-----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, QmHbMhr9fjghzQapC1Uiap7MXENH8w/atL1DrPnGII9JYApwsoRa+4Pze1ZUT0yu zdi9/0KnhGrGXPEHSlEGKg== 0001047469-99-021046.txt : 19990518 0001047469-99-021046.hdr.sgml : 19990518 ACCESSION NUMBER: 0001047469-99-021046 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 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: 99626623 BUSINESS ADDRESS: STREET 1: 501 BATH STREET CITY: SANTA BARBARA STATE: CA ZIP: 93101 BUSINESS PHONE: 8058846300 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 10-Q 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 MARCH 31, 1999 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 May 4, 1999, there were 10,542,997 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 MARCH 31, 1999 TABLE OF CONTENTS
PAGE ---- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 1999 (Unaudited) and December 31, 1998 3 Consolidated Statements of Operations for the Three Month Periods Ended March 31, 1999 and 1998 (Unaudited) 4 Consolidated Statements of Cash Flows for the Three Month Periods Ended March 31, 1999 and 1998 (Unaudited) 5 Notes to Consolidated Financial Statements (Unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 2. Changes in Securities and Use of Proceeds 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
March 31, December 31, 1999 1998 (Unaudited) ------------ ------------ ASSETS CURRENT ASSETS Cash and cash equivalents $ 588,759 911,179 Accounts receivable, net 4,335,567 4,804,532 Due from affiliates 168,797 501,858 Other current assets 643,721 921,435 ------------ ------------ Total current assets 5,736,844 7,139,004 Property and equipment, net 1,673,604 1,684,707 Goodwill, net 4,359,945 4,463,747 Other assets, net 1,253,197 1,346,896 ------------ ------------ Total assets $ 13,023,590 14,634,354 ------------ ------------ ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and other accrued expenses $ 2,857,041 2,643,761 Accrued network services costs 4,294,598 4,217,206 Sales and excise tax payable 1,475,506 1,433,483 Unearned revenue 867,948 954,101 Due to affiliates 193,368 324,020 Other current liabilities 653,091 589,392 ------------ ------------ Total current liabilities 10,341,552 10,161,963 Long term borrowings 2,188,458 1,112,890 Common stock subject to put option 168,867 168,867 Other liabilities 3,196 5,381 ------------ ------------ Total liabilities 12,702,073 11,449,101 ------------ ------------ STOCKHOLDERS' EQUITY Preferred stock, authorized 750,000 shares, $0.01 par value -- -- Series A convertible preferred stock, aurthorized 250,000 shares, $0.01 par value, cumulative as to 8% dividends, 147,700 shares issued and outstanding. (Liquidation preference of $704,032 including dividends in arrears.) 1,477 1,477 Common stock, authorized 20,000,000 shares, $0.01 par value, issued 10,565,335 and 10,409,473 shares at March 31, 1999 and December 31, 1998 respectively, including 112,578 shares subject to put options 104,527 102,969 Additional paid in capital 19,854,984 19,630,404 Accumulated deficit (19,639,360) (16,549,597) Treasury stock, $0.01 par value, 11,075 at March 31, 1999 and none at December 31, 1998 (111) -- ------------ ------------ Total stockholders' equity 321,517 3,185,253 Commitments and contingencies -- -- ------------ ------------ Total liabilities and stockholders' equity $ 13,023,590 14,634,354 ------------ ------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements. 3 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended March 31, --------------------------------- 1999 1998 ------------ ------------ REVENUES $ 9,322,414 12,444,839 COST OF REVENUES 6,620,713 9,287,995 ------------ ------------ GROSS MARGIN 2,701,701 3,156,844 Operating expenses Selling, general and administrative 5,289,312 4,582,446 Depreciation and amortization 394,579 278,868 ------------ ------------ Total operating expenses 5,683,891 4,861,314 ------------ ------------ OPERATING LOSS (2,982,190) (1,704,470) Interest expense (99,144) (11,975) Other income, net 15,203 43,955 ------------ ------------ Loss before income taxes (3,066,131) (1,672,490) Income taxes -- -- ------------ ------------ NET LOSS $ (3,066,131) (1,672,490) ------------ ------------ ------------ ------------ Net loss per share - basic and diluted $ (0.29) (0.18) ------------ ------------ ------------ ------------ Weighted average number of common shares - basic and diluted 10,482,416 9,477,489 ------------ ------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements. 4 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended March 31, ------------------------------- 1999 1998 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(3,066,131) (1,672,490) Adjustments to reconcile net loss to net to net cash used in operating activities: Depreciation and amortization 394,579 278,868 Loss on disposition of assets 14,562 -- Amortization of advanced commissions -- 173,919 Provision for bad debts 475,422 749,725 Stock compensation earned 81,356 234,098 Changes in certain operating assets and liabilities: Accounts receivable (6,457) (1,210,854) Due from affiliates 333,061 223,966 Other current assets 277,714 (321,100) Accounts payable and accrued liabilities 318,948 214,681 Due to affiliate (130,652) 176,617 ----------- ----------- Net cash used in operating activities (1,307,598) (1,152,570) CASH FLOWS FROM INVESTING ACTIVITIES: Additions of property and equipment (201,587) (88,431) Payments received on loans to affiliates -- 410,192 Proceeds from sale of property and equipment 1,050 -- ----------- ----------- Net cash provided by (used in) investing activities (200,537) 321,761 CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on capital leases (10,892) (12,142) Issuance of common stock for exercise of options 222,071 30,455 Preferred stock dividend payments (23,632) -- Borrowing on line of credit 9,716,886 -- Amounts paid on line of credit (8,641,318) -- Purchase of common stock for treasury (77,400) -- ----------- ----------- Net cash provided by financing activities 1,185,715 18,313 ----------- ----------- Net decrease in cash and cash equivalents (322,420) (812,496) Cash and cash equivalents at beginning of quarter 911,179 4,807,441 ----------- ----------- Cash and cash equivalents at end of quarter $ 588,759 3,994,945 ----------- ----------- ----------- -----------
See accompanying Notes to Consolidated Financial Statements. 5 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) March 31, 1999 and 1998 (1) BASIS OF PRESENTATION The unaudited consolidated financial statements of AvTel Communications, Inc. and Subsidiaries (the "Company") for the three month periods ended March 31, 1999 and 1998 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, 1998. 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 the entire 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.
March 31, 1999 1998 ------------ ------------ Numerator: Net loss $ (3,066,131) (1,672,490) Less preferred dividends 11,816 11,816 ------------ ------------ Loss applicable to common Shareholders $ (3,077,947) (1,684,306) ------------ ------------ ------------ ------------ Denominator: Weighted average number of common shares used in basic and diluted loss per common share 10,482,416 9,477,489 ------------ ------------ Basic and diluted loss per common share $ (0.29) (0.18) ------------ ------------ ------------ ------------
(3) STOCKHOLDERS' EQUITY During February 1999, the Company purchased 11,075 shares of its common stock at prices ranging from $5.875 to $7.41 in the open market pursuant to the Company's 1999 GO Plan. The 1999 GO Plan was established to provide the Company's employees with cash bonuses for up to four years to promote longevity of employment. (4) LIQUIDITY As shown in the consolidated financial statements for the three months ended March 31, 1999, the Company reported a net loss of $3,066,131. In addition, as of March 31, 1999, the Company had a working capital deficit of $4,604,708, and for the three months ended March 31, 1999, net cash used in operations totaled $1,307,598. As a result, the Company must obtain additional financing or make significant changes to operations. As of March 31, 1999, the Company was in violation of one provision of the Loan and Security Agreement with Coast Business Credit that stipulates that the Company must maintain a net worth equal to or greater than two million dollars. 6 Coast Business Credit has waived its right of acceleration of the obligation as it relates to the Company not meeting the net worth covenant through July 31, 1999, but retains its right of acceleration if the Company is in violation of the net worth covenant in any month after July 31, 1999. The Company believes that the Private Equity Line entered into by the Company as of April 23, 1999, together with the proceeds from the issuance of 1,500 shares of its newly-designated Series B Convertible Preferred Stock for $1,500,000 (Note 6), will enable the Company to meet the net worth covenant beginning July 31, 1999 as required by Coast Business Credit. The Private Equity Line provides for investors to purchase up to $13,500,000 of the Company's common stock, subject to the Company filing and maintaining an effective registration statement, trading price and volume minimums, and limits on the amount and frequency on sales of common stock under the line (Note 6). If the Company is unable to draw upon the Private Equity Line or other existing sources of capital or obtain new sources of capital in a timely manner, management has developed and intends to implement a plan that would allow the Company to continue to operate through the first quarter of 2000. This plan would include significantly reducing the Company's workforce, eliminating advertising expenditures, reducing professional services and reducing or eliminating other discretionary expenditures. (5) SEGMENT REPORTING The Company's two primary business segments are Business Markets Group ("BMG") and Channel Markets Group ("CMG"). BMG targets mid-size corporate customers for their broadband data, voice and Internet networking needs. Through a value-added sales process, the Company designs, provisions and manages its customers' networks. The Company provides a host of additional value-added services assisting its customers to create enhanced intranet and extranet applications. Additionally, BMG markets to its customer base a variety of traditional communications products and services such as Internet access, long distance telephone service, executive calling cards and audio/video conferencing. CMG targets and markets to distribution companies, agents, resellers and affinity groups ("Channel Partners") that maintain access to large groups of individuals and small businesses through affinity relationships and niche marketing strategies. Channel Partners include non-profit organizations and for-profit distribution groups. CMG provides Internet access, long distance telephone and other services to customers in 49 states. The Company measures the progress of BMG and CMG based on revenues, gross margin and earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is not a measure of financial performance under generally accepted accounting principles and should not be considered as an alternative to net income or cash flows from operations, as a measure of performance. The results for the three months ended March 31, 1999 and 1998 are as follows: 7
THREE MONTHS ENDED MARCH 31, 1999 BMG CMG Total --- --- ----- Revenues $ 2,761,953 6,560,461 9,322,414 Gross margin 646,874 2,054,827 2,701,701 Selling, general and administrative 1,979,956 3,309,356 5,289,312 Other income, net 16,600 (1,397) 15,203 EBITDA (1,316,482) (1,255,926) (2,572,408) Total assets 8,106,121 4,917,469 13,023,590 Gross margin $ 2,701,701 Selling, general and administrative 5,289,312 Depreciation and amortization 394,579 Interest expense (99,144) Other income, net 15,203 ---------- Net loss $ (3,066,131) ---------- ----------
THREE MONTHS ENDED MARCH 31, 1998 BMG CMG Total --- --- ----- Revenues $ 1,349,846 11,094,993 12,444,839 Gross margin 146,885 3,009,959 3,156,844 Selling, general and administrative 607,719 3,974,727 4,582,446 Other income, net 3,325 40,630 43,955 EBITDA (457,509) (924,138) (1,381,647) Total assets 2,495,046 14,961,216 17,456,262 Gross margin $ 3,156,844 Selling, general and administrative 4,582,446 Depreciation and amortization 278,868 Interest expense (11,975) Other income, net 43,955 ---------- Net loss $ (1,672,490) ---------- ----------
(6) SUBSEQUENT EVENTS On April 13, 1999, the Company sold 1,500 shares of its newly-designated Series B Convertible Preferred Stock (the "Series B Stock") to AMRO International, S.A., an entity organized under the laws of Panama, Austinvest Anstalt Balzers, an entity organized under the laws of Liechtenstein, and Esquire Trade & Finance Inc., an entity organized under the laws of the British Virgin Islands (the "Series B Investors") for $1,500,000. The Series B Stock has a liquidation preference of $1,000 per share. The Series B Stock will be entitled to an annual dividend of $30 per share, payable in cash or Common Stock, at the Company's option. The annual dividend will increase to $60 per share if the Company ever ceases to be listed on The NASDAQ Stock Market or any national securities exchange. The Series B Stock is convertible into Common Stock at the option of the Series B Investors at any time. The number of shares of Common Stock to be received by a Series B Investor upon conversion will equal the liquidation preference of the amount converted, divided by the conversion price. The conversion price will be the lesser of (1) $6.875, or (2) 89% of the lowest closing bid price for the Common Stock on The NASDAQ SmallCap Market during the five trading day period prior to the date of conversion. The conversion price will not be less than $3.00 for 180 days after the date of issuance of the Series B Stock. Thereafter the conversion price will not be less than $2.00 as long as certain revenue and EBITDA requirements are met. As a result, the Company could issue up to 750,000 shares of Common Stock upon conversion if all of the Series B Stock were converted at the lowest possible conversion price (assuming such revenue and EBITDA requirements continue to be met). Unless the Company shall have obtained the approval of its voting stockholders in accordance with the rules of The NASDAQ Stock Market, the Company will not issue shares of Common Stock upon conversion of any shares of Series B Stock if such issuance of Common Stock, when added to the number of shares of Common Stock previously issued by 8 the Company upon conversion of or as dividends on shares of the Series B Stock, would exceed 19.9% of the number of shares of Common Stock which were issued and outstanding on the original issuance date of the Series B Stock. The Company will pay converting Series B Investors in cash for any excess over such amount. The Company also issued the Series B Investors warrants to purchase up to 20,000 shares of Common Stock at a price of $8.60 per share. The warrants may be exercised beginning September 30, 1999, and terminate on March 31, 2002. The Company and the Series B Investors entered into a Registration Rights Agreement that requires the Company to file, and obtain and maintain the effectiveness of, a Registration Statement with the Securities and Exchange Commission (the "Commission") in order to register the public resale of all shares of the Common Stock acquired by the Series B Investors (a) upon conversion of the Series B Stock, (b) in payment of dividends on the Series B Stock, and (c) upon exercise of the warrants. The Company will be subject to significant monetary penalties if it fails to obtain or maintain the effectiveness of such Registration Statement. The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation for financial advisory services in connection with the placement of the Series B Stock. On April 23, 1999, the Company entered into a Private Equity Line with Cambois Finance, Inc., a British Virgin Islands corporation (the "Investor"). Pursuant to the Private Equity Line, the Investor, subject to the Company filing and maintaining an effective registration statement, trading price and volume minimums, and limits on the amount and frequency on sales of common stock under the line, agreed to purchase up to $13,500,000 of the Company's Common Stock (the "Common Stock") over three years, as, when and if shares are put to the Investor by the Company. The actual number of shares that may be issued by the Company under the Private Equity Line is limited to 2,103,939 shares, unless and until the Company obtains approval of the Private Equity Line from its stockholders pursuant to the applicable corporate governance rules of The NASDAQ Stock Market. The Company's ability to require the Investor to purchase Common Stock is subject to a number of significant conditions, including the continued effectiveness of the Registration Statement described below. There can be no assurance that the Investor will be able to purchase Common Stock when and as required by the Company under the Private Equity Line. The Company may put shares to the Investor in amounts ranging from $75,000 up to $2,000,000 (varying with the Common Stock's trading price and volume) every 15 trading days. The purchase price for the shares put to the Investor will be 89% of the lowest closing bid price for the Common Stock on The NASDAQ SmallCap Market during the five trading day period consisting of the two trading days preceding the delivery of the put notice to the Investor by the Company, the day of such delivery, and the two trading days after such delivery. The Company may not put shares to the Investor unless the lowest closing bid price during such five trading day period is in excess of $2.25 per share. The closing bid price for the Common Stock on April 30, 1999, was $5.625 per share. In connection with the Private Equity Line, the Company and the Investor entered into a Registration Rights Agreement that requires the Company to file, and obtain and maintain the effectiveness of, a Registration Statement on Form S-1 with the Commission in order to register the sale and public resale of shares of the Common Stock acquired by the Investor under the Private Equity Line (the "Registration Statement"). The Investor will be named as an underwriter in such Registration Statement. The Investor will also be subject to certain restrictions on short selling of the Common Stock and certain "blackout" periods on its ability to resell Common Stock under the Registration Statement. If the Registration Statement has not been declared effective by October 30, 1999, the 9 Investor's obligation to purchase Common Stock under the Private Equity Line shall terminate, and the Company will be required to pay the Investor $25,000 in liquidated damages. The Company has issued 3,000 shares of Common Stock to Trinity Capital Advisors, Inc. and is required to pay four percent of all proceeds actually received by the Company under the Private Equity Line to Trinity Capital Advisors, Inc. as compensation for financial advisory services in connection with the transactions set forth in the Private Equity Line. On April 1, 1999 the Company granted nonstatutory stock options to two board members to purchase 50,000 shares of the Company's common stock at an exercise price of $4.88 per share (fair market value at date of grant) vesting at a rate of 50% per year over two years. The Company also granted incentive stock options to three executive officers to purchase 300,000 shares of the Company's common stock at an exercise price of $4.88 per share (fair market value at date of grant) vesting at a rate of 25% per year over four years. These options were granted pursuant to the Company's 1998 Stock Incentive Plan. On April 6, 1999 a former employee of the Company relinquished 36,262 shares of the Company's common stock to settle an employee receivable. The shares where subsequently canceled and retired. On April 9, 1999 the Company granted nonstatutory stock options to a new board member to purchase 25,000 shares of the Company's common stock at an exercise price of $4.6875 per share (fair market value at date of grant). The options were granted pursuant to the Company's 1998 Stock Incentive Plan and vest at the rate of 50% per year over two years. On May 3, 1999 the Company granted incentive stock options to an executive officers to purchase 50,000 shares of the Company's common stock at an exercise price of $5.625 per share (fair market value at date of grant) vesting at a rate of 25% per year over four years. These options were granted pursuant to the Company's 1998 Stock Incentive Plan. 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 FOR THE YEAR ENDED DECEMBER 31, 1998. The following discussion and analysis should be read in connection with the unaudited consolidated financial statements for the three month periods ended March 31, 1999 and 1998 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, 1998. Overview AvTel Communications, Inc. (the "Company") is a provider of broadband network services integrating voice, data and Internet solutions. The Company sells and markets a broad range of telecommunications and advanced network 10 services through independent value added resellers, Affinity and agent organizations, and internal direct sales professionals. The Company targets mid-size corporations, small-office home-office professionals and select residential market segments through two primary business units; the Business Markets Group ("BMG") and the Channel Markets Group ("CMG"). On December 1, 1997, the Company acquired Matrix Telecom, Inc., a privately-held Texas corporation ("Matrix") by means of a share for share exchange. For accounting purposes, the acquisition was treated as a reverse acquisition with Matrix as the acquirer. Matrix was a provider of long distance telephone services and subsequently provides a bundled service including Internet access. On September 25, 1998, the Company acquired all of the issued and outstanding capital stock of Digital Media International, Inc. ("DMI"), a privately-held corporation based in Santa Barbara, California, which develops software for educational, entertainment and other applications. On November 19, 1998, the Company acquired all of the issued and outstanding capital stock of Remote Lojix/PCSI, Inc. ("RLI"), a privately-held corporation based in New York, which is a provider of system integration and local area network ("LAN") services to corporate customers. Results of Operations Consolidated Statements of Operations as a Percent of Revenue (Unaudited)
Three Months Ended March 31, 1999 1998 ------ ------ Revenues 100.00% 100.00% Cost of revenues 71.02% 74.63% Gross margin 28.98% 25.37% Operating expenses Selling, general and administrative 56.74% 36.82% Depreciation and amortization 4.23% 2.24% ------ ------ Total operating expenses 60.97% 39.06% ------ ------ Operating loss (31.99%) (13.69%) Interest expense (1.06%) (0.10%) Other income, net 0.16% 0.35% Net loss (32.89%) (13.44%) ------ ------ ------ ------
Three Months Ended March 31, 1999 compared with Three Months Ended March 31, 1998. Revenues Revenues for the three months ended March 31, 1999 were $9.3 million, a decline of 25.1% or $3.1 million from $12.4 million for the three months ended March 31, 1998. BMG revenue increased $1.4 million, which is in part attributable to the acquisition of RLI during the fourth quarter of 1998. CMG revenue decreased $4.5 million. CMG revenue from traditional voice products declined $4.7 million, while Internet revenue increased $167,000 or 21.0%. Historically, CMG has focused on selling retail long distance service through telemarketing, direct mail, and distributors or agents. During the fourth quarter of 1998, CMG implemented a new strategy to sell Internet access and additional voice services exclusively through affinity groups, agents and distributors with the main thrust focused on Internet access. 11 The primary source of revenues of the Company during the period continued to be voice distribution channels. Pricing pressures within the industry continued to reduce retail pricing of long distance products. These factors, similar in nature to those affecting all resellers of long distance, have continued to affect a decline in CMG revenues for the three months ended March 31, 1999 compared to the three months ended March 31, 1998. Decreases in CMG revenues were additionally affected by a continued attrition of a maturing customer base primarily in the areas of telemarketed and direct mail customers, which was determined not to be cost effective. Revenue from these bases decreased $1.9 million to $1.5 million for the three months ended March 31, 1999 from $3.4 million for the three months ended March 31, 1998. Consistent with plan, the Company determined to turn the sales force focus away from these channels and towards affinity and agent groups. Excluding consumer voice traffic, the Company's revenues generated by the data needs of its customers increased $1.7 million to $3.8 million for the three months ended March 31, 1999 from $2.1 million for the three months ended March 31, 1998. Accordingly, the Company's dependence on revenue from voice distribution channels decreased 23 percentage points to 60% of the Company's total revenue for the three months ended March 31, 1999 from 83% for the three months ended March 31, 1998. As of April 30, 1999, BMG had over 30 accounts in the process of activation and installation. The Company expects these new accounts to start producing revenue within 60 to 120 days. In addition, as of April 30, 1999, CMG had added seven new Internet Service Providers and four affinity groups with the ability to reach up to 180,000 members, with marketing agents nationwide. Data networking needs of the corporate customer and the Internet 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. Gross Margin Gross margin as a percentage of revenues increased by 3.6 percentage points to 29.0% for the three months ended March 31, 1999 from 25.4% for the three months ended March 31, 1998. Gross margin decreased $455,000 to $2.7 million for the three months ended March 31, 1999 from $3.2 million for the three months ended March 31, 1998. BMG gross margin as a percent of revenue increased 12.5 percentage points to 23.4% for the three months ended March 31, 1999 from 10.9% for the three months ended March 31, 1998. Two primary factors affected this increase. First, significantly lower rates were negotiated with the Company's major underlying carrier for dedicated traffic. These rates became effective February 15, 1999 and represent an approximate cost reduction of 20% on dedicated traffic. Secondly, with the acquisitions of RLI and DMI, BMG is able to sell and support higher margin products. CMG gross margin as a percent of revenue increased 4.2 percentage points to 31.3% for the three months ended March 31, 1999 from 27.1% for the three months ended March 31, 1998. The increasing Internet service gross margin, coupled with the stable and slightly increasing traditional voice gross margin, have resulted in an overall higher gross margin. Internet service gross margin within CMG increased $187,000 or 33.4% to $745,000 for the three months ended March 31, 1999 from $559,000 for the three months ended March 31, 1998. Provision for bad debt decreased $274,000, which was fully attributable to the decline in voice revenues. Selling, General, and Administrative Costs Selling, general, and administrative costs increased $707,000 to $5.3 million for the three months ended March 31, 1999 from $4.6 million for the three months ended March 31, 1998. As a percentage of revenues, selling, general, and administrative costs increased by 19.9 percentage points to 56.7% for the three months ended March 31, 1999 from 36.8% for the three months ended March 31, 1998. 12 BMG selling, general, and administrative costs increased $1.4 million to $2.0 million for the three months ended March 31, 1999 from $608,000 for the three months ended March 31, 1998. The primary reason for the increase was attributable to the acquisition of RLI and DMI in the fourth quarter of 1998. The remaining increase in cost was associated with expanded sales force and related expenses including general office expense, rent, utilities and travel expenditures. CMG selling, general, and administrative costs decreased $665,000 to $3.3 million for the three months ended March 31, 1999 from $4.0 million for the three months ended March 31, 1998. As a percent of revenue, selling, general, and administrative costs increased 14.6 percentage points to 50.4% for the three months ended March 31, 1999 from 35.8% for the three months ended March 31, 1998. The principal reason for the decrease in costs was attributable to the decline in billing and collection, and commission expenses associated with the decline in revenue. Stock compensation expense for the three months ended March 31, 1999 was $81,000 compared to $234,000 for the three months ended March 31, 1998, a decrease of $153,000. Certain option and restricted stock plans were accelerated and completely expensed during 1998. Additionally, commission expense declined $174,000 for the quarter ended March 31, 1999 due to the amortization of advanced commissions being fully realized during 1998. Depreciation and Amortization Depreciation and amortization increased $116,000 to $395,000 for the three months ended March 31, 1999 from $279,000 for the three months March 31, 1998. The increase primarily resulted from the acquisition and consolidation of assets related to the purchase of RLI and DMI during the fourth quarter of 1998, and the amortization of certain intangible costs related to a long term borrowing agreement entered into on October 1998. Interest Expense and Other Income, net Interest expense increased $87,000 to $99,000 for the three months ended March 31, 1999 from $12,000 for the three months ended March 31, 1998. The Company recognized $56,000 of interest expense from long term borrowings and $34,000 from accrued interest on liabilities acquired with the RLI purchase. Other income decreased $29,000 to $15,000 for the three months ended March 31, 1999 from $44,000 for the three months ended March 31, 1998 primarily due to the decrease of interest income from cash investments. Liquidity and Capital Resources As shown in the consolidated financial statements for the three months ended March 31, 1999, the Company reported a net loss of $3,066,131. In addition, as of March 31, 1999, the Company had a working capital deficit of $4,604,708, and for the three months ended March 31, 1999, net cash used in operations totaled $1,307,598. As a result, the Company must obtain additional financing or make significant changes to operations. As of March 31, 1999, the Company was in violation of one provision of the Loan and Security Agreement with Coast Business Credit that stipulates that the Company must maintain a net worth equal to or greater than two million dollars. Coast Business Credit has waived their right of acceleration of the obligation indefinitely as it relates to the Company not meeting the net worth covenant through July 31, 1999, but retains their right of acceleration if the Company is in violation of the net worth covenant in any month after July 31, 1999. The Company believes that the Private Equity Line entered into by the Company as of April 23, 1999 will enable the Company to meet the net worth covenant beginning August 1, 1999 as required by Coast Business Credit. The Private Equity Line provides for investors to purchase up to $13,500,000 of the Company's common stock, subject to the Company filing and maintaining an effective registration statement, trading price and volume minimums, and limits on the amount and frequency on sales of common stock under 13 the line (see Note 6 of Notes to Consolidated Financial Statements). In addition, on April 13, 1999, the Company sold 1,500 shares of its newly designated Series B Convertible Preferred Stock for $1,500,000 (see Note 6 of Notes to Consolidated Financial Statements). If the Company is unable to draw upon the Private Equity Line or other existing sources of capital or obtain new sources of capital in a timely, management has developed and intends to implement a plan that would allow the Company to continue to operate through the first quarter of 2000. This plan would include significantly reducing the Company's workforce, eliminating advertising expenditures, reducing professional services and reducing or eliminating other discretionary expenditures. The primary sources of operating cash flow for the Company are revenues derived from the sale of information technology and telecommunications services to individuals and business, and its secured credit facility. The primary uses of cash are payments to underlying network vendors for provisioning telecommunications facilities, to sales distributors for soliciting long distance sales, and to the major LECs for directly billing to and collecting from the end user. Net cash used in operating activities is $1.3 million for the three months ended March 31, 1999, compared to $1.2 million for the three months ended March 31, 1998. Net cash used in investing activities was $201,000 for the three months ended March 31, 1999, and net cash provided by investing activities was $322,000 for the three months ended March 31, 1998. The Company loaned $2.0 million to an affiliated company during 1997. Of such amount, $201,000 was repaid during 1997, $410,000 was repaid during the first quarter of 1998 and the remainder was repaid in subsequent quarters of 1998. Net cash provided by financing activities was $1.2 million and $18,000 for the three months ended March 31, 1999 and 1998, respectively. On October 2, 1998, the Company entered into a secured credit facility with Coast Business Credit. This credit facility consists of a line of credit of up to $7.5 million. Under the line of credit, the Company may borrow up to 75% of eligible receivables (as defined). In addition, the line of credit may be utilized in connection with certain acquisitions and equipment purchases as well as to provide a facility for issuing letters of credit. Borrowings under the line of credit bear interest, payable monthly, based upon the prime rate of Bank of America NT & SA plus 2% (9.75% at March 31, 1999). As of March 31, 1999, borrowing outstanding under the credit facility amounted to $2,188,000 with approximately $424,000 available for future borrowings. Borrowings under the credit facility are secured by substantially all of the assets of the Company. The credit facility expires on October 31, 2000. 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 and the Private Equity Line to help meet this need, as well as operating and capital expenditure needs, for the next twelve months. Year 2000 The Year 2000 issue concerns the inability of computer systems and certain other equipment to properly recognize and process data that uses two digits rather than four to designate particular years. The Company has initiated a Year 2000 Project Plan ("the Plan") to assess whether its systems that process date sensitive information will perform satisfactorily leading up to and beyond January 1, 2000. The goal of the Plan is to correct, prior to January 1, 2000, any Year 2000-related problem with critical systems, the failure of which could have a material adverse effect on the Company's operations. The Plan includes steps to (1) identify each critical system element that requires date code remediation, (2) establish a plan to remediate such systems, (3) implement all required remediations and (4) selectively test the remediated systems. 14 Thus far, the identification phase has identified Year 2000 issues in the following critical Company-owned and leased systems: rating and billing systems used by the Company to process and prepare billing data for its customer base. In addition, the Company receives critical services from providers of utilities and other services to facilities that house employees and equipment. The Company is also critically reliant upon the systems of other telecommunications providers on which the Company depends to deliver services and invoices to its customers. The identification and planning phases of the Plan are materially complete as they relate to Company-owned and leased systems. As they relate to third party vendors and other telecommunications carriers, the identification and planning phases are on-going and are expected to be materially complete during second quarter 1999. Based on work completed under the Plan to date, the Company currently intends to take the following additional steps under its Plan with respect to Company-owned and leased systems, third-party vendors and other telecommunications carriers: - - The Company generally plans to remediate Company-owned and leased rating, billing and collection systems through the revision or replacement of current system components. Necessary changes to Company-owned and leased systems are in process and are expected to be completed by third quarter 1999. The selective testing and verification of such changes are expected to be completed in the third quarter of 1999. Due to the large number of system components requiring remediation, the Company does not intend to test every remediated system but will rely upon the results of testing of the critical components of such systems to determine the effectiveness of remediation efforts. Components not tested are not considered critical to the Company's business. - - With respect to critical services provided by utilities and other third parties, the Company is in the process of contacting all such suppliers. Thus far, a majority of those suppliers who have responded have indicated that their systems and service delivery mechanisms are Year 2000 compliant or can be made so through currently available modifications. The Company plans to continue monitoring all third-party remediation efforts and to develop contingency plans for the delivery of such services as necessary. - - The Year 2000 compliance status of other telecommunications providers with which the Company's systems interact is not yet known. The Company is making inquiries of these providers to determine their compliance status and expects to obtain the results of compliance tests during second quarter 1999, although there can be no assurance that providers will supply this information. While the Company currently believes that it will be able to remediate and selectively test Company-owned and leased systems in time to minimize any detrimental effect on its operations, there can be no assurance that such steps will be successful. Failure by the Company to timely and effectively remediate its systems, or the failure of critical vendors and suppliers and other telecommunications carriers to remediate affected systems, could have a material adverse impact on the Company's business, financial condition, results of operations and prospects. Because the impact of Year 2000 issues on the Company is materially dependent on the mitigation efforts of parties outside the Company's control, the Company cannot assess with certainty the magnitude of any such potential adverse impact. However, based upon risk assessment work conducted thus far, the Company believes that the worst case scenario of the failure by the Company, its suppliers or other telecommunications carriers with which the Company interacts to resolve Year 2000 issues would be an inability by the Company to timely and accurately process service requests and to timely and accurately bill its customers. In addition to lost earnings, these failures 15 could also result in loss of customers due to service interruptions and billing errors, substantial claims by customers and increased expenses associated with stabilizing operations and executing mitigation plans. Contingency planning to maintain and restore service in the event of natural disasters, power failures and systems-related problems is a routine part of the Company's operations. The Company believes that such contingency plans will assist the Company in responding to the failure by outside service providers to successfully address Year 2000 issues. In addition, the Company is currently identifying and considering various Year 2000-specific contingency plans, including identification of alternate vendors and service providers and manual alternatives to system operations. These Year 2000-specific contingency plans are expected to be materially completed during the second quarter of 1999, but their review and development will continue throughout 1999. Although the total costs to implement the Plan cannot be precisely estimated, the Company incurred minimal costs to date (none of which was related to hardware costs) and anticipates spending an aggregate of up to $750,000 during 1999 (which includes $250,000 of hardware costs). These costs will be expensed as incurred, unless new systems or equipment are purchased that should be capitalized in accordance with generally accepted accounting principles. Some of the costs represent ongoing investment in systems upgrades, the timing of which is being accelerated in order to facilitate Year 2000 compliance. In some instances, such upgrades will position the Company to provide more and better-quality services to its customers than they currently receive. The Company expects to fund these costs with a combination of financing provided by the hardware vendor, cash provided by operations, and other debt or equity financing. Cost estimates and statements of the Company's plans discussed above are forward-looking statements that are derived using numerous assumptions of future events, many of which are outside the Company's control, including the availability and future cost of trained personnel and various other resources, third party modification plans, the absence of systems requiring remediation that have not yet been discovered, and other factors. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is not exposed to material future earnings or cash flow fluctuations, from changes in interest rates on its long-term debt at March 31, 1999. A hypothetical increase of 97 basis points in interest rate (ten percent of the Company's overall borrowing rate) would not result in a material fluctuation in future earnings or cash flow. The Company had not entered into any derivative financial instruments to manage interest rate risk or for speculative purposes and is currently not evaluating the future use of such financial instruments. 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On April 14, 1999, the Company filed a motion to dismiss the class action (IN RE AVTEL SECURITIES LITIGATION, Case No. 98-9236) currently pending in the United States District Court for the Central District of California regarding alleged securities fraud. (See AvTel Communications, Inc. FORM 10-K for the year ended December 31, 1998.) ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On April 13, 1999, the Company issued 1,500 shares of its newly created Series B Convertible Preferred Stock (the "Series B Stock"). The Certificate of Designations, Preferences and Rights of the Series B Stock provides that the holders of the Series B Stock are entitled to receive, before any cash dividend shall be declared and paid upon or set aside for the Company's Common Stock in any fiscal year of the Company, cumulative dividends payable in cash in an amount per share for such fiscal year equal to $30.00. In the event that the Company's Common Stock shall cease for any reason to be listed on The NASDAQ Stock Market or any national securities exchange, the cash dividend from such date forward shall be at the rate of $60.00 per share. The Company may pay any such dividend in the form of its Common Stock, valued at the closing bid price for the Common Stock on its principal market on the day prior to the dividend payment date. On March 17, 1999, the Company issued 14,845 shares of its Common Stock, which were not registered under the Securities Act, to one of its distributors upon the partial exercise of an existing stock option. No underwriters were used in this transaction and none of such shares were issued publicly. The Company relied on the exemptions from registration provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The distributor receiving shares is 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 distributor all material information with respect to the Company. The distributor signed a restricted stock agreement containing appropriate investment representations and covenants. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 Financial Data Schedule - Three Months Ended March 31, 1999 (b) Reports on Form 8-K The registrant filed no reports on Form 8-K during the quarter ended March 31, 1999. 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/ MICHAEL J. USSERY ------------------------------------ Michael J. Ussery CHIEF FINANCIAL OFFICER (Duly Authorized Officer and Principal Financial Officer, and Principal Accounting Officer) May 13, 1999 Exhibit Index Exhibit Number Exhibit Description - ------- ------------------- 27 Financial Data Schedule - Three Months Ended March 31, 1999 EX-27 2 EXHIBIT 27
5 THIS SCHEUDLE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF MARCH 31, 1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 589 0 4,336 0 0 5,737 1,674 0 13,024 10,342 2,188 0 1 105 216 13,024 0 9,322 0 6,620 5,684 0 99 (3,066) 0 (3,066) 0 0 0 (3,066) (0.29) (0.29)
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