-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Vhp4UIrkzRJFVmF/JTpS+1WSy2wp8iu/6K1qpvZobpM6SkLnYqwLkExPvrcz6C+h pLfPMgQxNCnzXCDx2cBbHQ== 0000939802-98-000057.txt : 19981113 0000939802-98-000057.hdr.sgml : 19981113 ACCESSION NUMBER: 0000939802-98-000057 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVTEL COMMUNICATIONS INC/DE CENTRAL INDEX KEY: 0001005974 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 870378021 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27580 FILM NUMBER: 98744528 BUSINESS ADDRESS: STREET 1: 501 BATH STREET CITY: SANTA BARBARA STATE: CA ZIP: 93101 BUSINESS PHONE: (805) 884- MAIL ADDRESS: STREET 1: 501 BATH STREET CITY: SANTA BARABARA STATE: CA ZIP: 93101 FORMER COMPANY: FORMER CONFORMED NAME: AVTEL COMMUNICATIONS INC/UT DATE OF NAME CHANGE: 19970109 FORMER COMPANY: FORMER CONFORMED NAME: HI TIGER INTERNATIONAL INC DATE OF NAME CHANGE: 19960119 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------- FORM 10-Q --------- [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 --------- 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 EX-10 2 Exhibit 10.1 AMENDMENT TO CARRIER TRANSPORT SWITCHED SERVICES AGREEMENT THIS AMENDMENT (the "Amendment") is made by SPRINT COMMUNICATIONS COMPANY L.P. ("Sprint") and MATRIX TELECOM, INC. ("Customer"), to that certain Carrier Transport Switched Services Agreement which was executed on or about April 6, 1998 (the "Agreement"). Sprint and Customer are "Parties" hereto. In consideration of the mutual promises contained herein, the Parties amend the Agreement as follows: 1. The following Attachments, or parts of an Attachment, are stricken from the Agreement in their entirety. Each Attachment, or part of an Attachment, so stricken shall be replaced as part of the Agreement with the attachment to this Amendment that bears the same title or heading. Attachment A shall be amended by adding the following paragraphs: SEPARATE PRODUCT HIERARCHY The entire Attachment C-1 (a) shall be added to the executed contract. Attachment C-1(a) is applicable only to all domestic interstate traffic of new ANI's only. All international and interstate traffic shall be priced according to the contract rates contained on Attachments C-16a-g and D-1a, respectively. Attachment C-1a shall be added to the Agreement in its entirety, and is applicable for all domestic interstate traffic of new ANI's only. Attachment C-16a-g shall be added to the Agreement in their entirety, and is applicable for all international traffic of new ANI's only. Attachment D-1a shall be added to the Agreement in its entirety, and is applicable for all domestic intrastate traffic of new ANI's only. 2. Effective upon execution by Matrix Telecom. 3. All other terms and conditions of this Agreement shall remain in full force and effect. 4. Sprint's offer to amend the Agreement shall be withdrawn if this Amendment is not executed by both Parties within 45 days after October 14, 1998. EXECUTED and made effective as provided herein. MATRIX TELECOM, INC. SPRINT COMMUNICATIONS COMPANY L.P. By: ------------------------ By: -------------------------- Title: ------------------------ Title: -------------------------- Date: ------------------------ Date: -------------------------- EX-10 3 LOAN AND SECURITY AGREEMENT Exhibit 10.2 LOAN AND SECURITY AGREEMENT by and between AVTEL COMMUNICATIONS, INC., a Delaware corporation, MATRIX TELECOM, INC., a Texas corporation and COAST BUSINESS CREDIT, a division of Southern Pacific Bank Dated as of October 2, 1998 TABLE OF CONTENTS Page 1. DEFINITIONS..........................................................1 Account Debtor..............................................1 Affiliate...................................................1 Audit.......................................................1 Availability................................................1 Billed Receivables..........................................1 Borrower....................................................1 Borrower's Address..........................................2 Business Day................................................2 Change of Control...........................................2 Closing Date................................................2 Coast.......................................................2 Code........................................................2 Collateral..................................................2 Credit Limit................................................2 Default.....................................................2 Deposit Account.............................................2 Dilution Percentage.........................................2 Dollars or $................................................2 Early Termination Fee.......................................2 EBIT........................................................2 EBITDA......................................................2 Eligible Receivables........................................2 Equipment...................................................3 Equipment Acquisition Loans.................................4 Event of Default............................................4 GAAP........................................................4 General Intangibles.........................................4 Inventory...................................................4 Letter of Credit............................................4 Letter of Credit Sublimit...................................4 Loan Documents..............................................4 Loans.......................................................4 Material Adverse Effect.....................................4 Maturity Date...............................................4 Maximum Dollar Amount.......................................4 Minimum Monthly Interest....................................5 Net Worth...................................................5 Obligations.................................................5 Permitted Liens.............................................5 Person......................................................5 Prime Rate..................................................5 Receivable Loans............................................5 Receivables.................................................5 Renewal Date................................................6 Renewal Fee.................................................6 Solvent.....................................................6 Unbilled Receivables........................................6 Term Loan...................................................6 Year or Yearly..............................................6 Year 2000 Problem...........................................6 Other Terms.................................................6 2. CREDIT FACILITIES....................................................6 2.1 Loans.......................................................6 2.2 Letters of Credit...........................................6 3. INTEREST AND FEES....................................................7 3.1 Interest....................................................7 3.2 Fees........................................................7 4. SECURITY INTEREST....................................................7 5. CONDITIONS PRECEDENT.................................................7 5.1 Status of Accounts at Closing...............................7 5.2 Minimum Availability........................................7 5.3 Landlord Waiver.............................................8 5.4 Executed Agreement..........................................8 5.5 Opinion of Borrower's Counsel...............................8 5.6 Priority of Coast's Liens...................................8 5.7 Insurance...................................................8 5.8 Borrower's Existence........................................8 5.9 Organizational Documents....................................8 5.10 Taxes.......................................................8 5.11 Year 2000 Problem Assessment Certificate....................8 5.12 Due Diligence...............................................8 5.13 Management Background Checks................................8 5.14 Lockbox/Triparty/Blocked Account Agreements.................8 5.15 Net Worth...................................................8 5.16 Other Documents and Agreements..............................9 6. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE BORROWER............9 6.1 Existence and Authority.....................................9 6.2 Name; Trade Names and Styles................................9 6.3 Place of Business; Location of Collateral...................9 6.4 Title to Collateral; Permitted Liens........................9 6.5 Maintenance of Collateral..................................10 6.6 Books and Records..........................................10 6.7 Financial Condition, Statements and Reports................10 6.8 Tax Returns and Payments; Pension Contributions............10 6.9 Compliance with Law........................................10 6.10 Litigation.................................................10 6.11 Use of Proceeds............................................10 6.12 Year 2000 Compliance.......................................10 7. RECEIVABLES.........................................................11 7.1 Representations Relating to Receivables....................11 7.2 Representations Relating to Documents and Legal Compliance.11 7.3 Schedules and Documents relating to Receivables............11 7.4 Collection of Receivables..................................11 7.5 Remittance of Proceeds.....................................11 7.6 Disputes...................................................12 7.7 Returns....................................................12 7.8 Verification...............................................12 7.9 No Liability...............................................12 8. ADDITIONAL DUTIES OF THE BORROWER...................................12 8.1 Financial and Other Covenants..............................12 8.2 Insurance..................................................12 8.3 Reports....................................................13 8.4 Access to Collateral, Books and Records....................13 8.5 Negative Covenants.........................................13 8.6 Litigation Cooperation.....................................14 8.7 Further Assurances.........................................14 9. TERM................................................................14 9.1 Maturity Date..............................................14 9.2 Early Termination..........................................14 9.3 Payment of Obligations.....................................14 10. EVENTS OF DEFAULT AND REMEDIES......................................14 10.1 Events of Default..........................................14 10.2 Remedies...................................................16 10.3 Standards for Determining Commercial Reasonableness........17 10.4 Power of Attorney..........................................17 10.5 Application of Proceeds....................................18 10.6 Remedies Cumulative........................................18 11. GENERAL PROVISIONS..................................................19 11.1 Interest Computation.......................................19 11.2 Application of Payments....................................19 11.3 Charges to Accounts........................................19 11.4 Monthly Accountings........................................19 11.5 Notices....................................................19 11.6 Severability...............................................19 11.7 Integration................................................19 11.8 Waivers....................................................19 11.9 No Liability for Ordinary Negligence.......................20 11.10 Amendment.....................................................20 11.11 Time of Essence...............................................20 11.12 Attorneys Fees, Costs and Charges.............................20 11.13 Benefit of Agreement..........................................20 11.14 Publicity.....................................................21 11.15 Paragraph Headings; Construction..............................21 11.16 Governing Law; Jurisdiction; Venue............................21 11.17 Mutual Waiver of Jury Trial...................................21 11.18 Confidentiality...............................................21 Coast Loan and Security Agreement Borrower: AVTEL COMMUNICATIONS, INC., a Delaware corporation Address: 501 Bath Street Santa Barbara, California 93101 Borrower: MATRIX TELECOM, INC., a Texas corporation Address: 8721 Airport Freeway Fort Worth, Texas 76180 Date: October 2, 1998 THIS LOAN AND SECURITY AGREEMENT is entered into on the above date between COAST BUSINESS CREDIT, a division of Southern Pacific Bank ("Coast"), a California corporation, with offices at 12121 Wilshire Boulevard, Suite 1111, Los Angeles, California 90025, and the borrowers named above (jointly and severally, the ABorrower@), whose chief executive offices are located at the above addresses (ABorrower=s Address@). The Schedule to this Agreement (the ASchedule@) shall for all purposes be deemed to be a part of this Agreement, and the same is an integral part of this Agreement. (Definitions of certain terms used in this Agreement are set forth in Section 1 below.) 1. DEFINITIONS. As used in this Agreement, the following terms have the following meanings: "Account Debtor" means the obligor on a Receivable or General Intangible. "Affiliate" means, with respect to any Person, a relative, partner, shareholder, director, officer, or employee of such Person, or any parent or subsidiary of such Person, or any Person controlling, controlled by or under common control with such Person. "Audit" means to inspect, audit and copy Borrower's books and records and the Collateral. Coast Business Credit Loan and Security Agreement "Availability" means the amount of Eligible Receivables multiplied by the advance percentage described in the Schedule net of Borrower's outstanding Obligations. "Billed Receivables" means Receivables that have been invoiced and sent to an Account Debtor for payment, by Borrower, by a local exchange carrier (including, Bell Atlantic, SBC Communications, Ameritech and US West), or by a third party billing company (including, OAN and GTE Choicebilling). "Borrower" has the meaning set forth in the introduction to this Agreement. "Borrower's Address" has the meaning set forth in the introduction to this Agreement. "Business Day" means a day on which Coast is open for business. "Change of Control" shall be deemed to have occurred at such time as a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) (other than the current holders of the ownership interests in any Borrower) becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, as a result of any single transaction, of more than twenty-five percent (25%) of the total voting power of all classes of stock or other ownership interests then outstanding of any Borrower normally entitled to vote in the election of directors or analogous governing body. "Closing Date" date of the initial funding under this Agreement. "Coast" has the meaning set forth in the introduction to this Agreement. "Code" means the Uniform Commercial Code as adopted and in effect in the State of California from time to time. "Collateral" has the meaning set forth in Section 4 hereof. "Credit Limit" means the maximum amount of Loans that Coast may make to Borrower pursuant to the amounts and percentages shown on the Schedule. "Default" means any event which with notice or passage of time or both, would constitute an Event of Default. "Deposit Account" has the meaning set forth in Section 9105 of the Code. "Dilution Percentage" shall mean the total amount of chargebacks, discounts and other items reducing the outstanding amounts of Receivables, calculated as a percentage of the total amount of outstanding Receivables. "Dollars or $" means United States dollars. "Early Termination Fee" means the amount set forth on the Schedule that Borrower must pay Coast if this Agreement is terminated by Borrower or Coast pursuant to Section 9.2 hereof. "EBIT" means, in any fiscal period, Borrower's consolidated net income (other than extraordinary or non-recurring items of Borrower for such period), plus (i) the amount of all interest expense and income tax expense of Borrower for such period, on a consolidated basis, and plus or minus (as the case may be) (ii) any other non-cash charges which have been added or subtracted, as the case may be, in calculating Borrower's consolidated net income for such period. "EBITDA" means, in any fiscal period, Borrower's consolidated net income (other than extraordinary or non-recurring items of Borrower for such period), plus (i) the amount of all interest expense, income tax expense, depreciation expense, and amortization expense of Borrower for such period, on a consolidated basis, and plus or minus (as the case may be) (ii) any other non-cash charges (including non-cash expenses for the amortization of stock options) which have been added or subtracted, as the case may be, in calculating Borrower's consolidated net income for such period. "Eligible Receivables" means Billed Receivables and Unbilled Receivables arising in the ordinary course of Borrower's business from the sale of goods or rendition of services, which Coast, in its sole reasonable credit judgment, shall deem eligible for borrowing, based on such considerations as Coast may from time to time deem appropriate. Eligible Receivables shall not include the following: (a) Billed Receivables that the Account Debtor has failed to pay within 90 days of invoice date or Accounts with selling terms of more than 30 days; (b) Unbilled Receivables that have not been invoiced and sent to an Account Debtor for payment within 45 days of Account Debtor's incurring of the obligation to be invoiced; (c) Receivables owed by an Account Debtor or its Affiliates where twenty-five percent (25%) or more of all Receivables owed by that Account Debtor (or its Affiliates) are deemed ineligible under clause (a) above; (d) Receivables with respect to which the Account Debtor is an employee, or agent of Borrower; (e) Receivables with respect to an Account Debtor who is an Affiliate of Borrower whose total obligations owing to Borrower exceed ten percent (10%) of all Eligible Receivables, to the extent of the obligation owing by such Account Debtor in excess of such percentage. (f) Receivables with respect to which goods are placed on consignment, guaranteed sale, sale or return, sale on approval, bill and hold, or other terms by reason of which the payment by the Account Debtor may be conditional; (g) Receivables that are not payable in Dollars or with respect to which the Account Debtor: (i) does not maintain its chief executive office in the United States, or (ii) is not organized under the laws of the United States or any State thereof, or (iii) is the government of any foreign country or sovereign state, or of any state, province, municipality, or other political subdivision thereof, or of any department, agency, public corporation, or other instrumentality thereof; (h) Receivables with respect to which the Account Debtor is either (i) the United States or any department, agency, or instrumentality of the United States (exclusive, however, of Accounts with respect to which Borrower has complied, to the satisfaction of Coast, with the Assignment of Claims Act, 31 U.S.C. ' 3727), or (ii) any State of the United States (exclusive, however, of Receivables owed by any State that does not have a statutory counterpart to the Assignment of Claims Act); (i) Receivables with respect to which the Account Debtor is a creditor of Borrower: (1) who has a right of setoff or who has asserted a right of setoff, but only to the extent of the setoff, or (2) who has disputed its liability, or has made any claim with respect to the Receivables, provided, however, that Coast, on a case-by-case basis and in its sole discretion, may limit this provision to the extent of the obligations in dispute; (j) Receivables with respect to an Account Debtor whose total obligations owing to Borrower exceed twenty percent (20%) of all Eligible Receivables, to the extent of the obligations owing by such Account Debtor in excess of such percentage; (k) Receivables with respect to which the Account Debtor is subject to any reorganization, bankruptcy, insolvency, arrangement, readjustment of debt, dissolution or liquidation proceeding, or becomes insolvent, or goes out of business; (l) Receivables the collection of which Coast, in its reasonable credit judgment, believes to be uncollectible by reason of the Account Debtor's financial condition; (m) Receivables with respect to which the goods giving rise to such Receivable have not been shipped and billed to the Account Debtor, the services giving rise to such Receivable have not been performed and accepted by the Account Debtor, or the Receivable otherwise does not represent a final sale except for those Receivables in which the Account Debtor has entered into an agreement with Borrower, in form and substance acceptable to Coast, whereby Borrower is contractually bound to pay the Receivables and/or estopped from contesting the Receivables; (n) Receivables with respect to which the Account Debtor is located in the states of New Jersey, Minnesota, Indiana, or West Virginia (or any other state that requires a creditor to file a Business Activity Report or similar document in order to bring suit or otherwise enforce its remedies against such Account Debtor in the courts or through any judicial process of such state), unless Borrower has qualified to do business in New Jersey, Minnesota, Indiana, West Virginia, or such other states, or has filed a Notice of Business Activities Report with the applicable division of taxation, the department of revenue, or with such other state offices, as appropriate, for the then-current year, or is exempt from such filing requirement; and (o) Receivables that represent progress payments or other advance billings that are due prior to the completion of performance by Borrower of the subject contract for goods or services except for those Receivables in which the Account Debtor has entered into an agreement with Borrower in form and substance acceptable to Coast, whereby Borrower is contractually bound to pay the Receivables and/or estopped from contesting the Receivables. "Equipment" means all of Borrower's present and hereafter acquired machinery, molds, machine tools, motors, furniture, equipment, furnishings, fixtures, trade fixtures, motor vehicles, tools, parts, dies, jigs, goods and other goods (other than Inventory) of every kind and description used in Borrower's operations or owned by Borrower and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions or improvements to any of the foregoing, wherever located. "Equipment Acquisition Loans" means the Loans described in Section [2(b)] of the Schedule. "Event of Default" means any of the events set forth in Section 10.1 of this Agreement. "GAAP" means generally accepted accounting principles as in effect from time to time in the United States, consistently applied. "General Intangibles" means all general intangibles of Borrower, whether now owned or hereafter created or acquired by Borrower, including, without limitation, all choses in action, causes of action, corporate or other business records, Deposit Accounts, investment property, inventions, designs, drawings, blueprints, patents, patent applications, trademarks and the goodwill of the business symbolized thereby, names, trade names, trade secrets, goodwill, copyrights, registrations, licenses, franchises, customer lists, security and other deposits, rights in all litigation presently or hereafter pending for any cause or claim (whether in contract, tort or otherwise), and all judgments now or hereafter arising therefrom, all claims of Borrower against Coast, rights to purchase or sell real or personal property, rights as a licensor or licensee of any kind, royalties, telephone numbers, proprietary information, purchase orders, and all insurance policies and claims (including without limitation life insurance, key man insurance, credit insurance, liability insurance, property insurance and other insurance), tax refunds and claims, computer programs, discs, tapes and tape files, claims under guaranties, security interests or other security held by or granted to Borrower, all rights to indemnification and all other intangible property of every kind and nature (other than Receivables). "Inventory" means all of Borrower's now owned and hereafter acquired goods, merchandise or other personal property, wherever located, to be furnished under any contract of service or held for sale or lease (including without limitation all raw materials, work in process, finished goods and goods in transit, and including without limitation all farm products), and all materials and supplies of every kind, nature and description which are or might be used or consumed in Borrower's business or used in connection with the manufacture, packing, shipping, advertising, selling or finishing of such goods, merchandise or other personal property, and all warehouse receipts, documents of title and other documents representing any of the foregoing. "Investment Property" has the meaning set forth in Section 9115 of the Code as in effect as of the date hereof. "Letter of Credit" has the meaning set forth in Section 2.2 hereof. "Letter of Credit Sublimit" has the meaning set forth in Section 2.2 hereof. "Loan Documents" means this Agreement, the agreements and documents listed on Section 5 of the Schedule, and any other agreement, instrument or document executed in connection herewith or therewith. "Loans" has the meaning set forth in Section 2.1 hereof. "Material Adverse Effect" means a material adverse effect on (i) the business, assets, financial condition or results of operations of Borrower or any subsidiary of Borrower or any guarantor of any of the Obligations, (ii) the ability of Borrower or any guarantor of any of the Obligations to perform its obligations under this Agreement (including, without limitation, repayment of the Obligations as they come due) or (iii) the validity or enforceability of this Agreement or any other agreement or document entered into by any party in connection herewith, or the rights or remedies of Coast hereunder or thereunder. "Maturity Date" means the date that this Agreement shall cease to be effective, as set forth on the Schedule, subject to the provisions of Section 9.1 and 9.2 hereof. "Maximum Dollar Amount" has the meaning set forth in Section 2 of the Schedule. "Minimum Monthly Interest" has the meaning set forth in Section 3 of the Schedule. "Net Worth" means consolidated shareholders's equity of a Person at any date determined in accordance with GAAP, plus subordinated debt. "Obligations" means all present and future Loans, advances, debts, liabilities, obligations, guaranties, covenants, duties and indebtedness at any time owing by Borrower to Coast, whether evidenced by this Agreement or any note or other instrument or document, whether arising from an extension of credit, opening of a letter of credit, banker's acceptance, loan, guaranty, indemnification or otherwise, whether direct or indirect (including, without limitation, those acquired by assignment and any participation by Coast in Borrower's debts owing to others), absolute or contingent, due or to become due, including, without limitation, all interest, charges, expenses, fees, attorneys' fees (including attorneys' fees and expenses incurred in bankruptcy), expert witness fees, audit fees, letter of credit fees, collateral monitoring fees, closing fees, facility fees, termination fees, minimum interest charges and any other sums chargeable to Borrower under this Agreement or under any other present or future instrument or agreement between Borrower and Coast. "Permitted Liens" means the following: (1) purchase money security interests in specific items of Equipment; (2) leases of specific items of Equipment; (3) liens for taxes not yet payable; (4) additional security interests and liens consented to in writing by Coast, which consent shall not be unreasonably withheld; (5) security interests being terminated substantially concurrently with this Agreement; (6) liens of materialmen, mechanics, warehousemen, carriers, or other similar liens arising in the ordinary course of business and securing obligations which are not delinquent; (7) liens incurred in connection with the extension, renewal or refinancing of the indebtedness secured by liens of the type described above in clauses (1) or (2) above, provided that any extension, renewal or replacement lien is limited to the property encumbered by the existing lien and the principal amount of the indebtedness being extended, renewed or refinanced does not increase; or (8) liens in favor of customs and revenue authorities which secure payment of customs duties in connection with the importation of goods. Coast will have the right to require, as a condition to its consent under subparagraph (4) above, that the holder of the additional security interest or lien sign an intercreditor agreement on Coast=s then standard form, acknowledge that the security interest is subordinate to the security interest in favor of Coast, and agree not to take any action to enforce its subordinate security interest so long as any Obligations remain outstanding, and that Borrower agree that any uncured default in any obligation secured by the subordinate security interest, subject to any applicable notice and cure period applicable thereto, shall also constitute an Event of Default under this Agreement. "Person" means any individual, sole proprietorship, general partnership, limited partnership, limited liability partnership, limited liability company, joint venture, trust, unincorporated organization, association, corporation, government, or any agency or political division thereof, or any other entity. "Prime Rate" means the actual "Reference Rate" or the substitute therefor of the Bank of America NT & SA, or its successor, whether or not that rate is the lowest interest rate charged by said bank. If the Prime Rate, as defined, is unavailable, "Prime Rate" shall mean the highest of the prime rates published in the Wall Street Journal on the first business day of the applicable month, as the base rate on corporate loans at large U.S. money center commercial banks. "Receivable Loans" means the Loans described in Section 2(a) of the Schedule. "Receivables" means all of Borrower's now owned and hereafter acquired accounts (whether or not earned by performance), letters of credit, contract rights, chattel paper, instruments, securities, documents, securities accounts, security entitlements, commodity contracts, commodity accounts, investment property and all other forms of obligations at any time owing to Borrower, all guaranties and other security therefor, all merchandise returned to or repossessed by Borrower, and all rights of stoppage in transit and all other rights or remedies of an unpaid vendor, lienor or secured party. "Renewal Date" shall mean the Maturity Date if this Agreement is renewed pursuant to Section 9.1 hereof, and each anniversary thereafter that this Agreement is renewed pursuant to Section 9.1 hereof. "Renewal Fee" means the fee that Borrower must pay Coast upon renewal of this Agreement pursuant to Section 9.1 hereof, in the amount set forth on the Schedule. "Solvent" means, with respect to any Person on a particular date, that on such date (a) at fair valuations, all of the properties and assets of such Person are greater than the sum of the debts, including contingent liabilities, of such Person, (b) the present fair salable value of the properties and assets of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured, (c) such Person is able to realize upon its properties and assets and pay its debts and other liabilities, contingent obligations and other commitments as they mature in the normal course of business, (d) such Person does not intend to, and does not believe that it will, incur debts beyond such Person's ability to pay as such debts mature, and (e) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such Person's properties and assets would constitute unreasonably small capital after giving due consideration to the prevailing practices in the industry in which such Person is engaged. In computing the amount of contingent liabilities at any time, it is intended that such liabilities will be computed at the amount that, in light of all the facts and circumstances existing at such time, represents the amount that reasonably can be expected to become an actual or matured liability. "Unbilled Receivables" means Receivables that have not been invoiced and sent to an Account Debtor for payment, by Borrower, by a local exchange carrier (including Bell Atlantic, SBC Communications, Ameritech and US West) or by a third party billing company (including, OAN and GTE Choicebilling). "Term Loan" means the Loans described in Section 2(c) of the Schedule. "Year or Yearly" shall mean a calendar year unless as otherwise set forth. "Year 2000 Problem" means the risk that computer systems, software and applications used by a Person may be unable to recognize and perform properly date-sensitive functions involving certain dates prior to and any dates after December 31, 1999. "Other Terms." All accounting terms used in this Agreement, unless otherwise indicated, shall have the meanings given to such terms in accordance with GAAP. All other terms contained in this Agreement, unless otherwise indicated, shall have the meanings provided by the Code, to the extent such terms are defined therein. 2. CREDIT FACILITIES. 2.1 Loans. Coast will make loans to Borrower (the "Loans"), in amounts and in percentages to be determined by Coast in its good faith discretion, up to the Credit Limit, provided no Default or Event of Default has occurred and is continuing. In addition, Coast may create reserves against or reduce its advance rates based upon Eligible Receivables without declaring a Default or an Event of Default if it determines that there has occurred a Material Adverse Effect. Notwithstanding the foregoing, Coast shall establish a reserve in an amount equal to 45% of all recurring telecommunication collections or such amount, determined by Coast in its sole discretion, which will ensure the monthly payment in full to the local exchange carriers but in no event will the reserve exceed the outstanding local exchange carrier obligations. Said reserve will be released upon Coast's: (1) receipt of satisfactory evidence of the wire transfer payments, or (2) the monthly payments by Coast, with the authorization of Borrower, to the local exchange carriers from established availability reserves. 2.2 Letters of Credit. At the request of Borrower, Coast may, in its sole discretion, arrange for the issuance of letters of credit for the account of Borrower (collectively, "Letters of Credit"), by issuing guarantees to the issuer of the letter of credit or by other means. All Letters of Credit shall be in form and substance satisfactory to Coast in its sole discretion. The aggregate face amount of all outstanding Letters of Credit from time to time shall not exceed the amount shown on the Schedule (the ALetter of Credit Sublimit@), and shall be reserved against Loans which would otherwise be available hereunder. Borrower shall pay all bank charges for the issuance of Letters of Credit. Any payment by Coast under or in connection with a Letter of Credit shall constitute a Loan hereunder on the date such payment is made. Each Letter of Credit shall have an expiry date no later than thirty (30) days prior to the Maturity Date. Borrower hereby agrees to indemnify, save, and hold Coast harmless from any loss, cost, expense, or liability, including payments made by Coast, expenses, and reasonable attorneys' fees incurred by Coast arising out of or in connection with any Letters of Credit. Borrower agrees to be bound by the regulations and interpretations of the issuer of any Letters of Credit guarantied by Coast and opened for Borrower's account or by Coast's interpretations of any Letter of Credit issued by Coast for Borrower's account, and Borrower understands and agrees that Coast shall not be liable for any error, negligence, or mistake, whether of omission or commission, in following Borrower's instructions or those contained in the Letters of Credit or any modifications, amendments, or supplements thereto. Borrower understands that Letters of Credit may require Coast to indemnify the issuing bank for certain costs or liabilities arising out of claims by Borrower against such issuing bank. Borrower hereby agrees to indemnify and hold Coast harmless with respect to any loss, cost, expense, or liability incurred by Coast under any Letter of Credit as a result of Coast's indemnification of any such issuing bank. The provisions of this Agreement, as it pertains to Letters of Credit, and any other present or future documents or agreements between Borrower and Coast relating to Letters of Credit are cumulative. 30 INTEREST AND FEES. 3.1 Interest. All Loans and all other monetary Obligations shall bear interest at the rate shown on the Schedule, except where expressly set forth to the contrary in this Agreement. Interest shall be payable monthly, on the last day of the month. Interest may, in Coast=s discretion, be charged to Borrower=s loan account, and the same shall thereafter bear interest at the same rate as the other Loans. Regardless of the amount of Obligations that may be outstanding from time to time, Borrower shall pay Coast Minimum Monthly Interest during the term of this Agreement with respect to the Receivable Loans in the amount set forth on the Schedule. 3.2 Fees. Borrower shall pay Coast the fee(s) shown on the Schedule, which are in addition to all interest and other sums payable to Coast under the Loan Documents and are deemed fully earned and are nonrefundable. 40 SECURITY INTEREST. To secure the payment and performance of all of the Obligations when due, Borrower hereby grants to Coast a security interest in all of Borrower's interest in the following, whether now owned or hereafter acquired, and wherever located: All Receivables, Inventory, Equipment, Investment Property, and General Intangibles, including, without limitation, all of Borrower's Deposit Accounts, and all money, and all property now or at any time in the future in Coast's possession (including claims and credit balances), and all proceeds of any of the foregoing (including proceeds of any insurance policies, proceeds of proceeds, and claims against third parties), all products of any of the foregoing, and all books and records related to any of the foregoing (all of the foregoing, together with all other property in which Coast may now or in the future be granted a lien or security interest, is referred to herein, collectively, as the "Collateral") 50 CONDITIONS PRECEDENT. The obligation of Coast to make the Loans is subject to the satisfaction, in the sole discretion of Coast, at or prior to the first advance of funds hereunder, of each, every and all of the following conditions: 5.1 Status of Accounts at Closing. No accounts payable shall be due and unpaid sixty (60) days past its due date except for such accounts payable being contested in good faith in appropriate proceedings and for which adequate reserves have been provided. 5.2 Minimum Availability. Borrower shall have minimum Availability, which shall include Borrower's cash on hand, immediately following the initial funding in the amount set forth on the Schedule. 5.3 Landlord Waiver. Coast shall have received duly executed landlord waivers and access agreements in form and substance satisfactory to Coast, in Coast's sole and absolute discretion, and, when deemed appropriate by Coast, in form for recording in the appropriate recording office, with respect to all leased locations where Borrower maintains any inventory or equipment. 5.4 Executed Agreement. Coast shall have received this Agreement duly executed and in form and substance satisfactory to Coast in its sole and absolute discretion. 5.5 Opinion of Borrower's Counsel. Coast shall have received an opinion of Borrower's counsel, in form and substance satisfactory to Coast in its sole and absolute discretion. 5.6 Priority of Coast's Liens. Coast shall have received the results of "of record" searches satisfactory to Coast in its sole and absolute discretion, reflecting its Uniform Commercial Code filings against Borrower indicating that Coast has a perfected, first priority lien in and upon all of the Collateral, subject only to Permitted Liens. 5.7 Insurance. Coast shall have received copies of the insurance binders or certificates evidencing Borrower's compliance with Section 8.2 hereof, including lender's loss payee endorsements. 5.8 Borrower's Existence. Coast shall have received copies of Borrower's articles or certificate of incorporation and all amendments thereto, and a Certificate of Good Standing, each certified by the Secretary of State of the state of Borrower's organization, and dated a recent date prior to the Closing Date, and Coast shall have received Certificates of Foreign Qualification for Borrower from the Secretary of State of each state wherein the failure to be so qualified could have a Material Adverse Effect. 5.9 Organizational Documents. Coast shall have received copies of Borrower's By-laws and all amendments thereto, and Coast shall have received copies of the resolutions of the board of directors of Borrower, authorizing the execution and delivery of this Agreement and the other documents contemplated hereby, and authorizing the transactions contemplated hereunder and thereunder, and authorizing specific officers of Borrower to execute the same on behalf of Borrower, in each case certified by the Secretary or other acceptable officer of Borrower as of the Closing Date. 5.10 Taxes. Coast shall have received evidence from Borrower that Borrower has complied with all tax withholding and Internal Revenue Service regulations and that Borrower has paid and is current on all taxes, whether federal, state or other applicable taxing body, in form and substance satisfactory to Coast in its sole and absolute discretion. 5.11 Year 2000 Problem Assessment Certificate. Coast shall have received a certificate from the relevant officer of Borrower to the effect that, as the result of a comprehensive assessment undertaken by Borrower of Borrower's computer systems, software and applications and after due inquiry made to Borrower's material suppliers, vendors and customers, Borrower knows of no facts that would cause Borrower to reasonably believe that the Year 2000 Problem will cause a Material Adverse Effect. 5.12 Due Diligence. Coast shall have completed its due diligence with respect to Borrower. 5.13 Management Background Checks. Coast shall have received the results of management background checks, including, without limitation, TRWs, tax lien and other litigation searches, LEXIS/NEXIS searches and such other due diligence as Coast may deem necessary, on certain key officers of Borrower selected by Coast in Coast's sole and absolute discretion. 5.14 Lockbox/Triparty/Blocked Account Agreements. Coast shall have received evidence that all cash remittances of Borrower shall be collected pursuant to one or more lockbox/triparty agreements or blocked account agreements, in form and substance acceptable to Coast. The agreements shall provide, without limitation, that remittances resulting from Borrower's invoicing of Receivables are to be remitted through a lockbox and remittances resulting from the invoicing of Receivables by a local exchange carrier or a third party billing company are to be remitted by wire transfer. The provisions of this paragraph which provide for agreements from the local exchange carriers and the third party billing companies (collectively, "third parties"), will be satisfied when Coast has received agreements from third parties whose collections on Receivables represent 80% of all collections on Receivables by third parties. The initial advance percentage against Receivables invoiced by third parties will be in an amount equal to the percentage of collections of those third parties who have provided signed agreements to Coast. Any remaining agreements from third parties are to be obtained subsequent to the initial advance of funds hereunder and will result in a commensurate percentage increase in the advance of funds. 5.15 Net Worth. Coast shall have received evidence satisfactory to Coast in its sole and absolute discretion that Borrower's Net Worth is equal to or greater than ($2,000,000). 5.16 Other Documents and Agreements. Coast shall have received such other agreements, instruments and documents as Coast may require in connection with the transactions contemplated hereby, all in form and substance satisfactory to Coast in Coast's sole and absolute discretion, and in form for filing in the appropriate filing office, including, but not limited to, those documents listed in Section 5 of the Schedule. 60 REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE BORROWER. In order to induce Coast to enter into this Agreement and to make Loans, Borrower represents and warrants to Coast as follows, and Borrower covenants that the following representations will continue to be true during the term hereof, and that Borrower will at all times during the term hereof comply with all of the following covenants: 6.1 Existence and Authority. Borrower is and will continue to be, duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization. Borrower is and will continue to be qualified and licensed to do business in all jurisdictions in which any failure to do so would have a Material Adverse Effect. The execution, delivery and performance by Borrower of this Agreement, and all other documents contemplated hereby (a) have been duly and validly authorized, (b) are enforceable against Borrower in accordance with their terms (except as enforcement may be limited by equitable principles and by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to creditors' rights generally), and (c) do not violate Borrower=s articles or certificate of incorporation or Borrower=s by-laws, or any law or any material agreement or instrument which is binding upon Borrower or its property, and (d) do not constitute grounds for acceleration of any material indebtedness or obligation under any material agreement or instrument which is binding upon Borrower or its property. 6.2 Name; Trade Names and Styles. The name of Borrower set forth in the heading to this Agreement is its correct name. Listed on the Schedule are all prior names of Borrower and all of Borrower=s present and prior trade names. Borrower shall give Coast thirty (30) days' prior written notice before changing its name or doing business under any other name. Borrower has complied, and will in the future comply, with all laws relating to the conduct of business under a fictitious business name. 6.3 Place of Business; Location of Collateral. The address set forth in the heading to this Agreement is Borrower's chief executive office. In addition, Borrower has places of business and Collateral is located only at the locations set forth on the Schedule. Borrower will give Coast at least thirty (30) days' prior written notice before opening any additional place of business, changing its chief executive office, or moving any of the Collateral to a location other than Borrower=s Address or one of the locations set forth on the Schedule. 6.4 Title to Collateral; Permitted Liens. Borrower is now, and will at all times in the future be, the sole owner of all the Collateral, except for items of Equipment which are leased by Borrower. The Collateral now is and will remain free and clear of any and all liens, charges, security interests, encumbrances and adverse claims, except for Permitted Liens. Coast now has, and will continue to have, a first-priority perfected and enforceable security interest in all of the Collateral, subject only to the Permitted Liens, and Borrower will at all times defend Coast and the Collateral against all claims of others. None of the Collateral now is or will be affixed to any real property in such a manner, or with such intent, as to become a fixture. Borrower is not and will not become a lessee under any real property lease pursuant to which the lessor may obtain any rights in any of the Collateral and no such lease now prohibits, restrains, impairs or will prohibit, restrain or impair Borrower's right to remove any Collateral from the leased premises. Whenever any Collateral is located upon premises in which any third party has an interest (whether as owner, mortgagee, beneficiary under a deed of trust, lien or otherwise), Borrower shall, whenever requested by Coast, use its best efforts to cause such third party to execute and deliver to Coast, in form acceptable to Coast, such waivers and subordinations as Coast shall reasonably specify, so as to ensure that Coast's rights in the Collateral are, and will continue to be, superior to the rights of any such third party. Borrower will keep in full force and effect, and will comply with all the terms of, any lease of real property where any of the Collateral now or in the future may be located. Coast agrees that its default rights resulting from Borrower's noncompliance with this paragraph are subject to the existence of a Material Adverse Effect. 6.5 Maintenance of Collateral. Borrower will maintain the Inventory and Equipment in good working condition, and Borrower will not use the Collateral for any unlawful purpose. Borrower will immediately advise Coast in writing of any material loss or damage to the Collateral. 6.6 Books and Records. Borrower has maintained and will maintain at Borrower's Address complete and accurate books and records, comprising an accounting system in accordance with GAAP. 6.7 Financial Condition, Statements and Reports. All financial statements now or in the future delivered to Coast have been, and will be, prepared in conformity with GAAP (except, in the case of unaudited financial statements, for the absence of footnotes and subject to normal year-end adjustments) and now and in the future will fairly reflect the financial condition of Borrower in all material respects, at the times and for the periods therein stated. Between the last date covered by any such statement provided to Coast and the date hereof, there has been no Material Adverse Effect. Borrower is now and will continue to be Solvent. 6.8 Tax Returns and Payments; Pension Contributions. Borrower has timely filed, and will timely file, all tax returns and reports required by foreign, federal, state and local law, and Borrower has timely paid, and will timely pay, all foreign, federal, state and local taxes, assessments, deposits and contributions now or in the future owed by Borrower. Borrower may, however, defer payment of any contested taxes, provided that Borrower (i) in good faith contests Borrower's obligation to pay the taxes by appropriate proceedings promptly and diligently instituted and conducted, (ii) notifies Coast in writing of the commencement of, and any material development in, the proceedings, and (iii) posts bonds or takes any other steps required to keep the contested taxes from becoming a lien upon any of the Collateral. As of the date hereof, Borrower is unaware of any claims or adjustments proposed for any of Borrower's prior tax years which could result in additional taxes becoming due and payable by Borrower. Borrower has paid, and shall continue to pay all amounts necessary to fund all present and future pension, profit sharing and deferred compensation plans in accordance with their terms, and Borrower has not and will not withdraw from participation in, permit partial or complete termination of, or permit the occurrence of any other event with respect to, any such plan which could result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency. Borrower shall, at all times, utilize the services of an outside payroll service providing for the automatic deposit of all payroll taxes payable by Borrower. 6.9 Compliance with Law. Borrower has complied, and will comply, in all material respects, with all provisions of all material foreign, federal, state and local laws and regulations relating to Borrower, including, but not limited to, the Fair Labor Standards Act, and those relating to Borrower's ownership of real or personal property, the conduct and licensing of Borrower's business, and environmental matters. 6.10 Litigation. Except as disclosed in the Schedule, there is no claim, suit, litigation, proceeding or investigation pending or (to best of Borrower=s knowledge) threatened by or against or affecting Borrower in any court or before any governmental agency (or any basis therefor known to Borrower) which may result, either separately or in the aggregate, in a Material Adverse Effect. Borrower will promptly inform Coast in writing, upon discovery by Borrower, of any claim, proceeding, litigation or investigation in the future threatened or instituted by or against Borrower involving an amount set forth on the Schedule. 6.11 Use of Proceeds. All proceeds of all Loans shall be used solely for lawful business purposes. Borrower is not purchasing or carrying any "margin stock" (as defined in Regulation G of the Board of Governors of the Federal Reserve System) and no part of the proceeds of any Loan will be used to purchase or carry any "margin stock" or to extend credit to others for the purpose of purchasing or carrying any "margin stock." 6.12 Year 2000 Compliance. As the result of a comprehensive review and assessment undertaken by Borrower of Borrower's computer systems, software and applications and after due inquiry made of Borrower's material suppliers, vendors and customers Borrower represents and warrants that the Year 2000 problem will not result in a Material Adverse Effect. 70 RECEIVABLES. 7.1 Representations Relating to Receivables. Borrower represents and warrants to Coast as follows: Each Receivable with respect to which Loans are requested by Borrower shall, on the date each Loan is requested and made, represent an undisputed bona fide existing unconditional obligation of the Account Debtor created by the sale, delivery and acceptance of goods or the rendition of services in the ordinary course of Borrower's business. 7.2 Representations Relating to Documents and Legal Compliance. Borrower represents and warrants to Coast as follows: All statements made and all unpaid balances appearing in all invoices, instruments and other documents evidencing the Receivables are and shall be true and correct and all such invoices, instruments and other documents and all of Borrower's books and records are and shall be genuine and in all respects what they purport to be. All sales and other transactions underlying or giving rise to each Receivable shall fully comply with all applicable laws and governmental rules and regulations. All signatures and indorsements on all documents, instruments, and agreements relating to all Receivables are and shall be genuine, and all such documents, instruments and agreements are and shall be legally enforceable in accordance with their terms (except as enforcement may be limited by equitable principles and by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to creditors' rights generally). 7.3 Schedules and Documents relating to Receivables. Borrower shall deliver to Coast via facsimile, unless otherwise directed by Coast, at such locations and at such intervals as Coast may request, transaction reports and loan requests, schedules of Receivables, and schedules of collections, all on Coast's standard forms; provided, however, that Borrower's failure to execute and deliver the same shall not affect or limit Coast's security interest and other rights in all of Borrower's Receivables, nor shall Coast's failure to advance or lend against a specific Receivable affect or limit Coast's security interest and other rights therein. Loan requests received after 10:30 A.M. Los Angeles, California time, will not be considered by Coast until the next Business Day. Together with each such schedule, or later if requested by Coast, Borrower shall furnish Coast with copies (or, at Coast's request, originals) of all contracts, orders, invoices, and other similar documents, and all original shipping instructions, delivery receipts, bills of lading, and other evidence of delivery, for any goods the sale or disposition of which gave rise to such Receivables, and Borrower warrants the genuineness of all of the foregoing. Borrower shall also furnish to Coast an aged accounts receivable trial balance in such form and at such intervals as Coast shall request. In addition, Borrower shall deliver to Coast the originals, as and when requested by Coast, of all instruments, chattel paper, security agreements, guarantees and other documents and property evidencing or securing any Receivables, upon receipt thereof and in the same form as received, with all necessary indorsements, all of which shall be with recourse. Borrower shall also provide Coast with copies of all credit memos as and when requested by Coast. 7.4 Collection of Receivables. Borrower shall have the right to collect all Receivables, unless and until an Event of Default has occurred. Borrower shall hold all payments on, and proceeds of, Receivables in trust for Coast, and Borrower shall deliver all such payments and proceeds to Coast within one (1) Business Day after receipt by Borrower, in their original form, duly endorsed to Coast, to be applied to the Obligations in such order as Coast shall determine. Coast may, in its discretion, require that all proceeds of Collateral be deposited by Borrower into a lockbox account, or such other "blocked account" as Coast may specify, pursuant to a blocked account agreement in such form as Coast may specify. Coast or its designee may, at any time, notify Account Debtors that Coast has been granted a security interest in the Receivables. 7.5 Remittance of Proceeds. All proceeds arising from the disposition of any Collateral shall be delivered to Coast within one (1) Business Day after receipt by Borrower, in their original form, duly endorsed to Coast, to be applied to the Obligations in such order as Coast shall determine. Borrower agrees that it will not commingle proceeds of Collateral with any of Borrower's other funds or property, but will hold such proceeds separate and apart from such other funds and property and in an express trust for Coast. Nothing in this Section limits the restrictions on disposition of Collateral set forth elsewhere in this Agreement. 7.6 Disputes. Borrower shall notify Coast promptly of all disputes or claims relating to Receivables. Borrower shall not forgive (completely or partially), compromise or settle any Receivable for less than payment in full, or agree to do any of the foregoing, except that Borrower may do so, provided that: (a) Borrower does so in good faith, in a commercially reasonable manner, in the ordinary course of business, and in arm=s length transactions, which are reported to Coast on the regular reports provided to Coast; (b) no Default or Event of Default has occurred and is continuing; and (c) taking into account all such discounts settlements and forgiveness, the total outstanding Loans will not exceed the Credit Limit. Coast may, at any time after the occurrence of an Event of Default, settle or adjust disputes or claims directly with Account Debtors for amounts and upon terms which Coast considers advisable in its reasonable credit judgment and, in all cases, Coast shall credit Borrower's Loan account with only the net amounts received by Coast in payment of any Receivables. 7.7 Returns. Provided no Event of Default has occurred and is continuing, if any Account Debtor returns any Inventory to Borrower in the ordinary course of its business, Borrower shall promptly determine the reason for such return and promptly issue a credit memorandum to the Account Debtor in the appropriate amount. In the event any attempted return occurs after the occurrence of any Event of Default, Borrower shall (a) hold the returned Inventory in trust for Coast, (b) segregate all returned Inventory from all of Borrower=s other property, (c) conspicuously label the returned Inventory as subject to Coast's security interest, and (d) immediately notify Coast of the return of any Inventory, specifying the reason for such return, the location and condition of the returned Inventory, and on Coast's request deliver such returned Inventory to Coast. 7.8 Verification. Coast may, from time to time, verify directly with the respective Account Debtors the validity, amount and other matters relating to the Receivables, by means of mail, telephone or otherwise, either in the name of Borrower or Coast or such other name as Coast may choose. 7.9 No Liability. Coast shall not under any circumstances be responsible or liable for any shortage or discrepancy in, damage to, or loss or destruction of, any goods, the sale or other disposition of which gives rise to a Receivable, or for any error, act, omission or delay of any kind occurring in the settlement, failure to settle, collection or failure to collect any Receivable, or for settling any Receivable in good faith for less than the full amount thereof, nor shall Coast be deemed to be responsible for any of Borrower's obligations under any contract or agreement giving rise to a Receivable. Nothing herein shall, however, relieve Coast from liability for the gross negligence or willful misconduct of Coast, or its directors, officers, employees, agents or contractors. 80 ADDITIONAL DUTIES OF THE BORROWER. 8.1 Financial and Other Covenants. Borrower shall at all times comply with the financial and other covenants set forth in the Schedule. 8.2 Insurance. Borrower shall, at all times insure all of the tangible personal property Collateral and carry such other business insurance, with insurers reasonably acceptable to Coast, in such form and amounts as Coast may reasonably require, and Borrower shall provide evidence of such insurance to Coast, so that Coast is satisfied that such insurance is, at all times, in full force and effect. All liability insurance policies of Borrower shall name Coast as an additional insured, and all property casualty and related insurance policies of Borrower shall name Coast as a loss payee thereon and Borrower shall cause a lender's loss payee endorsement in form reasonably acceptable to Coast. Upon receipt of the proceeds of any such insurance, Coast shall apply such proceeds in reduction of the Obligations as Coast shall determine in its sole discretion, except that, provided no Default or Event of Default has occurred and is continuing, Coast shall release to Borrower insurance proceeds with respect to Equipment totaling less than the amount set forth in Section 8 of the Schedule, which shall be utilized by Borrower for the replacement of the Equipment with respect to which the insurance proceeds were paid. Coast may require reasonable assurance that the insurance proceeds so released will be so used. If Borrower fails to provide or pay for any insurance, Coast may, but is not obligated to, obtain the same at Borrower's expense. Borrower shall promptly deliver to Coast copies of all reports made to insurance companies. 8.3 Reports. Borrower, at its expense, shall provide Coast with the written reports set forth in Section 8 of the Schedule, and such other written reports with respect to Borrower (including budgets, sales projections, operating plans and other financial documentation), as Coast shall from time to time reasonably specify. 8.4 Access to Collateral, Books and Records. At reasonable times but not less frequently than quarterly and on one (1) Business Day=s notice, Coast, or its agents, shall have the right to perform Audits. Coast shall take reasonable steps to keep confidential all confidential information obtained in any Audit, but Coast shall have the right to disclose any such information to its auditors, regulatory agencies, and attorneys, and pursuant to any subpoena or other legal process. The Audits shall be at Borrower=s expense and the charge for the Audits shall be Seven Hundred Fifty Dollars ($750) per person per day (or such higher amount as shall represent Coast's then current standard charge for the same), plus reasonable out-of-pocket expenses. Borrower will not enter into any agreement with any accounting firm, service bureau or third party to store Borrower's books or records at any location other than Borrower's Address, without first notifying Coast of the same and obtaining the written agreement from such accounting firm, service bureau or other third party to give Coast the same rights with respect to access to books and records and related rights as Coast has under this Loan Agreement. Borrower shall also take all necessary steps to assure that this material accounting and software, systems and applications, and those of its accounting firm, service bureau or any other third party vendor or supplier, will, on a timely basis, adequately and completely address the Year 2000 Problem in all material respects. 8.5 Negative Covenants. Borrower shall not, without Coast's prior written consent, do any of the following: (a) merge or consolidate with another entity, except in a transaction in which (i) the owners of the Borrower hold at least fifty percent (50%) of the ownership interest in the surviving entity immediately after such merger or consolidation, and (ii) the Borrower is the surviving entity; (b) acquire any assets, except (i) in the ordinary course of business, or (ii) in a transaction or a series of transactions not involving the payment of an aggregate amount in excess of the amount set forth in Section 8 of the Schedule; (c) enter into any other transaction outside the ordinary course of business; (d) sell or transfer any Collateral, except for the sale of finished Inventory in the ordinary course of Borrower's business, and except for the sale of obsolete or unneeded Equipment in the ordinary course of business; (e) store any Inventory or other Collateral with any warehouseman or other third party; (f) sell any Inventory on a sale-or-return, guaranteed sale, consignment, or other contingent basis; (g) make any loans of any money or other assets, except (i) advances to customers or suppliers in the ordinary course of business, (ii) travel advances, employee relocation loans and other employee loans and advances in the ordinary course of business, and (iii) loans to employees, officers and directors for the purpose of purchasing equity securities of the Borrower; (h) incur any debts, outside the ordinary course of business, which would have a Material Adverse Effect; (i) guarantee or otherwise become liable with respect to the obligations of another party or entity; (j) pay or declare any dividends or distributions on the ownership interests in Borrower (except for dividends or distributions payable solely in stock form of ownership interests in Borrower); (k) make any change in Borrower's capital structure which would have a Material Adverse Effect; (l) transfer or sidestream any funds to any Affiliate other than transfers between Borrowers; or (m) dissolve or elect to dissolve. Transactions permitted by the foregoing provisions of this Section are only permitted in the ordinary course of business as indicated and if no Default or Event of Default is continuing or would occur as a result of such transaction. 8.6 Litigation Cooperation. Should any third-party suit or proceeding be instituted by or against Coast with respect to any Collateral or relating to Borrower, Borrower shall, without expense to Coast, make available Borrower and its officers, employees and agents and Borrower's books and records, to the extent that Coast may deem them reasonably necessary in order to prosecute or defend any such suit or proceeding. 8.7 Further Assurances. Borrower agrees, at its expense, on request by Coast, to execute all documents and take all actions, as Coast, may deem reasonably necessary or useful in order to perfect and maintain Coast's perfected security interest in the Collateral, and in order to fully consummate the transactions contemplated by this Agreement. 90 TERM. 9.1 Maturity Date. This Agreement shall continue in effect until the Maturity Date; provided that the Maturity Date shall automatically be extended, and this Agreement shall automatically and continuously renew, for successive additional terms of one year each, unless one party gives written notice to the other, not less than one hundred twenty (120) days prior to the Maturity Date or the next Renewal Date, that such party elects to terminate this Agreement effective on the Maturity Date or such next Renewal Date. If this Agreement is renewed under this Section 9.1, Borrower shall pay to Coast a Renewal Fee in the amount shown in Section 3 of the Schedule. The Renewal Fee shall be due and payable on the Renewal Date and thereafter shall bear interest at a rate equal to the rate applicable to the Receivable Loans. 9.2 Early Termination. This Agreement may be terminated prior to the Maturity Date as follows: (a) by Borrower, effective on the last Business Day of the first full month following the calendar month in which written notice of termination is given to Coast; or (b) by Coast at any time after the occurrence of an Event of Default, without notice, effective immediately. If this Agreement is terminated by Borrower or by Coast under this Section 9.2, Borrower shall pay to Coast an Early Termination Fee in the amount shown in Section 3 of the Schedule. The Early Termination Fee shall be due and payable on the effective date of termination and thereafter shall bear interest until paid at a rate equal to the rate applicable to the Receivable Loans. 9.3 Payment of Obligations. On the Maturity Date or on any earlier effective date of termination, Borrower shall pay and perform in full all Obligations, whether evidenced by installment notes or otherwise, and whether or not all or any part of such Obligations are otherwise then due and payable. Notwithstanding any termination of this Agreement, all of Coast's security interests in all of the Collateral and all of the terms and provisions of this Agreement shall continue in full force and effect until all Obligations have been paid and performed in full; provided that, without limiting the fact that Loans are subject to the discretion of Coast, Coast may, in its sole discretion, refuse to make any further Loans after termination. No termination shall in any way affect or impair any right or remedy of Coast, nor shall any such termination relieve Borrower of any Obligation to Coast, until all of the Obligations have been paid and performed in full. Upon payment and performance in full of all the Obligations and termination of this Agreement, Coast shall promptly deliver to Borrower termination statements, requests for reconveyances and such other documents as may be required to fully terminate Coast's security interests. 100 EVENTS OF DEFAULT AND REMEDIES. 10.1 Events of Default. The occurrence of any of the following events shall constitute an "Event of Default" under this Agreement, and Borrower shall give Coast immediate written notice thereof: (a) Any warranty, representation, statement, report or certificate made or delivered to Coast by Borrower or any of Borrower's officers, employees or agents, now or in the future, shall be untrue or misleading and results in a Material Adverse Effect; or (b) Borrower shall fail to pay when due any Loan or any interest thereon or any other monetary Obligation; or (c) the total Loans and other Obligations outstanding at any time shall exceed the Credit Limit; or (d) Borrower shall fail to deliver the proceeds of Collateral to Coast as provided in Section 7.5 above, or shall fail to give Coast access to its books and records or Collateral as provided in Section 8.4 above, or shall breach any negative covenant set forth in Section 8.5 above; or (e) Borrower shall fail to comply with the financial covenants (if any) set forth in the Schedule or shall fail to perform any other non-monetary Obligation which by its nature cannot be cured; or (f) Borrower shall fail to perform any other non-monetary Obligation, which failure is not cured within ten (10) days after the date due; or (g) Any levy, assessment, attachment, seizure, lien or encumbrance (other than a Permitted Lien) is made on all or any part of the Collateral which is not cured within ten (10) days after the occurrence of the same; or (h) any default or event of default occurs under any obligation secured by a Permitted Lien that results in a Material Adverse Effect, which is not cured within any applicable cure period or waived in writing by the holder of the Permitted Lien; or (i) Borrower breaches any material contract or obligation, which has or may reasonably be expected to have a Material Adverse Effect; or (j) Dissolution, termination of existence, insolvency or business failure of Borrower or any guarantor of any of the Obligations; or appointment of a receiver, trustee or custodian, for all or any part of the property of, assignment for the benefit of creditors by, or the commencement of any proceeding by Borrower or any guarantor of any of the Obligations under any reorganization, bankruptcy, insolvency, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, now or in the future in effect; or (k) the commencement of any proceeding against Borrower or any guarantor of any of the Obligations under any reorganization, bankruptcy, insolvency, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, now or in the future in effect, which is (i) not timely controverted, or (ii) not cured by the dismissal thereof within thirty (30) days after the date commenced; or (l) revocation or termination of, or limitation or denial of liability upon, any guaranty of the Obligations or any attempt to do any of the foregoing, or commencement of proceedings by any guarantor of any of the Obligations under any bankruptcy or insolvency law; or (m) revocation or termination of, or limitation or denial of liability upon, any pledge of any certificate of deposit, securities or other property or asset of any kind pledged by any third party to secure any or all of the Obligations, or any attempt to do any of the foregoing, or commencement of proceedings by or against any such third party under any bankruptcy or insolvency law; or (n) Borrower or any guarantor of any of the Obligations makes any payment on account of any indebtedness or obligation which has been subordinated to the Obligations, other than as permitted in the applicable subordination agreement, or if any Person who has subordinated such indebtedness or obligations terminates or in any way limits his subordination agreement; or (o) Except as permitted under Section 8.5(a), Borrower shall suffer or experience any Change of Control without Coast's prior written consent, which consent shall be in the discretion of Coast in the exercise of its reasonable business judgment; or (p) Borrower shall generally not pay its debts as they become due, or Borrower shall conceal, remove or transfer any part of its property, with intent to hinder, delay or defraud its creditors, or make or suffer any transfer of any of its property which may be fraudulent under any bankruptcy, fraudulent conveyance or similar law; or (q) there shall be any Material Adverse Effect. Coast may cease making any Loans or extending any credit hereunder during any of the above cure periods. 10.2 Remedies. Upon the occurrence, and during the continuance, of any Event of Default, Coast, at its option, and without notice or demand of any kind (all of which are hereby expressly waived by Borrower), may do any one or more of the following: (a) Cease making Loans or otherwise extending credit to Borrower under this Agreement or any other document or agreement; (b) Accelerate and declare all or any part of the Obligations to be immediately due, payable and performable, notwithstanding any deferred or installment payments allowed by any instrument evidencing or relating to any Obligation; (c) Take possession of any or all of the Collateral wherever it may be found, and for that purpose Borrower hereby authorizes Coast without judicial process to enter onto any of Borrower's premises without interference to search for, take possession of, keep, store or remove any of the Collateral, and remain on the premises or cause a custodian to remain on the premises in exclusive control thereof, without charge for so long as Coast deems it reasonably necessary in order to complete the enforcement of its rights under this Agreement or any other agreement; provided, however, that should Coast seek to take possession of any of the Collateral by Court process, Borrower hereby irrevocably waives: (i) any bond and any surety or security relating thereto required by any statute, court rule or otherwise as an incident to such possession; (ii) any demand for possession prior to the commencement of any suit or action to recover possession thereof; and (iii) any requirement that Coast retain possession of, and not dispose of, any such Collateral until after trial or final judgment; (d) Require Borrower to assemble any or all of the Collateral and make it available to Coast at places designated by Coast which are reasonably convenient to Coast and Borrower, and to remove the Collateral to such locations as Coast may reasonably deem advisable; (e) Complete the processing, manufacturing or repair of any Collateral prior to a disposition thereof and, for such purpose and for the purpose of removal, Coast shall have the right to use Borrower's premises, vehicles, hoists, lifts, cranes, equipment and all other property without charge. Coast is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to Coast's benefit; (f) Sell, lease or otherwise dispose of any of the Collateral, in its condition at the time Coast obtains possession of it or after further manufacturing, processing or repair, at one or more public and/or private sales, in lots or in bulk, for cash, exchange or other property, or on credit, and to adjourn any such sale from time to time without notice other than oral announcement at the time scheduled for sale. Coast shall have the right to conduct such disposition on Borrower's premises without charge, for such time or times as Coast deems reasonable, or on Coast's premises, or elsewhere and the Collateral need not be located at the place of disposition. Coast may directly or through any affiliated company purchase or lease any Collateral at any such public disposition, and if permissible under applicable law, at any private disposition. Any sale or other disposition of Collateral shall not relieve Borrower of any liability Borrower may have if any Collateral is defective as to title or physical condition or otherwise at the time of sale; (g) Demand payment of, and collect any Receivables and General Intangibles comprising Collateral and, in connection therewith, Borrower irrevocably authorizes Coast to endorse or sign Borrower's name on all collections, receipts, instruments and other documents, to take possession of and open mail addressed to Borrower and remove therefrom payments made with respect to any item of the Collateral or proceeds thereof, and, in Coast's reasonable discretion, to grant extensions of time to pay, compromise claims and settle Receivables and the like for less than face value; and (h) Demand and receive possession of any of Borrower's federal and state income tax returns and the books and records utilized in the preparation thereof or referring thereto. All attorneys' fees, expenses, costs, liabilities and obligations incurred by Coast (including attorneys' fees and expenses incurred in connection with bankruptcy) with respect to the foregoing shall be due from the Borrower to Coast on demand. Coast may charge the same to Borrower=s loan account, and the same shall thereafter bear interest at the same rate as is applicable to the Receivable Loans. Without limiting any of Coast's rights and remedies, from and after the occurrence of any Event of Default, the interest rate applicable to the Obligations shall be increased by an additional three percent per annum. 10.3 Standards for Determining Commercial Reasonableness. Borrower and Coast agree that a sale or other disposition (collectively, Asale@) of any Collateral which complies with the following standards will conclusively be deemed to be commercially reasonable: (a) Notice of the sale is given to Borrower at least seven (7) days prior to the sale, and, in the case of a public sale, notice of the sale is published at least seven (7) days before the sale in a newspaper of general circulation in the county where the sale is to be conducted; (b) Notice of the sale describes the collateral in general, non-specific terms; (c) The sale is conducted at a place designated by Coast, with or without the Collateral being present; (d) The sale commences at any time between 8:00 a.m. and 6:00 p.m Los Angeles, California time; (e) Payment of the purchase price in cash or by cashier=s check or wire transfer is required; and (f) With respect to any sale of any of the Collateral, Coast may (but is not obligated to) direct any prospective purchaser to ascertain directly from Borrower any and all information concerning the same. Coast shall be free to employ other methods of noticing and selling the Collateral, in its discretion, if they are commercially reasonable. 10.4 Power of Attorney. Borrower grants to Coast an irrevocable power of attorney coupled with an interest, authorizing and permitting Coast (acting through any of its employees, attorneys or agents) at any time, at its option, but without obligation, with or without notice to Borrower, and at Borrower's expense, to do any or all of the following, in Borrower's name or otherwise, but Coast agrees to exercise the following powers in a commercially reasonable manner: (a) Execute on behalf of Borrower any documents that Coast may, in its sole discretion, deem advisable in order to perfect and maintain Coast's security interest in the Collateral, or in order to exercise a right of Borrower or Coast, or in order to fully consummate all the transactions contemplated under this Agreement, and all other present and future agreements relating to the Obligations; (b) After the occurrence of an Event of Default, execute on behalf of Borrower any document exercising, transferring or assigning any option to purchase, sell or otherwise dispose of or to lease (as lessor or lessee) any real or personal property which is part of Coast's Collateral or in which Coast has an interest; (c) After the occurrence of an Event of Default, execute on behalf of Borrower, any invoices relating to any Receivable, any draft against any Account Debtor and any notice to any Account Debtor, any proof of claim in bankruptcy, any Notice of Lien, claim of mechanic's, materialman's or other lien, or assignment or satisfaction of mechanic's, materialman's or other lien; (d) Take control in any manner of any cash or non-cash items of payment or proceeds of Collateral; endorse the name of Borrower upon any instruments, or documents, evidence of payment or Collateral that may come into Coast's possession; (e) Endorse all checks and other forms of remittances received by Coast; (f) After the occurrence of an Event of Default, pay, contest or settle any lien, charge, encumbrance, security interest and adverse claim in or to any of the Collateral, or any judgment based thereon, or otherwise take any action to terminate or discharge the same; (g After the occurrence of an Event of Default, grant extensions of time to pay, compromise claims and settle Receivables and General Intangibles for less than face value and execute all releases and other documents in connection therewith; (h After the occurrence of an Event of Default, pay any sums required on account of Borrower's taxes or to secure the release of any liens therefor, or both; (i After the occurrence of an Event of Default, settle and adjust, and give releases of, any insurance claim that relates to any of the Collateral and obtain payment therefor; (j Instruct any third party having custody or control of any books or records belonging to, or relating to, Borrower to give Coast the same rights of access and other rights with respect thereto as Coast has under this Agreement; and (k After the occurrence of an Event of Default, take any action or pay any sum required of Borrower pursuant to this Agreement and any other present or future agreements. Any and all sums paid and any and all costs, expenses, liabilities, obligations and attorneys' fees incurred by Coast (including attorneys' fees and expenses incurred pursuant to bankruptcy) with respect to the foregoing shall be added to and become part of the Obligations, and shall be payable on demand. Coast may charge the foregoing to Borrower=s loan account and the foregoing shall thereafter bear interest at the same rate applicable to the Receivable Loans. In no event shall Coast's rights under the foregoing power of attorney or any of Coast's other rights under this Agreement be deemed to indicate that Coast is in control of the business, management or properties of Borrower. Borrower shall pay, indemnify, defend, and hold Coast and each of its officers, directors, employees, counsel, agents, and attorneys-in-fact (each, an "Indemnified Person") harmless (to the fullest extent permitted by law) from and against any and all claims, demands, suits, actions, investigations, proceedings, and damages, and all attorneys fees and disbursements and other costs and expenses actually incurred in connection therewith (as and when they are incurred and irrespective of whether suit is brought), at any time asserted against, imposed upon, or incurred by any of them in connection with or as a result of or related to the execution, delivery, enforcement, performance, and administration of this Agreement and any other Loan Documents or the transactions contemplated herein, and with respect to any investigation, litigation, or proceeding related to this Agreement, any other Loan Document, or the use of the proceeds of the credit provided hereunder (irrespective of whether any Indemnified Person is a party thereto), or any act, omission, event or circumstance in any manner related thereto (all the foregoing, collectively, the "Indemnified Liabilities"). Borrower shall have no obligation to any Indemnified Person hereunder with respect to any Indemnified Liability resulting from the gross negligence or willful misconduct of any Indemnified Person or any contractor of any Indemnified Person. This provision shall survive the termination of this Agreement and the repayment of the Obligations. 10.5 Application of Proceeds. All proceeds realized as the result of any sale of the Collateral shall be applied by Coast first to the costs, expenses, liabilities, obligations and attorneys' fees incurred by Coast in the exercise of its rights under this Agreement, second to the interest due upon any of the Obligations, and third to the principal of the Obligations, in such order as Coast shall determine in its sole discretion. Any surplus shall be paid to Borrower or other persons legally entitled thereto; Borrower shall remain liable to Coast for any deficiency. If, Coast, in its sole discretion, directly or indirectly enters into a deferred payment or other credit transaction with any purchaser at any sale of Collateral, Coast shall have the option, exercisable at any time, in its sole discretion, of either reducing the Obligations by the principal amount of purchase price or deferring the reduction of the Obligations until the actual receipt by Coast of the cash therefor. 10.6 Remedies Cumulative. In addition to the rights and remedies set forth in this Agreement, Coast shall have all the other rights and remedies accorded a secured party in equity, under the Code, and under all other applicable laws, and under any other instrument or agreement now or in the future entered into between Coast and Borrower, and all of such rights and remedies are cumulative and none is exclusive. Exercise or partial exercise by Coast of one or more of its rights or remedies shall not be deemed an election, nor bar Coast from subsequent exercise or partial exercise of any other rights or remedies. The failure or delay of Coast to exercise any rights or remedies shall not operate as a waiver thereof, but all rights and remedies shall continue in full force and effect until all of the Obligations have been indefeasibly paid and performed. 11. GENERAL PROVISIONS. 11.1 Interest Computation. In computing interest on the Obligations, all checks, wire transfers and other items of payment received by Coast (including proceeds of Receivables and payment of the Obligations in full) shall be deemed applied by Coast on account of the Obligations two (2) Business Days after receipt by Coast of immediately available funds, and, for purposes of the foregoing, any such funds received after 10:30 AM Los Angeles, California time, on any day shall be deemed received on the next Business Day. Coast shall be entitled to charge Borrower's account for such two (2) Business Days of "clearance" or "float" at the rate(s) set forth in Section 3 of the Schedule on all checks, wire transfers and other items received by Coast, regardless of whether such two (2) Business Days of "clearance" or "float" actually occur, and shall be deemed to be the equivalent of charging two (2) Business Days of interest on such collections. This across-the-board two (2) Business Day clearance or float charge on all collections is acknowledged by the parties to constitute an integral aspect of the pricing of Coast's financing of Borrower. Coast shall not, however, be required to credit Borrower's account for the amount of any item of payment which is unsatisfactory to Coast in its reasonable credit judgment, and Coast may charge Borrower's loan account for the amount of any item of payment which is returned to Coast unpaid only if Coast previously shall have applied such item of payment. 11.2 Application of Payments. Subject to Section 7.5 hereof, all payments with respect to the Obligations may be applied, and in Coast's sole discretion reversed and re-applied, to the Obligations, in such order and manner as Coast shall determine in its sole discretion. 11.3 Charges to Accounts. Coast may, in its discretion, require that Borrower pay monetary Obligations in cash to Coast, or charge them to Borrower=s Loan account, in which event they will bear interest from the date due to the date paid at the same rate applicable to the Loans. 11.4 Monthly Accountings. Coast shall provide Borrower monthly with an account of advances, charges, expenses and payments made pursuant to this Agreement. Such account shall be deemed correct, accurate and binding on Borrower and an account stated (except for reverses and reapplications of payments made and corrections of errors discovered by Coast), unless Borrower notifies Coast in writing to the contrary within thirty (30) days after each account is rendered, describing the nature of any alleged errors or omissions. 11.5 Notices. All notices to be given under this Agreement shall be in writing and shall be given either personally or by reputable private delivery service or by regular first-class mail, facsimile or certified mail return receipt requested, addressed to Coast or Borrower at the addresses shown in the heading to this Agreement, or at any other address designated in writing by one party to the other party. Notices to Coast shall be directed to the Commercial Finance Division, to the attention of the Division Manager or the Division Credit Manager. All notices shall be deemed to have been given upon delivery in the case of notices personally delivered, faxed (at time of confirmation of transmission), or at the expiration of one (1) Business Day following delivery to the private delivery service, or two (2) Business Days following the deposit thereof in the United States mail, with postage prepaid. 11.6 Severability. Should any provision of this Agreement be held by any court of competent jurisdiction to be void or unenforceable, such defect shall not affect the remainder of this Agreement, which shall continue in full force and effect. 11.7 Integration. This Agreement and such other written agreements, documents and instruments as may be executed in connection herewith are the final, entire and complete agreement between Borrower and Coast and supersede all prior and contemporaneous negotiations and oral representations and agreements, all of which are merged and integrated in this Agreement. There are no oral understandings, representations or agreements between the parties which are not set forth in this Agreement or in other written agreements signed by the parties in connection herewith. 11.8 Waivers. The failure of Coast at any time or times to require Borrower to strictly comply with any of the provisions of this Agreement or any other present or future agreement between Borrower and Coast shall not waive or diminish any right of Coast later to demand and receive strict compliance therewith. Any waiver of any Default shall not waive or affect any other Default, whether prior or subsequent, and whether or not similar. None of the provisions of this Agreement or any other agreement now or in the future executed by Borrower and delivered to Coast shall be deemed to have been waived by any act or knowledge of Coast or its agents or employees, but only by a specific written waiver signed by an authorized officer of Coast and delivered to Borrower. Borrower waives demand, protest, notice of protest and notice of default or dishonor, notice of payment and nonpayment, release, compromise, settlement, extension or renewal of any commercial paper, instrument, account, General Intangible, document or guaranty at any time held by Coast on which Borrower is or may in any way be liable, and notice of any action taken by Coast, unless expressly required by this Agreement. 11.9 No Liability for Ordinary Negligence. Neither Coast, nor any of its directors, officers, employees, agents, attorneys or any other Person affiliated with or representing Coast shall be liable for any claims, demands, losses or damages, of any kind whatsoever, made, claimed, incurred or suffered by Borrower or any other party through the ordinary negligence of Coast, or any of its directors, officers, employees, agents, attorneys or any other Person affiliated with or representing Coast, but nothing herein shall relieve Coast from liability for the gross negligence or willful misconduct of Coast or its directors, officers, employees, agents or contractors. 11.10 Amendment. The terms and provisions of this Agreement may not be waived or amended, except in a writing executed by a duly authorized officer of Borrower and a duly authorized officer of Coast. 11.11 Time of Essence. Time is of the essence in the performance by Borrower of each and every obligation under this Agreement. 11.12 Attorneys Fees, Costs and Charges. Borrower shall reimburse Coast for all attorneys' fees (including attorneys' fees and expenses incurred pursuant to bankruptcy) and all filing, recording, search, title insurance, appraisal, audit, and other costs incurred by Coast, pursuant to, or in connection with, or relating to this Agreement (whether or not a lawsuit is filed), including, but not limited to, any attorneys' fees and costs (including attorneys' fees and expenses incurred pursuant to bankruptcy) Coast incurs in order to do the following: prepare and negotiate this Agreement and the documents relating to this Agreement; obtain legal advice in connection with this Agreement or Borrower; enforce, or seek to enforce, any of its rights; prosecute actions against, or defend actions by, Account Debtors; commence, intervene in, or defend any action or proceeding; initiate any complaint to be relieved of the automatic stay in bankruptcy; file or prosecute any probate claim, bankruptcy claim, third-party claim, or other claim; examine, audit, copy, and inspect any of the Collateral or any of Borrower's books and records; protect, obtain possession of, lease, dispose of, or otherwise enforce Coast=s security interest in, the Collateral; and otherwise represent Coast in any litigation relating to Borrower. If either Coast or Borrower files any lawsuit against the other predicated on a breach of this Agreement, the prevailing party in such action shall be entitled to recover its costs and attorneys' fees (including attorneys' fees and expenses incurred pursuant to bankruptcy), including (but not limited to) attorneys' fees and costs incurred in the enforcement of, execution upon or defense of any order, decree, award or judgment. Borrower shall also pay Coast=s standard charges for returned checks and for wire transfers, in effect from time to time. All attorneys' fees, costs and charges (including attorneys' fees and expenses incurred pursuant to bankruptcy) and other fees, costs and charges to which Coast may be entitled pursuant to this Agreement may be charged by Coast to Borrower=s loan account and shall thereafter bear interest at the same rate as the Receivable Loans. 11.13 Benefit of Agreement. The provisions of this Agreement shall be binding upon and inure to the benefit of the respective successors, assigns, heirs, beneficiaries and representatives of Borrower and Coast; provided, however, that Borrower may not assign or transfer any of its rights under this Agreement without the prior written consent of Coast, and any prohibited assignment shall be void. No consent by Coast to any assignment shall release Borrower from its liability for the Obligations. Coast may assign its rights and delegate its duties hereunder without the consent of Borrower and, so long as Coast remains the Agent under this Agreement, Coast may assign and delegate its duties hereunder without notice to Borrower. Coast reserves the right to syndicate all or a portion of the transaction created herein or sell, assign, transfer, negotiate, or grant participations in all or any part of, or any interest in Coast's rights and benefits hereunder. In connection with any such syndication, assignment or participation, Coast may, subject to the confidentiality provisions of Section 11.18 disclose all documents and information which Coast now or hereafter may have relating to Borrower or Borrower's business. To the extent that Coast assigns its rights and obligations hereunder to a third Person, Coast thereafter shall be released from such assigned obligations to Borrower to the extent arising after the date of the assignment, provided that the third Person assumes Coast's obligations hereunder. 11.14 Publicity. Coast is hereby authorized, at its expense, to issue appropriate press releases and to cause a tombstone to be published announcing the consummation of this transaction and the aggregate amount thereof. 11.15 Paragraph Headings; Construction. Paragraph headings are only used in this Agreement for convenience. Borrower and Coast acknowledge that the headings may not describe completely the subject matter of the applicable paragraph, and the headings shall not be used in any manner to construe, limit, define or interpret any term or provision of this Agreement. The term Aincluding@, whenever used in this Agreement, shall mean Aincluding (but not limited to)@. This Agreement has been fully reviewed and negotiated between the parties and no uncertainty or ambiguity in any term or provision of this Agreement shall be construed strictly against Coast or Borrower under any rule of construction or otherwise. 11.16 Governing Law; Jurisdiction; Venue. This Agreement and all acts and transactions hereunder and all rights and obligations of Coast and Borrower shall be governed by the internal laws of the State of California, without regard to its conflicts of law principles. As a material part of the consideration to Coast to enter into this Agreement, Borrower (a) agrees that all actions and proceedings relating directly or indirectly to this Agreement shall, at Coast's option, be litigated in courts located within California, and that the exclusive venue therefor shall be Los Angeles County; (b) consents to the jurisdiction and venue of any such court and consents to service of process in any such action or proceeding by personal delivery or any other method permitted by law; and (c) waives any and all rights Borrower may have to object to the jurisdiction of any such court, or to transfer or change the venue of any such action or proceeding. 11.17 Mutual Waiver of Jury Trial. BORROWER AND COAST EACH HEREBY WAIVE THE RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED UPON, ARISING OUT OF, OR IN ANY WAY RELATING TO, THIS AGREEMENT OR ANY OTHER PRESENT OR FUTURE INSTRUMENT OR AGREEMENT BETWEEN COAST AND BORROWER, OR ANY CONDUCT, ACTS OR OMISSIONS OF COAST OR BORROWER OR ANY OF THEIR DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, ATTORNEYS OR ANY OTHER PERSONS AFFILIATED WITH COAST OR BORROWER, IN ALL OF THE FOREGOING CASES, WHETHER SOUNDING IN CONTRACT OR TORT OR OTHERWISE. 11.18 Confidentiality. Coast will maintain the confidentiality of any non public information marked as confidential and relating to the business operations and methodology of Borrower and financial performance of Borrower ("Borrower Information") provided to Coast solely by the Borrower as required under the terms of this Agreement, and will not disclose Borrower Information to any person, other than employees, agents, attorneys or accountants of Coast. Coast will not disclose Borrower information to any other party unless, prior to such disclosure, Coast obtains an executed acknowledgment binding such party to maintain the confidentiality of the information, prohibiting its disclosure except for the purposes permitted under this Agreement, and agreeing that the information may not be used to compete with the Borrower in any way. In the event Coast receives a subpoena or other process for any Borrower Information, it will immediately give notice in writing of the subpoena or other process, including a copy thereof, to Borrower. BORROWER: AVTEL COMMUNICATIONS, INC., a Delaware corporation By --------------------------------- President or Vice President By --------------------------------- Secretary or Ass't Secretary MATRIX TELECOM, INC., a Texas corporation By --------------------------------- President or Vice President By --------------------------------- Secretary or Ass't Secretary COAST: COAST BUSINESS CREDIT, a division of Southern Pacific Bank By ------------------------------- Title: ------------------------------- Coast SCHEDULE TO LOAN AND SECURITY AGREEMENT Borrower: AVTEL COMMUNICATIONS, INC., a Delaware corporation Address: 501 Bath Street Santa Barbara, California 93101 Borrower: MATRIX TELECOM, INC., a Texas corporation Address: 8721 Airport Freeway Fort Worth, Texas 76180 Date: October 2, 1998 This Schedule forms an integral part of the Loan and Security Agreement between Coast Business Credit, a division of Southern Pacific Bank, and the above-borrower of even date. SECTION 2 - CREDIT FACILITIES Section 2.1 - Credit Limit: Loans in a total amount at any time outstanding not to exceed the lesser of a total of Seven Million Five Hundred Thousand Dollars ($7,500,000) at any one time outstanding (the AMaximum Dollar Amount@), or the sum of (a), (b) and (c) below: (a) Receivable Loans in an amount not to exceed 75% of the amount of Borrower=s Eligible Receivables (as defined in Section 1 of the Agreement), however, if the Dilution Percentage on the Billed Eligible Receivables and Unbilled Eligible Receivables is less than 5%, this advance rate will be increased to 85%, plus When Borrower attains a consolidated positive EBITDA, Borrower may convert the structure for obtaining Receivable Loans to the following: Advances up to three (3) times recurring monthly collections received by Coast measured on a trailing three-month moving average provided, however that the advances may not exceed either: (a) Eighty percent (80%) of the orderly liquidation value of Borrower's subscriber base, as determined by yearly appraisals (or, if an Event of Default exists, as frequently as required by Coast), to be conducted by an appraiser acceptable to Coast in its sole and absolute discretion; or (b) Four (4) times annualized trailing EBITDA based on a rolling six (6) months. (b) Equipment Acquisition Loans, to be drawn within eighteen (18) month(s) from the date hereof, in minimum advances of One Hundred Thousand Dollars ($100,000), commencing on the day such advance is made by Coast, and amortized pursuant to a thirty-six (36) month monthly amortization of principal plus interest, in a total amount not to exceed the lesser of: (1) Eighty percent (80%) of the cost of new Equipment (after subtracting taxes and installation charges) excluding furniture, fixtures, and computer equipment; and (2) Seven Hundred and Fifty Thousand Dollars ($750,000), plus Drawsunder this facility are subject to Borrower's attaining of EBIT/interest ratio equal to or greater than 1.25 measured on a quarterly rolling basis. (b) Coast may fund, subject to the Maximum Dollar Amount, Acquisitions from time to time, so long as an Event of Default will not result from the consummation of the proposed acquisition and so long as the assets being acquired, or the Corporation whose capital stock is being acquired, have reasonable business synergies with Borrower's business activities. Coast's decision to fund Acquisitions will be at Coast's sole and absolute discretion and will be subject to the completion of Coast's due diligence into the company to be acquired with the due diligence review to be acceptable to Coast in its sole and absolute discretion. Coast agrees that it will act in a reasonably prompt manner in deciding whether to fund Acquisitions; Section 2.2 - Letter of Credit Sublimit: One Million Dollars ($1,000,000) for Standby Letters of Credit. SECTION 3 - INTEREST AND FEES Section 3.1 - Interest Rate: A rate equal to the Prime Rate plus 2% per annum, calculated on the basis of a 360-day year for the actual number of days elapsed. The interest rate applicable to all Loans shall be adjusted monthly as of the first day of each month, and the interest to be charged for each month shall be based on the highest Prime Rate in effect during the prior month, but in no event shall the rate of interest charged on any Loans in any month be less than 9% per annum. Section 3.1 - Minimum Monthly Interest: The product of 20% of the Maximum Dollar Amount and the Interest Rate enumerated in Section 3.1 of the Schedule for the actual days in the month on the basis of a 360-day year. Section 3.2 - Loan Fee: One percent (1.0%) of the Maximum Dollar Amount, such amount being fully earned on the Closing Date, and payable: (1) one-half of one percent (.5%) on the Closing Date, with said one-half of one percent to apportioned by payment to Coast of .433% and payment to an intermediary of .067%, and (2) one-half of one percent (.5%) payable to Coast on the first anniversary of the Closing Date. Section 3.2 - Facility Fee: $1,500, per quarter, payable on the Closing Date (prorated for any partial quarter at the beginning of the term of this Agreement). Section 3.2 - Letter of Credit Fees: Two percent (2%) guarantee fee for all outstanding Letters of Credit per calendar month, plus bank charges and fees. Section 9.1 - Renewal Fee: .50% of the Maximum Dollar Amount per year. Section 9.2 - Early TerminationAn amount equal to two percent (2%) of the Maximum Dollar Fee: Amount (as defined in the Schedule), if termination occurs on or before the first anniversary of the effective date of this Agreement; and one percent (1%) of the Maximum Dollar Amount, if termination occurs after the first anniversary and before the Maturity Date. Notwithstanding the foregoing, if there is a public debt or equity funding that results in the Obligations being repaid in full, then the Early Termination Fee will be an amount equal to two percent (2%) of the Maximum Dollar Amount (as defined in the Schedule), if termination occurs during the first eleven (11) months immediately following the effective date of this Agreement; one percent (1%) if termination occurs during months twelve (12) through twenty-three (23); and there will be no early termination fee if termination occurs thereafter. SECTION 5 - CONDITIONS PRECEDENT Section 5.2 - Minimum Availability: $4,000,000 Section 5.13 - Other Documents and Agreements: 1. Joint and Several Borrower Rider; 2. UCC-1 financing statements, fixture filings and termination statements; 3. Intellectual Property Security Agreement; 4. Tri-Party Agreements with local exchange carriers and billing services; 5. Landlord Waivers; and 6. Lockbox Agreements. SECTION 6 - REPRESENTATIONS, WARRANTIES AND COVENANTS Section 6.2 - Prior Names of Borrower: None. Section 6.2 - Prior Trade Names of Borrower: None. Section 6.2 - Existing Trade Names of Borrower: AvTel AvTel Communications Matrix Matrix Telecom Section 6.3 - Other Locations and Addresses: Borrower - AvTel Communications, Inc. 23046 Avenida de la Carlota, Suite 600, Laguna Hills, CA 92653 350 W. Broadway, Suite 111, Salt Lake City, UT 84101 901 S. Orem Blvd., Orem, UT 84058 Borrower - Matrix Telecom, Inc. None. Section 6.10 - Material Adverse Litigation: Matrix Telecom, Inc. ("MTI") received a letter dated August 20, 1998 from O'Donnell, Ramis, Crew, Corrigan & Bacharach, LLP ("ORCCB"), as counsel to Matrix Communications Corporation ("MCC") which is located in Milwaukie, Oregon, alleging that Matrix's use of the name "MATRIX" or "MATRIX TELECOM" infringes on MCC's rights to the service mark "MATRIX COMMUNICATIONS." The ORCCB letter indicated that MCC had used the mark in Oregon and Southwest Washington since January 24, 1994 and the mark was registered by MCC in Oregon on June 23, 1993. Seed, Mackall & Cole ("SMC"), as counsel to MTI, responded to MCC's claim in SMC's September 3, 1998 letter to ORCCB. In SMC's letter, SMC advised MCC of the following: 1. MTI registered the service mark "MATRIX TELECOM" on the Principal Register of the United States Patent and Trademark Office on August 1, 1995. 2. MTI qualified to transact business in Oregon as a foreign corporation on February 24, 1992, and has been engaged in business in Oregon since at least that date. 3. MTI's predecessor entity, Matrix Telecom, a Texas partnership, has provided telecommunications services in Oregon since at least March 27, 1991. 4. MTI qualified to transact business as a foreign corporation in Washington on June 3, 1994 and has been engaged in providing telecommunications services in Washington since at least that date. As a result of the above, MTI believes that its rights to the mark are superior to the rights of MCC. SMC's letter to ORCCB demands that MCC immediately cease and desist further use of the mark and provide to SMC written assurance that MCC has complied with this demand no later than September 10, 1998. As of September 9, 1998, neither SMC nor MTI has received a response from ORCCB or MCC. MTI makes no representations or warranties about the outcome of the above claim. Section 6.10 - Future Claims and Litigation: Borrower will promptly inform Coast in writing of any claim, proceeding, litigation or investigation in the future threatened or instituted by or against Borrower involving any single claim of Fifty Thousand Dollars ($50,000) or more, or involving One Hundred Thousand Dollars ($100,000) or more in the aggregate. SECTION 8 - ADDITIONAL DUTIES OF BORROWER Section 8.1 - Other Provisions: 1. Borrower shall at all times maintain a minimum Net Worth equal to or greater than Two Million Dollars ($2,000,000). 2. Borrower shall at all times maintain a Minimum Availability equal to or greater than One Million Dollars ($1,000,000) until a positive EBITDA has been achieved for three consecutive months and until the ratio of EBIT/interest is equal to or greater than 1.25. 3. Each carrier accounts payable of Borrower shall be kept current during the term of this Agreement. Section 8.2 - Insurance: Subject to the limitations set forth in Section 8.2 of the Agreement, Coast shall release to Borrower insurance proceeds with respect to Equipment totaling less than One Hundred Thousand Dollars ($100,000) in a single transaction subject to a yearly limitation of Two Hundred and Fifty Thousand Dollars ($250,000). Section 8.3 - Reporting: Borrower shall provide Coast with the following: 1. Monthly Receivable agings, aged by invoice date, within ten (10) days after the end of each month. 2. Monthly accounts payable agings, aged by invoice date, and outstanding or held check registers within ten (10) days after the end of each month. 3. Monthly internally prepared financial statements, on a consolidating to consolidated basis, as soon as available, and in any event within thirty (30) days after the end of each month. 4. Quarterly internally prepared financial statements, as soon as available, and in any event within forty-five (45) days after the end of each fiscal quarter of Borrower. 5. Quarterly customer lists, including customer name, address, and phone number. 6. Annual financial statements, as soon as available, and in any event within ninety (90) days following the end of Borrower's fiscal year, containing the unqualified opinion of, and certified by, (a) an independent certified public accountant from a "Big Six" accounting firm or (b) an independent certified public accountant reasonably acceptable to Coast. 7. Monthly collateral/reserves roll forward with General Ledger reconciliation, in form and substance satisfactory to Coast, within ten (10) days after the end of each month. 8. Reports for Unbilled Receivables as frequently as Coast shall require, in form and substance satisfactory to Coast. 9. Monthly Atlantax, Inc. tax payment report, in form and substance satisfactory to Coast, within ten (10) days after the end of each month. 10. Annual projections, on a month-to-month basis, in form and substance satisfactory to Coast, are to be provided to Coast before each anniversary date of the effective date of this Agreement. 11. Weekly Borrowing Base reporting which includes sales, collections and credits, in form and substance satisfactory to Coast, within three (3) business days after the end of each week. Section 8.5 - Negative Covenants (Acquired Assets): Seven Hundred and Fifty Thousand Dollars ($750,000) in the aggregate for all acquisitions during a calendar year, or a proportionate amount for a partial year, but in no event will any single acquisition amount to over One Hundred Thousand Dollars ($100,000). SECTION 9 - TERM Section 9.1 - Maturity Date: The last Business Day of the month two (2) years from the Closing Date, subject to automatic renewal as provided in Section 9.1 of the Agreement, and early termination as provided in Section 9.2 of the Agreement. EX-27 4 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF SEPTEMBER 30, 1998 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS FOR THE NINE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 9-MOS DEC-31-1998 SEP-30-1998 2520 0 5560 0 0 9863 1564 0 12897 8592 0 1 0 116 3734 12897 34329 34329 24897 24897 14489 0 36 (4994) 0 0 0 0 0 (4994) (0.53) (0.53)
EX-27 5 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF SEPTEMBER 30, 1997 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH FLOWS FOR THE NINE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 9-MOS DEC-31-1997 SEP-30-1997 5188 0 7853 0 0 17634 1316 0 19085 10449 0 0 0 92 7965 19085 39244 39244 27304 27304 12138 0 9 12 (5) 0 0 0 0 7 (0.01) (0.01)
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