<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20529
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------- -------------
Commission File Number 333-33117
ECONOPHONE, INC.
------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 11-3132722
------------------------ ----------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
45 Broadway, 30th floor, New York, N.Y. 10006
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 444-6991
Not applicable
----------------------------------------------------
(Former address of principal executive offices) (Zip Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES ( X) NO ( )
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT JULY 31, 1998
------------------------------- -------------------------------------
Common Stock, $.01 par value 20,000,000
Non-Voting Common Stock, $.01 par value 56,000
1
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
1998 SECOND QUARTER REPORT ON FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Statement of Operations
Three and Six months ended June 30, 1998 and June 30, 1997
(unaudited) 3
Condensed Consolidated Balance Sheets -
June 30, 1998 (unaudited) and December 31,
1997 (derived from audited financial statements) 4
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 1998 and June 30, 1997
(unaudited)
5
Notes to Condensed Consolidated Financial
Statements (unaudited) 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
</TABLE>
2
<PAGE>
Part 1. Financial Information
Item 1. Condensed Consolidated Financial Statements and notes thereto
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands except basic loss per share)
(unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1997 1998 1997 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES $ 16,997 $ 48,754 $ 30,446 $ 90,414
COST OF SERVICES 13,322 35,585 24,012 67,041
-------- -------- -------- --------
Gross profit 3,675 13,169 6,434 23,373
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 7,741 19,272 12,896 34,756
DEPRECIATION AND AMORTIZATION 634 2,424 1,069 4,102
-------- -------- -------- --------
Loss from operations (4,700) (8,527) (7,531) (15,485)
OTHER INCOME (5) (196) 86 (269)
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net (22) (2) (28) 114
INTEREST EXPENSE, net (169) (6,597) (285) (12,276)
-------- -------- -------- --------
Net loss ($ 4,896) ($15,322) ($ 7,758) ($27,916)
-------- -------- -------- --------
-------- -------- -------- --------
BASIC LOSS PER SHARE ($ 0.27) ($ 0.77) ($ 0.43) ($ 1.40)
-------- -------- -------- --------
-------- -------- -------- --------
WEIGHTED AVERAGE NUMBER OF BASIC COMMON
SHARES OUTSTANDING 20,000 20,000 20,000 20,000
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
3
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, JUNE 30,
------ 1997 1998
------------ --------
(see note) (unaudited)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 67,202 $ 45,086
Marketable securities -- 134,956
Accounts receivable, net of allowance for doubtful accounts
of $1,594 and $4,838, respectively 16,796 29,291
Prepaid expenses and other current assets 1,868 4,637
Restricted cash and securities 10,463 9,591
--------- ---------
Total current assets 96,329 223,561
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, net of
accumulated depreciation and amortization of $3,690 and $6,561, 23,217 55,991
respectively
Debt issuance costs 6,355 12,947
Intangibles -- 20,613
Other assets 3,139 2,059
Restricted cash and securities 48,965 40,065
--------- ---------
Total assets $ 178,005 $ 355,236
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
---------------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 21,100 $ 26,495
Accrued expenses and other current liabilities 5,357 21,479
Interest accrued on Senior Notes 10,463 9,591
Current maturities of long-term debt 1,829 2,608
Current maturities of obligations under capital lease 156 141
Current maturities of notes payable - related party 315 308
Deferred revenue 2,568 4,083
--------- ---------
Total current liabilities 41,787 64,705
LONG-TERM DEBT 5,657 4,816
OBLIGATIONS UNDER CAPITAL LEASE 279 202
SENIOR NOTES 1997 149,680 149,960
SENIOR DISCOUNT NOTES 1998 -- 183,112
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK 14,328 14,373
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock-voting, par value $.0001 at December 31, 1997 and $.01 at
June 30, 1998; authorized 29,250,000 shares;
20,000,000 shares issued and outstanding in 1997 and 1998 2 200
Non-Voting common stock, par value $.0001 at December 31,
1997 and $.01 at June 30, 1998; authorized 500,000 shares; -- --
no shares issued and outstanding
Additional paid-in capital 6,082 5,895
Accumulated other comprehensive income (104) (360)
Retained earnings (deficit) (39,706) (67,667)
--------- ---------
Total stockholders' equity (deficit) (33,726) (61,932)
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 178,005 $ 355,236
--------- ---------
--------- ---------
</TABLE>
Note: The December 31, 1997 Balance Sheet is derived from audited financial
statements.
4
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six months ended June 30,
1997 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 7,758) ($ 27,916)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,069 4,102
Provision for doubtful accounts -- 3,244
Accreted interest expense -- 7,645
Changes in assets and liabilities:
Increase in accounts receivable (4,841) (15,739)
Increase in prepaid expenses and
other current assets (781) (2,769)
Increase/decrease in other assets (798) 501
Increase in accounts payable, accrued
expenses and other current liabilities 4,761 20,646
Increase in deferred revenue 650 1,515
--------- ---------
Net cash used in operating activities (7,698) (8,771)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (3,285) (35,645)
Net cash paid for acquisition -- (20,980)
Purchase of marketable securities -- (134,956)
--------- ---------
Net cash used in investing activities (3,285) (191,581)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bridge loan 7,000 --
Repayments of short-term borrowings (1,642) --
Proceeds from long-term debt 119 922
Repayments of long-term debt -- (984)
Repayments of notes payable - related party (6) (7)
Repayments of capital leases (128) (92)
Proceeds from senior discount notes -- 175,785
Payment of debt issuance costs -- (7,159)
--------- ---------
Net cash provided by financing activities 5,343 168,465
--------- ---------
(Decrease) in cash and cash equivalents,
(including restricted cash) (5,640) (31,887)
Cash and cash equivalents, beginning of period
(including restricted cash) 6,272 126,629
--------- ---------
Cash and cash equivalents, end of period
(including restricted cash) $ 632 $ 94,742
--------- ---------
--------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 245 $ 11,710
SUPPLEMENTAL DISCLOSURE OF NONCASH
ACTIVITIES:
Accretion of preferred stock $ 45 $ 46
Accrued dividends on preferred stock 879 --
Capital leases executed 2,472 --
DETAILS OF ACQUISITION:
Fair value of assets acquired -- (1,068)
Goodwill -- (20,613)
Liabilities assumed -- 701
--------- ---------
Net cash paid for acquisition -- ($ 20,980)
--------- ---------
--------- ---------
</TABLE>
5
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note A -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
of Econophone, Inc. ("Econophone" or the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted, although management
believes that the disclosures herein are adequate to make the information
presented not misleading. It is suggested that these financial statements be
read in conjunction with Econophone's audited annual consolidated financial
statements. In the opinion of management, all adjustments (consisting of only
normal recurring adjustments) considered necessary for a fair presentation have
been included. Certain reclassifications have been made to 1997 information to
conform to the presentation used in 1998. Operating results for the three-month
or six-month period ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998.
Note B -- Senior Discount Notes
Econophone consummated on February 18, 1998 its offering of $300.0
million aggregate principal amount at maturity of Senior Discount Notes (the
"1998 Notes"). The net proceeds of the offering were approximately $168.6
million. Each 1998 Note has a principal amount at maturity of $1,000 and an
initial value of $585.95. The 1998 Notes will fully accrete to face value on
February 15, 2003. The 1998 Notes mature on February 15, 2008. Interest on the
1998 Notes will be paid in cash at a rate of 11% per annum on February 15 and
August 15 of each year, beginning August 15, 2003. On or after February 15,
2003, the 1998 Notes will be redeemable at the option of the Company, in whole
or in part, at specified redemption prices plus accrued and unpaid interest, if
any. In addition, prior to February 15, 2001, up to 35% of the aggregate
principal amount of the 1998 Notes may be redeemed at 111% of their accreted
value with the proceeds of one or more public equity offerings. On April 24,
1998 the Company consummated an exchange offer for the 1998 Notes pursuant to
which holders of the 1998 Notes were entitled to exchange the 1998 Notes for
registered notes having terms identical to the 1998 Notes.
Note C - VoiceNet Acquisition
On February 12, 1998 the Company acquired VoiceNet Corporation, a major
distribution channel for the Company's calling card products. The initial
purchase price was $21.0 million, which was paid in cash. The sellers of
VoiceNet also are entitled to receive an earn-out based upon the revenue growth
of the VoiceNet business. Econophone has provided substantially all of
VoiceNet's transmission, billing and customer service functions since the
inception of the business relationship in April 1996.
The acquisition of VoiceNet has been accounted for under the purchase
method of accounting. Goodwill was recorded to the extent the purchase price
exceeded the fair value of the net assets purchased. Approximately $.4 million
of the initial purchase price reflects the underlying value of the assets
acquired and $20.6 million reflects goodwill. Goodwill is being amortized over
20 years. The pro forma effect of the acquisition is not material for the
six-month period ended June 30, 1998.
Note D - Telco Minority Interest
In the United Kingdom, the majority of Econophone's sales are made
through Telco Global Communications ("Telco"), its majority owned subsidiary
that was established during the fourth quarter of 1996. Telco's revenues are
derived primarily from international and domestic long distance services and the
sale of prepaid cards. On July 17, 1998, the Company acquired the 30% minority
interest in Telco in exchange of approximately $14.0 million in cash, payable by
the Company in quarterly installments, together with interest at a rate of 8.0%
per annum, over approximately three years. In addition, in connection with such
acquisition, (i) Telco obtained ownership rights with respect to certain
proprietary software used in Telco's business and (ii) the Company exchanged
options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock.
6
<PAGE>
Note E - Cash and Cash Equivalents
Cash equivalents consist of highly liquid investments with a maturity
of less than three months when purchased.
Note F - Comprehensive Income
Effective March 31, 1998, Econophone adopted Statement of Financial
Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive Income", which
establishes standards for reporting and display of comprehensive income and its
components (revenue, expenses, gains, and losses) in a full set of
general-purpose financial statements. For the six months ended June 30, 1998,
the components of other comprehensive income were immaterial. The components of
other comprehensive income consist primarily of foreign currency translation
adjustments.
Note G - Change in State of Incorporation
In February 1998, the New York corporation "Econophone, Inc." was
merged into its wholly-owned subsidiary named "Econophone, Inc." which had been
incorporated in the State of Delaware for the sole purpose of changing the state
of incorporation of the Company. The Delaware corporation was the surviving
entity in the merger. In connection with the foregoing, the par value of the
Company's common stock was changed to $.01 per share of voting and non-voting
common stock.
Note H -- Per Share Data
Per share data is based on the standards of SFAS No. 128 "Earnings Per
Share", which requires the presentation of basic EPS and diluted EPS. Basic EPS
is calculated by dividing income available to common shareholders by the
weighted average number of shares of common stock outstanding during the period.
Income available to shareholders is calculated as net income less dividends on
preferred stock, which in the second quarter and six-month period ended June 30,
1997 was approximately $446,000 and $879,000, respectively. Diluted EPS has not
been presented since the inclusion of outstanding options would be antidilutive.
Note I -- Retained Earnings
The change in retained earnings reflects net loss for the period, as
well as the accretion of preferred stock, which was approximately $22,000 and
$23,000 for the quarters ended June 30, 1997 and June 30, 1998, and
approximately $45,000 for both the six-month periods ended June 30, 1997 and
June 30, 1998.
7
<PAGE>
Item 2. 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 and the notes thereto included in the annual
report on Form 10-K for the year ended December 31, 1997 filed by Econophone
pursuant to the requirements of the Securities Exchange Act of 1934. Certain of
the matters discussed in this item may constitute forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. Forward-looking statements are
statements other than historical information or statements of current condition.
Some forward-looking statements may be identified by use of terms such as
"believes", "anticipates", "intends" or "expects". These forward-looking
statements relate to the plans, objectives and expectations of Econophone for
future operations and its business and the telecommunications industry
generally. In light of the risks and uncertainties inherent in all future
projections, the inclusion of forward-looking statements in this report should
not be regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved. The Company's revenues and
results of operations are difficult to forecast and could differ materially from
those projected in the forward-looking statements as a result of numerous
factors affecting one or more of the Company's markets, including the following:
(i) inaccuracies in the Company's forecasts of traffic or customers; (ii) highly
competitive market conditions; (iii) changes in or developments under laws,
regulations, licensing requirements or telecommunications standards; (iv)
changes in the availability of transmission facilities; (v) loss of a customer
which provides significant revenues to the Company; (vi) concentration of credit
risk; (vii) foreign currency fluctuations; (viii) loss of the services of key
officers, such as Alfred West, the Chairman and Chief Executive Officer, or Alan
L. Levy, the President and Chief Operating Officer or (ix) changes in
international settlement rates. The foregoing review of important factors should
not be construed as exhaustive. The Company undertakes no obligation to release
publicly the results of any future revisions it may make to any forward-looking
statement to reflect events or circumstances after the date hereof, including
the occurrence of unanticipated events.
Overview
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. Econophone's
customer base consists primarily of residential customers, small- and
medium-sized businesses and other telecommunications carriers. Econophone
currently offers a broad portfolio of telecommunications services including
international and domestic long distance, calling card, prepaid and wholesale
services in the United States, the United Kingdom and in selected markets in
continental Europe.
Econophone's strategy is to: (i) expand into additional geographic
markets in Continental Europe, the United Kingdom, the United States and Canada,
with a focus on markets that generate substantial international calling traffic;
(ii) add customers in its existing markets; (iii) migrate additional switched
traffic onto its expanding network and (iv) 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.
Econophone consummated on February 18, 1998 its offering of $300.0
million aggregate principal amount at maturity of Senior Discount Notes (the
"1998 Notes"). The net proceeds of the offering were approximately $168.6
million. The 1998 Notes mature on February 15, 2008. The net proceeds from the
offering are expected to be used primarily for the purchase of
telecommunications equipment and indefeasible rights of use ("IRUs").
Results of Operations
Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997
<TABLE>
<CAPTION>
Quarter Ended June 30,
1997 1998 % Change
------- ------- --------
(in thousands)
<S> <C> <C> <C>
Revenue
United States $10,392 $26,007 150%
United Kingdom 2,829 17,849 531%
Continental Europe 3,776 4,898 30%
------- ------- --------
Total $16,997 $48,754 187%
------- ------- --------
------- ------- --------
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended June 30,
1997 1998 % Change
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Billable minutes
of use
United States 49,582 121,653 145%
United Kingdom 7,350 80,324 993%
Continental Europe 3,424 9,468 177%
------- ------- -------
Total 60,356 211,445 250%
------- ------- -------
------- ------- -------
</TABLE>
Revenues. Revenues for the three months ended June 30, 1998 increased
187% to $48.8 million from $17.0 million for the three months ended June 30,
1997. Billable minutes of use increased 250% to 211.4 million in the current
quarter from 60.4 million in the comparable prior year quarter. The year-to-year
revenue increase was primarily attributable to strong customer growth in both
the United States and United Kingdom markets. The number of customers serviced
by the Company increased to approximately 234,000 at June 30,1998 from
approximately 66,000 at June 30,1997. Revenues for all products increased
substantially from the second quarter of 1997 to the second quarter of 1998. The
increase in revenues resulting from the growth in billable minutes was partially
offset by per-minute price reductions caused by increased competition, most
notably in the U.K. market.
Gross Profit. The gross profit margin of 27.0% reported for the quarter
ended June 30, 1998 increased 5.4% from the 21.6% achieved in the quarter ended
June 30, 1997. This increase was due to lower per-minute network costs and an
increase in the percentage of revenue derived from the higher margin U.K. and
Continental European markets, partially offset by price reductions occurring
primarily in the U.K. and Continental European markets. Network expansion and
increased utilization of transmission capacity contributed to lower per-minute
costs.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the second quarter of 1998 were $19.3 million,
representing 39.5% of revenue, compared to $7.7 million in the second quarter of
1997, or 45.5% of revenue. The decrease in selling, general and administrative
expenses as a percentage of revenues during the second quarter of 1998 was
primarily attributable to the significant increase in revenues from the second
quarter of the prior year.
Depreciation and amortization. Depreciation and amortization expenses
increased to $2.4 million for the three months ended June 30, 1998 from $.6
million for the three months ended June 30, 1997. This increase was
substantially due to the continuing build-out of the Company's network in the
United States, the United Kingdom and Continental Europe and amortization of
costs associated with the Company's issuance of $155.0 million aggregate
principal amount of 13-1/2% Senior Notes on July 1, 1997 (the "1997 Notes") and
the 1998 Notes and the amortization of goodwill from the purchase of
VoiceNet Corporation.
Interest expense, net. Interest expense increased to $10.4 million in
the second quarter of 1998 from $.3 million in the prior year comparable
quarter. This increase was attributable to the issuance of the 1997 Notes and
the 1998 Notes. Interest income increased to $3.8 million in the second quarter
of 1998 from less than $.1 million in the second quarter of 1997. This increase
was primarily due to interest income earned on the investment of the net
proceeds received in connection with these offerings.
Net loss. The Company reported a net loss of $15.3 million for the
second quarter of 1998, compared to a net loss of $4.9 million for the second
quarter of 1997. The increase is primarily due to the higher level of selling,
general and administrative expenses and higher debt service costs.
9
<PAGE>
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
<TABLE>
<CAPTION>
Six Months Ended June 30,
1997 1998 % Change
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Revenue
United States $18,896 $47,045 149%
United Kingdom 4,201 33,887 707%
Continental Europe 7,349 9,482 29%
------- ------- -------
Total $30,446 $90,414 197%
------- ------- -------
------- ------- -------
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
1997 1998 % Change
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Billable minutes of use
United States 87,747 212,300 142%
United Kingdom 10,136 140,566 1287%
Continental Europe 6,732 17,305 157%
------- ------- -------
Total 104,615 370,171 254%
------- ------- -------
------- ------- -------
</TABLE>
Revenues. Revenues for the six months ended June 30, 1998 increased
197% to $90.4 million from $30.4 million for the six months ended June 30, 1997.
Billable minutes of use increased 254% to 370.2 million in the first six months
of 1998, from 104.6 million in the comparable prior year six month period. The
year-to-year revenue increase was primarily attributable to strong customer
growth in both the United States and United Kingdom markets. Revenues for all
products increased substantially from the first half of 1997 to the first half
of 1998. The increase in revenues resulting from the growth in billable minutes
was partially offset by per-minute price reductions caused by increased
competition, most notably in the U.K. market.
Gross Profit. The gross profit margin of 25.9% reported for the
six-month period ended June 30, 1998 increased 4.8% from the 21.1% achieved in
the six-month period ended June 30, 1997. This increase was due to lower
per-minute network costs and an increase in the percentage of revenue derived
from the higher margin U.K. and Continental European markets, partially offset
by price reductions occurring primarily in the U.K. and Continental European
markets. Network expansion and increased utilization of transmission capacity
contributed to lower per-minute costs.
Selling, general and administrative expenses. Selling, general and
administrative expenses for the first half of 1998 were $34.8 million,
representing 38.4% of revenue, compared to $12.9 million in the first half of
1997, or 42.4% of revenue. The decrease in selling, general and administrative
expenses as a percentage of revenues during the first half of 1998 was primarily
attributable to the significant increase in revenues from the first half of the
prior year.
Depreciation and amortization. Depreciation and amortization expenses
increased to $4.1 million for the six-month period ended June 30, 1998 from $1.1
million for the six-month period ended June 30, 1997. This increase was
substantially due to the continuing build-out of the Company's network in the
United States, the United Kingdom and Continental Europe and amortization of
costs associated with the Company's issuance of $155.0 million aggregate
principal amount of 13-1/2% Senior Notes on July 1, 1997 (the "1997 Notes") and
the 1998 Notes and the amortization of goodwill from the purchase of
VoiceNet Corporation.
Interest expense, net. Interest expense increased to $18.5 million in
the first half of 1998 from $.4 million in the prior year comparable period.
This increase was attributable to the issuance of the 1997 Notes and the 1998
Notes. Interest income increased to $6.2 million in the first half of 1998 from
$.1 million in the comparable period of 1997. This increase was primarily due to
interest income earned on the investment of the net proceeds received in
connection with these offerings.
Net loss. The Company reported a net loss of $27.9 million for the
six-month period ended June 30, 1998, compared to a net loss of $7.8 million for
the comparable period of 1997. The increase is primarily due to the higher level
of selling, general and administrative expenses and higher debt service costs.
10
<PAGE>
Liquidity and Capital Resources
Econophone consummated on February 18, 1998 its offering of the 1998
Notes. The net proceeds of the offering were approximately $168.6 million. Each
1998 Note has a principal amount at maturity of $1,000 and an initial value of
$585.95. The 1998 Notes will fully accrete to face value on February 15, 2003.
The 1998 Notes mature on February 15, 2008. Interest on the 1998 Notes will be
paid in cash at a rate of 11% per annum on February 15 and August 15 of each
year, beginning August 15, 2003. On or after February 15, 2003, the 1998 Notes
will be redeemable at the option of the Company, in whole or in part, at
specified redemption prices plus accrued and unpaid interest, if any. In
addition, prior to February 15, 2001, up to 35% of the aggregate principal
amount of the 1998 Notes may be redeemed at 111% of their accreted value with
the proceeds of one or more public equity offerings. On April 24, 1998 the
Company consummated an exchange offer for the 1998 Notes pursuant to which
holders of the 1998 Notes were entitled to exchange the 1998 Notes for
registered notes having terms identical to the 1998 Notes.
On February 12, 1998 the Company acquired VoiceNet Corporation, a major
distribution channel for the Company's calling card products. The initial
purchase price was $21.0 million, which was paid in cash. The sellers of
VoiceNet also are entitled to receive an earn-out based upon the revenue growth
of the VoiceNet business. Econophone has provided substantially all of
VoiceNet's transmission, billing and customer service functions since the
inception of the business relationship in April 1996.
At June 30, 1998, Econophone had approximately $45.1 million in cash
and cash equivalents and $135.0 million in marketable securities, compared to
$67.2 million in cash and cash equivalents and $0 in marketable securities at
December 31, 1997. Econophone's net cash used by operating activities was $8.8
million for the six months ended June 30, 1998, and was primarily attributable
to a net loss of $27.9 million and an increase in accounts receivable of $15.7
million, partially offset by an increase in accounts payable of $20.6 million.
Cash used in investing activities of $191.6 million for the six months ended
June 30, 1998 was attributable to the purchase of marketable equity securities,
investments made primarily in switching and other telecommunications equipment
and IRUs and the VoiceNet acquisition. Cash provided by financing activities of
$168.5 million was primarily related to the proceeds aggregating $175.8 million
that were received in connection with the issuance of the 1998 Notes, partially
offset by payments of debt issuance costs related to the offering of $7.2
million.
Econophone currently expects capital expenditures during 1998 to range
between $50 million and $100 million, of which $35.6 million was expended during
the first six months of 1998. These investments will be made principally to
support the continued growth of Econophone's network, including the purchase of
telecommunications equipment and the purchase of additional transatlantic IRUs,
as well as the continued development of Econophone's back office capabilities,
including its management information and network management systems. In
addition, the Company may pursue acquisitions, joint ventures and other similar
alliances with telecommunications companies or complementary businesses.
Econophone's actual capital expenditures and cash requirements will
depend on numerous factors, including the nature of future expansion, the
availability of opportunities to acquire additional network infrastructure,
economic conditions, competition, regulatory developments and the ability to
incur debt and make capital expenditures under the terms of the 1997 Notes and
1998 Notes and the agreement with respect to its equipment financing from NTFC
Capital Corporation.
Econophone intends to fund its capital expenditures for the foreseeable
future with the proceeds remaining from the issuance of the 1997 Notes and 1998
Notes and, to the extent available on attractive terms, vendor or other
third-party financing. The Company, however, may require substantial amounts of
additional capital. There can be no assurance that such capital will be
available when necessary and, if available, on terms favorable to the Company.
11
<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 1997 and
1998 Notes is in U.S. dollars. For the first six months of 1998 and 1997,
approximately 46% and 37%, respectively, of Econophone's revenues were billed in
currencies other than the U.S. dollar, consisting primarily of British pounds
and Belgian francs. The effect of these fluctuations on Econophone's revenues
for the six months ended June 30, 1998 and 1997 was immaterial. 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 trade accounts receivables to hedge
foreign currency exposure and to control risks relating to currency
fluctuations. Econophone does not use derivative financial instruments for
speculative purposes. At June 30, 1998 and 1997, Econophone had no open foreign
currency hedging positions.
New Accounting Pronouncements
In June 1997, Statement of Financial Accounting Standards (SFAS) No.
130 -"Reporting Comprehensive Income" and SFAS No. 131 -"Disclosures about
Segments of an Enterprise and Related Information" were issued and are effective
for periods beginning after December 15, 1997, although SFAS No. 131 is not
required for interim reporting. SFAS No. 130 establishes standards for reporting
comprehensive income and its components. SFAS No. 131 establishes standards for
reporting financial and descriptive information regarding an enterprise's
operating segments. These standards increase disclosure only and will have no
impact on the Company's financial position or results of operations.
Year 2000 Compliance
The Company is currently in the process of identifying, evaluating and
implementing changes to computer programs necessary to address the year 2000
issue which is the result of computer programs having been written using two
digits instead of four to define a year. This issue affects computer systems
that have date sensitive programs that may recognize a date using "00" as 1900
rather than 2000. Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail, resulting in business
interruption. Because the Company is still in the process of identifying and
evaluating the necessary changes to its systems, the reasonably likely worst
case scenario arising from such failures is not clear. The Company does not
believe, however, that the cost of converting all internal systems
to be year 2000 compliant will be material to its financial condition or
results of operations. Costs related to the year 2000 issue are being expensed
as incurred.
The year 2000 issue is expected to affect the systems of various
entities with which the Company interacts. However, there can be no assurance
that the systems of other companies on which the Company's systems rely will be
timely converted, or that a failure by another company's systems to be year 2000
compliant would not have a material adverse effect on the Company.
12
<PAGE>
PART II - Other Information
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
In connection with the Company's acquisition of the minority interest
in its United Kingdom subsidiary, Telco Global Communications Limited ("Telco")
and the exchange of employee options in connection therewith, the holders of all
of the outstanding shares of the Company's common stock voted by unanimous
written consent dated July 14, 1998 to amend the Company's 1996 Flexible
Incentive Plan in order to facilitate the conversion of Telco employee options
to acquire Telco shares into non-voting restricted shares of common stock of the
Company. Such non-voting restricted shares may be converted into voting shares
of common stock following an initial public offering of the Company's common
stock upon payment of a nominal exercise price.
Item 5. Other Information
On July 17, 1998, the Company acquired the 30% minority interest in
Telco in exchange of approximately $14.0 million in cash, payable by the Company
in quarterly installments, together with interest at a rate of 8.0% per annum,
over approximately three years. In addition, in connection with such
acquisition, (i) Telco obtained ownership rights with respect to certain
proprietary software used in Telco's business and (ii) the Company exchanged
options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock. See Item 4.
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits - Exhibit 27.1 Financial Data Schedule.
(b) The Company filed no reports on Form 8-K during the period for
which this report is filed.
13
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ECONOPHONE, INC.
(registrant)
Date August 13, 1998 By /s/ ALAN LEVY
--------------------------------------
Name: Alan Levy
Title: President and Chief Operating Officer
Date August 13, 1998 By /s/ PHILLIP STORIN
--------------------------------------
Name: Phillip Storin
Title: Senior Vice President and
Chief Financial Officer
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION (in thousands) EXTRACTED
FROM THE CONSOLIDATED BALANCE SHEET AS OF JUNE 30,1998 AND THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 49,562
<SECURITIES> 130,480
<RECEIVABLES> 34,129
<ALLOWANCES> 4,838
<INVENTORY> 0
<CURRENT-ASSETS> 223,562
<PP&E> 62,552
<DEPRECIATION> 6,561
<TOTAL-ASSETS> 355,237
<CURRENT-LIABILITIES> 64,692
<BONDS> 338,090
0
14,373
<COMMON> 200
<OTHER-SE> (62,118)
<TOTAL-LIABILITY-AND-EQUITY> 355,237
<SALES> 90,414
<TOTAL-REVENUES> 90,414
<CGS> 67,041
<TOTAL-COSTS> 67,041
<OTHER-EXPENSES> 30,936
<LOSS-PROVISION> 3,820
<INTEREST-EXPENSE> (12,276)
<INCOME-PRETAX> (27,916)
<INCOME-TAX> 0
<INCOME-CONTINUING> (27,916)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,916)
<EPS-PRIMARY> (1.40)
<EPS-DILUTED> (1.40)
</TABLE>
