<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 September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________to _____________
Commission File Number 333-33117
ECONOPHONE, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 11-3132722
- ------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
95 Route 17 South, 3rd Floor, Paramus, N.J. 07652
---------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (201) 226-4500
45 Broadway, 30th Floor, New York, N.Y. 10006
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(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 OCTOBER 31, 1998
------------------------------- -------------------------------------
Common Stock, $.01 par value 20,000,000
Non-Voting Common Stock, $.01 par value 75,320
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
1998 THIRD QUARTER REPORT ON FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements
Condensed Consolidated Statements of Operations -
Three and Nine months ended September 30, 1998 and
September 30, 1997 (unaudited) 3
Condensed Consolidated Balance Sheets -
September 30, 1998 (unaudited) and December 31,
1997 (derived from audited financial statements) 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and September 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
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<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT BASIC LOSS PER SHARE)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES $ 22,692 $ 50,542 $ 53,138 $ 140,956
COST OF SERVICES 17,039 36,047 41,050 103,088
--------- --------- --------- ---------
Gross profit 5,653 14,495 12,088 37,868
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 9,625 22,364 22,521 57,121
DEPRECIATION AND AMORTIZATION 1,098 3,030 2,167 7,131
--------- --------- --------- ---------
Loss from operations (5,070) (10,899) (12,600) (26,384)
INTEREST EXPENSE (5,540) (10,863) (5,826) (29,366)
INTEREST INCOME 1,846 2,758 1,846 8,984
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net 45 (32) 16 80
OTHER INCOME (EXPENSE) 13 (223) 100 (492)
--------- --------- --------- ---------
Net loss $ (8,706) $ (19,259) $ (16,464) $ (47,178)
========= ========= ========= =========
BASIC LOSS PER SHARE $ (0.44) $ (0.96) $ (0.82) $ (2.36)
========= ========= ========= =========
WEIGHTED AVERAGE NUMBER OF BASIC COMMON
SHARES OUTSTANDING 20,000 20,000 20,000 20,000
========= ========= ========= =========
</TABLE>
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<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, SEPTEMBER 30,
1997 1998
----------- -----------
(see note) (unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 67,202 $ 95,355
Marketable securities - 58,097
Accounts receivable, net of allowance for doubtful accounts
of $1,594 and $6,257, respectively 16,796 36,476
Prepaid expenses and other current assets 1,868 3,691
Restricted cash and securities 10,463 4,359
----------- -----------
Total current assets 96,329 197,978
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, net of
accumulated depreciation and amortization of $3,690
and $8,377, respectively 23,217 82,894
Debt issuance costs 6,355 12,612
Intangibles - 35,065
Other assets 3,139 3,109
Restricted cash and securities 48,965 35,665
----------- -----------
Total assets $ 178,005 $ 367,323
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Accounts payable $ 21,100 $ 23,853
Accrued expenses and other current liabilities 5,356 27,869
Interest accrued on Senior Notes 10,463 4,359
Current maturities of long-term debt and capital leases 1,985 10,713
Current maturities of notes payable - related party 315 308
Deferred revenue 2,568 4,004
----------- -----------
Total current liabilities 41,787 71,106
LONG-TERM DEBT AND CAPITAL LEASES 5,936 24,920
SENIOR NOTES 1997 149,680 150,100
SENIOR DISCOUNT NOTES 1998 - 187,939
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK 14,328 14,396
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIENCY)
Common stock-voting, par value $.0001 at December 31, 1997
and $.01 at September 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 September 30, 1998; authorized 500,000
shares; 67,320 shares issued and outstanding - 1
Additional paid-in capital 6,082 5,926
Accumulated other comprehensive income (104) (313)
Retained earnings (accumulated deficit) (39,706) (86,952)
----------- -----------
Total stockholders' equity (deficiency) (33,726) (81,138)
----------- -----------
Total liabilities and stockholders' equity (deficiency) $ 178,005 $ 367,323
=========== ===========
</TABLE>
Note: The December 31, 1997 Balance Sheet is derived from audited financial
statements.
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<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine months ended September 30,
1997 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (16,464) $ (47,178)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,167 7,131
Provision for doubtful accounts 317 4,663
Accreted interest expense 140 12,574
Changes in assets and liabilities:
Increase in accounts receivable (9,673) (24,343)
Increase in prepaid expenses and
other current assets (716) (1,823)
(Increase) decrease in other assets (2,650) 262
Increase in accounts payable, accrued
expenses and other current liabilities 10,795 18,460
Increase in deferred revenue 1,350 1,436
----------- -----------
Net cash used in operating activities (14,734) (28,818)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (5,459) (56,363)
Net cash paid in acquisitions - (22,327)
Purchase of marketable securities - net - (58,097)
----------- -----------
Net cash used in investing activities (5,459) (136,787)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bridge loan 7,000 -
Repayments of bridge loan (7,000) -
Repayments of short-term borrowings (2,127) -
Proceeds from long-term debt and capital leases - 6,773
Repayments of long-term debt and capital leases (306) (1,096)
Repayments of notes payable - related party (9) (7)
Proceeds from senior discount notes 149,400 175,785
Proceeds from warrants 5,600 -
Payment of debt issuance costs (6,315) (7,144)
Issuance of common stock - 43
----------- -----------
Net cash provided by financing activities 146,243 174,354
----------- -----------
Increase in cash and cash equivalents,
(including restricted cash) 126,050 8,749
Cash and cash equivalents, beginning of period
(including restricted cash) 6,272 126,630
----------- -----------
Cash and cash equivalents, end of period
(including restricted cash) $ 132,322 $ 135,379
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Interest $ 372 $ 22,540
SUPPLEMENTAL DISCLOSURE OF NONCASH
ACTIVITIES:
Accretion of preferred stock $ 68 $ 68
Accrued dividends on preferred stock 879 -
Capital leases executed 2,472 8,000
Note issued for purchase of minority interest - Telco - 14,035
DETAILS OF ACQUISITIONS:
Fair value of assets acquired - (1,936)
Goodwill - (21,092)
Liabilities assumed - 701
----------- -----------
Net cash paid for acquisitions - $ (22,327)
=========== ===========
</TABLE>
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<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 nine-month period ended September 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 $0.4 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 nine-month
period ended September 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 for approximately $14.0 million in cash, payable by the
Company in quarterly installments, together with interest at a rate of 8.0% per
annum, over approximately three years. The entire purchase price is classified
as goodwill, which will be amortized over 20 years. In connection with such
acquisition, (i) Telco obtained ownership rights with respect to certain
proprietary software used in Telco's business and (ii) the Company converted
options to acquire Telco shares held by Telco employees into grants of
non-voting restricted shares of the Company's common stock.
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<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. The components of other comprehensive
income consist primarily of foreign currency translation adjustments. For the
nine months ended September 30, 1998, the components of other comprehensive
income were immaterial.
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 stockholders by the
weighted average number of shares of common stock outstanding during the period.
Income available to common stockholders is calculated as net income less
dividends on preferred stock, which in the third quarter and nine-month period
ended September 30, 1997 were approximately $0 and $879,000, respectively.
There were no dividends on preferred stock in 1998. Diluted EPS has not been
presented since the inclusion of outstanding options would be antidilutive.
NOTE I -- RETAINED EARNINGS (ACCUMULATED DEFICIT)
The change in retained earnings reflects net loss for the period, as well
as the accretion of preferred stock, which was approximately $23,000 for the
quarters ended September 30, 1997 and September 30, 1998, and approximately
$68,000 for the nine-month periods ended September 30, 1997 and September 30,
1998.
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<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 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 SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS
ENDED SEPTEMBER 30, 1997
QUARTER ENDED SEPTEMBER 30,
--------------------------------
1997 1998 % CHANGE
-------- -------- --------
REVENUE (in thousands)
United States $ 13,389 $ 33,307 149%
United Kingdom 5,128 11,665 127%
Continental Europe 4,175 5,570 33%
-------- -------- -----
Total $ 22,692 $ 50,542 123%
======== ======== =====
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<PAGE>
QUARTER ENDED SEPTEMBER 30,
--------------------------------
1997 1998 % CHANGE
-------- -------- --------
BILLABLE MINUTES OF USE (in thousands)
United States 69,088 154,355 123%
United Kingdom 19,815 70,913 258%
Continental Europe 4,509 11,876 163%
-------- -------- -----
Total 93,412 237,144 154%
======== ======== =====
REVENUES. Revenues for the three months ended September 30, 1998 increased
123% to $50.5 million from $22.7 million for the three months ended September
30, 1997. Billable minutes of use increased 154% to 237.1 million in the
current quarter from 93.4 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 96% to approximately 277,000 at
September 30, 1998 from approximately 141,000 at September 30, 1997. Revenues
for all products increased substantially from the third quarter of 1997 to the
third 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 significantly in the U.K. and Continental European
markets.
GROSS PROFIT. The gross profit margin of 28.7% reported for the quarter
ended September 30, 1998 increased 3.8% from the 24.9% achieved in the quarter
ended September 30, 1997. This improvement was attributable to network
expansion and increased utilization of transmission capacity, which contributed
to lower per-minute costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the third quarter of 1998 were $22.4 million,
representing 44.2% of revenue, compared to $9.6 million in the third quarter of
1997, or 42.4% of revenue. The increase in selling, general and administrative
expenses as a percentage of revenues during the third quarter of 1998 was
primarily attributable to higher staffing and marketing costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $3.0 million for the three months ended September 30, 1998 from
$1.1 million for the three months ended September 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 the 1998 Notes and the
amortization of goodwill from the purchase of VoiceNet Corporation and Telco
Global Communications.
INTEREST EXPENSE AND INTEREST INCOME. Interest expense increased to $10.9
million in the third quarter of 1998 from $5.5 million in the prior year
comparable quarter. This increase was attributable to the issuance of the 1998
Notes. Interest income increased to $2.8 million in the third quarter of 1998
from $1.8 million in the third quarter of 1997. This increase was primarily due
to interest income earned on the investment of the net proceeds received in
connection with this offering.
NET LOSS. The Company reported a net loss of $19.3 million for the third
quarter of 1998 compared to a net loss of $8.7 million for the third quarter of
1997. The increase is primarily due to the higher level of selling, general and
administrative expenses and higher debt service costs.
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<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1997
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1998 % CHANGE
-------- -------- --------
REVENUE (in thousands)
United States $ 32,492 $ 80,354 147%
United Kingdom 9,330 45,555 388%
Continental Europe 11,316 15,047 33%
-------- -------- -----
Total $ 53,138 $140,956 165%
======== ======== =====
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1997 1998 % CHANGE
-------- -------- --------
BILLABLE MINUTES OF USE (in thousands)
United States 156,835 366,655 134%
United Kingdom 29,951 211,478 606%
Continental Europe 11,241 29,181 160%
-------- -------- -----
Total 198,027 607,314 207%
======== ======== =====
REVENUES. Revenues for the nine months ended September 30, 1998 increased
165% to $141.0 million from $53.1 million for the nine months ended September
30, 1997. Billable minutes of use increased 207% to 607.3 million in the first
nine months of 1998 from 198.0 million in the comparable prior year nine-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 1997 to 1998. The increase in
revenues resulting from the growth in billable minutes was partially offset by
per-minute price reductions caused by increased competition, most significantly
in the U.K. and Continental European markets.
GROSS PROFIT. The gross profit margin of 26.9% reported for the nine-month
period ended September 30, 1998 increased 4.2% from the 22.7% achieved in the
nine-month period ended September 30, 1997. This increase was attributable to
network expansion and increased utilization of transmission capacity which
contributed to lower per-minute costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses in 1998 were $57.1 million, representing 40.5% of
revenue, compared to $22.5 million in 1997, or 42.4% of revenue. The decrease
in selling, general and administrative expenses as a percentage of revenues
during 1998 was primarily attributable to the significant increase in revenues
from the nine-month period of the prior year.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $7.1 million for the nine-month period ended September 30, 1998
from $2.2 million for the nine-month period ended September 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 and Telco Global Communications.
INTEREST EXPENSE AND INTEREST INCOME. Interest expense increased to $29.4
million in 1998 from $5.8 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 $9.0 million in 1998 from $1.8 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 $47.2 million for the
nine-month period ended September 30, 1998 compared to a net loss of $16.5
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.
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<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 is 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 September 30, 1998, Econophone had approximately $95.4 million in cash
and cash equivalents and $58.1 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 in operating activities was $28.8
million for the nine months ended September 30, 1998, and was primarily
attributable to a net loss of $47.2 million and an increase in accounts
receivable of $24.3 million, partially offset by an increase in accounts
payable, accrued expenses and other current liabilities of $18.5 million, and
accreted interest expense of $12.6 million. Net cash used in investing
activities of $136.8 million for the nine months ended September 30, 1998 was
attributable to the purchase of marketable securities, investments made
primarily in switching and other telecommunications equipment and IRUs and the
VoiceNet acquisition. Net cash provided by financing activities of $174.4
million was primarily related to the gross proceeds aggregating $175.8 million
that were received in connection with the issuance of the 1998 Notes.
Econophone currently expects capital expenditures during 1998 to be below
$100 million, of which $64.4 million was expended during the first nine 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.
The Company anticipates financing these expenditures primarily through term
notes, capital leases with various lending institutions or its own cash
resources. The Company's operations, continued development of its network and
continued geographic expansion will continue to require substantial capital
investment. Management believes it has the ability to continue to secure
long-term equipment financing and to obtain funds from the high yield bond and
equity markets. Management believes these abilities combined with available
borrowing capacity under existing lines of credit and its own cash resources
will be sufficient to fund capital expenditures, working capital needs and debt
repayment requirements for the foreseeable future.
The Company continually evaluates business opportunities, including
potential acquisitions. The primary focus of the Company's acquisition
activities is to make acquisitions that will complement the Company's current
product lines. One or more of such acquisitions could result in a substantial
change in the Company's operations and financial condition. The success of the
Company's acquisition activities will depend among other things, on the
availability of acquisition candidates, the availability of funds to finance
acquisitions and the availability of management resources to oversee the
operation of acquired businesses. While the Company has, from time to time, had
discussions with other telecommunications companies, it has no agreements in
place other than those previously disclosed.
-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 nine months of 1998 and 1997,
approximately 43% and 38%, 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 nine months ended September 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 September 30, 1998 and 1997, Econophone had $0 and $.1
million open foreign currency hedging positions, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In September 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 for approximately $14.0 million in cash, payable by the Company in
quarterly installments, together with interest at a rate of 8.0% per annum, over
approximately three years. 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: November 13, 1998 By /s/ ALAN LEVY
--------------------------------------
Name: Alan Levy
Title: President and Chief Operating Officer
Date: November 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 SEPTEMBER 30, 1998 AND THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 99,714
<SECURITIES> 58,097
<RECEIVABLES> 42,733
<ALLOWANCES> 6,257
<INVENTORY> 0
<CURRENT-ASSETS> 197,978
<PP&E> 91,271
<DEPRECIATION> 8,377
<TOTAL-ASSETS> 367,323
<CURRENT-LIABILITIES> 71,106
<BONDS> 362,959
0
14,396
<COMMON> 200
<OTHER-SE> (81,338)
<TOTAL-LIABILITY-AND-EQUITY> 367,323
<SALES> 140,956
<TOTAL-REVENUES> 140,956
<CGS> 103,088
<TOTAL-COSTS> 103,088
<OTHER-EXPENSES> 52,548
<LOSS-PROVISION> 4,663
<INTEREST-EXPENSE> 29,366
<INCOME-PRETAX> (47,178)
<INCOME-TAX> 0
<INCOME-CONTINUING> (47,178)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (47,178)
<EPS-PRIMARY> (2.36)
<EPS-DILUTED> (2.36)
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