respect to the shares
of Series A Preferred Stock being so converted, plus any dividends accrued
thereon, and (ii) the denominator of which is equal to $100.0 million plus the
number of dollars received by Econophone since November 1, 1996 from the
exercise of specified options or warrants. The number of shares of Common Stock
that each share of Series A Preferred Stock is converted into is subject to
antidilution adjustment in the event of certain issuances of Common Stock or
rights, options, warrants or convertible or exchangeable securities containing
the right to acquire shares of Common Stock at below fair market value.
REDEMPTION. Econophone is required to redeem the Series A Preferred Stock
on October 31, 2006 at a price per share equal to $100 per share plus an amount
equal to all accrued dividends (whether or not declared) on the Series A
Preferred Stock to the date of redemption. Any holder of Series A Preferred
Stock has the option to cause Econophone to redeem its shares in the event of
(i) an occurrence of certain changes of control, including if Alfred West ceases
to own voting securities representing at least 25% of the total voting power of
the outstanding voting securities of Econophone, or a person or group becomes
the beneficial owner of voting securities representing more voting power than
the voting securities then owned by Mr. West, (ii) the taking of any action by
Econophone without the approval, if required, of the holders of a majority of
the shares of the Series A Preferred Stock, (iii) non-compliance by Econophone
with restrictions on certain transactions with affiliates and shareholders, (iv)
Econophone's failure to maintain at least $10.0 million of "key man insurance"
on Mr. Alfred West until November 1, 1999 or (v) Econophone's failure to limit
its business to the telecommunications business (and businesses reasonably
related or ancillary thereto). Except as provided in the foregoing, so long as
the indebtedness under the NTFC Agreement is outstanding, Econophone is not
permitted to redeem the Series A Preferred Stock for cash, unless NTFC (or its
assignee) waives this limitation in advance in writing. In connection with the
Note Purchase Agreement, Econophone agreed to forego the right to redeem up to
40,000 shares of Series A Preferred Stock from Princes Gate at the stated value
of $100 per share plus accrued dividends. See "--Bridge Funding by Morgan
Stanley Group."
LIMITATION ON INDEBTEDNESS. Econophone and certain of its subsidiaries are
not permitted to incur any indebtedness except: (i) indebtedness in an aggregate
principal amount not to exceed $20.0 million outstanding at any time; (ii)
indebtedness incurred solely to fund the acquisition of assets used or useful in
the telecommunications business; (iii) indebtedness issued in a high yield
offering of debt securities having a maturity of at least 7 years and yielding
gross proceeds to Econophone of at least $75.0 million (net of any amount of
proceeds of such offering that is placed in escrow or any similar arrangement to
fund the payment of interest, premium (if any) or principal on such debt
securities); (iv) indebtedness to Econophone or certain subsidiaries; (v)
certain indebtedness or certain capital stock issued in exchange for, or the net
proceeds of which are used to exchange, refinance, refund or defease certain
outstanding indebtedness or capital stock subject to certain exceptions; (vi)
indebtedness (a) in respect of performance bonds, bankers' acceptances and
surety or appeal bonds provided in the ordinary course of business, (b) under
certain currency agreements and interest rate agreements, subject to certain
conditions, and (c) arising from certain agreements providing for
indemnification, adjustment of purchase price or similar options, or from
guarantees or letters of credit, surety bonds or performance bonds securing any
obligations of Econophone or any of its subsidiaries pursuant to such
agreements, in any case incurred in
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connection with the disposition of any business, assets or subsidiary of
Econophone, subject to certain exceptions.
LIMITATION ON RESTRICTED PAYMENTS. Subject to certain exceptions, the
ability of Econophone and certain subsidiaries to make investments is limited,
except for (i) an investment in Econophone or certain subsidiaries; (ii)
specified temporary cash investments; (iii) payroll, travel and similar advances
to cover matters that are expected at the time of such advances ultimately to be
treated as expenses in accordance with generally accepted accounting principles;
(iv) notes and other evidences of indebtedness, not to exceed $2.0 million at
any one time outstanding; (v) stock, obligations or securities received in
satisfaction of judgments; (vi) relocation and similar loans to employees of
Econophone or its subsidiaries not to exceed $150,000 at any one time
outstanding; (vii) loans to employees of Econophone or its subsidiaries, in each
case evidenced by an unsubordinated promissory note, for the purpose of enabling
such employees to purchase capital stock of Econophone, in an amount not to
exceed $1.5 million at any one time outstanding; (viii) investments, not to
exceed $5.0 million at any one time outstanding, if the Board of Directors of
Econophone has determined that such investments constitute strategic
investments; and (ix) investments in Darcom Limited in an amount not to exceed
the amount of net cash proceeds to Econophone from the incurrence of
indebtedness by, or the issuance of capital stock of, Econophone since November
1, 1996.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES. Subject to
certain exceptions, Econophone may not, and may not permit any subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or assets,
or the rendering of any service) with any holder (or any affiliate of such
holder) of 5% or more of any class of capital stock of Econophone or with any
affiliate of Econophone, except for transactions on terms at least as favorable
to Econophone or such subsidiary as could be obtained on an arm's-length basis
from a person that is not such an affiliate or 5% holder.
LIMITATION ON LIENS. Subject to certain exceptions, Econophone may not, and
may not permit certain subsidiaries to create, incur, assume or suffer to exist
any lien on any of its assets or properties of any character, or any shares of
capital stock or indebtedness.
KEY MAN INSURANCE. Until November 1, 1999, Econophone is required to
maintain in full force and effect "key man" insurance with a benefit of at least
$10.0 million in the event of the death or long term incapacity of Mr. Alfred
West, naming Econophone as sole beneficiary.
MAINTENANCE OF BUSINESS. Econophone and certain of its subsidiaries are
required to limit their business to the telecommunications business and
businesses reasonably related or ancillary thereto.
SECURITYHOLDERS AGREEMENT
Mr. Alfred West, Econophone and Princes Gate entered into a Securityholders
Agreement in connection with Princes Gate's investment in Econophone (the
"Securityholders Agreement"). Certain terms of the Securityholders Agreement are
discussed below.
REGISTRATION RIGHTS. The holders of the Series A Preferred Stock are
entitled to certain registration rights with respect to the shares of Common
Stock issuable upon the conversion of the Series A Preferred Stock and the
exercise of the Series A Warrants (all such shares of Common Stock being
"Registrable Shares"). If Econophone proposes to register any of its securities
under the Securities Act, the holders of the Series A Preferred Stock will be
entitled to notice thereof and, subject to certain restrictions, to include
their Registrable Shares in such registration. From November 1, 1999 until the
consummation by Econophone of an initial public offering of Common Stock,
holders of at least 50% of the outstanding Registrable Shares may (subject to
certain conditions) make a demand that Econophone file a registration statement
under the Securities Act. Thereafter, holders of at least 25% of the outstanding
Registrable
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Shares may make up to two demands of Econophone to file a registration statement
under the Securities Act, subject to certain conditions and limitations and
provided that (i) in the discretion of the lead underwriter of the prior
offering, no demand may be made within 180 days after the effective date of a
prior demand registration and (ii) no two such demands may be made within any
twelve month period. A holder of the Series A Preferred Stock's right to include
shares in an underwritten registration is subject to the right of the
underwriters to limit the number of shares included in the offering. Subject to
certain limitations, Econophone is required to bear all registration, legal and
other expenses in connection with these registrations and must provide
appropriate indemnification.
WARRANTS. If Econophone has not consummated an initial public offering by
November 1, 2000, Econophone will be required to issue warrants (the "Series A
Warrants") to the holders of the Series A Preferred Stock representing, in the
aggregate, 5% of the outstanding shares of Common Stock, calculated on a fully
diluted basis. Thereafter, at six month intervals until the consummation of an
initial public offering, Econophone will be required to issue additional Series
A Warrants to such holders to purchase shares of Common Stock representing, in
the aggregate, 5% of the outstanding shares of Common Stock, calculated on a
fully diluted basis. The right of the holders of the Series A Preferred Stock to
receive additional Series A Warrants shall terminate at such time as the holders
of the Series A Preferred Stock own shares of Common Stock, Series A Preferred
Stock and Series A Warrants representing, in the aggregate, 25% of the Common
Stock, calculated on a fully diluted basis. The Series A Warrants will have an
exercise price of $.01 per share, a 10-year duration and will be subject to a
warrant agreement containing customary provisions acceptable to the holders of
the Series A Preferred Stock (including adjustments for stock splits, reverse
stock splits and reclassifications).
PARTICIPATION IN SALES BY MR. ALFRED WEST. Holders of the Series A
Preferred Stock have the right to participate on a pro rata basis in sales of
Common Stock by Mr. West on the same terms and conditions as Mr. West. Under
certain circumstances, Mr. West has a right to require such persons to transfer
their shares on a pro rata basis on the same terms and conditions as Mr. West.
If the transfer by Mr. West would constitute a change of control pursuant to the
terms of the Series A Preferred Stock, holders of the Series A Preferred Stock
will be entitled to require Econophone to redeem their shares.
BRIDGE FUNDING BY MORGAN STANLEY GROUP
On April 24, 1997, Econophone entered into the Note Purchase Agreement,
pursuant to which Morgan Stanley Group an affiliate of Princes Gate agreed to
purchase from Econophone up to $15,000,000 of Bridge Notes. At such time,
Econophone paid to Morgan Stanley Group a commitment fee of $225,000 and agreed
to pay a further fee of 2% of the principal amount of each issuance after the
aggregate principal amount of Bridge Notes issued exceeded $5.0 million. Bridge
Notes totalling $7.0 million were issued under the Note Purchase Agreement on
the following dates: $3.0 million on April 24, 1997; $2.0 million on May 20,
1997; and $1.0 million on each of May 23, 1997 and May 30, 1997. The net
proceeds from the Bridge Notes purchased by Econophone were $6.6 million and
were used to fund equipment and other capital expenditures and operations.
Immediately following the consummation of the Offering, all of the
outstanding Bridge Notes ($7.0 million) were redeemed and all accrued interest
thereon ($143,750) paid. At such time, the facility represented by the Note
Purchase Agreement was terminated. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
In connection with the Note Purchase Agreement, Econophone agreed to (i)
forego the right to redeem up to 40,000 shares of Series A Preferred Stock from
Princes Gate at the stated value of $100 per share plus accrued dividends, (ii)
pay up to $100,000 of fees and expenses incurred by Morgan Stanley Group in
connection with the transactions contemplated by the Note Purchase Agreement and
(iii) grant to Morgan Stanley Group and its affiliates the right to act as sole
underwriter or placement agent in
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connection with the Offering and to act as lead underwriter for an initial
public offering of Common Stock, if any, effected before April 24, 2002.
PRIVATE PLACEMENT BY MORGAN STANLEY
Morgan Stanley, an affiliate of Princes Gate, acted as Placement Agent in
respect of the Offering. In connection with the Offering, Econophone entered
into a Placement Agreement with Morgan Stanley pursuant to which Morgan Stanley
purchased the Units for resale. The Placement Agreement provides, among other
things, that the Company and Morgan Stanley will indemnify each other against
certain liabilities, including liabilities under the Securities Act, and will
contribute to payments the other may be required to make in respect thereof. In
addition, pursuant to the Placement Agreement, Econophone has certain
obligations to register Notes, Warrants and shares of Common Stock on a shelf
registration statement at the request, and for the benefit of, Morgan Stanley
and any successor thereto. See "Plan of Distribution."
RELATED PARTY LOANS
On December 9, 1992, Econophone borrowed $200,000 from Mrs. Rose West, the
mother of Messrs. Alfred West and Steven West, pursuant to an unsecured
promissory note bearing interest at the rate of 9% per annum, payable on
maturity. The obligation matures on December 8, 1997. On November 16, 1993,
Econophone borrowed $108,000 from Mrs. West pursuant to an unsecured promissory
note that bears interest at a rate of 18% per annum, payable at maturity, and
that matures on November 15, 1998.
Since the third quarter of 1996, Mr. Alfred West has borrowed approximately
$213,522 from Econophone pursuant to unsecured, non-interest bearing notes,
repayable upon demand.
E-GRAM
Alfred West, the Chief Executive Officer of Econophone, owns 100% of the
stock of E-Gram Corporation. E-Gram Corporation is in the process of developing
an enhanced e-mail service that Econophone intends to license from E-Gram
Corporation on a non-exclusive basis. It is expected that this service will be
available for commercial use by the end of 1997. Pursuant to the Securityholders
Agreement, E-Gram Corporation is required to issue to Princes Gate shares of
E-Gram Corporation equal to 10% of the outstanding capital stock thereof upon
the commercialization of E-Gram Corporation's technology.
BILKE & ASSOCIATES
Econophone has from time to time purchased certain equipment from Bilke &
Associates, an independent consulting firm of which Mr. Paul Bilke, the Director
of Technology of Econophone, is a principal. Such purchases, which were made on
an arm's-length basis, were $227,000 in 1995 and $96,000 in 1996.
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DESCRIPTION OF CERTAIN INDEBTEDNESS
NTFC VENDOR FINANCING
On May 28, 1996, Econophone entered into a credit facility with NTFC, which
was increased on March 27, 1997 pursuant to the NTFC Agreement, permitting
Econophone to borrow up to $5.0 million to purchase equipment and to pay certain
other related expenses. As of September 30, 1997, $4.8 million, some of which
has been repaid, has been drawn down under two tranches of the facility to
purchase equipment and to pay certain other related expenses. These tranches are
to be paid in 60 equal monthly installments and mature between July 1, 2001 and
April 1, 2002 at an interest rate equal to the 90-day commercial paper rate plus
395 basis points, which will be adjusted quarterly. As of September 30, 1997,
$4.1 million of indebtedness was outstanding under the NTFC Agreement at an
interest rate of 5.63%. The NTFC Agreement requires mandatory prepayment of
amounts borrowed thereunder, among certain other circumstances, upon the
occurrence of any event pursuant to which the Series A Preferred Stock may be
redeemed.
Prior to the consummation of the Offering, certain covenants of the NTFC
Agreement were amended pursuant to the Second Amendment to the NTFC Agreement,
dated June 26, 1997 (the "Second Amendment"), to substantially conform such
covenants of the NTFC to the analogous covenants contained in the Indenture.
Following the execution and delivery of such amendment, the NTFC Agreement
permits the incurrence of indebtedness, the creation of liens and transactions
with affiliates on substantially the same terms as the Indenture. Pursuant to
the NTFC Agreement, Econophone may not become liable for any contingent
obligation except, in addition to certain other limited exceptions set forth in
the NTFC Agreement, (i) to the extent permitted under the Indenture, (ii) for
indebtedness of a majority-owned subsidiary engaged principally in the
telecommunications business and (iii) for indebtedness related to the purchase
or installation of additional telecommunications equipment or the purchase of
additional capacity.
The NTFC Agreement prohibits Econophone from making any distribution or any
redemption of capital stock, directly or indirectly, other than nominal payments
in lieu of the issuance of fractional shares upon an exercise of options,
warrants or similar agreements or conversion rights and other than any
repurchase of Warrants in connection with a repurchase offer by Econophone.
Except in connection with certain transactions with affiliates not involving a
change of control, Econophone may not enter into or become the subject of, any
merger, acquisition of consolidation, or liquidate, wind-up or dissolve itself
(or suffer any liquidation or dissolution), or convey, sell, lease, transfer or
otherwise dispose of all or any substantial part of its business or assets.
Econophone also may not make investments in, or advances or loans to, any
company not engaged principally in the telecommunications business other than on
arm's-length terms. In addition, Econophone may not enter into any new business
or make any material change in any of its business objectives, purpose and
operations from those related to the telecommunications industry.
Pursuant to the NTFC Agreement, Econophone may not cease to employ Alfred
West or suffer to exist any competition by any of Alfred West, Steven West or
Gary Bondi, with the business now or hereafter conducted by Econophone.
The Second Amendment to the NTFC Agreement requires Econophone to maintain a
Debt Service Coverage Ratio (as defined therein) for each quarter through
December 31, 1999 of not less than 1.10 to 1.00 and for each fiscal quarter
thereafter of not less than 1.25 to 1.00. In addition, Econophone must maintain
a cash balance of not less than $1,500,000. Econophone also must have EBITDA (as
defined in the NTFC Agreement) of not less than: ($10,000,000) for the fiscal
year ending December 31, 1997; ($5,000,000) for the fiscal year ending December
31, 1998; $3,000,000 for the fiscal year ending December 31, 1999; $10,000,000
for the fiscal year ending December 31, 2000; and $10,000,000 for the fiscal
year ending December 31, 2000. Prior to the execution and delivery of the Second
Amendment, Econophone
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was not in compliance with the then existing Debt Service Coverage Ratio,
minimum cash balance and EBITDA requirements of the NTFC Agreement, although
such noncompliance was waived by NTFC. The execution and delivery of the Second
Amendment was a condition to the consummation of the Offering.
Borrowings from NTFC are secured by the equipment purchased therewith and
general intangibles and intangible property that is associated with such
equipment.
IDT CORPORATION
On October 22, 1996, Econophone borrowed $2.9 million from IDT for working
capital purposes. Interest on the loan accrued at a rate of 13% per annum. All
amounts owed to IDT were repaid in advance of their scheduled maturity date in
August, 1997.
TELEGLOBE CANTAT-3 INC.
During December 1996, Econophone entered into an agreement with TeleGlobe
Cantat-3 Inc. ("TC-3"), pursuant to which Econophone acquired an IRU. The
principal balance due thereunder accrues interest at the London Interbank
Offered Rate plus 5% per annum, with payments to be made quarterly through June
2001. As of September 30, 1997, the aggregate balance due thereunder was
approximately $.2 million. The IRU purchased from TC-3 secures Econophone's
obligations to TC-3.
PRIVATE TRANS-ATLANTIC TELECOMMUNICATIONS SYSTEM-1 (N.J.) INC.
During 1994 and 1995, Econophone entered into four agreements with Private
Trans-Atlantic Telecommunications System-1 ("PTAT-1"), pursuant to which
Econophone acquired five IRUs on PTAT-1. The outstanding balance under the
agreements accrues interest at the rate of 12% per annum with payments to be
made quarterly through September 1998. As of September 30, 1997, the aggregate
balance due thereunder was approximately $.2 million. The IRUs purchased from
PTAT-1 secure Econophone's obligations to PTAT-1.
RELATED PARTY LOANS
In addition to the indebtedness described above, see "Certain Transactions"
for a description of certain other indebtedness of Econophone.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of Econophone's Common Stock as of October 1, 1997 by (i) each person
known by Econophone to own beneficially more than 5% of the outstanding Common
Stock, (ii) each of Econophone's directors, (iii) each of the chief executive
officer and the other four most highly compensated executive officers of
Econophone and (iv) the directors and executive officers as a group.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(1)
----------------------------------------
<S> <C> <C>
NAME AND ADDRESS NUMBER OF SHARES PERCENTAGE OF
OF BENEFICIAL OWNER OF COMMON STOCK COMMON STOCK(2)
- -------------------------------------------------------------------------- ------------------- -------------------
Alfred West............................................................... 11,000,000 47.0%
Steven West............................................................... 4,500,000 19.2%
Gary Bondi................................................................ 4,500,000 19.2%
Princes Gate Investors II, L.P............................................ 3,420,701(3) 14.6%
c/o Morgan Stanley & Co.
Incorporated
1585 Broadway
New York, NY 10036
Patrick Attallah.......................................................... 14,444(4) *
Paul E. Bilke............................................................. -- (5) *
Jeremy S. Kagan........................................................... -- (6) *
Alan L. Levy.............................................................. 888,890(7) 3.7%
Hartley R. Rogers(8)...................................................... -- --
All Directors and Executive Officers as a Group (8 persons)............... 20,903,334 85.9%
</TABLE>
- ------------------------
* Less than one percent.
(1) Except where otherwise indicated, Econophone believes that all persons
listed in the table, based on information provided by such persons, have
sole voting and dispositive power over the securities beneficially owned by
them, subject to community property laws, where applicable. For purposes of
this table, a person is deemed to be the "beneficial owner" of any shares
that such person has the right to acquire within 60 days from October 1,
1997. For purposes of computing the percentage of outstanding shares held by
each person named above on a given date, any security that such person has
the right to acquire within 60 days is deemed to be outstanding, but is not
deemed to be outstanding for the purpose of computing the percentage
ownership of any other person. Except where otherwise indicated, the address
of each person listed in the table is c/o Econophone, Inc., 45 Broadway, New
York, NY 10006.
(2) Determined on an as-converted basis, assuming the conversion of all issued
and outstanding shares of Series A Preferred Stock into Common Stock. As of
October 1, 1997, each share of Series A Preferred Stock was convertible into
24.43 shares of Common Stock, or a total of 3,420,701 shares of Common
Stock.
(3) Includes 31,704 shares of Series A Preferred Stock, which were convertible
into 774,528 shares of Common Stock on October 1, 1997, owned by affiliates
of Princes Gate over which Princes Gate has sole voting power.
(4) All of such shares are issuable upon the exercise of options. Does not
include options to purchase 25,556 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after October 1,
1997.
(5) Does not include options to purchase 30,000 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after October 1,
1997.
(6) Does not include options to purchase 30,000 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after October 1,
1997.
(7) All of such shares are issuable upon the exercise of options. Does not
include options to purchase 1,111,110 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after October 1,
1997.
(8) Hartley R. Rogers is no longer serving as a Director, effective as of
October 21, 1997.
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DESCRIPTION OF THE EXCHANGE NOTES
The Exchange Notes are to be issued under an Indenture, dated as of July 1,
1997, between the Company, as issuer, and The Bank of New York, as Trustee. A
copy of the Indenture is available upon request from the Company. The following
summary of certain provisions of the Indenture does not purport to be complete
and is subject to, and is qualified in its entirety by reference to, all the
provisions of the Indenture, including the definitions of certain terms therein
and those terms made a part thereof by reference to the Trust Indenture Act of
1939, as amended. Whenever particular defined terms of the Indenture not
otherwise defined herein are referred to, such defined terms are incorporated
herein by reference. The term "Note" or "Notes" includes the Original Notes and
the Exchange Notes. For definitions of certain capitalized terms used in the
following summary, see "--Certain Definitions."
GENERAL
The Notes are unsecured unsubordinated obligations of the Company, limited
to $155.0 million aggregate principal amount at maturity, and mature on July 15,
2007. Interest on the Notes accrues at the rate of 13 1/2% per annum from the
most recent interest payment date on which interest has been paid or provided
for or, if no interest has been paid or provided for, the Closing Date, payable
semiannually (to Holders of record at the close of business on the January 1 or
July 1 immediately preceding the interest payment date) on January 15 and July
15 of each year, commencing January 15, 1998.
Principal of, premium, if any, and interest on the Notes will be payable,
and the Notes may be exchanged or transferred, at the office or agency of the
Company in the Borough of Manhattan, the City of New York (which initially will
be the corporate trust office of the Trustee at 101 Barclay Street, New York,
New York 10286); PROVIDED that, at the option of the Company, payment of
interest may be made by check mailed to the Holders at their addresses as they
appear in the Security Register.
Exchange Notes initially will be represented by Global Notes. See
"--Book-Entry; Delivery and Form".
OPTIONAL REDEMPTION
The Notes will be redeemable, at the Company's option, in whole or in part,
at any time or from time to time, on or after July 15, 2002 and prior to
maturity, upon not less than 30 nor more than 60 days' prior notice mailed by
first class mail to each Holders' last address as it appears in the Security
Register, at the following Redemption Prices (expressed in percentages of
principal amount at maturity), plus accrued and unpaid interest, if any, to the
Redemption Date (subject to the right of Holders of record on the relevant
Regular Record Date that is on or prior to the Redemption Date to receive
interest due on an Interest Payment Date), if redeemed during the 12-month
period commencing July 15 of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- --------------------------------------------- ----------------
<S> <C>
2002 106.750%
2003 103.375%
2004 and thereafter 100.000%
</TABLE>
In addition, at any time prior to July 15, 2000, the Company may redeem up
to 35% of the aggregate principal amount of the Notes with the proceeds of one
or more Public Equity Offerings following which a Public Market occurs, at any
time as a whole, or from time to time in part, at a Redemption Price (expressed
as a percentage of principal amount on the Redemption Date) of 113.50%, plus
accrued and unpaid interest, if any, to the Redemption Date (subject to the
rights of Holders of record on the relevant Regular Record Date that is on or
prior to the Redemption Date to receive interest due on an Interest Payment
Date); PROVIDED that (1) at least $100.0 million aggregate principal amount at
maturity of Notes remains outstanding after each such redemption and (2) each
such redemption occurs within 180 days of the related Public Equity Offering.
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<PAGE>
In the case of any partial redemption, selection of the Notes for redemption
will be made by the Trustee in compliance with the requirements of the principal
national securities exchange, if any, on which the Notes are listed or, if the
Notes are not listed on a national securities exchange, on a pro rata basis, by
lot or by such other method as the Trustee in its sole discretion shall deem to
be fair and appropriate; PROVIDED that no Note of $1,000 in principal amount at
maturity or less shall be redeemed in part. If any Note is to be redeemed in
part only, the notice of redemption relating to such Note shall state the
portion of the principal amount at maturity thereof to be redeemed. A new Note
in principal amount at maturity equal to the unredeemed portion thereof will be
issued in the name of the Holder thereof upon cancellation of the original Note.
SECURITY
In accordance with the Indenture, the Company has purchased, and pledged to
the Trustee for the benefit of the Holders of the Notes, the Pledged Securities,
which consist of U.S. government securities, in such amount as will be
sufficient upon receipt of scheduled interest and principal payments of such
securities to provide for payment in full of the first six scheduled interest
payments due on the Notes. The Pledged Securities have been pledged by the
Company to the Trustee for the benefit of the Holders of the Notes pursuant to
the Pledge Agreement and will be held by the Trustee in the Pledge Account.
Pursuant to the Pledge Agreement, immediately prior to an Interest Payment Date
on the Notes, the Company may either deposit with the Trustee from funds
otherwise available to the Company cash sufficient to pay the interest scheduled
to be paid on such Interest Payment Date or the Company may direct the Trustee
to release from the Pledge Account proceeds sufficient to pay interest due on
the Notes on such Interest Payment Date. In the event that the Company exercises
the former option, the Company may thereafter direct the Trustee to release to
the Company proceeds or Pledged Securities from the Pledge Account in like
amount. A failure by the Company to pay interest on the Notes in a timely manner
through the first six scheduled interest payment dates will constitute an
immediate Event of Default under the Indenture, with no grace or cure period.
Interest earned on the Pledged Securities will be added to the Pledge
Account. In the event that the funds or Pledged Securities held in the Pledge
Account exceed the amount sufficient, in the opinion of a nationally recognized
firm of independent public accountants selected by the Company, to provide for
payment in full of the first six scheduled interest payments due on the Notes
(or, in the event an interest payment or payments have been made, an amount
sufficient to provide for payment in full of any interest payments remaining, up
to and including the sixth scheduled interest payment), the Trustee will be
permitted to release to the Company at the Company's request any such excess
amount. The Notes are secured by a first priority security interest in the
Pledged Securities and the Pledge Account.
REGISTRATION RIGHTS
There will be no registration rights with respect to the Exchange Notes,
except that the Company has granted certain registration rights to Morgan
Stanley and that certain brokers or dealers registered under the Exchange Act
who may be deemed to be "underwriters" with respect to the Exchange Notes may be
entitled to continuing registration rights which the Company granted with
respect to the Exchange Notes. See "Plan of Distribution."
RANKING
The indebtedness evidenced by the Notes ranks PARI PASSU in right of payment
with all existing and future unsubordinated indebtedness of the Company and
senior in right of payment to all existing and future subordinated indebtedness
of the Company. As of September 30, 1997, excluding the Notes, Econophone had
$5.3 million of indebtedness outstanding, all of which was senior indebtedness
and $5.0 million of which was secured indebtedness. The Notes are effectively
subordinated to such secured indebtedness to the extent of the collateral
therefor.
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<PAGE>
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
covenants and other provisions of the Indenture. Reference is made to the
Indenture for the full definition of all terms as well as any other capitalized
terms used herein for which no definition is provided. For purposes of these
definitions the terms "Note" or "Notes" shall mean the Original Notes and the
Exchange Notes.
"Acquired Indebtedness" means Indebtedness of a Person existing at the time
such Person becomes a Restricted Subsidiary or is merged into or consolidated
with a Restricted Subsidiary or assumed in connection with an Asset Acquisition
by a Restricted Subsidiary, whether or not Incurred in connection with, or in
anticipation of, such Person becoming a Restricted Subsidiary or such Asset
Acquisition; PROVIDED that Indebtedness of such Person which is redeemed,
defeased, retired or otherwise repaid at the time of or immediately upon
consummation of the transactions by which such Person becomes a Restricted
Subsidiary or such Asset Acquisition shall not be Acquired Indebtedness.
"Adjusted Consolidated Net Income" means, for any period, the aggregate net
income (or loss) of the Company and its Restricted Subsidiaries for such period
determined in conformity with GAAP; PROVIDED that the following items shall be
excluded in computing Adjusted Consolidated Net Income (without duplication):
(i) the net income (or loss) of any Person (other than net income or loss
attributable to a Restricted Subsidiary) in which any Person (other than the
Company or any of its Restricted Subsidiaries) has an equity interest and the
net income (or loss) of any Unrestricted Subsidiary, except that Adjusted
Consolidated Net Income for any period shall include the amount of dividends or
other distributions actually paid to the Company or any of its Restricted
Subsidiaries by such other Person or such Unrestricted Subsidiary during such
period; (ii) solely for the purposes of calculating the amount of Restricted
Payments that may be made pursuant to clause (C) of the first paragraph of the
"Limitation on Restricted Payments" covenant described below (and in such case,
except to the extent includable pursuant to clause (i) above), the net income
(or loss) of any Person accrued prior to the date it becomes a Restricted
Subsidiary or is merged into or consolidated with the Company or any of its
Restricted Subsidiaries or all or substantially all of the property and assets
of such Person are acquired by the Company or any of its Restricted
Subsidiaries; (iii) the net income of any Restricted Subsidiary to the extent
that the declaration or payment of dividends or similar distributions by such
Restricted Subsidiary of such net income is not at the time permitted by the
operation of the terms of its charter or any agreement, instrument, judgment,
decree, order, statute, rule or governmental regulation applicable to such
Restricted Subsidiary; (iv) any gains or losses attributable to Asset Sales; (v)
except for purposes of calculating the amount of Restricted Payments that may be
made pursuant to clause (C) of the first paragraph of the "Limitation on
Restricted Payments" covenant described below, any amount paid or accrued as
dividends on Preferred Stock of the Company or any Restricted Subsidiary owned
by Persons other than the Company and any of its Restricted Subsidiaries; and
(vi) all extraordinary gains and extraordinary losses.
"Adjusted Consolidated Net Tangible Assets" means the total amount of assets
of the Company and its Restricted Subsidiaries (less applicable depreciation,
amortization and other valuation reserves), except to the extent resulting from
write-ups of capital assets (excluding write-ups in connection with accounting
for acquisitions in conformity with GAAP), after deducting therefrom (i) all
current liabilities of the Company and its Restricted Subsidiaries (excluding
intercompany items) and (ii) all goodwill, trade names, trademarks, patents,
unamortized debt discount and expense and other like intangibles, all as set
forth on the most recent quarterly or annual consolidated balance sheet of the
Company and its Restricted Subsidiaries, prepared in conformity with GAAP and
filed with the Commission pursuant to the "Commission Reports and Reports to
Holders" covenant.
"Affiliate" means, as applied to any Person, any other Person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, means the
possession, directly or indirectly, of
88
<PAGE>
the power to direct or cause the direction of the management and policies of
such Person, whether through the ownership of voting securities, by contract or
otherwise.
"Asset Acquisition" means (i) an investment by the Company or any of its
Restricted Subsidiaries in any other Person pursuant to which such Person shall
become a Restricted Subsidiary or shall be merged into or consolidated with the
Company or any of its Restricted Subsidiaries; PROVIDED that such Person's
primary business is related, ancillary or complementary to the businesses of the
Company and its Restricted Subsidiaries on the date of such investment or (ii)
an acquisition by the Company or any of its Restricted Subsidiaries of the
property and assets of any Person other than the Company or any of its
Restricted Subsidiaries that constitute substantially all of a division or line
of business of such Person; PROVIDED that the property and assets acquired are
related, ancillary or complementary to the businesses of the Company and its
Restricted Subsidiaries on the date of such acquisition.
"Asset Disposition" means the sale or other disposition by the Company or
any of its Restricted Subsidiaries (other than to the Company or another
Restricted Subsidiary) of (i) all or substantially all of the Capital Stock of
any Restricted Subsidiary of the Company or (ii) all or substantially all of the
assets that constitute a division or line of business of the Company or any of
its Restricted Subsidiaries.
"Asset Sale" means any sale, transfer or other disposition (including by way
of merger, consolidation or sale-leaseback transaction but excluding any Lien
granted in compliance with the "Limitation on Liens" covenant ) in one
transaction or a series of related transactions by the Company or any of its
Restricted Subsidiaries to any Person other than the Company or any of its
Restricted Subsidiaries of (i) all or any of the Capital Stock of any Restricted
Subsidiary, (ii) all or substantially all of the property and assets of an
operating unit or business of the Company or any of its Restricted Subsidiaries
or (iii) any other property and assets of the Company or any of its Restricted
Subsidiaries outside the ordinary course of business of the Company or such
Restricted Subsidiary and, in each case, that is not (A) a Restricted Payment
permitted under the "Limitation on Restricted Payments" covenant or (B) governed
by the provisions of the Indenture applicable to mergers, consolidations and
sales of all or substantially all of the assets of the Company; PROVIDED that
"Asset Sale" shall not include (a) sales or other dispositions of inventory,
receivables and other current assets, (b) sales or other dispositions of assets
or the issuance of any Capital Stock of any Restricted Subsidiary or Permitted
Joint Venture for consideration at least equal to the fair market value of the
assets sold or disposed of, provided that the consideration received would
satisfy clause (B) of the "Limitation on Asset Sales" covenant, including
consideration that consists of technology, licenses or expertise useful in the
business of Econophone and its Restricted Subsidiaries, (c) sales or other
dispositions of obsolete or outdated equipment; PROVIDED that each such sale or
other disposition or series of such sales or such other dispositions shall not
involve assets that are material to the business of the Company and its
Restricted Subsidiaries, taken as a whole, and (d) sales or other dispositions
during any 12-month period of assets with an aggregate fair market value not in
excess of $1.0 million.
"Attributable Indebtedness" means when used in connection with a
sale-leaseback transaction referred to in the "Limitation on Sale-Leaseback
Transactions" covenant described below, at any date of determination, the
product of (i) the net proceeds from such sale-leaseback transaction and (ii) a
fraction, the numerator of which is the number of full years of the term of the
lease relating to the property involved in such sale-leaseback transaction
(without regard to any options to renew or extend such term) remaining at the
date of the making of such computation and the denominator of which is the
number of full years of the term of such lease (without regard to any options to
renew or extend such term) measured from the first day of such term.
"Average Life" means, at any date of determination with respect to any debt
security, the quotient obtained by dividing (i) the sum of the products of (a)
the number of years from such date of determination to the dates of each
successive scheduled principal payment of such debt security and (b) the amount
of such principal payment by (ii) the sum of all such principal payments.
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<PAGE>
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) in equity of such Person, whether now outstanding or
issued after the Closing Date, including, without limitation, all Common Stock
and Preferred Stock.
"Capitalized Lease" means, as applied to any Person, any lease of any
property (whether real, personal or mixed) of which the discounted present value
of the rental obligations of such Person as lessee, in conformity with GAAP, is
required to be capitalized on the balance sheet of such Person; and "Capitalized
Lease Obligations" means the discounted present value of the rental obligations
under such lease.
"Change of Control" means such time as (i) (a) prior to the occurrence of a
Public Market, a "person" or "group" (within the meaning of Section 13(d) or
14(d)(2) under the Exchange Act) becomes the ultimate "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act) of Voting Stock representing a
greater percentage of the total voting power of the Voting Stock of the Company,
on a fully diluted basis, than is held by the Existing Stockholders and their
Affiliates on such date and (b) after the occurrence of a Public Market, a
"person" or "group" (within the meaning of Section 13(d) or 14(d)(2) under the
Exchange Act) becomes the ultimate "beneficial owner" (as defined in Rule 13d-3
under the Exchange Act) of more than 35% of the total voting power of the Voting
Stock of the Company on a fully diluted basis and such ownership represents a
greater percentage of the total voting power of the Voting Stock of the Company,
on a fully diluted basis, than is held by the Existing Stockholders and their
Affiliates on such date; or (ii) individuals who on the Closing Date constitute
the Board of Directors (together with any new directors whose election by the
Board of Directors or whose nomination for election by the Company's
stockholders was approved by a vote of at least two-thirds of the members of the
Board of Directors then in office who either were members of the Board of
Directors on the Closing Date or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
members of the Board of Directors then in office.
"Closing Date" means July 1, 1997, the date on which the Notes originally
were issued under the Indenture.
"Common Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non voting) of such Person's equity, other than Preferred Stock of
such Person, whether outstanding prior to or issued after the Closing Date,
including, without limitation, all series and classes of such common stock.
"Consolidated EBITDA" means, for any period, the sum of the amounts for such
period of (i) Adjusted Consolidated Net Income, (ii) Consolidated Interest
Expense, to the extent such amount was deducted in calculating Adjusted
Consolidated Net Income, (iii) income taxes, to the extent such amount was
deducted in calculating Adjusted Consolidated Net Income (other than income
taxes (either positive or negative) attributable to extraordinary and
non-recurring gains or losses or sales of assets), (iv) depreciation expense, to
the extent such amount was deducted in calculating Adjusted Consolidated Net
Income, (v) amortization expense, to the extent such amount was deducted in
calculating Adjusted Consolidated Net Income, and (vi) all other non-cash items
reducing Adjusted Consolidated Net Income (other than items that will require
cash payments and for which an accrual or reserve is, or is required by GAAP to
be, made), less all non-cash items increasing Adjusted Consolidated Net Income,
all as determined on a consolidated basis for the Company and its Restricted
Subsidiaries in conformity with GAAP; PROVIDED that, if any Restricted
Subsidiary is not a Wholly Owned Restricted Subsidiary, Consolidated EBITDA
shall be reduced (to the extent not otherwise reduced in accordance with GAAP)
by an amount equal to (A) the amount of the Adjusted Consolidated Net Income
attributable to such Restricted Subsidiary multiplied by (B) the quotient of (1)
the number of shares of outstanding Common Stock of such Restricted Subsidiary
not owned on the last day of such period by the Company or any of its
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Restricted Subsidiaries divided by (2) the total number of shares of outstanding
Common Stock of such Restricted Subsidiary on the last day of such period.
"Consolidated Interest Expense" means, for any period, the aggregate amount
of interest in respect of Indebtedness (including, without limitation,
amortization of original issue discount on any Indebtedness and the interest
portion of any deferred payment obligation, calculated in accordance with the
effective interest method of accounting; all commissions, discounts and other
fees and charges owed with respect to letters of credit and bankers' acceptance
financing; the net costs associated with Interest Rate Agreements; and
Indebtedness that is Guaranteed or secured by the Company or any of its
Restricted Subsidiaries) and the interest component of Capitalized Lease
Obligations paid, accrued or scheduled to be paid or to be accrued by the
Company and its Restricted Subsidiaries during such period; EXCLUDING, HOWEVER,
(i) any amount of such interest of any Restricted Subsidiary if the net income
of such Restricted Subsidiary is excluded in the calculation of Adjusted
Consolidated Net Income pursuant to clause (iii) of the definition thereof (but
only in the same proportion as the net income of such Restricted Subsidiary is
excluded from the calculation of Adjusted Consolidated Net Income pursuant to
clause (iii) of the definition thereof) and (ii) any premiums, fees and expenses
(and any amortization thereof) payable in connection with the offering of the
Notes, all as determined on a consolidated basis (without taking into account
Unrestricted Subsidiaries) in conformity with GAAP.
"Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of
(i) the aggregate amount of Indebtedness of the Company and its Restricted
Subsidiaries on a consolidated basis outstanding on such Transaction Date to
(ii) the aggregate amount of Consolidated EBITDA for the then most recent four
fiscal quarters for which financial statements of the Company have been filed
with the Commission pursuant to the "Commission Reports and Reports to Holders"
covenant described below, or, with respect to quarters for which no reports are
required to be filed, for which such financial statements are then available, as
determined by the Company (such four fiscal quarter period being the "Four
Quarter Period"); PROVIDED that (A) (x) PRO FORMA effect shall be given to any
Indebtedness (including, if applicable, the Notes) Incurred during such Four
Quarter Period or subsequent to the end of such Four Quarter Period and on or
prior to the Transaction Date, in each case as if such Indebtedness had been
Incurred, and the proceeds thereof had been applied, on the first day of such
Four Quarter Period and (y) PRO FORMA effect shall be given to any Indebtedness
that was outstanding during such Four Quarter Period or thereafter but that is
not outstanding or is to be repaid, defeased or satisfied on the Transaction
Date, as if such Indebtedness had been repaid, defeased or satisfied on the
first day of the Four Quarter Period; (B) PRO FORMA effect shall be given to
Asset Dispositions and Asset Acquisitions (including giving PRO FORMA effect to
the application of proceeds of any Asset Disposition) that occur during the
period beginning on the first day of such Four Quarter Period and ending on the
Transaction Date (the "Reference Period"), as if they had occurred and such
proceeds had been applied on the first day of such Reference Period; and (C) PRO
FORMA effect shall be given to asset dispositions and asset acquisitions
(including giving PRO FORMA effect to the application of proceeds of any asset
disposition) that have been made by any Person that has become a Restricted
Subsidiary or has been merged with or into, or consolidated with, the Company or
any Restricted Subsidiary during such Reference Period and that would have
constituted Asset Dispositions or Asset Acquisitions had such transactions
occurred when such Person was a Restricted Subsidiary as if such asset
dispositions or asset acquisitions were Asset Dispositions or Asset Acquisitions
that occurred on the first day of such Reference Period; PROVIDED that to the
extent that clause (B) or (C) of this sentence requires that PRO FORMA effect be
given to an Asset Acquisition or Asset Disposition, such PRO FORMA calculation
shall be based upon the four full fiscal quarters immediately preceding the
Transaction Date of the Person, or division or line of business of the Person,
that is acquired or disposed for which financial information is available.
"Consolidated Net Tangible Assets" means the total book value of the assets
of the Company and its Restricted Subsidiaries (less applicable depreciation,
amortization and other valuation reserves) after deducting therefrom (i) all
current liabilities of the Company and its consolidated Restricted Subsidiaries
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(excluding intercompany items) and (ii) all goodwill, trade names, trademarks,
patents, unamortized debt discount and expense and other like intangibles, all
as set forth on the most recently available consolidated balance sheet of the
Company and its consolidated Restricted Subsidiaries, prepared in conformity
with GAAP.
"Consolidated Net Worth" means, at any date of determination, stockholders'
equity as set forth on the most recently available quarterly or annual
consolidated balance sheet of the Company and its Restricted Subsidiaries (which
shall be as of a date not more than 90 days prior to the date of such
computation, and which shall not take into account Unrestricted Subsidiaries),
less any amounts attributable to Disqualified Stock or any equity security
convertible into or exchangeable for Indebtedness, the cost of treasury stock
and the principal amount of any promissory notes receivable from the sale of the
Capital Stock of the Company or any of its Restricted Subsidiaries, each item to
be determined in conformity with GAAP (excluding the effects of foreign currency
exchange adjustments under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 52).
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Disqualified Stock" means any class or series of Capital Stock of any
Person that by its terms or otherwise is (i) required to be redeemed prior to
the Stated Maturity of the Notes, (ii) redeemable at the option of the holder of
such class or series of Capital Stock at any time prior to the Stated Maturity
of the Notes or (iii) convertible into or exchangeable for Capital Stock
referred to in clause (i) or (ii) above or Indebtedness having a scheduled
maturity prior to the Stated Maturity of the Notes; PROVIDED that any Capital
Stock that would not constitute Disqualified Stock but for provisions thereof
giving holders thereof the right to require such Person to repurchase or redeem
such Capital Stock upon the occurrence of an "asset sale" or "change of control"
occurring prior to the Stated Maturity of the Notes shall not constitute
Disqualified Stock if the "asset sale" or "change of control" provisions
applicable to such Capital Stock are no more favorable to the holders of such
Capital Stock than the provisions contained in "Limitation on Asset Sales" and
"Repurchase of Notes upon a Change of Control" covenants described below and
such Capital Stock specifically provides that such Person will not repurchase or
redeem any such stock pursuant to such provision prior to the Company's
repurchase of such Notes as are required to be repurchased pursuant to the
"Limitation on Asset Sales" and "Repurchase of Notes upon a Change of Control"
covenants described below.
"Existing Stockholders" means Alfred West, Steven West and any spouse or
lineal descendant thereof or any estate thereof or any trust of which any of the
foregoing are the exclusive beneficiaries and Princes Gate.
"fair market value" means the price that would be paid in an arm's-length
transaction between an informed and willing seller under no compulsion to sell
and an informed and willing buyer under no compulsion to buy, as determined in
good faith by the Board of Directors, whose determination shall be conclusive if
evidenced by a Board Resolution.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Closing Date, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession; PROVIDED, HOWEVER, that all reports and other financial
information provided by the Company to the Holders of the Notes or the Trustee
shall be prepared in accordance with GAAP as in effect on the date of such
report or other financial information. All ratios and computations contained or
referred to in the Indenture shall be
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computed in conformity with GAAP applied on a consistent basis, except that
calculations made for purposes of determining compliance with the terms of the
covenants and with other provisions of the Indenture shall be made without
giving effect to (i) the amortization or write off of any expenses incurred in
connection with the offering of the Notes, the Bridge Notes and the Series A
Preferred Stock and (ii) except as otherwise PROVIDED, the amortization of any
amounts required or permitted by Accounting Principles Board Opinion Nos. 16 and
17.
"Government Securities" means direct obligations of, obligations fully
guaranteed by, or participations in pools consisting solely of obligations of or
obligations guaranteed by, the United States of America for the payment of which
guarantee or obligations the full faith and credit of the United States of
America is pledged and which are not callable or redeemable at the option of the
issuer thereof.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness or other obligation of any
other Person and, without limiting the generality of the foregoing, any
obligation, direct or indirect, contingent or otherwise, of such Person (i) to
purchase or pay (or advance or supply funds for the purchase or payment of) such
Indebtedness or other obligation of such other Person (whether arising by virtue
of partnership arrangements, or by agreements to keep-well, to purchase assets,
goods, securities or services, to take-or-pay, or to maintain financial
statement conditions or otherwise) or (ii) entered into for purposes of assuring
in any other manner the obligee of such Indebtedness or other obligation of the
payment thereof or to protect such obligee against loss in respect thereof (in
whole or in part); PROVIDED that the term "Guarantee" shall not include
endorsements for collection or deposit in the ordinary course of business. The
term "Guarantee" used as a verb has a corresponding meaning.
"Incur" means, with respect to any Indebtedness, to incur, create, issue,
assume, Guarantee or otherwise become liable for or with respect to, or become
responsible for, the payment of, contingently or otherwise, such Indebtedness,
including an "Incurrence" of Indebtedness by reason of a Person becoming a
Restricted Subsidiary; PROVIDED that neither the accrual of interest nor the
accretion of original issue discount shall be considered an Incurrence of
Indebtedness.
"Indebtedness" means, with respect to any Person at any date of
determination (without duplication), (i) all indebtedness of such Person for
borrowed money, (ii) all obligations of such Person evidenced by bonds,
debentures, notes or other similar instruments, (iii) all obligations of such
Person in respect of letters of credit or other similar instruments (including
reimbursement obligations with respect thereto, but excluding obligations with
respect to letters of credit (including trade letters of credit) securing
obligations (other than obligations described in (i) or (ii) above or (v), (vi)
or (vii) below) entered into in the ordinary course of business of such Person
to the extent such letters of credit are not drawn upon or, if drawn upon, to
the extent such drawing is reimbursed no later than the third Business Day
following receipt by such Person of a demand for reimbursement), (iv) all
obligations of such Person to pay the deferred and unpaid purchase price of
property or services, which purchase price is due more than six months after the
date of placing such property in service or taking delivery and title thereto or
the completion of such services, except Trade Payables, (v) all obligations of
such Person as lessee under Capitalized Leases, (vi) all Indebtedness of other
Persons secured by a Lien on any asset of such Person, whether or not such
Indebtedness is assumed by such Person; PROVIDED that the amount of such
Indebtedness shall be the lesser of (A) the fair market value of such asset at
such date of determination and (B) the amount of such Indebtedness, (vii) all
Indebtedness of other Persons Guaranteed by such Person to the extent such
Indebtedness is Guaranteed by such Person and (viii) to the extent not otherwise
included in this definition, obligations under Currency Agreements and Interest
Rate Agreements. The amount of Indebtedness of any Person at any date shall be
the outstanding balance at such date of all unconditional obligations as
described above and, with respect to contingent obligations, the maximum
liability upon the occurrence of the contingency giving rise to the obligation,
PROVIDED (A) that the amount outstanding at any time of any Indebtedness issued
with original issue discount is the original issue price of such Indebtedness,
(B) that "Indebtedness" shall not include any money borrowed and set aside, at
the time of
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the incurrence of related Indebtedness, to fund cash interest payments on such
related Indebtedness, and shall also not include reasonable deferred
compensation for directors, officers or employees of the Company or its
Restricted Subsidiaries and (C) that "Indebtedness" shall not include any
liability for federal, state, local or other taxes.
"Interest Rate Agreement" means any interest rate protection agreement,
interest rate future agreement, interest rate option agreement, interest rate
swap agreement, interest rate cap agreement, interest rate collar agreement,
interest rate hedge agreement, option or future contract or other similar
agreement or arrangement.
"Investment" in any Person means any direct or indirect advance, loan or
other extension of credit (including, without limitation, by way of Guarantee or
similar arrangement; but excluding advances to customers in the ordinary course
of business that are, in conformity with GAAP, recorded as accounts receivable
on the balance sheet of the Company or its Restricted Subsidiaries and Trade
Payables for which the Company or its Restricted Subsidiaries receive fair
market value) or capital contribution to (by means of any transfer of cash or
other property), or any payment for property or services for the account or use
of, or any purchase or acquisition of Capital Stock, bonds, notes, debentures or
other similar instruments issued by, such Person and shall include (i) the
designation of a Restricted Subsidiary as an Unrestricted Subsidiary and (ii)
the fair market value of the Capital Stock (or any other Investment), held by
the Company or any of its Restricted Subsidiaries, of (or in) any Person that
has ceased to be a Restricted Subsidiary, including, without limitation, by
reason of any transaction permitted by clause (iii) of the "Limitation on the
Issuance and Sale of Capital Stock of Restricted Subsidiaries" covenant. For
purposes of the definition of "Unrestricted Subsidiary" and the "Limitation on
Restricted Payments" covenant described below, (i) "Investment" shall include
the fair market value of the assets (net of liabilities (other than liabilities
to the Company or any of its Subsidiaries)) of any Restricted Subsidiary at the
time that such Restricted Subsidiary is designated an Unrestricted Subsidiary,
(ii) the fair market value of the assets (net of liabilities (other than
liabilities to the Company or any of its Subsidiaries)) of any Unrestricted
Subsidiary at the time that such Unrestricted Subsidiary is designated a
Restricted Subsidiary shall be considered a reduction in outstanding Investments
and (iii) any property transferred to or from an Unrestricted Subsidiary shall
be valued at its fair market value at the time of such transfer.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including, without limitation, any conditional sale or other
title retention agreement or lease in the nature thereof or any agreement to
give any security interest).
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means, (a) with respect to any Asset Sale, the proceeds
of such Asset Sale in the form of cash or cash equivalents, including payments
in respect of deferred payment obligations (to the extent corresponding to the
principal, but not interest, component thereof) when received in the form of
cash or cash equivalents (except to the extent such obligations are financed or
sold with recourse to the Company or any Restricted Subsidiary) and proceeds
from the conversion of other property received when converted to cash or cash
equivalents, net of (i) brokerage commissions and other fees and expenses
(including fees and expenses of counsel and investment bankers) related to such
Asset Sale, (ii) provisions for all taxes (whether or not such taxes will
actually be paid or are payable) as a result of such Asset Sale without regard
to the consolidated results of operations of the Company and its Restricted
Subsidiaries, taken as a whole, (iii) any relocation expenses and severance or
shut-down costs incurred as a result of such Asset Sale, (iv) payments made to
repay Indebtedness or any other obligation outstanding at the time of such Asset
Sale that either (A) is secured by a Lien on the property or assets sold or (B)
is required to be paid as a result of such sale and (v) reserves against
adjustments in the sale price of the asset or assets subject to such Asset Sale
and reserves against any liabilities associated with such Asset Sale, including,
without limitation, pension and other post-employment benefit liabilities,
liabilities related to environmental matters and liabilities under any
indemnification obligations associated with such Asset
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Sale, all as determined in conformity with GAAP and (b) with respect to any
issuance or sale of Capital Stock, the proceeds of such issuance or sale in the
form of cash or cash equivalents, including payments in respect of deferred
payment obligations (to the extent corresponding to the principal, but not
interest, component thereof) when received in the form of cash or cash
equivalents (except to the extent such obligations are financed or sold with
recourse to the Company or any Restricted Subsidiary of the Company) and
proceeds from the conversion of other property received when converted to cash
or cash equivalents, net of attorney's fees, accountants' fees, underwriters' or
placement agents' fees, discounts or commissions and brokerage, consultant and
other fees incurred in connection with such issuance or sale and net of taxes
paid or payable as a result thereof.
"Offer to Purchase" means an offer to purchase Notes by the Company from the
Holders commenced by mailing a notice to the Trustee and each Holder stating:
(i) the covenant pursuant to which the offer is being made and that all Notes
validly tendered will be accepted for payment on a pro rata basis; (ii) the
purchase price and the date of purchase (which shall be a Business Day no
earlier than 30 days nor later than 60 days from the date such notice is mailed)
(the "Payment Date"); (iii) that any Note not tendered will continue to accrue
interest (or original issue discount) pursuant to its terms; (iv) that, unless
the Company defaults in the payment of the purchase price, any Note accepted for
payment pursuant to the Offer to Purchase shall cease to accrue interest (or
original issue discount) on and after the Payment Date; (v) that Holders
electing to have a Note purchased pursuant to the Offer to Purchase will be
required to surrender the Note, together with the form entitled "Option of the
Holder to Elect Purchase" on the reverse side of the Note completed, to the
Paying Agent at the address specified in the notice prior to the close of
business on the Business Day immediately preceding the Payment Date; (vi) that
Holders will be entitled to withdraw their election if the Paying Agent
receives, not later than the close of business on the third Business Day
immediately preceding the Payment Date, a telegram, facsimile transmission or
letter setting forth the name of such Holder, the principal amount at maturity
of Notes delivered for purchase and a statement that such Holder is withdrawing
his election to have such Notes purchased; and (vii) that Holders whose Notes
are being purchased only in part will be issued new Notes equal in principal
amount at maturity to the unpurchased portion of the Notes surrendered; PROVIDED
that each Note purchased and each new Note issued shall be in a principal amount
at maturity of $1,000 or integral multiples thereof. On the Payment Date, the
Company shall (i) accept for payment on a pro rata basis Notes or portions
thereof tendered pursuant to an Offer to Purchase; (ii) deposit with the Paying
Agent money sufficient to pay the purchase price of all Notes or portions
thereof so accepted; and (iii) deliver, or cause to be delivered, to the Trustee
all Notes or portions thereof so accepted together with an Officers' Certificate
specifying the Notes or portions thereof accepted for payment by the Company.
The Paying Agent shall promptly mail to the Holders of Notes so accepted payment
in an amount equal to the purchase price, and the Trustee shall promptly
authenticate and mail to such Holders a new Note equal in principal amount at
maturity to any unpurchased portion of the Note surrendered; PROVIDED that each
Note purchased and each new Note issued shall be in a principal amount at
maturity of $1,000 or integral multiples thereof. The Company will publicly
announce the results of an Offer to Purchase as soon as practicable after the
Payment Date. The Trustee shall act as the Paying Agent for an Offer to
Purchase. The Company will comply with Rule 14e-1 under the Exchange Act and any
other securities laws and regulations thereunder to the extent such laws and
regulations are applicable, in the event that the Company is required to
repurchase Notes pursuant to an Offer to Purchase.
"Permitted Investment" means (i) an Investment in the Company or a
Restricted Subsidiary or a Person which will, upon the making of such
Investment, become a Restricted Subsidiary or be merged or consolidated with or
into, or transfer or convey all or substantially all its assets to, the Company
or a Restricted Subsidiary; PROVIDED that such Person's primary business is
related, ancillary or complementary to the businesses of the Company and its
Restricted Subsidiaries on the date of such Investment; (ii) Temporary Cash
Investments; (iii) payroll, travel and similar advances to cover matters that
are expected at the time of such advances ultimately to be treated as expenses
in accordance with GAAP and reasonable advances to sales representatives; (iv)
Investments received in satisfaction of judgments,
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bankruptcy, insolvency, workouts or similar arrangements; (v) loans to employees
of the Company or any Restricted Subsidiary (A) evidenced by unsubordinated
promissory notes, to the extent the proceeds thereof are used to purchase
Capital Stock of the Company, that do not in the aggregate exceed at any one
time outstanding $3.0 million and (B) to pay relocation or similar expenses that
do not in the aggregate exceed at any one time outstanding $500,000; (vi)
Investments in debt securities or other evidences of Indebtedness (A) that are
issued by companies engaged in the telecommunications business and (B) for which
no public market exists; PROVIDED that when each Investment pursuant to this
clause (vi) is made, the aggregate amount of Investments outstanding under this
clause (vi) does not exceed the greater of (I) $2.0 million and (II) 1% of
Consolidated EBITDA for the Four Quarter Period; (vii) Investments existing on
the Closing Date; (viii) Strategic Investments not to exceed $10 million at any
one time outstanding; and (ix) Investments in Permitted Joint Ventures not to
exceed $10 million at any one time outstanding.
"Permitted Joint Venture" means any Unrestricted Subsidiary or any other
Person in which the Company or a Restricted Subsidiary owns, directly or
indirectly, an ownership interest (other than a Restricted Subsidiary) and whose
primary business is related, ancillary or complementary to the businesses of the
Company and its Restricted Subsidiaries at the time of determination.
"Permitted Liens" means (i) Liens for taxes, assessments, governmental
charges or claims that are being contested in good faith by appropriate legal
proceedings promptly instituted and diligently conducted and for which a reserve
or other appropriate provision, if any, as shall be required in conformity with
GAAP shall have been made; (ii) statutory and common law Liens of landlords and
carriers, warehousemen, mechanics, suppliers, materialmen, repairmen or other
similar Liens arising in the ordinary course of business and with respect to
amounts not yet delinquent or being contested in good faith by appropriate legal
proceedings promptly instituted and diligently conducted and for which a reserve
or other appropriate provision, if any, as shall be required in conformity with
GAAP shall have been made; (iii) Liens incurred or deposits made in the ordinary
course of business in connection with workers' compensation, unemployment
insurance and other types of social security; (iv) Liens incurred or deposits
made to secure the performance of tenders, bids, leases, statutory or regulatory
obligations, bankers' acceptances, surety and appeal bonds, government
contracts, performance and return-of-money bonds and other obligations of a
similar nature incurred in the ordinary course of business (exclusive of
obligations for the payment of borrowed money); (v) easements, rights-of-way,
municipal and zoning ordinances and similar charges, encumbrances, title defects
or other irregularities that do not materially interfere with the ordinary
course of business of the Company or any of its Restricted Subsidiaries; (vi)
Liens (including extensions and renewals thereof) upon real or personal property
acquired after the Closing Date; PROVIDED that (a) such Lien is created solely
for the purpose of securing Indebtedness Incurred, in accordance with the
"Limitation on Indebtedness" covenant described below, (1) to finance the cost
(including the cost of design, development, improvement, construction,
installation or integration) of the item of property or assets subject thereto
and such Lien is created prior to, at the time of or within six months after the
later of the acquisition, the completion of construction or the commencement of
full operation of such property or (2) to refinance any Indebtedness previously
so secured, (b) the principal amount of the Indebtedness secured by such Lien
does not exceed 100% of such cost and (c) any such Lien shall not extend to or
cover any property or assets other than such item of property or assets and any
improvements on such item; (vii) leases or subleases granted to others that do
not materially interfere with the ordinary course of business of the Company and
its Restricted Subsidiaries, taken as a whole; (viii) Liens encumbering property
or assets under construction arising from progress or partial payments by a
customer of the Company or its Restricted Subsidiaries relating to such property
or assets; (ix) any interest or title of a lessor in the property subject to any
Capitalized Lease or operating lease; (x) Liens arising from filing Uniform
Commercial Code financing statements regarding leases; (xi) Liens on property
of, or on shares of Capital Stock or Indebtedness of, any Person existing at the
time such Person becomes, or becomes a part of, any Restricted Subsidiary;
PROVIDED that such Liens do not extend to or cover any property or assets of the
Company or any Restricted Subsidiary other than the property, assets, Capital
Stock or Indebtedness of the Person so acquired; (xii) Liens in favor of the
Company or any Restricted Subsidiary; (xiii) Liens
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arising from the rendering of a final judgment or order against the Company or
any Restricted Subsidiary of the Company that does not give rise to an Event of
Default; (xiv) Liens securing reimbursement obligations with respect to letters
of credit that encumber documents and other property relating to such letters of
credit and the products and proceeds thereof; (xv) Liens in favor of customs and
revenue authorities arising as a matter of law to secure payment of customs
duties in connection with the importation of goods; (xvi) Liens encumbering
customary initial deposits and margin deposits, and other Liens that are within
the general parameters customary in the industry and incurred in the ordinary
course of business, in each case, securing Indebtedness under Interest Rate
Agreements and Currency Agreements and forward contracts, options, future
contracts, futures options or similar agreements or arrangements designed solely
to protect the Company or any of its Restricted Subsidiaries from fluctuations
in interest rates, currencies or the price of commodities; (xvii) Liens arising
out of conditional sale, title retention, consignment or similar arrangements
for the sale of goods entered into by the Company or any of its Restricted
Subsidiaries in the ordinary course of business in accordance with the past
practices of the Company and its Restricted Subsidiaries prior to the Closing
Date; (xviii) Liens on or sales of receivables and (xix) Liens existing on the
Closing Date.
"Pledge Account" means the account established with the Trustee pursuant to
the terms of the Pledge Agreement for the deposit of the Pledged Securities
purchased by the Company with a portion of the proceeds from the sale of the
Original Notes.
"Pledge Agreement" means the Collateral Pledge and Security Agreement, dated
as of July 1, 1997, made by the Company in favor of the Trustee, governing the
disbursement of funds from the Pledge Account, as such Agreement may be amended,
restated, supplemented or otherwise modified from time to time.
"Pledged Securities" means the securities originally purchased by the
Company with a portion of the proceeds from the sale of the Notes, which consist
of Government Securities, deposited in the Pledge Account, all in accordance
with the terms of the Pledge Agreement.
"Preferred Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) of such Person's preferred or preference equity, whether
now outstanding or issued after the Closing Date, including, without limitation,
all series and classes of such preferred stock or preference stock.
"Public Equity Offering" means an underwritten primary public offering of
Common Stock of the Company pursuant to an effective registration statement
under the Securities Act.
A "Public Market" shall be deemed to exist if (i) a Public Equity Offering
has been consummated and (ii) at least 15% of the total issued and outstanding
Common Stock of the Company has been distributed by means of an effective
registration statement under the Securities Act or sales pursuant to Rule 144
under the Securities Act.
"Released Indebtedness" means, with respect to any Asset Sale, Indebtedness
(i) which is owed by the Company or any Restricted Subsidiary (the "Obligors")
prior to such Asset Sale, (ii) which is assumed by the purchaser or any
affiliate thereof in connection with such Asset Sale and (iii) with respect to
which the Obligors receive written, unconditional, valid and enforceable
releases from each creditor, no later than the closing date of such Asset Sale.
"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
"S&P" means Standard & Poor's Ratings Services, a division of McGraw Hill,
Inc., and its successors.
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"Significant Subsidiary" means, at any date of determination, any Restricted
Subsidiary that, together with its Subsidiaries, (i) for the most recent fiscal
year of the Company, accounted for more than 10% of the consolidated revenues of
the Company and its Restricted Subsidiaries or (ii) as of the end of such fiscal
year, was the owner of more than 10% of the consolidated assets of the Company
and its Restricted Subsidiaries, all as set forth on the most recently available
consolidated financial statements of the Company for such fiscal year.
"Stated Maturity" means, (i) with respect to any debt security, the date
specified in such debt security as the fixed date on which the final installment
of principal of such debt security is due and payable and (ii) with respect to
any scheduled installment of principal of or interest on any debt security, the
date specified in such debt security as the fixed date on which such installment
is due and payable.
"Strategic Investments" means (A) Investments that the Board of Directors
has determined in good faith will enable the Company or any of its Restricted
Subsidiaries to obtain additional business that it might not be able to obtain
without making such Investment and (B) Investments in entities the principal
function of which is to perform research and development with respect to
products and services that may be used or useful in the telecommunications
business; PROVIDED that the Company or one of its Restricted Subsidiaries are
entitled or otherwise reasonably expected to obtain rights to such products or
services as a result of such Investment.
"Subsidiary" means, with respect to any Person, any corporation, association
or other business entity of which more than 50% of the voting power of the
outstanding Voting Stock is owned, directly or indirectly, by such Person and
one or more other Subsidiaries of such Person.
"Temporary Cash Investment" means any of the following: (i) direct
obligations of the United States of America or any agency thereof or obligations
fully and unconditionally guaranteed by the United States of America or any
agency thereof, (ii) bankers' acceptances, time deposit accounts, certificates
of deposit and money market deposits maturing within 270 days of the date of
acquisition thereof issued by a bank or trust company which is organized under
the laws of the United States of America, any state thereof or any foreign
country recognized by the United States, and which bank or trust company has
capital, surplus and undivided profits aggregating in excess of $50 million (or
the foreign currency equivalent thereof) and has outstanding debt which is rated
"A" (or such similar equivalent rating) or higher by at least one nationally
recognized statistical rating organization (as defined in Rule 436 under the
Securities Act) or any money-market fund sponsored by a registered broker dealer
or mutual fund distributor, (iii) repurchase obligations with a term of not more
than 30 days for underlying securities of the types described in clause (i)
above entered into with a bank meeting the qualifications described in clause
(ii) above, (iv) commercial paper, maturing not more than 270 days after the
date of acquisition, issued by a corporation (other than an Affiliate of the
Company) organized and in existence under the laws of the United States of
America, any state thereof or any foreign country recognized by the United
States of America with a rating at the time as of which any investment therein
is made of "P-1" (or higher) according to Moody's or "A-1" (or higher) according
to S&P, (v) securities with maturities of nine months or less from the date of
acquisition issued or fully and unconditionally guaranteed by any state,
commonwealth or territory of the United States of America, or by any political
subdivision or taxing authority thereof, and rated at least "A" by S&P or
Moody's, (vi) direct obligations of the British, Belgian, Dutch, French, German
or Swiss governments or obligations fully and unconditionally guaranteed by any
of such governments and (vii) certificates of deposit, bank promissory notes and
bankers' acceptances denominated in the currency of any country of the European
Union maturing not more than 365 days after the acquisition thereof and issued
or guaranteed by any one of the 20 largest banks (based on assets as of the
immediately preceding December 31) organized under the laws of any country in
the European Union; PROVIDED such bank is not under intervention, receivership
or any similar arrangement at the time of acquisition of such certificates of
deposit, bank promissory notes or bankers' acceptances; PROVIDED that the
aggregate principal amount of all obligations and Indebtedness included in
clauses (vi) and (vii) above shall not exceed at any one time outstanding $10
million.
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"Trade Payables" means, with respect to any Person, any accounts payable or
any other indebtedness or monetary obligation to trade creditors created,
assumed or Guaranteed by such Person or any of its Subsidiaries arising in the
ordinary course of business in connection with the acquisition of goods or
services.
"Transaction Date" means, with respect to the Incurrence of any Indebtedness
by the Company or any of its Restricted Subsidiaries, the date such Indebtedness
is to be Incurred and, with respect to any Restricted Payment, the date such
Restricted Payment is to be made.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Restricted
Subsidiary (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless such Subsidiary owns any
Capital Stock of, or owns or holds any Lien on any property of, the Company or
any Restricted Subsidiary; PROVIDED that (A) any Guarantee by the Company or any
Restricted Subsidiary of any Indebtedness of the Subsidiary being so designated
shall be deemed an "Incurrence" of such Indebtedness and an "Investment" by the
Company or such Restricted Subsidiary (or both, if applicable) at the time of
such designation; (B) either (I) the Subsidiary to be so designated has total
assets of $1,000 or less or (II) if such Subsidiary has assets greater than
$1,000, such designation would be permitted under the "Limitation on Restricted
Payments" covenant described below and (C) if applicable, the Incurrence of
Indebtedness and the Investment referred to in clause (A) of this proviso would
be permitted under the "Limitation on Indebtedness" and "Limitation on
Restricted Payments" covenants described below. The Board of Directors may
designate any Unrestricted Subsidiary to be a Restricted Subsidiary; PROVIDED
that immediately after giving effect to such designation (x) all Liens and
Indebtedness of such Unrestricted Subsidiary outstanding immediately after such
designation would, if Incurred at such time, have been permitted to be incurred
for all purposes of the Indenture and (y) no Default or Event of Default shall
have occurred and be continuing. Any such designation by the Board of Directors
shall be evidenced to the Trustee by promptly filing with the Trustee a copy of
the Board Resolution giving effect to such designation and an Officers'
Certificate certifying that such designation complied with the foregoing
provisions.
"Voting Stock" means with respect to any Person, Capital Stock of any class
or kind ordinarily having the power to vote for the election of directors,
managers or other voting members of the governing body of such Person.
"Wholly Owned" means, with respect to any Subsidiary of any Person, the
ownership of all of the outstanding Capital Stock of such Subsidiary (other than
any director's qualifying shares or Investments by foreign nationals mandated by
applicable law) by such Person or one or more Wholly Owned Subsidiaries of such
Person.
COVENANTS
The Indenture contains, among others, the following covenants.
LIMITATION ON INDEBTEDNESS
(a) The Company will not, and will not permit any of its Restricted
Subsidiaries to, Incur any Indebtedness (other than the Notes and Indebtedness
existing on the Closing Date); PROVIDED that the Company and any Restricted
Subsidiary may Incur Indebtedness (including Acquired Indebtedness) if, after
giving effect to the Incurrence of such Indebtedness and the receipt and
application of the proceeds therefrom, the Consolidated Leverage Ratio would be
greater than zero and (i) less than 5 to 1, for Indebtedness Incurred by the
Company, or (ii) less than 2 to 1, for Indebtedness Incurred by any Restricted
Subsidiary.
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Notwithstanding the foregoing, the Company and any Restricted Subsidiary
(except as specified below) may Incur each and all of the following: (i)
Indebtedness outstanding at any time in an aggregate principal amount not to
exceed $100 million, less any amount of Indebtedness permanently repaid as
provided under the "Limitation on Asset Sales" covenant described below; (ii)
Indebtedness (A) to the Company evidenced by an unsubordinated promissory note
or (B) to any of its Restricted Subsidiaries; provided that any event which
results in any such Restricted Subsidiary ceasing to be a Restricted Subsidiary
or any subsequent transfer of such Indebtedness (other than to the Company or
another Restricted Subsidiary) shall be deemed, in each case, to constitute an
Incurrence of such Indebtedness not permitted by this clause (ii); (iii)
Indebtedness issued in exchange for, or the net proceeds of which are used to
renew, extend, defease, refinance or refund, then outstanding Indebtedness,
other than Indebtedness Incurred under clause (i), (ii), (iv), (vi), (viii) or
(ix) of this paragraph, and any refinancings thereof in an amount not to exceed
the amount so renewed, extended, defeased, refinanced or refunded (plus
premiums, accrued interest, fees and expenses); PROVIDED that Indebtedness the
proceeds of which are used to renew, extend, defease, refinance or refund the
Notes in part or Indebtedness that is PARI PASSU with, or subordinated in right
of payment to, the Notes shall only be permitted under this clause (iii) if (A)
in case the Notes are refinanced in part or the Indebtedness to be refinanced is
PARI PASSU with the Notes, such new Indebtedness, by its terms or by the terms
of any agreement or instrument pursuant to which such new Indebtedness is
outstanding, is expressly made PARI PASSU with, or subordinate in right of
payment to, the remaining Notes, (B) in case the Indebtedness to be refinanced
is subordinated in right of payment to the Notes, such new Indebtedness, by its
terms or by the terms of any agreement or instrument pursuant to which such new
Indebtedness is issued or remains outstanding, is expressly made subordinate in
right of payment to the Notes at least to the extent that the Indebtedness to be
refinanced is subordinated to the Notes; and (C) such new Indebtedness,
determined as of the date of Incurrence of such new Indebtedness, does not
mature prior to the Stated Maturity of the Indebtedness to be renewed, extended,
defeased, refinanced or refunded, and the Average Life of such new Indebtedness
is at least equal to the remaining Average Life of the Indebtedness to be
renewed, extended, defeased, refinanced or refunded; and PROVIDED FURTHER that
in no event may Indebtedness of the Company be refinanced by means of any
Indebtedness of any Restricted Subsidiary pursuant to this clause (iii); (iv)
Indebtedness (A) in respect of performance, surety or appeal bonds provided in
the ordinary course of business, (B) under Currency Agreements and Interest Rate
Agreements; PROVIDED that such agreements (a) are designed solely to protect the
Company or its Subsidiaries against fluctuations in foreign currency exchange
rates or interest rates and (b) do not increase the Indebtedness of the obligor
outstanding at any time other than as a result of fluctuations in foreign
currency exchange rates or interest rates or by reason of fees, indemnities and
compensation payable thereunder and (C) arising from agreements providing for
indemnification, adjustment of purchase price or similar obligations, or from
Guarantees or letters of credit, surety bonds or performance bonds securing any
obligations of the Company or any of its Restricted Subsidiaries pursuant to
such agreements, in any case Incurred in connection with the disposition of any
business, assets or Restricted Subsidiary of the Company (other than Guarantees
of Indebtedness Incurred by any Person acquiring all or any portion of such
business, assets or Restricted Subsidiary of the Company for the purpose of
financing such acquisition), in a principal amount not to exceed the gross
proceeds actually received by the Company or any Restricted Subsidiary in
connection with such disposition; (v) Indebtedness of the Company, to the extent
the net proceeds thereof are promptly (A) used to purchase Notes tendered in an
Offer to Purchase made as a result of a Change in Control or (B) deposited to
defease the Notes as described below under "Defeasance"; (vi) Guarantees of the
Notes and Guarantees of Indebtedness of the Company by any Restricted Subsidiary
provided the Guarantee of such Indebtedness is permitted by and made in
accordance with the "Limitation on Issuance of Guarantees by Restricted
Subsidiaries" covenant described below; (vii) Indebtedness Incurred to finance
the cost (including the cost of design, development, construction, installation
or integration) of equipment, inventory or other tangible assets used or useful
in the telecommunications business of the Company and its Restricted
Subsidiaries acquired by the Company or a Restricted Subsidiary after the
Closing Date; (viii) Indebtedness of the Company not to exceed, at any one time
outstanding, two times the Net Cash
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Proceeds received by the Company after the Closing Date from the issuance and
sale of its Capital Stock (other than Disqualified Stock) to a Person that is
not a Subsidiary of the Company to the extent such Net Cash Proceeds have not
been used pursuant to clause (C)(2) of the first paragraph of, or clause (iii)
or (iv) of the second paragraph of, the "Limitation on Restricted Payments"
covenant described below to make a Restricted Payment; PROVIDED that such
Indebtedness does not mature prior to the Stated Maturity of the Notes and has
an Average Life longer than the Notes; and (ix) Indebtedness of the Company and
any Restricted Subsidiary; PROVIDED that at the time of the Incurrence of any
Indebtedness under this clause (ix) the amount of Indebtedness under this clause
(ix) does not exceed in aggregate 70% of the accounts receivable (net of
accounts more than 60 days past due and reserves and allowances for doubtful
accounts, determined in accordance with GAAP) of the Company and its Restricted
Subsidiaries on a consolidated basis as set forth on the balance sheet of the
Company most recently filed with the Commission pursuant to the "Commission
Reports and Reports to Holders" covenant.
(b) Notwithstanding any other provision of this "Limitation on Indebtedness"
covenant, the maximum amount of Indebtedness that the Company or a Restricted
Subsidiary may incur pursuant to this "Limitation on Indebtedness" covenant
shall not be deemed to be exceeded, with respect to any outstanding
Indebtedness, due solely to the result of fluctuations in the exchange rates of
currencies.
(c) For purposes of determining any particular amount of Indebtedness under
this "Limitation on Indebtedness" covenant, (1) Guarantees, Liens, letters of
credit or other obligations supporting Indebtedness otherwise included in the
determination of such particular amount shall not be included and (2) any Liens
granted pursuant to the equal and ratable provisions referred to in the
"Limitation on Liens" covenant described below shall not be treated as
Indebtedness. For purposes of determining compliance with this "Limitation on
Indebtedness" covenant, in the event that an item of Indebtedness meets the
criteria of more than one of the types of Indebtedness described in the above
clauses, the Company, in its sole discretion, shall classify such item of
Indebtedness and only be required to include the amount and type of such
Indebtedness in one of such clauses.
LIMITATION ON RESTRICTED PAYMENTS
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, (i) declare or pay any dividend or make any distribution
on or with respect to its Capital Stock (other than (x) dividends or
distributions payable solely in shares of its Capital Stock (other than
Disqualified Stock) or in options, warrants or other rights to acquire shares of
such Capital Stock and (y) pro rata dividends or distributions on Common Stock
of Restricted Subsidiaries held by minority stockholders, provided that such
dividends do not in the aggregate exceed the minority stockholders' pro rata
share of such Restricted Subsidiaries' net income from the first day of the
fiscal quarter beginning immediately following the Closing Date) held by Persons
other than the Company or any of its Restricted Subsidiaries, (ii) purchase,
redeem, retire or otherwise acquire for value any shares of Capital Stock of (x)
the Company or an Unrestricted Subsidiary (including options, warrants or other
rights to acquire such shares of Capital Stock) held by any Person other than
the Company or any Wholly Owned Restricted Subsidiary or (y) a Restricted
Subsidiary (including options, warrants or other rights to acquire such shares
of Capital Stock) held by any Affiliate of the Company (other than a Wholly
Owned Restricted Subsidiary) or any holder (or any Affiliate of such holder) of
5% or more of the Capital Stock of the Company, (iii) make any voluntary or
optional principal payment, or voluntary or optional redemption, repurchase,
defeasance, or other acquisition or retirement for value, of Indebtedness of the
Company (other than Indebtedness outstanding on the Closing Date) that is
subordinated in right of payment to the Notes (other than the purchase,
repurchase or the acquisition of Indebtedness in anticipation of satisfying a
sinking fund obligation, principal installment or final maturity, in any case
due within one year of the date of acquisition) or (iv) make any Investment,
other than a Permitted Investment, in any Person (such payments or any other
actions described in clauses (i) through (iv) being collectively "Restricted
Payments") if, at the time of, and after giving effect to, the proposed
Restricted Payment: (A) a Default or Event of Default shall have
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occurred and be continuing, (B) except with respect to Investments, the Company
could not Incur at least $1.00 of Indebtedness under the first paragraph of the
"Limitation on Indebtedness" covenant or (C) the aggregate amount of all
Restricted Payments (the amount, if other than in cash, to be determined in good
faith by the Board of Directors, whose determination shall be conclusive and
evidenced by a Board Resolution) made after the Closing Date shall exceed the
sum of (1) 50% of the aggregate amount of the Adjusted Consolidated Net Income
(or, if the Adjusted Consolidated Net Income is a loss, minus 100% of the amount
of such loss (determined by excluding amounts referred to in clause (3) below))
accrued on a cumulative basis during the period (taken as one accounting period)
beginning on the first day of the fiscal quarter immediately following the
Closing Date and ending on the last day of the last fiscal quarter preceding the
Transaction Date for which reports have been filed pursuant to the "Commission
Reports and Reports to Holders" covenant PLUS (2) (A) the aggregate Net Cash
Proceeds received by the Company after the Closing Date from the issuance and
sale permitted by the Indenture of its Capital Stock (other than Disqualified
Stock) to a Person who is not a Subsidiary of the Company, or from the issuance
to a Person who is not a Subsidiary of the Company of any options, warrants or
other rights to acquire Capital Stock of the Company (in each case, exclusive of
any convertible Indebtedness, Disqualified Stock or any options, warrants or
other rights that are redeemable at the option of the holder, or are required to
be redeemed, prior to the Stated Maturity of the Notes), (B) the aggregate Net
Cash Proceeds received after the Closing Date by the Company from the issuance
or sale (other than to a Subsidiary of the Company) of debt securities or shares
of Disqualified Stock that have been converted into or exchanged for Common
Stock of the Company, together with the aggregate cash received by the Company
at the time of such conversion or exchange, in each case except to the extent
such Net Cash Proceeds are used to Incur Indebtedness pursuant to clause (viii)
of the second paragraph of the "Limitation on Indebtedness" covenant, and (C)
the amount by which Indebtedness of the Company and its Restricted Subsidiaries
is reduced upon the conversion or exchange subsequent to the Closing Date of any
Indebtedness which is convertible into or exchangeable for Capital Stock (other
than Disqualified Stock) of the Company PLUS (3) an amount equal to the net
reduction in Investments (other than reductions in Permitted Investments) in any
Person resulting from payments of interest on Indebtedness, dividends,
repayments of loans or advances, or other transfers of assets, in each case to
the Company or any Restricted Subsidiary or from the Net Cash Proceeds from the
sale of any such Investment (except, in each case, to the extent any such
payment or proceeds are included in the calculation of Adjusted Consolidated Net
Income), or from redesignations of Unrestricted Subsidiaries as Restricted
Subsidiaries (valued in each case as provided in the definition of
"Investments"), not to exceed, in each case, the amount of Investments
previously made by the Company or any Restricted Subsidiary in such Person or
Unrestricted Subsidiary.
The foregoing provision shall not be violated by reason of: (i) the payment
of any dividend within 60 days after the date of declaration thereof if, at said
date of declaration, such payment would comply with the foregoing paragraph;
(ii) the redemption, repurchase, defeasance or other acquisition or retirement
for value of Indebtedness that is subordinated in right of payment to the Notes
including premium, if any, and accrued and unpaid interest, with the proceeds
of, or in exchange for, Indebtedness Incurred under clause (iii) of the second
paragraph of part (a) of the "Limitation on Indebtedness" covenant; (iii) the
repurchase, redemption or other acquisition of Capital Stock of the Company (or
options, warrants or other rights to acquire such Capital Stock) in exchange
for, or out of the proceeds of a substantially concurrent offering of, shares of
Capital Stock of the Company (other than Disqualified Stock); (iv) the making of
any principal payment or the repurchase, redemption, retirement, defeasance or
other acquisition for value of Indebtedness of the Company which is subordinated
in right of payment to the Notes in exchange for, or out of the proceeds of, a
substantially concurrent offering of, shares of the Capital Stock of the Company
(other than Disqualified Stock); (v) payments or distributions, to dissenting
stockholders pursuant to applicable law, pursuant to or in connection with a
consolidation, merger or transfer of assets that complies with the provisions of
the Indenture applicable to mergers, consolidations and transfers of all or
substantially all of the property and assets of the Company; (vi) the purchase,
redemption, acquisition, cancellation or other retirement for value of shares of
Capital Stock of the
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Company to the extent necessary, in the good faith judgment of the Board of
Directors of the Company, to prevent the loss or secure the renewal or
reinstatement of any license or franchise held by the Company or any Restricted
Subsidiary for any governmental agency; (vii) the declaration or payment of
dividends on the Common Stock of the Company following a Public Equity Offering
of such Common Stock, of up to 6% per annum of the Net Cash Proceeds received by
the Company in all Public Equity Offerings; (viii) the purchase, redemption,
retirement or other acquisition for value of Capital Stock of the Company, or
options to purchase such shares, held by directors, employees or former
directors or employees of the Company or any Restricted Subsidiary (or their
estates or beneficiaries under their estates) upon death, disability,
retirement, termination of employment or pursuant to the terms of any agreement
under which such shares of Capital Stock or options were issued; PROVIDED that
the aggregate consideration paid for such purchase, redemption, acquisition,
cancellation or other retirement of such shares of Capital Stock or options
after the Closing Date does not exceed $500,000 in any calendar year, or $2.0
million in the aggregate after the Closing Date; (ix) any Investment, to the
extent the consideration therefor paid by the Company and its Restricted
Subsidiaries consists solely of (A) Capital Stock (other than Disqualified
Stock) of the Company or (B) the Net Cash Proceeds from the sale of such Capital
Stock during the six months preceding such Investment, in each case except to
the extent such Capital Stock or Net Cash Proceeds have been used under clause
(iii) or (iv) above; or (x) repurchases of Warrants pursuant to a repurchase
offer by the Company; PROVIDED that, except in the case of clauses (i) and
(iii), no Default or Event of Default shall have occurred and be continuing or
occur as a consequence of the actions or payments set forth therein.
Each Restricted Payment permitted pursuant to the preceding paragraph (other
than the Restricted Payment referred to in clause (ii) thereof, an exchange of
Capital Stock for Capital Stock or Indebtedness referred to in clause (iii) or
(iv) thereof, the Net Cash Proceeds from any issuance of Capital Stock referred
to in clauses (iii) and (iv) thereof and the Restricted Payment referred to in
clause (ix)(A) thereof) shall be included in calculating whether the conditions
of clause (C) of the first paragraph of this "Limitation on Restricted Payments"
covenant have been met with respect to any subsequent Restricted Payments. In
the event the proceeds of an issuance of Capital Stock of the Company are used
for the redemption, repurchase or other acquisition of the Notes, or
Indebtedness that is PARI PASSU with the Notes, then the Net Cash Proceeds of
such issuance shall be included in clause (C) of the first paragraph of this
"Limitation on Restricted Payments" covenant only to the extent such proceeds
are not used for such redemption, repurchase or other acquisition of
Indebtedness.
Any Restricted Payments made other than in cash shall be valued at fair
market value. The amount of any Investment "outstanding" at any time shall be
deemed to be equal to the amount of such Investment on the date made, less the
return of capital to the Company and its Restricted Subsidiaries with respect to
such Investment (up to the amount of such Investment on the date made).
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES
The Company will not, and will not permit any Restricted Subsidiary to,
create or otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction of any kind on the ability of any Restricted
Subsidiary to (i) pay dividends or make any other distributions permitted by
applicable law on any Capital Stock of such Restricted Subsidiary owned by the
Company or any other Restricted Subsidiary, (ii) pay any Indebtedness owed to
the Company or any other Restricted Subsidiary, (iii) make loans or advances to
the Company or any other Restricted Subsidiary or (iv) transfer any of its
property or assets to the Company or any other Restricted Subsidiary.
The foregoing provisions shall not restrict any encumbrances or
restrictions: (i) existing on the Closing Date in the Indenture or any other
agreements in effect on the Closing Date, and any extensions, refinancings,
renewals or replacements of such agreements; PROVIDED that the encumbrances and
restrictions in any such extensions, refinancings, renewals or replacements are
no less favorable in any material respect to the Holders than those encumbrances
or restrictions that are then in effect and that are
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being extended, refinanced, renewed or replaced; (ii) existing under or by
reason of applicable law; (iii) existing with respect to any Person or the
property or assets of such Person acquired by the Company or any Restricted
Subsidiary, existing at the time of such acquisition and not incurred in
contemplation thereof, which encumbrances or restrictions are not applicable to
any Person or the property or assets of any Person other than such Person or the
property or assets of such Person so acquired, and any extensions, refinancings,
renewals or replacements of the agreement containing such encumbrance or
restriction; PROVIDED that the encumbrances and restrictions in any such
extensions, refinancings, renewals or replacements are no less favorable in any
material respect to the Holders than those encumbrances or restrictions that are
then in effect and that are being extended, refinanced, renewed or replaced;
(iv) in the case of clause (iv) of the first paragraph of this "Limitation on
Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries"
covenant, (A) that restrict in a customary manner the subletting, assignment or
transfer of any property or asset that is a lease, license, conveyance or
contract or similar property or asset, (B) existing by virtue of any transfer
of, agreement to transfer, option or right with respect to, or Lien on, any
property or assets of the Company, or any Restricted Subsidiary not otherwise
prohibited by the Indenture or (C) arising or agreed to in the ordinary course
of business, not relating to any Indebtedness, and that do not, individually or
in the aggregate, detract from the value of property or assets of the Company or
any Restricted Subsidiary in any manner material to the Company or any
Restricted Subsidiary; (v) with respect to a Restricted Subsidiary and imposed
pursuant to an agreement that has been entered into for the sale or disposition
of all or substantially all of the Capital Stock of, or property and assets of,
such Restricted Subsidiary; (vi) contained in the terms of Indebtedness having
an aggregate principal amount not in excess of the greater of (1) $10 million or
(2) 10% of Consolidated EBITDA for the Four Quarter Period or any agreement
pursuant to which such Indebtedness is outstanding (in each case Incurred by a
Restricted Subsidiary in compliance with the "Limitation on Indebtedness"
covenant) if (A) the encumbrance or restriction applies only in the event of a
payment default or a default with respect to a financial covenant contained in
such Indebtedness or agreement, (B) the encumbrance or restriction is not
materially more disadvantageous to the Holders than is customary in comparable
financings (as determined by the Company), (C) the Company determines that any
such encumbrance or restriction will not materially affect its ability to make
principal or interest payments on the Notes, (D) if the aggregate principal
amount of such Indebtedness exceeds the greater of (1) $5 million and (2) 5% of
Consolidated EBITDA for the Four Quarter Period, the documents pursuant to which
all such indebtedness in excess of such amount is outstanding expressly state
that such Restricted Subsidiary shall be entitled to take the actions referred
to in clauses (i) through (iv) of the first paragraph of this covenant in an
amount not to exceed 50% of the consolidated net income of such Restricted
Subsidiary (after making adjustments thereto in the nature of the adjustments
referred to in the definition of "Adjusted Consolidated Net Income") and (E) the
Investments made by the Company and its Restricted Subsidiaries in such
Restricted Subsidiary are reasonably related to the business of such Restricted
Subsidiary; and (vii) provisions contained in agreements or instruments which
prohibit the payment of dividends or the making of other distributions with
respect to any particular class of Capital Stock of a Person other than on a PRO
RATA basis. Nothing contained in this "Limitation on Dividend and Other Payment
Restrictions Affecting Restricted Subsidiaries" covenant shall prevent the
Company or any Restricted Subsidiary from (1) creating, incurring, assuming or
suffering to exist any Liens otherwise permitted in the "Limitation on Liens"
covenant or (2) restricting the sale or other disposition of property or assets
of the Company or any of its Restricted Subsidiaries that secure Indebtedness of
the Company or any of its Restricted Subsidiaries.
LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES
The Company will not sell, and will not permit any Restricted Subsidiary,
directly or indirectly, to issue or sell, any shares of Capital Stock of a
Restricted Subsidiary (including options, warrants or other rights to purchase
shares of such Capital Stock) except (i) to the Company or a Wholly Owned
Restricted Subsidiary; (ii) issuances of director's qualifying shares or sales
to foreign nationals of shares of Capital
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Stock of foreign Restricted Subsidiaries, to the extent required by applicable
law; (iii) if, immediately after giving effect to such issuance or sale, such
Restricted Subsidiary would no longer constitute a Restricted Subsidiary,
provided any Investment in such Person remaining after giving effect to such
issuance or sale would have been permitted to be made under the "Limitation on
Restricted Payments" covenant, if made on the date of such issuance or sale;
(iv) issuances or sales of Common Stock, the net cash proceeds of which, if any,
are promptly applied pursuant to clause (A) or (B) of the "Limitation on Asset
Sales" covenant and (v) issuances and sales of up to 6% of the Common Stock of
each Restricted Subsidiary in connection with employee benefit plans or
arrangements.
LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES
The Company will not permit any Restricted Subsidiary, directly or
indirectly, to Guarantee any Indebtedness of the Company which is PARI PASSU
with or subordinate in right of payment to the Notes ("Guaranteed
Indebtedness"), unless (i) such Restricted Subsidiary simultaneously executes
and delivers a supplemental indenture to the Indenture providing for a Guarantee
(a "Subsidiary Guarantee") of payment of the Notes by such Restricted Subsidiary
and (ii) such Restricted Subsidiary waives and will not in any manner whatsoever
claim or take the benefit or advantage of, any rights of reimbursement,
indemnity or subrogation or any other rights against the Company or any other
Restricted Subsidiary as a result of any payment by such Restricted Subsidiary
under its Subsidiary Guarantee; PROVIDED that this paragraph shall not be
applicable to any Guarantee of any Restricted Subsidiary that existed at the
time such Person became a Restricted Subsidiary and was not Incurred in
connection with, or in contemplation of, such Person becoming a Restricted
Subsidiary. If the Guaranteed Indebtedness is (A) PARI PASSU with the Notes,
then the Guarantee of such Guaranteed Indebtedness shall be PARI PASSU with, or
subordinated to, the Subsidiary Guarantee or (B) subordinated to the Notes, then
the Guarantee of such Guaranteed Indebtedness shall be subordinated to the
Subsidiary Guarantee at least to the extent that the Guaranteed Indebtedness is
subordinated to the Notes.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary may provide by its terms that it shall be automatically and
unconditionally released and discharged upon (i) any sale, exchange or transfer,
to any Person not an Affiliate of the Company, of all of the Company's and each
Restricted Subsidiary's Capital Stock in, or all or substantially all the assets
of, such Restricted Subsidiary (which sale, exchange or transfer is not
prohibited by the Indenture) or (ii) the release or discharge of the Guarantee
which resulted in the creation of such Subsidiary Guarantee, except a discharge
or release by or as a result of payment under such Guarantee.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or assets,
or the rendering of any service) with any holder (or any Affiliate of such
holder) of 5% or more of any class of Capital Stock of the Company or with any
Affiliate of the Company or any Restricted Subsidiary, except upon fair and
reasonable terms no less favorable to the Company or such Restricted Subsidiary
than could be obtained, at the time of such transaction or, if such transaction
is pursuant to a written agreement, at the time of the execution of the
agreement providing therefor, in a comparable arm's-length transaction with a
Person that is not such a holder or an Affiliate.
The foregoing limitation does not limit, and shall not apply to (i)
transactions (A) approved by a majority of the disinterested members of the
Board of Directors or (B) for which the Company or a Restricted Subsidiary
delivers to the Trustee a written opinion of a nationally recognized investment
banking firm stating that the transaction is fair to the Company or such
Restricted Subsidiary from a financial point of view, (ii) any transaction
solely between the Company and any of its Wholly Owned Restricted Subsidiaries
or solely between Wholly Owned Restricted Subsidiaries, (iii) the payment of
reasonable and customary regular fees to directors of the Company who are not
employees of the
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Company, (iv) any payments or other transactions pursuant to any tax-sharing
agreement between the Company and any other Person with which the Company files
a consolidated tax return or with which the Company is part of a consolidated
group for tax purposes, (v) any Restricted Payments not prohibited by the
"Limitation on Restricted Payments" covenant, (vi) employment agreements with,
and loans and advances to, officers and employees of the Company and its
Restricted Subsidiaries, in each case in the ordinary course of business, (vii)
customary indemnification arrangements in favor of directors and officers of the
Company and its Restricted Subsidiaries or (viii) transactions in accordance
with the provisions of the Series A Preferred Stock of the Company as set forth
in the Certificate of Incorporation of the Company on the Closing Date.
Notwithstanding the foregoing, any transaction covered by the first paragraph of
this "Limitation on Transactions with Shareholders and Affiliates" covenant and
not covered by clauses (ii) through (vi) of this paragraph, the aggregate amount
of which exceeds $3 million in value, must be approved or determined to be fair
in the manner provided for in clause (i)(A) or (B) above.
LIMITATION ON LIENS
The Company will not, and will not permit any Restricted Subsidiary to,
create, incur, assume or suffer to exist any Lien on any of its assets or
properties of any character, or any shares of Capital Stock or Indebtedness of
any Restricted Subsidiary, without making effective provision for all of the
Notes and all other amounts due under the Indenture to be directly secured
equally and ratably with (or, if the obligation or liability to be secured by
such Lien is subordinated in right of payment to the Notes, prior to) the
obligation or liability secured by such Lien unless, after giving effect
thereto, the aggregate amount of any Indebtedness so secured, plus the
Attributable Indebtedness for all sale-leaseback transactions permitted under
the "Limitation on Sale-Leaseback Transactions" covenant, does not exceed 10% of
Consolidated Net Tangible Assets.
The foregoing limitation does not apply to (i) Liens existing on the Closing
Date; (ii) Liens granted after the Closing Date on any assets or Capital Stock
of the Company or its Restricted Subsidiaries created in favor of the Holders;
(iii) Liens with respect to the assets of a Restricted Subsidiary granted by
such Restricted Subsidiary to the Company or a Wholly Owned Restricted
Subsidiary to secure Indebtedness owing to the Company or such other Restricted
Subsidiary; (iv) Liens securing Indebtedness which is Incurred to refinance
secured Indebtedness which is permitted to be Incurred under clause (iii) of the
second paragraph of the "Limitation on Indebtedness" covenant; PROVIDED that
such Liens do not extend to or cover any property or assets of the Company or
any Restricted Subsidiary other than the property or assets securing the
Indebtedness being refinanced; (v) Liens on assets acquired by the Company or
its Restricted Subsidiaries after the Closing Date, that are not incurred in
contemplation of or in connection with such acquisition; or (vi) Permitted
Liens.
In the event that the Lien the existence of which gives rise to a Lien
securing the Notes pursuant to the provisions of this covenant ceases to exist,
the Lien securing the Notes required by the first paragraph of this covenant
shall automatically be released and the Trustee shall execute appropriate
documentation.
LIMITATION ON SALE-LEASEBACK TRANSACTIONS
The Company will not, and will not permit any Restricted Subsidiary to enter
into any sale-leaseback transaction involving any of its assets or properties
whether now owned or hereafter acquired, whereby the Company or a Restricted
Subsidiary sells or transfers such assets or properties and then or thereafter
leases such assets or properties or any part thereof or any other assets or
properties which the Company or such Restricted Subsidiary, as the case may be,
intends to use for substantially the same purpose or purposes as the assets or
properties sold or transferred.
The foregoing restriction does not apply to any sale-leaseback transaction
if (i) the lease is for a period, including renewal rights, of not in excess of
three years; (ii) the lease secures or relates to industrial revenue or
pollution control bonds; (iii) the transaction is solely between the Company and
any Wholly
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Owned Restricted Subsidiary or solely between Wholly Owned Restricted
Subsidiaries; or (iv) the Company or such Restricted Subsidiary, within twelve
months after the sale or transfer of any assets or properties is completed,
applies an amount not less than the net proceeds received from such sale in
accordance with clause (A) or (B) of the first paragraph of the "Limitation on
Asset Sales" covenant described below.
LIMITATION ON ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate any Asset Sale unless (i) the consideration received by the Company
or such Restricted Subsidiary (including any Released Indebtedness) is at least
equal to the fair market value of the assets sold or disposed of and (ii) at
least 85% of the consideration received (including any Released Indebtedness)
consists of (1) cash, Temporary Cash Investments or Released Indebtedness and
(2) Indebtedness of any Person which is either repaid in cash or sold for cash
within 90 days of such Asset Sale (for purposes of calculating the amount of
such Indebtedness, such Indebtedness shall be valued at its principal amount, if
it matures within 180 days of the consummation of such Asset Sale, or its fair
market value, in all other cases). In the event and to the extent that the Net
Cash Proceeds received by the Company or any of its Restricted Subsidiaries from
one or more Asset Sales occurring on or after the Closing Date in any period of
12 consecutive months exceed 10% of Adjusted Consolidated Net Tangible Assets
(determined as of the date closest to the commencement of such 12-month period
for which a consolidated balance sheet of the Company and its subsidiaries has
been filed pursuant to the "Commission Reports and Reports to Holders"
covenant), then the Company shall or shall cause the relevant Restricted
Subsidiary to (i) within twelve months after the date Net Cash Proceeds so
received exceed 10% of Adjusted Consolidated Net Tangible Assets (A) apply an
amount equal to such excess Net Cash Proceeds to permanently repay
unsubordinated Indebtedness of the Company or any Restricted Subsidiary
providing a Subsidiary Guarantee pursuant to the "Limitation on Issuances of
Guarantees by Restricted Subsidiaries" covenant described above or Indebtedness
of any other Restricted Subsidiary, in each case owing to a Person other than
the Company or any of its Restricted Subsidiaries or (B) invest an equal amount,
or the amount not so applied pursuant to clause (A) (or enter into a definitive
agreement committing to so invest within twelve months after the date of such
agreement), in property or assets (other than current assets) of a nature or
type or that are used in a business (or in a company having property and assets
of a nature or type, or engaged in a business) similar or related to the nature
or type of the property and assets of, or the business of, the Company and its
Restricted Subsidiaries existing on the date of such investment and (ii) apply
(no later than the end of the twelve-month period referred to in clause (i))
such excess Net Cash Proceeds (to the extent not applied pursuant to clause (i))
as provided in the following paragraph of this "Limitation on Asset Sales"
covenant. The amount of such excess Net Cash Proceeds required to be applied (or
to be committed to be applied) during such twelve-month period as set forth in
clause (i) of the preceding sentence and not applied as so required by the end
of such period shall constitute "Excess Proceeds."
If, as of the first day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this
"Limitation on Asset Sales" covenant totals at least $5 million, the Company
must commence, not later than the fifteenth Business Day of such month, and
consummate an Offer to Purchase from the Holders on a pro rata basis an
aggregate principal amount of Notes on the relevant Payment Date equal to the
Excess Proceeds on such date, at a purchase price equal to 101% of the principal
amount of the Notes on the relevant Payment Date, plus accrued interest (if any)
to the Payment Date. Upon the consummation of an Offer to Purchase pursuant to
this covenant, the amount of Excess Proceeds shall be deemed to be equal to
zero, plus the amount of any Excess Proceeds not theretofore subject to an Offer
to Purchase.
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REPURCHASE OF NOTES UPON A CHANGE OF CONTROL
The Company must commence, within 30 days of the occurrence of a Change of
Control, and consummate an Offer to Purchase for all Notes then outstanding, at
a purchase price equal to 101% of the principal amount thereof on the relevant
Payment Date, plus accrued interest (if any) to the Payment Date.
There can be no assurance that the Company will have sufficient funds
available at the time of any Change of Control to make any debt payment
(including repurchases of Notes) required by the foregoing covenant (as well as
may be contained in other securities of the Company which might be outstanding
at the time). The above covenant requiring the Company to repurchase the Notes
will, unless consents are obtained, require the Company to repay all
indebtedness then outstanding which by its terms would prohibit such Note
repurchase, either prior to or concurrently with such Note repurchase.
Econophone will comply with the requirements of Rules 13e-4 and 14e-1 under
the Exchange Act and any other applicable federal securities laws in connection
with the repurchase of Notes as a result of a Change of Control.
COMMISSION REPORTS AND REPORTS TO HOLDERS
At all times from and after January 15, 1998, whether or not the Company is
then required to file reports with the Commission, the Company shall deliver for
filing to the Commission all such reports and other information as it would be
required to file with the Commission by Sections 13(a) or 15(d) under the
Exchange Act if it were subject thereto. The Company shall supply the Trustee
and each Holder, or shall supply to the Trustee for forwarding to each such
Holder, without cost to such Holder, copies of such reports and other
information. In addition, at all times prior to the Registration, upon the
request of any Holder or any prospective purchaser of the Notes designated by a
Holder, the Company shall supply to such Holder or such prospective purchaser
the information required under Rule 144A under the Securities Act.
EVENTS OF DEFAULT
The following events are defined as "Events of Default" in the Indenture:
(a) default in the payment of principal of (or premium, if any, on) any Note
when the same becomes due and payable at maturity, upon acceleration, redemption
or otherwise; (b) default in the payment of interest on any Note when the same
becomes due and payable, and such default continues for a period of 30 days;
PROVIDED that the failure to make any of the first six scheduled payments of
interest when due will constitute an Event of Default with no grace or cure
period; (c) default in the performance or breach of the provisions of the
Indenture applicable to mergers, consolidations and transfers of all or
substantially all of the assets of the Company or the failure to make or
consummate an Offer to Purchase in accordance with the "Limitation on Asset
Sales" or "Repurchase of Notes upon a Change of Control" covenant; (d) the
Company defaults in the performance of or breaches any other covenant or
agreement of the Company in the Indenture or under the Notes (other than a
default specified in clause (a), (b) or (c) above) and such default or breach
continues for a period of 30 consecutive days after written notice by the
Trustee or the Holders of 25% or more in aggregate principal amount at maturity
of the Notes; (e) there occurs with respect to any issue or issues of
Indebtedness of the Company or any Significant Subsidiary having an outstanding
principal amount of $5.0 million or more in the aggregate for all such issues of
all such Persons, whether such Indebtedness now exists or shall hereafter be
created, (I) an event of default that has caused the holder thereof to declare
such Indebtedness to be due and payable prior to its Stated Maturity and such
Indebtedness has not been discharged in full or such acceleration has not been
rescinded or annulled within 30 days of such acceleration and/or (II) the
failure to make a principal payment at the final (but not any interim) fixed
maturity and such defaulted payment shall not have been made, waived or extended
within 30 days of such payment default; (f) any final judgment or order (not
covered by insurance) for the
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payment of money in excess of $5.0 million in the aggregate for all such final
judgments or orders against all such Persons (treating any deductibles,
self-insurance or retention as not so covered) shall be rendered against the
Company or any Significant Subsidiary and shall not be paid or discharged, and
there shall be any period of 30 consecutive days following entry of the final
judgment or order that causes the aggregate amount for all such final judgments
or orders outstanding and not paid or discharged against all such Persons to
exceed $5.0 million during which a stay of enforcement of such final judgment or
order, by reason of a pending appeal or otherwise, shall not be in effect; (g) a
court having jurisdiction in the premises enters a decree or order for (A)
relief in respect of the Company or any Significant Subsidiary in an involuntary
case under any applicable bankruptcy, insolvency or other similar law now or
hereafter in effect, (B) appointment of a receiver, liquidator, assignee,
custodian, trustee, sequestrator or similar official of the Company or any
Significant Subsidiary or for all or substantially all of the property and
assets of the Company or any Significant Subsidiary or (C) the winding up or
liquidation of the affairs of the Company or any Significant Subsidiary and, in
each case, such decree or order shall remain unstayed and in effect for a period
of 30 consecutive days; (h) the Company or any Significant Subsidiary (A)
commences a voluntary case under any applicable bankruptcy, insolvency or other
similar law now or hereafter in effect, or consents to the entry of an order for
relief in an involuntary case under any such law, (B) consents to the
appointment of or taking possession by a receiver, liquidator, assignee,
custodian, trustee, sequestrator or similar official of the Company or any
Significant Subsidiary or for all or substantially all of the property and
assets of the Company or any Significant Subsidiary or (C) effects any general
assignment for the benefit of creditors; or (i) the Pledge Agreement shall cease
to be in full force and effect or enforceable in accordance with its terms,
other than in accordance with its terms.
If an Event of Default (other than an Event of Default specified in clause
(g) or (h) above that occurs with respect to the Company) occurs and is
continuing under the Indenture, the Trustee or the Holders of at least 25% in
aggregate principal amount at maturity of the outstanding Notes, by written
notice to the Company (and to the Trustee if such notice is given by the
Holders), may, and the Trustee at the request of such Holders shall, declare the
principal amount of, premium, if any, and accrued interest, if any, on the Notes
to be immediately due and payable. Upon a declaration of acceleration, such
principal amount, premium, if any, and accrued interest, if any, shall be
immediately due and payable. In the event of a declaration of acceleration
because an Event of Default set forth in clause (e) above has occurred and is
continuing, such declaration of acceleration shall be automatically rescinded
and annulled if the event of default triggering such Event of Default pursuant
to clause (e) shall be remedied or cured by the Company or the relevant
Significant Subsidiary or waived by the holders of the relevant Indebtedness
within 60 days after the declaration of acceleration with respect thereto. If an
Event of Default specified in clause (g) or (h) above occurs with respect to the
Company, the principal amount of, premium, if any, and accrued interest, if any,
on the Notes then outstanding shall IPSO FACTO become and be immediately due and
payable without any declaration or other act on the part of the Trustee or any
Holder. The Holders of at least a majority in principal amount at maturity of
the outstanding Notes, by written notice to the Company and to the Trustee, may
waive all past defaults and rescind and annul a declaration of acceleration and
its consequences if (i) all existing Events of Default, other than the
nonpayment of the principal amount of, premium, if any, and interest on the
Notes that have become due solely by such declaration of acceleration, have been
cured or waived and (ii) the rescission would not conflict with any judgment or
decree of a court of competent jurisdiction. For information as to the waiver of
defaults, see "--Modification and Waiver."
The Holders of at least a majority in aggregate principal amount at maturity
of the outstanding Notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee. However, the Trustee may refuse to follow any
direction that conflicts with law or the Indenture, that may involve the Trustee
in personal liability, or that the Trustee determines in good faith may be
unduly prejudicial to the rights of Holders of Notes not joining in the giving
of such direction and may take any other action it deems proper that is not
inconsistent with any such direction received from Holders of Notes. A Holder
may not pursue any remedy with respect to the Indenture or the Notes unless: (i)
the Holder gives the Trustee written notice of a
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continuing Event of Default; (ii) the Holders of at least 25% in aggregate
principal amount at maturity of outstanding Notes make a written request to the
Trustee to pursue the remedy; (iii) such Holder or Holders offer the Trustee
indemnity satisfactory to the Trustee against any costs, liability or expense;
(iv) the Trustee does not comply with the request within 60 days after receipt
of the request and the offer of indemnity; and (v) during such 60-day period,
the Holders of a majority in aggregate principal amount at maturity of the
outstanding Notes do not give the Trustee a direction that is inconsistent with
the request. However, such limitations do not apply to the right of any Holder
of a Note to receive payment of the principal of, premium, if any, or interest
on, such Note or to bring suit for the enforcement of any such payment, on or
after the due date expressed in the Notes, which right shall not be impaired or
affected without the consent of the Holder.
The Indenture requires certain officers of the Company to certify, on or
before a date not more than 90 days after the end of each fiscal year, that a
review has been conducted of the activities of the Company and its Restricted
Subsidiaries and the Company's and its Restricted Subsidiaries' performance
under the Indenture and that the Company has fulfilled all obligations
thereunder, or, if there has been a default in the fulfillment of any such
obligation, specifying each such default and the nature and status thereof. The
Company will also be obligated to notify the Trustee of any default or defaults
in the performance of any covenants or agreements under the Indenture.
CONSOLIDATION, MERGER AND SALE OF ASSETS
The Company will not consolidate with, merge with or into, or sell, convey,
transfer, lease or otherwise dispose of all or substantially all of its property
and assets (as an entirety or substantially an entirety in one transaction or a
series of related transactions) to any Person or permit any Person to merge with
or into the Company unless: (i) the Company shall be the continuing Person, or
the Person (if other than the Company) formed by such consolidation or into
which the Company is merged or that acquired or leased such property and assets
of the Company shall be a corporation organized and validly existing under the
laws of the United States of America or any jurisdiction thereof and shall
expressly assume, by a supplemental indenture, executed and delivered to the
Trustee, all of the obligations of the Company on all of the Notes and under the
Indenture; (ii) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing; (iii) immediately
after giving effect to such transaction on a pro forma basis, the Company or any
Person becoming the successor obligor of the Notes shall have a Consolidated Net
Worth equal to or greater than the Consolidated Net Worth of the Company
immediately prior to such transaction; (iv) immediately after giving effect to
such transaction on a pro forma basis, (A) the Consolidated Leverage Ratio of
the Company, or any Person becoming the successor obligor of the Notes, as the
case may be, is no worse than 110% of the Consolidated Leverage Ratio of the
Company without giving effect to such transaction or (B) the Company, or any
Person becoming the successor obligor of the Notes, as the case may be, could
Incur at least $1.00 of Indebtedness under the first paragraph of the
"Limitation on Indebtedness" covenant; PROVIDED that this clause (iv) shall not
apply to a consolidation or merger with or into a Wholly Owned Restricted
Subsidiary with a positive net worth; PROVIDED that, in connection with any such
merger or consolidation, no consideration (other than Common Stock in the
surviving Person or the Company) shall be issued or distributed to the
stockholders of the Company; and (v) the Company delivers to the Trustee an
Officers' Certificate (attaching the arithmetic computations to demonstrate
compliance with clauses (iii) and (iv)) and Opinion of Counsel, in each case
stating that such consolidation, merger or transfer and such supplemental
indenture complies with this provision and that all conditions precedent
provided for herein relating to such transaction have been complied with;
PROVIDED, HOWEVER, that clauses (iii) and (iv) above do not apply if, in the
good faith determination of the Board of Directors of the Company, whose
determination shall be evidenced by a Board Resolution, the principal purpose of
such transaction is to change the state of incorporation of the Company; and
PROVIDED FURTHER that any such transaction shall not have as one of its purposes
the evasion of the foregoing limitations.
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DEFEASANCE
DEFEASANCE AND DISCHARGE. The Indenture provides that the Company will be
deemed to have paid and will be discharged from any and all obligations in
respect of the Notes on the 123rd day after the deposit referred to below, and
the provisions of the Indenture will no longer be in effect with respect to the
Notes (except for, among other matters, certain obligations to register the
transfer or exchange of the Notes, to replace stolen, lost or mutilated Notes,
to maintain paying agencies and to hold monies for payment in trust) if, among
other things, (A) the Company has deposited with the Trustee, in trust, money
and/or U.S. Government Obligations that through the payment of interest and
principal in respect thereof in accordance with their terms will provide money
in an amount sufficient to pay the principal of, premium, if any, and accrued
interest on the Notes on the Stated Maturity of such payments in accordance with
the terms of the Indenture and the Notes, (B) the Company has delivered to the
Trustee (i) either (x) an Opinion of Counsel to the effect that Holders will not
recognize income, gain or loss for federal income tax purposes as a result of
the Company's exercise of its option under this "Defeasance" provision and will
be subject to federal income tax on the same amount and in the same manner and
at the same times as would have been the case if such deposit, defeasance and
discharge had not occurred, which Opinion of Counsel must be based upon (and
accompanied by a copy of) a ruling of the Internal Revenue Service to the same
effect unless there has been a change in applicable federal income tax law after
the Closing Date such that a ruling is no longer required or (y) a ruling
directed to the Trustee received from the Internal Revenue Service to the same
effect as the aforementioned Opinion of Counsel and (ii) an Opinion of Counsel
to the effect that the creation of the defeasance trust does not violate the
Investment Company Act of 1940 and after the passage of 123 days following the
deposit, the trust fund will not be subject to the effect of Section 547 of the
United States Bankruptcy Code or Section 15 of the New York Debtor and Creditor
Law, (C) immediately after giving effect to such deposit on a pro forma basis,
no Event of Default, or event that after the giving of notice or lapse of time
or both would become an Event of Default, shall have occurred and be continuing
on the date of such deposit or during the period ending on the 123rd day after
the date of such deposit, and such deposit shall not result in a breach or
violation of, or constitute a default under, any other agreement or instrument
to which the Company or any of its Subsidiaries is a party or by which the
Company, or any of its Subsidiaries is bound, and (D) if at such time the Notes
are listed on a national securities exchange, the Company has delivered to the
Trustee an Opinion of Counsel to the effect that the Notes will not be delisted
as a result of such deposit, defeasance and discharge.
DEFEASANCE OF CERTAIN COVENANTS AND CERTAIN EVENTS OF DEFAULT. The
Indenture further provides that the provisions of the Indenture will no longer
be in effect with respect to clauses (iii) and (iv) under "Consolidation, Merger
and Sale of Assets" and all the covenants described herein under "Covenants,"
clauses (c) and (d) under "Events of Default" with respect to such clauses (iii)
and (iv) under "Consolidation, Merger and Sale of Assets" and such covenants and
clauses (e) and (f) under "Events of Default" shall be deemed not to be Events
of Default, upon, among other things, the deposit with the Trustee, in trust, of
money and/or U.S. Government Obligations that through the payment of interest
and principal in respect thereof in accordance with their terms will provide
money in an amount sufficient to pay the principal of, premium, if any, and
accrued interest on the Notes on the Stated Maturity of such payments in
accordance with the terms of the Indenture and the Notes, the satisfaction of
the provisions described in clauses (B)(ii), (C) and (D) of the preceding
paragraph and the delivery by the Company to the Trustee of an Opinion of
Counsel to the effect that, among other things, the Holders will not recognize
income, gain or loss for federal income tax purposes as a result of such deposit
and defeasance of certain covenants and Events of Default and will be subject to
federal income tax on the same amount and in the same manner and at the same
times as would have been the case if such deposit and defeasance had not
occurred.
DEFEASANCE AND CERTAIN OTHER EVENTS OF DEFAULT. In the event the Company
exercises its option to omit compliance with certain covenants and provisions of
the Indenture with respect to the Notes as described in the immediately
preceding paragraph and the Notes are declared due and payable because of
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the occurrence of an Event of Default that remains applicable, the amount of
money and/or U.S. Government Obligations on deposit with the Trustee will be
sufficient to pay amounts due on the Notes at the time of their Stated Maturity
but may not be sufficient to pay amounts due on the Notes at the time of the
acceleration resulting from such Event of Default. However, the Company will
remain liable for such payments.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company and
the Trustee with the consent of the Holders of not less than a majority in
aggregate principal amount at maturity of the outstanding Notes; PROVIDED,
HOWEVER, that no such modification or amendment may, without the consent of each
Holder affected thereby, (i) change the Stated Maturity of the principal of, or
any installment of interest on, any Note, (ii) reduce the principal amount of,
or premium, if any, or interest on, any Note, (iii) change the place or currency
of payment of principal of, or premium, if any, or interest on, any Note, (iv)
impair the right to institute suit for the enforcement of any payment on or
after the Stated Maturity (or, in the case of a redemption, on or after the
Redemption Date) of any Note, (v) reduce the above-stated percentage of
outstanding Notes the consent of whose Holders is necessary to modify or amend
the Indenture, (vi) waive a default in the payment of principal of, premium, if
any, or interest on the Notes or (vii) reduce the percentage or aggregate
principal amount at maturity of outstanding Notes the consent of whose Holders
is necessary for waiver of compliance with certain provisions of the Indenture
or for waiver of certain defaults.
NO PERSONAL LIABILITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS, DIRECTORS, OR
EMPLOYEES
The Indenture provides that no recourse for the payment of the principal of,
premium, if any, or interest on any of the Notes or for any claim based thereon
or otherwise in respect thereof, and no recourse under or upon any obligation,
covenant or agreement of the Company in the Indenture or in any of the Notes or
because of the creation of any Indebtedness represented thereby, shall be had
against any incorporator, stockholder, officer, director, employee or
controlling person of the Company or of any successor Person thereof. Each
Holder, by accepting the Notes, waives and releases all such liability.
CONCERNING THE TRUSTEE
The Indenture provides that, except during the continuance of a Default, the
Trustee will not be liable, except for the performance of such duties as are
specifically set forth in such Indenture. If an Event of Default has occurred
and is continuing, the Trustee will use the same degree of care and skill in its
exercise as a prudent person would exercise under the circumstances in the
conduct of such person's own affairs.
The Indenture and provisions of the Trust Indenture Act of 1939, as amended,
incorporated by reference therein contain limitations on the rights of the
Trustee, should it become a creditor of the Company, to obtain payment of claims
in certain cases or to realize on certain property received by it in respect of
any such claims, as security or otherwise. The Trustee is permitted to engage in
other transactions; PROVIDED, HOWEVER, that, if it acquires any conflicting
interest, it must eliminate such conflict or resign.
BOOK-ENTRY; DELIVERY AND FORM
Ownership of beneficial interests in a Global Note will be limited to
persons who have accounts with DTC ("participants") or persons who hold
interests through participants. Ownership of beneficial interests in a Global
Note will be shown on, and the transfer of that ownership will be effected only
through, records maintained by DTC or its nominee (with respect to interests of
participants) and the records of participants (with respect to interests of
persons other than participants).
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So long as DTC, or its nominee, is the registered owner or holder of a
Global Note, DTC or such nominee, as the case may be, will be considered the
sole owner or holder of the Notes represented by such Global Note for all
purposes under the Indenture and the Notes. No beneficial owner of an interest
in a Global Note will be able to transfer that interest except in accordance
with applicable procedures of DTC, in addition to those provided for under the
Indenture.
Payments of the principal of, and interest on, the Global Notes will be made
to DTC or its nominee, as the case may be, as the registered owner thereof. None
of Econophone, the Trustee or any Paying Agent will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in the Global Notes or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interests.
Econophone expects that DTC or its nominee, upon receipt of any payment of
principal or interest in respect of a Global Note, will credit participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of such Global Note, as shown on the records
of DTC or its nominee. Econophone also expects that payments by participants to
owners of beneficial interests in such Global Note held through such
participants will be governed by standing instructions and customary practices,
as is now the case with securities held for the accounts of customers registered
in the names of nominees for such customers. Such payments will be the
responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same-day funds. If a holder
requires physical delivery of a Certificated Note for any reason, such holder
must transfer its interest in the Global Note in accordance with DTC's
applicable procedures.
Econophone expects that DTC will take any action permitted to be taken by a
holder of Notes (including the presentation of Notes for exchange as described
below) only at the direction of one or more participants to whose accounts the
DTC interests in the Global Notes are credited and only in respect of such
portion of the aggregate principal amount of Notes as to which such participant
or participants has or have given such direction. However, if there is an Event
of Default under the Notes, DTC will exchange the applicable Global Note for
certificated notes ("Certificated Notes"), which it will distribute to its
participants.
Econophone understands that: DTC is a limited-purpose trust company
organized under the laws of the State of New York, a "banking organization"
within the meaning of New York Banking Law, a member of the Federal Reserve
System, a "clearing corporation" within the meaning of the Uniform Commercial
Code and a "Clearing Agency" registered pursuant to the provisions of Section
17A of the Exchange Act. DTC was created to hold securities for its participants
and facilitate the clearance and settlement of securities transactions between
participants through electronic book-entry changes in accounts of its
participants, thereby eliminating the need for physical movement of certificates
and certain other organizations. Indirect access to the DTC system is available
to others such as banks, brokers, dealers and trust companies that clear through
or maintain a custodial relationship with a participant, either directly or
indirectly ("indirect participants").
Although DTC is expected to follow the foregoing procedures in order to
facilitate transfers of interests in the Global Notes among participants of DTC,
DTC is under no obligation to perform or continue to perform such procedures,
and such procedures may be discontinued at any time. Neither Econophone nor the
Trustee will have any responsibility for the performance by DTC or its direct or
indirect participants of their respective obligations under the rules and
procedures governing their operations.
CERTIFICATED NOTES. If DTC is at any time unwilling or unable to continue
as a depositary for the Global Notes and a successor depositary is not appointed
by Econophone within 90 days, Econophone will issue Certificated Notes in
exchange for the Global Notes.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is a summary of the material tax consequences of
the exchange of the Original Notes for the Exchange Notes and of the ownership
and disposition of the Exchange Notes under U.S. federal income tax laws. The
discussion does not deal with all possible tax consequences relating to an
investment in the Exchange Notes. In particular, the discussion does not address
the tax consequences under state, local and foreign tax laws. In addition, the
discussion does not address U.S. federal income tax consequences to persons who
do not hold the Exchange Notes as capital assets. The discussion also does not
address the tax treatment of holders that may be subject to special tax rules,
such as banks, insurance companies, dealers in securities and holders who hold
the Exchange Notes as part of a straddle or conversion transaction or whose
functional currency is not the dollar. Accordingly, each prospective investor
should consult its tax advisor regarding the tax consequences to it of an
investment in the Exchange Notes. The following discussion is based upon
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), the
regulations promulgated thereunder, rulings and judicial decisions as of the
date of this Prospectus, and such authorities may be repealed, revoked or
modified so as to result in federal income tax consequences different from those
discussed below, possibly with retroactive effect. As used herein, a "U.S.
Holder" is a beneficial owner who is (i) a citizen or resident of the United
States, (ii) a U.S. domestic corporation, (iii) an estate, the income of which
is subject to United States federal income tax regardless of the source or (iv)
a trust with respect to which a court within the United States is able to
exercise primary supervision over its administration and one or more United
States fiduciaries have the authority to control all its substantial decisions.
"A Non-U.S. Holder" is a beneficial owner who is not a U.S. Holder. The summary
of U.S. federal income tax consequences is based upon the advice of Schulte Roth
& Zabel LLP, counsel to Econophone.
THE FOLLOWING DISCUSSION IS FOR GENERAL INFORMATION ONLY. EACH HOLDER IS
STRONGLY URGED TO CONSULT WITH ITS OWN TAX ADVISORS TO DETERMINE THE IMPACT OF
SUCH HOLDER'S PERSONAL TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES,
INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN OR OTHER TAX LAWS OF
THE ACQUISITION, OWNERSHIP AND DISPOSITION OF THE NOTES AND WARRANTS.
ALLOCATION OF PURCHASE PRICE BETWEEN NOTES AND WARRANTS
THE ORIGINAL NOTES--UNITS
For U.S. federal income tax purposes, the Original Notes were originally
issued and sold as part of a Unit, comprised of one Original Note and one
Warrant to purchase 8.167 shares of Common Stock. The issue price of a Unit was
allocated between the Notes and the Warrants based on the Company's best
judgment of the relative fair market values of each such component of the Unit
on the issue date. The Company allocated $963.90 to each Note and $36.10 to each
Warrant. Under regulations issued under provisions of the Code relating to
original issue discount (the "OID Regulations"), each Holder will be bound by
such allocation for U.S. federal income tax purposes unless such Holder
discloses on a statement attached to its tax return for the taxable year that
includes the acquisition date of such Unit that its allocation differs from that
of the Company. No assurance can be given that the Internal Revenue Service (the
"IRS") will accept the Company's allocation. If the Company's allocation were
successfully challenged by the IRS, the issue price, original issue discount
accrual on the Note and gain or loss on the sale or disposition of a Note would
be different from that resulting under the allocation determined by the Company.
The exchange of Original Notes for Exchange Notes pursuant to the Exchange
Offer will not be a taxable event for federal income tax purposes. As a result,
there will not be any material U.S. federal income tax consequences to a holder
exchanging Original Notes for the Exchange Notes pursuant to the Exchange Offer.
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Because each Exchange Note is a continuation of the corresponding Original
Note, the remainder of this discussion of certain federal income tax
consideration generally refers only to "Notes".
NOTES
TAXATION OF INTEREST
Stated interest payments on the Notes will be taxable to a U.S. Holder when
received or accrued in accordance with such Holder's method of tax accounting.
ORIGINAL ISSUE DISCOUNT
GENERAL
The allocation of issue price to the Notes and the Warrants will generate a
discount element for the Notes. If a debt instrument is originally issued at a
discount that is equal to or greater than .25% multiplied by the product of its
"stated redemption price at maturity" (as defined below) and the number of
complete years to maturity from the issue date, the debt instrument will bear
OID for U.S. federal income tax purposes.
Because the Notes were issued with OID, each U.S. Holder is required to
include in income (regardless of whether such U.S. Holder is a cash or accrual
basis taxpayer) in each taxable year, in advance of the receipt of corresponding
cash payments on such Notes, that portion of the OID, computed on a constant
yield basis, attributable to each day during such year on which the U.S. Holder
held the Notes. See "--Taxation of Original Issue Discount."
The amount of OID with respect to each Note will be equal to the excess of
(i) its "stated redemption price at maturity" over (ii) its issue price. Under
the OID Regulations, the "stated redemption price at maturity" of each Note will
include all payments to be made in respect thereof other than payments of
"qualified stated interest." "Qualified stated interest" payments are payments
of interest which are unconditionally payable in cash or property (other than
debt instruments of the issuer) at least annually at a qualifying rate,
including a single fixed rate. The "issue price" of a Note is determined in the
manner described under "--Allocation of Purchase Price Between Notes and
Warrants."
TAXATION OF ORIGINAL ISSUE DISCOUNT
A U.S. Holder of a debt instrument issued with OID is required to include in
gross income for U.S. federal income tax purposes an amount equal to the sum of
the "daily portions" of such OID for all days during the taxable year on which
the Holder holds the debt instrument. The daily portions of OID required to be
included in a Holder's gross income in a taxable year will be determined upon a
constant yield basis by allocating to each day during the taxable year on which
the Holder holds the debt instrument a pro-rata portion of the OID on such debt
instrument which is attributable to the "accrual period" in which such day is
included. Accrual periods with respect to a Note may be of any length and may
vary in length over the term of the Note as long as (i) no accrual period is
longer than one year and (ii) each scheduled payment of interest or principal on
the Note occurs on either the final or first day of an accrual period. The
amount of the OID attributable to each "accrual period" will be the difference
between (A) the product of the "adjusted issue price" at the beginning of such
accrual period and the "yield to maturity" of the debt instrument (stated in a
manner appropriately taking into account the length of the accrual period) and
(B) qualified stated interest allocable to such accrual period. The "yield to
maturity" is the discount rate that, when used in computing the present value of
all payments to be made under the Notes produces an amount equal to the issue
price of the Notes. The "adjusted issue price" of a debt instrument at the
beginning of an accrual period is defined generally as the issue price of the
debt instrument plus the aggregate amount of OID that accrued in all prior
accrual periods, less any cash payments on the debt instrument other than
payments of qualified stated interest. Accordingly, a U.S. Holder of a Note will
be
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required to include OID in gross income for U.S. federal tax purposes in advance
of the receipt of cash in respect of such income. The amount of OID allocable to
an initial short accrual period may be computed using any reasonable method if
all other accrual periods, other than a final short accrual period, are of equal
length. The amount of OID allocable to the final accrual period at maturity of
the Note is the difference between (x) the amount payable at the maturity of the
Note (other than a payment of "qualified stated interest"), and (y) the Note's
adjusted issue price as of the beginning of the final accrual period.
The deduction by the Company of OID with respect to a Note will be denied
since the Note is an "applicable high yield discount obligation," as defined in
Section 163(i) of the Code. Although the Note is characterized as an applicable
high yield discount obligation, the Company would continue to be entitled to
deduct stated interest with respect to the Note as it accrues, but would not be
able to deduct OID with respect to the Note. A U.S. Holder may be entitled to
treat such OID as a dividend, which dividend may qualify for the dividends
received deduction generally available to U.S. Holders that are corporations.
Corporate U.S. Holders of Notes should consult with their own tax advisors as to
the applicability of the dividends received deduction.
ADJUSTED TAX BASIS OF NOTES
An original U.S. Holder's initial tax basis in a Note generally will be
equal to the portion of the issue price of a Unit that is properly allocable to
the Note, and thereafter such basis will be increased by the amount of OID that
is included in such U.S. Holder's income pursuant to the foregoing rules and
decreased by the amount of any cash payments received other than payments of
"qualified stated interest."
MARKET DISCOUNT, ACQUISITION PREMIUM
If a U.S. Holder purchases a Note for an amount that is less than the
adjusted issue price of the Note at the time of acquisition, the amount of such
difference will be treated as "market discount" for U.S. federal income tax
purposes, unless such difference is less than a specified DE MINIMIS amount.
Under the market discount rules, a U.S. Holder will be required to treat any
principal payment on a Note and any gain on the sale, exchange, retirement or
other disposition of a Note as ordinary income to the extent of the market
discount which has not previously been included in income and is treated as
having accrued on such Note at the time of such payment or disposition. If a
U.S. Holder makes a gift of a Note, accrued market discount, if any, will be
recognized as if such U.S. Holder had sold such Note for a price equal to its
fair market value. In addition, a U.S. Holder may be required to defer, until
the maturity of the Note or an earlier disposition of the Note in a taxable
transaction, the deduction of a portion of the interest expense on any
indebtedness incurred or continued to purchase or carry such Note.
Any market discount will be considered to accrue on a straight-line basis
during the period from the date of acquisition to the maturity date of the Note,
unless the U.S. Holder elects to accrue market discount on a constant interest
method. A U.S. Holder of a Note may elect to include market discount in income
currently as it accrues (on either a straight-line basis or constant interest
method), in which case the rules described above regarding the deferral of
interest deductions will not apply. This election to include market discount in
income currently, once made, applies to all market discount obligations acquired
by such U.S. Holder on or after the first day of the first taxable year to which
the election applies and may not be revoked without the consent of the IRS.
A U.S. Holder who acquires a Note for an amount that is greater than the
adjusted issue price of such Note but equal to or less than the sum of all
amounts payable on such Note after the purchase date will be considered to have
purchased such Note at an "acquisition premium." Under the acquisition premium
rules of the Code and the OID Regulations, the daily portion of OID which such
holder must include in its gross income with respect to such Note for any
taxable year will be reduced by an amount equal to the OID multiplied by a
fraction, the numerator of which is the amount of such acquisition premium and
the denominator of which is the OID remaining from the date the Note was
purchased to their maturity date.
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SALE OR REDEMPTION OF NOTES
Unless a nonrecognition provision applies, the sale, exchange, redemption
(including pursuant to an offer by Econophone) or other disposition of a Note
will be a taxable event for U.S. federal income tax purposes. In such event, a
U.S. Holder will recognize gain or loss equal to the difference between (i) the
amount of cash plus the fair market value of any property received upon such
sale, exchange, redemption or other taxable disposition and (ii) the U.S.
Holder's adjusted tax basis in the Note. Except with respect to accrued market
discount with respect to a Note, such gain or loss should be capital gain or
loss and will be long-term capital gain or loss if the Note has been held by the
U.S. Holder for more than one year at the time of such sale, exchange,
redemption or other disposition. The excess of net long-term capital gains over
net short-term capital losses is taxed at a lower rate than ordinary income for
certain non-corporate taxpayers. The distinction between capital gain or loss
and ordinary income or loss is also relevant for purposes of, among other
things, limitations on the deductibility of capital losses.
TAX CONSEQUENCES TO NON-U.S. HOLDERS
Under present U.S. federal income tax law, and subject to the discussion
below concerning backup withholding:
(a) payments of principal and interest (including OID) and premium on a
Note by the Company or any paying agent to any Non-U.S. Holder which does
not hold the Note in connection with a trade or business in the United
States, will not be subject to U.S. federal withholding tax, provided that,
in the case of amounts paid with respect to interest or accrued OID, (i)
such Non-U.S. Holder does not own, actually or constructively, 10 percent or
more of the total combined voting power of all classes of stock of the
Company entitled to vote, is not a controlled foreign corporation related,
directly or indirectly, to the Company through stock ownership, and is not a
bank receiving interest described in Section 881(c)(3)(A) of the Code and
(ii) the beneficial owner thereof fulfills the statement requirement set
forth in Section 871(h) or Section 881(c) of the Code (described below);
(b) such a non-U.S. Holder of a Note will not be subject to U.S. federal
income tax on gain realized on the sale, exchange or other disposition of
such Note unless such Non-U.S. Holder is an individual who is present in the
United States for 183 days or more in the taxable year of disposition and
certain other requirements are met.
Sections 871(h) and 881(c) of the Code require that, in order to obtain the
portfolio interest exemption from withholding tax described in paragraph (a)
above, either the beneficial owner of a Note or a securities clearing
organization, bank or other financial institution that holds customers'
securities in the ordinary course of its trade or business (a "Financial
Institution") and that is holding the Note on behalf of such beneficial owner,
files a statement with the withholding agent to the effect that the beneficial
owner of the Note is not a U.S. Holder. Under temporary United States Treasury
Regulations, such requirement will be fulfilled if the beneficial owner of a
Note certifies on IRS Form W-8, under penalties of perjury, that it is not a
U.S. Holder and provides its name and address, and files such statement with the
withholding agent, or if any Financial Institution holding the Note on behalf of
the beneficial owner files a statement with the withholding agent to the effect
it has received such a statement from the holder (and furnishes the withholding
agent with a copy thereof). A Non-U.S. Holder of a Note who does not meet the
requirements of the second preceding sentence would generally be subject to U.S.
federal withholding at a flat rate of 30% (or a lower applicable treaty rate) on
payments of interest (including OID) on the Notes. The IRS has proposed
regulations that if finalized would modify certain of the certification
requirements described above.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
United States, any interest (including any OID) on the Note and any gain
realized on the sale, exchange or other disposition of the Note which is
effectively connected with the conduct of such trade or business will generally
be subject to the regular United States income tax in the same manner as if the
Non-U.S. Holder were a U.S. Holder. In
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lieu of the certificate described in the preceding paragraph, such a Non-U.S.
Holder will be required to provide to the Company a properly executed IRS Form
4224 in order to claim an exemption from withholding tax on payments of interest
(or accrued OID) on a Note. In addition, if such Non-U.S. Holder is a
corporation, it may be subject to a branch profits tax equal to 30% (or such
lower rate as may be specified by an applicable income tax treaty) of its
effectively connected earnings and profits for the taxable year, subject to
certain adjustments. For purposes of the branch profits tax, interest (including
OID) on such a Note and any gain recognized on the sale, exchange or other
disposition of a Note will be included in the earnings and profits of such
Non-U.S. Holder.
Notes held by an individual who is neither a citizen nor a resident of the
United States for U.S. federal income tax purposes at the time of such
individual's death will not be subject to U.S. federal estate tax, provided that
the income from the Notes was not or would not have been effectively connected
with a U.S. trade or business of such individual and that such individual
qualified for the exemption from U.S. federal withholding tax (without regard to
the certification requirements) that is described above.
Non-U.S. Holders should consult with their tax advisers regarding U.S. and
foreign tax consequences with respect to the Notes.
BACKUP WITHHOLDING AND INFORMATION REPORTING
"Backup" withholding and information reporting requirements may apply to
certain payments of principal and interest (including OID) on a Note and to
certain payments of proceeds of the sale or retirement of a Note. The Company,
its agent, a broker, the Trustee or any paying agent, as the case may be, will
be required to withhold tax from any payment that is subject to backup
withholding at a rate of 31% of such payment if the U.S. Holder fails to furnish
his taxpayer identification number (social security number or employer
identification number), to certify that such U.S. Holder is not subject to
backup withholding, or to otherwise comply with the applicable requirements of
the backup withholding rules. Certain U.S. Holders (including, among others, all
corporations) are not subject to the backup withholding and information
reporting requirements.
Under current Treasury Regulations, backup withholding and information
reporting will not apply to payments made by the Company or any agent thereof
(in its capacity as such) to a Holder of a Note who has provided the required
certification under penalties of perjury that it is not a U.S. Holder as set
forth in clause (a)(ii) in the first paragraph under "--Tax Consequences to
Non-U.S. Holders" or has otherwise established an exemption (provided that
neither the Company nor such agent has actual knowledge that the Holder is a
U.S. Holder or that the conditions of such exemption are not in fact satisfied).
Payment of the proceeds from the sale by a Non-U.S. Holder of a Note made to
or through a foreign office of a broker will not be subject to U.S. information
reporting or backup withholding, except that if the broker is a U.S. person, a
controlled foreign corporation for U.S. federal income tax purposes or a foreign
person, 50% or more of whose gross income is effectively connected with a United
States trade or business for a specified three-year period, U.S. information
reporting, but not backup withholding, may apply to such payments. Payments of
the proceeds from the sale of a Note to or through the United States office of a
broker is subject to U.S. information reporting and backup withholding unless
the Holder certifies as to its non-U.S. status or otherwise establishes an
exemption from U.S. information reporting and backup withholding.
Any amounts withheld under the backup withholding rules from a payment to a
Holder may be claimed as a credit against such Holder's U.S. federal income tax
liability, provided that the required information is provided to the IRS.
The Company is required to furnish certain information to the IRS, and will
furnish annually to record holders of Notes, information with respect to
interest and OID accruing during the calendar year. The OID information will be
based upon the adjusted issue price of the debt instrument as if the Holder
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were the original Holder of the debt instrument. No assurance can be given that
the IRS will not challenge the accuracy of the reported information. Holders who
purchase Notes for an amount other than the adjusted issue price and/or on a
date other than the last day of an accrual period will be required to determine
for themselves the amount of OID, if any, they are required to include in gross
income for U.S. federal income tax purposes.
PLAN OF DISTRIBUTION
Reference is made to "The Exchange Offer" above for a description of the
Exchange Offer, including the purpose of the Exchange Offer, the basis upon
which the Exchange Notes are offered and expenses incurred in connection with
the Exchange Offer.
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus with
any resale of such Exchange Notes. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange for Original Notes where
such Original Notes were acquired as a result of market making activities or
other trading activities. The Company will, during the period ending 180 days
after the last Exchange Date, make this Prospectus, as amended or supplemented,
available to any broker-dealer for use in connection with any such resale.
Neither the Company nor any of its affiliates has entered into any
arrangement or understanding with any broker-dealer to distribute the Exchange
Notes and will not receive any proceeds from any sale of Exchange Notes by any
broker-dealers or any other persons. Exchange Notes received by broker-dealers
for their own account pursuant to the Exchange Offer may be sold from time to
time in one or more transactions in the over-the-counter market, in negotiated
transactions, through the writing of options on the Exchange Notes or a
combination of such methods of resale, at market prices prevailing at the time
of the resale, at prices related to such prevailing market prices or negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such broker or dealer and/or the purchaser of any such
Exchange Notes. Any broker or dealer that resells Exchange Notes that were
received by it for its own account pursuant to the Exchange Offer and any broker
or dealer that participates in a distribution of such Exchange Notes may be
deemed to be an "underwriter" within the meaning of the Securities Act and any
profit on any such resale of Exchange Notes and any commissions or concessions
received by any such person may be deemed to be underwriting compensation under
the Securities Act. The Letter of Transmittal states that by acknowledging that
it will deliver and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the Securities
Act.
Morgan Stanley has advised the Company that it intends to make a market in
the Exchange Notes; however, it is not obligated to do so and any such
market-making may be discontinued at any time without notice, in the sole
discretion of Morgan Stanley. To the extent Morgan Stanley is considered an
affiliate, within the meaning of Rule 405 under the Securities Act, of the
Company, the Company has advised Morgan Stanley that it must comply with the
registration and prospectus delivery requirements of the Securities Act
applicable to affiliates in connection with such secondary resale transactions.
See "Risk Factors--Lack of Public Market." To the extent that Morgan Stanley is
an "affiliate" of the Company, the Company is required to file a shelf
registration statement and keep such shelf registration statement effective in
order to provide Morgan Stanley with the ability to resell Exchange Notes that
it acquires from time to time in connection with any market-making activities.
The Company has agreed in the Registration Rights Agreement to pay all
expenses incident to the Exchange Offer other than commissions or concessions of
any brokers or dealers and expenses of counsel for the underwriters or Holders
of the Exchange Notes.
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LEGAL MATTERS
Certain legal matters in connection with the Exchange Notes being offered
hereby will be passed upon for the Company by Schulte Roth & Zabel LLP, 900
Third Avenue, New York, New York 10022.
EXPERTS
The financial statements and schedules included in this Prospectus and
elsewhere in the registration statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their report with respect
thereto, and is included herein in reliance upon the authority of said firm as
experts in accounting and auditing in giving said reports.
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GLOSSARY
CARRIER: A party that resells either owned or leased transmission capacity
to other resellers or to end-users.
CARRIER GRADE SWITCH: A switch of the type and quality typically used by a
PTO or other large telecommunications service provider.
FACILITIES-BASED: Ownership of long distance interexchange and transmission
facilities.
INTEREXCHANGE: Between two local telephone exchanges. "Interexchange
facilities" are facilities used to transmit calls between local telephone
exchanges. "Interexchange carriers" are carriers providing long distance
telephone service.
IRU: Indefeasible Rights of Use. The rights to use a telecommunications
system, usually an overseas cable, with most of the rights and interests of
ownership, but without the right to control or manage the facility and,
depending upon the particular agreement, without any right to salvage or duty to
dispose of the cable at the end of its useful life.
LEASED LINES: Point-to-point permanent connections that can carry voice and
data. Leased lines are owned and maintained by PTOs or third party resellers.
LEC: Local Exchange Carrier. Companies from which Econophone and other long
distance providers must purchase "access services" to originate and terminate
calls in the United States.
LOCAL CONNECTIVITY: Physical circuits connecting the facilities of a
telecommunications service provider to the interexchange and transmission
facilities of a PTO, providing it with access into and egress from the PSTN.
MULTIPLEXING EQUIPMENT: Equipment that compresses a telephone call so that
more calls can simultaneously travel over the same line.
NODE: Equipment that collects and relays telephone calls to a switch. A node
is functionally equivalent to a point of presence; however, unlike a point of
presence, a node is connected to multiplexing equipment that compresses the call
traffic to be transmitted to a switch.
POINT OF PRESENCE: A location where a long distance carrier has installed
transmission equipment that collects calling traffic and relays calls to a
switch. A point of presence features equipment that is functionally equivalent
to a node; however, unlike a node, the equipment at a point of presence is not
connected to multiplexing equipment.
PSTN: Public switched telephone network. Refers to the telephone network
accessible by the public at large through private lines, wireless systems and
pay phones.
PTO: Principal Telecommunications Operators. The dominant carrier in each
country, often government-owned or protected. Commonly referred to as the
Postal, Telephone and Telegraph Company, or PTT.
RBOC: Regional Bell Operating Company. The regional long distance service
providers divested by AT&T in 1984.
SWITCH: A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of voice and/or data.
VALUE-ADDED FEATURE: A feature coupled with a transmission service that
enhances, but is not necessary for providing, the transmission service.
Value-added features that can be offered with voice telephony include, without
limitation, speed dial, redial and voice mail.
VIRTUAL PRIVATE NETWORK: A service provided to customers that only can be
used to call preprogrammed calling locations, typically within the customer's
company. Calls are completed using abbreviated dialing.
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ECONOPHONE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................................................... F-2
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1995 AND 1996 AND UNAUDITED AS OF JUNE 30, 1997............. F-3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND FOR THE
UNAUDITED SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997................................................. F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND
FOR THE UNAUDITED SIX MONTH PERIOD ENDED JUNE 30, 1997................................................... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND FOR THE
UNAUDITED SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997................................................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................. F-7
</TABLE>
F-1
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Econophone, Inc.:
We have audited the accompanying consolidated balance sheets of Econophone,
Inc. (a New York corporation) and subsidiaries as of December 31, 1995 and 1996,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Econophone,
Inc. and subsidiaries as of December 31, 1995 and 1996, and the results of their
operations and their cash flows for each of the three years ended December 31,
1996, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
New York, New York
March 4, 1997 (except with respect to matters discussed in Note 15 as to which
the date is July 1, 1997)
F-2
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ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
AND JUNE 30, 1997
<TABLE>
<CAPTION>
JUNE 30,
1997
1995 1996 --------------
------------- -------------- (UNAUDITED)
<S> <C> <C> <C>
<CAPTION>
ASSETS
<S> <C> <C> <C>
CURRENT ASSETS:
Cash............................................................ $ 106,122 $ 6,271,641 $ 631,833
Accounts receivable, net of allowance for doubtful accounts of
$470,610, $761,372 and $761,372, respectively................. 7,349,134 7,946,042 12,764,690
Prepaid expenses and other current assets....................... 160,826 511,326 1,666,420
------------- -------------- --------------
Total current assets........................................ 7,616,082 14,729,009 15,062,943
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS net of accumulated
depreciation and amortization of $634,749, $1,643,151 and
$2,418,499, respectively (Note 4)............................... 2,581,317 6,242,472 11,224,774
OTHER ASSETS (Note 6)............................................. 310,822 1,783,855 1,935,802
------------- -------------- --------------
Total assets................................................ $ 10,508,221 $ 22,755,336 $ 28,223,519
------------- -------------- --------------
------------- -------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable................................................ $ 7,528,359 $ 5,190,086 $ 9,211,071
Accrued expenses and other current liabilities.................. 498,663 6,188,847 6,939,493
Short-term borrowings (Note 8).................................. 200,000 2,127,726 485,810
Current maturities of long-term debt (Note 8)................... 323,119 753,881 649,628
Current maturities of obligations under capital lease (Note
14)........................................................... 24,855 130,867 153,882
Current maturities of notes payable--related party (Note 12).... 9,981 7,884 10,234
Deferred revenue................................................ 494,409 859,803 1,509,803
Bridge loan payable............................................. -- -- 7,000,000
------------- -------------- --------------
Total current liabilities................................... 9,079,386 15,259,094 25,959,921
LONG-TERM DEBT (Note 8)........................................... 354,415 1,707,941 4,101,752
OBLIGATIONS UNDER CAPITAL LEASE (Note 14)......................... 36,332 235,074 385,758
NOTES PAYABLE--RELATED PARTY (Note 12)............................ 328,070 319,531 311,271
COMMITMENTS AND CONTINGENCIES (Note 14)
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note 11)......... -- 13,357,940 14,281,985
STOCKHOLDERS' EQUITY (DEFICIT) (Note 10):
Common stock--voting, par value $.0001; authorized 29,250,000
shares; 20,000,000 shares issued and outstanding in 1995 and
1996.......................................................... 2,000 2,000 2,000
Non-Voting Common stock, par value $.0001; authorized 500,000
shares; no shares issued and outstanding...................... -- -- --
Additional paid-in capital...................................... 391,883 481,870 481,870
Cumulative translation adjustment............................... -- -- (10,664)
Retained earnings (accumulated deficit)......................... 316,135 (8,608,114) (17,290,374)
------------- -------------- --------------
Total stockholders' equity (deficit)........................ 710,018 (8,124,244) (16,817,168)
------------- -------------- --------------
Total liabilities and stockholders' equity (deficit)........ $ 10,508,221 $ 22,755,336 $ 28,223,519
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-3
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE SIX
MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------ ----------------------------
1994 1995 1996 1996 1997
------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
REVENUES.............................. $ 8,522,611 $ 27,490,490 $ 45,102,882 $ 22,991,516 $ 30,445,881
COST OF SERVICES...................... 5,539,856 19,735,530 35,368,603 16,332,974 24,011,504
------------ ------------- ------------- ------------- -------------
Gross profit.................... 2,982,755 7,754,960 9,734,279 6,658,542 6,434,377
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES............................ 2,012,282 7,087,735 16,833,779 9,805,162 12,896,158
DEPRECIATION AND AMORTIZATION......... 168,022 388,508 1,049,651 382,383 1,069,190
------------ ------------- ------------- ------------- -------------
Income (loss) from operations... 802,451 278,717 (8,149,151) (3,529,003) (7,530,971)
OTHER INCOME.......................... -- 31,425 106,580 20,922 86,663
FOREIGN CURRENCY EXCHANGE GAIN (LOSS),
net................................. 100,000 (41,097) 26,649 (10,298) (28,321)
INTEREST EXPENSE, net................. (103,134) (147,826) (295,677) (77,929) (285,586)
------------ ------------- ------------- ------------- -------------
Income (loss) before provision
for taxes..................... 799,317 121,219 (8,311,599) $ (3,596,308) $ (7,758,215)
PROVISION (BENEFIT) FOR TAXES......... 72,994 -- -- -- --
------------ ------------- ------------- ------------- -------------
Net income (loss)............... $ 726,323 $ 121,219 $ (8,311,599) $ (3,596,308) $ (7,758,215)
------------ ------------- ------------- ------------- -------------
------------ ------------- ------------- ------------- -------------
EARNINGS (LOSS) PER SHARE............. $ .04 $ .01 $ (.42) $ (.18) $ (.39)
------------ ------------- ------------- ------------- -------------
------------ ------------- ------------- ------------- -------------
PRO FORMA INFORMATION (Note 2):
Income before pro forma provision
for income taxes.................. $ 799,317 $ 121,219
Pro forma provision for income
taxes............................. 344,762 41,214
------------ -------------
Pro forma net income............ $ 454,555 $ 80,005
------------ -------------
------------ -------------
PRO FORMA NET INCOME PER SHARE........ $ .02 $ .00
------------ -------------
------------ -------------
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES USED IN THE COMPUTATION...... 20,000,000 20,000,000 20,000,000 20,000,000 20,000,000
------------ ------------- ------------- ------------- -------------
------------ ------------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
AND THE SIX MONTH PERIOD ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL EARNINGS CUMULATIVE
----------------------- PAID-IN (ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL DEFICIT) ADJUSTMENT TOTAL
------------ --------- ---------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994.............. 20,000,000 $ 2,000 $ 391,883 $ 694,217 -- $ 1,088,100
Net income............................ -- -- -- 121,219 -- 121,219
Dividends............................. -- -- -- (499,301) -- (499,301)
------------ --------- ---------- -------------- ----------- --------------
BALANCE, December 31, 1995.............. 20,000,000 2,000 391,883 316,135 -- 710,018
Distribution of S Corporation
Earnings............................ -- -- -- (316,135) -- (316,135)
Contribution of Capital to C
Corporation......................... -- -- 89,987 -- -- 89,987
Net loss.............................. -- -- -- (8,311,599) -- (8,311,599)
Accretion of preferred stock.......... -- -- -- (15,115) -- (15,115)
Dividends on preferred stock.......... -- -- -- (281,400) -- (281,400)
------------ --------- ---------- -------------- ----------- --------------
BALANCE, December 31, 1996.............. 20,000,000 $ 2,000 $ 481,870 $ (8,608,114) -- $ (8,124,244)
Net Loss.............................. -- -- -- (7,758,215) -- (7,758,215)
Accretion of Preferred Stock.......... -- -- -- (45,451) -- (45,451)
Dividends on Preferred Stock.......... -- -- -- (878,594) -- (878,594)
Cumulative Translation Adjustment..... -- -- -- -- (10,664) (10,664)
------------ --------- ---------- -------------- ----------- --------------
BALANCE, June 30, 1997 (unaudited)...... 20,000,000 $ 2,000 $ 481,870 $ (17,290,374) $ (10,664) $ (16,817,168)
------------ --------- ---------- -------------- ----------- --------------
------------ --------- ---------- -------------- ----------- --------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
---------------------------------- ----------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)...................................... $ 726,323 $ 121,219 $(8,311,599) $(3,596,308) $(7,758,215)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities
Depreciation and amortization........................ 168,022 388,508 1,049,651 382,535 1,069,190
Provision for doubtful accounts...................... 420,126 721,215 290,762 (62,620) --
Effect of prior period adjustment directly related to
sales.............................................. 60,889 -- -- -- --
Changes in assets and liabilities
(Increase) decrease in accounts receivable........... (2,138,140) (5,694,774) (887,670) 1,550,514 (4,840,819)
Decrease (increase) in prepaid expenses and other
current assets..................................... 39,786 (189,879) (350,500) (144,200) (780,514)
Increase in other assets............................. -- -- (1,514,284) (2,109) (798,198)
Increase in accounts payable, accrued expenses and
other current liabilities.......................... 1,197,291 6,196,439 3,351,953 1,886,558 4,760,967
Increase in deferred revenue......................... -- 494,409 365,394 45,280 650,000
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) operating
activities....................................... 474,297 2,037,137 (6,006,293) 59,650 (7,697,589)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment..................... (735,555) (1,206,077) (4,246,997) (2,152,090) (3,285,305)
Issuance of note receivable............................ (65,000) -- -- -- --
---------- ---------- ---------- ---------- ----------
Net cash used in investing activities.............. (800,555) (1,206,077) (4,246,997) (2,152,090) (3,285,305)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of preferred stock.............. -- -- 13,061,425 -- --
Proceeds from bridge loan.............................. -- -- -- -- 7,000,000
Proceeds from line of credit........................... -- 1,760,000 800,000 -- --
Repayments of line of credit........................... (48,500) (1,860,000) (1,000,000) -- --
Proceeds from short-term borrowings.................... -- -- 5,436,582 50,000 --
Repayments of short-term borrowings.................... -- -- (3,308,855) (1,641,916)
Proceeds from long-term debt........................... 350,000 -- 2,232,195 4,201,847 118,618
Repayments of long-term debt........................... -- (116,400) (447,910) (548,009)
Repayments of notes payable--related party............. (8,080) (9,383) (10,636) (5,910)
Repayments of capital leases........................... -- (85,379) (117,844) (40,874) (127,706)
Dividend paid.......................................... -- (499,301) (226,148) (226,148) --
Net repayments of shareholder loans.................... (1,414) -- -- -- --
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) financing
activities....................................... 292,006 (810,463) 16,418,809 3,436,814 5,343,086
---------- ---------- ---------- ---------- ----------
(Decrease) increase in cash........................ (34,252) 20,597 6,165,519 1,344,374 (5,639,808)
CASH, beginning of period.............................. 119,777 85,525 106,122 106,122 6,271,641
---------- ---------- ---------- ---------- ----------
CASH, end of period.................................... $ 85,525 $ 106,122 $6,271,641 $1,450,496 $ 631,833
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for
Interest............................................. $ 60,661 $ 193,455 $ 210,280 $ 74,054 $ 245,297
Income taxes......................................... 8,000 193,554 -- -- --
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Accretion of preferred stock........................... $ -- $ -- $ 15,115 -- $ 45,451
Accrued dividends on preferred stock................... -- -- 281,400 -- 878,594
Capital leases entered into to purchase fixed assets... 170,000 471,000 423,060 -- 2,472,345
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996
1. NATURE OF BUSINESS
Econophone, Inc. ("Econophone") is a switch-based provider of long-distance
telecommunications services in certain major western European and U.S. markets.
Econophone's customer base consists primarily of small- and medium-sized
businesses, ethnic communities, expatriates and carriers, with a focus on
customers with significant international calling needs. In the United Kingdom
and the United States, Econophone provides principally international and
domestic long distance, calling card, prepaid and carrier services. In
continental Europe, Econophone provides principally international long distance,
calling card and prepaid services.
In March 1996, the Company changed its name to Econophone, Inc. from
Switchtel Communications Corp.
Econophone intends to significantly expand its operations in its current
markets and to enter into a number of markets where it currently does not have
operations. Econophone's prospects must, therefore, be considered in light of
the risks, expenses, problems and delays inherent in substantially expanding a
business and in establishing a new business in an evolving industry. The Company
is subject to a number of risks and uncertainties associated with its rapid
growth and current plans for expansion, including, among other things, its
limited operating history and its expectation to incur negative cash flow from
operations for at least the next couple of years and operating and net losses
for at least the next few years. In addition, the Company's dependence on
independent sales agents and resellers, its requirements for substantial capital
expenditures in the future and its current reliance on availability of
telecommunications transmission lines, which is limited, could influence the
Company's future results. (See further discussion included in "Risk Factors").
In April 1997, the Company received bridge financing to support capital
expenditures and general operations (Note 15).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Econophone and
its wholly owned subsidiaries: American Telemedia, Ltd. (England), Econophone,
Ltd. (Ireland), Econophone, Ltd. (Brussels), Econophone France SARL, Econophone
GmbH (Germany), Gemlink (Antwerp), Econophone (Hellas), S.A. (Greece), and its
70% owned subsidiary, Telco Global Communications Ltd. (England) (collectively,
the "Company"). The full amount of the net loss for the year ended December 31,
1996 for Telco Global Communications Ltd. has been recorded in the consolidated
financial statements of the Company. All significant intercompany balances and
transactions have been eliminated in consolidation.
INTERIM FINANCIAL INFORMATION
The unaudited consolidated balance sheet at June 30, 1997 and the
consolidated statements of operations, shareholders' equity and cash flows for
the three months ended June 30, 1997 and 1996 include, in the opinion of
management, all adjustments (consisting of normal recurring adjustments)
necessary to present fairly the Company's financial position and the Company's
results of operations and cash flows.
F-7
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company records revenue based on minutes of service provided. Deferred
revenue consists of unused minutes on prepaid calling cards.
PROPERTY AND EQUIPMENT
Depreciation of property and equipment is computed using the straight-line
method over the estimated useful lives of the respective assets, which range
from three to seven years. Beginning July 1996, the Company adjusted the useful
lives of equipment to be more reflective of their actual usefulness. The change
in estimate was accounted for on a going forward basis. The impact to the 1996
results of operations was not material. Amortization of leasehold improvements
is computed using the straight-line method over the lesser of the lease term or
estimated useful lives of the improvements.
INTERNAL-USE SOFTWARE
The Company capitalizes certain software development costs for internal use.
For the year ended December 31, 1996, the Company incurred approximately
$230,000 of such costs and have included them in Other Assets. The capitalized
software development costs are reported at the lower of unamortized cost or net
realizable value. These costs are amortized on a straight-line basis over the
estimated useful life, generally two years.
LONG-LIVED ASSETS
The Company's policy is to record long-lived assets at cost. In accordance
with Statement of Financial Accounting Standards No. 121 ("SFAS 121"),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," these assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amounts of the assets may
not be reasonable. Furthermore, the assets are evaluated for continuing value
and proper useful lives by comparison to expected future cash projections. At
December 31, 1996, the adoption of SFAS 121 did not have a material effect on
the Company. The Company amortizes these costs over the expected useful life of
the related asset.
INCOME TAXES
Prior to 1996, the Company was an S Corporation for federal and state income
tax purposes and, as a result, the earnings of the Company were taxable directly
to the shareholders. During 1996, the Company changed its tax status to a C
Corporation. In addition to the federal, state and local income taxes, the
F-8
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Company is also liable for New York State taxes as a telephone and transmission
corporation and for New York City General Corporation Tax and Utilities Tax.
In the accompanying financial statements, pro forma income taxes have been
provided for at the expected effective rate as if the Company was a C
Corporation for the years ended December 31, 1994 and 1995.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to be applied to taxable income in the year in which those temporary
differences are expected to be recovered or settled.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," encourages, but does not require
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to continue to account for stock-
based compensation awards to employees and directors using the intrinsic value
method prescribed in Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation cost for stock options awarded to employees and
directors is measured as the excess, if any, of the quoted market price of the
Company's stock at the date of grant over the amount an employee or director
must pay to acquire the stock.
As required, the Company has adopted SFAS No. 123 to account for stock-based
compensation awards to outside consultants and affiliates. Accordingly,
compensation costs for stock option awards to outside consultants and affiliates
is measured at the date of grant based on the fair value of the award using The
Black-Scholes option pricing model. (See Note 13).
FOREIGN CURRENCY EXCHANGE
The financial statements of all foreign subsidiaries were prepared in their
respective local currencies and translated into U.S. dollars based on the
current exchange rate at the end of the period for the balance sheet and a
weighted-average rate for the period on the statement of operations. Translation
adjustments generally are reflected as foreign currency translation adjustments
in the Statement of Stockholders' Equity and, accordingly, have no effect on net
income. Translation adjustments, which were immaterial for the years ended
December 31, 1996 and 1995, are reflected as foreign currency transaction
adjustments in the Statements of Operations. Transaction adjustments for all
foreign subsidiaries are included in income.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year's presentation.
PER SHARE DATA
Per share data is based on the weighted average number of common shares
outstanding and dilutive common equivalent shares assumed to be outstanding
during the period (using the treasury stock method
F-9
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
for dilutive common equivalent shares). Common equivalent shares consist of
options to purchase common stock.
Fully diluted loss per share has not been presented for the outstanding
options as they are anti-dilutive.
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 107 ("SFAS No. 107") entitled "Disclosures About Fair
Value of Financial Instruments," which requires entities to disclose information
about the fair values of their financial instruments.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
LONG AND SHORT-TERM DEBT
The carrying amount of the Company's short-term borrowings approximates fair
value. The fair value of the Company's long-term debt, including current
portions, is determined based on management's estimates of market prices for
similar debt instruments or on the current rates offered to the Company for debt
with similar maturities.
FOREIGN EXCHANGE CONTRACTS
The Company uses foreign exchange contracts from time to time to offset the
effects of exchange rate fluctuations of funds collectible in foreign currencies
in the United Kingdom. The funds are hedged approximately two to four weeks in
advance. This occurs when funds collected in British Pounds Sterling are
collected in the United Kingdom and transferred to the Company. As of December
31, 1996, the Company had no open foreign exchange contracts. As of December 31,
1995, the Company had open foreign exchange contracts totaling approximately
$1,634,000.
F-10
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------- JUNE 30
1995 1996 1997
------------ ------------ -------------
<S> <C> <C> <C>
Equipment......................................... $ 2,998,488 $ 7,189,102 $ 12,110,880
Computer software................................. 66,083 182,963 368,482
Furniture and fixture............................. 35,124 136,399 380,841
Leasehold improvements............................ 116,371 377,159 783,070
------------ ------------ -------------
3,216,066 7,885,623 13,643,273
Less-Accumulated depreciation and amortization.... (634,749) (1,643,151) (2,418,499)
------------ ------------ -------------
Property, equipment and leasehold
improvements, net......................... $ 2,581,317 $ 6,242,472 $ 11,224,774
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
Depreciation expense for the years ended December 31, 1995 and 1996 and for
the six month period ended June 30, 1997 was $366,019, $1,008,402 and $775,348,
respectively.
5. TERRITORIAL RIGHTS
In September 1994, the Company entered into a joint venture with Europhone
International Ltd. ("EI") to jointly market Econophone's services in the United
Kingdom. EI engaged in sales and marketing, while Econophone provided network
support, billing and transmission services.
In connection with the modification of the joint marketing arrangement which
occured in June 1996, EI granted the Company the right to compete with them in
exchange for forgiveness of the net receivable due to the Company of $2,000,000.
The Company has charged this to operations as an expense of the joint venture.
The Company had previously capitalized these territorial rights on the balance
sheet and assigned a fifteen year life to these rights. The effect of this
restatement is an additional $1,922,222 charged to earnings for the year ended
December 31, 1996.
6. OTHER ASSETS
Other assets consist primarily of security deposits and software development
costs.
F-11
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
7. CONCENTRATIONS
CREDIT RISK
The Company's trade accounts receivable are subject to credit risk. Although
diversified due to the large number of customers comprising the geographically
dispersed customer base, the Company does not require collateral or other
security to support its receivables. The Company's total sales and accounts
receivable for the years ended and as of December 31, 1994, 1995, and 1996 can
be detailed as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1994 1995 1996
----------------------- ----------------------- -----------------------
<CAPTION>
ACCOUNTS ACCOUNTS ACCOUNTS
REVENUES RECEIVABLE REVENUES RECEIVABLE REVENUES RECEIVABLE
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
England......................................... $3,143,051 $ 886,593 $14,172,747 $4,621,737 $15,583,016 $2,501,698
United States................................... 2,728,130 136,248 8,292,415 958,572 18,044,513 4,074,424
Belgium......................................... 2,463,407 998,225 4,235,155 1,416,526 9,276,700 1,630,538
Other Europe.................................... 188,023 76,193 790,173 822,909 2,198,653 500,753
---------- ----------- ---------- ----------- ---------- -----------
8,522,611 2,097,289 27,490,490 7,819,744 45,102,882 8,707,414
---------- ----------- ---------- ----------- ---------- -----------
---------- ----------- ---------- ----------- ---------- -----------
</TABLE>
Management does not anticipate incurring losses on its trade receivables in
excess of established allowances based on factors surrounding the credit risk of
specific customers and historical trends.
The revenues of Europhone International, which accounted for greater than
10% of total revenues in each of the past three years, were $15.3 million, $14.2
million and $3.1 million for each of the years ended December 31, 1996, 1995 and
1994, respectively.
SUPPLIER
Sprint Communication, Inc. ("Sprint"), the Company's principal supplier of
telephone lines, has a recorded lien on all accounts receivable of the Company.
This lien is subordinated to the debt owed to Israel Discount Bank of New York
(Note 8). For the years ended December 31, 1995 and 1996, Sprint supplied
approximately $10.2 million and $9.4 million, respectively, of telephone line
usage to the Company. This amount has been included in cost of services.
8. BORROWINGS
At December 31, 1996, the Company was obligated under the following debt
agreements:
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Short-term borrowings:
IDT note (a)...................................... $ 1,176,370 $ -- $ 1,176,370
Sprint note (b)................................... 951,356 -- 951,356
------------ ------------ ------------
$ 2,127,726 $ -- $ 2,127,726
------------ ------------ ------------
------------ ------------ ------------
Long-term debt:
NTFC note (c)..................................... $ 388,302 $ 1,424,945 $ 1,813,247
IDB note (d)...................................... 72,167 -- 72,167
Cable lines (e)................................... 293,412 282,996 576,408
------------ ------------ ------------
$ 753,881 $ 1,707,941 $ 2,461,822
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-12
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
8. BORROWINGS (CONTINUED)
- ------------------------
(a) On October 22, 1996, the Company borrowed $2,896,812 from IDT Corporation
("IDT"). The loan is evidenced by a secured promissory note due October 15,
1997. Interest accrues at a rate of 13% per annum. The collateral securing
repayment of the loan consists of the Company's fixed and intangible assets
as of June 30, 1996. The repayment of the loan commenced on October 31, 1996
with a payment of $1,500,000, and the balance will be comprised of twelve
successive monthly installments. As of December 31, 1996, the Company has
repaid a total of $1,720,442. IDT is also a customer of the Company.
(b) In October 1996, the Company converted a trade payable to Sprint
Communications Company L.P. ("Sprint") into a note payable. Such
indebtedness is evidenced by an unsecured promissory note due March 31,
1997. Interest accrues at a rate of 11% per annum. The repayment of the loan
commenced on October 30, 1996. As of December 31, 1996, the Company repaid a
total of $925,666.
(c) On May 28, 1996, the Company entered into an equipment loan and security
agreement with NTFC Capital Corporation ("NTFC") (as amended, the
"Agreement") permitting the Company to borrow up to $5.0 million to purchase
equipment and pay certain other related expenses. Through March 27, 1997,
$4.8 million has been drawn down under two tranches of the facility to
purchase equipment and to pay certain other related expenses. These tranches
are to be paid in 60 equal monthly installments and mature between July 1,
2001 and April 1, 2002 at an interest rate equal to the 90-day commercial
paper rate plus 395 basis points (9.41% at December 31, 1996), which will be
adjusted quarterly. As of March 31, 1997 $4.5 million of indebtedness was
outstanding under the NTFC Agreement. The NTFC Agreement as amended by the
Second Amendment, dated June 26, 1997, requires Econophone to maintain a
Debt Service Coverage Ratio (as defined therein) for each quarter through
December 31, 1999 of not less than 1.10 to 1.00 and for each fiscal quarter
thereafter of not less than 1.25 to 1.00. In addition, Econophone must
maintain a cash balance of not less than $1,500,000. Econophone also must
have EBITDA (as defined in the NTFC Agreement) of not less than:
($10,000,000) for the fiscal year ending December 31, 1997; ($5,000,000) for
the fiscal year ending December 31, 1998; $3,000,000 for the fiscal year
ending December 31, 1999; $10,000,000 for the fiscal year ending December
31, 2000; and $10,000,000 for the fiscal year ending December 31, 2000.
Prior to the execution and delivery of the Second Amendment, Econophone was
not in compliance with the then existing Debt Service Coverage Ratio,
minimum cash balance and EBITDA requirements of the NTFC Agreement, although
such noncompliance was waived by NTFC. The execution and delivery of the
Second Amendment was a condition to the closing of the Offering.
(d) The Company has an installment note with Israel Discount Bank of New York
("IDB") with a variable interest rate of 2.5% above prime rate (11% at
December 31, 1996). Monthly principal payments of $9,700 are required
through July 15, 1997, with a balloon payment on August 15, 1997. At
December 31, 1996, the Company was in compliance with the requirements to
maintain a compensating balance of 10% of the outstanding debt.
(e) The Company has six notes payable related to the purchase of cable lines.
Three of these notes bear interest at 12%, and mature through September
1998. The remaining three notes bear interest at LIBOR plus 5%, and mature
on June 30, 2001. These notes have quarterly principal and interest payments
ranging from $7,017 to $30,291.
F-13
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
8. BORROWINGS (CONTINUED)
Maturities of long-term debt over the next five years are as follows:
<TABLE>
<S> <C>
1997............................................................ $ 753,881
1998............................................................ 530,939
1999............................................................ 444,447
2000............................................................ 444,447
2001............................................................ 288,108
---------
Total........................................................... $2,461,822
---------
---------
</TABLE>
The Company also has a credit agreement with IDB pursuant to which
Econophone may borrow up to $300,000. Interest accrues on all amounts
outstanding at a rate equal to the prime rate plus 2% per annum. As of December
31, 1996, the Company had no borrowings outstanding against this credit
agreement.
9. TAXES
As a telephone carrier and reseller doing business in New York State, the
Company is required to file annual telephone and transmission tax returns in
accordance with New York State tax laws. These returns include taxes on net
worth, gross sales and gross profit. In addition, each type of tax requires an
additional tax surcharge. The Company also remits federal and state excise taxes
and state and city sales tax. All of these taxes are included in general and
administrative expenses.
As of December 31, 1996, the Company had a net operating loss carryforward
of approximately $6,300,000 which is available to reduce its U.S. federal
taxable income and expires in 2011. A valuation allowance has been established
against this amount due to the uncertainties surrounding the utilization of the
carryforward.
A value added tax "VAT" is a tax charged on goods and services that is
designed to be borne by the ultimate end user of the goods and services.
Pursuant to the Sixth European Commission (the "EC") VAT Directive adopted in
1977 (the "VAT Directive"), providers of telecommunications services in the
European Union are liable for VAT in the EU member state where the provider of
the services is established. The provider, in turn, charges VAT to its customers
at the rate prevailing in the provider's state of establishment. To date, the
collection of VAT by Econophone does not appear to have a material adverse
effect on its ability to attract or retain customers and the collection of VAT
has not required Econophone to reduce its prices to remain competitive.
10. STOCKHOLDERS' EQUITY (DEFICIT)
On November 1, 1996, the Company's Articles of Incorporation were amended to
change all of the authorized shares of Common Stock and Non-Voting Common Stock
from no par value per share to $.0001 per value per share, to increase the
number of shares of authorized Common Stock from 400 shares to 29,250,000
shares, to increase the number of authorized shares of Non-Voting Common Stock
from 19,600 shares to 500,000 shares and to authorize the issuance of 250,000
shares of Preferred Stock (Note 11). Additionally, the Company effected a
recapitalization whereby the outstanding shares of Common Stock were converted
on a 73,125:1 basis.
F-14
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
10. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)
All information contained in the accompanying financial statements and
footnotes has been retroactively restated to give effect to these transactions.
11. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
On November 1, 1996, the Company entered into a Securities Purchase
Agreement (the "Agreement") with Princes Gate Investors II, L.P., an affiliate
of Morgan Stanley & Co., Incorporated, whereby it authorized and issued 140,000
shares of $.01 par value Redeemable Convertible Preferred Stock (the "Series A
Preferred") for a purchase price of approximately $13,061,000, net of issuance
costs. The stated redemption value on the preferred stock is $14,000,000 (or
$100 per share). The Series A Preferred is senior to all other capital stock of
the Company.
The Series A Preferred shall accrue monthly cumulative dividends on each
outstanding share at a rate of $1.00 per month. The accrued and unpaid dividends
shall compound monthly at a rate of 12% per year. The dividends begin to accrue
and compound interest from the issuance date of the preferred stock and cease to
accrue upon the closing of a "High-Yield Offering," as defined in the Agreement.
The mandatory redemption of the Series A Preferred is October 31, 2006. The
redemption shall be in cash.
Each holder of the Series A Preferred shall have the right, at the option of
the holder, to convert any of its shares of Series A Preferred, into a number of
fully paid and nonassessable whole shares of common stock. At any time, any
holder of Series A Preferred Stock may convert all or any portion thereof into
Common Stock of Econophone. As of October 1, 1997, the shares of Series A
Preferred Stock outstanding were convertible into 3,420,701 shares of Common
Stock. Notwithstanding the foregoing, until November 2, 1997, the holders of
Series A Preferred Stock may only convert an aggregate of 100,000 shares of
Series A Preferred Stock. The number of shares of Common Stock that each share
of Series A Preferred Stock is convertible into is equal to the number of shares
of Common Stock outstanding on November 1, 1996 (on a fully diluted basis),
which was 22,564,000, multiplied by a fraction (i) the numerator of which is
equal to the stated value with respect to the shares of Series A Preferred Stock
being so converted, plus any dividends accrued thereon, and (ii) the denominator
of which is equal to $100.0 million plus the number of dollars received by
Econophone since November 1, 1996 from the exercise of specified options or
warrants.
12. RELATED PARTY TRANSACTIONS
The Company has notes payable at December 31, 1995 and 1996 due to various
related parties. These notes are unsecured, and accrue interest at annual rates
ranging from 9% to 18%. The maturities on the notes range from December 8, 1997
to November 15, 1998.
The Company has a non-interest bearing note receivable at December 31, 1996
for approximately $143,000 from a related party.
13. STOCK-BASED COMPENSATION PLANS
On October 31, 1996, the Board of Directors adopted the Econophone, Inc.
1996 Flexible Incentive Plan (the "1996 Plan") and an Incentive Stock Option
Agreement with the Chief Operating and Financial
F-15
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
Officer of the Company. The Company accounts for awards granted to employees and
directors under APB No. 25, under which no compensation cost has been recognized
for stock options granted. Had compensation cost for these stock options been
determined consistent with SFAS No. 123, the Company's net income and earnings
per share would have been reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
1996
-------------
<S> <C>
Net Income:
As Reported $ (8,311,599)
Pro Forma (8,525,201)
Primary EPS:
As Reported (.42)
Pro Forma (.43)
</TABLE>
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts as additional awards in future years are
anticipated.
During 1996, under the 1996 Plan, the Company granted 10,000 options to
outside consultants. All transactions with individuals other than those
considered employees, as set forth within the scope of APB No. 25, must be
accounted for under the provisions of SFAS No. 123. Under SFAS No. 123, the fair
value of the options granted to the consultants as of the date of grant using
the Black-Scholes pricing model is $8,936. The NQSOs (as hereinafter defined)
were granted to the consultants for terms of up to ten years, at an exercise
price of $2.50 and are exercisable in whole or in part at stated times from the
date of grant up to three years from the date of grant. As of December 31, 1996,
none of the options granted to the consultants were exercisable and the expense
recognized in fiscal 1996 relating to these options was $496.
The 1996 Plan authorizes the granting of awards, the exercise of which would
allow up to an aggregate of 3,000,000 shares of the Company's common stock to be
acquired by the holders of said awards. The awards can take the form of
Incentive Stock Options ("ISOs"), Non-qualified Stock Options (NQSOs), Stock
Appreciation Rights ("SARs"), Restricted Stock and Unrestricted Stock. The SARs
may be awarded either in tandem with options or on a stand-alone basis. Awards
may be granted to key employees, directors and consultants. ISOs and NQSOs are
granted in terms not to exceed ten years and become exercisable as set forth
when the award is granted. Options may be exercised in whole or in part. The
exercise price of the ISOs is the market price of the Company's common stock on
the date of grant. The exercise price of NQSOs shall never be less than the par
value of the Company's common stock. Any plan participant who is granted ISOs
and possesses more than 10% of the voting rights of the Company's outstanding
common stock must be granted an option price with at least 110% of the fair
market value on the date of grant and the option must be exercised within five
years from the date of grant. Under the Company's 1996 Plan, ISOs and have been
granted to key employees and directors for terms of up to ten years, at an
exercise price of $2.50, and are exercisable in whole or in part at stated times
from the date of grant up to three years from the date of grant. At December 31,
1996, 226,527 options were exercisable under the Company's 1996 Plan.
F-16
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
Option activity during 1996 is as follows:
<TABLE>
<CAPTION>
1996
---------------------------
<S> <C> <C>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
---------- ---------------
Outstanding at beginning of year.................................. -- --
Granted........................................................... 2,606,500 $ 2.50
Outstanding at end of year........................................ 2,606,500 2.50
----------
----------
Exercisable at end of year........................................ 226,527 2.50
Weighted average fair value of options granted.................... .89
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1996: risk-free interest rate of 6.23 percent;
expected life of three years; expected volatility of 43 percent and expected
dividend yield of zero percent.
The following table summarizes information with respect to stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ --------------------------------
NUMBER WEIGHTED AVERAGE NUMBER
EXERCISE OUTSTANDING AT REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
PRICE 12/31/96 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
- ----------- -------------- ------------------- ----------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
$ 2.50 2,606,500 9.65 $ 2.50 226,527 $ 2.50
</TABLE>
14. COMMITMENTS AND CONTINGENCIES
The Company has various lease agreements for offices, automobiles and other
property. Future minimum annual lease payments under the Company's operating and
capital leases with initial or remaining terms of one year or more at December
31, 1996 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASE
---------- ----------
<S> <C> <C>
1997.................................................................. $ 72,786 $ 130,867
1998.................................................................. 67,686 128,258
1999.................................................................. 51,353 63,450
2000.................................................................. 22,951 28,826
2001.................................................................. 13,728 14,540
---------- ----------
Total minimum lease payments.......................................... $ 228,504 $ 365,941
---------- ----------
---------- ----------
</TABLE>
The rent expense for the year ended December 31, 1996 is $393,904.
The Company has entered into employment agreements with certain officers
which expire by December 31, 1999. The aggregate commitment for future
compensation under these agreements is approximately $1,530,000. These officers
are also eligible for annual bonuses based on performance.
F-17
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
15. SUBSEQUENT EVENTS
On April 24, 1997, the Company authorized the issue and sale of $15.0
million of Senior Secured Increasing Rate Notes (the "Bridge Notes"), due April
24, 1998. The interest rate is 15% per annum for the first six months after the
Commitment Date, 16% per annum for the next three months and 17% per annum
thereafter. The Company will use the net proceeds of the Bridge Notes for
capital expenditures and general corporate purposes, including funding losses.
The Bridge Notes contain certain financial covenants that will restrict the sale
of assets, the incurrence of additional indebtedness and certain investments and
acquisitions by the Company.
On July 1, 1997, the Company authorized the issue and sale of 155,000 Units
(the "Offering"). Each Unit consisted of one 13.5% Senior Note (the "Senior
Notes"), due July 1, 2007 and one Warrant to purchase 8.167 shares of Common
Stock. The Company will use the net proceeds of the Senior Notes for capital
expenditures and general corporate purposes, including funding losses. The
Senior Notes contain certain financial covenants that will affect the sale of
assets, the incurrence of additional indebtedness and certain investments and
acquisitions by the Company.
F-18
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE NOTES TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT WOULD BE UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION
TO SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Available Information........................... 3
Prospectus Summary.............................. 4
Risk Factors.................................... 14
The Exchange Offer.............................. 29
Use of Proceeds................................. 37
Capitalization.................................. 38
Selected Consolidated Financial Data............ 39
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 41
Business........................................ 51
Management...................................... 72
Certain Transactions............................ 78
Description of Certain Indebtedness............. 83
Principal Stockholders.......................... 85
Description of the Exchange Notes............... 86
Certain Federal Income Tax Considerations....... 114
Plan of Distribution............................ 119
Legal Matters................................... 120
Experts......................................... 120
Glossary........................................ G-1
Index to Financial Statements................... F-1
</TABLE>
--------------------------
UNTIL FEBRUARY 3, 1998, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
ECONOPHONE, INC.
OFFER TO EXCHANGE
$155,000,000
OF NEW
13 1/2% SENIOR NOTES DUE 2007
FOR
$155,000,000
OF ANY AND ALL OUTSTANDING
13 1/2% SENIOR NOTES DUE 2007
---------------------
PROSPECTUS
---------------------
THE BANK OF NEW YORK
REORGANIZATION SECTION
101 BARCLAY STREET, FLOOR 7 EAST
NEW YORK, NEW YORK 10286
ATTN: SHILPA TRIVEDI
TELEPHONE:(212) 815-5789
FACSIMILE:(212) 815-6339
NOVEMBER 4, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article Sixth of the Certificate of Incorporation, as amended, provides for
indemnification of directors and officers to the fullest extent permitted by the
relevant provisions of the Business Corporation Law of the State of New York
(the "BCL"). The BCL permits a corporation to limit or eliminate a director's or
officer's personal liability to the corporation or the holders of its capital
stock for breach of duty. This limitation is generally unavailable for acts or
omissions by a director or officer which were (i) in bad faith, (ii) were the
result of active and deliberate dishonesty and were material to the cause of
action so adjudicated or (iii) involved a financial profit or other advantage to
which such director was not legally entitled. The Certificate of Incorporation
and the BCL also prohibit limitations on director or officer liability for acts
or omissions which resulted in a violation of a statute prohibiting certain
dividend declarations, certain payments to stockholders after dissolution and
particular types of loans. The effect of these provisions is to eliminate the
rights of Econophone and its stockholders (through stockholders' derivative
suits on behalf of Econophone) to recover monetary damages against a director or
officer for beach of fiduciary duty as a director (including breaches resulting
from grossly negligent behavior), except in the situations described above.
These provisions will not limit the liability of directors or officer under the
federal securities laws of the United States. Article Sixth of Econophone's
Certificate of Incorporation, as amended, is qualified in its entirety by
reference to the relevant provisions of the Certificate of Incorporation (filed
as Exhibit 3.1)
See Item 22 for a statement of the Company's undertaking as to the
Securities and Exchange Commission's position respecting indemnification arising
under the Securities Act of 1933.
II-1
<PAGE>
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -------------------------------------------------------------------------------------------------------
<S> <C>
3.1* Certificate of Incorporation of Econophone, Inc., as amended.
3.2* Amended and Restated Bylaws of Econophone, Inc.
4.1* Securityholders Agreement, dated as of November 1, 1996, between Alfred West, Econophone, Inc. and
Princes Gate Investors II, L.P.
4.2* Note Purchase Agreement, dated as of April 24, 1997, between Econophone, Inc. and Morgan Stanley Group
Inc.
4.3* Form of Note under Note Purchase Agreement.
4.4* Specimen of Econophone, Inc.'s 13 1/2% Senior Note due 2007.
4.5* Indenture, dated as of July 1, 1997, between Econophone, Inc. and The Bank of New York, as Trustee.
4.6* Notes Registration Rights Agreement, dated July 1, 1997, between Econophone, Inc. and Morgan Stanley &
Co., Incorporated.
4.7* Warrant Agreement, dated as of July 1, 1997, between Econophone, Inc., and The Bank of New York, as
Warrant Agent, containing as an exhibit, specimen of Warrant Certificate.
4.8* Warrant Registration Rights Agreement, dated as of July 1, 1997, between Econophone, Inc. and Morgan
Stanley & Co. Incorporated.
4.9* Collateral Pledge and Security Agreement, dated July 1, 1997, between Econophone, Inc. and The Bank of
New York, as Trustee and Custodian.
5.1* Opinion of Schulte Roth & Zabel LLP regarding legality.
8.1* Opinion of Schulte Roth & Zabel LLP regarding tax matters (contained in Exhibit 5.1).
10.1* Securities Purchase Agreement, dated as of November 1, 1996, between Econophone, Inc. and Princes Gate
Investors II, L.P.
10.2* Placement Agreement, dated June 26 1997, between Econophone, Inc. and Morgan Stanley & Co.
Incorporated, as Placement Agent.
10.3* Amended and Restated Equipment Loan and Security Agreement, dated as of March 27, 1997, between
Econophone, Inc. and NTFC Capital Corporation ("NTFC").
10.4* First Amendment to Amended and Restated Equipment Loan and Security Agreement, dated as of April 24,
1997, among Econophone, Inc., American Telemedia, Ltd. and NTFC.
10.5* Second Amendment to Amended and Restated Equipment Loan and Security Agreement, dated as of June 26,
1997, among Econophone, Inc., American Telemedia, Ltd. and NTFC.
10.6* Third Amendment to Amended and Restated Equipment Loan and Security Agreement, dated as of August 7,
1997, among Econophone, Inc., American Telemedia, Ltd. and NTFC.
10.7* Promissory Note, dated May 28, 1996, from Econophone, Inc. to NTFC.
10.8* Promissory Note, dated March 27, 1997, from Econophone, Inc. to NTFC.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -------------------------------------------------------------------------------------------------------
<S> <C>
10.9* Stock Pledge Agreement, dated March 27, 1997, between Alfred West and NTFC Capital Corporation.
10.10* Stock Pledge Agreement, dated March 27, 1997, between Steven West and NTFC Capital Corporation.
10.11* Stock Pledge Agreement, dated March 27, 1997, between Gary Bondi and NTFC Capital Corporation.
10.12* Employment Agreement, dated August 1, 1996, between Econophone, Inc. and Alan Levy, as amended October
31, 1996.
10.13* Employment Agreement, dated January 1, 1997, between Econophone, Inc. and Alfred West.
10.14* Amended and Restated Econophone, Inc. 1996 Flexible Incentive Plan.
10.15* Lease, dated January 31, 1997, between Paramount Group, Inc. (45 Broadway Limited Partnership) and
Econophone, Inc.
12.1* Statement of Computation of the Ratios of Earnings to Fixed Charges.
21.1* Subsidiaries of Econophone, Inc.
23.1 Consent of Arthur Andersen LLP.
23.2* Consent of Schulte Roth & Zabel LLP (contained in Exhibit 5.1).
25.1* Statement of Eligibility and Qualification (Form T-1) under the Trust Indenture Act of 1939 of The Bank
of New York.
27.1* Financial Data Schedule.
99.1* Form of Letter of Transmittal.
99.2* Notice of Guaranteed Delivery.
</TABLE>
- ------------------------
* Previously filed.
(b) Financial Statement Schedules.
Schedule II - Schedule of Valuation and Qualifying Accounts (included at
page S-1)
ITEM 22. UNDERTAKINGS
A. The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in
II-3
<PAGE>
the aggregate, the changes in volume and price represent no more than a
20 percent change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(4) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
(5) That every prospectus: (i) that is filed pursuant to paragraph (4)
immediately proceeding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Act and is used in connection with an offering of
securities subject to Rule 415, will be filed as a part of an amendment to
the registration statement and will not be used until such amendment is
effective, and that, for purposes of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
(6) To respond to requests for information that is incorporated by
reference into the prospectus pursuant to Item 4, 10(b), 11 or 13 of this
form, within one business day of receipt of such request, and to send the
incorporated documents by first class mail or other equally prompt means.
This includes information contained in documents filed subsequent to the
effective date of the registration statement through the date of responding
to the request.
(8) To supply by means of post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the registration statement when
it became effective.
B. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of New York, State of New
York on the fourth day of November, 1997.
<TABLE>
<S> <C> <C>
ECONOPHONE, INC.
By: /s/ ALAN L. LEVY
-----------------------------------------
Alan L. Levy
President, Chief Financial Officer
and Chief Operating Officer
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, the Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
Chief Executive Officer
/s/ ALFRED WEST and Chairman of the
- ------------------------------ Board of Directors November 4, 1997
Alfred West (Principal Executive
Officer)
President, Chief Financial
/s/ ALAN L. LEVY Officer, Chief Operating
- ------------------------------ Officer and Director November 4, 1997
Alan L. Levy (Principal Financial and
Accounting Officer)
/s/ GARY S. BONDI
- ------------------------------ Director and Treasurer November 4, 1997
Gary S. Bondi
/s/ STEVEN WEST
- ------------------------------ Director November 4, 1997
Steven West
II-5
<PAGE>
SCHEDULE II
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
CHARGES
BALANCE AT TO COSTS BALANCE AT
BEGINNING AND DEDUCTIONS END OF
OF PERIOD EXPENSES (A) PERIOD
---------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
December 31,
1996................................................. $ 470,610 $ 290,762 -- $ 761,372
1995................................................. 268,730 721,215 (519,335) 470,610
1994................................................. 118,604 420,126 (270,000) 268,730
June 30,
1997................................................. 761,372 -- -- 761,372
</TABLE>
- ------------------------
(a) Represents writeoffs, recoveries and other deductions.
S-1
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report (and to all references to our Firm) included in or made a part of this
Amendment No. 3 to Form S-4.
/s/ ARTHUR ANDERSEN LLP
New York, New York
November 4, 1997
