<PAGE>
Filed Pursuant to Rule 424(B)(3)
Registration No. 333-47711
ECONOPHONE, INC.
OFFER TO EXCHANGE $300,000,000 OF NEW
11% SENIOR DISCOUNT NOTES DUE 2008
FOR $300,000,000 OF ANY AND ALL OUTSTANDING
11% SENIOR DISCOUNT NOTES DUE 2008
Econophone, Inc., a Delaware 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 $300,000,000 in aggregate
principal amount of its 11% Senior Discount Notes due 2008 (the "Exchange
Notes") for a like principal amount of its 11% Senior Discount Notes due 2008
(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, rate of accretion, 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."
The Notes will mature on February 15, 2008. The Original Notes were, and the
Exchange Notes will be, issued at a substantial discount from their principal
amount at maturity and there will not be any payment of interest on the Notes
prior to August 15, 2003. Each Original Note has a principal amount at maturity
of $1,000 and an initial Accreted Value (as defined) of $585.95. The Accreted
Value of the Exchange Notes initially will be equal to the Accreted Value of the
Original Notes at the time of the consummation of the Exchange Offer. The Notes
will fully accrete to face value on February 15, 2003. From and after February
15, 2003, the Notes will bear interest, which will be payable in cash at a rate
of 11.0% per annum on each February 15 and August 15 (the "Interest Payment
Dates"), commencing August 15, 2003.
The Notes will be redeemable at the option of the Company, in whole or in
part, at any time on or after February 15, 2003, 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 February 15, 2001, the Company
may, in its discretion, redeem up to 35% of the aggregate principal amount of
the Notes at a redemption price equal to 111% of their Accreted Value with the
net proceeds of one or more Public Equity Offerings (as defined); provided that
(1) at least 65% of the initially issued 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 Accreted Value thereof, plus accrued and unpaid interest, if any, thereon.
See "Description of the Exchange Notes" and "Capitalization."
The Original Notes were issued and sold on February 18, 1998, 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 requirements of the Securities Act
(COVER PAGE CONTINUED)
------------------------
SEE "RISK FACTORS," COMMENCING ON PAGE 15, 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 March 23, 1998.
<PAGE>
(COVER PAGE CONTINUED)
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 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" or the "Placement Agent")
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 April 24, 1998, 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.
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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 currently subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Whether or not
the Company is then required to file reports with the Commission, so long as any
of the Notes are outstanding, the Company is required by the terms of the
Indenture, dated as of February 18, 1998 (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, 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 has filed with the Commission pursuant to Sections 13(a) or
15(d) under the Exchange Act, or would be required to file by such sections of
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 files 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.
CAUTIONARY STATEMENT ON FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this Prospectus that are not
historical facts, including, without limitation, certain statements made in the
sections hereof entitled "Risk Factors," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business," are statements
of future expections and other forward-looking statements within the meaning of
Section 27A of the Securities Act that are based on management's current views
and assumptions and involve known and unknown risks and uncertainties that could
cause actual results, performance or events to differ materially from those
expressed or implied in such statements, including, without limitation, (i) the
rate of expansion of Econophone's network and/or customer base, (ii) competitive
factors, (iii) changes in law and regulations, (iv) general economic conditions
and (v) currency exchange rates, in each case on a global, regional and/or
national basis. See also "Risk Factors" for additional cautionary statements
identifying important factors with respect to such forward-looking statements
that could cause actual results to differ materially from results referred to in
the forward-looking statements.
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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 February 18, 1998 the offering of $300.0 million
aggregate principal amount at maturity of 11% Senior Discount Notes due 2008 of
Econophone (the "Offering"). Econophone entered into a Notes Registration Rights
Agreement with Morgan Stanley 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 August 18, 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 August 18, 1998, interest (in addition to accretion of or interest
otherwise due on the Notes) will accrue at a rate per annum of .5% of the
Accreted Value of the Notes, from such date, payable in cash semiannually, in
arrears on each Interest Payment Date, commencing February 15, 1999. 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 rapidly growing switch-based provider of long distance
telecommunications services in selected major U.S. and western European markets.
Econophone's customer base consists primarily of residential customers, small-
and medium-sized businesses and other telecommunications carriers. 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. Since July 1997, Econophone has continued the
build-out of its domestic and international network, hired additional
experienced senior management, increased its sales and marketing activities and
consummated the acquisition of VoiceNet Corporation ("VoiceNet"), which
previously had been a reseller of Econophone's services. See "--Recent
Developments."
Through internal growth, Econophone's consolidated revenues have increased
from $3.5 million in 1993 to $83.0 million in 1997. During 1997, the United
States, continental Europe and the United Kingdom accounted for 59%, 22% and 19%
of Econophone's consolidated revenues, respectively.
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 1996. The European international long
distance market is the largest in the world, with approximately 28 billion
minutes or 40% of international calling volume originating in Europe in 1996.
The continental European
4
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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, until recently, 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. In most European Union ("EU") member
states, the ability to provide telecommunications services was liberalized on
January 1, 1998. Econophone believes that regulatory liberalization in
continental Europe and technological advancements will lead to market
developments similar to those that have occurred in the United States and the
United Kingdom, although certain European PTOs appear to be responding more
rapidly to competition than the former PTOs in the United States and the United
Kingdom.
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 large markets that generate substantial long distance and international
calling traffic, (ii) add customers in its existing markets, (iii) migrate
additional switched traffic on to its expanding network and (iv) deliver an
expanded portfolio of features and services to its customers.
Econophone has substantially increased its network infrastructure in the
last year. Econophone currently has switches in New York, London, Brussels and
Paris, network nodes in Antwerp, Berlin, Hamburg, Marseilles, Nice and Zurich
and points of presence ("POPs") serving a number of major cities in the
northeastern United States.
Econophone is continuing to significantly expand its U.S. and European
network. In addition, Econophone intends to expand its network into Canada
during 1998. In 1998, Econophone intends to add switches and points of presence
in the markets indicated below. Thereafter, Econophone intends to further expand
its network to additional markets in western Europe, the United States and
Canada as market and regulatory conditions warrant.
<TABLE>
<CAPTION>
NETWORK COMMERCIAL
MARKET ELEMENT OPERATION DATE
- ------------------- ---------------- ---------------
Los Angeles Switch 1Q98
<S> <C> <C>
Berlin* Switch 2Q98
Geneva Node 2Q98
Miami Switch 2Q98
Montreal POP 2Q98
Toronto Switch 2Q98
Washington, D.C.* Switch 2Q98
Chicago Switch 3Q98
Dallas Switch 3Q98
Frankfurt Switch 3Q98
--------------------------------
* Upgrade of existing node or
POP.
</TABLE>
Econophone's network elements are connected by a combination of owned
indefeasible rights of use ("IRUs") and transmission lines between various
network cities that are leased on a fixed cost basis. Econophone's IRUs and
leased lines result in reduced transmission costs once certain utilization
levels are reached because there is no significant marginal cost to Econophone
for carrying a call over owned facilities or those leased on a fixed cost basis.
As part of its expansion strategy, Econophone intends to acquire additional IRUs
and leased lines.
Econophone markets its services through various channels, each of which is
designed to serve a particular geographic market, customer group and product.
Econophone sells to non-business customers primarily through independent sales
representatives retained directly by Econophone or by master distributors and to
business customers and other telecommunications carriers primarily through its
internal sales forces. Depending upon the service, sales are made either
directly to end-users (e.g., residential and business long distance) or to
retail establishments for resale (e.g., prepaid cards). Econophone believes
5
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that its multi-channel marketing strategy enhances its growth prospects and
reduces the risks associated with dependence on a smaller number of distribution
channels.
Econophone believes that its principal competitive strengths are its carrier
grade network and low cost structure, both of which enable it to offer
competitive prices, and the diversity of its revenue base and marketing
channels. In addition, in its continental European markets, 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.
RECENT DEVELOPMENTS
Since July 1997, Econophone has continued the build-out of its domestic and
international network, hired additional experienced senior management, increased
its sales and marketing activities and acquired VoiceNet.
NETWORK EXPANSION; NEW GEOGRAPHIC MARKETS. In anticipation of the January
1, 1998 deregulation of the provision of telecommunications services in many EU
markets, Econophone added nodes in Berlin, Marseilles and Nice during the fourth
quarter of 1997. During that quarter, a node also was added in Zurich. During
the second quarter of 1998, Econophone expects to upgrade its Berlin node to a
switch and add a node in Geneva and, during the third quarter of 1998,
Econophone intends to add a switch in Frankfurt. In addition, Econophone is in
the process of seeking more favorable interconnection arrangements in Belgium,
France and Germany that would enable it to offer network access through
abbreviated dialing, originate calls in a greater number of cities and terminate
calls in such countries more cheaply. Econophone expects interconnection
agreements to be entered into in Belgium, France and Germany by the end of 1998.
Due to the significant increase during 1997 in Econophone's U.S. traffic,
Econophone intends to upgrade its Washington D.C. point of presence to a switch
during the first half of 1998 and to add switches in Los Angeles and Miami.
Econophone also intends to add switches in Chicago and Dallas during the third
quarter of 1998. These new switches will enable Econophone to increase its
addressable market and migrate a larger portion of its U.S. calling card traffic
on to its network, which will reduce its transmission costs.
During the first half of 1998, Econophone also intends to install a switch
in Toronto and a point of presence in Montreal, which will enable Econophone to
provide cost competitive international service in these markets.
As part of its network expansion, since July 1997, Econophone has continued
to expand its transmission capacity through the acquisition of additional IRUs
and leased lines. Econophone recently acquired IRUs on the AC-1 transatlantic
cable, over which it will be able to transmit 1,890 non-compressed simultaneous
calls (or 7,560 calls that are compressed). These IRUs are expected to become
operational during the second quarter of 1998.
EXPANSION OF SENIOR MANAGEMENT TEAM. During January 1998, Kevin Alward was
hired as President-North America and Phillip Storin was hired as Chief Financial
Officer and Senior Vice President. Mr. Alward previously served as President of
TotalTel, Inc., a provider of international telecommunications services to
retail and wholesale customers. Most recently, Mr. Storin served as the Chief
Financial Officer at U.S. Long Distance, a provider of telecommunications
services to business customers in the United States that was recently acquired
by LCI International, Inc. During December 1997, Richard Shorten was hired as
Senior Vice President and General Counsel. Mr. Shorten was previously with the
New York law firm of Cravath, Swaine & Moore.
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INCREASE IN SALES AND MARKETING. Since July 1997, Econophone has opened
sales offices in Berlin, Marseilles and Zurich and established a corporate sales
group in the United Kingdom. Econophone intends to open additional sales offices
and significantly increase local advertising in each of its markets in
furtherance of its multi-channel marketing strategy.
VOICENET ACQUISITION. On February 12, 1998, Econophone acquired VoiceNet, a
major reseller of the Company's calling card products. The initial purchase
price for VoiceNet was $21.0 million, which was paid out of cash on hand. The
sellers of VoiceNet also are entitled to receive an earn-out based upon the
revenue growth of the VoiceNet business for a period of up to one year following
the closing of the acquisition.
VoiceNet provides travellers and other callers with calling card services,
which are advertised primarily in in-flight magazines. Econophone has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996.
The acquisition of VoiceNet by Econophone ensures the continuity of
Econophone's sales through VoiceNet, provides Econophone with an established
U.S. calling card business and enables Econophone to cross-market many of its
other services to VoiceNet's customer base, which consisted of approximately
110,000 calling card holders during December 1997. The acquisition of VoiceNet
also will reduce Econophone's selling expenses in respect of services provided
to VoiceNet customers because, prior to the acquisition, Econophone paid
VoiceNet a commission on calling card usage by VoiceNet customers.
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 $30.1 million for the year ended
December 31, 1997 and, on a pro forma basis, assuming that the Offering and the
July 1, 1997 offering (the "1997 Unit Offering") of Units consisting of $155.0
million of senior notes (the "1997 Notes") and warrants (the "Warrants") to
purchase 1,265,885 shares of voting common stock ("Common Stock") of Econophone
had been consummated on January 1, 1997, a net loss of $61.4 million. Econophone
had a deficiency of earnings to fixed charges of $30.1 million ($61.4 million on
a pro forma basis) and negative EBITDA of $18.8 million for the year ended
December 31, 1997. Net cash used in operating activities for such period was
$12.2 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 2000. 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.
Econophone's principal executive offices are located at 45 Broadway, New
York, New York 10006. Its main telephone number is (212) 444-6991.
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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 $300.0 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.
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.
Expiration Date......... The Exchange Offer will expire at 5:00 p.m., New York City time,
on April 24, 1998, unless the Company decides to extend the
Expiration Date.
</TABLE>
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<TABLE>
<S> <C>
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>
9
<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 April 24, 1998.
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>
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<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........ $300.0 million principal amount of 11% Senior Discount Notes due
2008 of Econophone.
Maturity................ February 15, 2008.
Yield and Interest...... The Original Notes were, and the Exchange Notes are being, issued
at a substantial discount from their principal amount, and there
will not be any payment of interest on the Notes prior to August
15, 2003. The Notes will fully accrete to face value on February
15, 2003. From and after February 15, 2003, the Notes will bear
interest, which will be payable in cash at a rate of 11.0% per
annum on each February 15 and August 15 (the "Interest Payment
Dates"), commencing August 15, 2003. In addition to stated
interest, for U.S. federal income tax purposes, holders 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."
Optional Redemption..... On or after February 15, 2003, 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 February 15, 2001, up to 35% of
the aggregate principal amount of the Notes may be redeemed with
the proceeds of Public Equity Offerings (as defined herein) at
111.0% of their Accreted Value; provided, that after any such
redemptions Notes representing at least 65% of the Notes
initially issued remain outstanding. 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 Accreted Value thereof, plus accrued
and unpaid interest, if any. There can 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 December 31, 1997,
Econophone had $157.9 million of indebtedness outstanding, all of
which was unsubordinated and $149.7 million of which was secured
by $59.0 million of restricted cash. Substantially all of the
remaining indebtedness is secured by telecommunications assets.
The Notes are effectively subordinated to the secured
indebtedness of Econophone to the extent of the security
interests relating thereto.
</TABLE>
11
<PAGE>
<TABLE>
<S> <C>
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 (as defined herein) 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 affiliates, 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. These covenants are subject to significant
exceptions. See "Description of the Exchange Notes--Covenants."
Original Issue
Discount.............. The Exchange Notes will 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 (the "Holders") are
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>
12
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
THE SUMMARY CONSOLIDATED FINANCIAL DATA (EXCEPT FOR OTHER DATA, REGIONAL
DATA AND 1993 FINANCIAL DATA) FOR THE YEARS PRESENTED BELOW WAS DERIVED FROM THE
AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF ECONOPHONE. THE AUDITED
CONSOLIDATED FINANCIAL STATEMENTS OF ECONOPHONE AS OF DECEMBER 31, 1996 AND 1997
AND FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997, TOGETHER
WITH THE NOTES THERETO AND THE RELATED REPORT OF ARTHUR ANDERSEN LLP,
INDEPENDENT PUBLIC ACCOUNTANTS, ARE INCLUDED ELSEWHERE IN THIS PROSPECTUS. THE
SELECTED CONSOLIDATED FINANCIAL DATA FOR THE YEAR ENDED DECEMBER 31, 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 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>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1993(1) 1994 1995 1996 1997
----------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT REVENUE PER MINUTE AND RATIOS)
STATEMENT OF OPERATIONS DATA:
Revenues.................................................. $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 83,003
Cost of services.......................................... 2,761 5,540 19,735 35,369 63,707
Selling, general and administrative expense............... 497 2,013 7,087 16,834 37,898
Depreciation and amortization............................. 51 168 389 1,049 3,615
----------- --------- --------- --------- ---------
Income (loss) from operations............................. 219 802 279 (8,149) (22,217)
Interest income........................................... 6 6 19 84 3,689
Interest expense.......................................... (25) (109) (167) (380) (11,437)(2)
Other income (expense).................................... 6 100 (10) 133 (163)
Provision (benefit) for taxes............................. -- 73 -- -- --
----------- --------- --------- --------- ---------
Net income (loss)......................................... $ 206 $ 726 $ 121 $ (8,312) $ (30,128)
----------- --------- --------- --------- ---------
----------- --------- --------- --------- ---------
OTHER DATA:
Capital expenditures(3)................................... $ 605 $ 906 $ 1,677 $ 4,670 $ 19,021
EBITDA(4)................................................. 276 1,070 658 (6,967) (18,765)
Dividends and distributions declared...................... -- -- 499 508 879
Net cash provided by (used in) operating activities....... (190) 474 2,037 (6,006) (12,219)
Revenue per minute........................................ .70 .57 .43 .25
Minutes................................................... 12,196 47,859 104,566 330,144
Ratio of earnings to fixed charges(5)..................... 8.6x 7.2x 1.5x -- --
Deficiency of earnings available to cover fixed
charges(5).............................................. -- -- -- $ (8,312) $ (30,128)(6)
REGIONAL DATA:
Revenues
United States........................................... $ 2,728 $ 8,292 $ 18,185 $ 48,899
United Kingdom.......................................... 3,143 14,173 15,477 18,363
Continental Europe...................................... 2,652 5,025 11,441 15,741
Minutes
United States........................................... 5,707 23,411 68,247 244,095
United Kingdom.......................................... 4,532 20,592 27,968 68,810
Continental Europe...................................... 1,957 3,856 8,351 17,239
</TABLE>
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<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
AT DECEMBER 31, -------------------------
------------------------------------------ PRO FORMA
1993 1994 1995 1996 ACTUAL AS ADJUSTED(7)
--------- --------- --------- --------- --------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ 120 $ 86 $ 106 $ 6,272 $ 67,202 $ 215,534
Current assets................................... 852 2,588 7,616 14,729 96,329(8) 244,628(8)
Restricted cash.................................. -- -- -- -- 59,427(8) 59,427(8)
Total assets..................................... 1,541 4,034 10,508 22,755 178,005 352,975
Current portion of borrowings.................... 510 480 558 3,020 2,300 2,300
Long-term borrowings, less current portion....... 39 639 719 2,263 155,616 331,401
Redeemable convertible preferred stock........... -- -- -- 13,358 14,328 14,328
Total stockholders' equity (deficit)............. 708 1,088 710 (8,124) (33,726) (33,726)
</TABLE>
- ------------------------
(1) Regional revenue data and minute data for 1993 is not available.
(2) On a pro forma as adjusted basis, assuming the Offering closed on January 1,
1997, annual interest expense on the Notes for 1997 would have been $19.9
million.
(3) Capital expenditures include assets acquired through capital lease and other
financings.
(4) EBITDA represents net income (loss) plus net 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.
(5) 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.
(6) On an as adjusted basis, assuming that the Offering had been consummated on
January 1, 1997, the deficiency of earnings available to cover fixed charges
for the year ended December 31, 1997 would have been $50.9 million.
(7) The pro forma as adjusted balance sheet data gives effect to (i) the
Offering and (ii) the consummation of the acquisition of VoiceNet, as if
such events had occurred on December 31, 1997.
(8) Econophone used $57.4 million of the net proceeds from the 1997 Unit
Offering to purchase a portfolio 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 1997 Notes. Proceeds from the
Pledged Securities will be used by Econophone to make the first six semi-
annual scheduled interest payments on the 1997 Notes. Included in restricted
cash is $10.5 million, which is also included in current assets.
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<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 most of such markets have been limited. In addition,
the liberalization of the European regulatory environment is substantially
changing the nature of European telecommunications markets. See
"Business--Services," "Business--Competition" and "Business--Regulation."
Econophone is in the process of significantly expanding its operations in
its current markets and intends 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. Any of these factors could have a
material adverse effect on Econophone's business, financial condition, results
of operations and its ability to pay principal of and interest on the Notes. See
"--Implementation of Expansion Plans," "--Competition," "--Dependence on Third
Party Sales Organizations," "--Risks Associated with Rapidly Changing Industry;
Significant Price Declines," "--Risks Associated with Rapid Growth," "--Need for
Local Connectivity," "--Dependence on Effective Information Systems,"
"--Dependence Upon Key Personnel; Integration of Management," "--Dependence on
Equipment Supplier" and "Business--Services."
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 continues to expand 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 presently uses its
network primarily to originate, but not terminate, calls. Therefore, the
economic benefits of Econophone's network are primarily 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 continue 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 Econophone to implement its
expansion plans would have a material
15
<PAGE>
adverse effect on Econophone's business, financial condition, results of
operations and on its ability to pay principal of and interest on the Notes.
HIGH LEVERAGE, FUTURE LOSSES, DEFICIENCY OF EARNINGS TO FIXED CHARGES AND
NEGATIVE CASH FLOW
At December 31, 1997, on a pro forma as adjusted basis after giving effect
to the Offering, Econophone would have had total consolidated indebtedness of
approximately $333.7 million and a stockholders' deficit of approximately $33.7
million. The 1997 Notes have a principal amount at maturity of $155.0 million
and mature prior to the Notes. As of December 31, 1997, the 1997 Notes were
secured by $59.0 million of restricted cash. Econophone anticipates that it will
incur substantial additional indebtedness. Econophone had a net loss of $30.1
million for the year ended December 31, 1997. On an as adjusted basis, assuming
that the Offering and the 1997 Unit Offering had been consummated on January 1,
1997, Econophone would have had a net loss of $61.4 million for 1997. Econophone
also had negative EBITDA of $18.8 million for the year ended December 31, 1997.
Furthermore, Econophone's net cash used in operating activities was $12.2
million for the year ended December 31, 1997. Econophone expects to have
operating losses and net losses for at least the next several years and negative
EBITDA and negative cash flow from operations until at least 2000. There can be
no assurance that Econophone will ever operate at profitable levels, have
positive EBITDA or be able to service its indebtedness. 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 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 and the Indenture pertaining to the 1997 Notes (the "1997
Indenture") contain certain restrictive covenants. Such restrictions will
affect, and in many respects will 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 Certain Indebtedness--The 1997 Unit Offering" and "Description
of the Exchange Notes--Covenants." The terms of Econophone's Series A Preferred
Stock (the "Series A Preferred Stock") and the Secured Amended and Restated
Equipment Loan and Security Agreement (as amended, the "NTFC Agreement") between
Econophone and NTFC Capital Corporation ("NTFC") 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" and "Description of the Capital Stock--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; (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
16
<PAGE>
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."
COMPETITION
The provision of telecommunications services is extremely competitive and
will become increasingly so due to the reduction or elimination of regulatory
barriers to entry into telecommunications markets. Econophone believes that its
non-U.S. 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. It appears that continental European telecommunications
markets will experience price competition more rapidly and more extensively than
was experienced when deregulation occured in the United States and the United
Kingdom. Econophone's success will depend upon its ability to compete with a
variety of other telecommunications providers in each of its markets.
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 has implemented a program offering $.10 per
minute rates on certain calls to the United Kingdom and free U.S. domestic long
distance calls on Friday and MCI has priced certain domestic off-peak calls at
$.05 per minute. In the United Kingdom, the Office of Telecommunications
("Oftel"), the U.K. telecommunications regulatory authority, is expected to
require British Telecom to reduce its retail prices by continuing to impose a
price cap on its residential retail prices, although, since October 1997, it has
allowed British Telecom far more freedom in respect of its pricing of its retail
business services. In continental Europe, France Telecom and Deutsche Telekom
have recently taken steps to substantially reduce prices in an effort to protect
their market share and deter competitors, such as Econophone. France Telecom has
obtained approval to reduce retail prices on domestic and international long
distance services by an average of 9% during each of 1997 and 1998 and 4.5%
during each of 1999 and 2000. Deutsche Telekom will reduce retail prices on
domestic and international long distance service by up to 40% beginning March 1,
1998. Neither France Telecom nor Deutsche Telekom have reduced wholesale prices
to the same extent as retail prices. Price reductions by France Telecom and
Deutsche Telekom may over time create substantial pressure on Econophone's gross
margins in those countries. In the United States, the Federal Communications
Commission (the "FCC"), the U.S. telecommunications regulatory authority, also
has adopted rules which are designed to bring downward pressure on international
telephone rates. The FCC is requiring U.S. international facilities-based
carriers to negotiate lower settlement rates with correspondent foreign carriers
that deliver calls in foreign jurisdictions. The FCC expects such lower
settlement rates to become effective on a transitional basis, commencing January
1, 1999 for major countries, with lower settlement rates in effect for
substantially all countries by January 1, 2003. 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, results
of operations and its ability to pay principal of and interest on the Notes.
Econophone has experienced, and expects to continue to experience, declining
revenue per billable minute in all of its markets, including France and Germany,
in part as a result of increasing worldwide competition
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<PAGE>
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."
Competition is strong for all of Econophone's services. Competition for U.S.
calling card services is particularly intense. Larger service providers such as
AT&T, MCI and Sprint have substantial brand recognition and market penetration
for their calling cards, while a large number of smaller calling card providers
compete fiercely based almost entirely on price. In addition, the Regional Bell
Operating Companies ("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, and have
applied for FCC approval for "in region" market entry. To date, the FCC has
denied each of those applications. However, the FCC has been meeting with the
RBOCs to explain FCC requirements. This may lead to one or more successful RBOC
"in region" applications in the future. Recently, a lower court decision that is
currently being appealed invalidated the FCC's statutory authority for prior
approval of market entry by several RBOCs into certain "in region" long distance
markets.
Because all of Econophone's current and intended European markets (other
than the United Kingdom) have only recently liberalized or 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 European 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
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 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. For example, Deutsche Telekom recently proposed, subject to
regulatory approval, a fee of approximately 50 Deutsche Marks ("DM") for any
customer changing long distance service providers. In addition, in France, only
seven carriers will be able to provide long distance service using a single
digit prefix. Econophone does not expect to be one of these carriers. If the PTO
in any jurisdiction uses its competitive advantages to their fullest extent,
Econophone's operations in such jurisdiction would be adversely affected.
Further, if European PTOs persist in substantial retail price reductions, it
would have a material adverse effect on Econophone's ability to generate
positive gross margins in Europe, which will have a material adverse effect on
Econophone's ability to pay principal of and interest on the Notes.
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 creation of a new company
with the international facilities of the AT&T 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, the
pending acquisition of MCI by WorldCom, Inc. and the proposed acquisition of
Teleport Communications by AT&T may result in increased price competition for
retail services, but reduced competition for wholesale services used by
Econophone.
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, electric and other utilities, railways,
microwave carriers and large end users that have private networks. In addition,
existing telecommunications companies, including AT&T, are implementing plans to
offer voice telecommunications services over the Internet at substantially
reduced prices.
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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 business, financial condition, results of operations and its
ability to pay principal of and interest on the Notes. Many of Econophone's
larger competitors have lower incremental transmission costs than Econophone due
to, among other things, greater use of owned transmission capacity, more
favorable interconnection rates and volume discounts on transmission.
Furthermore, in certain European countries (including in France and Belgium),
telecommunications companies that make substantial investments in network
infrastructure will receive a substantial discount on interconnection rates.
Econophone does not expect to qualify for such a discount. In addition, certain
of Econophone's competitors offer customers an integrated full service
telecommunications package consisting of local and long distance voice, data and
Internet transmission. Econophone does not offer all of these types of service,
and presently does not intend to do so, which could have a material adverse
effect on Econophone's competitiveness and its 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 year
ended December 31, 1997, 52% of Econophone's revenues were attributable to
independent sales agents and 20% were attributable to resellers. 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, in late 1996, 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 exceptions. For 1996, Econophone's joint venture with EI and sales of
carrier services to EI contributed 32% of Econophone's consolidated revenues and
92% of its U.K. originated revenues. See "-- Dependence on Carrier 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. In addition, regulations pertaining to commercial
agents introduced by the European Union have given sales agents far greater
protection than before, resulting in the potential for increased termination
payments in the event of a dispute. 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 business, financial
condition, results of operations and its ability to pay principal of and
interest on the Notes.
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DEPENDENCE ON CARRIER CUSTOMERS
Revenues derived from carrier customers accounted for 20% of Econophone's
revenues during 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, financial
condition, results of operations and its ability to pay principal of and
interest on 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 the 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 exceptions. EI accounted for 12% 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 92% 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 13% of U.S. revenues and 8% of consolidated revenues in 1997.
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, 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's
business, financial condition, results of operations 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, results of operations and its
ability to pay principal of and interest on the Notes.
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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, the
international settlement rate system is in the process of collapsing. In
addition, EC Directive 97\33\EC (the "Interconnection Directive"), which became
effective January 1, 1998, requires EU operators with significant market power
to have charges for call termination for cross border traffic that are
cost-based and non-discriminatory, which will have an effect on settlement rates
with countries and territories outside the EU and may also contribute to the
collapse of the accounting rate system. For the foregoing reasons, price
reductions have begun to be reflected in international rates, particularly the
rates charged for calls between countries where competition exists. For example,
Sprint has reduced its rates on certain calls between the United States and the
United 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
adopted 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 telephone charges will be less affected by the distance a
call is carried, particularly with the possible increased use of voice services
over the Internet. As a consequence, Econophone would experience a substantial
reduction in its gross 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
business, financial condition, results of operations and its ability to pay
principal of and interest on the Notes. In addition, France Telecom and Deutsche
Telekom have recently taken steps to substantially reduce retail prices, in
excess of reductions in wholesale prices, in an effort to protect their market
share and deter competitors, such as Econophone. See "--Competition."
RISKS ASSOCIATED WITH RAPID GROWTH
Econophone has experienced rapid growth. Econophone's revenues were $3.5
million for 1993, increasing to $83.0 million for 1997.
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 business, financial condition, results
of operations and its ability to pay principal of and interest on the Notes. See
"--Dependence on Effective Information Systems" and "--Dependence on Key
Personnel; Integration of Management."
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RISKS ASSOCIATED WITH IMPOSITION OF VAT
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 EU member states but typically is between 15% and 21% of the
cost of the goods or services. Prior to January 1, 1997, pursuant to the Sixth
VAT Directive adopted in 1977 (the "VAT Directive"), providers of
telecommunications services in the EU were liable for VAT in the EU member state
where the provider of the services was "established" or where the provider had a
"fixed establishment" from where the services were provided. The provider
charged 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 cannot offset VAT and, therefore,
bear the cost of the tax. With respect to the provision of services by
Econophone to EU customers, other than in the United Kingdom, where it had a
fixed establishment, Econophone until recently had a competitive price advantage
over its competitors, including the PTOs. Because services to these customers
were provided by a company based in the United States, Econophone was not
required to charge VAT to them.
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 from between January 1, 1997 and July 1, 1997, EU member
states 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 now required to charge. Any such reduction could have a
material adverse effect on Econophone's business, financial condition, results
of operations and its ability to pay principal of and interest on the Notes.
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 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 and the 1997 Notes, will
be denominated in dollars. 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. In addition, as
part of its efforts to mitigate the exposure to changes in foreign exchange
rates, to the extent practicable, Econophone varies the portion of its
transmission purchased in U.S. dollars and other currencies. 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.
Since the first quarter of 1997, the U.S. dollar has appreciated relative to the
principal European currencies in which Econophone bills its European customers.
A sustained increase in the value of the U.S. dollar relative to such currencies
would reduce Econophone's gross margins on European calls and could have a
material adverse effect on Econophone's ability to pay principal of and interest
on the Notes. 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's business, financial condition, results of operations and
its ability to pay principal of and interest on the Notes. See
"Business--Regulation."
A substantial portion of Econophone's strategy is based upon the regulatory
liberalization of certain EU markets that occurred on January 1, 1998. In
anticipation of such liberalization, Econophone established operations and made
capital expenditures in certain EU countries and intends to continue to do so.
Although liberalization is a legal obligation required by EC directives, a
substantial portion of the more detailed EU regulatory framework to apply in the
new liberalized environment is not yet in place. In addition, certain EU member
states have been granted a derogation from liberalizing their telecommunication
markets. Ireland and Portugal have been granted a derogation until January 1,
2000. Spain has been granted a derogation entitling it to delay liberalization
until November 30, 1998. Luxembourg and Greece have been granted a derogation
entitling them to delay full liberalization until July 1, 1998 and January 1,
2001, respectively. There can be no assurance that each EU member state will
proceed with the expected liberalization on schedule or to the extent required
(although failure to do so would be a breach of EU law) 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 either
does not subsequently occur or is delayed.
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 will also apply to 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, although EU members have signed the World Trade
Organization agreement which allows access to their markets by other
signatories. In addition, 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 regulations only after a significant delay. In November 1997, the
European Commission commenced proceedings against seven EU member states,
including Belgium, for failure to implement certain EU telecommunications
directives fully. Even if a national government 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 France, the
telecommunications union has stated its objection to the current move towards
liberalization. In Germany, competitors of Deutsche Telekom have had to resort
to court proceedings to attempt to obtain unbundled access to the local loop and
the interconnection prices set by the relevant ministry have been challenged.
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 business, financial condition, results of operations and
its ability to pay principal of and interest on the Notes.
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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 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's business, financial
condition, results of operations and its ability to pay principal of and
interest on the Notes. 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 (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.
Beginning January 1, 1998, Econophone, as well as its U.S. competitors,
became obligated to make FCC-mandated contributions to universal service funds.
These funds subsidize the provision of telecommunications services in high cost
areas and to low-income customers, as well as the provision of
telecommunications and certain other services to eligible schools, libraries and
rural health care providers. The contributions are billed monthly and are
assessed based on intrastate, interstate and international "end-user" gross
telecommunications revenues. However, revenues from international calls that
both originate and terminate in foreign points are excluded from assessment. On
December 16, 1997, the FCC approved the following contribution factors for
carriers' first quarter 1998 contributions: (i) 3.19% for the high cost and low
income funds (interstate and international revenues); and (ii) 0.72% for the
schools, libraries and rural health care funds (intrastate, interstate and
international revenues). Econophone currently is evaluating which categories of
its revenues are subject to assessment and, as a result, has not
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filed a universal service fund worksheet. Because the contribution factors are
likely to vary quarterly, the annualized impact on Econophone cannot be
estimated at this time.
Additionally, effective January 1, 1998, Econophone is required to pay to
LECs specified presubscribed inter-exchange carrier charges ("PICCs") in order
to compensate such LECs for their investment in the telephone lines Econophone
uses to access its customers. The costs of these charges vary in amount
depending upon the type of presubscribed lines that are serviced by Econophone
and the individual LEC's revenue requirements. While Econophone currently
intends to pass through the costs of both the PICC and its universal service
fund contributions to its customers, there can be no assurance that Econophone
will be able to fully pass on such costs or that doing so will not result in a
loss of customers. In addition, the FCC orders implementing the universal
service contribution obligation and the PICC are both subject to petitions
seeking reconsideration by the FCC and to certain appeals. Until such petitions
or appeals are decided, there can be no assurance as to how the orders will be
implemented or enforced or what effect the orders generally will have on
competition within the telecommunications industry or specifically on the
competitive position of Econophone.
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 $0.35 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 and remanded to the FCC by the court for further
consideration. The FCC subsequently adopted a rate of $0.284 per call in lieu of
the $0.35 rate, effective October 7, 1997, and issued further clarifications of
its initial order. This decision is also before an appellate court and some
aspects of its implementation remain unclear. 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 $0.284 access
charge. Econophone recently began charging the $0.284 access charge. There can
be no assurance that, over time, Econophone will be able to fully pass the cost
of this charge 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 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, results of operations and its ability to pay principal of
and interest on the Notes would be materially and adversely affected. See
"Business--Regulation."
NEED FOR LOCAL CONNECTIVITY
To originate and terminate calls, Econophone requires "local connectivity,"
which is connection to the PSTN. Local connectivity can be obtained through
third parties or through interconnection agreements negotiated directly with
PTOs. Interconnection agreements may provide for more favorable carrier rates
based on volume and other benefits such as the ability to offer customers
abbreviated dialing. 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,
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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. Furthermore, where local connectivity is obtained
through third parties, there can be no assurance that Econophone will be able to
enter into interconnection agreements with PTOs on acceptable terms.
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 or on a timely basis.
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's business, financial condition, results of operations 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, 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. In several European countries, including France and Germany,
this currently is the case. Such rates may be too high to allow Econophone to
generate gross profit. In addition, PTOs will not necessarily be required by law
to allow Econophone to lease transmission lines. Even where applicable law
requires PTOs to lease transmission lines to other carriers, delays are
nevertheless being encountered with respect to the commencement of operations
and extensive delays are occurring with respect to the negotiation of leases and
interconnection agreements. In addition, disputes are occurring 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, results of operations and its ability to pay principal of
and interest on the Notes.
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DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
To complete its billing, Econophone must record and process large amounts of
data quickly and accurately. Econophone's public financial reporting
requirements also require it to process large amounts of information. While
Econophone believes its management information systems currently are adequate,
substantial investment will continue to be required to satisfy anticipated
billing and public financial reporting needs. Econophone believes that the
successful implementation and integration of enhanced and new information
systems will be important to its continued growth and its ability to bill
customers, monitor costs and other financial data 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. If Econophone's information systems prove to be
inadequate, it could have a material adverse effect on Econophone's business,
financial condition, results of operations and its ability to pay principal of
and interst on the Notes. 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
and Chief Operating Officer and a Director of Econophone, could have a material
adverse effect on Econophone, its ability to successfully implement its business
plan (including, without limitation, the continued roll-out of its network
infrastructure, its sales and marketing initiatives and the continued expansion
of its back-office capabilities) and its ability to pay principal of and
interest 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, although it intends to do so
with certain new senior employees. 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.
Pursuant to the NTFC Agreement, Econophone may not cease to employ Mr. West
(other than by reason of his death or disability) or suffer to exist any
material 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. See "Description of Certain
Indebtedness--NTFC Vendor Financing."
Econophone has significantly increased the size of its management team since
the second half of 1997. 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. In addition, the labor market for software engineers has been extremely
competitive recently and Econophone may lose key employees or be forced to
increase their compensation as a result. The loss of the services of key
personnel, or the inability to attract additional qualified personnel, could
have a
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material adverse effect on Econophone's business, financial condition, results
of operations and its ability to pay principal of and interest on the Notes.
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 and Mr. Alward,
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."
INTEGRATION OF VOICENET AND OTHER ACQUISITIONS
Although Econophone and VoiceNet have had an extensive business relationship
since VoiceNet's inception, VoiceNet will need to be integrated with
Econophone's existing operations. In particular, Econophone must maintain and
develop the numerous distributor relationships that have been critical to
VoiceNet's operations to date. The integration of VoiceNet also will entail,
among other things, the integration of management and other personnel and of
accounting and other record-keeping systems. Econophone has had limited
experience with the integration of acquired businesses and there can be no
assurance that it will be able to successfully integrate VoiceNet's operations.
Other acquisitions, if any, would pose even greater integration challenges.
DEPENDENCE ON EQUIPMENT SUPPLIER
Econophone purchases a significant portion of its switching equipment from
Northern Telecom. There can be no assurance that Econophone will be able to
acquire the switches that it will require as it continues to expand its network
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, results of operations and its ability to pay
principal of and interest on the Notes. See "Business--Network Infrastructure."
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, beneficially own, in the aggregate, approximately 85.5%
of the outstanding shares of Common Stock (assuming conversion of the Series A
Preferred Stock, but not giving effect to the issuance or exercise of any
warrants or options issued by Econophone). To the extent such stockholders
exercise their voting rights in concert, such stockholders will have the ability
to control the election of all members of Econophone's Board of Directors, 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. In addition, the
affirmative vote of such stockholders will be required to effect a change of
control of Econophone. The exercise of these powers may present conflicts of
interest between these individuals and the holders of the Notes. See "Principal
Stockholders."
POTENTIAL INABILITY TO REPAY NOTES AND OTHER INDEBTEDNESS UPON A CHANGE OF
CONTROL
The Indenture and the 1997 Indenture provide that, upon the occurrence of a
Change of Control thereunder, Econophone must make an offer to purchase all of
the Notes and 1997 Notes issued and then outstanding at a purchase price equal
to 101% of the then Accreted Value or principal amount thereof plus accrued
interest (if any) thereon to the payment date. Under the NTFC Agreement, a
change of control
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(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 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, the Certificate of
Incorporation and/or the 1997 Indenture, 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, NTFC would be
entitled to receive payment of all outstanding obligations under the NTFC
Agreement and the holders of the Series A Preferred Stock and the 1997 Notes
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, the 1997
Notes and the Notes. Such a failure would constitute an Event of Default under
the 1997 Indenture and the Indenture and the NTFC Agreement. See "Certain
Transactions--Investment by Princes Gate" and "Description of Certain
Indebtedness--NTFC Vendor Financing."
ORIGINAL ISSUE DISCOUNT CONSEQUENCES
The Exchange Notes will 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. A holder of a Note
will be required to include in such holder's income for federal income tax
purposes original issue discount with respect to the Note as it accrues although
no cash payments of interest on the Notes are scheduled to be made until 2003.
See "Certain Federal Income Tax Considerations--Original Issue Discount."
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.
In addition, the Notes constitute "applicable high yield discount
obligations" ("AHYDOs") for federal income tax purposes. As a result, Econophone
will not be permitted to deduct original issue discount in respect of the Notes
until amounts corresponding to such discount are paid in cash. See "Certain
Federal Income Tax Considerations--United States Holders; Applicable High Yield
Discount Obligations."
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.
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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 February
18, 1998 (the "Closing Date") to Morgan Stanley, the Placement Agent thereof,
pursuant to a Placement Agreement, dated February 12, 1998 (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 February 18, 1998 (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 August 18, 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."
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 April 24,
1998 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.
Holders of Original Notes that are accepted for exchange will not receive
accrued interest thereon at the time of the consummation of the Exchange Offer.
The Accreted Value of the Exchange Notes initially will be equal to the Accreted
Value of the Original Notes at the time of the the consummation of the Exchange
Offer. Cash interest on the Exchange Notes will not accrue prior to February 15,
2003. Commencing August 15, 2003, cash interest on the Exchange Notes will be
payable on February 15 and August 15 of each year at a rate of 11.0% per annum.
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As of the date of this Prospectus, $300.0 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.
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
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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 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.
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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 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
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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 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
35
<PAGE>
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 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.
36
<PAGE>
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 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: Denise Robinson
or
BY FACSIMILE:
The Bank of New York
Attention: Denise Robinson
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
37
<PAGE>
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, 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."
38
<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 sale of the Notes was approximately
$169.1 million. The net proceeds of the Offering will be used primarily for the
purchase of telecommunications equipment and IRUs. Net proceeds from the
Offering not immediately required for the foregoing purposes are invested in
short term, interest-bearing, investment grade securities, subject to
restrictions in the Indenture.
39
<PAGE>
CAPITALIZATION
The following table sets forth the cash and capitalization of Econophone (i)
at December 31, 1997 and (ii) on a pro forma as adjusted basis giving effect to
the Offering and the acquisition of VoiceNet (not including any payment for the
sellers' earn-out). This information should be read in conjunction with the
Financial Statements and the notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
----------------------------
PRO FORMA
ACTUAL AS ADJUSTED
--------------- -----------
<S> <C> <C>
(IN THOUSANDS)
Cash, cash equivalents and restricted cash.......................................... $ 126,629 $ 274,961
--------------- -----------
--------------- -----------
Current portion of long-term debt and capital lease obligations(1).................. 2,300 2,300
Long-term debt and capital lease obligations:
Capital leases.................................................................... 279 279
1997 Notes(2)..................................................................... 149,680 149,680
Notes offered hereby.............................................................. -- 175,785
Other long-term debt(1)........................................................... 5,657 5,657
--------------- -----------
Total long-term debt and capital lease obligations............................ 155,616 331,401
Redeemable convertible preferred stock.............................................. 14,328 14,328
Stockholders' equity (deficit):
Common Stock-voting, $.0001 par value, 29,250,000 shares authorized, 20,000,000
shares issued and outstanding(3)................................................ 2 2
Non-voting common stock, $.0001 par value, 500,000 shares authorized, no shares
issued and outstanding.......................................................... -- --
Additional paid-in capital(4)..................................................... 6,082 6,082
Cumulative translation adjustment................................................. (104) (104)
Accumulated deficit............................................................... (39,706) (39,706)
--------------- -----------
Total stockholders' equity (deficit).......................................... (33,726) (33,726)
--------------- -----------
Total capitalization...................................................... $ 138,518 $ 314,303
--------------- -----------
--------------- -----------
</TABLE>
- ------------------------------
(1) Through December 31, 2002, other long-term debt of Econophone matures as
follows:
<TABLE>
<CAPTION>
Year of Maturity Amount
- -------------------------------------------------------------------------------------- ---------
<S> <C>
1998.................................................................................. $2,144,000
1999.................................................................................. 1,689,000
2000.................................................................................. 1,689,000
2001.................................................................................. 1,500,000
2002.................................................................................. 779,000
</TABLE>
(2) The annual interest to be paid on the 1997 Notes is $20,925,000.
(3) Based on the number of shares outstanding on December 31, 1997. Does not
include (i) 2,901,445 shares of Common Stock issuable upon the exercise of
options to employees granted pursuant to the 1996 Flexible Incentive Plan
(the "Incentive Plan") at a weighted average exercise price of $2.74, (ii)
3,420,701 shares of Common Stock issuable upon conversion of the Series A
Preferred Stock at December 31, 1997 or (iii) 1,265,885 shares of Common
Stock issuable upon exercise of the Warrants issued in connection with the
1997 Unit Offering. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources,"
"Management--Executive Compensaiton--1996 Flexible Incentive Plan" and
"Certain Transactions--Investment by Princes Gate."
(4) Includes $5.6 million attributable to the Warrants, which 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 1997
Notes and will be amortized over the term of the 1997 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
between Econophone and the Placement Agent in connection with the 1997 Unit
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 1997 Unit
Offering and the prices of similar securities of generally comparable
companies. The Warrants expire on June 30, 2007.
40
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data (except for Other Data, Regional
Data and 1993 financial data) for the years presented below was derived from the
audited consolidated financial statements of Econophone. The audited
consolidated financial statements of Econophone as of December 31, 1996 and 1997
and for each of the three years in the period ended December 31, 1997, together
with the notes thereto and the related report of Arthur Andersen LLP,
independent public accountants, are included elsewhere in this Prospectus. The
selected consolidated financial data for the year ended December 31, 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 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>
YEARS ENDED DECEMBER 31,
-------------------------------------------------------
1993(1) 1994 1995 1996 1997
----------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT REVENUE PER MINUTE AND RATIOS)
STATEMENT OF OPERATIONS DATA:
Revenues............................................................. $ 3,528 $ 8,523 $ 27,490 $ 45,103 $ 83,003
Cost of services..................................................... 2,761 5,540 19,735 35,369 63,707
Selling, general and administrative expense.......................... 497 2,013 7,087 16,834 37,898
Depreciation and amortization........................................ 51 168 389 1,049 3,615
----------- --------- --------- --------- ---------
Income (loss) from operations........................................ 219 802 279 (8,149) (22,217)
Interest income...................................................... 6 6 19 84 3,689
Interest expense..................................................... (25) (109) (167) (380) (11,437)(2)
Other income (expense)............................................... 6 100 (10) 133 (163)
Provision (benefit) for taxes........................................ -- 73 -- -- --
----------- --------- --------- --------- ---------
Net income (loss).................................................... $ 206 $ 726 $ 121 $ (8,312) $ (30,128)
----------- --------- --------- --------- ---------
----------- --------- --------- --------- ---------
OTHER DATA:
Capital expenditures(3).............................................. $ 605 $ 906 $ 1,677 $ 4,670 $ 19,021
EBITDA(4)............................................................ 276 1,070 658 (6,967) (18,765)
Dividends and distributions declared................................. -- -- 499 508 879
Net cash provided by (used in) operating activities.................. (190) 474 2,037 (6,006) (12,219)
Revenue per minute................................................... .70 .57 .43 .25
Minutes.............................................................. 12,196 47,859 104,566 330,144
Ratio of earnings to fixed charges(5)................................ 8.6x 7.2x 1.5x -- --
Deficiency of earnings available to cover fixed charges(5)........... -- -- -- $ (8,312) $ (30,128)(6)
REGIONAL DATA:
Revenues
United States...................................................... $ 2,728 $ 8,292 $ 18,185 $ 48,899
United Kingdom..................................................... 3,143 14,173 15,477 18,363
Continental Europe................................................. 2,652 5,025 11,441 15,741
Minutes
United States...................................................... 5,707 23,411 68,247 244,095
United Kingdom..................................................... 4,532 20,592 27,968 68,810
Continental Europe................................................. 1,957 3,856 8,351 17,239
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
AT DECEMBER 31, -------------------------
------------------------------------------ PRO FORMA
1993 1994 1995 1996 ACTUAL AS ADJUSTED(7)
--------- --------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents................................ $ 120 $ 86 $ 106 $ 6,272 67,202 215,534
Current assets........................................... 852 2,588 7,616 14,729 96,329(8) 244,628(8)
Restricted cash.......................................... -- -- -- -- 59,427(8) 59,427(8)
Total assets............................................. 1,541 4,034 10,508 22,755 178,005 352,975
Current portion of borrowings............................ 510 480 558 3,020 2,300 2,300
Long-term borrowings, less current portion............... 39 639 719 2,263 155,616 331,401
Redeemable convertible preferred stock................... -- -- -- 13,358 14,328 14,328
Total stockholders' equity (deficit)..................... 708 1,088 710 (8,124) (33,726) (33,726)
</TABLE>
- ------------------------
(1) Regional revenue data and minute data for 1993 is not available.
(2) On a pro forma as adjusted basis, assuming the Offering closed on January 1,
1997, annual interest expense on the Notes for 1997 would have been $19.9
million.
(3) Capital expenditures include assets acquired through capital lease financing
and other debt.
(4) EBITDA represents net income (loss) plus net 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.
(5) 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.
(6) On an as adjusted basis, assuming that the Offering had been consummated on
January 1, 1997, the deficiency of earnings available to cover fixed charges
for the year ended December 31, 1997 would have been $50.9 million.
(7) The pro forma as adjusted balance sheet data gives effect to (i) the
Offering and (ii) the consummation of the acquisition of VoiceNet, as if
such events had occurred on December 31, 1997.
(8) Econophone used $57.4 million of the net proceeds from the 1997 Unit
Offering to purchase the Pledged Securities. Proceeds from the Pledged
Securities will be used by Econophone to make the first six scheduled
interest payments on the 1997 Notes. Included in restricted cash is $10.5
million, included in current assets.
42
<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.S., U.K. and continental European operations for
the years ended December 31, 1995, 1996 and 1997. Over time, Econophone expects
its European markets to contribute an increasingly larger percentage of its
revenues.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUE
United States............................................... $ 8,292 $ 18,185 $ 48,899
United Kingdom.............................................. 14,173 15,477 18,363
Continental Europe.......................................... 5,025 11,441 15,741
BILLABLE MINUTES OF USE
United States............................................... 23,411 68,247 244,095
United Kingdom.............................................. 20,592 27,968 68,810
Continental Europe.......................................... 3,856 8,351 17,239
</TABLE>
Econophone generally prices its services at a discount to the primary
carrier (or carriers) in each of its 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 business, financial condition, results
of operations and its 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."
43
<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 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 (excluding carrier services) now are sold in the United
Kingdom primarily through Telco Global Communications ("Telco"), a
majority-owned subsidiary of Econophone. Telco began marketing efforts during
the first quarter of 1997. During 1997, Econophone's U.K. revenues were $18.4
million, $10.6 million of which was generated by Telco. See "Business--Sales and
Marketing."
Until recently, Econophone was not required to charge VAT to its customers
based in the European Union, other than in the United Kingdom, where it was
required to charge VAT. This resulted in a competitive price advantage for
Econophone over competitors, including the PTOs, who were required to charge VAT
to such customers. 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 now required to charge. See
"Risk Factors--Risks Associated With Imposition of VAT."
In continental Europe, France Telecom and Deutsche Telekom have recently
taken steps to substantially reduce prices in an effort to protect their market
share and deter competitors, such as Econophone. France Telecom has obtained
approval to reduce retail prices on domestic and international long distance
services by an average of 9% during each of 1997 and 1998 and 4.5% during each
of 1999 and 2000. Deutsche Telekom will reduce retail prices on domestic and
international long distance service by up to 40% beginning March 1, 1998.
Neither France Telecom nor Deutsche Telekom have reduced or proposed reducing
wholesale prices to the same extent as retail prices. Price reductions by France
Telecom and Deutsche Telekom, may over time, create substantial pressure on
Econophone's gross margins in France and Germany. See "Risk
Factors--Competition."
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.
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 consist of IRU costs. IRU costs are included in depreciation and
amortization, involve only fixed costs and no per minute charges and are,
therefore, a more cost-effective means of transmitting traffic once certain
volume levels
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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 recently completed the purchase of five
half-circuits on PTAT-1 and one on Cantat-3, which were previously leased.
Econophone also recently purchased IRUs on the AC-1 transatlantic cable, which
are expected to become operational during the second quarter of 1998. See
"Business--Network Infrastructure--Transmission Capacity."
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.
The FCC adopted, effective October 7, 1997, a $0.284 access charge for each
call made using toll free access from a payphone in the United States. The FCC's
decision is before an appellate court. Econophone recently began to charge the
$0.284 access charge to its customers. If this charge is upheld, there can be no
assurance that Econophone will over time 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. Had such access charge been in
effect during all of 1997, the aggregate payphone access charge paid by
Econophone would have been approximately $3.3 million.
Beginning January 1, 1998, Econophone, as well as its U.S. competitors,
became obligated to make FCC-mandated contributions to universal service funds.
These funds subsidize the provision of telecommunications services in high cost
areas and to low-income customers, as well as the provisions of
telecommunications and certain other services to eligible schools, libraries and
rural health care providers. The contributions are billed monthly and are
assessed based on intrastate, interstate and international "end-user" gross
telecommunications revenues. However, revenues from international calls that
both originate and terminate in foreign points are excluded from assessment. On
December 16, 1997, the FCC approved the following contribution factors for
carriers' first quarter 1998 contributions: (i) 3.19% for the high cost and low
income funds (interstate and international revenues); and (ii) 0.72% for the
schools, libraries and rural health care funds (intrastate, interstate and
international revenues). Econophone currently is evaluating which categories of
its revenues are subject to assessment and, as a result, has not filed a
universal service fund worksheet. Because the contribution factors are likely to
vary quarterly, the annualized impact on Econophone cannot be estimated at this
time.
Additionally, effective January 1, 1998, Econophone is required to pay to
LECs specified PICCs in order to compensate such LECs for their investment in
the telephone lines Econophone uses to access its customers. The costs of these
charges vary in amount depending upon the type of presubscribed lines that are
serviced by Econophone and the individual LEC's revenue requirements. While
Econophone currently intends to pass through the costs of both the PICC and its
universal service fund contributions to its customers, there can be no assurance
that Econophone will be able to fully pass on such costs or that doing so will
not result in a loss of customers. In addition, the FCC orders implementing the
universal service contribution obligation and the PICC are both subject to
petitions seeking reconsideration by the FCC and to certain appeals. Until such
petitions or appeals are decided, there can be no assurance as to how the orders
will be implemented or enforced or what effect the orders generally will have on
competition within the telecommunications industry or specifically on the
competitive position of Econophone. See "Risk Factors -- Regulatory
Restrictions."
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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 resellers. 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.
For the year ended December 31, 1997, commissions earned by VoiceNet
accounted for $5.7 million, or 43%, of selling expenses. Commissions were based
on calling card usage by VoiceNet customers and consisted of two components: (i)
commissions received by VoiceNet that it retained; and (ii) commissions received
by VoiceNet that it subsequently paid to its independent sales agents. As of the
date of consummation of the acquisition of VoiceNet, that portion of commissions
paid to and retained by VoiceNet has been eliminated. For the year ended
December 31, 1997, $2.3 million of the commissions paid to VoiceNet were
retained by VoiceNet.
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 has and will
continue to increase significantly its selling expenses due to costs associated
with operating and staffing sales offices. Econophone expects these costs 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."
Deutsche Telekom recently proposed, subject to regulatory approval, a fee of
approximately DM50 for a customer to change long distance service providers. If
Econophone were required to bear this cost in order to remain competitive, its
selling expenses in Germany would be increased. See "Risk Factors--
Competition."
GENERAL AND ADMINISTRATIVE EXPENSES
Since the fourth quarter of 1996, Econophone has significantly increased the
size of its management team and established new sales offices in London, Paris,
Berlin, Brussels, Hamburg, Marseilles and Zurich, all of which resulted in an
increase in general and administrative expenses. Since the fourth quarter of
1996, general and administrative expenses have primarily consisted of expanding
Econophone's customer service, billing, financial reporting and other management
information systems and network management systems and organizational expenses
related to entering additional markets. Such expenses have been and will
continue to be incurred in advance of anticipated related revenues and are
expected to decline as a percentage of revenues over time. Econophone intends to
establish sales offices in additional network cities, which will further
increase general and administrative expenses.
INTEREST EXPENSE
Prior to July 1, 1997, interest expense principally consisted of interest
payable in connection with equipment financing loans and short-term
indebtedness. The 1997 Notes were issued on July 1, 1997 and currently
constitute most of Econophone's interest expense. Annual interest expense on the
1997 Notes is $20.9 million. Econophone used $57.4 million of the net proceeds
from the 1997 Unit Offering to purchase the Pledged Securities. Proceeds from
the Pledged Securities will be used by Econphone to make the first six scheduled
interest payments on the 1997 Notes. Thereafter, interest on the 1997 Notes will
be paid out of other cash sources. Interest expense will increase substantially
as a result of the Offering.
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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. For the years ended 1995, 1996 and 1997,
approximately 60%, 40% and 40%, 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 year ended December 31, 1997 was a reduction of
$2.7 million or 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, 1997,
Econophone had $0.3 million in 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. As part of its
efforts to mitigate exposure to changes in foreign exchange rates, to the extent
practicable, Econophone also varies the portion of its transmission capacity
purchased in U.S. dollars and other currencies. Since the first quarter of 1997,
the U.S. dollar has appreciated relative to the principal European currencies in
which Econophone bills its European customers. A sustained increase in the value
of the U.S. dollar relative to such currencies would reduce Econophone's gross
margins on European calls and could have a material adverse effect on
Econophone's ability to pay principal of and interest on the Notes. See "Risk
Factors-- Devaluation and Currency Risks."
THE VOICENET ACQUISITION
On February 12, 1998, Econophone acquired VoiceNet, a major reseller of
Econophone's calling card products. The initial purchase price for VoiceNet was
$21.0 million, which was paid out of cash on hand. The sellers of VoiceNet also
are entitled to receive an earn-out based upon the revenue growth of the
VoiceNet business for a period of up to one year following the closing of the
acquisition if certain performance criteria are met. See "Risk
Factors--Integration of VoiceNet."
VoiceNet provides travellers and other callers with calling card services,
which are advertised primarily in in-flight magazines. Econophone has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996. The acquisition of VoiceNet by Econophone ensures
the continuity of Econophone's sales to VoiceNet, provides Econophone with an
established U.S. calling card business and enables Econophone to cross-market
its other services to VoiceNet's customer base, which during December 1997
consisted of approximately 110,000 calling card holders. The acquisition of
VoiceNet also will reduce Econophone's selling expenses in respect of services
provided to VoiceNet customers. See "--Selling Expenses."
The acquisition of VoiceNet will be accounted for under the purchase method
of accounting. Goodwill is recorded to the extent the purchase price exceeds the
fair value of the net assets purchased. Based on Econophone's preliminary
analysis, approximately $1.0 million of the initial purchase price will reflect
the underlying value of the assets acquired and $20.0 million will reflect
goodwill. Goodwill will be amortized over 15 years.
ACQUISITION OF TELCO MINORITY INTEREST
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
through its wholly-owned subsidiary, ATL. On January 29, 1998, Econophone
received notice from Goldvalley Limited ("Goldvalley"), the minority partner in
Telco, that pursuant to existing arrangements between Econophone and Goldvalley,
Goldvalley has elected to exercise an option to cause Econophone to acquire
Goldvalley's interest in Telco. The parties recently commenced
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negotiations with respect to the terms of such acquisition, including the form
and amount of the consideration. There can be no assurance whether such
acquisition ultimately will be consummated, and if consummated, whether it will
be on terms favorable to Econophone.
NEW ACCOUNTING PRONOUNCEMENTS
During 1997, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 128, "Earnings Per Share." This statement established 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. Econophone has adopted the provisions of SFAS No. 128 as of
December 31, 1997.
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. 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.
RESULTS OF OPERATIONS
The following table presents certain data concerning Econophone's results of
operations for the years ended December 31, 1995, 1996 and 1997.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues..................................................................... $ 27,490 $ 45,103 $ 83,003
Cost of services............................................................. 19,735 35,369 63,707
Selling expenses............................................................. 3,934 7,821 13,357
General and administrative expenses.......................................... 3,153 9,013 24,541
Depreciation and amortization................................................ 389 1,049 3,615
Net income (loss)............................................................ 121 (8,312) (30,128)
</TABLE>
1997 COMPARED TO 1996
REVENUES. Total revenues for 1997 increased by 84% to $83.0 million on
330.1 million billable minutes of use from $45.1 million on 104.6 million
billable minutes of use for 1996. Billable minutes of use increased by 216% for
1997 from 1996. Growth in revenues during 1997 primarily was attributable to
additional minutes of use, particularly in the United States, offset in part by
a substantial decline in prices, as a result of increased competition. This
competition was a primary factor for the average revenue per minute decrease
from $.43 during 1996 to $.25 during 1997. An additional factor in the decrease
in revenues per minute was a larger portion of national, as opposed to
international, minutes of use. The increase in revenues was primarily
attributable to sales by VoiceNet of $23.6 million for 1997, compared to $1.9
million for 1996.
In the United Kingdom, revenues increased to $18.4 million from $15.5
million, primarily due to sales by Telco which increased to $10.6 million in
1997 from $1.3 million in 1996. Increases in U.K. revenue were
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partially offset by the termination of Econophone's business relationship with
EI, which accounted for $14.2 million in revenues in 1996. During the fourth
quarter of 1996, Econophone began marketing efforts in the U.K. through Telco,
its majority owned subsidiary. During 1997, U.K. revenues consisted principally
of $10.6 million from international and domestic long distance and prepaid card
services attributable to Telco, as well as $7.2 million from carrier services
sold through American Telemedia Limited ("ATL"), a wholly-owned subsidiary of
Econophone. Average U.K. revenue per minute decreased from $.55 per minute
during 1996 to $.27 per minute during 1997. This reduction was due principally
to sales of a larger percentage of domestic long distance minutes, which are
sold at lower rates than international minutes, and to increased price
competition.
In continental Europe, revenues increased by 38% to $15.7 million from $11.4
million. This increase was attributable to an increase in prepaid card services,
primarily in France and Germany. Average continental European revenue per minute
decreased from $1.37 per minute during 1996 to $.91 per minute during 1997. This
decrease was due to lower rates in France and Germany.
In the United States, revenues grew by 169% to $48.9 million from $18.2
million. This increase was due principally to calling card revenues attributable
to sales by VoiceNet, which were $23.6 million during 1997, compared to $1.9
million during 1996. VoiceNet began reselling Econophone's calling card services
to end users during the second quarter of 1996. The remainder of the increase
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 $.20 per minute during 1997 from $.27 per minute
during 1996. This reduction was due principally to sales of a larger percentage
of domestic long distance minutes, which are sold at lower rates than
international minutes, and to increased price competition.
During 1997, Econophone experienced an average customer turnover or "churn"
rate of approximately 5% relating to U.S., U.K. and continental European "1+",
"1xxx" and calling card services. To date, Econophone's revenues and margins
have not been materially impacted by its "churn" rate. Econophone's "churn" rate
with respect to any given period consists of the average number of customers
that ceased using Econophone's services during any month during the period
divided by the average monthly number of customers for the period. Customers
that have ceased using Econophone's services during any given month are those
customers who used Econophone's services during the prior month but not during
any subsequent month during the applicable period.
COST OF SERVICES. Cost of services increased to $63.7 million for 1997 from
$35.4 million for 1996. As a percentage of revenues, cost of services decreased
slightly to approximately 77% for 1997 from approximately 78% for 1996. Average
cost per minute for 1997 decreased to $.19 from $.34 for 1996. This was a result
of increased use of owned and leased line transmission capacity acquired by
Econophone during the period, as well as obtaining better prices on switched
transmission capacity because of the growth of Econophone's minutes of traffic
and more available capacity.
SELLING EXPENSES. Selling expenses increased to $13.4 million for 1997 from
$7.8 million for 1996, and, as a percentage of revenues, were 16% for 1997 and
17% for 1996. The increase in selling expenses primarily consisted of
commissions paid to resellers (principally VoiceNet) and independent agents,
expenses associated with Econophone's sales offices in London, Brussels, Hamburg
and Paris and expenses attributable to Econophone's customer service department,
which has been substantially enlarged since June of 1996. For 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 $24.5 million for 1997 from $9.0 million for 1996, and, as a
percentage of revenues, increased to 30% for 1997 from 20% for 1996. The
increase in general and administrative expenses was primarily attributable to an
increase in payroll costs related to additional management and staff in the
areas of finance, network management and
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information systems at Econophone's Manhattan, New York, Brooklyn, New York and
College Station, Texas facilities, as well as the London, Brussels, Hamburg and
Paris offices.
In connection with the termination of Econophone's joint venture with EI
during June 1996, EI granted Econophone the right to compete with EI in the
United Kingdom in exchange for forgiveness of a net receivable due to Econophone
of $2.0 million. The forgiveness of the receivable has been reclassified as an
expense of the joint venture and has been charged to operations. Econophone
previously had capitalized the U.K. territorial rights granted to it by EI on
its consolidated balance sheet and was amortizing the rights over a 15 year
life. Econophone subsequently decided to write off this asset, resulting in an
additional $1.9 million charge in 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased to $3.6 million for 1997 from $1.0 million for 1996. This increase was
substantially due to the depreciation associated with upgrades in Econophone's
switch in New York and installation of multiplexing equipment in New York and
London, as well as amortization of costs associated with the 1997 Unit Offering.
BAD DEBT EXPENSE. Econophone had bad debt expense of $3.9 million for 1997,
compared to bad debt expense of $2.0 million for 1996, which was due to the $2.0
million charge relating to EI during 1996.
INTEREST EXPENSE. Econophone had $11.4 million of interest expense during
1997, as compared to interest expense of $0.4 million during 1996. Interest
expense has increased substantially as a result of the 1997 Unit Offering, with
$10.5 million of 1997 expense attributable to the 1997 Unit Offering. Interest
expense will increase substantially as a result of the Offering.
NET LOSS. Econophone had a net loss of $30.1 million during 1997, compared
to a net loss of $8.3 million during 1996. The increase is primarily due to
costs associated with increasing the internal infrastructure, building the
network, marketing, commissions paid to resellers and interest expense related
to the 1997 Notes. Net loss is expected to increase substantially over the near
term, primarily due to interest expense incurred on the Notes and the 1997
Notes.
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 from 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 paid. In addition,
Econophone agreed not to solicit sales from customers of the joint venture,
subject to
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certain permitted exceptions. See "Risk Factors--Dependence on Carrier
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 EXPENSE. Econophone had bad debt expense of $2.0 million during
1996, compared to bad debt expense of $.2 million during 1995. For bad debt
expense in 1996, $2.0 million was attributable to the charge relating to EI
during 1996.
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LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, Econophone had approximately $67.2 million in cash and
cash equivalents, excluding the Pledged Securities, but including other unused
net proceeds of the 1997 Unit Offering, which are invested in short term,
interest-bearing, investment grade securities, as compared to cash and cash
equivalents of $6.3 million at December 31, 1996. Econophone's net cash used by
operating activities was $12.2 million for 1997, primarily due to a net loss of
$30.1 million, an increase in accounts receivable of $10.7 million, and an
increase in other assets of $1.7 million, offset by an increase in accounts
payable of $15.9 million, an increase in accrued interest on the 1997 Notes of
$10.5 million and depreciation and amortization of $2.6 million. Cash used for
investing in property and equipment of $13.3 million for 1997 was primarily
attributable to the implementation and expansion of Econophone's network in
Europe. Cash provided by financing activities of $145.8 million was primarily
related to cash received from the sale of the 1997 Notes and Warrants of $155.0
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 for 1995.
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 and $1.2 million for 1996 and 1995,
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 Investors II, L.P. ("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.
Capital expenditures during 1997 were $19.0 million. Capital expenditures
for 1997 related 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 Antwerp, Berlin, Brussels, Hamburg,
London, Los Angeles, Marseilles, 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. Capital
expenditures for 1998 are budgeted at $58.0 million and are expected to consist
of the purchase of telecommunications equipment and IRUs, network management
systems and management information systems.
Econophone expects to continue to make further significant capital
expenditures as it continues to expand the geographic scope of its services in
Europe, the United Kingdom, the United States and Canada, and as it continues 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 1997 Indenture and the NTFC
Agreement.
The initial purchase price for VoiceNet was $21.0 million, which was paid
out of cash on hand. The sellers of VoiceNet also are entitled to an earn-out
based upon the revenue growth of the VoiceNet business for a period of up to one
year following the closing of the acquisition if certain performance criteria
are met.
The net proceeds from the Offering, which were approximately $169.1 million,
together with the remaining proceeds from the 1997 Unit Offering, and, to the
extent available on favorable terms, vendor financing, will be used to fund
Econophone's continued 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 2000,
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
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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."
PRIOR FINANCINGS. 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 four primary sources of funding:
(i) Princes Gate; (ii) NTFC; (iii) the sale of Bridge Notes to Morgan Stanley
Group, an affiliate of the Placement Agent and Princes Gate, and (iv) the 1997
Unit Offering.
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. 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."
On May 28, 1996, Econophone entered into a credit facility with NTFC, which
has been amended and increased as to amount on several occasions. On January 28,
1998, the NTFC credit facility was amended and restated in its entirety in order
to effect various amendments and increase the amount of NTFC's commitment
thereunder (as amended and restated, the "NTFC Facility"). The NTFC Facility
provides for borrowings by Econophone and its subsidiaries to fund certain
equipment acquisition costs and related expenses. The NTFC Facility provides for
an aggregate commitment of NTFC of $24.0 million pursuant to three tranches of
$2.0 million, $3.0 million and $19.0 million. Loans borrowed under each tranche
of the NTFC Facility amortize in equal monthly installments over a five year
period ending on July 1, 2001, April 1, 2002 and January 1, 2003, respectively.
As of December 31, 1997, the aggregate amount outstanding under all tranches of
the NTFC Facility was $7.1 million. Loans under the NTFC Facility accrue
interest at an interest rate equal to the 90-day commercial paper rate plus 395
basis points (an interest rate of 9.55% as of January 1, 1998), subject to
certain quarterly adjustments depending upon financial performance. All of the
equipment purchased with the proceeds of the NTFC Facility has been pledged to
NTFC. See "Description of Certain Indebtedness--NTFC Vendor Financing."
On April 24, 1997, Econophone entered into a Note Purchase Agreement (the
"Note Purchase Agreement") with Morgan Stanley Group, pursuant to which Morgan
Stanley Group agreed to purchase from Econophone up to $15.0 million 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 2.0% 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 sold by Econophone
were $6.6 million and were used to fund equipment and other capital expenditures
and operations. Immediately following the consummation of the 1997 Unit
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 1997 Unit Offering. In
connection with the 1997 Unit Offering, Econophone issued $155.0 million in
aggregate principal amount of 1997 Notes and Warrants to purchase 1,265,885
shares of Common Stock. The net proceeds of the 1997 Unit Offering were
approximately $148.1 million. Of this amount, approximately $57.4 million was
used to purchase the Pledged Securities, the proceeds of which will be used to
make the first six scheduled interest payments on the 1997 Notes. See
"Description of Certain Indebtedness -- The 1997 Unit Offering."
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BUSINESS
Econophone is a rapidly growing switch-based provider of long distance
telecommunications services in selected major U.S. and western European markets.
Econophone's customer base consists primarily of residential customers, small-
and medium-sized businesses and other telecommunications carriers. 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 was incorporated in the State of New York under the name
"Switchtel Communications Corp." on July 10, 1992. During 1996, the name of the
Company was changed to "Econophone, Inc." A wholly-owned subsidiary named
"Econophone, Inc." was subsequently incorporated in the State of Delaware for
the sole purpose of changing the state of incorporation of the Company, and the
New York parent corporation was merged into the Delaware subsidiary on February
11, 1998, with the Delaware corporation being the surviving entity. Econophone's
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 1996. 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 13% per annum through the year 2000. Based on this
estimate, worldwide international long distance traffic is projected to increase
from approximately 70 billion minutes in 1996 to over 114 billion minutes by the
year 2000. The market for these services is highly concentrated in more
developed countries, with approximately 40% and 27% of 1996 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 and multicurrency 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 24 billion minutes of outgoing calls or
34% of international calling volume in 1996. In most EU member states, the
ability to provide telecommunications services was liberalized on January 1,
1998. Until such time, most continental European PTOs 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 until recently 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
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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.
Econophone believes that regulatory liberalization in many countries in
continental Europe will 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,
although certain European PTOs appear to be responding more rapidly to
competition than the former PTOs in the United States and the United Kingdom.
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 200 public telecommunications operators
licensed to operate in the U.K. market.
According to Oftel, during the period April 1996 to March 1997, the amount
of international calls originating from the United Kingdom was approximately 4.5
billion minutes, of which 47% were from residential users and 53% from business
users. Over the same period, there were 39.7 billion minutes of U.K. domestic
long distance calls, of which 55% were from residential users and 45% were from
business users.
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. Since October 1997, British Telecom has set
its own prices for services that are competitive, with an overall price cap on
the basket of non-competitive services. Oftel does, however, have 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 December 1996, the U.K. government issued the first licenses for the
provision of international facilities-based services, which until then only
British Telecom and Mercury had been authorized to provide. ATL, a wholly-owned
subsidiary of 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 has been able to acquire international
circuits originating in the United Kingdom. See "--Network Infrastructure--
Transmission Capacity."
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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 19 billion minutes or 27% of global international calling
volume originated in the United States in 1996. 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 7 billion minutes in 1989 to approximately 19 billion minutes in
1996, a compound annual growth rate of approximately 16%. 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.
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 1996, per minute settlement
payments by U.S. based carriers to foreign PTOs fell 39%, from $.70 per minute
to $.43 per minute. However, over this same period, per minute international
billed revenues fell only 27%, from $1.02 in 1989 to $.74 in 1996. As a result,
gross profit margin for outbound international calls (before local access
charges) grew from 31% in 1989 to 42% in 1996. The FCC has recently issued
benchmark levels for settlement rates, of between $.15 and $.23 per minute, in
an effort to reduce the settlement rates charged and paid by U.S. based
carriers. Such benchmark rates are substantially lower than the current
settlement rates. The FCC has encouraged carriers to use alternative measures to
terminate international traffic other than through operating agreements and the
international settlement process. 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."
Econophone also provides domestic long distance services to a substantial
portion of its U.S. customers and, as part of its strategy, is increasing its
U.S. domestic long distance business, including through its acquisition of
VoiceNet. According to the FCC, the U.S. domestic long distance market grew in
total minutes at an annual compound rate of approximately 7.8% from 1989 to
1996. 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 (i) expand into additional geographic markets in
continental Europe, the United Kingdom, the United States and Canada, with a
focus on large markets that generate substantial long distance and international
calling traffic, (ii) add customers in its existing markets, (iii) migrate
additional switched traffic on to 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. Over time, Econophone expects its European markets to contribute
an increasing percentage of its revenues.
- EXPAND INTO NEW MARKETS. During 1997, Econophone installed switches in
Brussels, London and Paris, nodes in Antwerp, Berlin, Marseilles, Nice and
Zurich and points of presence serving a
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number of major cities in the northeastern United States. During 1998,
Econophone's network expansion will be focused on North America and
continental Europe. During 1998, Econophone intends to install switches in
Chicago, Dallas, Frankfurt, Los Angeles and Miami and a node in Geneva.
This expansion is largely driven by existing customer calling patterns.
Econophone also intends to expand its network into Canada, with the
installation of a switch in Toronto and a point of presence in Montreal.
In addition, Econophone intends to upgrade its node in Berlin and point of
presence in Washington, D.C. to switches. Econophone's network expansion
will enable it to route calls from each of its new network cities,
providing for more cost-efficient transmission from these cities. The
switches in Chicago, Dallas, Los Angeles and Miami and the point of
presence in Montreal also will enable Econophone to provide international
and domestic long distance service originating in those cities through
"1+" access. Econophone intends to enter additional markets in western
Europe, the United States and Canada as market and regulatory conditions
warrant. See "--The Econophone Network--European Expansion," "--The
Econophone Network--U.S. Expansion" and "--Regulation."
Econophone also is in the process of seeking to enter into interconnection
agreements in Belgium, France and Germany. Interconnection agreements would
provide Econophone with a direct connection to the PSTN in such countries,
which would enable it to provide network access through abbreviated
dialing, originate calls in a greater number of cities and terminate calls
in such countries more cheaply. In particular, in Germany, interconnection
to the PSTN would enable Econophone to offer domestic long distance service
through "1+" access in its German network cities. Econophone expects the
foregoing interconnection agreements to be obtained by the end of 1998.
- ADD CUSTOMERS IN EXISTING MARKETS. By adding customers in its existing
markets, Econophone is able to increase network utilization, which reduces
transmission costs per minute. Econophone markets its services through
various channels, each of which is designed to serve a particular
geographic market, customer group and product. Econophone sells to
non-business customers primarily through independent sales representatives
retained directly by Econophone or by master distributors and to business
customers and other telecommunications carriers primarily through its
internal sales forces. Depending upon the service, sales are made either
directly to end-users (e.g., residential and business long distance) or to
retail establishments for resale (e.g., prepaid cards). Econophone
believes that its multi-channel marketing strategy enhances its growth
prospects and reduces the risks associated with dependence on a smaller
number of distribution channels. See "-- Sales and Marketing."
As of December 31, 1997, Econophone had (i) 122, (ii) 28,180 and (iii) 305
independent sales representatives, and 23, 19 and 9 internal sales
representatives, in continental Europe, the United Kingdom and the United
States, respectively.
Econophone intends to continue to advertise VoiceNet's calling card
services primarily through in-flight magazines and through advertisements
placed in high traffic locations such as restaurants. Econophone also
intends to cross-market many of its other services to VoiceNet's customer
base, which consisted of approximately 110,000 calling card holders for
December 1997, and to use VoiceNet's expertise to market its calling card
services in Europe.
- MIGRATE ADDITIONAL TRAFFIC ON TO ECONOPHONE NETWORK. By transmitting a
greater portion of its calls over its network, Econophone reduces its
transmission costs. Transmission costs are reduced because, once certain
volume levels are met, it is cheaper to transmit calls over lines that are
owned or leased on a fixed cost basis than lines leased on a per-minute
basis. In addition, local access (which can be used in Econophone's
network cities), is less expensive for Econophone than national or
international toll-free access. Econophone is increasing the percentage of
traffic carried on its network by installing additional switches, nodes
and points of presence, which increases
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Econophone's addressable market, and by increasing the transmission
capacity that it owns or obtains on a fixed-cost lease basis. See "--The
Econophone Network."
- CONTINUE TO DEVELOP AND INTRODUCE INNOVATIVE SERVICES AND FEATURES.
Econophone strives to differentiate itself from its competitors by
designing value-added features and integrating these features into its
services and network. Features under development include voice mail and
conference calling, both of which Econophone plans to introduce during the
first half of 1998. 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,
Switzerland 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. International and long distance
service accounted for $17.7 million or 21% of total revenues during 1997, and
$8.0 million (44%) and $9.6 million (20%) of U.K., and U.S. revenues,
respectively. See "--Network Infrastructure--Access Methods."
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 provided this service throughout England. For the year
ended December 31, 1997, approximately 70% of Econophone's U.K. revenues from
international and domestic long distance service were derived from the London
area, with the remainder derived principally from Manchester and Leeds.
Econophone's services are at present principally used by its U.K. customers to
make domestic long distance calls. See "--The Econophone Network--European
Expansion" and "--Network Infrastructure."
CONTINENTAL EUROPE. Econophone has offered international long distance
service to customers in Hamburg since February 1997, to customers in Antwerp,
Brussels and Paris since March 1997 and to customers in Berlin, Marseilles, Nice
and Zurich since the fourth quarter of 1997. During the second quarter of 1998,
Econophone intends to add a node in Geneva and, during the third quarter of
1998, Econophone intends to add a switch in Frankfurt, both of which will enable
Econophone to offer international long distance service to customers in those
cities. At present, Econophone cannot offer intra-European international long
distance service other than from its network cities on a cost-efficient basis.
Econophone is in the process of seeking to enter into interconnection
agreements in Belgium, France and Germany, which would provide it with a direct
connection to the PSTN in such countries, enabling it to provide international
long distance service through abbreviated dialing and originate calls in a
greater
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number of cities. In Germany, interconnection to the PSTN would enable
Econophone to provide domestic long distance service through "1+" access in its
German network cities. Econophone expects the foregoing interconnection
agreements to be obtained by the end of 1998. See "--Strategy."
UNITED STATES. Econophone has offered international and domestic long
distance service in the New York metropolitan area since March 1994 and in
Baltimore, Connecticut, northern New Jersey, Philadelphia and Washington, D.C.
since the first quarter of 1997. During 1998, Econophone intends to install
switches in Chicago, Dallas, Los Angeles and Miami, which will enable it to
offer international and domestic long distance in those markets. See "--The
Econophone Network--U.S. Expansion."
CANADA. During the first half of 1998, Econophone intends to expand its
network into Canada by installing a switch in Toronto and a point of presence in
Montreal. This will enable Econophone to offer international and domestic long
distance service in both cities.
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, including those that
are marketed through VoiceNet, are sold to customers who use its calling card
service primarily 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 and domestic 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 does not presently offer
competitive rates on intra-European calls made by calling card customers. See
"--The Econophone Network."
In 1997, calling card service in the United Kingdom, continental Europe and
the United States accounted for $0.5 million, $4.2 million and $23.6 million, or
1%, 5% and 28%, of Econophone's revenues, respectively. Substantially all of
Econophone's U.S. calling card sales are attributable to VoiceNet. A definitive
agreement to acquire VoiceNet was entered into on January 28, 1998. On February
12, 1998, Econophone acquired VoiceNet, which ensures the continuity of
Econophone's sales to VoiceNet and provides Econophone with an established U.S.
calling card business.
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 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 is an early
entrant into the market for prepaid services in
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continental Europe. In 1997, prepaid card services in the United Kingdom,
continental Europe and the United States accounted for $2.6 million, $11.5
million and $6.0 million, or 3%, 14% and 7%, of Econophone's revenues,
respectively.
Econophone's software development group has developed a new prepaid service
called "Debit Phone." Debit Phone was introduced in the United Kingdom during
the first quarter of 1998 and is expected to be introduced in the United States
by the end of the second quarter of 1998. Debit Phone allows customers 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 recognizes the customer's telephone
number and deducts the cost of the call from the customer's prepaid account
balance. Debit Phone customers are able to replenish their balances on line by
credit card or by purchasing vouchers. Customers also can 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. U.S. carrier customers buy transmission from
Econophone in bulk almost exclusively based on price. In the United Kingdom,
Econophone believes that many of its carrier customers instead choose Econophone
for access to its software platform, which, among other things, allows them to
utilize Econophone's software technology to sell calling cards and prepaid cards
and perform specialized billing functions. However, Econophone's U.K. carrier
customers are also price sensitive.
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, especially those in the United States, 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. In 1997,
sales of transmission capacity to carrier customers in the United Kingdom and
the United States accounted for $7.2 million and $9.7 million respectively, or
20% of Econophone's total revenues. See "Risk Factors--Dependence on Carrier
Customers" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
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
the United Kingdom.
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Econophone intends to introduce dedicated access service in its continental
European network cities during 1998.
During 1997, sales of toll free and dedicated access service accounted for
an insignificant amount of Econophone's revenues. Econophone expects that
revenues from these services will continue to represent a relatively small
portion of its revenues.
VALUE-ADDED FEATURES
Econophone strives to differentiate itself from its competitors by designing
value-added features and integrating these features into its services and
network and believes that its emphasis on technological innovation and quality
is one of its competitive strengths. 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. 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 the first quarter of 1998, Econophone intends to introduce
voicemail and conference calling capability. Econophone believes that its
emphasis on technological innovation and quality is one of its principal
competitive strengths.
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, Berlin, Hamburg,
Marseilles, Nice and Zurich, (iii) points of presence in Baltimore, Connecticut,
northern 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 and the introduction of
its network in Canada. 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
During 1997, Econophone significantly expanded its network in continental
Europe. 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 lines. Econophone also installed nodes in Antwerp and Hamburg that are
connected to the Brussels and London switches by leased lines. In addition,
during the first quarter of
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1997, Econophone installed its own switch in London. Prior to that time,
Econophone had leased a portion of Colt's London switch. Nodes in Berlin,
Marseilles, Nice and Zurich were installed during the fourth quarter of 1997.
The Berlin, Marseilles, Nice and Zurich nodes are connected to Econophone's
Hamburg, Paris and London node and switches, respectively, by leased line. The
Geneva node will be connected to the Zurich node by leased line.
During the second and third quarters of 1998, Econophone intends to install
a switch in Frankfurt and a node in Geneva and to upgrade its node in Berlin to
a switch. These switches will enable Econophone to route calls from these
cities, rather than transmitting them to another network city with a switch for
routing, which will result in more cost-efficient transmission.
Econophone also is in the process of seeking to enter into interconnection
agreements in Belgium, France and Germany, which would provide it with a direct
connection to the PSTN in such countries, enabling it to provide network access
through abbreviated dialing, originate calls in a greater number of cities and
terminate calls in such countries more cheaply. In Germany, interconnection to
the PSTN would enable Econophone to offer domestic long distance service through
"1+" access in its German network cities. Econophone expects the foregoing
interconnection agreements to be obtained by the end of 1998. See "--Strategy."
In addition to increasing its addressable market, the expansion of
Econophone's network in continental Europe enables it to provide intra-European
international long distance service from more continental European cities 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 can use less expensive local dial-up access
instead of international toll free access.
U.S. AND CANADIAN EXPANSION
During 1998, Econophone intends to substantially expand its network in North
America, particularly in the United States. This expansion is largely driven by
existing customer calling patterns. During the first half of 1998, Econophone
intends to install switches in Los Angeles and Miami. During the third quarter
of 1998, Econophone also intends to install switches in Chicago and Dallas.
These switches will enable Econophone to offer international and domestic long
distance service through "1+" access and carrier services from those cities. In
those cities in which Econophone has a switch, it is able to route traffic,
which provides for more cost-efficient transmission.
Econophone also intends to upgrade its point of presence in Washington, D.C.
to a switch during the second quarter of 1998. This upgrade will allow for more
cost-efficient transmission by enabling Econophone to route calls from
Washington D.C.
Econophone intends to establish additional switches in other selected U.S.
markets that generate substantial long distance calling traffic.
During the second quarter of 1998, Econophone also intends to install a
switch in Toronto and a point of presence in Montreal. In both cities,
Econophone intends to target customers with significant international calling
needs.
OPERATING AGREEMENTS
Econophone has entered into operating agreements with OTE, the Greek PTO,
Golden Lines International Telecommunications Services, an Israeli carrier, and
Utel in the Ukraine. Econophone's operating agreements provide it with a direct
interconnection to the foregoing carriers. By entering into operating
agreements, Econophone is able to obtain more favorable termination rates.
Operating
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agreements also enable Econophone to better control the quality of the
terminating segment of a call and can provide for favorable transit rates to
third countries (such as between Greece and Turkey). In addition, pursuant to
its operating agreements, Econophone's correspondent carriers are required to
send to Econophone a specified portion of their traffic. The revenues for
terminating this traffic are substantially in excess of Econophone's actual
termination costs, which increases Econophone's overall gross margins or enables
it to price its services more competitively. As part of its strategy, as market
and regulatory conditions warrant, Econophone intends to enter into additional
operating agreements with foreign carriers.
NETWORK INFRASTRUCTURE
NETWORK HARDWARE
Econophone's network employs Northern Telecom carrier grade switches.
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.
CARRIER GRADE SWITCHES. Carrier grade switches enable Econophone's network
to interconnect directly with the networks of PTOs and LECs, subject to
applicable regulatory requirements and an inter-connection agreement having been
entered into.
In Europe, carrier grade switches enable Econophone to provide international
and domestic long distance service utilizing abbreviated dialing. Carrier grade
switches also enable Econophone to originate calls in a greater number of cities
in countries in which it is connected to the PTO's network and terminate calls
in such countries more cheaply. In addition, Econophone is able to provide
domestic long distance service to the extent permitted by law. Many of
Econophone's competitors in continental Europe do not utilize carrier grade
switches and, therefore, cannot provide service on the same basis as Econophone,
which Econophone believes provides it with a competitive advantage over those
competitors. See "-- Strategy," "--Services--International and Domestic Long
Distance Service--United Kingdom," "-- Services--International and Domestic Long
Distance Service--Continental Europe" and "--The Econophone Network--European
Expansion."
In the United States, Econophone's carrier grade switches enable it to
interconnect with LECs. This interconnection reduces Econophone's transmission
costs.
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) and leased lines
between Brussels and New York, Econophone's network utilizes "fast signaling"
(also known as "SS7", "CCS7" or "EUROISDN"). 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.
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 and conference calling. 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."
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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 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 owns five IRUs on the PTAT-1 transatlantic cable, one IRU on the
Cantat-3 transatlantic cable and one IRU on the TAT 12/13 transatlantic cable.
Econophone also recently acquired 63 IRUs on the AC-1 transatlantic cable, which
will enable it to transmit 1,890 non-compressed simultaneous calls (or 7,560
calls that are compressed). Econophone's IRUs on the AC-1 transatlantic cable
are expected to become operational during the second quarter of 1998. As part of
its expansion strategy, Econophone intends to acquire additional IRUs, including
half-circuits originating in the United Kingdom running between the United
Kingdom and selected continental European cities.
In addition to utilizing IRUs to carry traffic, Econophone utilizes leased
lines. Econophone's aggregate cost for its leased lines for the month ended
December 31, 1997 was approximately $.3 million. Leased line costs will
substantially increase as Econophone expands its network to the extent that
Econophone leases additional lines instead of purchasing them.
Listed below are Econophone's currently operational IRUs and principal
leased lines and the maximum number of calls that can be carried at one time
over each circuit. Other than Econophone's circuits from New York to London,
which are owned, all of the lines listed below are leased lines.
<TABLE>
<CAPTION>
SIMULTANEOUS
TRANSMISSION LINES CALLS(1)
- -------------------------------------------------------------------------------- -----------------
<S> <C>
Los Angeles -- New York......................................................... 696
London -- New York.............................................................. 680
New Brunswick, New Jersey -- New York........................................... 336
Paris -- London................................................................. 240
Newark -- New York.............................................................. 192
Washington, D.C. -- New York.................................................... 168
Brussels -- Antwerp............................................................. 120
Brussels -- London.............................................................. 120
Brussels -- New York............................................................ 120
Hamburg -- Berlin............................................................... 120
Philadelphia -- New York........................................................ 96
Baltimore -- New York........................................................... 72
New Haven, Connecticut -- New York.............................................. 72
Brussels -- Paris............................................................... 60
Hamburg -- London............................................................... 60
Paris -- Nice................................................................... 60
Paris -- Marseilles............................................................. 60
London -- Zurich................................................................ 60
</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.
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.
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In addition, during November, 1997, Econophone entered into a Service
Agreement with Intelsat. Pursuant to this Agreement, Econophone has a direct
link to Intelsat's satellite, which reduces Econophone's transmission costs on
certain calls. Econophone's Intelsat link also enables it to more efficiently
carry traffic to certain countries that do not have direct fiber links to the
country in which Econophone's originating switch is located.
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 devoted
approximately $2.0 million to enhancing and developing its network management
systems during 1997 and has budgeted $7.0 million in 1998 to further enhancing
and developing its network management systems.
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 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 U.S. switch or point of presence and is
expected to be available in Germany in the future.
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. See "--The Econophone Network."
Econophone is in the process of seeking to enter into interconnection
agreements in Belgium, France and Germany that would enable it to provide
network access in those countries through abbreviated dialing (the equivalent of
"1xxx" or "1+"). Econophone expects these interconnection agreements to be
obtained by the end of 1998.
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,
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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. During
1997, Econophone introduced dedicated access service in the United Kingdom. In
continental Europe, Econophone intends to introduce dedicated access during
1998. 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 for
Econophone 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.
SALES AND MARKETING
Econophone's services are marketed primarily to residential customers and
small- and medium-sized businesses, with a focus on customers with significant
long distance calling needs. Econophone also sells transmission capacity to
carriers in the United States and the United Kingdom. As of December 31, 1997,
Econophone had 37,751, 3,769 and 125,705 customer accounts in the United
Kingdom, continental Europe and the United States, respectively, generating
approximately 69 million, 17 million and 244 million minutes of calling traffic,
respectively, for the year then ended. Econophone markets its services through
various channels, each of which is tailored to the particular geographic market,
customer group and product. Econophone believes that its multi-channel marketing
strategy enhances its growth prospects and reduces the risks associated with
dependence on a smaller number of distribution channels. See "--Strategy."
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
through its wholly-owned subsidiary, ATL. On January 29, 1998, Econophone
received notice from Goldvalley, the minority partner in Telco, that pursuant to
existing arrangements between Econophone and Goldvalley, Goldvalley has elected
to exercise an option to cause Econophone to acquire Goldvalley's interest in
Telco. The parties recently commenced negotiations with respect to the terms of
such acquisition, including the form and amount of the consideration. There can
be no assurance whether such acquisition ultimately will be consummated, and if
consummated, on terms favorable to Econophone.
As of December 31, 1997, Telco had retained 28,180 independent sales
representatives in the United Kingdom, primarily through master agents. A
substantial number of these sales representatives also sell products and
services other than long distance telephone service of other companies. As of
December 31, 1997, Telco also had 8 internal sales representatives, which sell
Econophone's services primarily to business users. Prior to April 1997,
Econophone's services were marketed only in the London area. Since that time,
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Econophone has been able to provide services on a U.K.-wide basis and its
services have been marketed by Telco and ATL in additional U.K. markets,
consisting principally of Manchester and Leeds. Prior to the establishment of
Telco, Econophone's services in the United Kingdom primarily were marketed under
a joint venture between Econophone and EI. See "Risk Factors--Dependence on
Third Party Sales Organizations," "Risk Factors--Dependence on Carrier
Customers" and "Management's Discussion of Financial Condition and Results of
Operations."
As of December 31, 1997, Econophone had 23 internal sales representatives
and 122 independent sales representatives in continental Europe. Econophone's
internal sales representatives are based in Antwerp, Berlin, Brussels, Hamburg
and Paris. In all five of these cities, Econophone is expanding its internal
sales forces and recruiting additional independent sales representatives. In
addition to the foregoing cities, Econophone also has independent sales
representatives in Amsterdam and Zurich. 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.
Econophone also typically 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.
During December 1997, Econophone, through Telco, implemented a sales and
marketing strategy in Germany similar to that utilized in the United Kingdom,
retaining master agents who then retain individual independent sales
representatives. As of December 31, 1997, Telco had approximately 150 direct and
indirect independent sales representatives in Germany and intends to
significantly expand this distribution channel. Telco's German sales force will
concentrate on sales to residential customers. Econophone's internal sales force
in Hamburg will continue to concentrate on prepaid card sales and sales to
business customers.
In the United States, Econophone's services have been sold primarily in the
New York metropolitan area. Econophone has begun to focus its marketing efforts
on its other U.S. network cities and, as of December 31, 1997, Econophone had 9
internal sales representatives and 305 independent sales representatives in the
United States.
VoiceNet's calling card services are marketed primarily through in-flight
magazines and through advertising materials placed in high traffic locations,
such as restaurants. Econophone intends to cross-market many of its other
services to VoiceNet's customer base, which for December 1997, consisted of
approximately 110,000 calling card holders, and to use VoiceNet's marketing
expertise to market its calling card services in Europe.
In Canada, Econophone intends to market its services primarily through
independent sales representatives. Initially, Econophone intends to market its
services in Canada primarily to ethnic communities that generate substantial
international calling volume.
Econophone's internal sales forces concentrate primarily on sales to
small-and medium-sized businesses and to other carriers, while independent sales
representatives concentrate primarily on residential sales. Econophone believes
that local internal sales forces 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.
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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.
INFORMATION TECHNOLOGY
Econophone believes that advanced, effective and flexible billing, public
financial reporting and customer service information systems are vital for its
operations and continued growth. Econophone engages in design and integration of
billing, public financial reporting and customer service information systems at
its College Station, Texas and Brooklyn, New York facilities, where it employs
26 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 information systems are
adequate, substantial investment will be required to maintain the adequacy of
these systems as Econophone expands its operations. Econophone currently is in
the process of upgrading its billing systems to a format that will provide for
greater expandability and that will accommodate greater customer volumes.
Econophone expended approximately $1.4 million during 1997 to enhance current
and develop new customer service, billing, financial reporting and other
management information systems and has budgeted $3.4 million for such
expenditures during 1998. See "Risk Factors--Dependence on Effective Information
Systems" and "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 "AT&T Unisource," and the
corresponding alliance with WorldPartners, 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 has 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
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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.
See "Risk Factors--Competition."
In the United States, Econophone's competitors include AT&T, MCI, Sprint and
numerous other carriers and providers, including calling card providers, for
domestic and international long distance calls. Competition is strong for all of
Econophone's services. Competition for U.S. calling card services is
particularly intense. Larger service providers such as AT&T, MCI and Sprint have
substantial brand recognition and market penetration for their calling cards,
while a large number of smaller calling card providers compete fiercely based
almost entirely on price.
As a result of the Communications Act of 1996 (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, and have applied for FCC approval for
"in region" market entry. To date, the FCC has denied each of these
applications. However, the FCC has been meeting with the RBOCs to explain FCC
requirements. This may lead to one or more successful RBOC "in region"
applications in the future. Recently, a lower court decision, which is currently
being appealed, invalidated the FCC's statutory authority for prior approval of
market entry by several RBOCs into certain "in region" long distance markets. 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 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.
The World Trade Organization (the "WTO") recently concluded an agreement,
known as the WTO Basic Telecommunications Service Agreement (the "WTO
Agreement"), which will open the telecommunications markets of the 70 signatory
countries to foreign carriers on varying dates. The WTO Agreement became
effective February 5, 1998. 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 on a
reasonable and non-discriminatory basis. The WTO Agreement affords no private
right of action, however, so a company would have to pursue any complaint at the
national government level. 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, 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 merger between
Bell Atlantic and NYNEX, the pending acquisition of MCI by Worldcom, Inc., the
proposed acquisition of Teleport Communications by AT&T and the creation of a
new company with the national and/or 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 providing national
and/or international long distance voice transmission (including AT&T), 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
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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, business, financial
condition, results of operations and its ability to pay principal of and
interest on the Notes. Many of Econophone's larger competitors have lower
incremental transmission costs than Econophone due to, among other things,
greater use of owned transmission capacity, more favorable interconnection rates
and volume discounts on transmission. Furthermore, in certain European countries
(including in France and Belgium), telecommunications companies that make
substantial investments in network infrastructure will receive a substantial
discount on interconnection rates. Econophone does not expect to qualify for
such a discount. In addition, certain of Econophone's competitors offer
customers an integrated full service telecommunications package consisting of
local and long distance voice, data and Internet transmission. Econophone does
not offer all of these types of service, and presently does not intend to do so,
which could have a material adverse effect on Econophone's competitiveness and
its ability to make payments of 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
Over the last decade, the telecommunications market in the EU has been
subject to gradual liberalization. Some EU member states (including the United
Kingdom, Sweden and Finland) have opened up their markets on their own
initiative and are already substantially liberalized. In other member states,
liberalization has come about through the implementation of EU legislation and
in most of these member states the liberalization process and the establishment
of a liberalized regulatory framework are still in their initial stages.
National governments must pass legislation within their countries to give effect
to EC directives. Each EU member state in which Econophone currently conducts
its business will continue to, in part, have a different regulatory regime. The
requirements for Econophone to obtain necessary approvals vary considerably from
country to country and are expected to continue to so vary. See "Risk
Factors--Regulatory Restrictions."
As a first step towards removing PTOs' monopolies in each member state and
enabling competition both within each member state and between them, in 1990,
the European Commission issued a Directive on Competition in the Markets for
Telecommunications Services (the "Services Directive"). The effect of the
Services Directive was 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.
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The Service Directive was amended by later directives concerned with
liberalizing various sections of the telecommunications market. Finally, 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, to fully liberalize the
supply of all telecommunications services and the provision of
telecommunications infrastructure by January 1, 1998. 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 been granted a
derogation entitling it to delay compliance with the Services Directive, as
amended, until November 30, 1998 and Luxembourg and Greece have been granted a
derogation entitling them to delay compliance until June 30, 1998 and January 1,
2001, respectively.
The Full Competition Directive abolished, as of January 1, 1998 (subject to
permitted derogations by EU member states described above), 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
the provision of 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) provided 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 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 were not considered to be
competitive. From January 1997, these remaining restrictions on international
simple resale have been removed, although the United Kingdom has reserved the
right to reimpose proportionate return conditions in the event that market
distortions occur. However, the ability of EU member states to in the future
enact restrictions on the provision of telecommunications services is limited
due to the WTO Agreement. See "--World Trade Organization Initiatives."
In addition to the abolition of special and exclusive rights, the Council of
the European Communities has adopted regulatory measures in order to harmonize
the rules applying in the liberalized EU telecommunications environment. In this
respect, an Open Network Provision ("ONP") Framework Directive was adopted in
1990. Further more specific directives, which include the ONP Leased Lines
Directive, the ONP Voice Telephony Directive, the ONP (Adaptation of the
Framework and Leased Lines to a Competitive Environment) Directive and the
Interconnection Directive, as well as directives concerned with licensing and
satellite PCS services have been adopted. In addition an amendment to the
Interconnection Directive, which would provide for equal access and number
portability has been proposed. Equal access would enable a customer to access
Econophone's network over another operator's network, without dialing an access
code, by notifying the network operator that it wishes all long distance calls
to be carried by Econophone. Oftel has already indicated that it will seek to
defer the implementation of equal access in the United Kingdom. Number
portability would enable customers to retain their existing telephone numbers
when switching to alternative carriers and is already available (although not
universally) in the United Kingdom. Additional directives, in addition to those
described above, remain to be adopted by the Council of the European
Communities, although their final content and timing of implementation cannot be
predicted at this time.
UNITED KINGDOM
The telecommunications services provided by Econophone in the United Kingdom
are subject to and affected by legislation and the terms of its licenses.
Licenses are granted by the Secretary of State for Trade
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and Industry but enforced by Oftel under powers granted by the
Telecommunications Act 1984. 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 operate under individual
licenses granted by the Secretary of State for Trade and Industry pursuant to
the Telecommunications Act 1984. International simple resellers operate under
registrable class licenses. 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). The statutory instrument implementing the
Interconnection Directive extends this requirement to operators with "relevant
connectable system status." Oftel has stated that the categories of companies
that qualify for relevant connectable system status are 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 its subsidiary ATL, held an
International Simple Resale ("ISR") license in the United Kingdom, which
entitled it to resell international message, telephone and private line
services. All ISRs were revoked on December 31, 1997 and all holders were
required to reapply to the Secretary of State for Trade and Industry to be
registered under the new International Simple Voice Resale Class License (the
"ISVR"), which authorizes the same activities as the old ISR. ATL, a subsidiary
of Econophone, has registered itself under the ISVR. The ISVR license enables
ATL 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 facilities vested with British Telecom and Mercury. All other
operators were required to buy leased capacity from British Telecom or Mercury,
rather than installing their own facilities or 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. ATL was awarded an
IFL during the second quarter of 1997.
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. The WTO Agreement becomes effective on February 5,
1998. 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 on a reasonable
and non-discriminatory basis. The WTO Agreement affords no private right of
action, however, so a company would have to pursue any complaint at the national
government level. 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.
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BELGIUM
Until January 1, 1998, the provision of "telephone services" was reserved
for the Belgian PTO. "Telephone services" consist of real-time voice telephony
involving switching in Belgium. Services that did not constitute "telephone
services" could be provided by private service providers that are duly licensed.
Prior to January 1, 1998, a subsidiary of Econophone was 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. Econophone
currently has pending an application for a license to provide "telephone
services" in Belgium.
FRANCE
Beginning on January 1, 1998, licensed private service providers were able
to offer domestic and international long distance voice telephony services to
the general public in France. These services are 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 intends to file an application for a license to provide
international and long distance voice telephony services to the general public
utilizing local dial-up access.
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. The provision by Econophone of domestic long distance
service in Germany under the presently planned technical setup would involve
switching and would, therefore, require a license. Econophone currently has
pending an application for a license to be able to provide such service.
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.
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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, New
Zealand and Australia. 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 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, New Zealand and Australia, 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, to pay each
payphone operator $0.35 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 and was remanded to the FCC by the court for further
consideration. The FCC subsequently adopted a rate of $0.284, in lieu of the
$0.35 rate, effective October 7, 1997 and made further clarifications of its
initial order. This decision is also before an appellate court and some aspects
of its implementation remain unclear. There can be no assurance that Econophone
will be able to fully pass the cost of this charge, if applied to Econophone, 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.
Beginning January 1, 1998, Econophone, as well as its U.S. competitors,
became obligated to make FCC-mandated contributions to universal service funds.
These funds subsidize the provision of
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telecommunications services in high cost areas and to low-income customers, as
well as the provisions of telecommunications and certain other services to
eligible schools, libraries and rural health care providers. The contributions
are billed monthly and are assessed based on intrastate, interstate and
international "end-user" gross telecommunications revenues. However, revenues
from international calls that both originate and terminate in foreign points are
excluded from assessment. On December 16, 1997, the FCC approved the following
contribution factors for carriers' first quarter 1998 contributions: (i) 3.19%
for the high cost and low income funds (interstate and international revenues);
and (ii) 0.72% for the schools, libraries and rural health care funds
(intrastate, interstate and international revenues). Because the contribution
factors are likely to vary quarterly, the annualized impact on Econophone cannot
be estimated at this time. Econophone currently is evaluating which categories
of its revenues are subject to assessment and, as a result, has not filed a
universal service fund worksheet.
Additionally, effective January 1, 1998, Econophone is required to pay to
LECs specified PICCs in order to compensate such LECs for their investment in
the telephone lines Econophone uses to access its customers. The costs of these
charges vary in amount depending upon the type of presubscribed lines that are
serviced by Econophone and the individual LEC's revenue requirements. While
Econophone currently intends to pass through the costs of both the PICC and its
universal service fund contributions to its customers, there can be no assurance
that Econophone will be able to fully pass on such costs or that doing so will
not result in a loss of customers. In addition, the FCC orders implementing the
universal service contribution obligation and the PICC are both subject to
petitions seeking reconsideration by the FCC and to certain appeals. Until such
petitions or appeals are decided, there can be no assurance as to how the orders
will be implemented or enforced or what effect the orders generally will have on
competition within the telecommunications industry or specifically on the
competitive position of Econophone. See "Risk Factors--Regulatory Restrictions."
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, Inc., a New York corporation, the predecessor to Econophone
("Econophone NY"), has received authority, pursuant to state regulation,
certification, tariffs, notifications, or on an unregulated basis, to provide
intrastate long distance service in 49 states. Econophone and Econophone NY are
in the process of transferring such authorities from Econophone NY to
Econophone, or notifying or obtaining the approval of the state regulatory
authorities of the merger of Econophone NY into Econophone, where required.
Econophone anticipates that it will obtain all required state regulatory
approvals.
EMPLOYEES
As of December 31, 1997, Econophone had 408 employees worldwide. Of this
total, 248 were based in the United States and 160 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, Marseilles, London, Paris and Zurich.
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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.
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 Antwerp, Athens, Berlin, Hamburg, Marseilles and
Zurich.
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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 and Director
Kevin A. Alward...................................... 30 President-North America
Phillip J. Storin.................................... 47 Senior Vice President and Chief Financial Officer
Richard L. Shorten, Jr............................... 30 Senior Vice President and General Counsel
Abe Grohman.......................................... 37 Vice President, Chief Information Officer
Jeremy S. Kagan...................................... 32 Vice President of Service Systems
Patrick Attallah..................................... 32 Vice President of European Sales and Marketing
Charles D. Briggs.................................... 41 Vice President of Network Operations
Ira M. Riesenberg.................................... 36 Corporate Controller
Gary S. Bondi........................................ 46 Director and Treasurer
Steven West.......................................... 47 Director
Stephen Munger....................................... 40 Director
</TABLE>
Directors of Econophone each serve for a term of one year or until their
successors are elected. 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. The holders of the
Series A Preferred Stock have, since the issuance thereof, had the right to vote
as a separate class to elect one director. Stephen Munger currently serves in
such capacity.
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 AND DIRECTOR. Mr. Levy has
served as Econophone's Chief Operating Officer since August 1996, as a Director
since January 1997 and as President since August 1997. Mr. Levy also served as
Chief Financial Officer from August 1996 to January 1998. 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
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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.
KEVIN A. ALWARD, PRESIDENT-NORTH AMERICA. Mr. Alward has served as
Econophone's President-North America since February 1998. From October 1996 to
January 1998, Mr. Alward served as Director, President and Chief Operating
Officer of TotalTel USA Communications. From 1994 to October 1996, Mr. Alward
served as President of TotalTel, Inc., the principal operating subisidary of
TotalTel USA Communications. From 1992 to 1994, Mr. Alward served as Senior Vice
President at TotalTel USA Communications and assumed the additional
responsibilities of Chief Operating Officer in 1993, a position he held until
1994. Mr. Alward also served from 1991 to 1992 as Vice President of Marketing at
TotalTel USA Communications, and from 1990 to 1991 as Manager of Sales. Mr.
Alward served as a sales account executive at TotalTel USA Communications from
1988 to 1990.
PHILLIP J. STORIN, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. Mr.
Storin has served as a Senior Vice President and the Chief Financial Officer of
Econophone since February 1998. From May 1996 to January 1998, Mr. Storin served
as Chief Financial Officer of U.S. Long Distance, and from October 1994 to May
1996 served as Corporate Controller. From July 1992 to October 1994, Mr. Storin
served as Vice President, Accounting at U.S. Long Distance. Before joining U.S.
Long Distance, Mr. Storin served for five years as Director of Accounting for
Dell Computer Corporation. Prior to such time, Mr. Storin served in various
financial management positions at Datapoint Computer Corporation and Westvaco
Corporation. Mr. Storin is a Certified Public Accountant and a Certified
Management Accountant.
RICHARD L. SHORTEN, JR., SENIOR VICE PRESIDENT AND GENERAL COUNSEL. Mr.
Shorten has served as a Senior Vice President and the General Counsel of
Econophone since December 1997. From September 1992 to December 1997, Mr.
Shorten was an associate at the New York law firm Cravath, Swaine & Moore, where
he specialized in a variety of areas of corporate representation, including
securities, finance and mergers and acquistions.
ABE GROHMAN, VICE PRESIDENT, CHIEF INFORMATION OFFICER. Mr. Grohman has
served as Chief Information Officer since October 1997. From September 1994 to
September 1997, Mr. Grohman was the Director of Management Information Systems
for LDM Systems Inc., a switchless reseller. From May 1986 to September 1994,
Mr. Grohman was President of DBA Consulting, an independent data processing
consulting company.
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.
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 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.
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
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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 served as the Assistant Controller at
Computron, and from April 1990 to March 1994 served as Accounting Manager. Mr.
Riesenberg served as Accounting Manager for Transnet Corporation from November
1988 to April 1990. Before Transnet, Mr. Riesenberg was at Stanley Marks &
Company, an accounting firm. Mr. Riesenberg is a Certified Public Accountant and
a member of the American Institute of Certified Public Accountants.
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.
STEPHEN MUNGER, DIRECTOR. Mr. Munger has served as a Director of Econophone
since November 1997. Mr. Munger is a Managing Director in the Mergers,
Acquisitions and Restructuring Department of Morgan Stanley & Co. Incorporated
and Head of the Private Investment Department. He joined Morgan Stanley in 1988
as a Vice President in the Corporate Finance Department. He became a Principal
in 1990 and a Managing Director in 1993. In 1993 and 1994, Mr. Munger was
Investment Banking Division Operations Officer and Administrative Director of
the Corporate Finance Department, respectively.
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.
Alfred West, Alan L. Levy, Gary S. Bondi, Stephen West and Hartley R.
Rogers, a former director of Econophone, participated in deliberations
concerning executive officer compensation during 1997. Alfred West and Alan L.
Levy 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, which is an affiliate of Morgan Stanley, owns 140,000 shares of Series A
Preferred Stock. Effective November 1997, the holders of the Series A Preferred
Stock designated Stephen Munger as a Director. 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 1997 Unit Offering and is the
Placement Agent in connection with the Offering. See "--Executive Compensation"
and "Certain Transactions."
EXECUTIVE COMPENSATION
At December 31, 1997, the chief executive officer and other four most highly
compensated executive officers of Econophone were Mr. Alfred West and Messrs.
Levy, Shorten, Grohman and Kagan. The following table summarizes all 1997 plan
and non-plan compensation awarded to, earned by or paid to Mr. West and Messrs.
Levy, Shorten, Grohman and Kagan. Messrs. Alward and Storin commenced employment
with the Company during February 1998 (Messrs. West, Levy, Alward, Storin,
Shorten, Grohman and Kagan are referred to herein as the "Named Executive
Officers").
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1997 SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
-------------------
SHARES OF
ANNUAL COMPENSATION COMMON STOCK
------------------------ UNDERLYING OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION SALARY (1) BONUS GRANTED COMPENSATION(1)
- ------------------------------------------------ ------------ ---------- ------------------- -----------------
<S> <C> <C> <C> <C>
Alfred West (2)................................. $ 323,784 $ 422,992(3) -- $ 4,725(4)
Chief Executive Officer
Alan L. Levy (5)................................ 210,000 116,250(6) -- --
President and Chief Operating Officer
Kevin A. Alward (7)............................. -- -- -- --
President--North America
Phillip J. Storin (8)........................... -- -- -- --
Senior Vice President--Chief Financial Officer
Richard L. Shorten, Jr. (9)..................... 6,875 -- 50,000 --
Senior Vice President--General Counsel
Abe Grohman (10)................................ 29,167 -- 50,000 --
Chief Information Officer
Jeremy S. Kagan................................. 125,000 -- -- --
Vice President of Service Systems
</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 1997.
(2) See "--Employment Agreements and Arrangements" for a description of Mr.
West's Employment Agreement.
(3) Consists of $127,686 of 1996 bonus paid in 1997 and $295,306 of 1997 bonus
paid in 1997.
(4) Consists of compensation in respect of life insurance, of which Mr. West's
designee is the beneficiary, paid by Econophone.
(5) See "--Employment Agreements and Arrangements" for a description of Mr.
Levy's Employment Agreement.
(6) Consists of $37,500 of 1996 bonus paid in 1997 and $78,750 of 1997 bonus
paid in 1997.
(7) Mr. Alward commenced employment with Econophone during February 1998.
(8) Mr. Storin commenced employment with Econophone during February 1998.
(9) Mr. Shorten joined Econophone on December 15, 1997.
(10) Mr. Grohman joined Econophone on October 20, 1997.
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1996 FLEXIBLE INCENTIVE PLAN
Econophone has adopted 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 4,000,000 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), if 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 December 31, 1997, Econophone had issued options to purchase 2,901,445
shares of Common Stock under the Incentive Plan, 1,109,445 of which were
exercisable as of such date.
The following table sets forth grants of options to purchase shares of
Common Stock of Econophone made during 1997 to each Named Executive Officer.
OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------- POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
OPTIONS ANNUAL RATES OF STOCK
GRANTED TO PRICE APPRECIATION FOR
NUMBER OF EMPLOYEES EXERCISE OPTION TERM
SECURITIES IN FISCAL PRICE PER EXPIRATION ----------------------
NAME UNDERLYING OPTIONS YEAR 1997 SHARE($) DATE 5% ($) 10%($)
- --------------------------- ------------------ ----------- ----------- ------------ ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Alfred West................ -- -- -- -- -- --
Alan L. Levy............... -- -- -- -- -- --
Kevin A. Alward (1)........ -- -- -- -- -- --
Phillip J. Storin (2)...... -- -- -- -- -- --
Richard L. Shorten, Jr..... 50,000 16.7% $ 5.00 11/1/2007 $ 157,223 $ 398,435
Abe Grohman................ 50,000 16.7% $ 5.00 11/1/2007 $ 157,223 $ 398,435
Jeremy S. Kagan............ -- -- -- -- -- --
</TABLE>
- ------------------------
(1) Mr. Alward commenced employment with Econophone during February 1998.
(2) Mr. Storin commenced employment with Econophone during February 1998.
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<PAGE>
The following table sets forth options exercised during 1997 and the fiscal
year-end value of unexercised options for each Named Executive Officer.
OPTION EXERCISES IN 1997 AND 1997 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1997 DECEMBER 31, 1997
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............... -- -- 944,446 1,055,554 $ 2,361,115 $ 2,638,885
Kevin A. Alward (2)........ -- -- -- -- -- --
Phillip J. Storin (3)...... -- -- -- -- -- --
Richard L. Shorten, Jr..... -- -- 0 50,000 0 0
Abe Grohman................ -- -- 0 50,000 0 0
Jeremy S. Kagan............ -- -- 10,000 20,000 25,000 50,000
</TABLE>
- ------------------------
(1) No options were exercised during 1997.
(2) Mr. Alward commenced employment with Econophone during February 1998.
(3) Mr. Storin commenced employment with Econophone during February 1998.
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 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 President and Chief Operating Officer of Econophone. 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
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<PAGE>
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. Shorten, Grohman and Kagan do not have employment agreements with
Econophone. As of January 1, 1998, the annual salary (exclusive of any bonus)
for Messrs. Shorten, Grohman and Kagan was $165,000, $140,000 and $125,000,
respectively. The Company expects to enter into employment agreements with
Messrs. Alward and Storin providing for annual base salary of $216,000 and
$180,000, respectively. Messrs. Alward and Storin also will be granted options
under the Incentive Plan during 1998.
LIMITATIONS ON OFFICERS' AND DIRECTORS' LIABILITY
Econophone's Certificate of Incorporation indemnifies its officers and
directors to the fullest extent permitted by the Delaware General Corporation
Law (the "GCL"). Under Section 145 of the GCL, a corporation may indemnify its
directors, officers, employees and agents and its former directors, officers,
employees and agents and those who serve, at the corporation's request, in such
capacities with another enterprise, against expenses (including attorneys'
fees), as well as judgments, fines and settlements in nonderivative lawsuits,
actually and reasonably incurred in connection with the defense of any action,
suit or proceeding in which they or any of them were or are made parties or are
threatened to be made parties by reason of their serving or having served in
such capacity. The GCL provides, however, that such person must have acted in
good faith and in a manner such person reasonably believed to be in (or not
opposed to) the best interests of the corporation and, in the case of a criminal
action, such person must have had no reasonable cause to be believe his or her
conduct was unlawful. In addition, the GCL does not permit indemnification in an
action or suit by or in the right of the corporation, where such person has been
adjudged liable to the corporation, unless, and only to the extent that, a court
determines that such person fairly and reasonably is entitled to indemnity for
costs the court deems proper in light of liability adjudication. Indemnity is
mandatory to the extent a claim, issue or matter has been successfully defended.
The Certificate of Incorporation and the GCL 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
foregoing 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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<PAGE>
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.
The Series A Preferred Stock is convertible into 3,420,701 shares of Common
Stock.
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 1997 Unit Offering,
Econophone was 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 became no more restrictive than
the analogous covenants contained in the Indenture dated as of July 1, 1997,
between the Company and The Bank of New York, as trustee.
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 Delaware 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 1997 Unit 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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<PAGE>
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 December 31,
1997, the shares of Series A Preferred Stock outstanding were convertible into
3,420,701 shares of Common 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, dated April 24, 1997, between the Company and Morgan
Stnaley & Co. Incorporated, as placement agent, 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 occurring
prior to March 1, 1998, which is underwritten or placed by an investment bank of
national standing; (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 connection with the disposition of any
business, assets or subsidiary of Econophone, subject to certain exceptions.
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<PAGE>
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 (references below to "Series A Preferred Stock" apply equally to
the Common Stock issuable upon the conversion thereof).
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 (as hereinafter defined) (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 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
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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 the Placement Agent and
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 sold by Econophone were $6.6
million and were used to fund equipment and other capital expenditures and
operations.
Immediately following the consummation of the 1997 Unit 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 connection with the 1997 Unit Offering and to
act as lead underwriter in the event of Econophone's initial public offering.
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<PAGE>
PRIVATE PLACEMENT OF UNITS AND NOTES BY MORGAN STANLEY
The Placement Agent acted as placement agent in respect of the 1997 Unit
Offering and the Offering. In connection with the 1997 Unit Offering and the
Offering, Econophone entered into Placement Agreements with the Placement Agent
pursuant to which it purchased the Units or Notes for resale. The Placement
Agreements provide, among other things, that the Company and the Placement Agent
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
Agreements, Econophone has certain obligations to register 1997 Notes, Warrants,
shares of Common Stock and Notes on a shelf registration statement at the
request, and for the benefit of, the Placement Agent and any successor thereto.
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 matured on December 8, 1997 and, on such date, was
converted into a demand obligation. 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 $214,022 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. 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.
MINORITY INTEREST IN ECONOPHONE SERVICES GMBH
The brother-in-law of Alfred West owns a 28% interest in Econophone's Swiss
subsidiary, Econophone Services GmbH. Econophone Services GmbH is in the initial
stages of commencing marketing efforts in Zurich and is expected to, over time,
market Econophone's services in additional Swiss markets.
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<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
THE 1997 UNIT OFFERING
In connection with the 1997 Unit Offering, Econophone issued $155.0 million
of 13 1/2% Senior Notes due 2007 pursuant to the 1997 Indenture among the
Company and The Bank of New York, as trustee. On December 5, 1997, the Company
consummated an offer to exchange the notes issued in the 1997 Unit Offering (the
"1997 Original Notes") for $155.0 million principal amount at maturity of notes
that had been registered under the Securities Act (the "1997 Exchange Notes").
As used below and elsewhere herein, the term "1997 Notes" includes the 1997
Original Notes and the 1997 Exchange Notes. As indicated herein, the terms of
the 1997 Notes are substantially similar to those of the Notes. See "Description
of the Exchange Notes."
PRINCIPAL, MATURITY AND INTEREST
The 1997 Notes are unsecured unsubordinated obligations of Econophone,
limited to $155.0 million aggregate principal amount at maturity, and mature on
July 15, 2007. Interest on the 1997 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, 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. At
the closing of the 1997 Unit Offering, Econophone used $57.6 of the net proceeds
of the 1997 Unit Offering to purchase the Pledged Securities, which were pledged
as security for the payment of interest on the principal of the 1997 Notes.
Proceeds from the Pledged Securities are being used by Econophone to make
interest payments on the 1997 Notes through July 15, 2000. The Pledged
Securities are being held by a trustee pending disbursement.
OPTIONAL REDEMPTION
The 1997 Notes will be redeemable, at Econophone'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, at the following redemption prices (expressed in percentages of
principal amount at maturity), plus accrued and unpaid interest, if any, to the
redemption 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, Econophone may redeem up to
35% of the aggregate principal amount of the 1997 Notes with the net proceeds of
one or more sales of common equity at a redemption price of 113.50%, plus
accrued and unpaid interest, if any, to the redemption date; PROVIDED that (1)
at least $100.0 million aggregate principal amount at maturity of 1997 Notes
remains outstanding after each such redemption and (2) each such redemption
occurs within 180 days of the related sale of common equity.
RANKING
The indebtedness evidenced by the 1997 Notes ranks PARI PASSU in right of
payment with all existing and future unsubordinated indebtedness of Econophone
and senior in right of payment to all existing and future subordinated
indebtedness of Econophone.
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<PAGE>
COVENANTS
The 1997 Indenture restricts, on substantially the same terms as the
Indenture, among other things, Econophone's ability to incur additional
indebtedness, pay dividends or make certain other restricted payments, incur
certain liens to secure pari passu or subordinated indebtedness, engage in any
sale and lease-back transaction, sell, assign, transfer, lease, convey or
otherwise dispose of substantially all of the assets of Econophone, enter into
certain transactions with affiliates, or incur indebtedness that is subordinated
in right of payment to any senior indebtedness and senior in right of payment to
the 1997 Notes. The 1997 Indenture permits, under the same circumstances as the
Indenture, Econophone's subsidiaries to be deemed unrestricted subsidiaries and
thus not subject to the restrictions of the 1997 Indenture.
REPURCHASE OF 1997 NOTES UPON A CHANGE OF CONTROL
Econophone must commence, within 30 days of the occurrence of a Change of
Control (as defined in the 1997 Indenture), and consummate an offer to purchase
for cash all 1997 Notes then outstanding at a purchase price equal to 101% of
the outstanding principal amount, plus accrued interest (if any) at such time.
The foregoing covenant requiring Econophone to repurchase the 1997 Notes will,
unless consents are obtained, require Econophone to repay all indebtedness then
outstanding which by its terms would prohibit such 1997 Note repurchase, either
prior to or concurrently with such 1997 Note repurchase.
EVENTS OF DEFAULT
The 1997 Indenture contains standard events of default, including, but not
limited to, (i) defaults in the payment of principal, premium or interest, (ii)
defaults in the compliance with covenants contained in the 1997 Indenture, (iii)
cross defaults on more than $5.0 million of other indebtedness, (iv) failure to
pay more than $5.0 million of judgments that have not been stayed by appeal or
otherwise and (v) the bankruptcy of Econophone or certain of its subsidiaries.
The events of default contained in the 1997 Indenture are the same as those
contained in the Indenture.
NTFC VENDOR FINANCING
On May 28, 1996, Econophone entered into a credit facility with NTFC, which
has been amended and increased as to amount on several occasions. On January 28,
1998, the NTFC credit facility was amended and restated in its entirety in order
to effect various amendments and increase the amount of NTFC's commitment
thereunder (such credit facility, as amended and restated, is referred to herein
as the "NTFC Facility"). The NTFC Facility provides for borrowings by Econophone
and its subsidiaries to fund certain equipment acquisition costs and related
expenses. The NTFC Facility provides for an aggregate commitment of NTFC of
$24.0 million pursuant to three tranches of $2.0 million, $3.0 million and $19.0
million. Loans borrowed under each tranche of the NTFC Facility amortize in
equal monthly installments over a five year period ending on July 1, 2001, April
1, 2002 and January 1, 2003, respectively. As of December 31, 1997, the
aggregate amount outstanding under all tranches of the NTFC Facility was $7.1
million. Loans under the NTFC Facility accrue interest at an interest rate equal
to the 90-day commercial paper rate plus 395 basis points (an interest rate of
9.55% as of January 1, 1998), subject to certain quarterly adjustments depending
upon financial performance. All of the equipment purchased with the proceeds of
the NTFC Facility has been pledged to NTFC.
The NTFC Facility permits the incurrence of indebtedness (including
contingent obligations), the creation of liens and transactions with affiliates
on substantially the same terms as the Indenture.
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
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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 (other than by reason of his death or disability) or suffer to exist any
material competition by any of Alfred West, Steven West or Gary Bondi, with the
business now or hereafter conducted by Econophone.
The NTFC Facility 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 specified minimum cash
balances (certain related business investments and acquisitions qualify as cash
for the foregoing purposes). Econophone also must have EBITDA (as defined in the
NTFC Facility) of not less than: negative $5,500,000 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.
Borrowings from NTFC are secured by the equipment purchased therewith and
general intangibles and intangible property that is associated with such
equipment.
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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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of Econophone's Common Stock as of January 1, 1998 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 Named 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(3) 47.0%
Steven West............................................................... 4,500,000(4) 19.2%
Gary Bondi................................................................ 4,500,000(5) 19.2%
Princes Gate Investors II, L.P............................................ 3,420,701(6) 14.6%
c/o Morgan Stanley & Co. Incorporated
1585 Broadway
New York, NY 10036
Kevin A. Alward........................................................... -- (7) --
Abe Grohman............................................................... -- (8) *
Jeremy S. Kagan........................................................... 10,000(9) *
Alan L. Levy.............................................................. 1,055,557(10) 4.3%
Stephen Munger............................................................ -- --
Richard L. Shorten, Jr.................................................... -- (11) --
Phillip J. Storin......................................................... -- (12) --
All Directors and Executive Officers as a Group (10 persons).............. 21,065,557 85.4%
</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 January 1,
1998. 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
January 1, 1998, 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 860,000 shares held by AT Econ Ltd. Partnership.
(4) Includes 860,000 shares held by SS Econ Ltd. Partnership and 85,000 shares
held by SS Econ Ltd. Partnership No. 2.
(5) Includes 860,000 shares held by GS Econ Ltd. Partnership.
(6) Includes 31,704 shares of Series A Preferred Stock, which were convertible
into 774,528 shares of Common Stock on January 1,1998, owned by affiliates
of Princes Gate over which Princes Gate has sole voting power.
(7) Mr. Alward commenced employment with Econophone during February 1998 and
will be granted options under the Incentive Plan during 1998.
(8) Does not include options to purchase 50,000 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after January 1,
1998.
(9) Does not include options to purchase 20,000 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after January 1,
1998.
(10) All of such shares are issuable upon the exercise of options. Does not
include options to purchase 944,443 shares of Common Stock under the
Incentive Plan which are not exercisable within 60 days after January 1,
1998.
(11) Does not include options to purchase 50,000 shares of Common Stock under
the Incentive Plan which are not exercisable within 60 days after January 1,
1998.
(12) Mr. Storin commenced employment with Econophone during February 1998 and
will be granted options under the Incentive Plan during 1998.
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DESCRIPTION OF THE EXCHANGE NOTES
The Exchange Notes are to be issued under an Indenture, dated as of February
18, 1998, 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 $300.0 million aggregate principal amount at maturity, and will mature on
February 15, 2008. Although for federal income tax purposes a significant amount
of original issue discount, taxable as ordinary income, will be recognized by a
Holder as such discount accrues, no interest will be payable on the Notes prior
to August 15, 2003. From and after February 15, 2003, interest on the Notes will
accrue at the rate of 11.0% from February 15, 2003 or from the most recent
Interest Payment Date to which interest has been paid or provided for, payable
semiannually (to Holders of record at the close of business on the February 1 or
August 1 immediately preceding the Interest Payment Date) on February 15 and
August 15 of each year, commencing August 15 , 2003. Interest will be computed
on the basis of a 360-day year of twelve 30-day months.
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.
The 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 February 15, 2003 and prior to
maturity, upon not less than 30 nor more than 60 days' prior notice mailed by
first class mail to each Holder's 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 February 15 of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- --------------------------------------------- ----------------
<S> <C>
2003 105.500%
2004 103.667%
2005 101.833%
2006 and thereafter 100.000%
</TABLE>
In addition, at any time prior to February 15, 2001, the Company may redeem
up to 35% of the initial aggregate principal amount of the Notes originally
issued 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
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Redemption Price (expressed as a percentage of Accreted Value on the Redemption
Date) of 111.0%; PROVIDED that (1) at least 65% of the initially issued Notes
remain outstanding and (2) each such redemption occurs within 180 days of the
related Public Equity Offering.
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.
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 December 31, 1997, Econophone had $157.9 million of
indebtedness outstanding, all of which was unsubordinated and $149.7 million of
which was secured by $59.0 million of restricted cash. Substantially all of the
remaining indebtedness is secured by telecommunications assets. The Notes are
effectively subordinated to the secured indebtedness to the extent of the
security interest related thereto.
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 the purposes of these
definitions, the terms "Note" or "Notes" shall mean the Original Notes and the
Exchange Notes.
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<PAGE>
"Accreted Value" means, for any Specified Date, the amount provided below
for each $1,000 principal amount at maturity of Notes:
(i) if the Specified Date occurs on one of the following dates (each a
"Semi-Annual Accrual Date"), the Accreted Value will equal the amount set
forth below for such Semi-Annual Accrual Date:
<TABLE>
<CAPTION>
ACCRETED
SEMI-ANNUAL ACCRUAL DATE VALUE
- ------------------------------------------------------------------------------- -------------
<S> <C>
August 15, 1998................................................................ $ 617.62
February 15, 1999.............................................................. $ 651.59
August 15, 1999................................................................ $ 687.43
February 15, 2000.............................................................. $ 725.24
August 15, 2000................................................................ $ 765.13
February 15, 2001.............................................................. $ 807.21
August 15, 2001................................................................ $ 851.61
February 15, 2002.............................................................. $ 898.45
August 15, 2002................................................................ $ 947.86
February 15, 2003.............................................................. $ 1,000.00
</TABLE>
(ii) if the Specified Date occurs before the first Semi-Annual Accrual
Date, the Accreted Value will equal the sum of (a) $585.95 and (b) an amount
equal to the product of (1) the Accreted Value for the First Semi-Annual
Accrual Date less $585.95 MULTIPLIED by (2) a fraction, the numerator of
which is the number of days from the Closing Date to the Specified Date,
using a 360-day year of twelve 30-day months, and the denominator of which
is the number of days from the Closing Date to the first Semi-Annual Accrual
Date, using a 360-day year of twelve 30-day months;
(iii) if the Specified Date occurs between two Semi-Annual Accrual
Dates, the Accreted Value will equal the sum of (a) the Accreted Value for
the Semi-Annual Accrual Date immediately preceding such Specified Date and
(b) an amount equal to the product of (1) the Accreted Value for the
immediately following Semi-Annual Accrual Date less the Accreted Value for
the immediately preceding Semi-Annual Accrual Date MULTIPLIED by (2) a
fraction, the numerator of which is the number of days from the immediately
preceding Semi-Annual Accrual Date to the Specified Date, using a 360-day
year of twelve 30-day months, and the denominator of which is 180; or
(iv) if the Specified Date occurs after the last Semi-Annual Accrual
Date, the Accreted Value will equal $1,000.
"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 that is not a Restricted Subsidiary,
except (x) with respect to net income, to the extent of the amount of dividends
or other distributions actually paid to the Company or any of its Restricted
Subsidiaries by such Person during such period and (y) with respect to net
losses, to the extent of the amount of Investments made by the Company or any
Restricted Subsidiary in such Person 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
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<PAGE>
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 (on an after tax basis)
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; (vi) all extraordinary gains and extraordinary losses
and (vii) any compensation expense paid or payable solely with Capital Stock
(other than Disqualified Stock) of the Company or any options, warrants or other
rights to acquire Capital Stock (other than Disqualified Stock) of the Company.
"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 or provided to the Trustee 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 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 constitutes 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 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
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and assets (other than the Capital Stock of, or other Investment in, an
Unrestricted Subsidiary) 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
constitute property or assets of the kind described in clause (B) of the
"Limitation on Asset Sales" covenant, including consideration that consists of
technology, licenses or expertise useful in the business of the Company 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 connnection 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.
"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 outstanding on the
Closing Date or issued thereafter, 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.
"Capitalized Lease Obligations" means the discounted present value of the
rental obligations under a Capitalized 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) of 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
of 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
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any new directors whose election to 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 the date on which the Notes are originally 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 on the Closing Date or issued thereafter,
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 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
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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
(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
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"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; PROVIDED that for purposes of clause (viii) of
the second paragraph of the "Limitation on Indebtedness" covenant, (x) the fair
market value of any security registered under the Exchange Act shall be the
average of the closing prices, regular way, of such security for the 20
consecutive trading days immediately preceding the applicable capital
contribution or sale of Capital Stock and (y) in the event the aggregate fair
market value of any other property (other than cash or cash equivalents)
received by the Company exceeds $10 million, the fair market value of such
property shall be determined by a nationally recognized investment banking firm
and set forth in their written opinion which shall be delivered to the Trustee.
"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 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.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness 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 of
such other Person (whether arising by virtue of partnership arrangements, or by
agreements to keep-well, to purchase assets, goods, securities or services
(unless such purchase arrangements are on arm's-length terms and are entered
into in the ordinary course of business), 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 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 Acquired Indebtedness; PROVIDED that neither
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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 Capitalized
Lease Obligations of such Person, (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 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;
PROVIDED that the fair market value of the Investment remaining in any Person
that has ceased to be a Restricted Subsidiary shall not exceed the aggregate
amount of Investments previously made in such Person valued at the time such
Investments were made less the net reduction in such Investments. 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 Restricted Subsidiaries)) of any Restricted Subsidiary at
the time that such Restricted Subsidiary is designated an Unrestricted
Subsidiary, (ii) the fair market value of the
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assets (net of liabilities (other than liabilities to the Company or any of its
Restricted 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 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) 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
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each new Note issued shall be in a principal amount at maturity of $1,000 or an
integral multiple 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 an integral
multiple 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, 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 $10.0 million at any one time outstanding; (ix)
Investments in Permitted Joint Ventures not to exceed $10.0 million at any one
time outstanding; (x) Investments in prepaid expenses, negotiable instruments
held for collection and lease, utility and worker's compensation, performance
and other similar deposits; and (xi) Interest Rate Agreements and Currency
Agreements designed solely to protect the Company or its Restricted Subsidiaries
against fluctuations in interest rates or foreign currency exchange rates.
"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'
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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, acquisition, construction, installation, transportation 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 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; (xix) Liens existing on the Closing Date and (xx)
Liens that secure Indebtedness in an aggregate principal amount not in excess of
$5.0 million at any time outstanding.
"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
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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 Group, a division of McGraw Hill,
Inc., and its successors.
"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.
"Specified Date" means any Redemption Date, any Payment Date for an Offer to
Purchase or any date on which the Notes first become due and payable after an
Event of Default.
"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.
"Strategic Subordinated Indebtedness" means Indebtedness of the Company
Incurred to finance the acquisition of a Person engaged in a business that is
related, ancillary or complementary to the business conducted by the Company or
any of its Restricted Subsidiaries, which Indebtedness by its terms, or by the
terms of any agreement or instrument pursuant to which such Indebtedness is
Incurred, (i) is expressly made subordinate in right of payment to the Notes and
(ii) provides that no payment of principal, premium or interest on, or any other
payment with respect to, such Indebtedness may be made prior to the payment in
full of all of the Company's obligations under the Notes; PROVIDED that such
Indebtedness may provide for and be repaid at any time from the proceeds of a
capital contribution or the sale of Capital Stock (other than Disqualified
Stock) of the Company after the Incurrence of such Indebtedness.
"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 one year 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 $50.0 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
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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
one year 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
$10.0 million.
"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
(and shall be deemed to have been 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.
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"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 will contain, 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 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.
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 $100.0 million, less any amount of such Indebtedness permanently repaid
as provided under the "Limitation on Asset Sales" covenant described below; (ii)
Indebtedness owed (A) to the Company evidenced by a promissory note or (B) to
any Restricted Subsidiary; 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 (xii) 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 Restricted
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
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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 (other than Guarantees of Indebtedness
Incurred by any Person acquiring all or any portion of such business, assets or
Restricted Subsidiary 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 (including Guarantees) Incurred to finance the cost
(including the cost of design, development, improvement, acquisition,
construction, installation, transportation or integration) to acquire equipment,
inventory or other tangible assets used or useful in the telecommunications
business of the Company and its Restricted Subsidiaries acquired (including
acquisitions by way of Capitalized Lease and acquisitions of the Capital Stock
of a Person that becomes a Restricted Subsidiary to the extent of the fair
market value of the equipment, inventory or other assets so 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 sum of
(A) the Net Cash Proceeds received by the Company after the Closing Date as a
capital contribution or 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 (I) such capital contribution or Net Cash Proceeds have not been used
pursuant to clause (C)(2) of the first paragraph of, or clause (iii), (iv) or
(viii) of the second paragraph of, the "Limitation on Restricted Payments"
covenant described below to make a Restricted Payment and (II) if such capital
contribution or Net Cash Proceeds are used to consummate a transaction pursuant
to which the Company Incurs Acquired Indebtedness, the amount of such Net Cash
Proceeds exceeds one-half of the amount of Acquired Indebtedness so Incurred and
(B) 80% of the fair market value of property (other than cash and cash
equivalents) received by the Company after the Closing Date as a capital
contribution or 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 (I) such capital contribution or sale of Capital Stock has not been used
pursuant to clause (iii), (iv) or (viii) of the second paragraph of the
"Limitation on Restricted Payments" covenant described below to make a
Restricted Payment and (II) if such capital contribution or Capital Stock is
used to consummate a transaction pursuant to which the Company Incurs Acquired
Indebtedness, 80% of the fair market value of the property received exceeds
one-half of the amount of Acquired Indebtedness so Incurred; PROVIDED that such
Indebtedness does not mature prior to the Stated Maturity of the Notes and has
an Average Life longer than the Notes; (ix) Acquired Indebtedness; (x) Strategic
Subordinated Indebtedness; (xi) subordinated Indebtedness of the Company (in
addition to Indebtedness permitted under clauses (i) through (x) above and
clause (xii) below) in an aggregate principal amount outstanding at any time not
to exceed $100.0 million, less any amount of such Indebtedness permanently
repaid as provided under the "Limitation on Asset Sales" covenant described
below; and (xii) Indebtedness of the Company and any Restricted Subsidiary;
PROVIDED that at the time of the Incurrence of any Indebtedness under this
clause (xii) the amount of Indebtedness under this clause (xii) 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.
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(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, and from time to
time may reclassify, 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) 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 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) above 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
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 with the Commission 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 as a
capital contribution or 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
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pursuant to clause (viii) of the second paragraph under 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
an Unrestricted Subsidiary (or options, warrants or other rights to acquire such
Capital Stock) in exchange for, or out of the proceeds of a capital contribution
to the Company or a substantially concurrent offering of, shares of Capital
Stock (other than Disqualified Stock) of the Company (or options, warrants or
other rights to acquire such Capital 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
capital contribution to the Company or a substantially concurrent offering of,
shares of the Capital Stock (other than Disqualified Stock) of the Company (or
options, warrants or other rights to acquire such Capital 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 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 from 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) Investments in any Person the primary business
of which is related, ancillary or complementary to the business of the Company
and its Restricted Subsidiaries on the date of such Investments; PROVIDED that
the aggregate amount of Investments made pursuant to this clause (viii) does not
exceed the sum of (a) $20.0 million and (b) the amount of Net Cash Proceeds
received by the Company after the Closing Date as a capital contribution or from
the sale of its Capital Stock (other than Disqualified Stock) to a Person who is
not a Subsidiary of the Company, except to the extent such Net Cash Proceeds are
used to Incur Indebtedness pursuant to clause (viii) of the second paragraph
under the "Limitation on Indebtedness" covenant or to make Restricted Payments
pursuant to clause (C)(2) of the first paragraph, or clause (iii) or (iv) of
this paragraph, of this "Limitation on Restricted Payments" covenant, and (c)
the net reduction in Investments made pursuant to this clause (viii) resulting
from distributions on or repayments of such Investments 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 is included in the calculation of Adjusted
Consolidated Net Income) or from such Person becoming a Restricted Subsidiary
(valued in each case as provided in the definition of "Investments"), PROVIDED
that the net reduction in any Investment shall not exceed the amount of such
Investment; (ix) the purchase, redemption, retirement or other acquisition for
value of shares of Capital Stock of the Company, or options to purchase such
shares,
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held by directors, officers or employees or former directors, officers 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 $5.0 million in the
aggregate after the Closing Date; (x) any Investment, to the extent the
consideration therefor paid by the Company and its Restricted Subsidiaries
consists solely of Capital Stock (other than Disqualified Stock) of the Company;
(xi) repurchases of Warrants pursuant to a Repurchase Offer; or (xii) other
Restricted Payments in an aggregate amount not to exceed $2.0 million; 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 and the Restricted Payment referred to in clause (x) thereof) and
the Net Cash Proceeds from any issuance of Capital Stock referred to in clauses
(iii), (iv) and (viii) 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.
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 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,
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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) $10.0 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) $5.0 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 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 of a Restricted Subsidiary, provided that the Company or such Restricted
Subsidiary applies the Net Cash Proceeds, if any, of any such sale in accordance
with 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
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("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 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 $3.0 million in value, must be approved or
determined to be fair in the manner provided for in clause (i)(A) or (B) above.
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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 (including, without limitation, licenses), 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; (vi) Liens on the
Capital Stock of, or any property or assets of, a Restricted Subsidiary securing
Indebtedness of such Restricted Subsidiary permitted under the "Limitation on
Indebtedness" covenant; or (vii) 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 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 75% 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
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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), PROVIDED, HOWEVER, that this clause (ii)
shall not apply to any long-term assignments in capacity in a telecommunications
network. 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
with the Commission 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 (as determined
in good faith by the Board of Directors, whose determination shall be conclusive
and evidenced by a Board Resolution) 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 $5.0 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 Accreted Value of Notes on the relevant Payment Date equal to the
Excess Proceeds on such date, at a purchase price equal to 101% of the Accreted
Value of the Notes on the relevant Payment Date, plus, in each case, 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.
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 Accreted Value 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.
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COMMISSION REPORTS AND REPORTS TO HOLDERS
The Company shall file with the Commission the annual, quarterly and other
reports and other information required by Section 13(a) or 15(d) of the Exchange
Act, regardless of whether such sections of the Exchange Act are applicable to
the Company, and shall mail or cause to be mailed copies of such reports to
Holders and the Trustee within 15 days after the date it would have been
required to file such reports with the Commission had it been subject to such
sections; PROVIDED, HOWEVER, that the copies of such reports mailed to Holders
may omit exhibits, which the Company will supply to any Holder at such Holder's
request.
EVENTS OF DEFAULT
The following events will be defined as "Events of Default" in the
Indenture: (a) default in the payment of principal or Accreted Value 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; (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 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;
or (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.
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
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at least 25% in aggregate principal amount at maturity of the Notes then
outstanding, 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 Accreted Value of, premium, if any, and accrued interest, if
any, on the Notes to be immediately due and payable. Upon a declaration of
acceleration, such Accreted Value, 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 Accreted Value 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 Accreted Value 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 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 with respect to complying with
the request; (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 Accreted Value 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 will require 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
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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,
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 (x) a consolidation, merger or sale of all (but
not less than all) of the assets of the Company if all Liens and Indebtedness of
the Company or any Person becoming the successor obligor on the Notes, as the
case may be, and its Restricted Subsidiaries outstanding immediately after such
transaction would, if Incurred at such time, have been permitted to be Incurred
(and all such Liens and Indebtedness, other than Liens and Indebtedness of the
Company and its Restricted Subsidiaries outstanding immediately prior to the
transaction, shall be deemed to have been Incurred) for all purposes of the
Indenture or (y) a consolidation, merger or sale of all or substantially all of
the assets of the Company if 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 Leverage Ratio equal to or less than the
Consolidated Leverage Ratio of the Company immediately prior to such
transaction; and (v) the Company delivers to the Trustee an Officers'
Certificate (attaching the arithmetic computations to demonstrate compliance
with clauses (iii) and (iv) above) 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 that
such transaction shall not have as one of its purposes the evasion of the
foregoing limitations.
DEFEASANCE
DEFEASANCE AND DISCHARGE. The Indenture will provide 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,
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(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 will provide 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," and that clause (c) under "Events of Default" with respect to such
clauses (iii) and (iv) under "Consolidation, Merger and Sale of Assets," clause
(d) under "Events of Default" with respect to such other 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 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 Accreted Value 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.
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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 of the rights and powers vested in it under the Indenture 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
THE GLOBAL NOTES. 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).
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.
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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 SUMMARY OF FEDERAL INCOME TAX CONSEQUENCES SET FORTH BELOW IS FOR
GENERAL INFORMATION ONLY. PROSPECTIVE PURCHASERS OF THE NOTES ARE URGED TO
CONSULT THEIR OWN TAX ADVISORS AS TO THE FEDERAL, STATE, LOCAL AND OTHER TAX
CONSEQUENCES OF ACQUIRING, OWNING AND DISPOSING OF THE NOTES.
The following discussion summarizes certain material United States federal
income tax consequences of the exchange of the Original Notes for the Exchange
Notes and the ownership and disposition of the Exchange Notes. The discussion is
based on the United States Internal Revenue Code of 1986, as amended (the
"Code"), currently applicable Treasury regulations promulgated thereunder, and
judicial and administrative interpretations thereof, all as in effect on the
date hereof. 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. There can be no assurance that the Internal
Revenue Service ("IRS") will not take a contrary view, and no ruling from the
IRS has been or will be sought. The following discussion is intended as a
descriptive summary only. It is not a complete analysis and does not address tax
consequences of holding the Exchange Notes that may be relevant to investors in
special tax situations, such as insurance companies, banks, investors subject to
the alternative minimum tax, tax-exempt organizations, dealers in securities or
other investors holding the Exchange Notes as other than capital assets, and
investors holding the Exchange Notes as a hedge or as part of a hedging,
straddle or conversion transaction. Finally, the discussion does not address the
effect of any United States state or local tax law or foreign tax law. The
summary of U.S. federal income taxes below is based upon the advice of Schulte
Roth & Zabel LLP, counsel to Econophone.
For purposes of this summary, the term "U.S. Holder" means a beneficial
owner of an Exchange Note that is (a) an individual who is a United States
citizen or resident, (b) a corporation, partnership or other entity created or
organized under the laws of the United States or any political subdivision
thereof, (c) an estate the income of which is subject to federal income tax
regardless of source, or (d) a trust if a court within the United States is able
to exercise primary supervision over the administration of the trust and one or
more U.S. persons have the authority to control all substantial decisions of the
trust. The term "Non-U.S. Holder" means a beneficial owner of an Exchange Note
that is not a U.S. Holder.
UNITED STATES HOLDERS
EXCHANGE
The exchange of Original Notes for Exchange Notes pursuant to the Exchange
Offer will not be a taxable event for U.S. 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 Exchange Notes pursuant to the Exchange
Offer.
Because each Exchange Note will be treated as a continuation of the
corresponding Original Note, the remainder of this discussion of federal income
tax considerations generally refers to "Notes."
ORIGINAL ISSUE DISCOUNT
GENERAL. A debt obligation that has an issue price that is less than its
stated redemption price at maturity ("SRPM") by more than a DE MINIMIS amount is
treated as issued with OID for federal income tax purposes. As explained below,
the issue price of the Notes was substantially less than their SRPM, so the
Notes were issued with original issue discount ("OID").
Generally, the issue price of a Note was the first price at which a
substantial amount of the Notes was sold to the public (ignoring sales to bond
houses, brokers, or similar persons or organizations acting in the capacity of
underwriters, placement agents, or wholesalers). The SRPM of a Note is the sum
of all
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payments provided by the Note that are not payments of "qualified stated
interest". "Qualified stated interest" generally means stated interest that is
unconditionally payable in cash or property other than debt instruments of the
Company at least annually at a single fixed rate (or at certain qualifying
variable rates) applied to the outstanding principal amount of the Note. The
Notes were issued at a discount from their stated principal amount. In addition,
stated interest on the Notes is not payable until August 15, 2003. As a result,
the stated interest on the Notes will not be "qualified stated interest" and all
payments of stated interest will be included in the SRPM of the Notes.
Accordingly, the Notes were issued with OID.
U.S. Holders must generally include OID in gross income for federal income
tax purposes on an annual basis under a constant yield method without regard to
the holder's method of accounting for tax purposes. As a result, U.S. Holders
will generally be required to include OID in income in advance of the receipt of
cash attributable to the stated interest. OID accrues based on a compounded,
constant yield to maturity. Accordingly, U.S. Holders of Notes will be required
to include in income increasingly greater amounts of OID in successive accrual
periods. However, U.S. Holders generally will not be required to include
separately in income cash payments received on the Notes, even if denominated as
interest. The aggregate amount of OID on each Note equals the excess of such
Note's SRPM over such Note's issue price.
The amount of OID includible in income by a U.S. Holder of a Note is the sum
of the "daily portions" of OID with respect to the Note for each day during the
taxable year (or portion of the taxable year) in which such U.S. Holder held
such Note. The daily portion is determined by allocating to each day in any
"accrual period" a pro rata portion of the OID allocable to that accrual period.
The "accrual period" for a Note may be of any length and may vary in length over
the term of the Note, provided that each accrual period is no longer than one
year and each scheduled payment of principal or interest occurs on the first day
or the final day of an accrual period.
In general, the amount of OID allocable to an accrual period is an amount
equal to the product of the Note's adjusted issue price at the beginning of such
accrual period and its yield to maturity (determined on the basis of compounding
at the close of each accrual period and properly adjusted for the length of the
accrual period). The Notes' yield to maturity is the rate that, when used to
determine the present value of all payments due under the Notes, produces an
amount equal to the issue price of the Notes. The yield must be constant over
the term and must be calculated to at least two decimal places (e.g., 10.50%).
OID allocable to a final accrual period is the difference between the amount
payable at maturity and the adjusted issue price at the beginning of the final
accrual period. The "adjusted issue price" of a Note at the beginning of any
accrual period is equal to its issue price increased by the accrued OID for each
prior accrual period (determined without regard to the amortization of any
acquisition premium, as described below) and reduced by any payments made on
such Note on or before the first day of the accrual period.
The Treasury regulations contain special rules that allow any reasonable
method to be used in determining the amount of OID allocable to a short initial
accrual period, provided all other accrual periods are of equal length, and
require that the amount of OID allocable to the final accrual period equals the
excess of the amount payable at the maturity of the Note (other than any payment
of qualified stated interest) over the Note's adjusted issue price as of the
beginning of such final accrual period. In addition, if an interval between
payments of qualified stated interest contains more than one accrual period,
then the amount of qualified stated interest payable at the end of such interval
is allocated pro rata (on the basis of their relative lengths) between the
accrual periods contained in the interval.
The Company does not intend to treat the possibility of an optional
redemption or of the repurchase of the Notes upon a Change of Control as giving
rise to any additional accrual of OID or recognition of ordinary income upon
redemption, sale or exchange of a Note.
APPLICABLE HIGH YIELD DISCOUNT OBLIGATIONS. The Notes are considered
"applicable high yield discount obligations" ("AHYDOs") under Section 163(i) of
the Code. As a result, the Company will not be
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permitted to deduct any OID in respect to the Notes until amounts corresponding
to such OID are paid in cash.
MARKET DISCOUNT. A U.S. Holder that purchases a Note at a market discount
(as described below) generally will be required to treat any principal payments
on, or any gain on the disposition (including by way of a gift) or maturity of,
such Note as ordinary income to the extent of the accrued market discount (not
previously included in income) at the time of such payment or disposition. In
general, market discount is the amount by which a Note's adjusted issue price
exceeds the U.S. Holder's basis in the Note immediately after the Note is
acquired. If such difference is less than a specified DE MINIMIS amount, the
market discount will be disregarded. Market discount on a Note will accrue
ratably during the period from the date of acquisition to the maturity of a
Note, unless the U.S. Holder elects to accrue such market discount on the
constant yield method. This election is irrevocable and applies only to the Note
for which it is made.
The U.S. Holder may also elect to include market discount in income
currently as it accrues. This election, once made, applies to all market
discount obligations acquired 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. Generally, if a Note with market discount is transferred in certain
non-taxable transactions, the market discount will be transferred to the
property received in exchange for the Note; however, under certain limited
circumstances, the market discount will be includible as ordinary income as if
such Note had been sold at its fair market value. A U.S. Holder that does not
elect to include market discount in income currently may be required to defer
deductions for interest on borrowings incurred or continued to purchase or carry
such Note in an amount not exceeding the accrued market discount on such Note,
until the maturity of the Note or, in certain circumstances, the earlier
disposition of such Note.
ACQUISITION PREMIUM. A U.S. Holder that purchases a Note for an amount that
is greater than the adjusted issue price of such Note, but that is less than or
equal to the sum of the amounts payable on the 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 Treasury regulations
thereunder, the amount of OID that such U.S. Holder must include in its gross
income with respect to such Note will be reduced (but not below zero) for each
accrual period by the portion of acquisition premium properly allocable to the
period.
SALE, RETIREMENT AND OTHER DISPOSITION OF THE NOTES. In general, a U.S.
Holder's adjusted tax basis in a Note will equal the cost of such Note to the
U.S. Holder, increased by the amount of any OID or market discount previously
included in the U.S. Holder's income with respect to the Note, and reduced by
the amount of (i) any payments made on the Note and (ii) any amortizable bond
premium previously deducted from the U.S. Holder's income.
A U.S. Holder will generally recognize gain or loss on the sale, retirement
or other disposition (including redemption) of a Note in an amount equal to the
difference between (i) the amount of cash and the fair market value of property
received by such U.S. Holder on such disposition (less any amounts attributable
to, and taxable as, accrued but unpaid interest) and (ii) the U.S. Holder's
adjusted tax basis in the Note (as described above). Gain or loss upon the sale,
retirement or other disposition (including redemption) of a Note will be capital
gain or loss (except that any portion of such gain attributable to market
discount will be ordinary income). Under recently enacted legislation, the
maximum individual U.S. federal income tax rate on net capital gains is 20% for
capital assets held for more than 18 months and 28% for capital assets held for
more than 12 months but not more than 18 months. Gains on the sale of capital
assets held for one year or less are subject to U.S. federal income tax at
ordinary income tax rates. Certain limitations exist on the deductibility of
capital losses by both corporations and individual taxpayers.
124
<PAGE>
NON-U.S. HOLDERS
Subject to the discussion of backup withholding below, a Non-U.S. Holder
will generally not be subject to U.S. federal income or withholding tax on
payments of principal, premium, if any, and interest (including OID) on the
Notes under the portfolio interest exemption of the Code, provided that (in the
case of interest, including OID): (i) the Non-U.S. Holder does not actually or
constructively own 10% or more of the total combined voting power of all classes
of stock of the Company entitled to vote; (ii) the Non-U.S. Holder is not a
controlled foreign corporation that is related to the Company through stock
ownership; (iii) such interest or OID is not effectively connected with a United
States trade or business of the Non-U.S. Holder; (iv) the Non-U.S. Holder is not
a bank receiving interest described under Section 881(c)(3)(A) of the Code; and
(v) generally either (a) the beneficial owner of the Notes certifies to the
Company or its agent, under penalties of perjury, that it is a Non-U.S. Holder
and provides a completed IRS Form W-8 ("Certificate of Foreign Status") or (b) a
securities clearing organization, bank or other financial institution which
holds customers' securities in the ordinary course of its trade or business (a
"financial institution") and which holds the Notes, certifies to the Company or
its agent, under penalties of perjury, that it has received Form W-8 from the
beneficial owner or that it has received from another financial institution a
Form W-8 and furnishes the payor with a copy thereof. If any of the situations
described in proviso (i), (ii) or (v) of the preceding sentence do not exist,
interest on the Notes when received is subject to United States withholding tax
at the rate of 30% unless an income tax treaty between the United States and the
country of which the Non-U.S. Holder is a tax resident provides for the
elimination or reduction in the rate of U.S. federal withholding tax.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the
United States and interest (including OID) on the Note is effectively connected
with the conduct of such trade or business, such Non-U.S. Holder, although
exempt from U.S. federal withholding tax by reason of the delivery of a properly
completed Form 4224 (or, after December 31, 1998, a Form W-8), will be subject
to U.S. federal income tax on such interest (including OID) and on any gain
realized on the sale, exchange or other disposition of a Note in the same manner
as if it were a U.S. Holder. In addition, if such Non-U.S. Holder is a foreign
corporation, it may be subject to a branch profits tax equal to 30% of its
effectively connected earnings and profits for that taxable year, unless the
branch profits tax is reduced or eliminated under an applicable income tax
treaty.
SALE, RETIREMENT AND OTHER DISPOSITION OF NOTES. A Non-U.S. Holder
generally will not be subject to U.S. federal income tax on any gain realized in
connection with the sale, exchange, retirement or other disposition of Notes
(other than gain attributable to accrued interest or OID, which is addressed in
the preceding paragraph), unless: (i) the gain is effectively connected with a
trade or business carried on by the Non-U.S. Holder within the United States;
(ii) if a tax treaty applies, the gain is attributable to an office or other
fixed place of business maintained in the United Stated by the Non-U.S. Holder;
or (iii) in the case of an individual holder, (a) such holder is present in the
United States for 183 days or more in the taxable year of disposition and
certain other conditions are satisfied, or (b) the Non-U.S. Holder is subject to
tax pursuant to provisions of the Code applicable to United States expatriates.
UNITED STATES INFORMATION REPORTING AND BACKUP WITHHOLDING
In general, payments to certain non-corporate U.S. Holders of principal,
premium (if any) and interest (including OID) on a Note, and the proceeds of
sale or other disposition of a Note before maturity will be subject to U.S.
information reporting requirements and "backup" withholding tax at a rate of 31%
backup withholding will apply only if such U.S. Holder fails to supply a correct
taxpayer identification number ("TIN") which, in the case of an individual,
would be his or her Social Security Number, furnishes an incorrect TIN, is
notified by the Internal Revenue Service ("IRS") that it has failed to properly
report payments of interest and dividends or under certain circumstances, fails
to certify, under penalty of perjury, that it has furnished a correct TIN and
has not been notified by the IRS that it is subject to backup
125
<PAGE>
withholding. U.S. Holders should consult their own tax advisors regarding their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption if applicable.
In general, there is no U.S. information reporting requirement or backup
withholding tax on payments to Non-U.S. Holders who provide the appropriate
certification described above regarding qualification for the portfolio interest
exemption from U.S. federal income tax for payments of principal or interest
(including OID) on the Notes, provided in each case that the Company or its
paying agent, as the case may be, does not have actual knowledge that the payee
is a United States person.
Payment by the Company of principal on the Notes or payment by a United
States office of a broker of the proceeds of a sale of Notes is subject to both
backup withholding and information reporting unless the beneficial owner
provides a completed IRS Form W-8 which certifies under penalties of perjury
that such owner is a Non-U.S. Holder who meets all the requirements for
exemption from U.S. federal income tax on any gain from the sale, exchange or
retirement of the Notes.
In general, backup withholding and information reporting will not apply to a
payment of the gross proceeds of a sale of Notes effected at a foreign office of
a broker. If, however, such broker is, for U.S. federal income tax purposes, a
U.S. person, a controlled foreign corporation or a foreign person 50% or more of
whose gross income for certain periods is derived from activities that are
effectively connected with the conduct of a trade or business in the United
States, or in the case of payments made after December 31, 1998, a foreign
partnership with certain connections to the United States, such payments will
not be subject to backup withholding, but will be subject to information
reporting unless such broker has documentary evidence in its records that the
beneficial owner is a Non-U.S. Holder and certain other conditions are met, or
the beneficial owner otherwise establishes an exemption, provided such broker
does not have actual knowledge that the payee is a United States person.
Non-U.S. Holders should consult their tax advisors regarding the application of
these rules to their particular situations, the availability of an exemption
therefrom and the procedure for obtaining such an exemption, if available.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be allowed as a refund or a credit against such
holder's U.S. federal income tax liability, provided the required information is
furnished to the IRS.
126
<PAGE>
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 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 the 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 underwriter 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 Notes 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.
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.
127
<PAGE>
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.
POP: 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.
G-1
<PAGE>
ECONOPHONE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................................................... F-2
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1996 AND 1997............................................... F-3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997................. F-4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND
1997..................................................................................................... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
Econophone, Inc.:
We have audited the accompanying consolidated balance sheets of Econophone,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1997,
and the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the three years ended December 31, 1997.
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, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years ended December 31,
1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
New York, New York
February 12, 1998
F-2
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1996 1997
---------- -----------
<S> <C> <C>
<CAPTION>
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............................................................. $6,271,641 $67,201,901
Accounts receivable, net of allowance for doubtful accounts of $761,372 and
$1,593,531, respectively............................................................ 7,946,042 16,796,253
Prepaid expenses and other current assets............................................. 863,735 1,867,941
Restricted cash and securities........................................................ -- 10,462,500
---------- -----------
Total current assets.............................................................. 15,081,418 96,328,595
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS net of accumulated depreciation and
amortization of $1,643,151 and $3,689,550, respectively (Note 4)...................... 6,242,472 23,216,765
Debt issuance costs..................................................................... -- 6,355,491
Other assets (Note 6)................................................................... 1,431,446 3,139,117
Restricted cash and securities.......................................................... -- 48,964,970
---------- -----------
Total assets...................................................................... $22,755,336 $178,004,938
---------- -----------
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable...................................................................... $5,190,086 $21,100,675
Accrued expenses and other current liabilities........................................ 6,188,847 5,355,975
Interest accrued on Senior Notes...................................................... -- 10,462,500
Short-term borrowings (Note 8)........................................................ 2,127,726 --
Current maturities of long-term debt (Note 8)......................................... 753,881 1,828,962
Current maturities of obligations under capital lease (Note 14)....................... 130,867 156,067
Current maturities of notes payable--related party (Note 12).......................... 7,884 315,493
Deferred revenue...................................................................... 859,803 2,567,606
---------- -----------
Total current liabilities......................................................... 15,259,094 41,787,278
LONG-TERM DEBT (Note 8)................................................................. 1,707,941 5,657,042
OBLIGATIONS UNDER CAPITAL LEASE (Note 14)............................................... 235,074 278,667
NOTES PAYABLE--RELATED PARTY (Note 12).................................................. 319,531 --
SENIOR NOTES............................................................................ -- 149,680,000
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note 11)............................... 13,357,940 14,327,588
COMMITMENTS AND CONTINGENCIES (Note 14)
STOCKHOLDERS' EQUITY (DEFICIT) (Note 10):
Common stock--voting, par value $.0001; authorized 29,250,000 shares; 20,000,000
shares issued and outstanding in 1996 and 1997...................................... 2,000 2,000
Non-Voting Common stock, par value $.0001; authorized 500,000 shares; no shares issued
and outstanding..................................................................... -- --
Additional paid-in capital............................................................ 481,870 6,081,870
Cumulative translation adjustment..................................................... -- (103,880)
Retained earnings (deficit)........................................................... (8,608,114) (39,705,627)
---------- -----------
Total stockholders' equity (deficit).............................................. (8,124,244) (33,725,637)
---------- -----------
Total liabilities and stockholders' equity (deficit).............................. $22,755,336 $178,004,938
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
REVENUES...................................................................... $27,490,490 $45,102,882 $83,002,625
COST OF SERVICES.............................................................. 19,735,530 35,368,603 63,707,453
---------- ---------- -----------
Gross profit............................................................ 7,754,960 9,734,279 19,295,172
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.................................. 7,087,735 16,833,779 37,897,940
DEPRECIATION AND AMORTIZATION................................................. 388,508 1,049,651 3,615,283
---------- ---------- -----------
Income (loss) from operations........................................... 278,717 (8,149,151) (22,218,051)
OTHER INCOME.................................................................. 31,425 106,580 101,926
FOREIGN CURRENCY EXCHANGE GAIN (LOSS), net.................................... (41,097) 26,649 (264,521)
INTEREST EXPENSE, net......................................................... (147,826) (295,677) (7,747,219)
---------- ---------- -----------
Net income (loss)....................................................... $ 121,219 $(8,311,599) $(30,127,865)
---------- ---------- -----------
---------- ---------- -----------
BASIC EARNINGS (LOSS) PER SHARE (Note 2)...................................... $ .01 $ (0.43) $ (1.55)
---------- ---------- -----------
---------- ---------- -----------
PRO FORMA INFORMATION (Note 2):
Income before pro forma provision for income taxes.......................... $ 121,219
Pro forma provision for income taxes........................................ 41,214
----------
Pro forma net income.................................................... $ 80,005
----------
----------
PRO FORMA NET INCOME PER SHARE................................................ $ .00
----------
----------
WEIGHTED AVERAGE NUMBER OF BASIC COMMON SHARES OUTSTANDING (Note 2)........... 20,000,000 20,000,000 20,000,000
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 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
Distribution of S Corporation Earnings....... -- -- -- (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..................................... -- -- -- (30,127,865) -- (30,127,865)
Warrants..................................... -- -- 5,600,000 -- -- 5,600,000
Accretion of preferred stock................. -- -- -- (91,054) -- (91,054)
Dividends on preferred stock................. -- -- -- (878,594) -- (878,594)
Cumulative translation adjustment............ -- -- -- -- (103,880) (103,880)
---------- ----------- ---------- ------------ ----------- ------------
BALANCE, December 31, 1997................... 20,000,000 $ 2,000 $6,081,870 ($39,705,627) $(103,880) ($33,725,637)
---------- ----------- ---------- ------------ ----------- ------------
---------- ----------- ---------- ------------ ----------- ------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................... $ 121,219 $(8,311,599) $(30,127,865)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization............................................. 388,508 1,049,651 3,615,283
Provision for doubtful accounts........................................... 721,215 290,762 832,159
Accreted interest expense................................................. -- -- 280,000
Changes in assets and liabilities:
Increase in accounts receivable........................................... (5,694,774) (887,670) (9,682,370)
Increase in prepaid expenses and other current assets..................... (189,879) (350,500) (1,004,206)
Increase in other assets.................................................. -- (1,514,284) (3,276,550)
Increase in accounts payable, accrued expenses and other current
liabilities............................................................. 6,196,439 3,351,953 14,973,832
Increase in interest accrued on senior notes.............................. -- -- 10,462,500
Increase in deferred revenue.............................................. 494,409 365,394 1,707,803
---------- ---------- -----------
Net cash provided by (used in) operating activities..................... 2,037,137 (6,006,293) (12,219,414)
---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................................... (1,206,077) (4,246,997) (13,266,837)
---------- ---------- -----------
Net cash used in investing activities................................... (1,206,077) (4,246,997) (13,266,837)
---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of preferred stock................................... -- 13,061,425 --
Proceeds from line of credit................................................ 1,760,000 800,000 --
Repayment of line of credit................................................. (1,860,000) (1,000,000) --
Proceeds from short term borrowing.......................................... -- 5,436,582 --
Repayments of short-term borrowings......................................... -- (3,308,855) (2,127,726)
Proceeds from long-term debt................................................ -- 2,232,195 --
Repayments of long-term debt................................................ (116,400) (447,910) (428,268)
Repayments of notes payable--related party.................................. (9,383) (10,636) (11,922)
Repayments of capital leases................................................ (85,379) (117,844) (232,612)
Dividends paid.............................................................. (499,301) (226,148) --
Proceeds from senior notes.................................................. -- -- 149,400,000
Proceeds from warrants...................................................... -- -- 5,600,000
Payment of debt issuance cost............................................... -- -- (6,355,491)
Proceeds from bridge loan................................................... -- -- 7,000,000
Repayments of bridge loan................................................... -- -- (7,000,000)
---------- ---------- -----------
Net cash provided by (used in) financing activities..................... (810,463) 16,418,809 145,843,981
---------- ---------- -----------
Increase in cash and cash equivalents, (including restricted cash and
securities)............................................................... 20,597 6,165,519 120,357,730
Cash and cash equivalents, beginning of period.............................. 85,525 106,122 6,271,641
---------- ---------- -----------
Cash and cash equivalents, end of period (including restricted cash and
securities)............................................................... $ 106,122 $6,271,641 $126,629,371
---------- ---------- -----------
---------- ---------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.................................................................. $ 193,455 $ 210,280 $ 504,981
Income Taxes.............................................................. 193,554 -- --
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Accretion of preferred stock................................................ $ -- $ 15,115 $ 91,054
Accrued dividends on preferred stock........................................ -- 281,400 878,594
Capital leases entered into................................................. 471,000 423,000 5,753,855
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. NATURE OF BUSINESS
Econophone, Inc. ("Econophone") is a rapidly growing switch-based provider
of long-distance telecommunications services in selected major U.S. and western
European markets. Econophone's customer base consists primarily of residential
customers, small- and medium-sized businesses and other telecommunications
carriers. 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Econophone and
its wholly owned subsidiaries, its 70% owned subsidiary, Telco Global
Communications Ltd. (England) and its 72% owned subsidiary, Econophone Services
GmbH (Switzerland) (collectively, the "Company"). The full amount of the net
loss for the year ended December 31, 1997 for Telco Global Communications Ltd.
and Econophone Services GmbH have been recorded in the consolidated financial
statements of the Company. All significant intercompany balances and
transactions have been eliminated in consolidation.
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.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
less than three months when purchased.
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 fifteen 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, 1997, the Company incurred approximately
$897,000 of such costs and has included them in Other Assets. The capitalized
software development costs are reported at the lower of unamortized cost or
F-7
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
net realizable value. These costs are amortized on a straight-line basis over
the estimated useful life, generally two years. Such costs were immaterial,
prior to 1997.
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 recoverable. 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 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 year ended December 31, 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. Deferred income taxes are
not provided on undistributed earnings of foreign subsidiaries since such
earnings are currently expected to be permanently reinvested outside the United
States.
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 fair value of the Company's
stock at the date of grant over the amount an employee or director must pay to
acquire the stock.
The Company accounts for stock-based compensation awards to outside
consultants and affiliates based on the fair value of such awards. 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).
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. SFAS No. 130
F-8
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, upon adoption.
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. Foreign currency transaction adjustments are reflected in the Statements
of Operations.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year's presentation.
PER SHARE DATA
During 1997, SFAS No. 128 "Earnings per Share" was issued and became
effective for the Company's December 31, 1997 financial statements. SFAS No. 128
establishes new standards for computing and presenting earnings per share (EPS).
The new standard 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.
Diluted EPS is calculated by dividing income available to common shareholders by
the weighted average number of common shares outstanding adjusted to reflect
potentially dilutive securities. Diluted EPS has not been presented since the
inclusion of outstanding options would be antidilutive.
The following is the reconciliation of net income (loss) per share as of
December 31,
<TABLE>
<CAPTION>
1995 1996 1997
---------- ------------- --------------
<S> <C> <C> <C>
Net income (loss)................................. $ 121,219 ($ 8,311,599) ($ 30,127,865)
Less Dividends on Preferred Stock................. 0 (281,400) (878,594)
---------- ------------- --------------
Income (loss) available to common shareholders.... $ 121,219 $ (8,592,999) $ (31,006,459)
---------- ------------- --------------
---------- ------------- --------------
</TABLE>
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 market prices for similar debt instruments or
on the current rates offered to the Company for debt with similar maturities.
F-9
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
3. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
As of December 31, 1997, the fair value based upon quotes from securities
dealers and carrying value of the Company's Senior Notes were $168,175,000 and
$149,680,000 respectively.
FOREIGN EXCHANGE CONTRACTS
The Company 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 in British Pounds, Belgian Francs and French Francs.
The Company does not use derivative financial instruments for speculative
purposes and, at December 31, 1996, the Company had no open foreign currency
hedging positions. At December 31, 1997, the Company had $300,000 of open
foreign currency hedging positions.
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------
1996 1997
------------ -------------
<S> <C> <C>
Equipment........................................................ $ 7,189,102 $ 23,403,236
Computer software................................................ 182,963 1,365,820
Furniture and fixture............................................ 136,399 634,269
Leasehold improvements........................................... 377,159 1,502,990
------------ -------------
7,885,623 26,906,315
Less-Accumulated depreciation and amortization................... (1,643,151) (3,689,550)
------------ -------------
Property, equipment and leasehold improvements, net........ $ 6,242,472 $ 23,216,765
------------ -------------
------------ -------------
</TABLE>
Depreciation expense for the years ended December 31, 1996 and 1997, was
$1,008,402 and $2,296,855, 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 charged this to operations in 1996 as an expense of the joint
venture.
6. OTHER ASSETS
Other assets consist primarily of security deposits and software development
costs.
7. FOREIGN OPERATIONS AND CONCENTRATIONS
FOREIGN OPERATIONS
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, operating income
F-10
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
7. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
(before interest, foreign currency exchange and other income) and identifiable
assets by geographical area for the years ended and as of December 31, 1995,
1996 and 1997 are as follows:
<TABLE>
<CAPTION>
UNITED OTHER
ENGLAND STATES BELGIUM EUROPE CONSOLIDATED
------------- -------------- ------------- ------------ --------------
<S> <C> <C> <C> <C> <C>
1995
Revenues............................ $ 14,172,747 $ 8,292,415 $ 4,235,155 $ 790,173 $ 27,490,490
------------- -------------- ------------- ------------ --------------
------------- -------------- ------------- ------------ --------------
Operating income.................... $ 143,693 $ 84,074 $ 42,939 $ 8,011 $ 278,717
Corporate expenses.................. (157,498)
--------------
$ 121,219
--------------
--------------
Account receivable.................. $ 4,343,590 $ 900,883 $ 1,331,276 $ 773,385 $ 7,349,134
Other identifiable assets........... -- 2,183,642 397,675 -- 2,581,317
Corporate assets.................... 577,770
--------------
$ 10,508,221
--------------
--------------
1996
Revenues............................ $ 15,477,308 $ 18,185,110 $ 9,037,967 $ 2,402,497 $ 45,102,882
------------- -------------- ------------- ------------ --------------
------------- -------------- ------------- ------------ --------------
Operating loss...................... ($ 2,472,933) ($3,855,148) ($1,472,157) ($348,913) ($8,149,151)
Corporate expenses.................. (162,448)
--------------
($8,311,599)
--------------
--------------
Accounts receivable................. $ 2,282,951 $ 3,718,158 $ 1,487,965 $ 456,968 $ 7,946,042
Other identifiable assets........... 1,423,097 4,001,405 847,181 200,789 6,472,472
Corporate assets.................... 8,336,822
--------------
$ 22,755,336
--------------
--------------
1997
Revenues............................ $ 18,362,999 $ 48,898,882 $ 7,980,848 $ 7,759,896 $ 83,002,625
------------- -------------- ------------- ------------ --------------
------------- -------------- ------------- ------------ --------------
Operating loss...................... ($ 2,966,508) ($ 17,213,062) ($374,446) ($664,033) ($ 21,218,049)
Corporate expenses.................. (7,909,816)
--------------
($ 29,127,865)
--------------
--------------
Accounts receivable................. $ 5,252,202 $ 9,034,226 $ 1,250,317 $ 1,259,508 $ 16,796,253
Other identifiable assets........... 6,731,185 16,514,567 462,682 405,331 24,113,765
Corporate assets.................... 137,094,920
--------------
$ 178,004,938
--------------
--------------
</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 accounted for $13.2 million or 48%
in 1995 and $14.2 million or 32% in 1996. The relationship was terminated in
December 1996.
F-11
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
7. FOREIGN OPERATIONS AND CONCENTRATIONS (CONTINUED)
SUPPLIERS
Sprint Communication, Inc. ("Sprint"), one of the Company's principal
suppliers 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, 1996 and 1997, Sprint
supplied approximately $9.4 million and $6.0 million respectively, of telephone
line usage to the Company. In addition, Switch Services, Inc. ("SSI") supplied
approximately $6.9 million of telephone line usage to the Company in 1997. These
amounts have been included in cost of services.
8. BORROWINGS
At December 31, 1997, the Company was obligated under the following debt
agreements:
<TABLE>
<CAPTION>
CURRENT LONG-TERM TOTAL
------------ -------------- --------------
<S> <C> <C> <C>
Long-term debt:
NTFC note (a)................................ $ 1,633,136 $ 5,521,792 $ 7,154,928
Cable lines (b).............................. 195,826 135,250 331,076
Senior notes (c)............................. 149,680,000 149,680,000
------------ -------------- --------------
$ 1,828,962 $ 155,337,042 $ 157,166,004
------------ -------------- --------------
------------ -------------- --------------
</TABLE>
- ------------------------
(a) On May 28, 1996, Econophone entered into a credit facility with NTFC, which
has been amended and increased as to amount on several occasions. On January
28, 1998, the NTFC credit facility was amended and restated in its entirety
in order to effect various amendments and increase the amount of NTFC's
commitment thereunder (such credit facility, as amended and restated, is
referred to herein as the "NTFC Facility"). The NTFC Facility provides for
borrowings by Econophone and its subsidiaries to fund certain equipment
acquisition costs and related expenses. The NTFC Facility provides for an
aggregate commitment of NTFC of $24.0 million pursuant to three tranches of
$2.0 million, $3.0 million and $19.0 million. Loans borrowed under each
tranche of the NTFC Facility amortize in equal monthly installments over a
five year period ending on July 1, 2001, April 1, 2002 and January 1, 2003,
respectively. As of December 31, 1997, the aggregate amount outstanding
under all tranches of the NTFC Facility was $7,154,928. Loans under the NTFC
Facility accrue interest at an interest rate equal to the 90-day commercial
paper rate plus 395 basis points, subject to certain quarterly adjustments
depending upon financial performance. All of the equipment purchased with
the proceeds of the NTFC Facility has been pledged to NTFC.
The NTFC Facility requires Econophone to maintain a Debt Service Coverage
Ratio 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 specified minimum cash balances
(certain related business investments and acquisitions qualify as cash for
the foregoing purposes). Econophone also must have EBITDA (as defined in the
NTFC Facility) of not less than: negative $5,500,000 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
F-12
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
8. BORROWINGS (CONTINUED)
fiscal year ending December 31, 2001. Econophone was in compliance with
these covenants at December 31, 1997.
(b) 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 $5,849 to $30,291.
(c) The 1997 Unit Offering
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. On December 5, 1997, the Company
consummated an offer to exchange the notes issued in the 1997 Unit Offering
for $155.0 million of notes that had been registered under the Securities
Act.
The 1997 Notes are unsecured unsubordinated obligations of Econophone,
limited to $155.0 million aggregate principal amount at maturity, and mature
on July 15, 2007. Interest on the 1997 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, 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. At the closing of the 1997 Unit Offering, Econophone used
$57.4 of the net proceeds of the 1997 Unit Offering to purchase the Pledged
Securities, which were pledged as security for the payment of interest on
the principal of the 1997 Notes. Proceeds from the Pledged Securities are
being used by Econophone to make interest payments on the 1997 Notes through
July 15, 2000. The Pledged Securities are being held by a trustee pending
disbursement.
Maturities of other long-term debt over the next five years are as follows:
<TABLE>
<S> <C>
1998............................................................ $2,144,455
1999............................................................ 1,689,280
2000............................................................ 1,688,848
2001............................................................ 1,499,620
2002............................................................ 779,294
---------
Total........................................................... $7,801,497
---------
---------
</TABLE>
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 other state and local sales taxes. All of these taxes are included in
general and administrative expenses.
F-13
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
9. TAXES (CONTINUED)
As of December 31, 1997, the Company had a net operating loss carryforward
of approximately $36,000,000 which is available to reduce its future taxable
income and expires at various dates through 2012. A valuation allowance of
approximately $14,000,000 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 country 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.
Econophone's foreign subsidiaries file separate tax returns and provide for
taxes accordingly.
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.
All information contained in the accompanying financial statements and
footnotes has been retroactively restated to give effect to these transactions.
Included within additional paid in capital, is $5.6 million attributable to
the Warrants, which 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 1997 Notes and will be amortized over the term of the 1997
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 between Econophone and the Placement Agent in connection with the 1997
Unit Offering. Among the factors considered in making such determinations 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 1997 Unit Offering and the prices
of similar securities of generally comparable companies. The Warrants expire on
June 30, 2007.
F-14
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
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 accrued monthly cumulative dividends on each
outstanding share at a rate of $1.00 per month. The accrued and unpaid dividends
compound monthly at a rate of 12% per year. The dividends began to accrue and
compound interest from the issuance date of the preferred stock and ceased to
accrue on July 1, 1997, when the Senior Notes were issued.
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 December 31, 1997, the shares of Series A
Preferred Stock outstanding were convertible into 3,420,701 shares of Common
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, 1996 and 1997 due to various
related parties. These notes are unsecured, and accrue interest at annual rates
ranging from 9% to 18%. One note is a demand obligation while the others have
maturities which range through November 15, 1998.
The Company has a non-interest bearing note receivable at December 31, 1997
for approximately $215,000 from a related party.
The brother-in-law of Alfred West owns a 28% interest in Econophone's Swiss
subsidiary, Econo-
phone Services GmbH.
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 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
F-15
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
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 1997
------------- ---------------
<S> <C> <C>
Net Loss:
Available to $ (8,592,999) $ (31,006,459)
Common
Shareholders
Pro Forma (9,088,001) (31,797,731)
Basic EPS:
As Reported $ (.43) $ (1.55)
Pro Forma (.45) (1.59)
</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
and 1997, 0 and 1,667 of the options granted to the consultants were
exercisable, respectively, and the expense recognized in 1996 and 1997 relating
to these options was $496 and $2,976, respectively.
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 and 1997, 226,527 and 1,109,250 options respectively, were exercisable
under the Company's 1996 Plan.
F-16
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
Option activity during 1996 and 1997 is as follows:
<TABLE>
<CAPTION>
1996 1997
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- --------------- ---------- ---------------
Outstanding at beginning of year...... -- -- 2,606,500 $ 2.50
Granted............................... 2,606,500 $ 2.50 294,945 5.00
Outstanding at end of year............ 2,606,500 2.50 2,901,445 2.74
---------- ---------- -----
---------- ---------- -----
Exercisable at end of year............ 226,527 2.50 1,109,250 2.50
Weighted average fair value of options
granted............................. .89 1.91
</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 and 1997: risk-free interest rate of 6.23%
for 1996 and 1997; expected life of three years for 1996 and 1997; expected
volatility of 43% for 1996 and 47% for 1997 and expected dividend yield of zero
percent for 1996 and 1997.
The following table summarizes information with respect to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ --------------------------------
NUMBER WEIGHTED AVERAGE NUMBER
EXERCISE OUTSTANDING AT REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
PRICE 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- ------------- -------------- ------------------- ----------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
$2.50-$5.00 2,901,445 8.97 $ 2.74 1,109,250 $ 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, 1997 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASE
------------ ----------
<S> <C> <C>
1998................................................................ $ 1,500,451 $ 156,067
1999................................................................ 1,535,221 159,311
2000................................................................ 1,593,025 97,105
2001................................................................ 1,629,640 21,481
2002................................................................ 1,450,602 770
------------ ----------
Total minimum lease payments........................................ $ 7,708,939 $ 434,734
------------ ----------
------------ ----------
</TABLE>
The rent expense for the year ended December 31, 1996 and 1997 was
approximately $394,000 and 1,378,000, respectively.
F-17
<PAGE>
ECONOPHONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1996 AND 1997
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In January, 1998, the Company obtained a line of credit from European
American Bank ("EAB") in the amount of $2,000,000 and a foreign exchange line in
the amount of $5,000,000, which are collateralized by $2,300,000 in time
deposits. Interest is charged at the prime rate in effect, and is payable
monthly from the date of advance of the line.
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 $990,000. These officers
are also eligible for annual bonuses based on performance.
On January 29, 1998, the Company received notice from the minority partner
in Telco, that pursuant to existing arrangements between them, it has elected to
exercise an option to cause the Company to acquire its interest in Telco. The
parties recently commenced negotiations with respect to the terms of such
acquisition, including the form and amount of the consideration. There can be no
assurance whether such acquisition ultimately will be consummated, and if
consummated, on terms favorable to the Company.
15. SUBSEQUENT EVENTS
VOICENET ACQUISITION. A definitive agreement to acquire VoiceNet was
entered into on January 28, 1998. The closing of the VoiceNet Acquisition
occurred on February 12, 1998. The initial purchase price for VoiceNet was $21.0
million and was paid out of cash on hand. The sellers of VoiceNet also are
entitled to receive an earn-out based upon the revenue growth of the VoiceNet
business for a period of up to one year following the closing of the
acquisition.
VoiceNet provides travellers and other callers with calling card services,
which are advertised primarily in in-flight magazines. Econophone has provided
substantially all of VoiceNet's transmission, billing and customer service
functions since April 1996.
SENIOR DISCOUNT NOTES. During February 1998, the Company authorized the
issue and sale of Senior Discount Notes. The Notes will be unsecured
unsubordinated obligations of the Company, initially limited to $300 million
aggregate principal amount at maturity, and will mature on February 15, 2008.
Although for federal income tax purposes a significant amount of original issue
discount, taxable as ordinary income, will be recognized by the Holder as such
discount accrues from the Closing Date, no interest will be payable on the Notes
prior to February 15, 2003. From and after February 15, 2003, interest on the
Notes will accrue at 11.0% from February 15, 2003 or from the most recent
Interest Payment Date to which interest has been paid or provided for, payable
semiannually (to Holders of record at the close of business on the February 1 or
August 1 immediately preceding the Interest Payment Date) on February 15 and
August 15 of each year, commencing August 15, 2003. Interest will be computed on
the basis of a 360-day year of twelve 30-day months.
F-18
<PAGE>
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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
Cautionary Statement on Forward-Looking
Statements.................................... 3
Prospectus Summary.............................. 4
Risk Factors.................................... 15
The Exchange Offer.............................. 31
Use of Proceeds................................. 39
Capitalization.................................. 40
Selected Consolidated Financial Data............ 41
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 43
Business........................................ 54
Management...................................... 77
Certain Transactions............................ 84
Description of Certain Indebtedness............. 89
Principal Stockholders.......................... 92
Description of the Exchange Notes............... 93
Certain Federal Income Tax Considerations....... 122
Plan of Distribution............................ 127
Legal Matters................................... 127
Experts......................................... 127
Glossary........................................ G-1
Index to Financial Statements................... F-1
</TABLE>
--------------------------
UNTIL MAY 4, 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
$300,000,000
OF NEW
11% SENIOR DISCOUNT NOTES DUE 2008
FOR
$300,000,000
OF ANY AND ALL OUTSTANDING
11% SENIOR DISCOUNT NOTES DUE 2008
---------------------
PROSPECTUS
---------------------
THE BANK OF NEW YORK
REORGANIZATION SECTION
101 BARCLAY STREET, FLOOR 7 EAST
NEW YORK, NEW YORK 10286
ATTN: DENISE ROBINSON
TELEPHONE:(212) 815-5789
FACSIMILE:(212) 815-6339
MARCH 23, 1998
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