SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27580
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AVTEL COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT SPECIFIED IN ITS CHARTER)
---------
DELAWARE 87-0378021
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(805) 884-6300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
As of October 22, 1998, there were 9,541,063 shares of the Registrant's Common
Stock, par value $0.01 per share, issued and outstanding, excluding treasury
stock.
1
AVTEL COMMUNICATIONS, INC.
QUARTER ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
PAGE
----
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30,
1998 (Unaudited) and December 31, 1997 .................. 3
Consolidated Statements of Operations for the
Three Month and Nine Month Periods Ended September 30,
1998 and 1997 (Unaudited) ...................... 4
Consolidated Statements of Cash Flows for the
Nine Month Periods Ended September 30, 1998 and 1997
(Unaudited) ....................................... 5
Notes to Consolidated Financial Statements
(Unaudited) ............................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..................... 9
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds ................. 17
Item 5. Other Information ......................................... 17
Item 6. Exhibits and Reports on Form 8-K .......................... 17
Signature Page ............................................................ 18
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1998 1997
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................... $ 2,520,357 4,807,441
Accounts receivable, net .................... 5,559,788 6,961,953
Due from affiliates ......................... 515,314 2,127,771
Federal and state income tax receivable ..... 97,190 598,970
Other current assets ........................ 1,170,727 861,950
------------ ------------
Total current assets .................. 9,863,376 15,358,085
------------ ------------
Property and equipment, net ................... 1,563,961 1,791,682
Other assets, net ............................. 1,470,088 1,575,083
------------ ------------
Total assets ........................... $ 12,897,425 18,724,850
============ ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Accounts payable and other
accrued expenses ......................... $ 1,535,231 1,546,762
Accrued network services costs .............. 3,757,901 4,319,198
Sales and excise tax payable ................ 1,081,565 736,012
Due to affiliates ........................... 1,627,102 2,719,417
Other current liabilities ................... 590,519 466,039
------------ ------------
Total current liabilities .............. 8,592,318 9,787,428
------------ ------------
Deferred income taxes ......................... 498,712 498,712
Common stock subject to put option ............ 217,114 578,880
Other liabilities ............................. 8,149 50,782
------------ ------------
Total liabilities ...................... 9,316,293 10,915,802
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, authorized 1,000,000
shares, $0.01 par value, including
Series A convertible preferred stock,
authorized 250,000 shares, $0.01 par
value, cumulative as to 8% dividends,
147,700 and 207,700 shares issued and
outstanding September 30, 1998 and
December 31, 1997 respectively
(Liquidation preference of $727,664
and $910,800 at September 30, 1998 and
December 31, 1997 respectively,
including dividends accrued) ............... 1,477 2,077
Common stock, authorized 20,000,000
shares, $0.01 par value, 11,726,852
and 11,437,056 shares issued at
September 30, 1998 and December 31, 1997
respectively, including 144,743 and
385,920 shares subject to put options
on September 30, 1998 and December 31,
1997 respectively ........................... 115,821 110,511
Additional paid in capital .................... 17,902,105 17,138,739
Retained earnings (accumulated deficit) ....... (14,416,255) (9,422,279)
Treasury stock, 2,201,601 and 1,999,997
shares at September 30, 1998 and
December 31, 1997 respectively .............. (22,016) (20,000)
------------ ------------
Total stockholders' equity ............. 3,581,132 7,809,048
------------ ------------
Commitments and contingencies ................. -- --
------------ ------------
Total liabilities and stockholder's equity $ 12,897,425 18,724,850
============ ============
See accompanying Notes to Consolidated Financial Statements.
3
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues .................... $ 10,589,137 12,403,290 34,328,842 39,244,448
Cost of revenues ............ 7,252,847 8,911,113 24,896,860 27,304,366
------------ ------------ ------------ ------------
Gross margin ................ 3,336,290 3,492,177 9,431,982 11,940,082
Operating expenses
Selling, general & admin .. 4,297,879 3,725,137 13,682,911 11,622,850
Depreciation & amortization 261,449 150,837 805,687 515,037
------------ ------------ ------------ ------------
Total operating expenses 4,559,328 3,875,974 14,488,598 12,137,887
------------ ------------ ------------ ------------
Operating loss .............. (1,223,038) (383,797) (5,056,616) (197,805)
Interest expense ............ (6,367) (2,140) (35,669) (9,026)
Other income, net ........... 20,866 99,577 98,309 219,099
------------ ------------ ------------ ------------
Income(loss) before income .. (1,208,539) (286,360) (4,993,976) 12,268
Income tax expense (benefit) 0 (120,274) 0 5,152
------------ ------------ ------------ ------------
Net income (loss) ........... $ (1,208,539) (166,086) (4,993,976) 7,116
============ ============ ============ ============
Net loss per share
- basic and diluted ...... $ (0.13) (0.02)* (0.53) (0.01)*
============ ============ ============ ============
Weighted average number of
common shares .............. 9,526,410 9,366,667* 9,518,132 9,366,522*
============ ============ ============ ============
* The 1997 per share and share amounts are presented on a pro forma basis.
(Note 7)
See accompanying Notes to Consolidated Financial Statements.
4
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months
Ended September 30,
--------------------------
1998 1997
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .............................. $(4,993,976) 7,116
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization ............ 805,687 515,037
Amortization of advanced commissions ..... 220,928 1,130,762
Provision for bad debts .................. 2,128,608 1,220,265
Loss on disposition of assets ......... 4,232 0
Stock compensation earned ................ 674,169 0
Changes in assets and liabilities:
Accounts receivable ...................... (678,393) 1,433,859
Due from affiliates ...................... (114,144) (104,061)
Other current assets ..................... 445,340 (351,479)
Accounts payable and accrued liabilities . (265,724) (1,700,141)
Due to affiliate ......................... (1,092,315) 213,167
----------- -----------
Net cash provided by (used in)
operating activities ..................... (2,865,588) 2,364,525
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............. (282,114) (158,412)
Loans to affiliates ............................ 0 (2,000,000)
Loan to Remote Lojix/PCSI ...................... (500,000) 0
Payments on loans to affiliates ................ 1,726,601 145,567
Cash received in acquisition ................... 25,917 211,172
Other, net ..................................... (6,850) 2,748
----------- -----------
Net cash provided by (used in)
investing activities ..................... 963,554 (1,798,925)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital leases ........... (43,926) 0
Issuance of common stock for exercise of
options .................................... 93,876 0
Purchase of notes receivable ................... (435,000) 0
----------- -----------
Net cash used in financing activities (385,050) 0
----------- -----------
Net increase (decrease) in cash and cash
equivalents .................................. (2,287,084) 565,600
Cash and cash equivalents at beginning of period . 4,807,441 4,622,395
----------- -----------
Cash and cash equivalents at end of period ....... $ 2,520,357 5,187,995
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
5
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998 and 1997
(1) Basis of Presentation
---------------------
The unaudited consolidated financial statements of AvTel Communications,
Inc. and Subsidiaries (the "Company") for the three month and nine month periods
ended September 30, 1998 and 1997 have been prepared in accordance with
generally accepted accounting principles for interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements
and should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's Form 10-K for the year
ended December 31, 1997. All significant intercompany balances and transactions
have been eliminated in consolidation. In the opinion of management, all
adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation of the interim financial information have been
included. The results of operations for any interim period are not necessarily
indicative of the results of operations for a full year.
(2) Earnings Per Common Share
-------------------------
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"), in the fourth quarter of
1997 which required companies to present basic earnings per share and diluted
earnings per share. Basic earnings per share is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. The Company has restated its
September 30, 1997 earnings per share calculations to reflect the adoption of
SFAS 128.
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Net Income (Loss) (1,208,539) (166,086) (4,993,976) 7,116
Less preferred dividends 11,816 20,000 35,448 60,000
---------- ---------- ---------- ----------
Income (Loss) applicable
to common shareholders (1,220,355) (186,086) (5,029,424) (52,884)
========== ========== ========== ==========
Weighted average number of
common shares 9,526,410 9,366,667* 9,518,132 9,366,522*
========== ========== ========== ==========
Net income (loss) per common
share - basic and diluted (0.13) (0.02)* (0.53) (0.01)*
========== ========== ========== ==========
* The 1997 amounts are presented on a pro forma basis. (see Note 7)
(3) Stock Compensation
------------------
On January 1, 1998 the Company granted options to purchase 75,000 of the
Company's common shares at an exercise price of $1.50 per share. On March 1,
1998 the Company granted options to purchase 100,000 of the Company's common
shares at an exercise price of $1.50 per share. These options become exercisable
based on qualified billings of long distance customers generated by the
optionees from the respective dates of grant through December 31, 2000.
On February 24, 1998 the Company's Board of Directors approved the grant of
a total of 120,000 shares of restricted common stock to two board members
pursuant to the Company's 1997 Stock Incentive Plan. The restricted stock
provisions will lapse over four years or fully lapse in the event of death or
permanent disability of the grantees.
6
On February 26, 1998 the Company granted incentive stock options to purchase
11,250 of the Company's common shares at an exercise price of $6.00 per share.
The options were granted pursuant to the Company's 1997 Stock Incentive Plan and
vest at the rate of 50% per year over two years.
On May 22, 1998 the Company registered 1,292,000 shares of its common stock
with the Securities and Exchange Commission with respect to stock options under
The New BestConnections, Inc. Amended and Restated 1997 Stock Option Plan.
On May 28, 1998 the Shareholder's approved the 1998 Stock Incentive Plan
which provides for the issuance of up to 1,500,000 shares of AvTel common stock
pursuant to stock options and issuances of restricted stock, as well as for the
grant of stock appreciation rights. On September 30, 1998 the Company registered
the 1,500,000 shares with the Securities and Exchange Commission.
On August 10, 1998 the Company relinquished its rights to repurchase common
stock shares issuable under option agreements awarded to individuals in 1997 by
New BestConnections, Inc., a subsidiary of the Company (the "SOES Options"). In
accordance with the terms of such option agreements, as a result of such
relinquishment, the SOES Options will terminate on December 9, 1998, to the
extent they have not been exercised by that date. Compensation expense of
$298,000 was recognized in 1998 and $499,000 in 1997 for the SOES Options. As of
September 30, 1998, none of these options had been exercised. As of October 31,
1998, 5,000 options were exercised by cash purchases and 32,500 options were
exercised through a cashless exercise offer whereas the Company agreed to
purchase up to one-half of the shares issuable at a price of $3.00 per share.
Pursuant to the Company's 1998 Stock Incentive Plan, in September 1998 the
Company granted incentive stock options to purchase the Company's common shares
as follows:
10,000 shares exercisable at a price of $2.75 per share, vesting over
three years at a rate of 33 1/3% per year.
20,000 shares exercisable at a price of $2.75 per share, vesting over
two years at a rate of 50% per year.
50,000 shares exercisable at a price of $2.75 per share, vesting over
four years at a rate of 25% per year.
2,000 shares exercisable at a price of $3.00 per share, vesting over
four years at a rate of 25% per year.
15,000 shares exercisable at a price of $2.375 per share, vesting over
four years at a rate of 25% per year.
On September 14, 1998 the Company granted nonstatutory stock options to
purchase 50,000 shares at a exercise price of the lesser of $6.00 or the fair
market value of the common stock on October 1, 1998, vesting over four years at
a rate of 25% per year
On September 25, 1998 the Company granted 20,000 shares of restricted stock
under the 1998 Stock Incentive Plan that vest based on the net revenues of a
segment of the Company as of December 31, 1999.
(4) Comprehensive Income (Loss)
---------------------------
In June 1997, Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income," ("SFAS No. 130") was issued. SFAS No. 130
establishes standards for reporting and displaying comprehensive income and its
components in an annual financial statement that is displayed with the same
prominence as other annual financial statements. Reclassification of financial
statements for earlier periods, provided for comparative purposes, is required.
The statement also requires the accumulated balance of other comprehensive
income to be displayed separately from retained earnings and additional paid-in
capital in the equity section of the statement of financial position. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997.
Comprehensive income (loss) for the three month and nine month periods ended
September 30, 1998 and 1997 is equal to net income (loss) reported for such
periods.
7
(5) Conversion of Preferred Stock
-----------------------------
On January 22, 1998, and February 26, 1998, a total of 60,000 shares of the
Company's preferred stock was converted to 60,000 shares of the Company's common
stock.
(6) Acquisition
-----------
On September 25, 1998 the Company acquired all of the capital stock of
Digital Media International, Inc. ("DMI"). The Company exchanged 30,000 shares
of its common stock valued at $71,250 for all the outstanding common stock of
DMI. The transaction was accounted for under the purchase method of accounting.
The following assets were acquired, liabilities assumed and common stock issued:
Current assets $ 50,105
Fixed assets 44,313
Goodwill 117,169
Accounts payable and accrued expenses (166,254)
Common stock issued (71,250)
--------
Cash acquired $ 25,917
========
Pro forma results of operations are not materially different from historical
results.
(7) Pro Forma Results of Operations
-------------------------------
Pro forma results of operations of the Company as if the reverse
acquisition of AvTel by Matrix, and the acquisitions of WestNet Communications,
Inc. and BestConnections, Inc. had occurred as of January 1, 1997, are as
follows:
Three Months Nine Months
Ended September 30, 1997 Ended September 30, 1997
Revenue $13,133,122 41,444,847
Net loss (512,285) (9,858,423)
Pro forma net loss
per share - basic and dilute (0.05) (1.05)
(8) Note Receivable
---------------
On July 22, 1998 the Company, as part of the consideration for the
acquisition of a company, loaned Remote Lojix/PCSI, Inc. ("RLI") $500,000,
evidenced by a promissory note. The interest rate is at 15% per annum with a
maturity date of November 1, 1998. The note is secured by a Security Agreement
granting the Company interest in all assets of RLI and a guaranty executed by
the majority shareholder and President of RLI. The Company and RLI are currently
discussing an extension of the Note.
(9) Related Party Transactions
--------------------------
On July 2, 1998 the Company purchased notes receivable from one of the
Company's significant shareholders at a discount. The notes receivable evidenced
loans made by the significant shareholder in 1996 to Matrix employees to finance
their purchases of Matrix common stock (which was subsequently converted to
shares of the Company's common stock). Each of the employees who delivered a
note receivable also entered into a Buyback Agreement dated October 6, 1996 (the
"Buyback Agreement"), pursuant to which the Company is entitled to repurchase a
portion of such employee's stock upon the termination of his or her employment.
The original notes, plus accrued interest, at the date of purchase by the
Company evidenced a total amount of $573,000. The Company purchased these notes
for $435,000.
On July 6, 1998 the Company repurchased 23,170 shares of its common stock
subject to the Buyback Agreement from a terminated employee. The Company
exercised its right to purchase 21,443 of such shares at a price of $1.51 per
share, and the former employee used the $32,379 in proceeds to reduce the amount
of his note. The Company repurchased an additional 1,727 shares in satisfaction
of the remaining balance of $12,088 on the former employee's note.
On July 11, 1998 the Company repurchased 178,434 shares of its common stock
subject to the Buyback Agreement from a terminated employee. The Company
exercised its right to purchase 171,547 of such shares at a price of $1.70 per
8
share, and the former employee used the $292,134 in proceeds to reduce the
amount of his note. The Company repurchased an additional 6,887 shares in
satisfaction of the remaining balance of $63,630 on the former employee's note.
(10) Contingencies
-------------
The Company is a party to legal proceedings incidental to its business
which, in the opinion of management, are not expected to have a material adverse
effect on the Company's consolidated financial position or operating results.
(11) Subsequent Events
-----------------
The Company entered into a Loan and Security Agreement with Coast Business
Credit, a division of Southern Pacific Bank ("Coast"), a California corporation
on October 2, 1998. It provides for an asset based revolving credit line with a
floating interest rate equal to prime plus 2%. The credit limit is the lesser of
$7,500,000 or a percentage of the amount of the Company's eligible receivables
and other items. As of the date of the agreement the percentage of the amount of
eligible receivables was 75%. The agreement calls for a minimum borrowing of
$1,500,000 with a two year term.
On August 18, 1998, the Company entered into an Amended Stock Purchase
Agreement with the shareholders of Remote Lojix/PCSI, Inc. ("RLI") to acquire
100% of RLI's stock. The transaction will be accounted for under the purchase
method of accounting. The agreement provides that AvTel common stock will be
issued for all the then outstanding shares of RLI, and certain earnout shares
will be issued contingent upon future earnings of RLI. The parties are currently
negotiating the satisfaction of certain of the conditions to closing. The
Company expects the transaction will be completed in the fourth quarter of 1998.
Subsequent to September 30, 1998, the Company entered into a Letter of
Intent to sell the assets of The Friendly Net, LLC, a wholly subsidiary of the
Company. The Company expects the transaction will be completed in the fourth
quarter of 1998.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS DOCUMENT THAT
ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE.
ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ARE BASED ON
INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES
NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. ACTUAL EVENTS AND
OUTCOMES COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF MANY FACTORS, INCLUDING THOSE DESCRIBED HEREIN AND
THOSE SET FORTH IN THE RISK FACTORS DESCRIBED IN ITEM 1 OF THE COMPANY'S ANNUAL
REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL
14, 1998.
The following discussion and analysis should be read in connection with the
unaudited consolidated financial statements for the three month and nine month
periods ended September 30, 1998 and 1997 of the Registrant and related notes
included elsewhere in this report and the consolidated financial statements and
related management discussion and analysis included in the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997.
Overview
AvTel Communications, Inc. (the "Company," the "Registrant" or "AvTel")
was formerly a Utah corporation. On December 1, 1997, the Company merged with
and into its wholly-owned Delaware subsidiary, thus effecting the Company's
reincorporation in Delaware (the "Reincorporation Merger"). The conversion of
the Company's stock in the Reincorporation Merger resulted in an effective
one-for-four reverse stock split, which was effective on December 1, 1997 (the
"Reverse Stock Split"). All share and option numbers and prices set forth herein
have been adjusted to reflect the Reverse Stock Split.
9
On December 1, 1997, the Company acquired Matrix Telecom, Inc., a
privately-held Texas corporation ("Matrix Telecom") by means of a share for
share exchange (the "Share Exchange"). Matrix Telecom was a provider of long
distance telephone services and subsequently provides a bundled service
including internet. The Reincorporation Merger and the Reverse Stock Split were
conditions to the closing of the Share Exchange.
The Share Exchange was effected pursuant to a Stock Exchange Agreement
dated April 29, 1997, and subsequently amended, pursuant to which the persons
and entities who owned the issued and outstanding common stock of Matrix Telecom
("Matrix Telecom Stockholders") transferred to AvTel all of their Matrix Telecom
stock and, in exchange, AvTel issued to the Matrix Telecom Stockholders shares
of AvTel's Common Stock. Following the Share Exchange, the former Matrix Telecom
Stockholders owned approximately 81% of the issued and outstanding Common Stock
of the Company.
For accounting purposes, the Share Exchange was treated as a reverse
acquisition of AvTel by Matrix Telecom. AvTel was the legal acquirer and
accordingly, the Share Exchange was effected by the issuance of AvTel Common
Stock in exchange for all of the common stock then outstanding of Matrix
Telecom. In addition, holders of Matrix Telecom outstanding stock options
received non-qualified stock options of AvTel. The following discussion of
results of operations reflects the operations of Matrix Telecom prior to
December 1, 1997 and reflects the combined operations of AvTel and Matrix
Telecom subsequent to December 1, 1997. Accordingly, references to the Company
refer to operations of Matrix Telecom prior to the Share Exchange and the
combined operations of AvTel and Matrix Telecom subsequent to the Share
Exchange. The reverse acquisition of AvTel by Matrix Telecom was accounted for
using the purchase method of accounting.
Results of Operations
Consolidated Statements of Operations as a Percent of Revenue
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
REVENUES ........................... 100.00% 100.00% 100.00% 100.00%
COST OF REVENUES ................... 68.49% 71.84% 72.52% 69.58%
-------- -------- ------- -------
GROSS MARGIN ....................... 31.51% 28.16% 27.48% 30.42%
Operating expenses
Selling, general and administrative 40.59% 30.03% 39.86% 29.62%
Depreciation and amortization .... 2.47% 1.22% 2.35% 1.31%
-------- -------- ------- -------
Total operating expenses ...... 43.06% 31.25% 42.21% 30.93%
------- -------- ------- -------
OPERATING INCOME (LOSS) ............ (11.55%) (3.09%) (14.73%) (0.50%)
Interest expense ................... (0.06%) (0.02%) (0.10%) (0.02%)
Other income, net .................. 0.20% 0.80% 0.29% 0.56%
-------- -------- ------- -------
Income (loss) before income taxes .. (11.41%) (2.31%) (14.55%) 0.03%
Income tax expense (benefit) ....... 0.00% (0.97%) 0.00% 0.01%
-------- -------- ------- -------
NET INCOME (LOSS) .................. (11.41%) (1.34%) (14.55%) 0.02%
======== ======== ======= =======
Three Months Ended September 30,1998 compared with Three Months Ended September
30, 1997
Revenues
Revenues for the three months ended September 30, 1998 were $10.6 million,
a decline of 14.6% or $1.8 million from $12.4 million for the three months ended
September 30, 1997.
10
The focus of the Company is to be a fully integrated provider of
telecommunications and data networking services. The merger of AvTel
Communications and Matrix Telecom, effective December 1, 1997, provided the
Company with substantial growth opportunities. By acquiring Matrix, the Company
integrated a large voice customer base supported by a sophisticated back office
and information technology group into AvTel's highly skilled data networking
services group which provided broadband network services of voice, data and
video to the mid-size corporate customers.
The primary source of revenues of the Company during the period continued
to be voice distribution channels of the Company's wholly owned subsidiary,
Matrix Telecom. Factors similar in nature to those affecting all resellers of
long distance have continued to effect a decline in revenues for the three
months ended September 30, 1998 compared to the three months ended September 30,
1997. Due to pricing pressures within the industry and the competitive
reductions by the first tier carriers, the Company similarly continued to reduce
retail pricing of long distance products to meet consumer expectations.
Decreases in revenues were additionally affected by a continued attrition
of a maturing customer base primarily in the areas of telemarketing and direct
mail which in the opinion of management was not cost effective. Even though the
Company's volume discounts are passed through to the long distance end user,
higher customer attrition rates have continued. The effects of competitive lower
pricing as well as the decline of the customer base is expected to lessen
dramatically as pricing within the industry slows and reaches its floor, and the
Company increases its focus on third party distributors. Management additionally
anticipates that the revenue decrease will stabilize as the continued
integration of and revenue from the corporate data networking and internet
services of the Company continues to expand and grow beyond the long distance
portion.
Decreases in revenues were anticipated by the Company beginning in the
first quarter of 1998. At that time, the new management team chose to
discontinue and reduce certain unprofitable distribution channels of its
subsidiary. Revenue from these channels has decreased 41.4% or $6.3 million for
the nine months ended September 30, 1998 compared to the nine months ended
September 30, 1997. Management continued in third quarter of 1998 to reduce the
Company's dependence on low margin, high churn segments and to increase its
resources in the business markets with higher average billing and retention
rates, niche ethnic consumer markets, small office-home office ("SOHO")
distributors and agents, and internet service providers. With emphasis on
maintaining and increasing certain segments, revenues in these areas have
increased 48.9% or $4.0 million for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997.
Data networking needs of the corporate customer have continued to drive and
change the telecom industry. The future focus of the Company continues to move
toward incorporating voice and data networking solutions into the construction
of corporate Intranets and Wide Area Networks which will decrease its dependence
on traditional long distance services of the residential consumer. The primary
focus of the Company has been to move quickly and efficiently towards becoming a
viable resource to the corporate world having few options in this new wave of
technology. Excluding consumer voice traffic, the Company's revenues generated
by the data needs of its customers as a percentage of total revenues increased
18.6% or $160,965 for the third quarter of 1998 compared to the first quarter of
1998. This percentage is expected to increase as the Company completes its
continued integration of its corporate broadband network and its growth counters
the decline of the long distance business.
Gross Margin
Gross margin decreased $155,887 to $3.3 million for the three months ended
September 30, 1998 from $3.5 million for the three months ended September 30,
1997. As a percentage of revenues, gross margin increased by 3.4 percentage
points to 31.51% for the three months ended September 30, 1998 from 28.16% for
the three months ended September 30, 1997. The increase in gross margin as a
percentage of revenues primarily resulted from decreases of network and leased
facilities that outweighed increases in the bad debt and fraud expenses, all of
which are included in cost of sales.
Network cost as a percentage of revenues decreased by 7.5 percentage points
to 60.0% for the three months ended September 30, 1998 from 67.4% for three
months ended September 30, 1997. The primary factor that effected this decrease
as a percentage was significantly lower rates, which went into effect July of
1998, negotiated with one of the Company's major underlying carriers. Network
cost as a percentage of revenue decreased by 7.3 percentage points to 60.0% for
11
the three months ended September 30, 1998 from 67.3% for the three months ended
June 30, 1998.
Bad debt expense as a percentage of revenues increased by 2.4 percentage
points to 6.2% for the three months ended September 30, 1998 compared to 3.8%
for the three months ended September 30, 1997. The increased bad debt expense
primarily resulted from decreased collection percentages from the Local Exchange
Carriers ("LECs") in certain geographical regions. The majority of the Company's
revenues are billed by the LECs and the Company's bad debt expense was affected
by the lower collection percentages of the LECs. Collection policies and
aggressiveness in collection procedures among the LECs vary. A significant
amount of new sales growth was experienced in a particular geographic location
in which the LECs collection percentages were considerably lower, and the
Company's bad debt expense as a percentage of revenues increased. The majority
of new products being sold by the Company have been designed as direct billed or
electronic internet billed products, and the collection percentages experienced
by the Company's internal collection staff are significantly higher than those
of the LECs. Therefore, as the number of customers being billed by the LEC
decreases, and the Company implements its policy of moving away from the LEC
billing services, bad debt expense as a percentage of revenue is anticipated to
decrease. As of September 30, 1998, 48% of the Company's revenue was direct
billed compared to 20% as of September 30, 1997.
Fraud expense as a percentage of revenues increased by 1.7 percentage
points to 2.3% for the three months ended September 30, 1998 compared to 0.6%
for the three months ended September 30, 1997. This increase is primarily
associated with travel card fraud. During the third quarter the Company
restricted the issuance of travel cards with international calling ability. In
addition, the Company's major international carrier provided the Company greater
flexibility to monitor and suspend travel card activity suspected as fraudulent.
The Company expects that this will help limit fraud expense in future quarters.
Selling, General, and Administrative Costs
Selling, general, and administrative costs increased $572,742 to $4.3
million for the three months ended September 30, 1998 from $3.7 million for the
three months ended September 30, 1997. As a percentage of revenues, selling,
general, and administrative costs increased by 10.55 percentage points to 40.59%
for the three months ended September 30, 1998 from 30.03% for the three months
ended September 30, 1997. Decreased revenues contributed to 2.35 percentage
points increase as a percentage of revenues. 1.05% or $110,659 was expensed for
stock compensation expense for the three months ended September 30, 1998
compared to $0 for the three months ended September 30, 1997. Certain
non-employee agents were granted options for participation in the generation of
new business for the Company. Accordingly, stock compensation was expensed under
the requirements of SFAS No. 123. The remaining increase in cost was
attributable to selling, general, and administrative costs associated with the
merger of AvTel and Matrix, effective December 1, 1997. As of September 30,
1998, the Company had three operating divisions, two primary business locations
and remote employees in several states compared to one operating division and
one location with no remote employees as of September 30, 1997. Additionally, a
more comprehensive corporate structure was required for a public company.
Depreciation and Amortization
Depreciation and amortization increased $110,612 to $261,449 for the three
months ended September 30, 1998 from $150,837 for the three months September 30,
1997. The increase primarily resulted from amortization of intangibles
associated with the merger of AvTel and Matrix. Similarly, the acquisition and
consolidation of assets related to the merger resulted in some increases in
depreciation expense.
Interest Expense and Other Income, Net
Interest expense and other income net of other expenses decreased $82,938
to $14,499 for the three months ended September 30, 1998 from $97,437 for the
three months ended September 30, 1997. Interest expense continued to be
insignificant in amount since the Company has had sufficient cash to meet
operations and capital expenditures. Interest income was lower in 1998 compared
to 1997 primarily from a decrease in cash reserves. Included in other income for
1997 was $52,555 for the reimbursement of expenses incurred in prior years from
an affiliated company. Due to the Loan and Security Agreement entered into with
Coast Business Credit, the Company has a minimum commitment of $10,000 per month
in interest expense starting in October 1998.
12
Income Taxes
Income tax expense has not been recorded for the three months ended
September 30, 1998 compared to the three months ended September 30, 1997 since
there has been a loss from operations for the three months ended September 30,
1998.
Nine Months Ended September 30, 1998 compared with Nine Months Ended September
30, 1997
Revenues
Revenues for the nine months ended September 30, 1998 were $34.3 million, a
decline of 12.5% or $4.9 million from $39.2 million for the nine months ended
September 30, 1997.
See Results of Operations for the three months ended September 30, 1998
compared with the three months ended September 30, 1997. The decline in revenues
is fully described above in the section, Revenues. All of the reasons discussed
above are applicable for the nine months ended September 30, 1998 compared to
the nine months ended September 30, 1997.
Gross Margin
Gross margin decreased $2.5 million to $9.4 million for the nine months
ended September 30, 1998 from $11.9 million for the nine months ended September
30. 1997. As a percentage of revenues, gross margin decreased by 2.95 percentage
points to 27.48% for the nine months ended September 30, 1998 from 30.42% for
the nine months ended September 30, 1997. The decrease in gross margin as a
percentage of revenues primarily resulted from an increase in bad debt expense.
Network cost as a percentage of revenues changed by immaterial amounts for
the nine months ended September 30, 1998 compared to the nine months ended
September 30, 1997. Significantly lower rates, which went into effect July of
1998, negotiated with one of the Company's major underlying carriers allowed the
Company to attain the same percentage for the nine months ended September 30,
1998 as it had for the nine months ended September 30, 1997.
Bad debt expense as a percentage of revenues increased by 3.1 percentage
points to 6.2% for the nine months ended September 30, 1998 from 3.1% for the
nine months ended September 30, 1997. Reasons for the increase in bad debt
expense as a percentage of revenue are comparable and fully explained above in
the Gross Margin section. See Results of Operations for the three months ended
September 30, 1998 compared to the three months ended September 30, 1997.
Selling, General, and Administrative Costs
Selling, general, and administrative costs increased approximately $2.1
million for the nine months ended September 30, 1998 compared to the nine months
ended September 30, 1997. As a percentage of revenues, selling, general, and
administrative costs increased by 10.24 percentage points to 39.86% for the nine
months ended September 30, 1998 from 29.62% for the nine months ended September
30, 1997. 1.96% or $674,169 was expensed for stock compensation expense for the
nine months ended September 30, 1998 compared to $0 for the nine months ended
September 30, 1997. Certain non-employee agents were granted options for
participation in the generation of new business for the Company. Accordingly,
stock compensation was expensed under the requirements of SFAS No. 123. $588,640
was incurred for solicitation of new marketing and sales channels for the nine
months ended September 30, 1998 compared to $51,795 for the nine months ended
September 30, 1997. The remaining increase in cost was attributable to selling,
general, and administrative costs associated with the merger of AvTel and
Matrix, effective December 1, 1997. See Results of Operations for the three
months ended September 30, 1998 compared with the three months ended September
30, 1997. The merger related costs are fully described above in the section,
Selling, General, and Administrative Costs. All of the reasons discussed above
are applicable for the nine months ended September 30, 1998 compared to the nine
months ended September 30, 1997.
Depreciation and Amortization
Depreciation and amortization increased $290,650 to $805,687 for the nine
months ended September 30, 1998 from $515,037 for the nine months ended
13
September 30, 1997. $263,833 of the increase was due to amortization of
intangibles associated with the merger of AvTel and Matrix.
Interest Expense and Other Income, Net
Interest expense and other income net of other expenses decreased $147,433
to $62,640 for the nine months ended September 30, 1998 from $210,073 for the
nine months ended September 30, 1997. Interest expense continued to be
insignificant in amount since the Company has had sufficient cash to meet
operations and capital expenditures. Interest income decreased $53,601 to
$96,281 for the nine months ended September 30, 1998 from $149,882 for the nine
months ended September 30, 1997 primarily from a decrease in cash reserves.
Included in other expense for 1997 was $52,555 for the reimbursement of expenses
incurred in prior years from an affiliated company. Due to the Loan and Security
Agreement entered into with Coast Business Credit, the Company has a minimum
commitment of $10,000 per month in interest expense starting in October 1998.
Income Taxes
Income tax expense has not been recorded for the nine months ended
September 30, 1998 compared to the nine months ended September 30, 1997 since
there has been a loss from operations for the nine months ended September 30,
1998.
Liquidity and Capital Resources
The primary source of operating cash flow for the Company has been revenues
derived from the resale of domestic and international long distance
telecommunications services. Providing data networking solutions for the
construction of corporate Intranets and Wide Area Networks has become a growing
source of revenues. Minor sources of revenues include the provision of back
office support and earnings from investment income.
The primary uses of cash are payments to underlying network vendors for
provisioning long distance facilities, commission payments to sales
distributors, and payments to the major LECs for billing and collecting services
directly from end users.
Net cash used in operating activities is $2.9 million for the nine months
ended September 30, 1998, compared to net cash provided by operating activities
of $2.4 million for the nine months ended September 30, 1997. Primarily, the
change resulted from the Company's net loss of $5.0 million reported for the
nine months ended September 30, 1998 compared to net income of $7,116 reported
for the nine months ended September 30, 1997.
For reasons more fully described above under the heading Results of
Operations, the Company's net loss resulted from declining revenues of the
Company's wholly-owned subsidiary, Matrix Telecom, increased bad debt and fraud,
and increased expenditures in sales and marketing. Declining revenues have been
caused in part by industry competition, changes in certain marketing channels
and management's decision to discontinue relationships with certain unprofitable
sales distributors, which have in the past contributed a significant share of
revenues. Similarly, the increase in bad debt expense for the nine months ended
September 30, 1998 associated with decreased collection percentages from the
LEC's has affected margins.
Net cash provided by investing activities for the nine months ended
September 30, 1998 was $963,554 compared to net cash used in investing
activities of approximately $1.8 million for the nine months ended September 30,
1997. The Company loaned $2.0 million to an affiliated company, Core Marketing,
LLC ("Core") during the nine months ended September 30, 1997. $1,726,601 was
paid by Core on its loan during the nine months ended September 30, 1998. The
Company loaned $500,000 to a company to be acquired, RLI, (Note 8), during the
nine months ended September 30, 1998. Approximately $282,114 was paid to
purchase equipment during the nine months ended September 30, 1998. The majority
of equipment purchases were for computer and computer related assets. The
company anticipates significant disbursements for the Year 2000 compliance
requirements that will be financed through equipment leases and the Coast
Business Credit loan agreement.
Working capital at September 30, 1998 is $1.3 million compared to $5.6
million at December 31, 1997, a decrease of $4.3 million. Cash balances at
September 30, 1998 are $2.5 million compared to $4.8 million at December 31,
1997, a decrease of approximately $2.3 million. As discussed above, the Company
received $1.7 million on an outstanding loan.
14
The Company entered into a Loan and Security Agreement with Coast Business
Credit, a division of Southern Pacific Bank ("Coast"), a California corporation
on October 2, 1998. The agreement provides for an asset based revolving credit
line with a floating interest rate equal to prime plus 2%, subject to a minimum
interest rate of 8% per annum. The credit limit is the lesser of $7,500,000 or a
percentage of the amount of the Company's eligible receivables and other items.
The agreement calls for a minimum borrowing of $1,500,000, a $2,000,000 minimum
net worth requirement and a two year term, subject to extension.
The Company in the past has been able to finance its operations from net
cash provided by operating activities without the need to borrow on a long-term
basis. Since December 31, 1997, the Company has continued to be able to finance
its operations and capital expenditures, which have consisted primarily of
property and equipment, from cash and cash equivalents at the beginning of the
year.
The Company anticipates that future operations and growth strategies
(including possible acquisitions) of the Company will require funding from other
sources. The Company entered into the Coast agreement to help meet this need, as
well as operating and capital expenditure needs, for the next twelve months. In
addition to debt financing, the Company may utilize its capital stock as a
source of financing.
Year 2000
The Year 2000 problem is the inability of a meaningful proportion of the
world's computers, software applications and embedded semiconductor chips to
cope with the change of the year from 1999 to 2000. This issue can be traced to
the infancy of computing, when computer data and programs were designed to save
memory space by truncating the date field to just six digits (two for the day,
two for the month, and two for the year). Therefore, information applications
automatically assumed that the two-digit year field represented a year within
the 20th century. As a result of this, systems could fail to operate or fail to
produce correct results at the start of the 21st century.
Assessment
The Year 2000 problem affects computers, software, and other equipment used,
operated, or maintained by the Company for itself and its customers.
Accordingly, the Company is currently assessing the potential impact of, and the
costs of remediating, the Year 2000 problem for its internal systems and on
facilities systems and equipment.
The Company's business is substantially dependent upon the operation of
computer systems including the billing system that is utilized to rate and
format calls for billing. In addition, the Company is relying on the systems of
third parties to originate and terminate calls, transmit calls to the Company,
and process bills to end users. The Company has launched efforts involving
leaders from the operational areas of the Company which could be affected by the
Year 2000 problem. This effort was initiated pursuant to the direction of the
Board of Directors and has the involvement of top management and its objectives
are top priority.
The Company is in the process of identifying the computers, software
applications, and related equipment used in connection with its operations that
must be modified, upgraded, or replaced to minimize the possibility of a
material disruption of its business. The Company has commenced the process of
modifying, upgrading, and replacing systems which have already been assessed as
adversely affected by the Year 2000 problem, and expects to have all other major
systems assessed, and if need be, modified, before the occurrence of any
material disruption of its business. The Company expects to complete this
process by the middle of 1999.
In addition to computers and related systems, the operation of office and
facilities equipment, such as fax machines, copiers, telephone switches,
security systems and other common devices may be affected by the Year 2000
problem. The Company is currently assessing the potential effect of, and costs
of remediating, the Year 2000 problem on its office and facilities systems and
equipment.
The Company has initiated communications with third party suppliers of
products/services used, operated, or maintained by the Company to identify and,
to the extent possible, to resolve issues involving the Year 2000 problem.
However,
15
the Company has limited or no control over the actions of these third party
suppliers. Thus, while the Company expects that it will be able to resolve any
significant Year 2000 problems with these systems, there can be no assurance
that these suppliers will resolve any or all Year 2000 problems with these
systems before the occurrence of a material disruption to the business of the
Company or any of its customers. Any failure of these third parties to timely
resolve Year 2000 problems with their systems could have a material adverse
effect on the Company's business, financial condition, and results of
operations.
Impact of Year 2000 Problems
Because the Company's assessment is not complete, the Company has not yet
estimated the total cost to the Company of completing any required
modifications, upgrades, or replacements of either the operational systems, or
facilities systems and equipment. The Company does anticipate significant
disbursements for the year 2000 compliance requirements that will be financed
through equipment leases and the Coast Business Credit loan agreement.
The Company expects to identify and resolve all Year 2000 problems that
could materially adversely affect its business operations. However, management
believes that it is not possible to determine with complete certainty that all
Year 2000 problems affecting the Company or its customers and suppliers have
been identified or corrected. The number of devices that could be affected and
the interactions among these devices are simply too numerous. In addition, no
one can accurately predict how many Year 2000 problem-related failures will
occur or the severity, duration, or financial consequences of these perhaps
inevitable failures. As a result, management expects that the Company will
likely suffer the following consequences:
A number of operational inconveniences and inefficiencies for the
Company and its customers and will divert management's time and
attention and financial and human resources from its ordinary business
activities;
A lesser number of serious system failures that will require
significant efforts by the Company or its customers to prevent or
alleviate material business disruptions;
Several routine business disputes and claims for pricing adjustments or
penalties due to Year 2000 problems by customers, which will be
resolved in the ordinary course of business; and
A few serious business disputes alleging that the Company failed to
comply with the terms of its contracts or industry standards of
performance, some of which could result in litigation or contract
termination.
Contingency Plans
The Company will develop contingency plans to be implemented if its efforts
to identify and correct Year 2000 problems affecting its operational systems and
facilities systems and equipment are not effective. The Company expects to
complete its contingency plans by the middle of 1999. Depending on the systems
affected, any contingency plans developed by the Company, if implemented, could
have a material adverse effect on the Company's financial condition and results
of operation.
Disclaimer
The discussion of the Company's efforts, and management's expectations
relating to Year 2000 compliance are forward-looking statements. The Company's
ability to achieve Year 2000 compliance and the level of incremental costs
associated therewith, could be adversely impacted by, among other things, the
availability and cost of programming and testing resources, vendors' ability to
modify proprietary software, and unanticipated problems identified in the
ongoing compliance review.
16
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 25, 1998, the Company issued 30,000 shares of its common
stock, which were not registered under the Securities Act, in connection with
the acquisition of Digital Media International, Inc., a Pennsylvania corporation
("DMI"), by means of a stock-for-stock exchange. No underwriters were used in
the transaction and none of such shares were issued publicly. The Company relied
on the exemptions from registration provided by Sections 3(a) (11) and 4(2) of
the Securities Act and Rule 505 of Regulation D promulgated thereunder. The
persons receiving shares were the three former DMI shareholders. These persons
were and are believed by the Company to possess the requisite level of financial
sophistication and experience in order to qualify for such exemptions. The
Company made available to the recipients of such Common Stock all material
information with respect to the Company and the share exchange. Each such person
signed an exchange agreement containing appropriate investment representations
and covenants.
ITEM 5. OTHER INFORMATION
On October 1, 1998, M. Scott Hall joined the Company as Senior Vice
President, Consumer Markets.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Admendment To Carrier Transport Switched Services Agreement dated
October 15, 1998, between Matrix Telecom and Sprint
Communications Company L.P.
10.2 Loan and Security Agreement dated October 2, 1998, among
registrant, Matrix Telecom and Coast Business Credit
27.1 Financial Data Schedule - Nine Months Ended September 30, 1998
27.2 Restated Financial Data Schedule - Nine Months Ended September
30, 1997
(b) Reports on Form 8-K
The registrant filed no reports on Form 8-K during the quarter ended
September 30, 1998.
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVTEL COMMUNICATIONS, INC.,
a Delaware corporation
By: /S/ JAMES P. PISANI
------------------------------------
JAMES P. PISANI
PRESIDENT, CHIEF OPERATING OFFICER,
CHIEF FINANCIAL OFFICER AND
SECRETARY (Duly Authorized Officer and
Principal Financial Officer)
November 11, 1998
18
Exhibit Index
Exhibit
Number Exhibit Description
- ------- -------------------
10.1 Admendment To Carrier Transport Switched Services Agreement dated October
15, 1998, between Matrix Telecom and Sprint Communications Company L.P.
10.2 Loan and Security Agreement dated October 2, 1998, among registrant, Matrix
Telecom and Coast Business Credit
27.1 Financial Data Schedule - Nine Months Ended September 30, 1998
27.2 Restated Financial Data Schedule - Nine Months Ended September 30, 1997