-----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, FrY7T7j6arOxOxaFUqy/PBPp9CUE2xUy9wwD8NbzRB8/0RiPIKHnbTJbuGiJq0JP Hr3i5cx912z5iZwJ4jh7UQ== 0001047469-99-015070.txt : 19990416 0001047469-99-015070.hdr.sgml : 19990416 ACCESSION NUMBER: 0001047469-99-015070 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 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-K405 SEC ACT: SEC FILE NUMBER: 000-27580 FILM NUMBER: 99595021 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-K405 1 FORM 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. For Fiscal Year Ended: December 31, 1998 OR [ ] TRANSITION REPORT UNDER 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 in Its Charter) DELAWARE 87-0378021 (State or Other (I.R.S. Employer Jurisdiction of Identification No.) Incorporation or Organization) 501 Bath Street, 93101 Santa Barbara, CA (Zip Code) (Address of Principal Executive Offices)
(Issuer's Telephone Number, Including Area Code) (805) 884-6300 Securities registered under Section 12(b) of the Act: None. -------------------------- Securities registered under Section 12(g) of the Act: Common Stock Par Value $0.01 (Title of class) -------------------------- Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained in this form herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $45,593,193, computed at the last sale price of such Common Stock on The Nasdaq SmallCap Market as of March 17, 1999. APPLICABLE ONLY TO CORPORATE REGISTRANTS As of March 17, 1999, there were 10,539,123 shares of the Registrant's Common Stock, par value $0.01, issued and outstanding, excluding treasury stock. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated by reference to the Registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on or about May 27, 1999, which will be filed with the Commission within 120 days after the end of the Registrant's fiscal year. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
ITEM NUMBER PAGE NUMBER - ------------------------------------------------------------------------------------------------------ ----------------- PART I 1. Business................................................................................... 4 2. Properties................................................................................. 15 3. Legal Proceedings.......................................................................... 15 4. Submission of Matters to a Vote of Security Holders........................................ 16 PART II 5. Market for Common Equity and Related Stockholder Matters................................... 17 6. Selected Financial Data.................................................................... 18 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 19 7A. Quantitative and Qualitative Disclosures about Market Risk................................. 28 8. Financial Statements and Supplementary Data................................................ 28 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure....... 29 PART III 10. Directors and Executive Officers of the Registrant......................................... 29 11. Executive Compensation..................................................................... 29 12. Security Ownership of Certain Beneficial Owners and Management............................. 29 13. Certain Relationships and Related Transactions............................................. 29 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 29
3 PART I ITEM 1. BUSINESS INTRODUCTORY STATEMENT THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL INFORMATION OR STATEMENTS OF CURRENT CONDITION AND RELATE TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY. FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S STRATEGIES, PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS. SOME FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "BELIEVES," "ANTICIPATES," "INTENDS" OR "EXPECTS." THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. THE CAUTIONARY STATEMENTS MADE IN THIS ANNUAL REPORT SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS ANNUAL REPORT. BACKGROUND GENERAL AvTel Communications, Inc. (the "Company" or "AvTel") 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 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. The Company 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. HISTORY The Company was incorporated on October 31, 1981, but did not commence its current business until February, 1995. Prior to October 23, 1996, the Company conducted operations under the name "Hi, Tiger International, Inc.". The name change was effected in connection with the Company's acquisition of AvTel Holdings, Inc., a California corporation ("AHI") on that date. As a result of the acquisition of AHI, the Company implemented a complete change in its Board of Directors and executive management, began to pursue several acquisitions and strategic alliances and started development of a sales and operational strategy to position the Company as a telecommunications carrier providing a comprehensive array of broadband voice and data network services. The acquisition of AHI was effected pursuant to the merger of a wholly-owned subsidiary of the Company with and into AHI (the "AHI Merger") as a result of which the Company acquired 100% of the 4 issued and outstanding capital stock of AHI in exchange for 1,063,127 shares of the Company Common Stock, representing approximately 61% of the issued and outstanding Company Common Stock after giving effect to the AHI Merger, and 250,000 shares of newly authorized shares of the Company's Series A Convertible Preferred Stock. For accounting purposes, the acquisition was treated as a reverse acquisition with AHI as the acquirer. In November, 1996, the Company acquired Silicon Beach Communications, Inc. ("SBC"), an Internet Service Provider ("ISP") and provider of software development services. In February, 1997, the Company acquired all of the issued and outstanding capital stock of WestNet Communications, Inc. ("WNI"), a Ventura, California ISP. Following completion of this acquisition, the Company began to integrate the customer bases, network facilities and other operations of SBC and WNI in order to achieve desired efficiencies and economies of scale. On December 1, 1997, the Company acquired Matrix Telecom, Inc., a privately-held Texas corporation ("Matrix") by means of a share for share exchange (the "Share Exchange"). Matrix is a provider of long distance telephone services. See "Background--Acquisition of Matrix" below. The Reincorporation Merger and the Reverse Stock Split were conditions to the closing of the Share Exchange. 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. In November, 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 in the eastern United States. ACQUISITION OF MATRIX AvTel and Matrix entered into a Stock Exchange Agreement dated April 29, 1997, and subsequently amended (the "Exchange Agreement"), pursuant to which the persons or entities who owned the issued and outstanding common stock of Matrix ("Matrix Stockholders") would transfer to AvTel all of their Matrix stock and, in exchange, AvTel would issue to the Matrix Stockholders shares of the Company's Common Stock (the "Share Exchange"). The Share Exchange was completed pursuant to the terms of the Exchange Agreement on December 1, 1997. For accounting purposes, the acquisition was treated as a reverse acquisition with Matrix as the acquirer. In connection with the completion of the Share Exchange, the Matrix Stockholders and the Company entered into a Registration Rights and Lockup Agreement dated December 1, 1997 (the "Registration Rights and Lockup Agreement"). Pursuant to the Registration Rights and Lockup Agreement, certain persons and entities who held an aggregate of 85.2% of the outstanding Matrix Common Stock agreed, for a two-year period commencing on the closing of the Share Exchange, not to offer, pledge, sell, or otherwise dispose of any shares of the Company issued to them pursuant to the terms of the Exchange Agreement. As of March 17, 1999, this "lockup" provision relates to a total of 6,457,123 shares of AvTel stock held by the following shareholders: Ronald L. Jensen (329,321 shares), Gladys Jensen (731,847 shares), James J. Jensen (851,738 shares), Jami J. Jensen (851,738 shares), Janet Jensen Krieger (961,939 shares), Jeffrey J. Jensen (851,738 shares), Julie J. Jensen (851,738 shares), The RJ & GJ Foundation (329,692 shares), The Janet Foundation (24,124 shares), The OUI Foundation (24,124 shares), The Chasdrew Foundation (24,124 shares), John E. Allen (125,000 shares), Anthony E. Papa (250,000 shares) and James P. Pisani (250,000 shares)(together, the "Lockup Stockholders"). The Registration Rights and Lockup Agreement requires that the Company use its best efforts to file a shelf registration statement providing for the sale by the Lockup Stockholders of all securities issued to them in connection with the Exchange Agreement, subject to the two-year holding restriction imposed on the Lockup Stockholders described above. Under the Registration Rights and Lockup Agreement, the Company is obliged to use its reasonable efforts to keep the shelf registration statement effective on a 5 continuous basis for a period described in the Registration Rights and Lockup Agreement. The Lockup Stockholders may also require the Company to undertake up to two additional demand registrations of their securities if the shelf registration is not in place. All costs and expenses of both shelf and demand registrations (excluding any underwriting discounts and fees of counsel to the Lockup Stockholders) will be borne by the Company. BUSINESS OF THE COMPANY 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 services through independent value added resellers 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"). BUSINESS MARKETS GROUP BMG targets mid-size corporate customers for their broadband data, voice and Internet networking needs. Following this sales strategy, the Company's objective is to become the underlying telecommunications carrier for the transport of data, voice and Internet traffic. Through a value-added sales process, the Company designs, provisions and manages its customers' networks. The Company will provide a host of additional value added services assisting its customers to create enhanced intranet and extranet applications. The Company believes its strategy to focus on the corporate customer for enterprise-wide network services offers significant opportunity. BMG cross-markets to its customer base a variety of traditional telecommunications products and services such as long distance telephone service, executive calling cards and video/audio conferencing. INDUSTRY. Information technology has fast become a driving force in telecommunications. The Company's BMG strategy is driven by corporate end users' needs for network connectivity as a result of new software applications and technology advancements developed in the information technology arena. This has become a critical element in the ability of businesses, professional and other organizations to improve productivity and lower costs. This can be accomplished through the use of a variety of telecommunications services, including branch office, remote office and telecommuter networking ("intranets") as well as providing network access to customers, vendors, suppliers ("extranets") and the Internet. While management expects these factors to continue to increase market demand for these services, there are no assurances regarding the size of such demand or that the Company will be selected to provide its services in response to such demand. INTERNETWORKING. At an increasing rate, business, professional and other organizations are seeking to inter-network their LANs and WANs to share information and computing resources for applications such as e-mail, transaction processing, the sharing of databases, multi-site engineering and product development and electronic image transfer. The communications traffic of many organizations has grown steadily during the past two decades leading to enterprise-wide networks facilitating rapid and efficient data communications between work groups, departments and branch locations. Additionally, a shift to enterprise-wide remote access has occurred due to increased business mobility, increased telecommuting, reduced cost of WAN services and widespread adoption of remote access standards. Internet and remote access devices extend the organization network beyond the branch office, bringing remote users closer to the enterprise and permitting connection to the corporate LAN so users can work anywhere, any time. Users can access e-mail, databases and servers as if they were in the corporate office. The recent availability of reliable IP voice technology within an enterprise-wide data network has created additional cost-saving incentives for businesses to implement advanced network solutions. The Company believes that, as a result of these shifts, internetworking, the method used for interconnecting networks, will continue to grow. This is reflected in the growth in sales and distribution of 6 routers, remote access servers, intranet software and other various components that enable internetworking. As the computing paradigm continues to migrate to network-centric architectures, enterprise-wide networks allow those technologies to be implemented. The Company's strategy recognizes the opportunity to bridge the gap between telecom and computer providers and simplify networking complexities by becoming a single source for enterprise-wide services and support. CONNECTIVITY AND BANDWIDTH. The Company believes that communications requirements such as bandwidth availability and network design are replacing computer requirements such as processor speed, memory or operating systems as the delimiting factors for business applications. Video conferencing, remote patient diagnostics with medical imaging and telecommuting are all business applications in which the success of the deployment is defined by the available bandwidth. The ultimate realization of this trend is the Web and applications developed with Internet-specific tools. Web-based applications are computer platform and operating system independent but depend entirely upon connectivity and bandwidth for successful deployment and execution. As a result, connectivity is becoming one of the most important factors in enhancing business productivity and customer service. Large corporations have historically created private wide area networks through leased dedicated data lines. However, dedicated point-to-point facilities have several deficiencies: leased lines are very expensive; remote offices and telecommuters are omitted; and leased lines are not suited for unscheduled and asynchronous communications. Accordingly, small and medium size companies that have sought the benefits of internetworking have been required to use modems and dial-up telephone lines which are generally too slow to handle today's applications. Growing demands for high speed capabilities have given way to the emergence of new carrier-based data communication services to overcome the deficiencies of both dedicated leased and dial-up lines. WAN solutions vary substantially depending on an organization's size and communications needs. Traditionally, wideband digital transmission circuits (such as T1 and DS-1) were leased from public carriers to provide voice, fax and data communications links between larger offices and low speed leased lines (such as DS-O) for branch office connectivity. For some applications, however, this has proven expensive and inefficient because the entire bandwidth capacity is dedicated 24 hours per day, whether or not it is used. Packet-based services were developed to address the issue of allocation and utilization. Today, "fast packet" networking technologies such as Frame Relay and Asynchronous Transfer Mode ("ATM") have emerged as an integrated, cost-effective, flexible WAN solution. These networks allow for "bandwidth on demand" between any two endpoints on a WAN. STRATEGY. The implementation of the Company's BMG strategy involves the marketing of products and services integrated into enterprise-wide network solutions for business customers. These enterprise-wide solutions include network design, system integration and service, WAN connectivity, voice connectivity, Internet access and World-Wide Web ("Web") development. BMG's sales and marketing activities result in monthly, recurring revenues from networking customers under multi-year term agreements. The group's primary sales strategy includes in-house direct sales professionals and an agent program through which BMG distributes its services through value added resellers ("VARs") of information technology products. BMG leverages the existing customer relationships of these VARs gaining more immediate access to a wider group of prospective customers and greater credibility in the sales process. Additionally, this VAR channel becomes the service organization for the Company's business customers requiring on-site repair and maintenance visits. CHANNEL MARKETS GROUP CMG markets domestic and international long distance telephone services, Internet access and related services through 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 7 groups. The Company's Channel Partners generally require business-to-business account management, have a large and somewhat captive audience of members/customers and distribute information and services. Historically, telecommunications companies have leveraged third party organizations to sell long distance telephone service to their member/customers sharing a percentage of the revenues generated by the group. The Company has recognized that the Internet explosion has created an "eBusiness Imperative" among these organizations that is generating new sales opportunities for the Company. The Company assists these organizations in designing and launching their Web presence and seeks to sell Internet access and additional telecom services to the organization's member/customer base. In turn, the Channel Partner participates in the revenue generated by their members' use of the Company's services. The Company believes that it is one of a few companies offering Channel Partners a turnkey-solution with private labeling and total technical, billing and customer service support. CMG provides Internet access, long distance telephone and other services to customers in 49 states. The Company is fully certified or registered in all states where required and operates under Section 214 authority from the Federal Communications Commission ("FCC"). The Company, through a wholly owned subsidiary has a national-deployed Carrier Identification Code ("CIC"). The CIC provides the Company greater network flexibility and permits the Company to market to subscribers of other carriers by having the customer dial the CIC directly, a process, which is known in the industry as "casual calling." The Company maintains its own convergent billing platform, rating system and monitoring center. The Company and various subsidiary companies market CMG's services under a variety of brands, which include AvTel-TM-, Matrix Telecom-Registered Trademark-, MatrixInet-TM-, Silicon Beach-TM-, WestNet Communications-TM-, Remote Lojix-TM-, Addictive Media-TM- and Digital Meteor-TM-. Channel Partners, at their expense, utilize a variety of marketing strategies which include direct mail, outbound telemarketing and direct sales. In November, 1998, the Company introduced its nationwide Internet access program for dial-up connectivity. This program is provided by the Company to the public under the MatrixInet-TM- brand, and is also available under a private label arrangement for certain Channel Partners. Channel Partners generally market to niche consumer segments such as non-profit affinity membership groups, ethnic affinity groups and home based business professionals. These independent distributor groups are provided with a variety of value-added support services which include: an in-house multi-lingual Customer Service department open 24 hours a day, 7 days a week; direct electronic provisioning to local exchange carriers ("LECs"); and custom billing and management reports available in paper format or on line through the Company's eBill and NetAgent platforms. The Company believes that its agreements with Channel Partners provides highly-leveraged access to large, loyal groups of individuals. The Company also believes that accessing these individuals through its Channel Partners enables lower marketing expenditures, lower customer churn and a greater customer motivation to purchase additional services. OPERATIONS AND SUPPORT CUSTOMER SERVICE CENTER. The Company's inbound customer service center is designed to provide the Company's customer base with a high-level of service and support. Customer Service Representatives ("CSRs") are available 24 hours a day, 7 days a week in order to answer inquiries generated by the Company's marketing campaigns, as well as to support existing customers. CSRs are trained to answer a broad range of inquiries from prospective customers relating to service, pricing, and optional features. In addition to competitive rates and a wide variety of products, the Company is able to offer business customers a highly specialized direct bill summary package that includes call summaries by account code, department, employee, project, client, area code, country code, and time-of-day. Customer call management reports are available in a variety of media formats including electronic support via the Internet. The Company's call center and technical support center are equipped with state-of-the-art computer and telecommunications technology. Incoming calls are managed with the help of an automatic call distributor and an automated attendant. Such a system allows for management of call queue time, the 8 formation of distinct work groups for different projects, and on-line monitoring of customer service calls for quality assurance purposes. Bilingual CSRs are available during day and evening shifts. BILLING AND INFORMATION SYSTEMS. The Company has dedicated substantial resources to its management information systems. The Company's information systems enable the Company to (1) monitor and respond to the evolving needs of its customers by developing new and customized services; (2) provide sophisticated billing information that can be tailored to meet the requirements of its customer base; (3) provide high quality customer service; (4) detect and minimize fraud; (5) verify payables to suppliers; and (6) integrate additions to its customer base. In addition, the Company has complete facilities for rating, formatting and distributing direct bills to its larger commercial subscribers. Small business customers and individuals may receive either a direct or a LEC bill, depending upon the services provided to the customer. The Company provides secure remote electronic access to certain activation, provision and billing information to its customers through the Internet. The Company has invested in call rating, billing, and customer service infrastructure. In addition, the Company holds billing and collection agreements with LECs, including all of the Regional Bell Operating Companies ("RBOCs"), and independent local exchange companies ("ILECs"). These billing agreements permit the Company to include its billing on the customer's local telephone bill. The Company's billing information systems and services also allows it to provide direct bills to customers in a paper format and electronically through the Internet. STRATEGIC ALLIANCES AND CARRIER AGREEMENTS. The Company has executed strategic agreements with Sprint for its underlying voice carrier services, Qwest and IXC for data carrier services and GST, GTE and PSINet for Internet access services. As noted above, the Company holds billing and collection agreements with all of the RBOCs and ILEC's. The Company developed with Prosoft I-Net Solutions a specialized training program designed to educate value-added resellers of the Company's services on the integration of data, voice and video products. ACE CERTIFIED ENGINEER TRAINING PROGRAM. On March 16, 1998 the Company announced the availability of its ACE Certified Engineering training program. The ACE program has been designed specifically for value added resellers in the telecommunications industry. The ACE program provides a complete curriculum over a broad range of courses. The program includes four tracks: 1) a general overview of the telecommunications industry and technologies; 2) voice equipment and network design; 3) data communications and network design; and 4) the integration of voice, video and data, traffic design and network engineering. Each track is a technical course focusing on how to use, engineer and integrate proven and leading-edge voice, video and data networking technologies. The complete program includes on-line and classroom training and course work requiring 128 hours of in-depth course work and labs. REGULATION The services which the Company provides, either directly or through its subsidiaries, are subject to varying degrees of federal, state and local regulation. The FCC exercises jurisdiction over all facilities of, and services offered by, telecommunications common carriers to the extent that they involve the provision, origination or termination of jurisdictionally interstate or international communications. The state public service commissions ("PSCs") retain jurisdiction over jurisdictionally intrastate communications. The FCC and relevant PSCs have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities and the terms and conditions under which the Company's services are provided. In general, neither the FCC nor the relevant state PSCs exercise direct oversight over cost justification for the Company's services or the Company's profit levels, but either or both may do so in the future. However, the Company is required by federal and state law and regulations to file tariffs listing the rates, terms and conditions of services provided. The Company generally is also required to obtain certification from the relevant state PSC prior to the initiation of certain intrastate service, and is required to maintain a certificate issued by the FCC in connection with the provision of certain international services. Any 9 failure to maintain proper federal and state tariffs or certification or any difficulties or delays in obtaining required authorization could have a material adverse effect on the Company. COMPETITION The telecommunications industry is highly competitive and affected by rapid regulatory and technological change. The Company believes that the principal competitive factors in its business include pricing, customer service, network quality, service offerings and the flexibility to adapt to changing market conditions. The Company's future success will depend in part upon its ability to compete with AT&T, MCI Worldcom, Sprint and other carriers (including the RBOCs when approved to enter the long distance market) and other long distance providers, and America On-Line and other national and local ISPs, many of which have considerably greater financial and other resources than the Company. INTELLECTUAL PROPERTY The Company has registered several trademarks for use in its marketing materials. The Matrix Telecom name and logo, used by the Company to market Internet access, long distance service, and calling card services is a registered trademark. The Company also uses several unregistered trademarks as part of its BMG and CMG businesses, including AvTel-TM-, MatrixInet-TM-, Silicon Beach-TM-, Addictive Media-TM- and Digital Meteor-TM-, which it may seek to register. While the Company believes these trademarks are important to its business, the Company does not believe that failure to register these trademarks poses any material risk of infringement on its rights to use such trademarks. EMPLOYEES As of March 15, 1999, the Company, including its subsidiaries, had approximately 255 full-time employees. None of the employees of the Company are represented by a union. The Company supplements its work force from time to time with contractors, administrative personnel through employment agencies, and part time employees. The Company believes that it has good relations with its employees. EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below is information with respect to each executive officer of the Company: ANTHONY E. PAPA, age 36, has been the Chairman of the Board and Chief Executive Officer of the Company since October 1996. Mr. Papa was also President of the Company from October 1996 until February 1998. Prior to October, 1996, Mr. Papa had served as President of ICS Communications, Inc.("ICS"), Richardson, Texas, a national provider of cable television, wireless paging, local and long-distance telephone services from December 1992. Before joining ICS, Mr. Papa served as general manager for Spectradyne, Inc., the largest provider of pay-per-view entertainment and interactive services to the hospitality industry. Mr. Papa is a director of International School of Information Management, Inc., an accredited university and an electronic publisher and provider of electronic services, and a director of ABC-Clio, Inc., an international publisher of historical reference materials for institutions of higher education. Mr. Papa received a B.S. in Management from Iona College, in New Rochelle, New York. JAMES P. PISANI, age 34, has been the President of the Company since February 1998, and has served as Chief Operating Officer, Chief Financial Officer and Secretary of the Company since October 1996. Mr. Pisani has also served as Chief Accounting Officer of the Company since October 1998. From October 1996 to February 1998, Mr. Pisani was the Executive Vice President of the Company. Prior to October 1996, he served as Vice President of Sales and National Accounts for ICS. While at ICS, Mr. Pisani was responsible for that firm's business-to-business and consumer sales activities. Prior to joining ICS, from June 1989 to June 1994, Mr. Pisani served as Vice President of a national mortgage banking firm serving, primarily, institutional accounts. Mr. Pisani graduated from Princeton University in 1986, with a degree in Economics. 10 M. SCOTT HALL, age 40, was appointed Senior Vice President of the Company's Channel Markets Group in October 1998. From November 1994 to September 1998, Mr. Hall was Vice President of One Call Communications, Inc., a long-distance and Internet service provider. Prior to that time, Mr. Hall was Manager, Business Development for Transnational Communications. Mr. Hall graduated from the University of Hawaii in 1982, with a B.A. in Sociology. FRANK A. LEONE, age 52, was appointed President of the Company's Business Markets Group in November 1998. From November 1996 to July 1998, Mr. Leone was Executive Vice President of Sales for First Image Management Company, a division of First Data Corporation. From November 1994 to November 1996, Mr. Leone was President of FAL Consultants, in which capacity he provided strategy and marketing consulting to corporations. Prior to that time, Mr. Leone held an executive management position with Recycled Paper Greetings, the fourth largest greeting card manufacturer in the U.S., and executive management positions with Baxter Healthcare Corporation and Xerox Corporation. Mr. Leone graduated from Gannon University, Erie, Pennsylvania, with a B.S. in Business Administration. JOE RENTERIA, JR., age 52, was appointed Vice President, Information Systems of AvTel on February 25, 1999. Prior to that time, he had been employed for more than five years by Matrix. During his tenure with Matrix, Mr. Renteria has served as Manager of Data Processing, Director of Information Services and was promoted to Vice President of Information Services in May of 1997. Prior to joining Matrix, Mr. Renteria held various information technology management positions, primarily in the manufacturing sector. RECENT DEVELOPMENTS BOARD OF DIRECTORS On December 17, 1998, Gregory T. Mutz resigned from the Company's Board of Directors. On April 9, 1999, the Board elected Anthony D. Martin to fill the vacancy created by the resignation of Gregory T. Mutz. STOCK REPURCHASE In connection with a newly -established employee incentive plan, on January 29, 1999, AvTel commenced a small program to repurchase shares of its own Common Stock on The Nasdaq SmallCap Market. In connection with this program, AvTel spent approximately $77,400 to repurchase 11,075 shares of the Common Stock. These shares will be held in treasury. SALE OF SERIES B CONVERTIBLE PREFERRED STOCK 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 low closing bid price for the Common Stock on The Nasdaq SmallCap Market at the time 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 11 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 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 arranging the placement of the Series B Stock. RISK FACTORS IN EVALUATING THE COMPANY, ITS BUSINESS, OPERATIONS AND FINANCIAL POSITION, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS FORM 10-K. THE FOLLOWING FACTORS, AMONG OTHERS, COULD AFFECT THE COMPANY'S ACTUAL FUTURE OPERATING RESULTS AND COULD CAUSE SUCH RESULTS TO DIFFER FROM THE RESULTS DISCUSSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY. LOSSES; OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS The Company has had significant recurring losses in its last four fiscal quarters. The Company's future operating results are difficult to forecast with any degree of accuracy because a number of factors (including those described below) subject these results to significant fluctuations. FACTORS INFLUENCING OPERATING RESULTS, INCLUDING REVENUES, COSTS AND MARGINS The Company's revenues, costs and expenses have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future as a result of numerous factors. The Company's revenues in any given period can vary due to factors such as call volume fluctuations; the addition or loss of major customers, whether through competition, merger, consolidation or otherwise; pricing pressure resulting from increased competition; and technical difficulties with or failures of portions of the network used by the Company that impact the Company's ability to provide service to or bill its customers. The Company's cost of services and operating expenses in any given period can vary due to factors such as fluctuations in rates charged by carriers to terminate the Company's traffic; increases in bad debt expense and reserves; compensation expense resulting from stock options granted by the Company; changes in the Company's sales incentive plans; and costs associated with changes in staffing levels of sales, marketing, technical support and administrative personnel. In addition, the Company's operating results can vary due to factors 12 such as loss of favorable routing options; actions by regulatory entities; and general economic and political conditions. VOLATILITY OF STOCK PRICE The Company's Common Stock has been traded on The Nasdaq SmallCap Market since May 28, 1998. Trading in the Company's stock was halted by Nasdaq after the close of trading on November 12, 1998, through the close of trading on November 13, 1998, as a result of an unusual upsurge in its stock price and trading volume. See "Legal Proceedings." The trading volume of the Common Stock has been variable, but generally low. As a result, relatively small trades may significantly affect the market price of the Common Stock. The market price of the shares of Common Stock has been highly volatile and may be significantly affected by factors such as actual or anticipated fluctuations in the Company's operating results, the announcement of potential acquisitions by the Company, changes in regulations, activities of the largest domestic providers, industry consolidation and mergers, conditions and trends in the telecommunications market, adoption of new accounting standards affecting the telecommunications industry, changes in recommendations and estimates by securities analysts, general market conditions and other factors. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the shares of emerging growth companies like the Company. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. SECURITIES CLASS ACTION LITIGATION As noted above, on November 12, 1998, the Company experienced an unusual upsurge in its stock price and trading volume. This unusual event has triggered the initiation of class action litigation under the federal securities laws. See "Legal Proceedings." The Company believes that these claims are without merit and intends to defend vigorously this litigation. However, it is not possible at this time for the Company to predict with certainty the outcome of this litigation. Even if the Company prevails in the litigation, the expenses of the defense could have a material adverse effect on the Company's operating results and financial condition. RISKS INHERENT IN ACQUISITION STRATEGY An important component of the Company's past growth has been to develop its business through acquisitions. This growth strategy is dependent on the continued availability of suitable acquisition candidates and subjects the Company to a number of risks. Acquisitions may place significant demands on the Company's financial and management resources, as the process for integrating acquired operations presents a significant challenge to the Company's management and may lead to unanticipated costs or a diversion of management's attention from day-to-day operations. There can be no assurance that the Company will be able to successfully integrate any acquisitions made by the Company in the future into Company operations. Additionally, the Company may incur unknown liabilities despite management's efforts to investigate the operations of the acquired business. POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION The Company's business is subject to various federal and state laws, regulations, agency actions and court decisions. These laws, regulations, actions and decisions may impose prior certification, notification, registration and/or tariff requirements. Certificates of authority can generally be conditioned, modified or revoked by state regulatory authorities for failure to comply with state laws and regulations. Fines and other penalties, including revocation of a certificate of authority, may be imposed. In addition, future changes in any of these sources of regulation could have a material adverse effect on the Company's business, operating results and financial condition. 13 DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the efforts of senior management personnel, in particular, Anthony E. Papa, the Company's Chairman and Chief Executive Officer, and James P. Pisani, the Company's President and Chief Operating Officer. The Company believes that its future success will depend in large part upon its continuing ability to attract and retain highly skilled personnel. Competition for qualified, high-level telecommunications personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of the services of one or more of the Company's key individuals, or the failure to attract and retain other key personnel, could materially adversely affect the Company's business, operating results and financial condition. SIGNIFICANT COMPETITION The telecommunications industry is intensely competitive and subject to rapid change. The Company's competitors include facilities-based and non-facilities-based providers, many of which have substantially more resources than the Company. Providers compete on the basis of price, customer service, transmission quality, breadth of service offerings and value-added services. Additionally, the telecommunications industry is in a period of rapid technological evolution, marked by the introduction of competitive product and service offerings, such as the utilization of the Internet for international voice and data communications. The Company is unable to predict which technological development will challenge its competitive position or the amount of expenditures will be required to respond to a rapidly changing technological environment. The Company believes that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect the Company's gross margins if the Company is not able to reduce its costs commensurate with such price reductions. NEED FOR ADDITIONAL CAPITAL In the past, the Company's cash flow from operations, together with its secured borrowings, has been sufficient to meet its working capital and capital expenditure requirements. The Company does not expect to generate sufficient cash flow to fully implement its business strategy without raising additional capital. The Company is actively pursuing an equity line of credit through discussion with potential investors. If the Company is unable to obtain financing in a timely manner and on acceptable terms, management is developing and intends to implement a plan that would allow the Company to continue to operate through 1999. This plan would include reducing the Company's workforce, eliminating advertising expenditures, reducing professional services and reducing or eliminating other discretionary expenditures. YEAR 2000 COMPUTER PROGRAM FAILURE A significant percentage of the software that runs most of the computers in the United States relies on two-digit date codes to perform computations and decision -making functions. Commencing on January 1, 2000, these computer programs may fail from an inability to interpret date codes properly, misinterpreting "00" as the year 1900 rather than 2000. In association with Electronic Data Systems Corporation (the Company's principal software vendor for such systems), the Company is in the process of upgrading the Company's billing, credit and call tracking systems to become Year 2000 compliant, at a cost to the Company of approximately $750,000. At the same time, a number of the computers of the Company's vendors that interface with the Company's systems may run on programs that have Year 2000 problems and may disrupt the Company's billing, credit and tracking systems. Failure of any of the computer programs integral to the Company's vendors could adversely affect the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 14 FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-K, including without limitation, statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward - looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward - looking statements. Such factors include, among others, those set forth above. GIVEN THESE UNCERTAINTIES, THE STOCKHOLDERS OF THE COMPANY ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. ITEM 2. PROPERTIES The Company does not own any real property. The table below sets forth certain information with respect to the material properties leased by the Company, including the Company's executive offices in Santa Barbara, California. All of such properties consist of office space. The Company and its subsidiaries also operate points-of-presence for the purpose of creating local access points to its network backbone.
CURRENT MONTHLY LOCATION SQUARE FEET EXPIRATION DATE(2) RENT(1) - ----------------------------------------------------------------- ----------- ------------------ -------------- 501 Bath Street.................................................. 6,798 March 2003 $ 11,863 Santa Barbara, CA 8721 Airport Freeway............................................. 24,500 June 2000 $ 23,050 Fort Worth, TX 104 West Anapamu................................................. 3,441 November 2001 $ 4,800 Suites C&D Santa Barbara, CA 70 West 36(th) St., Suite 605.................................... 2,500 December 2002 $ 4,800 New York, NY 38 East 32(nd) St., 8(th) Floor.................................. 4,400 February 2004 $ 4,416 New York, NY 1600 Parkwood Circle............................................. 2,190 December 2001 $ 3,750 Suite 603 Atlanta, GA 2333 Mill Creek Drive............................................ 1,446 February 2001 $ 3,370 Suite 120 Laguna Hills, CA
- ------------------------ (1) All amounts shown are on a "triple net" basis. (2) Subject to certain renewal options held by the Company. ITEM 3. LEGAL PROCEEDINGS The Company is the defendant in a class action under the federal securities laws (IN RE AVTEL SECURITIES LITIGATION, Case No. 98-9236) currently pending in the United States District Court for the Central District of California. This litigation is the consolidation of five separate class action suits that were filed against the Company and certain of its officers, alleging securities fraud. The plaintiffs are members of the class of investors who purchased shares of the Company's Common Stock on November 12, 1998. On that day, the 15 trading price for the Common Stock on The Nasdaq SmallCap Market rose from $2.125 to $31 per share, with more than 3 million shares trading. The plaintiffs allege that a press release issued by the Company on November 12, 1998, announcing the launch of its subsidiaries' DSLink Service for high speed Internet access, and an interview with AvTel Chief Executive Officer Anthony E. Papa concerning that service, as reported by Bloomberg News, were misleading and caused a fraud on the market for the Company's publicly-traded securities. This matter is still in the early stages of litigation. The plaintiffs filed a consolidated and amended complaint on March 15, 1999, and the Company is in the process of responding to that complaint. The plaintiffs have yet to state the amount of damages they seek. The Company contends that its statements were not misleading, and intends to defend vigorously this securities litigation. However, it is not possible to predict at this time the likely outcome of this action or the cost the Company will incur in defending the action. The Company is not aware of any proceedings against the Company contemplated by any governmental authority. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 16 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Since May 28, 1998, the Company's Common Stock has been traded on The Nasdaq SmallCap Market under the trading symbol "AVCO". Prior to its listing on The Nasdaq SmallCap Market, the Common Stock traded on the Electronic Bulletin Board. There is no established public trading market for the Company's Preferred Stock. The following table sets forth, for the indicated periods, high and low price information for the Company's Common Stock. High and low bid information is provided with respect to periods prior to May 28, 1998. High and low prices for periods after May 28, 1998, reflect high and low sales prices. Such information was provided by Nasdaq, various market makers and on-line quote reporting services. The quotations provided reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. All prices have been adjusted to reflect the Reverse Stock Split.
YEAR ENDING DECEMBER 31, 1997 HIGH LOW First Quarter $ 3.50 $ 2.00 Second Quarter $ 18.00 $ 3.13 Third Quarter $ 19.00 $ 9.75 Fourth Quarter $ 19.00 $ 7.00 YEAR ENDING DECEMBER 31, 1998 First Quarter $ 8.63 $ 4.94 Second Quarter $ 15.88 $ 7.67 Third Quarter $ 8.00 $ 1.75 Fourth Quarter $ 31.00 $ 2.00
The number of shareholders of record of the Company Common Stock as of March 17, 1999, was 396. At that date there were two record holders of the Company's Preferred Stock. The Company has not paid any cash dividends on its Common Stock to date and does not anticipate paying dividends in the foreseeable future. It is the present intention of management to utilize all available funds for the development of the Company's business. The terms of the Company's Series A Convertible Preferred Stock prevent the payment of any dividend on the Company's Common Stock unless (1) all cumulative dividends on the Series A Convertible Preferred Stock have been fully paid, and (2) the holders of at least 50% of the outstanding shares of the Series A Convertible Preferred Stock have approved such dividend. The terms of the Company's Series B Convertible Preferred Stock also prohibit payment of any dividends on the Common Stock prior to the holder of the Series B Stock receiving their dividends. In addition, the terms of the Company's secured credit agreement provide that the Company cannot declare a dividend on any of its ownership interests without the secured lender's approval. In July 1997, New Best Connections, Inc. ("Best"), a subsidiary of Matrix, issued options to purchase Matrix Common Stock to 41 individuals in recognition of their past services to Best, Matrix and related companies (and in satisfaction of certain obligations of Best to shareholders of Matrix who had contributed shares of Matrix stock to Best for this purpose). As a result of the Share Exchange, the shares of Matrix Common Stock subject to such options were converted into shares of the Company's Common Stock. The exercise price for such options was $1.50 per share. During the year ending December 31, 1998, (1) options were exercised for 107,250 shares, (2) options for 67,250 shares were cancelled in connection with the exercise of other options, and (3) options for 73,000 shares were forfeited or expired unexercised. At December 31, 1998, none of such options remained outstanding. No underwriters were used in connection with these option exercises and none of the shares issued upon exercise was issued publicly. The Company 17 has relied on the exemptions from registration provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The optionees 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. On November 19, 1998, the Company issued 650,000 shares of its Common Stock, which were not registered under the Securities Act, in connection with the acquisition of Remote Lojix/PCSI, Inc., a New York corporation ("RLI"). 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 persons receiving shares were the 20 shareholders of RLI. These persons 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. Each such person signed a stock purchase agreement containing appropriate investment representations and covenants. ITEM 6. SELECTED FINANCIAL DATA For accounting purposes, the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. Accordingly, the Company's results of operations reflect the operations of Matrix prior to December 1, 1997 and reflect the combined operations of AvTel and Matrix subsequent to December 1, 1997. The following selected operations data of the Company for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 and balance sheet data as of December 31, 1998, 1997, 1996, 1995 and 1994 have been derived from the Company's (or Matrix's) audited financial statements. These selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere herein. STATEMENT OF OPERATIONS DATA:
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------- -------------- ------------- ------------- ------------- Revenues............................ $ 44,013,498 $ 51,389,080 $ 71,558,295 $ 64,289,718 $ 59,551,307 Operating income (loss)............. (7,423,753) (10,757,960) 4,091,034 2,422,393 604,109 Net income (loss)................... (7,127,318) (10,191,720) 2,566,734 (2,440,493) 643,200 Net loss per common share --basic and diluted............... (0.74) (1.23) N/A N/A N/A Cash dividends per common share...................... -- -- -- -- --
- ------------------------ N/A--Not applicable BALANCE SHEET DATA:
AS OF DECEMBER 31, ------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------- ------------- ------------- ------------- ------------- Working capital (deficit)............ $ (3,022,959) $ 5,570,657 $ 6,066,620 $ 206,071 $ (140,741) Total Assets......................... 14,634,354 18,724,850 20,338,404 17,580,694 14,957,279 Long term borrowings................. 1,112,890 -- -- -- -- Stockholders' Equity................. 3,185,253 7,809,048 7,861,883 3,539,522 2,372,333
- ------------------------ Notes to Selected Financial Data 18 (1) Matrix was originally formed May 29, 1990 as a Texas general partnership. The partners consisted of Matrix Communications, Limited ("MCL") a Texas limited liability partnership and Onward and Upward, Inc. ("OUI"). Effective January 1, 1994, the partnership was dissolved. Prior to the dissolution, cash distributions were made to OUI in satisfaction of its partnership interest. Concurrent with the dissolution, all remaining tangible and intangible assets and liabilities of Matrix then owned by MCL were transferred to Matrix Telecom, Inc., a Texas corporation. Effective June 30, 1995, MCL was liquidated and its sole asset (Matrix capital stock) was distributed to MCL's partners in proportion to their ownership interests. (2) Matrix's original stock issuance consisted of 100 common shares. Effective December 31, 1994, a 10 for 1 stock split was declared. Concurrent with the dissolution of MCL on June 30, 1995, Matrix's then outstanding 1,000 shares of common stock were canceled and 100,000 shares were distributed to the prior MCL partners in proportion to the ownership interest in MCL. Effective March 10, 1997, an 18 for 1 stock split was declared resulting in 3,484,260 shares being then outstanding. On December 1, 1997, the Company effected the Reverse Stock Split as part of the Reincorporation Merger, and then acquired Matrix through the issuance of 9,582,493 shares of Common Stock (including 1,999,997 shares held as treasury stock after the Share Exchange which have subsequently been cancelled). All share amounts have been restated to reflect the stock splits and share exchanges. (3) In October 1995, Matrix issued 2,405,499 shares of its common stock valued at $3,607,682 in exchange for all of the outstanding common stock of DNS Communications, Inc., a Houston based long distance reseller. Subsequent to the acquisition, the operations of DNS generated substantial losses. DNS's customer churn rate and bad debts as well as projected cash flows were evaluated as of December 31, 1995, and it was determined that the remaining investment in the DNS acquired customer base totaling approximately $4,462,000 should be written off. (4) Per share amounts are not reflected for 1996, 1995 and 1994 due to the recapitalization of the Company as a result of the reverse acquisition in 1997. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKGROUND The following information should be read in connection with the consolidated financial statements of the Company and related notes included elsewhere in this report. SHARE EXCHANGE As described above under "Business--Background--Acquisition of Matrix," on December 1, 1997, AvTel and Matrix completed the Share Exchange. For accounting purposes, the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. 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. In addition, holders of Matrix outstanding stock options received non-qualified stock options of AvTel. The following discussion of results of operations reflects the operations of Matrix prior to December 1, 1997 and reflects the combined operations of AvTel and Matrix subsequent to December 1, 1997. Accordingly, references to the Company refer to operations of Matrix prior to the Share Exchange and the combined operations of Matrix and AvTel subsequent to the Share Exchange. The reverse acquisition of AvTel by Matrix was accounted for using the purchase method of accounting. In order to value the consideration given in the Share Exchange, the market price of AvTel's Common Stock for a period immediately preceding the announcement of the Share Exchange was used. As of the date of acquisition, the Company determined the fair value of the net tangible and intangible assets and liabilities acquired. The underlying fair value of AvTel's net assets was substantially less than the indicated market value of AvTel's common and preferred stock. Accordingly, the Company recorded a charge to income of $9.1 million immediately subsequent to the reverse acquisition. 19 ACQUISITION OF NEW BEST CONNECTIONS, INC. Effective July 1, 1997, Matrix acquired New Best Connections, Inc., a Texas corporation ("Best"), an affiliate of Matrix through substantially similar common ownership, by means of a share-for-share exchange. Best's primary assets were cash of $211,000, ownership of shares of Matrix common stock, and Best's relationships with the field force of sales agents. The assets and liabilities of Best were recorded at their historical cost, which approximated the fair value of such assets as of July 1, 1997. ACQUISITION AND DISPOSITION OF DNS COMMUNICATIONS, INC. In October 1995, Matrix issued shares of its common stock valued at $3.6 million in exchange for all of the outstanding common stock of DNS Communications, Inc. ("DNS"), a Houston-based long distance reseller. The transaction was accounted for under the purchase method. The purchase price in excess of the book value of DNS net assets was pushed down to DNS and was allocated based upon the estimated fair value of the assets and liabilities acquired at the date of acquisition. Subsequent to the acquisition, the operations of DNS generated substantial losses. DNS's customer churn rate and bad debts as well as projected cash flows were evaluated and as of December 31, 1995 it was determined that the remaining investment in the DNS acquired customer base totaling approximately $4.4 million should be written off. In June 1996, Matrix sold the customer base acquired in the DNS acquisition in addition to certain blocks of customers acquired during 1995 and 1996 together with related assets to a former officer of Matrix and a former shareholder of DNS for approximately $5.2 million. Matrix recorded a gain on this sale of approximately $3.2 million. Due to the timing of the acquisition and subsequent decision to sell the operations of DNS, Matrix has recorded its interest in DNS operations using the equity method of accounting. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997 REVENUES Revenues for the year ended December 31, 1998 decreased 14.4% or $7.4 million to $44.0 million from $51.4 million for the year ended December 31, 1997. The decrease in revenues resulted primarily from the reorganization and repositioning of the Company's Channel Markets Group ("CMG"). The focus of the Company is to be a provider of broadband network services integrating voice, data and internet solutions to mid-size corporations, small-office home-office professionals and select residential market segments. Historically, CMG has focused on selling retail long distance telephone 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. The primary source of revenues of the Company during 1998 continued to be voice distribution channels. Factors similar in nature to those affecting all resellers of long distance have continued to effect a decline in revenues. 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, terminated the direct marketing of casual calling products and discontinued the telemarketing of residential customers. Long distance revenue, excluding discontinued sales channels, decreased 9.5% while the associated minutes of usage decreased only 3.8% for the year ended December 31, 1998 compared to the year ended December 31, 1997. Long distance revenue from affiliated companies was $4.6 million and $3.6 million for the years ended December 31, 1998 and December 31, 1997, respectively. 20 Decreases in revenues were additionally affected by a continued attrition and price reductions of a maturing customer. The effects of reduced revenue from discontinued sales channels is expected to be offset by increasing revenues from the Company's repositioning of CMG and the addition of new marketing organizations. The effects of competitive lower pricing as well as the decline of the customer base is expected to lessen dramatically as pricing decreases within the industry and reaches its floor, and the Company increases its focus on third party distributors, affinity groups and niche markets. Management additionally anticipates that the revenue decrease will stabilize as the continued integration of and revenue from the Business Markets Group ("BMG") targeting corporate data networking, voice and Internet service needs continues to expand and grow beyond the long distance portion. Decreases in revenues resulting from the Share Exchange of AvTel and Matrix effective December 1, 1997 were anticipated by the Company beginning in the first quarter of 1998. At that time, the management team chose to discontinue and reduce certain unprofitable distribution channels. Management continued throughout 1998 to reduce the Company's dependence on low margin, high churn segments and to focus its resources in the business markets with higher average billing and retention rates, niche ethnic consumer markets, small office-home office distributors and agents, and internet service providers. For the year ended December 31, 1998, revenues generated from discontinued sales channels decreased 43.4% or $8.2 million to $10.7 million from $18.9 million for the year ended December 31, 1997. Long distance revenue generated from agents increased 3.5% or $665,000 to $19.5 million for the year ended December 31, 1998 from $18.9 million for the year ended December 31, 1997. 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 the Company's 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. With the acquisition of RLI effective November 1, 1998, the Company recognized $1.0 million in technology systems integration and repair service revenues for the two months ended December 31, 1998. GROSS MARGIN Gross margin decreased $3.0 million to $12.2 million for the year ended December 31, 1998 from $15.2 million for the year ended December 31, 1997. As a percentage of revenues, gross margin decreased by 1.9 percentage points to 27.6% for the year ended December 31, 1998 from 29.5% for the year ended December 31, 1997. The decrease in gross margin as a percentage of revenues primarily resulted from an increase in bad debt expenses, which was partially offset by decreases of network cost from renegotiated contracts and leased facilities, all of which are included in cost of sales. Network cost as a percentage of revenues decreased by 1.3 percentage points to 65.2% for the year ended December 31, 1998 from 66.5% for year ended December 31, 1997. The primary factor that effected this decrease was significantly lower wholesale rates, which went into effect March and July of 1998, negotiated with the Company's major underlying carriers. Bad debt expense as a percentage of revenues increased by 2.6 percentage points to 6.2% for the year ended December 31, 1998 compared to 3.6% for the year ended December 31, 1997. The increased bad debt expense primarily resulted from decreased collection percentages from the Local Exchange Carriers ("LECs") in certain geographical regions, primarily the northeastern portion of the United States. This related principally to the Company's now discontinued casual calling business. 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 casual calling was experienced in the northeastern portion of the United States in which the LECs' collection percentages were considerably lower, and the 21 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 bad debt percentages experienced by the Company's internal collection staff are significantly lower than those of the LECs. For the fourth quarter of 1998, the Company experienced an average bad debt percentage of 3.8% on direct billed products and 9.1% on LEC billed products. 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 December 31, 1998, 58% of the Company's revenue was direct billed compared to 23% as of December 31, 1997. SELLING, GENERAL, AND ADMINISTRATIVE COSTS Selling, general, and administrative costs increased $2.4 million to $18.5 million for the year ended December 31, 1998 from $16.1 million for the year ended December 31, 1997. As a percentage of revenues, selling, general, and administrative costs increased by 10.6 percentage points to 42.0% for the year ended December 31, 1998 from 31.4% for the year ended December 31, 1997. The primary reason for the increase to selling, general, and administrative costs was the expanded sales force and related expenses including general office expense, rent, utilities and travel expenditures. The remaining increase in cost was attributable to the purchase of RLI by the Company, effective November 1, 1998. As of December 31, 1998, the Company had three primary business locations, eight additional sales locations throughout the United States and 47 sales and marketing related employees compared to two primary business locations, two remote sales locations and 21 sales and marketing related employees as of December 31, 1997. The decrease in revenue as explained above resulted in a decrease in selling expenses of $1.6 million for the year ended December 31, 1998. Stock compensation expense for the year ended December 31, 1998 was $477,000 compared to $749,000 for the year ended December 31, 1997. The change was due primarily to two circumstances. First, during 1998, the Company caused certain options previously granted to accelerate (and to expire if not exercised before December 13, 1998). As a result, fewer of such options were exercised than contemplated in 1997, and the stock price used to calculate stock compensation expense for such options was considerably lower than in 1997. The resulting decrease in stock compensation expense was partially offset by additional expense recognized in connection with the early vesting of a restricted stock grant to a departing director. 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. DEPRECIATION AND AMORTIZATION Depreciation and amortization increased $427,000 to $1,107,000 for the year ended December 31, 1998 from $680,000 for the year ended December 31, 1997. The increase primarily resulted from amortization of the acquired customer base associated with the Share Exchange of AvTel and Matrix effective December 1, 1997. The customer base is amortized on a straight-line basis over five years. Similarly, the acquisition and consolidation of assets related to the Share Exchange resulted in some increases in depreciation expense. As a result of the acquisitions of DMI and RLI in the fourth quarter of 1998, the company recognized goodwill in the amount of $4.5 million. Goodwill is amortized on a straight-line basis over fifteen years. RLI comprised $4.4 million of goodwill. Goodwill was determined by the purchase price in excess of net liabilities assumed. RLI provides service and installation of local area networks. Their name and reputation in their existing geographical area is strong and facilitates RLI's entry into other geographical markets. The service provided is generally recurring and RLI's clientele is comprised of large, stable companies that are loyal to their product and level of service provided. 22 INTEREST EXPENSE AND OTHER INCOME, NET Interest expense and other income net of other expenses decreased $195,000 to $95,000 for the year ended December 31, 1998 from $290,000 for the year ended December 31, 1997. Interest expense increased $74,000 to $86,000 for the year ended December 31, 1998 from $12,000 for the year ended December 31, 1997 due to interest on the Coast Business Credit line of credit and leased equipment acquired as the result of the Share Exchange of AvTel and Matrix. Other income decreased $121,000 to $181,000 for the year ended December 31, 1998 from $302,000 for the year ended December 31, 1997 primarily due to the decrease of interest earned from cash investments. INCOME TAXES The Company recognized a tax benefit of $202,000 for the year ended December 31, 1998 compared to $276,000 for the year ended December 31, 1997. The tax benefit in 1998 resulted from the loss from operations. As of December 31, 1998, the Company has net operating loss carryforwards for federal tax purposes of approximately $9.1 million which are available on a limited basis to offset future federal taxable income, if any, through 2018. YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996 REVENUE Revenue for the year ended December 31, 1997, decreased 28.1% or $20.2 million to $51.4 million from $71.6 million for the year ended December 31, 1996. The decrease in revenue resulted primarily from decreases in sales from three significant sales channels, all of which were affiliated with the Company through substantially common ownership prior to the Share Exchange of AvTel and Matrix effective December 1, 1997. These sales channels were a distributor selling via telemarketing, a distributor focusing on the casual or dial-around customer, and a DNS distributor of long distance services. The relationship with the DNS distributor was terminated resulting from the sale of the DNS customer bases in June of 1996. The Company in 1997 chose to reduce its focus on the promotion of the dial-around customer due to the significant costs of direct mailing and bad debt associated with this product. Reduced sales from the telemarketing distributor resulted from the erosion of the retail pricing in the market for the residential consumer. Pricing continued to decline during 1997, and attrition from a maturing customer base resulted in losing customers on higher gross margin products. Attrition rates associated with long distance products are a normal industry occurrence; however, methods of calculation differ within the industry. The Company sought to reduce its risk from reliance on a small group of distributors, and refocused to obtain multiple revenue sources external to the Company. New distributors significantly contributed to the mix in 1997. 1997 sales from sources other than the Company's primary 1996 distributors increased more than 20%. GROSS MARGIN Gross margin decreased $8.7 million in 1997, to $15.2 million for the year ended December 31, 1997 from $23.9 million for the year ended December 31, 1996. As a percentage of net sales gross margin decreased 3.9 percentage points to 29.5% for the year ended December 31, 1997 from 33.4% for the year ended December 31, 1996. Two primary factors contributed to the decrease in gross margin in 1997. First, due to increasing competitive market demands, the Company was forced to continue decreasing its retail rates in 1997 to meet the competitive rate reductions; however, the underlying carrier costs to the Company did not change due to contractual commitments. Accordingly, cost of network as a percentage of revenue increased reflecting a lower gross margin in 1997 over 1996. 23 Second, bad debt as a percentage of revenue increased approximately 2% in 1997, primarily resulting from increased bad debt associated with the casual or dial-around product. The majority of the Company's revenues were billed and collected from the Local Exchange Carriers ("LECs"), with which the Company has agreements. Collection policies and aggressiveness in collection procedures differ among the LECs. The Company experienced significant sales growth in a geographical location in which the LECs bad debt percentages were significantly higher than other LECs. SELLING, GENERAL, AND ADMINISTRATIVE COSTS The Company's selling, general, and administrative costs decreased $2.7 million in 1997 from 1996. As a percentage of revenue, such costs increased 5.1 percentage points to 31.4% for the year ended December 31, 1997 compared to 26.3% for the year ended December 31, 1996. This increase resulted primarily from the decrease in revenues causing the expense as a percentage of revenue to increase. Certain changes are more fully described below. Certain selling, general, and administrative costs related to the addition of AvTel operations to Matrix subsequent to the effective date of the Share Exchange, December 1, 1997, amounted to approximately $286,000, accounting for .56% of the increase as a percentage of revenues in 1997 over 1996. Selling costs related to direct mailing to the casual or dial-around customer (which were absorbed by the sales distributor in 1996) were approximately $605,000 in 1997, accounting for 1.18% of the increase as a percentage of revenues in 1997 over 1996. Salary expenses increased approximately $651,000 between the years, or 3.76% as a percentage of revenues in 1997 over 1996, resulting primarily from integration of AvTel employees subsequent to the Share Exchange and the addition of certain sales and marketing personnel in 1997. Billing and collection fees and distributor commissions decreased approximately $3.9 million, or 1.82% as a percentage of revenues. Most of the new products sold in 1997 were direct billed. As the percentage of direct billed customers increased, billing and collection fees have decreased. Similarly, as sales of certain products having a higher commission structure have declined, commission expense has also declined. Certain regulatory and professional services increased approximately $266,000, or 1.22% as a percentage of revenues in 1997 over 1996. Carrier fees specific to telecommunication providers upon reaching certain thresholds of customers were met in the last half of the year in 1996; therefore, increased fees in 1997 resulted from being charged the lower volume based fees for a full year. Professional fees increased in 1997 over 1996 for two primary reasons. First, due to increased market demands for information systems programmers, the Company was forced to secure external contractors. Second, certain telemarketing and verification costs associated with the sales process increased in 1997 primarily resulting from the sales distributor absorbing these costs in 1996. Other selling, general and administrative costs decreased approximately $213,000 in 1997. As a percentage of revenue, these costs increased .81% in 1997 over 1996 due to decreasing revenues. ACQUISITION-RELATED WRITEOFF The $9.1 million write off relates to the Share Exchange and is discussed under "Background" above. DEPRECIATION AND AMORTIZATION Depreciation and amortization expense decreased approximately $314,000 for the year ended December 31, 1997, compared to the year ended December 31, 1996, resulting primarily from older assets becoming fully depreciated. 24 INTEREST EXPENSE AND OTHER INCOME, NET Interest expense decreased $219,000 to $12,000 for the year ended December 31, 1997 from $231,000 for the year ended December 31, 1996. The decrease resulted from reduced borrowings in 1997 compared to 1996. The Company had sufficient cash from operations to meet operating expenses and capital expenditures. Other income net of other expenses increased more than 11% for 1997 over 1996 primarily resulting from increases in interest earned from cash investments. INCOME TAXES The Company recognized a tax benefit of $276,000 for the year ended December 31, 1997 compared to a tax expense of $1.7 million for the year ended December 31, 1996. The tax benefit in 1997 resulted from the loss from operations for the year 1997. LIQUIDITY AND CAPITAL RESOURCES The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements during the years ended December 31, 1998 and 1997, the Company reported net losses of $7,127,318 and $10,191,720, respectively. In addition, as of December 31, 1998, the Company had a working capital deficit of $3,022,959, and for the year ended December 31, 1998, net cash used in operations totaled $5,978,797. As a result, as of December 31, 1998, unless the Company effects substantial changes in its operating methods, the Company does not have sufficient resources to meet its anticipated operating requirements during 1999 without obtaining additional financing. The Company is actively pursuing an equity line of credit through discussion with potential investors. If the Company is unable to obtain financing in a timely manner and on acceptable terms, management is developing and intends to implement a plan that would allow the Company to continue to operate through 1999. This plan would include significantly reducing the Company's workforce, eliminating advertising expenditures, reducing professional services and reducing or eliminating other discretionary expenditures. 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 December 31, 1998). As of December 31, 1998, borrowing outstanding under the credit facility amounted to $1,113,000 with approximately $1,634,000 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. Subsequent to the end of the year, the Company sold $1,500,000 of its Series B Convertible Preferred Stock in a private placement. The Company is also actively pursuing a private equity line of credit arrangement with potential investors which may enable the Company to raise additional capital through subsequent sales of its Common Stock. See "Business--Recent Developments." The primary sources of operating cash flow for the Company are (1) revenues derived from the sale of information technology and telecommunications services to individuals and business, and (2) its secured credit facility. Minor sources of revenues are received for the provision of back office support to affiliated and non-affiliated companies and for earnings from investment income. 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 billing and collecting directly from the end user. Net cash used in operations totaled $6.0 million for the year ended December 31, 1998, and net cash 25 provided by operations was $1.7 million for the year ended December 31, 1997, and $1.0 million for the year ended December 31, 1996. As of December 31, 1998, the Company had a working capital deficit of $3.0 million. The Company's accounts receivable decreased to $4.8 million at December 31, 1998 from $7.0 million at December 31, 1997. The decrease was primarily due to a corresponding decrease in sales described elsewhere in this discussion. Current liabilities increased to $10.2 million as of December 31, 1998 from $9.8 million as of December 31, 1997. The increase in current liabilities is due to the additional liabilities acquired with the purchase of RLI, offset by the decrease in accrued liabilities due to a corresponding decrease in sales. Sales and excise taxes included in current liabilities increased to $1.4 million for the year ended December 31, 1998 from $736,000 for the year ended December 31, 1997, as a result of the tax liabilities assumed with the purchase of RLI. Due to affiliates decreased to $324,000 for the year ended December 31, 1998 from $2.7 million for the year ended December 31, 1997. In 1998, Pacific Gateway Exchange ("PGE") was no longer affiliated with the Company. As of December 31, 1997, $2.3 million was included in due to affiliates associated with PGE. Prior to the Share Exchange, the Company loaned $2.0 million to an affiliated company, Core Marketing, LLC, during 1997. Of such amount, $201,000 was repaid prior to December 31, 1997, and the remainder was repaid in 1998. The Company has been able to finance its capital expenditures, which have consisted primarily of property and equipment, from funds generated from operations and, commencing in the last quarter of 1998, with the proceeds of its secured credit facility. An important component of the Company's past growth has been to develop its business through acquisitions, including the Share Exchange and the acquisitions of RLI and DMI. The Company intends to continue this strategy. In appropriate circumstances, the Company may utilize its capital stock for acquisitions in addition to debt and equity financing. YEAR 2000 COMPLIANCE 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. 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 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. 26 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 systems, third-party vendors and other telecommunications carriers: - The Company generally plans to remediate Company-owned rating, billing and collection systems through the revision or replacement of current system components. Necessary changes to Company-owned 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 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 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 during 1998 (none of which was related to hardware costs) and anticipates spending an aggregate of approximately $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 27 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. INFLATION The Company does not believe that the relatively moderate rates of inflation over the past three years have had a significant effect on its net sales or its profitability. RECENTLY-ISSUED ACCOUNTING PRONOUNCEMENTS On January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income and net unrealized gains (losses) on securities and is presented in the consolidated statements of stockholders' equity and comprehensive income. The statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Comprehensive income (loss) for the years ended December 31, 1998, 1997 and 1996 is equal to net income (loss) reported for such periods. In 1998, the Company adopted the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, but retains the requirement to report information about major customers. See Note 11 of the Notes To Consolidated Financial Statements for segment disclosures. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. This statement is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. Management does not anticipate that this statement will have a material impact on the Company's consolidated financial statements. ITEM 7A 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 December 31, 1998. 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company and supplementary data are included beginning immediately following the signature page to this report. 28 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the caption "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the captions "Stock Ownership" and "Principal Shareholders." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the captions "Certain Relationships and Transactions." ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The index to the financial statements and financial statement schedules filed as part of this report is set forth immediately following the signature page. (b) The Company did not file any Current Reports on Form 8-K during the quarter ending December 31, 1998. (c) The index to the exhibits filed as part of this report is set forth immediately following the financial statements. 29 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on it behalf by the undersigned, thereunto duly authorized. AVTEL COMMUNICATIONS, INC. Dated: April 14, 1999 By /s/ ANTHONY E. PAPA ----------------------------------------- Anthony E. Papa, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 13th day of April, 1999. AVTEL COMMUNICATIONS, INC. By /s/ ANTHONY E. PAPA ----------------------------------------- Anthony E. Papa, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER (PRINCIPAL EXECUTIVE OFFICER) By /s/ JAMES P. PISANI ----------------------------------------- James P. Pisani, PRESIDENT, CHIEF OPERATING OFFICER AND CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER) By /s/ JOHN E. ALLEN ----------------------------------------- John E. Allen DIRECTOR By /s/ JEFFREY J. JENSEN ----------------------------------------- Jeffrey J. Jensen DIRECTOR By ----------------------------------------- Anthony D. Martin DIRECTOR
30 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE --------- Independent Auditors' Report............................................................................... F-2 Consolidated Balance Sheets, December 31, 1998 and 1997.................................................... F-3 Consolidated Statements of Operations, Years ended December 31, 1998, 1997 and 1996........................ F-4 Consolidated Statements of Stockholders' Equity, Years ended December 31, 1998, 1997 and 1996................................................................................................. F-5 Consolidated Statements of Cash Flows, Years ended December 31, 1998, 1997 and 1996........................ F-6 Notes to Consolidated Financial Statements................................................................. F-7 Schedule II--Valuation and Qualifying Accounts, Years ended December 31, 1998, 1997, and 1996................................................................................................. F-26
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors AvTel Communications, Inc.: We have audited the accompanying consolidated balance sheets of AvTel Communications, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AvTel Communications, Inc. and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Dallas, Texas April 14, 1999 F-2 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997
1998 1997 ------------- ------------- ASSETS Current assets: Cash and cash equivalents........................................................ $ 911,179 4,807,441 Accounts receivable, net......................................................... 4,804,532 6,961,953 Due from affiliates.............................................................. 501,858 2,127,771 Federal and state income tax receivable.......................................... -- 598,970 Other current assets............................................................. 921,435 861,950 ------------- ------------- Total current assets........................................................... 7,139,004 15,358,085 Property and equipment, net........................................................ 1,684,707 1,791,682 Goodwill, net...................................................................... 4,463,747 -- Other assets, net.................................................................. 1,346,896 1,575,083 ------------- ------------- Total assets................................................................... $ 14,634,354 18,724,850 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and other accrued expenses...................................... $ 2,643,761 1,546,762 Accrued network service costs.................................................... 4,217,206 4,319,198 Sales and excise taxes payable................................................... 1,433,483 736,012 Unearned revenue................................................................. 954,101 -- Due to affiliates................................................................ 324,020 2,719,417 Other current liabilities........................................................ 589,392 466,039 ------------- ------------- Total current liabilities...................................................... 10,161,963 9,787,428 Deferred income taxes.............................................................. -- 498,712 Long term borrowings............................................................... 1,112,890 -- Other liabilities.................................................................. 5,381 50,782 Common stock subject to put option (note 4)........................................ 168,867 578,880 ------------- ------------- Total liabilities.............................................................. 11,449,101 10,915,802 ------------- ------------- Stockholders' equity: Preferred stock, authorized 750,000 shares, $0.01 par value...................... -- -- 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 at December 31, 1998 and 1997 respectively. (Liquidation preference of $704,032 December 31, 1998 including dividends in arrears.)................. 1,477 2,077 Common stock, Authorized 20,000,000 shares, $0.01 par value; issued 10,409,473 and 11,437,056 shares at December 31, 1998 and 1997 respectively, including 112,578 and 385,920 shares subject to put options on December 31, 1998 and 1997 respectively................................................................... 102,969 110,511 Additional paid in capital....................................................... 19,630,404 17,138,739 Accumulated deficit.............................................................. (16,549,597) (9,422,279) Treasury stock, none at December 31, 1998 and 1,999,997 common shares at December 31, 1997....................................................................... -- (20,000) ------------- ------------- Total stockholders' equity..................................................... 3,185,253 7,809,048 ------------- ------------- Commitments and contingencies Total liabilities and stockholders' equity..................................... $ 14,634,354 18,724,850 ------------- ------------- ------------- -------------
See accompanying notes to consolidated financial statements. F-3 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------- -------------- ------------- Revenues (note 6).................................................. $ 44,013,498 51,389,080 71,558,295 Cost of revenues (note 6).......................................... 31,849,354 36,227,507 47,674,396 ------------- -------------- ------------- Gross margin................................................... 12,164,144 15,161,573 23,883,899 ------------- -------------- ------------- Operating expenses: Selling, general and administrative (note 6)..................... 18,480,576 16,141,132 18,798,925 Acquisition related write off (note 2)........................... -- 9,098,545 -- Depreciation and amortization.................................... 1,107,321 679,856 993,940 ------------- -------------- ------------- 19,587,897 25,919,533 19,792,865 ------------- -------------- ------------- Operating income (loss)........................................ (7,423,753) (10,757,960) 4,091,034 Interest expense (note 6).......................................... (86,251) (11,692) (230,922) Other income, net.................................................. 181,107 301,580 393,498 ------------- -------------- ------------- Income (loss) before income tax expense........................ (7,328,897) (10,468,072) 4,253,610 ------------- -------------- ------------- Income tax expense (benefit)....................................... (201,579) (276,352) 1,686,876 ------------- -------------- ------------- ------------- -------------- ------------- Net income (loss).............................................. $ (7,127,318) (10,191,720) 2,566,734 ------------- -------------- ------------- ------------- -------------- ------------- Net loss per common share--basic and diluted (note 8).............. $ (0.74) (1.23) ------------- -------------- ------------- -------------- Weighted average number of common shares........................... 9,633,474 8,267,296 ------------- -------------- ------------- --------------
See accompanying notes to consolidated financial statements. F-4 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
PREFERRED STOCK COMMON STOCK -------------------- ---------------------------- SHARES AMOUNT SHARES AMOUNT --------- -------- ------------ ------------- Balances at December 31, 1995........... -- -- 6,872,883 5,336,815 Purchase of common stock.............. -- -- -- -- Issuance of common stock.............. -- -- 1,463,771 2,195,211 Net income............................ -- -- -- -- --------- -------- ------------ ------------- Balances at December 31, 1996........... -- -- 8,336,654 7,532,026 Acquisition of Best (note 2).......... -- -- 934,987 3,361,208 Share for share exchange between AvTel and Matrix (note 2): Reverse acquisition of AvTel........ 207,700 2,077 1,839,563 18,396 Reflect new capitalization of Company........................... -- -- (171,548) (10,802,234) Issuance of common stock for exercise of options.......................... -- -- 15,000 150 Expired put options (note 4).......... -- -- 96,480 965 Stock compensation earned (note 7).... -- -- -- -- Net loss.............................. -- -- -- -- --------- -------- ------------ ------------- Balances at December 31, 1997........... 207,700 $ 2,077 11,051,136 $ 110,511 Conversion of preferred stock (note 4).................................. (60,000) (600) 60,000 600 Issuance of common stock for exercise of options and restricted common stock............................... -- -- 473,326 4,733 Issuance of common stock for acquisitions (note 2)............... -- -- 680,000 6,800 Expired put options (note 4).......... -- -- 48,187 482 Exercised put options (note 6)........ -- -- 185,847 1,859 Purchase of officer notes receivable (note 6)............................ -- -- -- -- Stock compensation earned (note 7).... -- -- -- -- Retirement of treasury stock.......... -- -- (2,201,601) (22,016) Net loss.............................. -- -- -- -- --------- -------- ------------ ------------- Balances at December 31, 1998........... 147,700 $ 1,477 10,296,895 $ 102,969 --------- -------- ------------ ------------- --------- -------- ------------ ------------- RETAINED ADDITIONAL EARNINGS TREASURY STOCK PAID IN (ACCUMULATED ----------------------- CAPITAL DEFICIT) SHARES AMOUNT TOTAL ---------- ------------ ---------- ----------- ----------- Balances at December 31, 1995........... -- (1,797,293) -- -- 3,539,522 Purchase of common stock.............. -- -- (171,548) (439,584) (439,584) Issuance of common stock.............. -- -- -- -- 2,195,211 Net income............................ -- 2,566,734 -- -- 2,566,734 ---------- ------------ ---------- ----------- ----------- Balances at December 31, 1996........... -- 769,441 (171,548) (439,584) 7,861,883 Acquisition of Best (note 2).......... -- -- (1,999,997) (3,317,940) 43,268 Share for share exchange between AvTel and Matrix (note 2): Reverse acquisition of AvTel........ 9,129,040 -- -- -- 9,149,513 Reflect new capitalization of Company........................... 7,064,710 -- 171,548 3,737,524 -- Issuance of common stock for exercise of options.......................... 52,350 -- -- -- 52,500 Expired put options (note 4).......... 143,755 -- -- -- 144,720 Stock compensation earned (note 7).... 748,884 -- -- -- 748,884 Net loss.............................. -- (10,191,720) -- -- (10,191,720) ---------- ------------ ---------- ----------- ----------- Balances at December 31, 1997........... 17,138,739 (9,422,279) (1,999,997) $ (20,000) 7,809,048 Conversion of preferred stock (note 4).................................. -- -- -- -- -- Issuance of common stock for exercise of options and restricted common stock............................... 512,879 -- -- -- 517,612 Issuance of common stock for acquisitions (note 2)............... 1,526,950 -- -- -- 1,533,750 Expired put options (note 4).......... 36,770 -- -- -- 37,252 Exercised put options (note 6)........ 372,918 -- (201,604) (2,016) 372,761 Purchase of officer notes receivable (note 6)............................ (435,000 ) -- -- -- (435,000) Stock compensation earned (note 7).... 477,148 -- -- -- 477,148 Retirement of treasury stock.......... -- -- 2,201,601 22,016 -- Net loss.............................. -- (7,127,318) -- -- (7,127,318) ---------- ------------ ---------- ----------- ----------- Balances at December 31, 1998........... 19,630,404 (16,549,597) -- $ -- 3,185,253 ---------- ------------ ---------- ----------- ----------- ---------- ------------ ---------- ----------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-5 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ----------- ------------ ----------- Cash flows from operating activities: Net income (loss)..................................................................... $(7,127,318) $(10,191,720) 2,566,734 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization....................................................... 1,107,321 679,856 993,940 Amortization of advanced commissions................................................ 220,928 1,355,492 618,791 Acquisition related write off....................................................... -- 9,098,545 -- Gain on disposition of assets....................................................... (83,139) -- -- Provision for bad debts............................................................. 2,727,803 1,829,770 1,461,471 Deferred income taxes............................................................... (498,712) (80,377) (321,678) Stock compensation earned........................................................... 477,148 748,884 -- Equity in income of DNS............................................................. -- -- (122,327) Changes in certain operating assets and liabilities: Accounts receivable............................................................... 374,477 1,969,332 (1,971,970) Due from affiliates............................................................... (106,071) (915,357) 345,336 Federal and state income tax receivable........................................... 583,906 (598,970) -- Other current assets.............................................................. (224,820) 1,787,672 (393,781) Accounts payable and accrued liabilities.......................................... (1,034,923) (2,876,789) (1,397,160) Due to affiliates................................................................. (2,395,397) (1,138,568) (742,663) ----------- ------------ ----------- Net cash provided by (used in) operating activities............................. (5,978,797) 1,667,770 1,036,693 ----------- ------------ ----------- Cash flows from investing activities: Cash received (paid) in acquisitions (note 2)......................................... (474,082) 477,643 -- Loans to affiliate.................................................................... -- (2,000,000) -- Payments received on loans to affiliates.............................................. 1,798,889 201,111 -- Purchase of property and equipment.................................................... (473,089) (212,421) (701,718) Repayments from DNS, net.............................................................. -- -- 1,577,432 Proceeds from sale of property and equipment.......................................... 94,370 2,749 (14,482) ----------- ------------ ----------- Net cash provided by (used in) investing activities............................. 946,088 (1,530,918) 861,232 ----------- ------------ ----------- Cash flows from financing activities: Principal payments on capital leases.................................................. (59,055) (4,306) -- Issuance of common stock for exercise of options...................................... 517,612 52,500 -- Borrowings on line of credit.......................................................... 9,753,467 -- -- Amounts paid on line of credit........................................................ (8,640,577) -- -- Purchase of officer notes receivable.................................................. (435,000) -- -- Purchase of common stock for treasury................................................. -- -- (439,583) ----------- ------------ ----------- Net cash provided by (used in) financing activities............................. 1,136,447 48,194 (439,583) ----------- ------------ ----------- Net increase (decrease) in cash and cash equivalents.................................... (3,896,262) 185,046 1,458,342 Cash and cash equivalents at beginning of year.......................................... 4,807,441 4,622,395 3,164,053 ----------- ------------ ----------- Cash and cash equivalents at end of year................................................ $ 911,179 $ 4,807,441 4,622,395 ----------- ------------ ----------- ----------- ------------ ----------- Cash paid (received) during the year for: Interest.............................................................................. $ 86,121 11,594 212,404 ----------- ------------ ----------- ----------- ------------ ----------- Income taxes, net of refunds.......................................................... $ (487,007) 925,161 1,482,103 Noncash financing activities: Common stock issued for advanced commissions.......................................... $ -- -- 2,195,211 ----------- ------------ ----------- ----------- ------------ ----------- Common stock issued for receivable from major shareholder............................. $ -- -- 723,600 ----------- ------------ ----------- ----------- ------------ ----------- Common stock issued for Best acquisition.............................................. $ -- 3,361,208 -- ----------- ------------ ----------- ----------- ------------ ----------- Treasury stock acquired with Best acquisition......................................... $ -- (3,317,940) -- ----------- ------------ ----------- ----------- ------------ ----------- Common and preferred stock issued in AvTel reverse acquisition........................ $ -- 9,149,513 -- ----------- ------------ ----------- ----------- ------------ ----------- Common stock issued for DMI acquisition............................................... $ 30,000 -- -- ----------- ------------ ----------- ----------- ------------ ----------- Common stock issued for RLI acquisition............................................... $ 650,000 -- -- ----------- ------------ ----------- ----------- ------------ -----------
See accompanying notes to consolidated financial statements. F-6 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997, AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) BUSINESS AND BACKGROUND On December 1, 1997, AvTel Communications, Inc. ("AvTel") and Matrix Telecom, Inc. ("Matrix") completed a share for share exchange pursuant to a stock exchange agreement dated April 29, 1997 as subsequently amended ("Share Exchange"). For accounting purposes, the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. AvTel was the legal acquirer and accordingly, the Share Exchange was effected by the issuance by AvTel of 9,582,493 shares of common stock in exchange for all of the common stock then outstanding of Matrix. In addition, holders of outstanding Matrix stock options received 22,338 non-qualified stock options of AvTel. The purchase method of accounting was used, with Matrix being treated as the acquirer for accounting purposes. The results of operations reported in the accompanying consolidated financial statements reflect the operations of Matrix prior to December 1, 1997 and the combined operations of AvTel and Matrix subsequent to December 1, 1997. References to the "Company" refer to operations of Matrix prior to the Share Exchange and the combined operations of Matrix and AvTel subsequent to the Share Exchange. As a result of the Share Exchange, Matrix became a wholly owned subsidiary of AvTel. (See note 2). The Share Exchange provided that each Matrix shareholder would receive 2.4819 AvTel common shares for each common share of Matrix then issued including treasury shares held by Matrix. For periods prior to the December 1, 1997 Share Exchange, all share amounts have been restated to reflect the Share Exchange as a 2.4819 for one stock split. In addition, on March 10, 1997 Matrix declared an 18 for one stock split. All share amounts have also been restated to reflect this stock split. AvTel was formed to be a provider of broadband network services integrating voice, data and Internet solutions for individuals and corporate customers. The Company sells and markets a broad range of telecommunications and advanced network services through independent value added resellers, third party marketing 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, its Business Markets Group ("BMG") and Channel Markets Group ("CMG"). BMG targets mid-size corporate customers for their broadband data, voice and Internet networking needs. Following this sales strategy, the Company's objective is to become the underlying telecommunications carrier for the transport of data, voice and Internet traffic. Through a value-added sales process, the Company designs, provisions and manages its customers' networks. The Company will provide 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 long distance telephone service, executive calling cards and video/audio conferencing. CMG targets and markets to distribution companies, agents, resellers and affinity groups that maintain access to large groups of individuals and small businesses through affinity relationships and niche marketing strategies. CMG provides Internet access, long distance telephone and other services to customers in 49 states. The Company is fully certified or registered in all states where required and operates under Section 214 authority from the Federal Communications Commission ("FCC"). The Company, through a wholly owned subsidiary, has a national-deployed Carrier Identification Code ("CIC"). The Company maintains its own convergent billing platform, rating system and monitoring center. F-7 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (B) LIQUIDITY The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements during the years ended December 31, 1998 and 1997, the Company reported net losses of $7,127,318 and $10,191,720, respectively. In addition, as of December 31, 1998, the Company had a working capital deficit of $3,022,959, and for the year ended December 31, 1998, net cash used in operations totaled $5,978,797. As a result, as of December 31, 1998, unless the Company effects substantial changes in its operating methods, the Company does not have sufficient resources to meet its anticipated operating requirements during 1999 without obtaining additional financing. The Company is actively pursuing an equity line of credit through discussion with potential investors. If the Company is unable to obtain financing in a timely manner and on acceptable terms, management is developing and intends to implement a plan that would allow the Company to continue to operate through 1999. This plan would include significantly reducing the Company's workforce, eliminating advertising expenditures, reducing professional services and reducing or eliminating other discretionary expenditures. (C) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. (D) CASH AND CASH EQUIVALENTS For purposes of the statement of cash flows, the Company considers all demand deposits, time deposits, and other highly liquid investments with a remaining maturity at date of purchase of less than ninety days to be cash equivalents. (E) COMMISSIONS Commissions to sales agents are paid and expensed based on a percentage of billings as incurred. Commissions paid in advance of $221,000 as of December 31, 1997, included in other current assets, were expensed over a period of eighteen months based on estimated billings of the customers for which the commissions were paid. The above advances were fully expensed during 1998 and no additional advance commission payments were made. (F) REVENUE RECOGNITION Long distance, frame relay, Internet, systems integration and repair service revenues are recognized as service is provided. Amounts paid in advance are recorded as unearned revenue and recognized as services are provided. (G) PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Maintenance and repairs are charged against income as incurred, while renewals and major replacements are capitalized. The cost and related accumulated depreciation of assets sold or retired are removed from the accounts, and any resulting gain or loss is F-8 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) reflected in operations. The Company provides depreciation on fixed assets using the straight-line method over the estimated useful lives of the respective assets. (H) GOODWILL Goodwill of $4.5 million, which is net of amortization of $19,000 as of December 31, 1998, represents the excess of purchase price over fair value of net assets acquired in the DMI and RLI acquisitions and is amortized on a straight-line basis over fifteen years. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future cash flows of the acquired operation. The amount of goodwill impairment, if any, is measured based on expected undiscounted future operating cash flows expected to be generated by the acquired business. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved. (I) INCOME TAXES The Company utilizes the asset and liability method for accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (J) USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (K) CONCENTRATIONS OF CREDIT RISK The Company's subscribers are primarily small business owners and residential subscribers and are not concentrated in any specific geographic region of the United States. The Company has agreements with Local Exchange Companies, which provide billing and collection services to the majority of the Company's subscribers. A significant portion of the Company's accounts receivable is due from these companies. (L) ACCOUNTS RECEIVABLE Accounts receivable are net of allowances for doubtful accounts and other provisions of $935,000 and $982,000 as of December 31, 1998 and 1997, respectively. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of subscribers, historical trends and other information. F-9 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (M) FINANCIAL INSTRUMENTS The Company's financial instruments include cash, receivables, payables, and accrued expenses. The carrying amount of such financial instruments approximates fair value because of the short maturity of these instruments. (N) ACQUIRED CUSTOMER BASE Acquired customer base of $1,240,000, which is net of accumulated amortization of $343,000 at December 31, 1998, included in other assets, is being amortized on a straight-line basis over five years. The Company assesses the recoverability of this intangible asset by determining whether the acquired customer base balance can be recovered through undiscounted future operating cash flows of the acquired operations. The amount of impairment, if any, is measured based on projected discounted cash flows. The assessment of the recoverability of the acquired customer base will be impacted if estimated future operating cash flows are not achieved. (O) IMPAIRMENT OF LONG-LIVED ASSETS In January, 1996, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 121"). SFAS No. 121 requires that long-lived assets and certain intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the net asset exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. (P) COMPREHENSIVE INCOME In 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income includes net income and other comprehensive income, which is generally composed of changes in the fair value of available-for-sale marketable securities, foreign currency translation adjustments and adjustments to recognize additional minimum pension liabilities. The statement requires additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Comprehensive income (loss) for the years ended December 31, 1998, 1997 and 1996 is equal to net income (loss) reported for such periods. (Q) SEGMENT REPORTING In 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" (SFAS No. 131"). SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. (See Note 11). F-10 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (R) RECLASSIFICATIONS Certain reclassifications have been made to prior period amounts in order to conform to current year presentation. (2) ACQUISITIONS MATRIX TELECOM, INC.-- On December 1, 1997, AvTel and Matrix completed the Share Exchange. For accounting purposes the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. 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. In addition, holders of outstanding Matrix stock options received non-qualified stock options of the Company. Immediately after the Share Exchange the former shareholders of Matrix held approximately 84% of the then outstanding common stock of the Company. The consummation of the Share Exchange was subject to the satisfaction of several conditions by AvTel. These included the reincorporation of AvTel (then a Utah corporation; "AvTel Utah") in Delaware by way of a merger (the "Reincorporation Merger") with and into AvTel Communications, Inc., a Delaware corporation, a wholly-owned subsidiary formed for the sole purpose of this merger. As part of the merger, AvTel (the surviving Delaware corporation) issued to its stockholders one share of new Delaware Common Stock for each four shares of AvTel-Utah's Common Stock outstanding immediately prior to the Reincorporation Merger. AvTel's Series A Convertible Preferred Stock and its outstanding options were similarly adjusted. Accordingly, the Reincorporation Merger essentially effected a one for four reverse stock split of AvTel's shares. The reverse acquisition of AvTel by Matrix was accounted for using the purchase method of accounting. In order to value the consideration given in the Share Exchange the market price of AvTel's common stock for a period immediately preceding the announcement of the Share Exchange was used. As of the date of acquisition, the Company determined the fair value of the net tangible and intangible assets acquired and liabilities assumed. Concurrently, the Company determined that the carrying amount of recorded goodwill was not recoverable. Accordingly, the Company recorded a charge to income of $9,098,545 immediately subsequent to the reverse acquisition. In connection with the completion of the Share Exchange, the Company entered into a Registration Rights and Lockup Agreement dated December 1, 1997 (the "Registration Rights and Lockup Agreement"). The Registration Rights and Lockup Agreement requires that the Company use its best efforts to file a shelf registration statement providing for the sale by certain stockholders of all securities issued to them in connection with the Exchange Agreement, subject to a two-year holding restriction imposed on such stockholders. Under the Registration Rights and Lockup Agreement, the Company is obliged to use its reasonable efforts to keep the shelf registration statement effective on a continuous basis for a period described in the Registration Rights and Lockup Agreement. Such stockholders may also require the Company to undertake up to two additional demand registrations of their securities if the shelf registration is not in place. As of April 14, 1999, this registration obligation related to 6,457,123 shares held by 14 stockholders. BEST CONNECTIONS, INC. ("BEST")-- Effective July 1, 1997, shareholders of Best, an affiliate of Matrix through substantially common ownership, contributed their ownership of Best to Matrix in exchange for F-11 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (2) ACQUISITIONS (CONTINUED) 934,987 shares of Matrix common stock. Best's primary assets were 1,999,997 shares of Matrix common stock and cash of $211,000. The assets and liabilities of Best were recorded at their historical cost which approximated the fair value of such assets as of July 1, 1997. As a result of the combination, Matrix assumed the obligation to grant up to 1,999,997 stock options to agents of Best and certain employees of affiliated companies. Such option grants relate to services, including sales promotion activities, to be performed by the recipients on behalf of the Company. Accordingly, the fair value of such options is being charged to expense by the Company as the related services are provided. DIGITAL MEDIA, INC. ("DMI")-- Effective September 25, 1998, the Company acquired all of the capital stock of DMI, a California based developer of multimedia software. The Company exchanged 30,000 shares of its common stock valued at $71,250 for all of the outstanding common stock of DMI. The transaction was accounted for under the purchase method of accounting. The assets and liabilities of DMI were recorded at their historical cost which approximated their fair value at September 25, 1998. The Company recorded goodwill of approximately $117,000, which represents the excess of the purchase price over the fair value of the net assets received. The goodwill is being amortized on a straight-line basis over fifteen years. REMOTE LOJIX/PCSI, INC. ("RLI")-- Effective November 1, 1998, the Company acquired all of the capital stock of RLI, a New York based provider of information technology services to corporate customers. The Company exchanged 650,000 shares of its common stock valued at $1,462,500 and the outstanding balance of a $500,000 loan from the Company for all of the outstanding common stock of RLI. The transaction was accounted for under the purchase method of accounting. The assets and liabilities of RLI were recorded at their historical cost which approximated the fair value at November 1, 1998. The Company recorded goodwill of approximately $4.4 million, which represents the excess of the purchase price over the fair value of the assets received. The goodwill is being amortized on a straight-line basis over fifteen years. Unaudited pro forma results of operations of the Company as if the share exchange of Matrix and the acquisitions of Best, DMI and RLI had occurred as of the beginning of the periods presented is as follows:
YEAR ENDED DECEMBER 31 ------------------------------ 1998 1997 -------------- -------------- Revenue......................................................... $ 49,711,440 $ 58,967,268 Loss from operations............................................ (8,909,490) (12,749,469) Net loss........................................................ (9,124,180) (12,378,014) Proforma net loss per share..................................... $ (0.89) $ (1.02)
The pro forma financial information has been prepared for comparative purposes only and does not purport to indicate the results of operations that would have occurred had the acquisition been made at the beginning of the period indicated, or which may occur in the future. F-12 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (2) ACQUISITIONS (CONTINUED) As of the date of acquisitions, the fair market value of the assets acquired and liabilities assumed included the following:
1998 ----------------------------------------- DMI RLI TOTAL ------------- ----------- ------------- Current assets other than cash........................ $ 50,105 1,034,803 1,084,908 Property and equipment................................ 44,313 132,169 176,482 Goodwill.............................................. 117,169 4,375,191 4,492,360 Current liabilities................................... (166,255) (3,579,663) (3,745,918) Common stock issued................................... (71,250) (1,462,500) (1,533,750) ------------- ----------- ------------- Cash acquired (paid).................................. $ 25,918 (500,000) (474,082) ------------- ----------- ------------- ------------- ----------- ------------- 1997 ----------------------------------------- MATRIX BEST TOTAL ------------- ----------- ------------- Current assets other than cash........................ $ 258,041 -- 258,041 Property and equipment................................ 577,836 15,137 592,973 Customer base......................................... 1,583,000 -- 1,583,000 Goodwill.............................................. 9,098,545 -- 9,098,545 Current liabilities................................... (1,945,526) (183,041) (2,128,567) Long-term liabilities................................. (688,854) -- (688,854) Common and preferred stock issued..................... (9,149,513) (3,361,208) (12,510,721) Treasury stock acquired............................... -- 3,317,940 3,317,940 ------------- ----------- ------------- Cash acquired......................................... $ 266,471 211,172 477,643 ------------- ----------- ------------- ------------- ----------- -------------
(3) PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
ESTIMATED DECEMBER 31 USEFUL --------------------------- LIFE 1998 1997 ---------- ------------ ------------ Communications system................... 2-5 years $ 1,318,326 $ 1,318,326 Office furniture and equipment.......... 1-7 years 3,420,773 2,945,795 Leasehold improvements.................. lease term 521,319 416,220 ------------ ------------ Total property and equipment............ 5,260,418 4,680,341 Accumulated depreciation and amortization.......................... (3,575,711) (2,888,659) ------------ ------------ Property and equipment, net............. $ 1,684,707 $ 1,791,682 ------------ ------------ ------------ ------------
Depreciation expense was $737,000, $632,000 and $877,000 for 1998, 1997 and 1996, respectively. F-13 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (4) STOCKHOLDERS' EQUITY The Series A convertible preferred shareholders are entitled to receive cumulative annual dividends at a rate of 8% and are entitled to a preference in liquidation in the amount of $4 per share plus unpaid dividends. There were $137,000 cumulative Series A convertible preferred stock dividends in arrears at December 31, 1998. The Series A preferred stock is convertible, on a one-for-one basis, into shares of Company common stock. During 1998, a total of 60,000 shares of the Company's Series A convertible preferred stock was converted to 60,000 shares of the Company's common stock. In December 1998, the Company retired all of its outstanding treasury stock. In December 1996, the Company issued 1,463,771 shares of common stock for future commissions due to affiliates as of October 31, 1996. A value of $1.50 per share was used in determining the number of shares to issue in settlement of the $2,195,211 obligation. Of this amount, $221,000, $1,355,000 and $619,000 was expensed as commission expense in 1998, 1997 and 1996, respectively. During 1996, the Company sold to certain employees 482,400 shares of common stock at $1.50 per share. As of December 31, 1996, the Company had recorded a $723,600 receivable for such shares, which was subsequently collected. Proceeds used to repay the $723,600 receivable were loaned to the employees by a major shareholder of the Company. As of December 31, 1998 and 1997, the shares subject to this agreement could be put to the Company at the option of the employee at approximately $1.50 per share ($168,867 and $578,880), respectively. Such amounts have been included in other liabilities. Under certain circumstances (e.g. employee termination) the Company has a call at the same amounts. The call and put rights vest over a period of five years. As of December 31, 1998, these rights were forty percent vested. Activity in common stock outstanding related to shares subject to put follows:
SHARES AMOUNT ---------- ----------- Sale of common shares subject to put................................. 482,400 $ 723,600 Increase in share value subject to put charged to expense............ -- 172,400 ---------- ----------- Balance, December 31, 1996......................................... 482,400 896,000 Decrease in share value subject to put recorded as a reduction to expense............................................................ -- (172,400) Vested shares no longer subject to put............................... (96,480) (144,720) ---------- ----------- Balance, December 31, 1997......................................... 385,920 578,880 Vested shares no longer subject to put............................... (48,187) (37,253) Called shares subject to put......................................... (225,155) (372,760) ---------- ----------- Balance, December 31, 1998......................................... 112,578 $ 168,867 ---------- ----------- ---------- -----------
During May 1996, the Company purchased 171,548 shares of its common stock as treasury stock for $439,584. As further discussed in note 8 in connection with the Best and Matrix combination effective July 1, 1997, Matrix acquired an additional 1,999,997 shares of its common stock as treasury stock. As a part of the recapitalization done in connection with the AvTel reverse acquisition, Matrix retired the 171,548 shares of its common stock discussed above and the Company recorded the remaining treasury stock at par value. F-14 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (5) FEDERAL AND STATE INCOME TAXES The provision for income taxes consisted of the following:
1998 1997 1996 ----------- ----------- ------------ Current tax expense (benefit): Federal............................................. $ -- $ (234,899) $ 1,751,047 State and local..................................... 7,531 (41,453) 257,507 ----------- ----------- ------------ 7,531 (276,352) 2,008,554 ----------- ----------- ------------ Deferred tax expense (benefit): Federal............................................. (209,110) -- (254,350) State and local..................................... -- -- (67,328) ----------- ----------- ------------ (209,110) -- (321,678) ----------- ----------- ------------ $ (201,579) $ (276,352) $ 1,686,876 ----------- ----------- ------------ ----------- ----------- ------------
Income tax expense differs from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income as a result of the following:
1998 1997 1996 ------------- ------------- ------------ Computed "expected" tax expense (benefit)......... $ (2,491,825) $ (3,559,144) $ 1,404,637 State and local taxes, net of federal income tax effect.......................................... (135,961) (27,359) 125,518 Other nondeductible items......................... 22,539 3,093,522 -- Losses not providing tax benefit.................. 2,594,289 330,190 -- Other............................................. (190,621) (113,561) 156,721 ------------- ------------- ------------ $ (201,579) $ (276,352) $ 1,686,876 ------------- ------------- ------------ ------------- ------------- ------------
Deferred income taxes as of December 31, 1998 and 1997 reflect the impact of temporary differences between financial statement carrying amounts and tax bases of assets and liabilities. The tax effects of F-15 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (5) FEDERAL AND STATE INCOME TAXES (CONTINUED) temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 1998 and 1997 are presented below:
DECEMBER 31 ---------------------- 1998 1997 ---------- ---------- Deferred tax assets Net operating loss carryovers.................... $3,494,634 $ 814,425 Compensation related items....................... 480,137 299,554 Contingent liabilities and other................. 268,340 204,978 ---------- ---------- Gross deferred tax asset......................... 4,243,111 1,318,957 Less valuation allowance......................... (3,778,958) (1,184,669) ---------- ---------- Net deferred tax asset......................... 464,153 134,288 Deferred tax liabilities: Customer base intangible......................... (464,153) (633,000) ---------- ---------- Net deferred tax liability..................... $ -- $ (498,712) ---------- ---------- ---------- ----------
The valuation allowance for deferred tax assets increased $2,594,289 and $1,184,669 during 1998 and 1997, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and prior taxes paid in making this assessment. Based upon its evaluation of these factors, management believes that it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowance, at December 31, 1998. At December 31, 1998, the Company has net operating loss carryforwards for federal tax purposes of approximately $9,153,822 which are available on a limited basis to offset future federal taxable income, if any, through 2018. When realized, such benefit will first be utilized to reduce intangible assets recorded in the reverse acquisition of AvTel by Matrix. (6) RELATED PARTY TRANSACTIONS The Company has had transactions in the normal course of business with various companies which are affiliated with shareholders of the Company. Pacific Gateway Exchange, Inc. ("PGE") provides the Company with significant domestic and international transmission services. As of January 1, 1998, PGE was no longer affiliated with the Company. During 1998, a director and several significant holders of the Company's common stock divested themselves of a substantial portion of their holdings of PGE common stock; they have advised the Company that they no longer could be deemed to be in control of PGE. A significant number of the Company's employees were leased from United Group Service Center, an affiliate, which provides such services to a number of affiliated companies. This lease agreement was terminated on December 31, 1998, at which time these individuals became employees of the Company. The Company provides long distance and data network service to a number of affiliated companies. F-16 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (6) RELATED PARTY TRANSACTIONS (CONTINUED) Balances with affiliates related to operating activities are settled monthly. In addition, the Company has made both interest bearing and non-interest bearing advances to affiliated companies. Due from affiliates consists of the following:
DECEMBER 31 -------------------- 1998 1997 --------- --------- Core Marketing--note receivable due September 1, 1998................................................ $ -- $1,798,889 UICI Administrators (long distance services).......... 308,346 94,417 Interactive Media Works (IMW) (long distance services)........................................... 6,214 25,263 Core Marketing (long distance services)............... 82,695 111,280 AMLI Management Co. (long distance services).......... 10,695 -- Other receivables from various affiliates............. 93,908 97,922 --------- --------- $ 501,858 $2,127,771 --------- --------- --------- ---------
Due to affiliates consists of the following:
1998 1997 ---------- ------------ PGE (not considered an affiliate in 1998)........................... $ -- 2,335,787 Group Association (UGA) and Core Marketing (commissions)............ 5,339 134,618 Other payables to various affiliates................................ 318,681 249,012 ---------- ------------ $ 324,020 2,719,417 ---------- ------------ ---------- ------------
F-17 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (6) RELATED PARTY TRANSACTIONS (CONTINUED) Significant services and transactions incurred in the normal course of operations with affiliated companies are summarized as follows:
1998 1997 1996 ------------ ------------ ------------- Revenues include the following: U.S. Telco-billing and collection services, customer service and accounting services............................................... $ -- $ 200,370 $ -- Long distance revenues from affiliates: UGA, UICI, IMW, Core Marketing, and AMLI............................................... 4,592,040 3,351,375 5,445,903 ------------ ------------ ------------- $ 4,592,040 $ 3,551,745 $ 5,445,903 ------------ ------------ ------------- ------------ ------------ ------------- Cost of revenues includes the following: Network transmission services--PGE (not considered an affiliate in 1998)............................................................. $ -- 15,917,688 20,527,236 ------------ ------------ ------------- ------------ ------------ ------------- Selling, general and administrative expenses include the following: Expenses paid on behalf of PGE (not considered an affiliate in 1998) for access services, for which the Company was reimbursed......... $ -- 3,534,154 5,040,051 Expenses incurred for leasing employees from United Group Service Center............................................................ 5,581,428 4,395,820 4,542,007 Sales commissions to affiliates: Core Marketing, UICI, UGA, Best Connections and AMLI.............. 140,187 990,533 5,335,233 Overhead expenses reimbursed to/from UGA Divisions.................. 241,810 110,761 77,231 Core Marketing--casual mailings and telemarketing................... 21,425 603,742 -- ------------ ------------ ------------- $ 5,984,850 $ 9,635,010 $ 14,994,522 ------------ ------------ ------------- ------------ ------------ ------------- Interest expense includes the following: Interest paid to shareholder........................................ $ -- $ -- $ 173,380 ------------ ------------ ------------- ------------ ------------ -------------
During 1997, the Company loaned $2,000,000 to an affiliated company, Core Marketing, LLC. Of such amount, $201,000 was repaid in 1997 and the remainder was repaid in 1998. In July 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 has the option (but no obligation) 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 was $573,000. The Company purchased these notes for $435,000. F-18 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (6) RELATED PARTY TRANSACTIONS In connection with the purchase of the notes receivable above, the Company repurchased 240,912 shares of its common stock subject to the Buyback Agreement from terminated employees. The Company exercised its right to repurchase 225,154 of such shares at a price range of $1.51 to $1.70 per share, and the former employees used the $373,081 in proceeds to reduce the amount of their notes. The Company repurchased an additional 15,758 shares in satisfaction of the remaining balance of $116,085 on the former employees' notes. (7) STOCK COMPENSATION AVTEL OPTIONS--Prior to the Share Exchange AvTel adopted a 1997 Incentive Stock Option Plan (the "AvTel 1997 Plan") for option grants to officers and key employees. The AvTel 1997 Plan authorizes grants of options to purchase up to 250,000 shares of authorized but unissued common stock and 125,000 shares of restricted common stock. Stock options are to be granted with an exercise price greater than or equal to the stock's fair market value at the date of grant. Options generally vest 25% after one year and 25% each year thereafter until fully vested. Such options typically expire after ten years. In addition, AvTel had other options which had been granted prior to the adoption of the AvTel 1997 Plan. After the Share Exchange all outstanding options became obligations of the Company. On January 1, 1998, the Company granted options to purchase 75,000 shares of the Company's common stock at an exercise price of $1.50 per share. On March 1, 1998 the Company granted options to purchase 100,000 shares of the Company's common stock 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. As of December 31, 1998, 27,316 options are exercisable. 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. During 1998 one of the board members resigned from the board and his 60,000 shares were vested immediately. As of December 31, 1998, only those 60,000 shares of restricted common stock are vested. During 1998, the Company adopted the 1998 Stock Incentive Plan (the "AvTel 1998 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. Stock options are to be granted with an exercise price greater than or equal to the stock's fair market value at the date of grant. Options generally vest 25% after one year and 25% each year thereafter until fully vested. Such options typically expire after ten years. As of December 31, 1998, the Company granted 671,000 options under the AvTel 1998 Plan. Exercise prices range from $2.375 to $4.00 per share. MATRIX OPTIONS--Prior to the Share Exchange, the Board of Directors of Matrix approved stock options for certain officers and employees. Stock option transactions of Matrix are included in the table below. At the time of the Share Exchange, Matrix had 22,338 options outstanding to purchase its common stock. In connection with the Share Exchange, the Company reissued these stock options and they vested immediately. These reissued options expire in December 2002. F-19 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (7) STOCK COMPENSATION (CONTINUED) The Company applies APB Opinion No. 25 in accounting for the AvTel 1997 Plan, 1998 Stock Incentive Plan and the Matrix options discussed above; and, accordingly, no compensation cost has been recognized for its stock options issued to employees in the financial statements. For stock options granted to non-employees, the Company accounts for such options in accordance with the requirements of SFAS No. 123. Had the Company determined compensation cost based on the fair value at the grant date for stock options issued to employees under SFAS No. 123, the Company's net loss in 1998 and 1997 would not have materially changed. BEST CONNECTIONS, INC. OPTIONS--As discussed in Note 2, as a result of the Matrix combination with Best, Matrix assumed the obligation to issue stock options to Best's agents under Best's 1997 Option Plan. Effective as of the date of combination, July 1, 1997, 1,292,000 options to purchase Matrix common shares were granted to Best agents at $1.50 per share, which will result in aggregate commission expense of approximately $764,000 over the vesting period. The option price per share was $1.50. The agents' options become exercisable no later than December 31, 1999 and may be exercised earlier based on qualified billings of long distance customers generated by the agents during six month measurement periods. After the Share Exchange such options became obligations of the Company. As of December 31, 1998, 641,532 options have been earned and 172,120 exercised under the Plan and the Company recorded expense totaling approximately $132,000 and $249,000 related to such options based on qualified billings for 1998 and 1997, respectively. Options generally expire two years from the date they become exercisable or sixty days subsequent to termination of employment. The per share weighted average fair value of stock options granted on July 1, 1997 was $.59 on the date of the grant using the Black-Scholes option--pricing model with the following weighted-average assumptions: expected volatility of 30%, risk-free interest rate of 6.0%, and an expected life of 3.5 years. BEST CONNECTIONS, INC. OPTIONS AND RESTRICTED STOCK AGREEMENTS--As discussed in Note 2 as a result of the Matrix combination with Best, Matrix assumed the obligation to issue stock options, consisting of Matrix common shares owned by Best, to employees of affiliated companies. Effective July 15, 1997, the Company issued 247,500 options to purchase an equal number of shares of its common stock, at $1.50 per share subject to the provisions of a Restricted Stock Agreement. The Restricted Stock Agreement includes a call provision by the Company that lapses 10 percent each six months beginning December 15, 1997 through June 15, 2002 or fully lapses in the event of death or permanent disability of the option holder. The call price is equal to the initial purchase price of $1.50 plus the aggregate amount of net income or less the aggregate amount of net losses per share for each fiscal quarter beginning after December 15, 1997; provided that the call price could not be less than $1.50 per share. During 1998 AvTel relinquished its right to call the shares which caused the options to vest immediately and to expire if not exercised before December 13, 1998. AvTel provided the holders the option of a "cashless" exercise by purchasing up to one half the shares issuable at $3.00 The Company recognized expense over the life of the options in accordance with the provisions of SFAS No. 123 and recorded expense of $500,000 in 1997 and a reduction of expense of $170,000 in 1998. At December 31, 1998, 107,250 options had been exercised, 67,250 were used for the cashless exercise, 45,500 expired, and 27,500 were cancelled. F-20 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (7) STOCK COMPENSATION (CONTINUED) Stock option activity is as follows:
WEIGHTED AVERAGE EXERCISE OPTIONS PRICE ---------- ----------------- Outstanding at December 31, 1995............................... 53,607 $ 2.24 Canceled..................................................... (31,269) 2.24 ---------- Outstanding at December 31, 1996............................... 22,338 2.24 AvTel options outstanding at time of Share Exchange.......... 255,109 4.52 Granted...................................................... 1,539,500 1.50 Exercised.................................................... (15,000) 3.50 ---------- Outstanding at December 31, 1997............................... 1,801,947 1.78 Granted...................................................... 1,024,500 3.31 Expired...................................................... (46,750) 1.54 Forfeited.................................................... (106,999) 1.91 Exercised.................................................... (353,327) 1.81 ---------- Outstanding at December 31, 1998............................... 2,319,371 2.45 ---------- ----- ---------- ----- Exercisable at December 31, 1995............................. -- $ -- Exercisable at December 31, 1996............................. 3,574 2.24 Exercisable at December 31, 1997............................. 349,972 2.21 Exercisable at December 31, 1998............................. 524,849 2.16
Total expense recorded for stock based awards during 1998 and 1997 was $477,148 and $748,884, respectively. The following table summarizes certain information about the Company's stock options at December 31, 1998.
OPTIONS OUTSTANDING ----------------------------------------- WEIGHTED AVERAGE WEIGHTED OPTIONS EXERCISABLE REMAINING AVERAGE ------------------------------------ RANGE OF NUMBER OF CONTRACTUAL EXERCISE NUMBER OF OPTIONS WEIGHTED AVERAGE EXERCISE PRICES OPTIONS LIFE PRICE EXERCISABLE EXERCISE PRICE - ---------------- ---------- -------------- ------------- ----------------- ----------------- $ 1.50 - 2.25 1,427,218 2.5 years $ 1.57 462,334 $ 1.54 2.38 - 3.30 303,749 8.5 2.92 26,736 2.93 4.00 - 6.00 555,112 9.9 4.02 2,487 4.00 6.75 - 8.00 17,093 8.9 7.47 17,093 7.47 12.00 - 14.00 16,199 8.1 12.77 16,199 12.77 ---------- -------------- ------ ------- ------ 2,319,371 5.1 2.45 524,849 2.16 ---------- ------- ---------- -------
F-21 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (8) 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.
1998 1997 ------------- -------------- Numerator: Net loss..................................................... $ (7,127,318) (10,191,720) Less preferred dividends..................................... 47,264 5,540 ------------- -------------- Loss applicable to common shareholders..................... $ (7,174,582) (10,197,260) ------------- -------------- ------------- -------------- Denominator: Weighted average number of common shares used in basic and diluted loss per common share.............................. 9,633,474 8,267,296 ------------- -------------- ------------- -------------- Basic and diluted loss per common share...................... $ (0.74) (1.23) ------------- -------------- ------------- --------------
Per share amounts are not reflected for 1996 due to the recapitalization of the Company as a result of the reverse acquisition in 1997. (9) LEASING ACTIVITIES AND OTHER COMMITMENTS The Company leases office space and various equipment under operating leases expiring in various years through 2004. In the normal course of business, operating leases are generally renewed or replaced by other leases. Total rental expenses were $546,000 in 1998, $245,000 in 1997, and $325,000 in 1996. Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) and future minimum capital lease payments as of December 31, 1998 are: 1999--$731,000; 2000--$688,000; 2001--$426,000; 2002--$307,000; and 2003--$101,224. Substantially all of the Company's switching and transmission facilities have been provided by two suppliers under negotiated contractual agreements. The Company purchases long distance services at certain per-minute rates, which vary depending on the time and type of call. At December 31, 1998, there are outstanding contractual agreements committing the Company to $18,570,000 minimum usage through February 15, 2000. (10) REVOLVING LINE OF CREDIT In 1998, the Company entered into a Loan and Security Agreement with a bank, which provides for an asset-based revolving credit line with a floating interest rate of prime plus 2% (9.75% at December 31, 1998), payable monthly. 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. Borrowings are secured by substantially all of the assets of the Company. The agreement also calls for a minimum borrowing of $1,500,000 with a two-year term. At December 31, 1998, there was $1,112,890 outstanding under the agreement, and an additional $1,655,000 was eligible for borrowing under the revolving credit line. The Loan and Security Agreement contains restrictions on net worth, future acquisitions and other transactions. F-22 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (11) SEGMENT REPORTING In June 1997, the Financial Accounting Standards Board issued Statement No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which the Company adopted in 1998. The Company identifies such segments based on management responsibility. 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 long distance telephone service, executive calling cards and wireless paging. 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. During 1998, the Company measured and monitored the progress of BMG and CMG based on revenues from external customers and gross margin. The results for the year ended December 31, 1998 are as follows:
YEAR ENDED DECEMBER 31, 1998 - --------------------------------------------------------------------------------------------- BMG CMG TOTAL ------------ ------------- ------------- Revenue from external customers.................. $ 6,338,114 37,675,384 44,013,498 Gross margin..................................... 1,846,895 10,317,249 12,164,144 Total assets..................................... 8,079,998 6,554,356 14,634,354
YEAR ENDED DECEMBER 31, 1997 - --------------------------------------------------------------------------------------------- BMG CMG TOTAL ------------ ------------- ------------- Revenue from external customers.................. $ 5,791,993 45,597,087 51,389,080 Gross margin..................................... 1,715,205 13,446,368 15,161,573 Total assets..................................... 2,241,825 16,483,025 18,724,850
YEAR ENDED DECEMBER 31, 1996 - --------------------------------------------------------------------------------------------- BMG CMG TOTAL ------------ ------------- ------------- Revenue from external customers.................. $ 6,368,460 65,189,835 71,558,295 Gross margin..................................... 2,135,461 21,748,438 23,883,899 Total assets..................................... 705,964 19,632,440 20,338,404
(12) CONTINGENCIES The Company's common stock has been traded on The Nasdaq SmallCap Market since May 28, 1998. Trading in the Company's stock was halted by Nasdaq after the close of trading on November 12, 1998, F-23 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (12) CONTINGENCIES (CONTINUED) through the close of trading on November 13, 1998, as a result of an unusual upsurge in its stock price and trading volume. This unusual event has triggered the initiation of class action litigation under the federal securities laws. The Company believes that these claims are without merit and intends to defend vigorously this litigation. However, it is not possible at this time for the Company to predict with certainty the outcome of this litigation. Even if the Company prevails in the litigation, the expenses of the defense could have a material adverse effect on the Company's operating results and financial condition. The Company presently has other contingent liabilities relating to various lawsuits and other matters related to the conduct of its business. On the basis of information furnished by counsel and others, management believes these contingencies upon resolution will not materially affect the financial condition or results of operations of the Company. (13) 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 low closing bid price for the Common Stock on The Nasdaq SmallCap Market at the time 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 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 F-24 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997, AND 1996 (13) SUBSEQUENT EVENTS (CONTINUED) 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 arranging the placement of the Series B Stock. F-25 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
BALANCE AT BALANCE AT BEGINNING END OF DESCRIPTION OF PERIOD ADDITIONS DEDUCTIONS PERIOD - -------------------------------------------------- ----------- ------------- ------------- ---------- Allowance for doubtful Accounts and other Provisions--years ended: December 31, 1998............................... $ 982,000 2,728,000(a) 2,775,000(b) 935,000 ----------- ------------- ------------- ---------- ----------- ------------- ------------- ---------- December 31, 1997............................... $ 627,000 1,830,000(a) 1,475,000(b) 982,000 ----------- ------------- ------------- ---------- ----------- ------------- ------------- ---------- December 31, 1996............................... $ 730,000 1,461,000(a) 1,564,000(b) 627,000 ----------- ------------- ------------- ---------- ----------- ------------- ------------- ---------- Valuation allowance for deferred tax assets: December 31, 1998............................... $ 1,185,000 2,594,000(c) -- 3,779,000 ----------- ------------- ------------- ---------- ----------- ------------- ------------- ---------- December 31, 1997............................... $ -- 1,185,000(c) -- 1,185,000 ----------- ------------- ------------- ---------- ----------- ------------- ------------- ---------- December 31, 1996............................... $ -- -- -- -- ----------- ------------- ------------- ---------- ----------- ------------- ------------- ----------
- ------------------------ (a) Charged to cost of revenues. (b) Amounts written off. (c) Recognized as a component of deferred tax assets. F-26 EXHIBIT INDEX
EXHIBIT NUMBER TITLE OF DOCUMENT - ------ -------------------------------------------------------------------------- 2.1 Acquisition Agreement, dated as of August 30, 1996, by and among Hi-Tiger International, Inc., a Utah corporation, AvTel Communications, Inc., a Utah corporation, and AvTel Holdings, Inc., a California corporation. (Incorporated by reference to Exhibit A to Registrant's Information Statement on Schedule 14C dated October 2, 1996). 2.2 Amendment No. 1 to Acquisition Agreement, dated October 22, 1996, among Hi-Tiger International, Inc., AvTel Communications, Inc. and AvTel Holdings, Inc. (Incorporated by reference to Exhibit 2.2 to Registrant's Current Report on Form 8-K dated October 23, 1996). 2.3 Stock Exchange Agreement, dated as of April 29, 1997, by and between the Registrant and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated April 30, 1997). 2.4 Amendment to Stock Exchange Agreement, dated as of August 25, 1997, by and between the Registrant and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated August 25, 1997). 2.5 Agreement and Plan of Merger, dated as of October 3, 1997, between AvTel Communications, Inc., a Delaware corporation and AvTel Communications, Inc., a Utah corporation. (Incorporated by reference to Exhibit 2.7 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 2.6 Stock Purchase Agreement, dated as of July 22, 1998, among the Registrant and the shareholders of Remote Lojix/PCSI, Inc. 2.7 First Amendment to Stock Purchase Agreement, dated as of August 18, 1998, among the Registrant and the shareholders of Remote Lojix/PCSI, Inc. 2.8 Earnout Agreement, dated as of October 30, 1998, among the Registrant and certain shareholders of Remote Lojix/PCSI, Inc. 3.1 Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 3.2 Certificate of Designations, Preferences and Rights of Series B Convertible Preferred Stock. 3.3 Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 10.1 Rights Agreements dated October 23, 1996, between the Registrant and holders of the Registrant's Series A Convertible Preferred Stock. (Incorporated by reference to Exhibit 4.2 to Registrant's Current Report on Form 8-K dated October 23, 1996). 10.2 1997 Stock Incentive Plan. (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement on Schedule 14A dated January 8, 1997.) 10.3 1998 Stock Incentive Plan. (Incorporated by reference to Exhibit A to Registrant's definitive Proxy Statement on Schedule 14A dated April 28, 1998).
I-1
EXHIBIT NUMBER TITLE OF DOCUMENT - ------ -------------------------------------------------------------------------- 10.4 New Best Connections, Inc. Amended and Restated 1997 Option Plan. (Incorporated by reference to Exhibit 4.2 to Registrant's Registration Statement on Form S-8 dated May 22, 1998). 10.5 First Amendment to New Best Connections, Inc. Amended and Restated 1997 Option Plan. 10.6 Registration Rights and Lockup Agreement dated December 1, 1997, between the Registrant and Matrix Telecom, Inc., on behalf of the stockholders of Matrix, (Incorporated by reference to Exhibit 4 to Registrant's Current Report on Form 8-K dated December 1, 1997). 10.7 Triple Net Real Property Lease (Multi-Tenant Building) dated as of February 16, 1998, by and between Bath Street Partners, a California limited partnership and the Company. (Incorporated by reference to Exhibit 10.8 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997). 10.8 Commercial Lease Agreement dated February 28, 1995, Matrix Telecom, Inc. and Ameritas Life Insurance Corp., as amended by Lease Modification Agreement dated March 2, 1995. (Incorporated by reference to Exhibit 10.9 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997). 10.9 Resale Solutions Switched Services Agreement dated March 12, 1998, between Matrix Telecom, Inc. and Sprint Communications Company L.P. (Incorporated by reference to Exhibit 10.10 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997). 10.10 Amendment to Carrier Transport Switched Services Agreement dated October 15, 1998, between Matrix Telecom and Sprint Communications Company L.P. (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.11 Loan and Security Agreement dated October 2, 1998, among Registrant, Matrix Telecom, Inc. and Coast Business Credit. (Incorporated by reference to Exhibit 10.2 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998). 10.12 License Agreement dated as of March 1, 1999, between Matrix Telecom, Inc. and Electronic Data Systems Corporation. 10.13 Convertible Preferred Stock and Warrants Purchase Agreement dated as of April 5, 1999, among Registrant, AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. 10.14 Registration Rights Agreement dated as of April 5, 1999, among Registrant, AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. 10.15 Stock Purchase Warrants granted by Registrant to AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. 21 List of Subsidiaries. 23 Consent of KPMG LLP. 27 Financial Data Schedule.
I-2 EX-2.6 2 EXHIBIT 2.6 Exhibit 2.6 STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT (this "Agreement") is entered into as of July 22, 1998, between AVTEL COMMUNICATIONS, INC., a Delaware corporation ("AVTEL"), and the stockholders of REMOTE LOJIX/PCSI, INC., a New York corporation ("RLI"), executing this Agreement (the "STOCKHOLDERS"). RECITALS A. The Stockholders own the shares (the "STOCKHOLDER SHARES") of the common stock, par value $.001 per share, of RLI ("RLI COMMON STOCK") in the amounts set forth beside their respective names on Schedule 2.2 to this Agreement. B. RLI and its subsidiaries are engaged in the installation, service and repair of computers and related equipment, accessories and supplies, the maintenance of computer systems via maintenance contracts and the provision of related consulting services (the "BUSINESS"). C. The Stockholders desire to sell, and AvTel desires to buy, the Stockholder Shares on the terms and conditions set forth herein. AGREEMENT In consideration of the mutual promises contained herein and intending to be legally bound the parties agree as follows: 1. PURCHASE AND SALE; CLOSING. 1.1 TRANSFER OF STOCKHOLDER SHARES BY THE STOCKHOLDERS. Subject to the terms and conditions of this Agreement, the Stockholders agree to sell the Stockholder Shares and deliver the certificates evidencing the Stockholder Shares to AvTel at the Closing (as defined below). The certificates will be properly endorsed for transfer to or accompanied by a duly executed stock power in favor of AvTel or its affiliate, as AvTel may have directed prior to the Closing Date (as defined below), and otherwise in a form acceptable for transfer on the books of RLI. If any stock certificate to be delivered to AvTel by the Stockholders at Closing shall have been lost, stolen or destroyed, AvTel may, in its reasonable discretion, require the owner of such lost, stolen or destroyed stock certificate to provide an appropriate affidavit of ownership and indemnity or other document(s) evidencing ownership of such Stockholder Shares satisfactory to AvTel. The Stockholders will pay any transfer Taxes (as defined in Section 2.4) payable with respect to the transfer of the Stockholder Shares. 1.2 PURCHASE OF THE STOCKHOLDER SHARES BY AVTEL; PURCHASE PRICE. Subject to the terms and conditions of this Agreement, AvTel agrees to purchase the Stockholder Shares from the Stockholders. The purchase price for the Stockholder Shares and for the Covenants not to Compete set forth in Section 5.1 hereof (the "PURCHASE PRICE") shall be paid as set forth below. 1.2.1 INITIAL EXCHANGE SHARES. At the Closing, AvTel shall issue a total of 350,000 shares (the "INITIAL EXCHANGE SHARES") of its Common Stock, par value $.01 per share (the "AVTEL COMMON STOCK") to the Stockholders, to be divided among the Stockholders in the same proportion that the number of Stockholder Shares owned by each Stockholder (as set forth on Schedule 2.2) represents to the total number of Shares. For purposes of calculating the number of Initial Exchange Shares to be received by each Stockholder, the numbers shall be rounded to the nearest whole share as required to avoid issuance of fractional shares. As of the Closing Date, the Initial Exchange Shares will not be registered under any federal or state securities laws. At the Closing, Jeffrey P. Leventhal shall deposit 65,000 of his Initial Exchange Shares into an escrow account pursuant to an Escrow Agreement substantially in the form attached hereto as Exhibit A (the "ESCROW AGREEMENT"). 1.2.2 EARNOUT SHARES. If, and only if, RLI has met the performance standards set forth in Section 1.2.2(B) below during the twelve-month period commencing on the first day of the month following the Closing Date and ending on the last day of the twelfth month thereafter (the "EARNOUT DATE"), then as soon as practicable, but in no event later than sixty days after the Earnout Date, AvTel shall issue that number of shares of AvTel Common Stock as calculated below (the "EARNOUT SHARES") to the Stockholders, to be divided among the Stockholders in the same proportion as the Initial Exchange Shares. For purposes of calculating the number of Earnout Shares to be received by each Stockholder, the numbers shall be rounded to the nearest whole share as required to avoid issuance of fractional shares. As of the Closing Date, the Earnout Shares will not be registered under any federal or state securities laws. 1. The number of Earnout Shares to be issued, if any, shall be as follows: (1) The aggregate number of the Earnout Shares to be issued, if any, upon satisfaction of the requirements contained in Section 1.2.2(B)(1) below shall be calculated by dividing the sum of $1,250,000 by the Closing Share Price. (2) The additional aggregate number of the Earnout Shares to be issued, if any, if the requirements contained in Section 1.2.2(B)(2) below are satisfied shall be calculated by dividing the sum of $250,000 by the Closing Share Price. (3) The "CLOSING SHARE PRICE" shall mean the average closing price as publicly reported by the Nasdaq Stock Market as of 4:00 p.m. Eastern Time of AvTel Common Stock over the last sixty trading days ending with (and including) the second business day prior to the Earnout Date. 2. The Earnout Shares shall be delivered only if the following requirements are met: (1) The Earnout Shares contemplated by Section 1.2.2(A)(1) shall be delivered if, and only if, during the twelve-month period ending on the Earnout Date, RLI has had both (i) net revenues from operation of not less than $6,500,000, and (ii) net income (net of non-recurring charges and allocation of parent corporation overhead) greater than zero, in each case as determined by AvTel's independent auditors (which shall be a nationally-recognized accounting firm) in accordance with generally accepted accounting principles ("GAAP"), and calculated prior to the effect of any other acquisitions. (2) The Earnout Shares contemplated by Section 1.2.2(A)(2) shall be delivered if, and only if, during the twelve-month period ending on the Earnout Date, RLI has had both (i) net revenues from operation of not less than $6,500,000, and (ii) net income (net of non-recurring charges and allocation of parent corporation overhead) of at least $250,000, in each case as determined by AvTel's independent auditors (which shall be a nationally-recognized accounting firm) in accordance with GAAP, and calculated prior to the effect of any other acquisitions. 1.2.3 PRO RATA REDUCTION. If the Stockholders who have signed this Agreement by the Closing Date hold less than one hundred percent (100%) of the shares of RLI Common Stock outstanding on the Closing Date, and AvTel waives the condition precedent to its obligations to close contained in Section 6.2.14, then the number of Initial Exchange Shares and Earnout Shares, if any, to be delivered by AvTel shall be reduced pro rata. 1.2.4 RESTRICTIVE LEGEND. The Initial Exchange Shares and the Earnout Shares, if any, to be issued pursuant to this Agreement shall be characterized as "restricted securities" for purposes of Rule 144 under the Securities Act of 1933, as amended (the "Securities Act") and each certificate representing any such shares shall bear a legend identical or similar in effect to the following legend (together with any other legend or legends required by applicable state securities laws or otherwise): "THE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE ASSIGNED, PLEDGED, OR HYPOTHECATED UNLESS AND UNTIL REGISTERED UNDER SUCH ACT, OR UNLESS THE COMPANY HAS RECEIVED AN OPINION OF COUNSEL OR OTHER EVIDENCE, SATISFACTORY TO THE COMPANY AND ITS COUNSEL, THAT SUCH REGISTRATION IS NOT REQUIRED." 1.2.5 ALLOCATION TO COVENANT NOT TO COMPETE. The parties agree that $10,000 of the Purchase Price shall be allocated to the Covenant not to Compete set forth in Section 5.1 of this Agreement. Such allocation shall be for financial accounting and tax purposes only and shall not affect or limit in any way the liability of the Stockholders for breach of such Covenant not to Compete. 1.3 THE CLOSING. The closing of the transfer of the Stockholder Shares (the "Closing") will take place at the offices of Seed, Mackall & Cole LLP, 1332 Anacapa Street, Suite 200, Santa Barbara, California (or such other place as the parties may mutually agree), at such date and time as the parties shall mutually agree. Such date and time are referred to as the "Closing Date". At the Closing, AvTel shall be entered on the records of RLI as the sole shareholder of RLI having the right to vote on all matters which the shareholders of RLI are entitled to vote pursuant to the Certificate of Incorporation and the Bylaws of RLI and applicable law, the right to receive dividends and such other rights generally accruing to shareholders of RLI. 1.4 STOCKHOLDER REPRESENTATIVE. Each of the Stockholders hereby constitutes and appoints Jeffrey P. Leventhal (the "STOCKHOLDER REPRESENTATIVE") to execute and deliver any instruments or other documents, and to make such decisions and to take such other action on behalf of such Stockholder as may be necessary or appropriate in connection with such Stockholder's rights and obligations under this Agreement, and each such Stockholder hereby agrees to be bound by any such instrument or other document executed and delivered by the Stockholder Representative, and any such decision made or other action taken by the Stockholder Representative, pursuant to the terms of this Agreement. The Stockholder Representative shall not be liable to the Stockholders for any action taken or omitted by him in connection with the performance of his duties and obligations hereunder, except for his own gross negligence or willful misconduct. 2. REPRESENTATIONS AND WARRANTIES OF THE STOCKHOLDERS. The Stockholders, jointly and severally, hereby represent and warrant to AvTel, as of the datehereof and as of the Closing Date, as follows: 2.1 ORGANIZATION AND RELATED MATTERS. 2.1.1 RLI. RLI is a corporation duly organized, validly existing and in good standing under the laws of the State of New York. Except as set forth in Schedule 2.1 hereto, RLI is duly qualified or licensed to do business as a foreign corporation in good standing in all jurisdictions in which the character or the location of the assets owned or leased by it or the nature of the Business conducted by it requires qualification or licensing. RLI's failure to be qualified or licensed to do business in any jurisdiction or jurisdictions where such qualification or licensing is required does not and will not have a material adverse effect on RLI or the Business. A list of all jurisdictions where RLI is qualified or licensed to do business is set forth in Schedule 2.1 hereto. RLI has all necessary corporate power and authority to own its properties and assets and to carry on its Business as now conducted. Schedule 2.1 correctly lists the current directors and executive officers of RLI and sets forth an organizational chart with respect to RLI's operations and employees. True, correct and complete copies of the certificate of incorporation and bylaws of RLI as in effect on the date hereof have been delivered to AvTel. 2.1.2 SUBSIDIARIES. Each of the direct and indirect subsidiaries of RLI is set forth on Schedule 2.1 (the "SUBSIDIARIES"). Except for the Subsidiaries, RLI has no subsidiaries, is not a partner or participant in any partnerships or joint ventures, and does not own, directly or indirectly, any interests in any other corporation, partnership, limited liability company or other entity. Each of the Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction identified in Schedule 2.1. Except as set forth in Schedule 2.1 hereto, each of the Subsidiaries is duly qualified or licensed to do business as a foreign corporation in good standing in all jurisdictions in which the character or the location of the assets owned or leased by it or the nature of the Business conducted by it requires qualification or licensing. A Subsidiary's failure to be qualified or licensed to do business in any jurisdiction or jurisdictions where such qualification or licensing is required does not and will not have a material adverse effect on such Subsidiary or the Business. A list of all jurisdictions where each Subsidiary is qualified or licensed to do business is set forth in Schedule 2.1 hereto. Each of the Subsidiaries has all necessary corporate power and authority to own its properties and assets and to carry on its Business as now conducted. Schedule 2.1 correctly lists the current directors and executive officers of each of the Subsidiaries and sets forth an organizational chart with respect to each of the Subsidiaries's operations and employees. True, correct and complete copies of the certificate or articles of incorporation and bylaws of each of the Subsidiaries as in effect on the date hereof have been delivered to AvTel. All references to RLI in this Agreement shall be deemed to include RLI and its Subsidiaries. 2.1.3 THE STOCKHOLDERS. Each of the Stockholders is listed on Schedule 2.1, together with such Stockholder's address and Social Security Number or Tax Identification Number. Each of the Stockholders has all necessary power and authority to execute, deliver and perform this Agreement and any related agreements to which such Stockholder is a party. 2.2 CAPITAL STOCK. 2.2.1 OWNERSHIP OF STOCKHOLDER SHARES. The Stockholders own the Stockholder Shares beneficially and of record in the amounts set forth on Schedule 2.2. Except as set forth on Schedule 2.2, the Stockholder Shares are owned free and clear of any claim, charge, easement, encumbrance, lease, covenant, security interest, lien, option, pledge, rights of others, or restriction (whether on voting, sale, transfer, disposition or otherwise), whether imposed by agreement, understanding, law, equity or otherwise, except for any restrictions on transfer generally arising under any applicable federal or state securities law (each an "Encumbrance"). At the Closing, AvTel will acquire good and marketable title to and complete ownership of the Stockholder Shares, free and clear of any Encumbrance. The representations of the Stockholders in this Section 2.2.1 are made only as to the Stockholder Shares of such Stockholder. 2.2.2 CAPITALIZATION. The authorized capital stock of RLI consists of 10,000,000 shares of RLI Common Stock, of which 4,195,963 shares are issued and outstanding on the date hereof. On the Closing Date, there will be 4,177,796 shares of RLI Common Stock issued and outstanding. The authorized, issued and outstanding capital stock of each of the Subsidiaries is as set forth on Schedule 2.2. RLI owns, beneficially and of record, of all of the capital stock of each of the Subsidiaries, free and clear of any Encumbrances. Except as set forth on Exhibit 2.2, there are no outstanding options, warrants or other rights to subscribe for or purchase, or contracts or other obligations to issue or grant any rights to ac quire, any stock or securities of RLI or the Subsidiaries, or to restructure or recapitalize RLI or the Subsidiaries. On the Closing Date, there will be no outstanding options, warrants or other rights to subscribe for or purchase, or contracts or other obligations to issue or grant any rights to acquire, any stock or securities of RLI or the Subsidiaries, or to restructure or recapitalize RLI or the Subsidiaries. Except as set forth on Schedule 2.2 hereto, there are no outstanding contracts of the Stockholders, RLI or the Subsidiaries to repurchase, redeem or otherwise acquire any securities of RLI or the Subsidiaries. The Stockholder Shares, and the shares of the capital stock of each of the Subsidiaries, are duly authorized, validly issued and outstanding and are fully paid and nonassessable and were issued in conformity with applicable laws. There are no preemptive rights in respect of any equity securities of RLI. 2.2.3 PCSI HOLDERS. The stock records of RLI reflect that, as of the date hereof, 18,167 shares of the RLI Common Stock are held by unidentified former shareholders of The Technical Services Group, Inc. ("PCSI"), a New York corporation acquired by RLI as of January 1, 1997. Such holders are referred to hereinafter as the "PCSI HOLDERS." 2.3 FINANCIAL STATEMENTS; CHANGES; CONTINGENCIES. 2.3.1 FINANCIAL STATEMENTS. 1. The Stockholders have delivered to AvTel consolidated and consolidating balance sheets for RLI and its Subsidiaries at December 31, 1997 and the related consolidated and consolidating statements of operations, changes in stockholder's equity and cash flow for the period then ended (the "Audited Financial Statements"). The Audited Financial Statements have been audited by Bloom & Company (the "Auditors") whose reports thereon are included with such Audited Financial Statements. The Audited Financial Statements have been prepared in conformity with GAAP. Such statements of operations and cash flow present fairly the results of operations and cash flows of RLI and its Subsidiaries for the respective periods covered, and the balance sheets present fairly the financial condition of RLI and its Subsidiaries as of their respective dates. 2. The Stockholders have delivered to AvTel consolidated and consolidating balance sheets for RLI and its Subsidiaries at May 31, 1998 and the related consolidated and consolidating statements of operations and cash flows and changes in stockholder's equity for the period then ended (the "INTERIM FINANCIAL STATEMENTS" and, together with the Audited Financial Statements, the "RLI FINANCIAL STATEMENTS"). The Interim Financial Statements have been certified by the chief executive officer of RLI. The Interim Financial Statements have been prepared in conformity with GAAP applied on a basis consistent with the Audited Financial Statements. The statements of operations and cash flows present fairly the results of operations and cash flows of RLI and its Subsidiaries for the period covered, and the balance sheets present fairly the financial condition of RLI as of their date. The Interim Financial Statements reflect all adjustments (which consist only of normal recurring adjustments not material in amount and include but are not limited to estimated provisions for year-end adjustments) necessary for a fair presentation. 3. At the dates of each such balance sheet, RLI had any no material liability (actual, contingent or accrued) that, in accordance with GAAP applied on a consistent basis, should have been shown or reflected therein but was not. Since January 1, 1997, there has been no change in any of the significant accounting policies, practices or procedures of RLI. 2.3.2 NO MATERIAL ADVERSE CHANGES. Except as set forth on Schedule 2.3, since January 1, 1998, whether or not in the ordinary course of business, there has not been, occurred or arisen: 1. any change in or event affecting the Stockholders, RLI, the Subsidiaries, the Business or the Stockholder Shares that has had or may reasonably be expected to have a material adverse effect on the Stockholders, RLI, the Business, or the Stockholder Shares, 2. any agreement, condition, action or omission which would be pro scribed by (or require consent under) Section 4.3 had it existed, occurred or arisen after the date of this Agreement, 3. any strike or other labor dispute, or 4. any casualty, loss, damage or destruction (whether or not covered by insurance) of any material property of RLI that is material or that has involved or may involve a loss to RLI in excess of applicable insurance coverage. 2.3.3 NO OTHER LIABILITIES OR CONTINGENCIES. Neither RLI nor any of the Subsidiaries has any liabilities of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, probable of assertion or not, except liabilities that (i) are reflected or disclosed in the RLI Financial Statements, (ii) were incurred after December 31, 1997, in the ordinary course of business and in the aggregate do not exceed $10,000 or (iii) are set forth in Schedule 2.3 hereto. 2.3.4 DIVIDENDS AND OTHER DISTRIBUTIONS. Except as set forth on Schedule 2.3, there has been no dividend or other distribution of assets or securities whether consisting of money, property or any other thing of value, declared, issued or paid by RLI subsequent to December 31, 1997. 2.4 TAX AND OTHER RETURNS AND REPORTS. Except as set forth in Schedule 2.4, RLI has timely filed or will file prior to Closing all required Tax Returns and has paid or will have paid by Closing all Taxes due for all periods ending on or before the Closing Date. Adequate provision has been made in the books and records of RLI, and to the extent required by GAAP, in the RLI Financial Statements, for all Taxes whether or not due and payable and whether or not disputed. Except as set forth on Schedule 2.4, RLI has withheld and paid all Taxes required to be withheld and paid in connection with amounts paid or owing to any employee, independent contractor, customer, creditor, stockholder or other third party. RLI has not elected to be treated as a consenting corporation under Section 341(f) of the Internal Revenue Code of 1986, as amended (the "Code"). Schedule 2.4 lists the date or dates through which the Internal Revenue Service and any other government or any agency, bureau, board, commission, court, department, official, political subdivision, tribunal or other instrumentality of any government, whether federal, state or local, domestic or foreign (a "GOVERNMENTAL ENTITY") have examined the United States federal income Tax Returns and any other Tax Returns of RLI. All required Tax Returns, including amendments to date, have been prepared in good faith without negligence or willful misrepresentation and are complete and accurate in all material respects. Except as set forth in the Schedule 2.4, no Governmental Entity has, during the past three years, examined or is in the process of examining any Tax Returns of RLI. Except as set forth on Schedule 2.4, no Governmental Entity has proposed (tentatively or definitively), asserted or assessed or, to the best knowledge of the Stockholders, threatened to propose or assert, any deficiency, assessment or claim for Taxes and there would be no basis for any such delinquency assessment or claim. For the purposes of this Agreement, (i) "TAX" means any foreign, federal, state, county or local income, sales and use, excise, franchise, real and personal property, transfer, gross receipt, capital stock, production, business and occupation, disability, employment, payroll, severance or withholding tax or charge imposed by any Governmental Entity any interest and penalties (civil or criminal) related thereto or to the nonpayment thereof, and any losses or expenses in connection with the determination, settlement or litigation of any Tax liability, and (ii) "Tax Return" means a report, return or other information required to be supplied to a Governmental Entity with respect to Taxes including, where permitted or required, combined or consolidated returns for any group of entities that includes RLI. 2.5 MATERIAL CONTRACTS. Schedule 2.5 lists each agreement, arrangement, bond, commitment, franchise, indemnity, indenture, instrument, lease, license or understanding, whether or not in writing (each a "Contract") to which RLI or any of its Subsidiaries is a party or to which any of them or any of their respective properties is subject or by which any thereof is bound that (a) after December 31, 1997, obligates such party to pay an amount of $25,000 or more, (b) has an unexpired term as of December 31, 1997 in excess of one year, (c) represents a Contract upon which the Business is substantially dependent or which is otherwise material to such Business, (d) provides for an extension of credit other than consistent with normal credit terms, (e) limits or restricts the ability of RLI or any of the Subsidiaries to compete or otherwise to conduct its business in any manner or place, (f) provides for a guaranty or indemnity by RLI or any of the Subsidiaries, (g) grants a power of attorney, agency or similar authority to another person or entity, (h) contains a right of first refusal, (i) related to the possession or use of any real property, or (j) was not made in the ordinary course of business. Each of the Contracts listed on Schedule 2.5 shall be deemed to be a "MATERIAL CONTRACT." True copies of the Material Contracts, including all amendments and supplements, have been delivered to AvTel. Each Material Contract is valid and binding obligation of the parties thereto; RLI and the Subsidiaries have duly performed all their obligations thereunder to the extent that such obligations to perform have accrued; and no breach or default, alleged breach or default, or event which would (with the passage of time, notice or both) constitute a breach or default thereunder by RLI or any Subsidiary, or, to the best knowledge of the Stockholders, any other party or obligor with respect thereto, has occurred or as a result of this Agreement or performance will occur. Except as set forth in Schedule 2.8 hereto, consummation of the transactions contemplated by this Agreement will not (and will not give any person a right to) terminate or modify any rights of, or accelerate or augment any obligation of, RLI or any Subsidiary. 2.6 REAL AND PERSONAL PROPERTY; TITLE TO PROPERTY; LEASES. Neither RLI nor any Subsidiary owns, directly or indirectly, any interest whatsoever in any real property, other than leasehold interests pursuant to office leases included in the Material Contracts. Schedule 2.6 lists all tangible personal property of RLI and the Subsidiaries material to the Business and designates any leasehold interests therein. Except as set forth in Schedule 2.6, RLI or the relevant Subsidiary has good and marketable title to, or a valid leasehold interest in (as designated in Schedule 2.6), all such items of tangible personal property, free and clear of any Encumbrances. All material tangible properties of RLI and the Subsidiaries (excluding any inventory) are in a good state of maintenance and repair (except for ordinary wear and tear) and are adequate for the Business. All material leasehold properties held by RLI or any Subsidiary as lessee are held under valid, binding and enforceable leases, subject only to such exceptions as are not, individually or in the aggregate, material to the Business. 2.7 INTELLECTUAL PROPERTY. Schedule 2.7 lists any and all copyrights, patents, service marks, trademarks, tradenames, and all registrations or application for registration of any of the foregoing, used in the Business or in which RLI or any Subsidiary has an interest and the nature of such interest, including all licenses or other rights with respect to any of the foregoing. In addition, RLI has previously provided in writing to AvTel descriptions of any and all trade secrets or other confidential information or know-how used in the Business or in which RLI or any Subsidiary has an interest. All of the foregoing assets, properties and interests are referred to as the "Intellectual Property." RLI has complete rights to and ownership of all Intellectual Property the absence of which would have a material adverse effect on the Business. Neither RLI nor any Subsidiary uses any Intellectual Property by consent of any other person or is required to or makes any payments to others with respect thereto, and, except as set forth in Schedule 2.7, the Intellectual Property of RLI and the Subsidiaries is fully assignable free and clear of any Encumbrances. Neither the Stockholders nor RLI nor any Subsidiary has received any notice to the effect (or is otherwise aware) that the Intellectual Property or any use by RLI or any Subsidiary of any such property conflicts with or allegedly conflicts with or infringes the rights of any person or entity. 2.8 AUTHORIZATION; NO CONFLICTS. This Agreement and any related agreements each constitutes the legally valid and binding obligation of the Stockholders, enforceable against the Stockholders in accordance with its terms except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors rights generally. The execution, delivery and performance of this Agreement by the Stockholders and the execution, delivery and performance of any related agreements or contemplated transactions by the Stockholders or RLI will not violate, or constitute a breach or default (whether upon lapse of time and/or the occurrence of any act or event or otherwise) under, the certificate of incorporation or bylaws of RLI or any Contract of the Stockholders, RLI or any Subsidiary, result in the imposition of any Encumbrance against any material asset or properties of RLI or any Subsidiary, or violate any statute or other law, rule, regulation, or interpretation of any Governmental Entity (each a "LAW"). Schedule 2.8 lists all approvals, authorizations, consents, qualifications or registrations, or any waivers of any of the foregoing, required to be obtained from, or any notices, statements or other communications required to be filed with or delivered to, any Governmental Authority or any other person or entity ("APPROVALS") required to be obtained by the Stockholders, RLI or any Subsidiary to consummate the transactions contemplated by this Agreement. Except for matters identified in Schedule 2.8 as requiring that certain actions be taken by or with respect to a third party or Governmental Entity, the execution and delivery of this Agreement by the Stockholders and the performance of this Agreement and any related or contemplated transactions by the Stockholders or RLI will not require filing or registration with, or the issuance of any Approval by, any other third party or Governmental Entity. 2.9 LEGAL PROCEEDINGS. Except as set forth in Schedule 2.9, there is no decree, injunction, judgment, order, ruling, assessment or writ (each an "ORDER") or any action, complaint, petition, investiga tion, suit or other proceeding, whether civil or criminal, in law or in equity, or before any arbitrator or Governmental Entity (each an "ACTION") pending, or, to the best knowledge of the Stockholders, threatened, against or affecting the Stockholders, RLI, any Subsidiary or any of their respective properties or assets that individually or when aggregated with one or more other Orders or Actions has or might reasonably be expected to have a material adverse effect on the Business, on the Stockholders's ability to perform this Agreement, or on any aspect of the transactions contemplated by this Agreement. Schedule 2.9 lists each Order and each Action that involves a claim or potential claim against, or that enjoins or seeks to enjoin any activity by, RLI or any Subsidiary. Except as set forth in Schedule 2.9, there is no matter as to which RLI or any Subsidiary has received any notice, claim or assertion, or, to the best knowledge of the Stockholders, which otherwise has been threatened or is reasonably expected to be threatened or initiated, against or affecting any director, officer, employee, agent or representative of RLI or any other person or entity, nor to the best knowledge of the Stockholders is there any reasonable basis therefor, in connection with which any such person or entity has or may reasonably be expected to have any right to be indemnified by RLI. 2.10 MINUTE BOOKS. The minute books of RLI and the Subsidiaries provided to AvTel accurately reflect all actions and proceedings taken to date by the shareholders, board of directors and committees of RLI and the Subsidiaries. The stock record books of RLI and the Subsidiaries reflect accurately all transactions in the capital stock of RLI and the Subsidiaries. 2.11 ACCOUNTING RECORDS; INTERNAL CONTROLS. 2.11.1 ACCOUNTING RECORDS. Since January 1, 1997, RLI and its Subsidiaries have maintained records that accurately and validly reflect their transactions, and accounting controls sufficient to insure that such transactions are (i) executed in accordance with management's general or specific authorization and (ii) recorded in conformity with GAAP so as to maintain accountability for assets. 2.11.2 DATA PROCESSING; ACCESS. Such records, to the extent they contain important information that is not easily and readily available elsewhere, have been duplicated, and such duplicates are stored safely and securely pursuant to procedures and techniques utilized by companies of comparable size in similar lines of business. The data processing equipment, data transmission equipment, related peripheral equipment and software used by RLI in the operation of the Business (including any disaster recovery facility) to generate and retrieve such records are comparable in performance, condition and capacity with those utilized by companies of comparable size in similar lines of business. 2.11.3 YEAR 2000 COMPLIANCE. Except as set forth in Schedule 2.11, all software and systems (i) utilized by RLI and its Subsidiaries, and (ii) sold to or maintained for customers by RLI, are Year 2000 compliant, and will continue to function in the ordinary course of business on and after January 1, 2000. 2.12 INSURANCE. RLI is, and at all times since inception has been, insured with reputable insurers against all risks normally insured against by companies in similar lines of business, and all of the insurance policies and bonds maintained by RLI are in full force and effect. Schedule 2.12 lists all insurance policies and bonds that are material to the Business. RLI is not in default under any such policy or bond. RLI has timely filed claims with its insurers with respect to all matters and occurrences for which it has coverage. All insurance policies maintained by RLI will remain in full force and effect and may reasonably be expected to be renewed on comparable terms following consummation of the transactions contemplated by this Agreement (subject to continuing compliance with the applicable terms thereof and any right of insurers to terminate without cause), and RLI has received no notice or other indication from any insurer or agent of any intent to cancel or not so renew any of such insurance policies. 2.13 PERMITS. Except as set forth in Schedule 2.13, each of RLI and its Subsidiaries holds all licenses, permits, franchises, certificates of authority, or orders, or any waivers of the foregoing, required to be issued by any Governmental Entity ("PERMITS") that are required by any Governmental Entity to permit it to conduct its Business as now conducted, and the absence of which would cause a material adverse effect on RLI, the relevant Subsidiary or its Business. All such Permits are valid and in full force and effect and will remain so upon consummation of the transactions contemplated by this Agreement. No suspension, cancellation or termination of any of such Permits is threatened or imminent. 2.14 COMPLIANCE WITH LAW. Each of RLI and its Subsidiaries conducts and has conducted its business, in all material respects, in accordance with all applicable Laws including, without limitation, those applicable to discrimination in employment, the Americans with Disabilities Act, occupational safety and health, trade practices, competition and pricing, employment, retirement and labor relations. The forms, procedures and practices of RLI and its Subsidiaries are in compliance with all such Laws, in all material respects. 2.15 EMPLOYEES. Schedule 2.15 contains a true and correct list of all employees to whom RLI or any Subsidiary is paying compensation, including bonuses and incentives for services rendered or otherwise, the annual salary, average commission, or hourly wage compensation of each such employee, and any bonus paid to each respective employee relating to services rendered during the 1997 fiscal year. AvTel has been provided a copy of all W-2 forms distributed to each such employee in respect to compensation received from RLI or any Subsidiary in the 1997 tax year. Since January 1, 1997, RLI has not experienced any labor disputes, union organization attempts or any work stoppage due to labor disagreements in connection with its business. There is no labor strike, dispute, request for representation, slowdown or stoppage actually pending or threatened against or affecting RLI or any of the Subsidiaries. All workers' compensation and unemployment compensation insurance premiums due have been fully paid or accrued in the RLI Financial Statements. 2.16 EMPLOYEE BENEFITS. 2.16.1 EMPLOYEE BENEFIT PLANS, COLLECTIVE BARGAINING AND EMPLOYEE AGREEMENTS, AND SIMILAR ARRANGEMENTS. 1. Schedule 2.16 lists all employee benefit plans and collective bargaining, employment or severance agreements or other similar arrangements to which RLI or any Subsidiary is or ever has been a party or by which it is or ever has been bound, legally or otherwise, including, without limitation, (a) any profit-sharing, deferred compensation, bonus, stock option, stock purchase, pension, retainer, consulting, retirement, severance, welfare or incentive plan, agreement or arrangement, (b) any plan, agreement or arrangement providing for "fringe benefits" or perquisites to employees, officers, directors or agents, including but not limited to benefits relating to automobiles, clubs, vacation, child care, parenting, sabbatical, sick leave, medical, dental, hospitalization, life insurance and other types of insurance, (c) any employment agreement or (d) any other "employee benefit plan" (within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended, and the related regulations and published interpretations ("ERISA")). 2. The Stockholders have delivered to AvTel true and complete copies of all documents and summary plan descriptions with respect to such plans, agreements and arrangements, or summary descriptions of any such plans, agreements or arrangements not otherwise in writing. 3. There are no negotiations, demands or proposals that are pending or have been made which concern matters now covered, or that would be covered, by plans, agreements or arrangements of the type described in this Section. 4. RLI is in full compliance with the applicable provisions of ERISA (as amended through the date of this Agreement), the regulations and published authorities thereunder, and all other Laws applicable with respect to all such employee benefit plans, agreements and arrangements. RLI has performed all of its obligations under all such plans, agreements and arrangements. To the best knowledge of the Stockholders, there are no Actions (other than routine claims for benefits) pending or threatened against such plans or their assets, or arising out of such plans, agreements or arrangements, and, to the best knowledge of the Stockholders, no facts exist which could give rise to any such Actions. 5. Except as specified in Schedule 2.16, each of the plans, agreements or arrangements can be terminated by RLI within a period of 30 days following the Closing Date, without payment of any additional compensation or amount or the additional vesting or acceleration of any such benefits. 2.16.2 QUALIFIED PLANS. No plan listed in Schedule 2.16 is a stock bonus, pension or profit-sharing plan within the meaning of Section 401(a) of the Code. No plan listed in Schedule 2.16 is a "MULTIEMPLOYER PLAN" (within the meaning of Section 3(37) of ERISA). RLI has never contributed to or had an obligation to contribute to any multiemployer plan. 2.16.3 HEALTH PLANS. All group health plans of RLI and any Subsidiary or Affiliate (as defined in Section 2.17) have been operated in compliance with the group health plan continuation coverage requirements of Section 162(k) of the Code to the extent such requirements are applicable. 2.16.4 FINES AND PENALTIES. There has been no act or omission by RLI or any Subsidiary or Affiliate that has given rise to or may give rise to fines, penalties, taxes, or related charges under Section 502(c) or (k) or Section 4071 of ERISA or Chapter 43 of the Code. 2.17 AFFILIATE INTERESTS AND TRANSACTIONS. Neither the Stockholders nor any Affiliate of the Stockholders, RLI or any Subsidiary nor any officer or director of any thereof, nor Associate of any such individual, has any material interest in any property used in or pertaining to the Business. Except as set forth in Schedule 2.17, no such person or entity has engaged in any Transaction or entered into any Contract with RLI or any Subsidiary. No such person or entity is indebted or otherwise obligated to RLI or any Subsidiary; and RLI is not indebted or otherwise obligated to any such person or entity, except for amounts due under normal arrangements applicable to all employees generally as to salary or reimbursement of ordinary business expenses not unusual in amount or significance. The consummation of the transactions contemplated by this Agreement will not (either alone, or upon the occurrence of any act or event, or with the lapse of time, or both) result in any benefit or payment (severance or other) arising or becoming due from RLI to any person or entity. For the purposes of this Agreement, (i) "AFFILIATE" means a person or entity that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, a specified person or entity, and (ii) an "ASSOCIATE" of a person means: (x) a corporation or organization (other than RLI or a Subsidiary) of which such person is an officer or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity securities; (ii) any trust or other estate in which such person has a substantial beneficial interest or as to which such person serves as trustee or in a similar capacity; and (iii) any relative or spouse of such person or any relative of such spouse. 2.18 BANK ACCOUNTS, POWERS, ETC. Schedule 2.18 ("BANK LIST") lists each bank, trust company, savings institution, brokerage firm, mutual fund or other financial institution with which RLI or any Subsidiary has an account or safe deposit box and the names and identification of all persons authorized to draw thereon or to have access thereto, and lists the names of each person or entity holding powers of attorney or agency authority from RLI or any Subsidiary and a summary of the terms thereof. 2.19 NO BROKERS OR FINDERS. No agent, broker, finder, or investment or commercial banker, or other person or firm engaged by or acting on behalf of the Stockholders or RLI or any of their respective Affiliates in connection with the negotiation, execution or performance of this Agreement or the transactions contemplated by this Agreement, is or will be entitled to any brokerage or finder's or similar fee or other commission as a result of this Agreement or such transactions. 2.20 INVENTORIES. None of the inventories of RLI and its Subsidiaries represent goods held on consignment, and such inventories are maintained on the premises of RLI or its Subsidiaries. The Stockholders make no other representations with respect to the inventories of RLI, which will be delivered on an "as-is" basis. 2.21 RECEIVABLES. All receivables of RLI and its Subsidiaries, whether reflected on the balance sheet or otherwise, represent sales actually made in the ordinary course of business, and, to the best knowledge of the Stockholders, are current and fully collectible net of any reserves shown on the balance sheet (which reserves are adequate and were calculated on a basis consistent with GAAP and past practices) within 120 days. The Stockholders have delivered to AvTel a complete and accurate aging list of all receivables of RLI as of a date not more than thirty days prior to the date hereof (and as of a date not more than thirty days prior to the Closing Date). 2.22 CUSTOMERS AND SUPPLIERS. Schedule 2.22 lists the names of and describes all Contracts with and the approximate percentage of Business attributable to, the ten largest customers of and ten most significant suppliers of the Business at the date of this Agreement, and any sole-source suppliers of significant goods or services (other than electricity, gas, telephone or water) to RLI with respect to which alternative sources of supply are not readily available on comparable terms and conditions. 2.23 ENVIRONMENTAL COMPLIANCE. Except as set forth in Schedule 2.23 hereto, (i) RLI and its Subsidiaries have not generated, used, transported, treated, stored, released or disposed of, and have not suffered or permitted anyone else to generate, use, transport, treat, store, release or dispose of any Hazardous Substance in violation of any Laws; (ii) there has not been any generation, use, transportation, treatment, storage, release or disposal of any Hazardous Substance in connection with the conduct of the Business of RLI or any Subsidiary or the use of any property or facility of RLI or any Subsidiary or, to the knowledge of the Stockholders, any nearby or adjacent properties or facilities, which has created or might reasonably be expected to create any liability under any Laws or which would require reporting to or notification of any Governmental Entity; (iii) no asbestos or polychlorinated biphenyl or underground storage tank is contained in or located at any facility of RLI or any Subsidiary; and (iv) any Hazardous Substance handled or dealt with in any way in connection with the Business of RLI, whether before or during the Stockholders' ownership, has been and is being handled or dealt with in all respects in compliance with applicable Laws. For the purposes of this Agreement, "HAZARDOUS SUBSTANCE" means (but shall not be limited to) substances that are defined or listed in, or otherwise classified pursuant to, any applicable Laws as "hazardous substances," "hazardous materials," "hazardous wastes" or "toxic substances," or any other formulation intended to define, list or classify substances by reason of deleterious properties such as ignitibility, corrosivity, reactivity, radioactivity, carcinogenicity, reproductive toxicity or "EP toxicity," and petroleum and drilling fluids, produced waters and other wastes associated with the exploration, development, or production of crude oil, natural gas or geothermal energy. 2.24 ACCURACY OF INFORMATION. None of the information supplied or to be supplied in writing by or on behalf of the Stockholders or RLI to AvTel, its agents or representatives in connection with these transactions, this Agreement or the negotiations leading up to this Agreement did contain, or at the respective times such information is delivered, will contain any untrue statement of a material fact, or omitted or will omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. If any of such information at any time subsequent to delivery and prior to Closing becomes untrue or misleading, in any material respect, the Stockholders will promptly notify AvTel in writing of such fact and the reason for such change. 2.25 PURCHASE FOR OWN ACCOUNT. Each of the Stockholders are acquiring the Initial Exchange Shares and the Earnout Shares, if any, for investment and for their own account, and not with a view to or for sale in connection with any distribution of any part thereof. 2.26 INVESTMENT EXPERIENCE. Each Stockholder has such knowledge and experience in financial and business matters that such Stockholder is capable of evaluating the risks of such Stockholder's proposed investment in the Initial Exchange Shares and the Earnout Shares, if any, and is able to bear the economic risk of its proposed investment. 2.27 INFORMATION CONCERNING AVTEL. The Stockholders have received copies of AvTel's Annual Report on Form 10-K for the year ended December 31, 1997, Quarterly Report on Form 10-Q for the quarter ending March 31, 1998, and Proxy Statement for its 1998 Annual Meeting of Stockholders, each as filed with the Securities and Exchange Commission (the "SEC"). The Stockholders have heretofore discussed AvTel and its plans, operations and financial condition with AvTel's officers and have heretofore received all such information as the Stockholders have deemed necessary and appropriate to enable the Stockholders to evaluate the financial risk inherent in making an investment in the Initial Exchange Shares and the Earnout Shares, if any, and the Stockholders have received satisfactory and complete information concerning the business and financial condition of AvTel in response to all inquiries in respect thereof. 2.28 RESTRICTED SECURITIES. The Stockholders understand and acknowledge that: 2.28.1 NO REGISTRATION. The AvTel Common Stock to be issued pursuant to Section 1.2 has not been registered under the Securities Act of 1933, as amended (the "Act"), or any state securities laws and it must be held indefinitely unless such AvTel Common Stock is subsequently registered under the Act and qualified under such state laws or an exemption from such registration and qualification is available and, except as set forth in Section 5.2, AvTel is under no obligation to register any of such AvTel Common Stock. 2.28.2 LEGENDS. The share certificate representing such AvTel Common Stock will be stamped with legends as set forth in Section 1.2.3. 2.28.3 STOP TRANSFER INSTRUCTIONS. AvTel will issue stop transfer instructions in accordance with this Agreement to its transfer agent with respect to such AvTel Common Stock. 3. REPRESENTATIONS AND WARRANTIES OF AVTEL. AvTel represents and warrants to the Stockholders, as of the date hereof and as of the Closing Date, as follows: 3.1 ORGANIZATION AND RELATED MATTERS. AvTel is a corporation duly organized, validly existing and in good standing under the laws of Delaware. AvTel has all necessary corporate power and authority to carry on its business as now being conducted. AvTel has the necessary corporate power and authority to execute, deliver and perform this Agreement and any related agreements to which it is a party. AvTel is duly qualified to transact business as a foreign corporation in each jurisdiction where the failure to be so qualified would have a material adverse effect on its business. AvTel's principal executive offices are located in the State of California. 3.2 AUTHORIZATION. The execution, delivery and performance of this Agreement and any related agreements by AvTel has been duly and validly authorized by all necessary corporate action on the part of AvTel. This Agreement constitutes the legal, valid and binding obligation of AvTel, enforceable against AvTel in accordance with its terms except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors' rights generally. 3.3 NO CONFLICTS. Except as set forth on Schedule 3.3, the execution, delivery and performance of this Agreement and any related agreements by AvTel will not violate the provisions of, or constitute a breach or default whether upon lapse of time and/or the occurrence of any act or event or otherwise under (a) the certificate of incorporation or bylaws of AvTel, (b) any Law to which AvTel is subject or (c) any Contract to which AvTel is a party that is material to the financial condition, results of operations or conduct of the business of AvTel. 3.4 VALID ISSUANCE OF AVTEL COMMON STOCK. Each of the Initial Exchange Shares and the Earnout Shares, if any, when issued, sold and delivered in accordance with the terms hereof, shall be duly and validly issued, fully paid and nonassessable. The Initial Exchange Shares and the Earnout Shares, if any, shall not be registered under the Securities Act of 1933, as amended. 3.5 NO BROKERS OR FINDERS. No agent, broker, finder or investment or commercial banker, or other person or firms engaged by or acting on behalf of AvTel or its Affiliates in connection with the negotiation, execution or performance of this Agreement or the transactions contemplated by this Agreement, is or will be entitled to any broker's or finder's or similar fees or other commissions as a result of this Agreement or such transactions. 3.6 LEGAL PROCEEDINGS. There is no Order or Action pending or to the best knowledge of AvTel, threatened against AvTel that individually or when aggregated with one or more other Actions has or might reasonably be expected to have a material adverse effect on AvTel's ability to perform this Agreement. 3.7 NASDAQ LISTING. AvTel Common Stock is listed for trading on The Nasdaq SmallCap MarketK of The Nasdaq Stock Market, Inc. 3.8 ACCURACY OF INFORMATION. None of the documents and reports filed by AvTel with the SEC contained any untrue statement of material fact or omitted to state any material fact necessary to make the information contained therein, in light of the circumstances under which they were made, not misleading as of the date of such document or report. None of the other information supplied or to be supplied in writing by or on behalf of AvTel to the Stockholders, their agents or representatives in connection with these transactions, this Agreement or the negotiations leading up to this Agreement did contain, or at the respective times such information is delivered, will contain any untrue statement of a material fact, or omitted or will omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. If any of such information at any time subsequent to delivery and prior to Closing becomes untrue or misleading, in any material respect, AvTel will promptly notify the Stockholders in writing of such fact and the reason for such change. 4. COVENANTS TO BE PERFORMED PRIOR TO CLOSING 4.1 ACCESS. The Stockholders shall cause RLI and the Subsidiaries to authorize and permit AvTel and its representatives (which term shall be deemed to include its independent accountants and counsel) to have reasonable access during normal business hours, upon reasonable notice and in such manner as will not unreasonably interfere with the conduct of the Business, to all of their respective properties, books, records, operating instructions and procedures, Tax Returns and all other information with respect to the Business as AvTel may from time to time request, and to make copies of such books, records and other documents and to discuss its Business with such other persons, including, without limitation, its directors, officers, employees, accountants, counsel, suppliers, customers, and creditors, as AvTel considers necessary or appropriate for the purposes of familiarizing itself with the Business, obtaining any necessary Approvals of or Permits for the transactions contemplated by this Agreement and conducting an evaluation of the organization and Business of RLI and its Subsidiaries. Without limiting the generality of the foregoing, AvTel shall be entitled to conduct or cause to be conducted such physical inspections as AvTel shall deem necessary or useful in connection with its acquisition of the Stockholder Shares. 4.2 MATERIAL ADVERSE CHANGES; REPORTS; FINANCIAL STATEMENTS. The Stockholders will promptly notify AvTel of any event of which the Stockholders obtain knowledge which has had or might reasonably be expected to have a material adverse effect on the Business or which if known as of the date hereof would have been required to be disclosed to AvTel. The Stockholders will cause RLI to prepare additional interim financial statements as soon as practicable after the end of each month to provide copies of such financial statements promptly to AvTel. 4.3 CONDUCT OF BUSINESS. The Stockholders agree with and for the benefit of AvTel that RLI and it Subsidiaries shall not, without the prior consent in writing of AvTel, which may be withheld for any reason: 4.3.1 conduct the Business in any manner except in the ordinary course consistent with prudent industry practice; or 4.3.2 amend, terminate, fail to renew or renegotiate any Material Contract or default (or take or omit to take any action that, with or without the giving of notice or passage of time, would constitute a default) in any of its obligations under any Material Contract or enter into any new Material Contract or take any action that would jeopardize the continuance of its material supplier or customer relationships; or 4.3.3 terminate, amend or fail to renew any existing insurance coverage; or 4.3.4 terminate or fail to renew or preserve any Permits; or 4.3.5 except as contemplated by Section 4.10 or Section 4.12, incur or agree to incur any obligation or liability (absolute or contingent) that individually calls for payment by RLI or any Subsidiary of more than $5,000 in any specific case or $25,000 in the aggregate; or 4.3.6 make any loan, guaranty or other extension of credit, or enter into any commitment to make any loan, guaranty or other extension of credit, to or for the benefit of any director, officer, employee, stockholder or any of their respective associates or affiliates; or 4.3.7 grant any general or uniform increase in the rates of pay or benefits to officers, directors or employees (or a class thereof) or any increase in salary or benefits of any officer, director, employee or agent or pay any bonus to any person, or enter into any new employment, collective bargaining or severance agreement; or 4.3.8 sell, transfer, mortgage, encumber or otherwise dispose of any assets or any liabilities, except in the ordinary course of business; or 4.3.9 except as contemplated by Section 4.12, issue, sell, redeem or acquire for value, or agree to do so, any debt obligations or equity securities of RLI or any of its Subsidiaries; or 4.3.10 except as contemplated by Section 4.12, declare, issue, make or pay any dividend or other distribution of assets, whether consisting of money, other personal property, real property or other thing of value, to its shareholders, or split, combine, dividend, distribute or reclassify any shares of its equity securities; or 4.3.11 change or amend its certificate of incorporation or bylaws; or 4.3.12 make any capital expenditures or commitments with respect thereto; or 4.3.13 except as contemplated by Section 4.10 or Section 4.12, make special or extraordinary payments to any person; or 4.3.14 make any material investment, by purchase, contributions to capital, property transfers, or otherwise, in any other person or entity; or 4.3.15 dispose of or permit to lapse any rights to the use of any Intellectual Property or dispose of or disclose any Intellectual Property not a matter of public knowledge; or 4.3.16 directly or indirectly terminate or reduce or commit to terminate or reduce any bank line of credit or the availability of any funds under any other agreement or understanding, other than through the use thereof in the ordinary course; or 4.3.17 except as contemplated by Section 4.10, compromise or otherwise settle any claims, or adjust any assertion or claim of a deficiency in Taxes (or interest thereon or penalties in connection therewith) or make any Tax election or make any change in any method or period of accounting or in any accounting policy, practice or procedure; or 4.3.18 introduce any new method of management or operation in respect of the Business; or 4.3.19 agree to or make any commitment to take any actions prohibited by this Section 4.3. 4.4 NOTIFICATION OF CERTAIN MATTERS. The Stockholders shall give prompt notice to AvTel, and AvTel shall give prompt notice to the Stockholder Representative, of (i) the occurrence, or failure to occur, of any event that would be likely to cause any representation or warranty contained in this Agreement to be untrue or inaccurate in any material respect at any time from the date of this Agreement to the Closing Date and (ii) any failure of AvTel or the Stockholders, as the case may be, to comply with or satisfy, in any material respect, any covenant, condition or agreement to be complied with or satisfied by it under this Agreement. No such notification shall affect the representations or warranties of the parties or the conditions to their respective obligations hereunder. 4.5 PERMITS AND APPROVALS. 4.5.1 The Stockholders and AvTel each agree to cooperate and use their best efforts to obtain (and will immediately prepare all registrations, filings and applications, requests and notices preliminary to all) Approvals and Permits that may be necessary or which may be reasonably requested by AvTel to consummate the transactions contemplated by this Agreement. 4.5.2 To the extent that the Approval of a third party with respect to any Contract is required in connection with the transactions contemplated by this Agreement, the Stockholders shall use their best efforts (and shall cause RLI to use its best efforts) to obtain such Approval prior to the Closing Date (but without limitation on AvTel's rights under Section 6.2). 4.6 NO TRANSFER OF STOCKHOLDER SHARES. Each of the Stockholders agrees that such Stockholder will not sell, transfer, pledge, hypothecate or otherwise encumber or dispose of any of the Stockholder Shares. Each Stockholder will comply will all applicable securities and other laws and regulations relating to this Agreement or the transactions contemplated hereby. 4.7 PRESERVATION OF BUSINESS PRIOR TO CLOSING DATE. During the period beginning on the date hereof and ending on the Closing Date, (a) the Stockholders will use their best efforts to preserve the Business and to preserve the goodwill of customers, suppliers and others having business relations with RLI, and (b) the Stockholders and AvTel will consult with each other concerning, and the Stockholders will cooperate to keep available to AvTel, the services of the officers and employees of RLI that AvTel may wish to have RLI retain. Nothing in this Section shall obligate AvTel or RLI after the Closing to retain or offer employment to any officer or employee of RLI. 4.8 ELIMINATION OF AFFILIATE LIABILITIES. Prior to the Closing Date, the Stockholders shall pur chase, cause to be repaid or (with respect to guarantees) assume liability for (i) any and all loans or other extensions of credit made or guaranteed by RLI or any Subsidiary to or for the benefit of any director, officer, or employee of RLI, or any of their Associates and (ii) any and all loans, guarantees or other extensions of credit of any amount made to or for the benefit of the Stockholders or any Affiliate of the Stockholders, in each case other than loans from RLI to Jeffrey P. Leventhal outstanding on the date hereof and not in excess of $269,000 in the aggregate, including all accrued interest thereon (the "LEVENTHAL ADVANCES"). Prior to the Closing, RLI will cancel the obligation of Jeffrey P. Leventhal to repay the Leventhal Advances; provided, however, that any Tax liability relating to such cancellation shall be borne solely by Jeffrey P. Leventhal. At the Closing Date, neither AvTel nor RLI shall have any continuing commitment, obligation or liability of any kind with respect to the persons referred to in subsections (i) and (ii) above. The Stockholders agree to indemnify AvTel and RLI for any Losses with respect to any such commitment, obligation or liability not fully assumed or discharged as contemplated, other than the Leventhal Advances. The Stockholders further represent that the transactions contemplated by this Section will have no adverse effect on the Business. 4.9 EXCLUSIVITY. Neither the Stockholders, RLI nor any of their respective Affiliates shall, directly or indirectly, solicit, initiate or encourage any offer or engage in any discussions or negotiations (other than with AvTel) concerning any sale of the Stockholder Shares or of the Business or assets of RLI or the Subsidiaries or any material part thereof, or any similar business combination or transaction. Neither the Stockholders, RLI nor any of their respective Affiliates shall furnish any information with respect to RLI or the Business to any person in connection with any such offer or transaction. If the Stockholders or RLI receive any offer or inquiry with respect to any of the foregoing types of transactions, the Stockholders will promptly inform AvTel of such offer or inquiry. 4.10 NEGOTIATION OF TAX LIABILITIES. RLI has outstanding certain Tax liabilities to federal and state Tax authorities as set forth on the balance sheet contained in the Interim Financial Statements and in Schedule 2.4 hereto. Prior to Closing, the Stockholders hereby agree to cause RLI to use its best efforts to negotiate with such Tax authorities for full and complete releases of all such Taxes (together with all related interest, penalties and other claims and charges), in form and substance satisfactory to AvTel (the "TAX RELEASES"). The payments to be made by RLI for the release of all federal Tax liabilities shall not exceed $700,000 and shall consist of (i) a down payment not in excess of $500,000, and (ii) additional post-Closing installment payments not in excess of $200,000 subject to terms and conditions approved in advance by AvTel (such installment payments being referred to as the "IRS Installment Payments"). The payments to be made by RLI for the release of all other tax liabilities shall not exceed $250,000. 4.11 LINE OF CREDIT NOTE. AvTel agrees to make available to RLI a loan of up to $500,000 pursuant to the terms of the Secured Promissory Note in substantially the form attached hereto as Exhibit B (the "LINE OF CREDIT NOTE"). The proceeds of the Line of Credit Note shall be used only for the purpose of obtaining the Tax Releases, and any advance on the Line of Credit Note may only be made after RLI has presented AvTel with evidence satisfactory to AvTel that such advance will enable RLI to obtain a particular Tax Release on appropriately discounted terms. All advances under the Line of Credit Note will be personally guaranteed by Jeffrey P. Leventhal and will be secured by all of the assets of RLI, with such personal guaranty and security agreement to be in the form contemplated in the Line of Credit Note. 4.12 BUYOUT OF PCSI HOLDERS. On or prior to the Closing Date, the Stockholders will purchase, or will cause RLI to repurchase or otherwise reacquire, all shares of the RLI Common Stock reflected on RLI's stock records as being held by the PCSI Holders for an aggregate purchase price of not less than $35,000. If such shares are repurchased by RLI, the aggregate purchase price shall not exceed $40,000. 4.13 REASONABLE EFFORTS. The Stockholders agree that from the date hereof to the Closing Date, they shall use their reasonable efforts, and cause RLI to use its reasonable efforts, to satisfy the conditions precedent to the Closing to the extent that such conditions are to be satisfied by the Stockholders. 5. ADDITIONAL CONTINUING COVENANTS 5.1 COVENANT NOT TO COMPETE. 5.1.1 RESTRICTIONS ON COMPETITIVE ACTIVITIES. The Stockholders agree that after the Closing AvTel and RLI shall be entitled to the goodwill and going concern value of the Business and to protect and preserve the same to the maximum extent permitted by law. The Stockholders also acknowledge that their management contributions to the Business have been uniquely valuable and involve proprietary information that would be competitively unfair to make available to any competitor of RLI. For these and other reasons and as an inducement to AvTel to enter into this Agreement, each of the Stockholders agrees that, for a period of two years after the Closing Date, such Stockholder will not, directly or indirectly, for its own benefit or as agent for another, carry on or participate in the ownership, management or control of, or the financing of, or be employed by, or consult for or otherwise render services to, or allow its name or reputation to be used in or by any other present or future business enterprise that is in competition with the Business as carried on by AvTel, RLI or any of their present or future Affiliates. Subject to the two-year limitation set forth above, this agreement of the Stockholders shall be effective in each separate county and parish in each of the fifty states of the United States of America (each a "Location") for so long as AvTel, RLI or any person entitled to or acquiring ownership of the goodwill of the Business or the Stockholder Shares through AvTel carries on a like business therein. 5.1.2 EXCEPTIONS. Nothing contained herein shall limit the right of a Stockholder as an investor to hold and make investments in securities of any corporation or limited partnership that is registered on a national securities exchange or admitted to trading privileges thereon or actively traded in a generally recognized over-the-counter market, provided the Stockholders's equity interest therein does not exceed 5% of the outstanding shares or interests in such corporation or partnership. 5.1.3 RESTRICTIONS ON SOLICITING EMPLOYEES. In addition, to protect AvTel against any efforts by the Stockholders to cause employees of RLI to terminate their employment, each of the Stockholders agrees that for a period of two years following the Closing Date, the Stockholders will not directly or indirectly (i) induce any employee of RLI or any Subsidiary (other than Steve Leventhal and Richard Leventhal) to leave RLI or such Subsidiary or to accept any other employment or position, or (ii) assist any other entity in hiring any such employee. 5.1.4 SPECIAL REMEDIES AND ENFORCEMENT. The Stockholders recognize and agree that a breach by a Stockholder of any of the covenants set forth in this Section 5.1 could cause irreparable harm to AvTel, RLI and their respective successors, that AvTel's remedies at law in the event of such breach would be inadequate, and that, accordingly, in the event of such breach a restraining order or injunction or both may be issued against the breaching Stockholder, in addition to any other rights and remedies which are available to AvTel. If this Section 5.1 is more restrictive than permitted by the Laws of the jurisdiction in which AvTel seeks enforcement hereof, this Section 5.1 shall be limited to the extent required to permit enforcement under such Laws. Without limiting the generality of the foregoing, the parties intend that the covenants contained in the preceding portions of this Section 5.1 shall be construed as a series of separate covenants, one for each Location specified. Except for geographic coverage, each such separate covenant shall be deemed identical in terms. It is the desire and intent of the parties hereto that the provisions of this Section 5.1 shall be enforced to the fullest extent (both geographical and temporal) permissible under the laws and public policies applied in each jurisdiction in which enforcement is sought. If the final judgment of a court of competent jurisdiction declares that any term or provision of this Section 5.1 is invalid or unenforceable, the Parties agree that the court making the determination of invalidity or unenforceability shall have the power to reduce the scope, duration, or area of the term or provision, to delete specific words or phrases, or to replace any invalid or unenforceable term or provision with a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision, and this Agreement shall be enforceable as so modified. If any particular provision or portion of this Section 5.1 shall be adjudicated to be invalid or unenforceable, such adjudication shall apply only with respect to the operation of this Section 5.1 in the particular jurisdiction in which such adjudication is made. 5.2 REGISTRATION RIGHTS 5.2.1 DEFINITIONS. For purposes of this Section 5.2, the terms "register", "registered" and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act, and the declaration or ordering of effectiveness of such registration statement or document. 5.2.2 PIGGYBACK REGISTRATION. If at any time after the Closing Date AvTel shall propose to register any of the AvTel Common Stock for sale or disposition for its own account for cash under the Securities Act in a public offering, other than a registration relating to stock options, employee benefit plans (defined in accordance with SEC regulations) or acquisitions, AvTel shall: 1. Promptly give the Stockholder Representative at least thirty (30) days' written notice prior to the filing thereof, which notice shall include the proposed date on which the registration statement is to be filed, the proposed price per share and a list of the jurisdictions in which AvTel intends to attempt to qualify such securities under the applicable blue sky or other state securities laws ("BLUE SKY LAWS"); and 2. Include in such registration (and any related qualification under Blue Sky Laws), and in any underwriting involved therein, ten percent (10%) of the Initial Exchange Shares and Earnout Shares, if any (the "REGISTRABLE SHARES"), then held by each of the Stockholders which are specified in a written request made by the Stockholder Representative within ten (10) days after receipt of such written notice from AvTel by the Stockholder Representative. 5.2.3 UNDERWRITING AGREEMENT. The right of the Stockholders to registration pursuant to this Section 5.2 shall be conditioned upon the Stockholders' participation in any underwriting relating to AvTel's registered public offering. The Stockholders shall (together with AvTel) enter into an underwriting agreement in customary form with the underwriter or underwriters selected by AvTel. Notwithstanding any provision of this Section 5.2, if the underwriter in its reasonable judgment determines that marketing factors require a limitation of the number of securities to be underwritten, the underwriter may exclude some or all of the Registrable Shares for which the Stockholders seek registration from inclusion in the registration and underwriting; provided, however, that if AvTel proposes to include in such registration shares of capital stock held by shareholders of AvTel other than the Stockholders ("Other Holders"), then the number of shares to be so excluded shall be allocated among the Stockholders and the Other Holders pro rata based upon the number of shares of capital stock proposed to be included in the registration by each of them. 5.2.4 EXPENSES OF REGISTRATION. AvTel shall bear all registration costs and expenses related to any registration and underwriting contemplated by this Article 5.2, except that the selling Stockholders shall bear (i) all underwriting commissions relating to the Registrable Shares registered and (ii) the fees and expenses of legal counsel to the Stockholders. 5.3 NONDISCLOSURE OF PROPRIETARY DATA. Neither the Stockholders nor any of their representatives shall, at any time prior to the second anniversary of the Closing Date, make use of, divulge or otherwise disclose, directly or indirectly, any trade secret or other proprietary data (including, but not limited to, any customer list, record or financial information) concerning the business or policies of RLI or its Subsidiaries that the Stockholders or any representative of the Stockholders may have learned as a shareholder, employee, officer or director of RLI. In addition, for two years after the Closing Date, neither the Stockholders nor any of their representatives shall make use of, divulge or otherwise disclose, directly or indirectly, to persons other than AvTel, any confidential information concerning the business or policies of RLI or its Subsidiaries which may have been learned in any such capacity. Nothing in this Section shall prevent a Stockholder who is employed by RLI or its Subsidiaries from using such information in the proper course of his or her employment. The Stockholders recognize and agree that a breach by a Stockholder of any of the covenants set forth in this Section 5.3 could cause irreparable harm to AvTel, RLI and their respective successors, that AvTel's remedies at law in the event of such breach would be inadequate, and that, accordingly, in the event of such breach a restraining order or injunction or both may be issued against the breaching Stockholder, in addition to any other rights and remedies which are available to AvTel. 5.4 TAX RETURNS; RESPONSIBILITY FOR CERTAIN TAX MATTERS. The following provisions shall govern the allocation of responsibility as between AvTel, RLI, and the Stockholders for certain Tax matters following the Closing Date: 5.4.1 TAX PERIODS ENDING ON OR BEFORE THE CLOSING DATE. RLI shall prepare or cause to be prepared and file or cause to be filed all Tax Returns for it for all Tax periods ending on or prior to the Closing Date which are filed after the Closing Date. AvTel shall permit the Stockholder Representative to review and comment on each such Tax Return described in the preceding sentence prior to filing. The Stockholders shall reimburse AvTel for Taxes of RLI with respect to such periods within fifteen (15) days after payment by AvTel or RLI of such Taxes to the extent such Taxes are not reflected in the reserve for Tax liability (rather than any reserve for deferred Taxes established to reflect timing differences between book and Tax income) set forth or included on the face of the RLI Financial Statements. 5.4.2 TAX PERIODS BEGINNING BEFORE AND ENDING AFTER THE CLOSING DATE. RLI shall prepare or cause to be prepared and file or cause to be filed any Tax Returns of RLI for Tax periods which begin before the Closing Date and end after the Closing Date. 5.4.3 COOPERATION ON TAX MATTERS. 1. The Stockholders shall, and shall cause their Affiliates to, cooperate fully, as and to the extent reasonably requested by the other party, in connection with the filing of Tax Returns pursuant to this Section and any audit, litigation or other proceeding with respect to Taxes. Such cooperation shall include the retention and (upon the other party's request) the provision of records and information which are reasonably relevant to any such audit, litigation or other proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. 2. AvTel and the Stockholders agree (i) to retain all books and records with respect to Tax matters pertinent to RLI relating to any taxable period beginning before the Closing Date until the expiration of the statute of limitations (and, to the extent notified by AvTel or the Stockholder Representative, any extensions thereof) of the respective taxable periods, and to abide by all record retention agreements entered into with any taxing authority, and (ii) to give the other party reasonable written notice prior to transferring, destroying or discarding any such books and records and, if the other party so requests, RLI or the Stockholder Representative, as the case may be, shall allow the other party to take possession of such books and records. Any information obtained pursuant to this Section or pursuant to any other Section hereof providing for the sharing of information or the review of any Tax Return or other Schedule relating to Taxes shall be subject to Section 9.9. 3. AvTel and the Stockholders further agree, upon request, to use their best efforts to obtain any certificate or other document from any governmental authority or any other person as may be necessary to mitigate, reduce or eliminate any Tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby). 5.5 SECURITIES LAWS MATTERS. Each of the Stockholders agrees not to sell, transfer, convey or otherwise distribute shares of AvTel Common Stock received pursuant to this Agreement over which such Stockholder has direct or indirect control without registration under the Securities Act and applicable federal and state securities laws, except pursuant to an exemption from registration thereunder. Each of the Stockholders will comply in all respects with such laws. 5.6 PAYMENT OF IRS INSTALLMENTS. AvTel will cause RLI to make the IRS Installment Payments on the terms approved by AvTel pursuant to Section 4.10. 6. CONDITIONS OF PURCHASE 6.1 GENERAL CONDITIONS. The obligations of the parties to effect the Closing shall be subject to the following conditions unless waived in writing by all parties: 6.1.1 NO ORDERS; LEGAL PROCEEDINGS. No Law or Order shall have been enacted, entered, issued, promulgated or enforced by any Governmental Entity, nor shall any Action have been instituted and remain pending at what would otherwise be the Closing Date, which prohibits or restricts or would (if successful) prohibit or restrict the transactions contemplated by this Agreement or (with respect to obligations of AvTel only) which would not permit the Business as presently conducted to continue unimpaired following the Closing Date. 6.1.2 APPROVALS. All Permits and Approvals with respect to the transactions contemplated hereby required to be obtained from any Governmental Entity shall have been received or obtained on or prior to the Closing Date. 6.2 CONDITIONS TO OBLIGATIONS OF AVTEL. The obligations of AvTel to effect the Closing shall be subject to the following additional conditions except to the extent waived in writing by AvTel: 6.2.1 REPRESENTATIONS AND WARRANTIES AND COVENANTS OF THE STOCKHOLDERS. The representations and warranties of the Stockholders herein contained shall be true in all material respects at the Closing Date with the same effect as though made at such time; the Stockholders shall have in all material respects performed all obligations and complied with all covenants and conditions required by this Agreement to be performed or complied with by them at or prior to the Closing Date. 6.2.2 NO MATERIAL ADVERSE CHANGE. There shall not have been any material adverse change in or affecting the Business subsequent to December 31, 1997. 6.2.3 LIMITATION ON TOTAL DEBT. As of the Closing Date, RLI and its Subsidiaries shall not have outstanding more than an aggregate of $550,000 in total debt, as determined in accordance with GAAP, excluding (i) the Line of Credit Note to AvTel, (ii) the obligation to make the IRS Installment Payments, and (iii) payment obligations to taxing authorities other than the Internal Revenue Service of not more than $250,000. 6.2.4 REVENUES FOR INTERIM PERIOD. RLI and its Subsidiaries shall have had net revenues for the period from January 1, 1998 to the Closing Date greater than or equal to that amount which, if annualized on a proportional basis for all of 1998, would equal $4,700,000. 6.2.5 CONSENTS. The Stockholders shall have obtained and provided to AvTel all required Approvals and Permits listed on Schedule 2.8, each in form and substance satisfactory to AvTel. 6.2.6 CERTIFICATE OF STOCKHOLDER REPRESENTATIVE. The Stockholder Representative shall have delivered to AvTel a certificate dated the Closing Date, on behalf of all of the Stockholders, in form and substance satisfactory to AvTel, certifying that the conditions set forth in Sections 6.2.1, 6.2.2, 6.2.3, 6.2.4, 6.2.5, 6.2.12 and 6.2.13 have been fully satisfied.. 6.2.7 OPINION OF COUNSEL. AvTel shall receive at the Closing from Rosen & Tetelman, counsel to the Stockholders, an opinion dated the Closing Date, in form and substance substantially as set forth in Exhibit C. 6.2.8 COMFORT LETTER. AvTel shall receive at the Closing from the Auditors a comfort letter dated not more than five business days prior to the Closing Date substantially in form of Exhibit D hereto and in substance reasonably satisfactory to AvTel. 6.2.9 RESIGNATION OF DIRECTORS AND OFFICERS. The directors of RLI and each of the Subsidiaries and the officers of RLI and Subsidiaries (other than those designated in writing by AvTel) shall have submitted their resignations in writing to RLI and AvTel. Such resignations of officers and direc tors (in such capacity) shall be effective upon the Closing. 6.2.10 DUE DILIGENCE. AvTel shall not, in the course of its on-going business investigation, have discovered information not previously disclosed by the Stockholders, RLI or its Subsidiaries, which AvTel reasonably believes has or is likely to have a materially adverse effect on the Business or is materially inconsistent with information disclosed to AvTel prior to the date hereof. 6.2.11 KEY EMPLOYEES. Jeffrey P. Leventhal shall have entered into an employment agreement (the "EMPLOYMENT AGREEMENT") with RLI in a form reasonably satisfactory to Jeffrey P. Leventhal and to AvTel, and containing the terms set forth in of Exhibit E hereto. AvTel shall be reasonably satisfied that the other significant employees of RLI and its Subsidiaries are willing to remain employees of RLI or its Subsidiaries (or become employees of AvTel) on terms reasonably satisfactory to AvTel following the consummation of the transactions contemplated by this Agreement. 6.2.12 TAX RELEASES. RLI shall have obtained a Tax Release from the Internal Revenue Service with respect to all federal Tax liabilities for consideration consisting of a down payment not in excess of $500,000 and the IRS Installment Payments not in excess of $200,000, on the terms contemplated by Section 4.10 hereof. 6.2.13 BUYOUT OF PCSI HOLDERS. The Stockholders and/or RLI shall have completed the acquisition of the shares of RLI Common Stock held by the PCSI Holders on the terms contemplated by Section 4.11 hereof. 6.2.14 EXECUTION OF AGREEMENT BY STOCKHOLDERS. This Agreement shall have been duly and validly executed by Stockholders holding one hundred percent (100%) of the shares of RLI Common Stock outstanding as of the Closing. 6.3 CONDITIONS TO OBLIGATIONS OF THE STOCKHOLDERS. The obligations of the Stockholders to effect the Closing shall be subject to the following conditions, except to the extent waived in writing by the Stockholders: 6.3.1 REPRESENTATIONS AND WARRANTIES AND COVENANTS OF AVTEL. The representations and warranties of AvTel herein contained shall be true in all material respects at the Closing Date with the same effect as though made at such time; AvTel shall have in all material respects performed all obligations and complied with all covenants and conditions required by this Agreement to be performed or complied with by it at or prior to the Closing Date, and AvTel shall have delivered to the Stockholders an officers' certificate of AvTel in form reasonably satisfactory to the Stockholders, dated the Closing Date, to such effect. 6.3.2 CONSENTS. AvTel shall have obtained and provided to the Stockholders all required Approvals and Permits listed on Schedule 3.3, each in form and substance satisfactory to the Stockholders. 6.3.3 EMPLOYEE STOCK OPTIONS. Concurrently with the Closing, AvTel shall have awarded 5,000 incentive stock options pursuant to its 1998 Stock Incentive Plan (the "1998 PLAN") to each of Neil Brenner and Andy Denton, who are employees of RLI or one or more of its Subsidiaries. Such options shall be subject to all of the terms and conditions of the 1998 Plan and shall become exercisable as to fifty percent (50%) of the shares to which they relate on the first anniversary of the Closing Date, and shall be fully exercisable on the second anniversary of the Closing Date, provided that such individuals remain employed by AvTel or one of its Affiliates. 6.3.4 OPINION OF COUNSEL. The Stockholder Representative shall receive at the Closing from Seed, Mackall & Cole LLP, counsel to AvTel, an opinion dated the Closing Date, in form and substance substantially as set forth in Exhibit F. 6.3.5 RELEASE OF PERSONAL GUARANTIES. The parties shall have obtained releases of Jeffrey P. Leventhal's material personal guaranties of RLI's obligations, in each case on terms reasonably satisfactory to Jeffrey P. Leventhal and AvTel. 7. TERMINATION OF OBLIGATIONS; SURVIVAL 7.1 TERMINATION OF AGREEMENT. Anything herein to the contrary notwithstanding, this Agreement and the transactions contemplated by this Agreement shall terminate if the Closing does not occur on or before midnight on August 31, 1998, unless extended by mutual consent in writing of AvTel and the Stockholders and otherwise may be terminated at any time before the Closing as follows and in no other manner: 7.1.1 MUTUAL CONSENT. By mutual consent in writing of AvTel and the Stockholders. 7.1.2 MATERIAL BREACH. By AvTel or the Stockholders if there has been a material misrepresentation or other material breach by the other party (or, in the case of AvTel, by the Stockholders or RLI) in its representations, warranties and covenants set forth herein; provided, however, that if such breach is susceptible to cure, the breaching party shall have ten business days in which to cure such breach after receipt of notice from the other party of its intention to terminate this Agreement if such breach continues. 7.2 EFFECT OF TERMINATION. In the event that this Agreement shall be terminated pursuant to Section 7.1, all further obligations of the parties under this Agreement shall terminate without further liability of any party to another; provided that the obligations of the parties contained in Section 9.9 and Section 9.11 shall survive any such termination. A termination under Section 7.1.2 shall not relieve any party of any liability for a breach of, or for any misrepresentation under this Agreement, or be deemed to constitute a waiver of any available remedy (including specific performance if available) for any such breach or misrepresentation. 7.3 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Except as set forth herein, the representations and warranties of the parties contained in or made pursuant to this Agreement shall survive the Closing, without regard to any investigation made by the other party hereto, for a period of one year after the Closing Date. All covenants and agreements of the parties contained in this Agreement shall survive the Closing in accordance with their stated terms or, if no term is stated, then one year from the Closing Date. Notwithstanding anything to the contrary herein, (a) the representations and warranties contained in Section 2.2 shall survive the Closing for a period of six years after the Closing Date; and (b) the representations and warranties contained in Section 2.4 shall survive for the period of time equal to the applicable statute of limitations in respect of claims relating thereto, plus 90 days. 8. INDEMNIFICATION 8.1 OBLIGATIONS OF THE STOCKHOLDERS. Each of the Stockholders, severally but not jointly, agrees to indemnify and hold harmless AvTel, RLI and their respective directors, officers, employees, Affiliates, agents and assigns (the "AVTEL PARTIES") from and against such Stockholder's Allocable Portion (as defined in below) of any and all actions, costs, damages, disbursements, expenses, liabilities, losses, deficiencies, obligations, penalties or settlements of any kind or nature, whether foreseeable or unforeseeable, including but not limited to, interest or other carrying costs, legal, accounting and other professional fees and expenses incurred in the investigation, collection, prosecution and defense of claims and amounts paid in settlement (collectively, "Losses"), that may be imposed on or otherwise incurred or suffered by any of such persons or entities, directly or indirectly, as a result of, or based upon or arising from: 8.1.1 any inaccuracy in or breach or nonperformance of any of the representations, warranties, covenants or agreements made by the Stockholders in or pursuant to this Agreement (without giving effect to any materiality qualifications contained in any such representation or warranty); or 8.1.2 any transactions among or involving the Stockholders, RLI and the PCSI Holders including, without limitation, the acquisition of the shares of RLI Common Stock held by the PCSI Holders on the terms contemplated by Section 4.11 hereof; or 8.1.3 any Order or Action pending or threatened on or prior to the Closing Date which is not set forth in Schedule 2.9; or 8.1.4 any Order or Action (i) set forth in Schedule 2.9 (other than the litigation with Thomas J. Ferrara described therein), but only to the extent that the Losses (excluding attorneys' fees and expenses relating thereto) therefrom exceed $50,000; or (ii) relating to Thomas J. Ferrara but only to the extent that Losses (excluding attorneys' fees and expenses relating thereto) therefrom exceed the aggregate amount of salary and commission owing to Thomas J. Ferrara on the date hereof (provided, however, that any settlement or judgment that requires the issuance of not more than 40,000 shares of AvTel Common Stock to or on behalf of Thomas J. Ferrara shall be handled solely by means of the Escrow Agreement); or 8.1.5 any indemnification required by Section 4.8. The "Allocable Portion" of a Stockholder shall mean that fraction equal to the number of Stockholder Shares held by such Stockholder on the Closing Date divided by the total number of Stockholder Shares outstanding on the Closing Date. Notwithstanding anything in this Agreement to the contrary, the indemnification obligations of Jeffrey P. Leventhal under this Section 8 shall be joint and several with the indemnification obligations of all of the Stockholders as a group. 8.2 OBLIGATIONS OF AVTEL. AvTel agrees to indemnify and hold harmless the Stockholders from and against any Losses of the Stockholders, directly or indirectly, as a result of, or based upon or arising from, any inaccuracy in or breach or nonperformance of any of the representations, warranties, covenants or agreements made by AvTel in or pursuant to this Agreement (without giving effect to any materiality qualifications contained in any such representation or warranty). 8.3 CERTAIN TAX MATTERS. 8.3.1 THE STOCKHOLDERS INDEMNITY. The Stockholders agree to indemnify, defend and hold harmless the AvTel Parties against (i) any Tax payable by or on behalf of the Stockholders, RLI or any of their Affiliates for any taxable period ending or treated by this Agreement as ending on or prior to the Closing Date, (ii) any deficiencies in any Tax payable by or on behalf of the Stockholders, RLI or any of their Affiliates arising from any audit by any taxing agency or authority with respect to any period ending or treated by this Agreement as ending on or prior to the Closing Date, (iii) any claim or demand for reimbursement or indemnification resulting from any transfer by the Stockholders or RLI prior to the Closing of any Tax benefits or credits to any other person, or (iv) any transfer Tax liabilities arising out of the transfer of the Stockholder Shares. 8.3.2 AUDIT MATTERS. AvTel shall have the responsibility for, and the right to control, at its expense, the audit (and disposition thereof) of any Tax Return of RLI relating to periods ending on or prior to the Closing Date. The Stockholder Representative shall have the right directly or through its designated representatives, to review in advance and comment upon all submissions made in the course of audits or appeals thereof to any Governmental Entity relating to periods ending or treated by this Agreement as ending on or prior to the Closing Date. 8.4 LIMITATIONS ON INDEMNIFICATION. 8.4.1 WITH RESPECT TO STOCKHOLDERS' OBLIGATIONS. The Stockholders' obligation to indemnify the AvTel Parties for Losses under Section 8.1.1 (i) shall accrue only if the aggregate of all such Losses exceeds $50,000, and (ii) shall be limited in the aggregate to an amount equal to the aggregate value of the Purchase Price actually delivered by AvTel as measured on the date (or dates) received. The limitations set forth in this Section 8.4.1 shall not apply to the indemnification obligations of the Stockholders with respect to any Losses that have resulted from (i) a breach of the representations and warranties contained in Section 2.2, Section 2.4 or Section 2.23, or (ii) a breach of the covenant contained in Section 5.5. The limitations set forth in this Section 8.4.1 shall not apply to the indemnification obligations of the Stockholders under Section 8.1.4 and Section 8.3 of this Agreement. 8.4.2 WITH RESPECT TO AVTEL'S OBLIGATIONS. AvTel's obligation to indemnify the Stockholders for Losses under Section 8.2 (i) shall accrue only if the aggregate of all such Losses exceeds $50,000, and (ii) shall be limited in the aggregate to an amount equal to the value of the Purchase Price actually delivered by AvTel. 8.4.3 FRAUD OR WILLFUL BREACH. The parties hereby agree that the limitations set forth in Section 8.4.1 and Section 8.4.2 shall not apply to the indemnification obligations of any party with respect to any Losses that have resulted proximately from the fraud or willful breach of such party. 8.4.4 APPLICATION TO OTHER REMEDIES. The limitations contained in this Section 8.4 shall apply to the parties' liability for indemnification or otherwise. Nothing herein shall limit a party's ability to obtain injunctive or equitable relief if otherwise authorized by this Agreement. 8.5 PROCEDURE. 8.5.1 NOTICE. Any party seeking indemnification with respect to any Loss (the "INDEMNIFIED PARTY") shall give notice to the party required to provide indemnity hereunder (the "INDEMNIFYING PARTY"). 8.5.2 DEFENSE. If any claim, demand or liability is asserted by any third party against any Indemnified Party, the Indemnifying Party shall upon the written request of the Indemnified Party, defend any actions or proceedings brought against the Indemnified Party in respect of matters embraced by the indemnity, but the Indemnified Party shall have the right to conduct and control the defense, compromise or settlement of any indemnifiable claim if the Indemnified Party chooses to do so, on behalf of and for the account and risk of the Indemnifying Party who shall be bound by the result so obtained to the extent provided herein. If, after a request to defend any action or proceeding, the Indemnifying Party neglects to defend the Indemnified Party, a recovery against the latter suffered by it in good faith, is conclusive in its favor against the Indemnifying Party, provided however that, if the Indemnifying Party has not received reasonable notice of the action or proceeding against the Indemnified Party, or is not allowed to control its defense, judgment against the Indemnified Party is only presumptive evidence against the Indemnifying Party. Each party hereto, to the extent that it is or becomes an Indemnifying Party, hereby stipulates that a judgment against the Indemnified Party shall be conclusive upon the Indemnifying Party. The parties shall cooperate in the defense of all third party claims which may give rise to indemnifiable claims hereunder. 8.5.3 TAX ADJUSTMENTS. Any amounts payable by the Indemnifying Party to or on behalf of an Indemnified Party in respect of a Loss shall be adjusted as follows: 1. If such Indemnified Party is liable for any additional Taxes as a result of the payment of amounts in respect of an indemnifiable claim, the Indemnifying Party will pay to the Indemnified Party in addition to such amounts in respect of the Loss within 10 days after being notified by the Indemnified Party of the payment of such liability (x) an amount equal to such additional Taxes (the "TAX REIMBURSEMENT AMOUNT") plus (y) any additional amounts required to pay additional Taxes imposed with respect to the Tax Reimbursement Amount and with respect to amounts payable under this clause (y), with the result that the Indemnified Party shall have received from the Indemnifying Party, net of the payment of Taxes, an amount equal to the Loss. 2. The Indemnified Party shall reimburse the Indemnifying Party an amount equal to the net reduction in any year in the liability for Taxes (that are based upon or measured by income) of the Indemnified Party or any member of a consolidated or combined tax group of which the Indemnified Party is, or was at any time, part, which reduction is actually realized with respect to any period after the Closing Date and which reduction would not have been realized but for the amounts paid (or any audit adjustment or deficiency with respect thereto, if applicable) in respect of a Loss, or amounts paid by the Indemnified Party pursuant to this paragraph (a "NET TAX BENEFIT"). The amount of any Net Tax Benefit shall be paid not later than 15 days after the date on which such Net Tax Benefit shall be realized. Any expenses associated with the realization of a Net Tax Benefit or any contest or proceeding with respect to a Net Tax Benefit shall be deemed to reduce such Net Tax Benefit. 8.6 PAYMENTS BY STOCKHOLDERS. Subject to Section 8.9, if a Stockholder owes any amount to AvTel pursuant to Section 8.1, such Stockholder may determine to pay such amount either (i) in cash, or (ii) by delivery of shares of AvTel Common Stock. If a Stockholder delivers shares of AvTel Common Stock, the value of such shares shall be deemed to be equal to the average closing price as publicly reported by the Nasdaq Stock Market as of 4:00 p.m. Eastern Time of AvTel Common Stock over the last sixty trading days ending with (and including) the second business day prior to the date such payment is to be made. 8.7 SURVIVAL. This Section 8 shall survive any termination of this Agreement. Any matter as to which a claim has been asserted by notice to the other party that is pending or unresolved at the end of the survival period of the applicable representation, warranty or covenant (as set forth in Section 7.3) shall continue to be covered by this Section 8 notwithstanding the termination of such survival period until such matter is finally terminated or otherwise resolved by the parties under this Agreement and any amounts payable hereunder are finally determined and paid. 8.8 NOTICE OF CLAIMS. The Stockholders agree to notify AvTel and AvTel agrees to notify the Stockholder Representative of any liabilities, claims or misrepresentations, breaches or other matters covered by this Section 8 upon discovery or receipt of notice thereof (other than from the other party hereto), whether before or after Closing. 8.9 OFFSET. If any matter as to which AvTel may be able to assert a claim hereunder is pending or unresolved at the time that AvTel is otherwise required to deliver any Earnout Shares to the Stockholders under this Agreement, AvTel shall have the right, in addition to other rights and remedies (whether under this Agreement or applicable Law), to withhold from such delivery that number of Earnout Shares determined by dividing the amount of the claim (provided it is then asserted in accordance with the provisions hereof) by the Closing Share Price. If it is finally determined that all or a portion of such amount claimed was not due AvTel under this Section 8, then AvTel shall promptly deliver to the Stockholders the Earnout Shares (or portion thereof) improperly retained. 9. GENERAL 9.1 AMENDMENTS; WAIVERS. This Agreement and any schedule or exhibit attached hereto may be amended only by agreement in writing of all parties. No waiver of any provision nor consent to any exception to the terms of this Agreement or any agreement contemplated hereby shall be effective unless in writing and signed by the party to be bound and then only to the specific purpose, extent and instance so provided. 9.2 SCHEDULES; EXHIBITS; INTEGRATION. Each schedule and exhibit delivered pursuant to the terms of this Agreement shall be in writing and shall constitute a part of this Agreement, although schedules need not be attached to each copy of this Agreement. This Agreement, together with such schedules and exhibits, constitutes the entire agreement among the parties pertaining to the subject matter hereof and supersedes all prior agreements and understandings of the parties in connection therewith. If any matter is disclosed or described in one schedule, and such disclosure or description would by its express terms serve as sufficient disclosure of such matter for purposes of any other schedule in which such matter is required to be disclosed, then such disclosure or description shall automatically be deemed to have been disclosed or described in each such other schedule. 9.3 BEST EFFORTS; FURTHER ASSURANCES. 9.3.1 STANDARD. Each party will use its best efforts to cause all conditions to its obligations to be timely satisfied and to perform and fulfill all obligations on its part to be performed and fulfilled under this Agreement, to the end that the transactions contemplated by this Agreement shall be effected substantially in accordance with its terms as soon as reasonably practicable. The parties shall cooperate with each other in such actions and in securing requisite Approvals. 9.3.2 LIMITATION. As used in this Agreement, the term "best efforts" shall not mean efforts which require the performing party to do any act that is unreasonable under the circumstances, to make any capital contribution or to expend any funds other than reasonable out-of-pocket expenses incurred in satisfying its obligations hereunder, including but not limited to the fees, expenses and disbursements of its accountants, actuaries, counsel and other professionals. 9.4 GOVERNING LAW. This Agreement and the legal relations between the parties shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and performed in such State and without regard to conflicts of law doctrines except to the extent that certain matters are preempted by federal law. 9.5 NO ASSIGNMENT. Neither this Agreement nor any rights or obligations under it are assignable except that AvTel may assign its rights hereunder (including but not limited to its rights under Section 8) to any subsidiary or affiliate of AvTel or to any post-Closing purchaser of the Stockholder Shares or of a substantial part of the assets of RLI. AvTel shall give the Stockholder Representative ten days prior written notice of any such assignment; provided, however, that any failure to give such notice shall not affect the rights of AvTel (or its assignee) or the obligations of the Stockholders hereunder. 9.6 HEADINGS. The descriptive headings of the Sections and subsections of this Agreement are for convenience only and do not constitute a part of this Agreement. 9.7 COUNTERPARTS; BINDING EFFECT. This Agreement and any amendment hereto or any other agreement (or document) delivered pursuant hereto may be executed in one or more counterparts and by different parties in separate counterparts. All of such counterparts shall constitute one and the same agreement (or other document) and shall become effective (unless otherwise provided therein) when one or more counterparts have been signed by each party and delivered to the other party. This Agreement shall be binding upon the signatories hereto when executed by AvTel and at least one Stockholder. Additional Stockholders executing this Agreement after the date hereof and on or prior to the Closing Date shall be bound as if they had executed this Agreement on the date hereof. 9.8 PARTIES IN INTEREST. This Agreement shall be binding upon and inure to the benefit of each party, and nothing in this Agreement, express or implied, is intended to confer upon any other person any rights or remedies of any nature whatsoever under or by reason of this Agreement. Nothing in this Agreement is intended to relieve or discharge the obligation of any third person to (or to confer any right of subrogation or action over against) any party to this Agreement. 9.9 CONFIDENTIALITY; PUBLICITY.. Each party agrees to protect the confidentiality of all information that is furnished by the other party and designated in writing as confidential by such other party or its representatives in connection with the transactions contemplated by this Agreement. If for any reason such transactions are not consummated, the receiving party shall, on request, return or destroy all such written information. This Section shall not apply to any information (i) already known to the receiving party or its representatives or to others not bound by a duty of confidentiality or which becomes publicly available through no fault of the receiving party or its representatives, (ii) the use of which is necessary or appropriate in making any filing or obtaining any financing, consent or approval required for the consummation of such transactions, or (iii) the furnishing or use of which is required by, or necessary or appropriate in connection, with legal proceedings. Except as necessary to obtain required third party consents, or to the extent required by law, without the prior written consent of the other party, neither AvTel nor the Stockholders will make (and each will direct its Affiliates and representatives not to make) directly or indirectly, any public comment, statement, or communication with respect to, or otherwise to disclose or to permit the disclosure of the existence of this Agreement, the transactions contemplated hereby, or any of the terms, conditions, or other aspects hereof. 9.10 NOTICES. Any notice or other communication hereunder must be given in writing and either (a) delivered in person, (b) transmitted by telex, telefax or telecommunications mechanism provided that any notice so given is also mailed as provided in clause (c) or (c) mailed by first class mail, postage prepaid, as follows: If to AvTel addressed to: If to Stockholder Representative addressed to: AvTel Communications, Inc. Remote Lojix/PCSI, Inc. 501 Bath Street 38 East 32nd Street Santa Barbara, CA 93101 New York, NY 10016 Attention: James P. Pisani Attention: Jeffrey P. Leventhal Facsimile No. (805) 884-6311 Facsimile No. With a copy to: With a copy to: Seed, Mackall & Cole LLP Rosen & Tetelman 1332 Anacapa Street, Suite 200 501 Fifth Avenue, Suite 1404 Santa Barbara, CA 93101 New York, NY 10017 Attention: Thomas N. Harding, Attention: Ted D. Rosen, Esq. Esq. Facsimile No. (805) 962-1404 Facsimile No. (212) 972-3555 If to any individual Stockholder, addressed to such Stockholder at the address set forth for such Stockholder in Schedule 2.1 hereto or to such other address or to such other person as either party shall have last designated by such notice to the other party. Each such notice or other communication shall be effective (i) if given by telecommunication, when transmitted to the applicable number so specified in (or pursuant to) this Section 9.10 and an appropriate answerback is received, (ii) if given by mail, three days after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid or (iii) if given by any other means, when actually delivered at such address. 9.11 EXPENSES. The Stockholders and AvTel shall each pay their own expenses incident to the negotiation, preparation and performance of this Agreement and the transactions contemplated hereby, including but not limited to the fees, expenses and disbursements of their respective counsel; provided that RLI may pay not more than $25,000 of the expenses relating to the transactions contemplated hereby. 9.12 WAIVER. No failure on the part of any party to exercise or delay in exercising any right hereunder shall be deemed a waiver thereof, nor shall any single or partial exercise preclude any further or other exercise of such or any other right. 9.13 ATTORNEY FEES. In the event of any Action for the breach of this Agreement or misrepresentation by any party, the prevailing party shall be entitled to reasonable attorney's fees, costs and expenses incurred in connection with such Action. 9.14 REPRESENTATION BY COUNSEL; INTERPRETATION. The Stockholders and AvTel each acknowledge that each party to this Agreement has been represented by counsel in connection with this Agreement and the transactions contemplated by this Agreement. Each of the Stockholders further acknowledges that Rosen & Tetelman has acted as counsel only for RLI and Jeffrey P. Leventhal, and that each of the other Stockholders has access to counsel other than Rosen & Tetelman. Accordingly, any rule of Law or any legal decision that would require interpretation of any claimed ambiguities in this Agreement against the party that drafted it has no application and is expressly waived. The provisions of this Agreement shall be interpreted in a reasonable manner to effect the intent of AvTel and the Stockholders. 9.15 SEVERABILITY. If any provision of this Agreement is determined to be invalid, illegal or unenforceable by any Governmental Entity, the remaining provisions of this Agreement shall remain in full force and effect provided that the essential terms and conditions of this Agreement for both parties remain valid, binding and enforceable IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be executed by its duly authorized officers as of the day and year first above written. "AvTel" AVTEL COMMUNICATIONS, INC., a Delaware corporation By /S/ JAMES P. PISANI ------------------- James P. Pisani President "STOCKHOLDERS" /S/ MATTHEW BLUMENTHAL ------------------- /S/ SARAH CHOI ----------- /S/ KENNETH W. SCOTT ----------------- /S/ MURRAY LEVRANT --------------- /S/ SHEILA LEVRANT --------------- /S/ JEFFREY LEVENTHAL ------------------ LEVENTHAL PAGET, LLC By: /S/ JEFFREY LEVENTHAL ---------------------- Jeffrey Leventhal /S/ RICHARD REICH -------------- ROSEN & TETELMAN By: /S/ TED D. ROSEN ------------------ Ted D. Rosen, Partner /S/ NEIL BRENNER ------------- /S/ ANDY DENTON ------------ /S/ ANTHONY TUREL -------------- /S/ DANIEL M. MURPHY ----------------- ALLIANCE CAPITAL INVESTMENTS CORP. By: /S/ STACIE GREENE ------------------ Stacie Greene, President /S/ ELMER DUWAYNE CARLSON ---------------------- /S/ KENNETH A. BARTON ------------------ /S/ MARK SACKSTEIN --------------- HST PARTNERS BY: /S/ LISA DAVIS ----------------- Lisa Davis, Partner [Exhibits and Schedules omitted] EX-2.7 3 EXHIBIT 2.7 Exhibit 2.7 FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT THIS FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT (this "Amendment") is entered into as of August 18, 1998, between AVTEL COMMUNICATIONS, INC., a Delaware corporation ("AVTEL"), and the stockholders (the "STOCKHOLDERS") of REMOTE LOJIX/PCSI, INC., a New York corporation ("RLI"), who have executed the Stock Purchase Agreement dated July 22, 1998 (the "STOCK PURCHASE AGREEMENT"). RECITALS A. The parties hereto have entered into the Stock Purchase Agreement pursuant to which AvTel will acquire the capital stock of RLI. B. The parties hereto have determined to amend the Stock Purchase Agreement as set forth herein. AGREEMENT In consideration of the mutual promises contained herein and intending to be legally bound, the parties agree as follows: 1. AMENDMENT OF SECTION 1.2.1. Section 1.2.1 is hereby amended to read in its entirety as follows: "1.2.1 INITIAL EXCHANGE SHARES. At the Closing, AvTel shall issue a total of 500,000 shares (the "INITIAL EXCHANGE SHARES") of its Common Stock, par value $.01 per share (the "AVTEL COMMON STOCK") to the Stockholders, to be divided among the Stockholders in the same proportion that the number of Stockholder Shares owned by each Stockholder (as set forth on Schedule 2.2) represents to the total number of Stockholder Shares. For purposes of calculating the number of Initial Exchange Shares to be received by each Stockholder, the numbers shall be rounded to the nearest whole share as required to avoid issuance of fractional shares. As of the Closing Date, the Initial Exchange Shares will not be registered under any federal or state securities laws. At the Closing, Jeffrey P. Leventhal shall deposit 95,000 of his Initial Exchange Shares into an escrow account pursuant to an Escrow Agreement substantially in the form attached hereto as Exhibit A (the "ESCROW AGREEMENT")." 2. AMENDMENT OF SECTION 1.2.2. Section 1.2.2 is hereby amended by adding the following as Section 1.2.2(C): "C. At the Closing, AvTel will issue a total of 9,535 shares of AvTel Common Stock (the "DELIVERED EARNOUT SHARES") to the following Stockholders: Dr. Kenneth A. Barton, Elmer DuWayne Carlson, HST Partners, Murray & Sheila Levant - JTROS, Daniel M. Murphy, Kenneth W. Scott and Dr. Anthony Turel. The Delivered Earnout Shares shall be divided among such named Stockholders in the same proportion that the number of Stockholder Shares owned by each such named Stockholder (as set forth on Schedule 2.2) represents to the total number of Stockholder Shares held by such named Stockholders. For purposes of calculating the number of Delivered Earnout Shares to be received by each such named Stockholder, the numbers shall be rounded to the nearest whole share as required to avoid issuance of fractional shares. The number of Delivered Earnout Shares has been determined as if RLI had already met the requirements set forth in Section 1.2.2(b)(2), using the average closing price of AvTel Common Stock over the last seventy-five trading days ending on the second business day prior to the date of this Amendment. The parties hereto agree that the Delivered Earnout Shares are delivered to such named Stockholders in full satisfaction of any and all obligations of AvTel to deliver Earnout Shares to such named Stockholders." 3. AMENDMENT OF SECTION 2.2.2. Section 2.2.2 is hereby amended to read in its entirety as follows: "2.2.2 CAPITALIZATION. The authorized capital stock of RLI consists of 10,000,000 shares of RLI Common Stock, of which 4,195,963 shares are issued and outstanding on the date hereof. On the Closing Date, there will be 4,157,796 shares of RLI Common Stock issued and outstanding. The authorized, issued and outstanding capital stock of each of the Subsidiaries is as set forth on Schedule 2.2. RLI owns, beneficially and of record, of all of the capital stock of each of the Subsidiaries, free and clear of any Encumbrances. Except as set forth on Exhibit 2.2, there are no outstanding options, warrants or other rights to subscribe for or purchase, or contracts or other obligations to issue or grant any rights to acquire, any stock or securities of RLI or the Subsidiaries, or to restructure or recapitalize RLI or the Subsidiaries. On the Closing Date, there will be no outstanding options, warrants or other rights to subscribe for or purchase, or contracts or other obligations to issue or grant any rights to acquire, any stock or securities of RLI or the Subsidiaries, or to restructure or recapitalize RLI or the Subsidiaries. Except as set forth on Schedule 2.2 hereto, there are no outstanding contracts of the Stockholders, RLI or the Subsidiaries to repurchase, redeem or otherwise acquire any securities of RLI or the Subsidiaries. The Stockholder Shares, and the shares of the capital stock of each of the Subsidiaries, are duly authorized, validly issued and outstanding and are fully paid and nonassessable and were issued in conformity with applicable laws. There are no preemptive rights in respect of any equity securities of RLI. " 4. AMENDMENT OF SECTION 2.27. Section 2.27 is hereby amended to read in its entirety as follows: "2.27 INFORMATION CONCERNING AVTEL. The Stockholders have received copies of AvTel's Annual Report on Form 10-K for the year ended December 31, 1997, Quarterly Reports on Form 10-Q for the quarters ending March 31 and June 30, 1998, and the Proxy Statement for AvTel's 1998 Annual Meeting of Stockholders, each as filed with the Securities and Exchange Commission (the "SEC"). The Stockholders have heretofore discussed AvTel and its plans, operations and financial condition with AvTel's officers and have heretofore received all such information as the Stockholders have deemed necessary and appropriate to enable the Stockholders to evaluate the financial risk inherent in making an investment in the Initial Exchange Shares and the Earnout Shares, if any, and the Stockholders have received satisfactory and complete information concerning the business and financial condition of AvTel in response to all inquiries in respect thereof." 5. AMENDMENT OF SECTION 4.12. Section 4.12 is hereby amended to read in its entirety as follows: "4.12 BUYOUT OF PCSI HOLDERS. On or prior to the Closing Date, the Stockholders will purchase, or will cause RLI to repurchase or otherwise reacquire, all shares of the RLI Common Stock reflected on RLI's stock records as being held by the PCSI Holders for an aggregate purchase price of not less than $15,000. If such shares are repurchased by RLI, the aggregate purchase price shall not exceed $15,200." 6. AMENDMENT OF SECTION 5.2.2. Section 5.2.2(B) is hereby amended to read in its entirety as follows: "B. Include in such registration (and any related qualification under Blue Sky Laws), and in any underwriting involved therein, the Initial Exchange Shares and Earnout Shares, if any (the "REGISTRABLE SHARES"), then held by each of the Stockholders which are specified in a written request made by the Stockholder Representative within ten (10) days after receipt of such written notice from AvTel by the Stockholder Representative; provided, however, that the Registrable Shares shall include only ten percent (10%) of the Initial Exchange Shares and Earnout Shares, if any, then held by each of Jeffrey P. Leventhal, Sarah Choi, Rich Reich, Matt Blumenthal, Neil Brenner, Andy Denton and Leventhal Paget LLC." 7. AMENDMENT OF SECTION 8.1.4. Section 8.1.4 is hereby amended to read in its entirety as follows: "8.1.4 any Order or Action (i) set forth in Schedule 2.9 (other than the litigation with Thomas J. Ferrara described therein), but only to the extent that the Losses (excluding attorneys' fees and expenses relating thereto) therefrom exceed $50,000; or (ii) relating to Thomas J. Ferrara but only to the extent that Losses (excluding attorneys' fees and expenses relating thereto) therefrom exceed the aggregate amount of salary and commission owing to Thomas J. Ferrara on the date hereof (provided, however, that any settlement or judgment that requires the issuance of not more than 58,500 shares of AvTel Common Stock to or on behalf of Thomas J. Ferrara shall be handled solely by means of the Escrow Agreement); or" 8. AMENDMENT OF SECTION 3 OF ESCROW AGREEMENT. Section 3 of the Escrow Agreement attached as Exhibit A to the Stock Purchase Agreement is hereby amended to read in its entirety as follows: "3. DEPOSIT OF THE ESCROW SHARES. On the Closing Date, AvTel shall deliver to Escrow Agent 95,000 shares of AvTel Common Stock (the "Escrow Shares") to which Leventhal would otherwise be entitled (in his capacity as a shareholder of RLI) under the Stock Purchase Agreement. The Escrow Shares shall consist of (i) a certificate representing 58,500 shares (referred to herein as the "Ferrara Shares"), and (ii) a certificate representing 36,500 shares (referred to herein as the "General Shares")." 9. NO OTHER MODIFICATION. Except as specifically amended hereby, the Stock Purchase Agreement shall continue unchanged and in full force and effect. All of the provisions contained in Section 9 of the Stock Purchase Agreement shall apply to this Amendment. IN WITNESS WHEREOF, each of the parties hereto has executed this Amendment as of the day and year first above written. "AVTEL" AVTEL COMMUNICATIONS, INC., a Delaware corporation By /S/ JAMES P. PISANI -------------------- James P. Pisani President "STOCKHOLDERS" /S/ JEFFREY LEVENTHAL ------------------- Name: Jeffrey Leventhal LEVENTHAL PAGET, LLC By: /S/ JEFFREY LEVENTHAL ---------------------- Name : Jeffrey Leventhal Title: Manager /S/ MATTHEW BLUMENTHAL ---------------------- Name : Matthew Blumenthal /S/ KENNETH W. SCOTT -------------------- Name: Kenneth W. Scott /S/ MURRAY LEVRANT ------------------ Name : Murray Levrant /S/ SHEILA LEVRANT ----------------- Name: Sheila Levrant /S/ SARAH CHOI -------------- Name : Sarah Choi /S/ RICHARD REICH ----------------- Name : Richard Reich Rosen & Tetelman By: /S/ TED D. ROSEN ----------------- Name : Ted D. Rosen Title: Partner /S/ NEIL BRENNER ---------------- Name : Neil Brenner /S/ ANDY DENTON --------------- Name : Andy Denton /S/ ANTHONY TUREL ----------------- Name : Anthony Turel /S/ DANIEL M. MURPHY -------------------- Name : Daniel M. Murphy ALLIANCE CAPITAL INVESTMENTS CORP. By: /S/ STACIE GREENE ------------------ Name : Stacie Greene Title: President /S/ ELMER DUWAYNE CARLSON ------------------------- Name : Elmer DuWayne Carlson /S/ KENNETH A. BARTON --------------------- Name : Kenneth A. Barton /S/ MARK SACKSTEIN ------------------ Name : Mark Sackstein HST PARTNERS By: /S/ LISA DAVIS ----------------- Name : Lisa Davis Title: Partner EX-2.8 4 EXHIBIT 2.8 Exhibit 2.8 EARNOUT AGREEMENT, dated as of October 30, 1998, to the Stock Purchase Agreement, dated July 22, 1998 and the First Amendment to Stock Purchase Agreement, dated as of August 18, 1998 (the "Stock Purchase Agreement") by and between AvTel Communications, Inc., a Delaware corporation ("AvTel"), and Jeffrey Leventhal, Sarah Choi, Richard Reich, Matthew Blumenthal, Mark Sackstein, Neil Brenner, Andy Denton, Alliance Capital Investments Corp. ("Alliance Capital"), Leventhal Paget, LLC and Rosen & Tetelman. 1) Capitalized terms not otherwise defined herein are used herein as set forth in the Stock Purchase Agreement. 2) Jeffrey Leventhal, Sarah Choi, Richard Reich, Matthew Blumenthal, Neil Brenner and Andy Denton shall be defined herein as the "Employee Stockholders" and Mark Sackstein, Alliance Capital, Leventhal Paget, LLC and Rosen & Tetelman shall be defined herein as the "Non-Employee Stockholders". 3) At the Closing, AvTel will issue a total of 140,140 shares of AvTel Common Stock (the "ALTERNATE DELIVERED EARNOUT SHARES") to the following Stockholders: Jeffrey P. Leventhal, Sarah Choi, Rich Reich, Matt Blumenthal, Mark Sackstein, Neil Brenner, Andy Denton, Alliance Capital, Leventhal Paget, LLC and Rosen & Tetelman. The number of Alternate Delivered Earnout Shares has been determined as if RLI had already met the requirements set forth in Section 1.2.2(b)(2), using $10.00 as the divisor for the Employee Shareholders and $7.00 as the divisor for the Non-Employee Shareholders. For purposes of calculating the number of Alternate Delivered Earnout Shares to be received by each such named Stockholder, the numbers shall be rounded to the nearest whole share as required to avoid issuance of fractional shares. The parties hereto agree that the Alternate Delivered Earnout Shares are delivered to such named Stockholders in full satisfaction of any and all obligations of AvTel to deliver Earnout Shares to such named Stockholders and such Shares shall not be refundable. Thus, the Alternate Delivered Earnout Shares will be delivered at Closing as follows:
Stockholder Alternate Delivered Earnout Shares - ----------- ---------------------------------- Jeffrey Leventhal 93,224 Sarah Choi 5,215 Richard Reich 5,215 Matthew Blumenthal 5,215 Alliance Capital 8,241 Leventhal Paget 8,851 Mark Sackstein 7,450 Rosen & Tetelman 533 Neil Brenner 3,098 Andy Denton 3,098
4) The Alternate Delivered Earnout Shares to be included in the definition of "Registrable Shares" under Section 5.2.2 (B) of the First Amendment to the Stock Purchase Agreement, dated as of August 18, 1998 (the "First Amendment") by and between AvTel, the Stockholders and RLI. 5) Except as amended hereby, the Stock Purchase Agreement shall continue unchanged and in full force and effect. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. AVTEL COMMUNICATIONS,INC. By: /S/ JAMES P. PISANI ------------------- James P. Pisani Title: President /S/ JEFFREY P. LEVENTHAL ------------------------ Jeffrey P. Leventhal LEVENTHAL PAGET, LLC By:/S/ JEFFREY LEVENTHAL ------------------------ Jeffrey Leventhal /S/ SARAH CHOI /S/ MARK SACKSTEIN - -------------- ------------------ Sarah Choi Mark Sackstein /S/ RICHARD REICH /S/ NEIL BRENNER - ----------------- ---------------- Richard Reich Neil Brenner /S/MATTHEW BLUMENTHAL /S/ ANDY DENTON - --------------------- --------------- Matthew Blumenthal Andy Denton ALLIANCE CAPITAL INVESTMENTS CORP. By: /S/ STACIE GREENE ----------------- Stacie Greene Title: President ROSEN & TETELMAN By: /S/ TED D. ROSEN --------------------- Ted D. Rosen, Partner EX-3.2 5 EXHIBIT 3.2 EXHIBIT 3.2 CERTIFICATE OF DESIGNATIONS, PREFERENCES AND RIGHTS OF SERIES B CONVERTIBLE PREFERRED STOCK OF AVTEL COMMUNICATIONS, INC. PURSUANT TO SECTION 151 OF THE DELAWARE GENERAL CORPORATION LAW The undersigned, being the Chief Executive Officer of AvTel Communications, Inc., a corporation organized and existing under and by virtue of the laws of the State of Delaware (hereinafter the "Corporation"), DO HEREBY CERTIFY: FIRST: That pursuant to authority expressly granted and vested in the Board of Directors of said Corporation by the provisions of Article IV of the Corporation's Certificate of Incorporation, said Board of Directors adopted the following resolution on March 31, 1999 determining the designations, preferences and rights of its Series B Convertible Preferred Stock: RESOLVED: That pursuant to the authority vested in the Board of Directors of the Corporation by Article IV of the Corporation's Certificate of Incorporation (the "Certificate of Incorporation"), a series of Preferred Stock of the Corporation be, and it hereby is, created out of the authorized but unissued shares of the capital stock of the Corporation, such series to be designated Series B Convertible Preferred Stock (the "Series B Convertible Preferred Stock"), to consist of 1,500 shares, par value $.01 per share, of which the preferences and relative and other rights, and the qualifications, limitations or restrictions thereof, shall be as set forth in the Certificate of Designations annexed hereto: 1. NUMBER OF SHARES OF SERIES B CONVERTIBLE PREFERRED STOCK. Of the 750,000 shares of authorized but undesignated Preferred Stock, $.01 par value ("Preferred Stock") of the Corporation, one thousand five hundred (1,500) shares shall be designated and known as Series B Convertible Preferred Stock, par value $.01 per share ("Series B Convertible Preferred Stock"). 2. VOTING. (a) Unless required by law, no holder of any shares of Series B Convertible Preferred Stock shall be entitled to vote at any meeting of stockholders of the Corporation (or any written actions of stockholders in lieu of meetings) with respect to any matters presented to the stockholders of the Corporation for their action or consideration. Notwithstanding the foregoing, the Corporation shall provide each holder of record of Series B Convertible Preferred Stock with timely notice of every meeting of stockholders of the Corporation and shall provide each holder with copies of all proxy materials distributed in connection therewith. (b) So long as shares of Series B Convertible Preferred Stock are outstanding, the Corporation shall not, without first obtaining the approval (by vote or written consent, as provided by the Delaware General Corporation Law) of the holders of at least 85% in interest of the then outstanding shares of Series B Convertible Preferred Stock: (i) alter or change the rights, preferences or privileges of the Series B Convertible Preferred Stock; (ii) create any new class or series of capital stock having parity with or a preference over the Series B Convertible Preferred Stock as to distribution of assets upon liquidation, dissolution or winding up of the Corporation ("Senior Securities") or alter or change the rights, preferences or privileges of any Senior Securities so as to affect adversely the Series B Convertible Preferred Stock; (iii) increase the authorized number of shares of Series B Convertible Preferred Stock; or (iv) do any act or thing not authorized or contemplated by this Certificate of Designations which would result in taxation of the holders of shares of the Series B Convertible Preferred Stock under Section 305 of the Internal Revenue Code of 1986, as amended (or any comparable provision of the Internal Revenue Code as hereafter from time to time amended). In the event holders of at least 85% in interest of the then outstanding shares of Series B Convertible Preferred Stock agree to allow the Corporation to alter or change the rights, preferences or privileges of the shares of Series B Convertible Preferred Stock, pursuant to subsection (b) above, so as to affect the Series B Convertible Preferred Stock, then the Corporation will deliver notice of such approved change to the holders of the Series B Convertible Preferred Stock that did not agree to such alteration or change (the "Dissenting Holders") and Dissenting Holders shall have the right for a period of thirty (30) days to convert any and all shares of then held Series B Convertible Preferred Stock pursuant to the terms of this Certificate of Designation as in effect prior to such alteration or change, or else to continue to hold their shares of Series B Convertible Preferred Stock. 3. DIVIDENDS. The holders of shares of Series B Convertible Preferred Stock shall be entitled to receive, before any cash dividend shall be declared and paid upon or set aside for the Common Stock in any fiscal year of the Corporation, out of funds legally available for that purpose, cumulative dividends payable in cash in an amount per share for such fiscal year equal to $30.00. Such dividends shall accrue daily and be payable quarterly on March 31, June 30, September 30 and December 31 of each year, commencing June 30, 1999. In the event that the Corporation'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 Corporation may pay any such dividend in the form of Common Stock, valued at the closing bid price for the Common Stock on the Principal Market on the day prior to the dividend payment date. 4. LIQUIDATION. (a) If the Corporation shall commence a voluntary case under the Federal bankruptcy laws or any other applicable Federal or State bankruptcy, insolvency or similar law, or consent to the entry of an order for relief in an involuntary case under any law or to the appointment of a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other similar official) of the Corporation or of any substantial part of its property, or make an assignment for the benefit of its creditors, or admit in writing its inability to pay its debts generally as they become due, or if a decree or order for relief in respect of the Corporation shall be entered by a court having jurisdiction in the premises in an involuntary case under the Federal bankruptcy laws or any other applicable Federal or State bankruptcy, insolvency or similar law resulting in the appointment of a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other similar official) of the Corporation or of any substantial part of its property, or ordering the winding up or liquidation of its affairs, and any such decree or order shall be unstayed and in effect for a period of thirty (30) consecutive days and, on account of any such event, the Corporation shall liquidate, dissolve or wind up, or if the Corporation shall otherwise liquidate, dissolve or wind up (each such event being considered a "Liquidating Event"), no distribution shall be made to the holders of any shares of capital stock of the Corporation other than Senior Securities (as defined below) upon liquidation, dissolution or winding up unless prior thereto, the holders of shares of Series B Convertible Preferred Stock shall have received the Liquidation Preference (as defined in Section 4(c)) with respect to each share. If upon the occurrence of a Liquidation Event, the assets and funds available for distribution among the holders of the Series B Convertible Preferred Stock and holders of securities ranking pari passu as to preference upon liquidation with the Series B Convertible Preferred Stock shall be insufficient to permit the payment to such holders of the preferential amounts payable thereon, then the entire assets and funds of the Corporation legally available for distribution to the Series B Convertible Preferred Stock and such pari passu securities shall be distributed ratably among such shares in proportion to the ratio that that Liquidation Preference payable on each such share bears to the aggregate Liquidation Preference payable on all such shares. (b) At the option of each holder, the sale, conveyance of disposition of all or substantially all of the assets of the Corporation, the effectuation by the Corporation of a transaction or series or related transactions in which more than 50% of the voting power of the Corporation is disposed of, or the consolidation, merger or other business combination of the Corporation with or into any other person or persons when the Corporation is not the survivor shall be deemed to be a liquidation, dissolution or winding up of the Corporation pursuant to which the Corporation shall be required to distribute, upon consummation of and as a condition to such transaction an amount equal to the Liquidation Preference with respect to each outstanding share of Series B Convertible Preferred Stock held by such holder in accordance with and subject to the terms of this Section 4. (c) The Liquidation Preference shall be the Stated Value of $1,000 per share of Series B Convertible Preferred Stock plus all accrued but unpaid dividends. The Corporation's Series A Preferred Stock shall constitute Senior Securities and shall be ranked senior to the Series B Convertible Preferred Stock in respect of the distribution of assets upon a Liquidating Event and for purposes of receiving cash dividends. 5. OPTIONAL CONVERSION. The holders of shares of Series B Convertible Preferred Stock shall have the following conversion rights: (a) RIGHT TO CONVERT; CONVERSION PRICE. Subject to the terms, conditions, and restrictions of this Section 5, the holder of any shares of Series B Convertible Preferred Stock shall have the right to convert each such share of Series B Convertible Preferred Stock (except that upon any liquidation of the Corporation, the right of conversion shall terminate at the close of business on the business day fixed for payment of the amount distributable on the Series B Convertible Preferred Stock) into an amount of shares of Common Stock equal to the Stated Value of such share or shares of Series B Convertible Preferred Stock divided by (i) the lowest closing bid price, as reported by Bloomberg L.P., on the principal market for the Corporation's Common Stock based on trading volume (the "Principal Market") during the period of five consecutive trading days ending with the last trading day prior to the date of conversion (the "Conversion Date") (the "Market Price"), after (ii) discounting the Market Price by 11% to determine the conversion price (the "Conversion Price"). To illustrate, if the Market Price as of the Conversion Date is $1.00 and 100 shares of Series B Convertible Preferred Stock are being converted, the Stated Value for which would be $100,000, then the Conversion Price shall be $0.89 per share of Common Stock ($1.00 x .89), whereupon the Stated Value of $100,000 of Series B Convertible Preferred Stock would entitle the holder thereof to convert the 100 shares of Series B Convertible Preferred Stock into 112,359 shares of Common Stock ($100,000 divided by $0.89 equals 112,359). However, in no event shall the Conversion Price be greater than 100% of the closing bid price of the Common Stock on the Principal Market on the Original Issuance Date, as defined in the next paragraph (the "Maximum Conversion Price") nor less than three dollars ($3.00) prior to 180 days from the Original Issuance Date, as defined in the next paragraph, or less than two dollars ($2.00) at any time thereafter (the "Minimum Conversion Price") except that there shall be no Minimum Conversion Price if (i) the Corporation shall report on its Form 10-Q or QSB or 10-K or KSB for the applicable quarter gross revenues of less than (w) $8,200,000 for the quarter ended March 31, 1999, (x) $10,000,000 for the quarter ended June 30, 1999, (y) $12,000,000 for the quarter ended September 30, 1999 or (z) $15,000,000 for the quarter ended December 31, 1999. In addition, there shall be no Minimum Conversion Price if the Corporation shall report EBITDA for the month ending December 31, 1999 of less than zero dollars. The Corporation covenants that it shall report such month-end EBITDA on a Form 8-K report no later than February 28, 2000. In addition, if the Conversion Price on any Conversion Date is less than $4.00, then the Corporation shall have the option, prior to or within two business hours (which may carry over to the next business day if after 4:00 p.m. Eastern time at the Corporation) of receipt of a Conversion Notice from a holder and upon prior written notice to the holder, to pay the holder in shares of Common Stock as set forth above, or else in cash in an amount equal to (i) the closing ask price on the Principal Market on the Conversion Date multiplied by (ii) the number of shares of Common Stock which would otherwise be issuable to the holder upon such conversion, or any combination of cash and Common Stock. If notice of the Corporation's election to pay the holder in cash is not received by the holder prior to or within two business hours of the receipt by the Corporation of a Conversion Notice, the Corporation shall issue the holder shares of Common Stock unless otherwise consented to by the holder. Any conversion which is paid in cash shall be paid within three (3) business days of the Conversion Date, or else the late delivery payments set forth in Section 5(d)(ii) hereof shall apply to such late payment, and, upon demand of the holder in such event of late delivery, the holder may require the Corporation to deliver the shares otherwise issuable upon such conversion. Unless the Corporation shall have obtained the approval of its voting stockholders to such issuance in accordance with the applicable rules of the Principal Market, if any, the Corporation shall not issue shares of Common Stock upon conversion of any shares of Series B Convertible Preferred Stock if such issuance of Common Stock, when added to the number of shares of Common Stock previously issued by the Corporation upon conversion of or as dividends on shares of the Series B Convertible Preferred Stock, or issued upon exercise of the Stock Purchase Warrants issued in conjunction with the issuance of shares of Series B Convertible Preferred Stock, would exceed 19.9% of the number of shares of the Corporation's Common Stock which were issued and outstanding on the Original Issuance Date. The right to convert shares of Series B Convertible Preferred Stock shall be pro rated among the original purchasers of such shares and their respective subsequent transferees, if any, in order to comply with the aforesaid overall limitation. In the event that the Corporation has not obtained stockholder approval of such issuance prior to receipt of a Conversion Notice which would otherwise violate this provision, the Corporation shall honor such conversion request (resulting in an issuance in excess of 19.9%) in cash in an amount equal to (i) the closing ask price on the Principal Market on the day prior to the Conversion Date multiplied by (ii) the number of shares of Common Stock which would otherwise be issuable to the holder upon such conversion. (b) CONVERSION DATE. (i) The holder of any shares of Series B Convertible Preferred Stock may convert the shares of Series B Convertible Preferred Stock purchased by such holder from the Company 90 days from the Original Issuance Date, or if the holder accepts the Maximum Conversion Price at the Conversion Price, then such shares shall be convertible at any time after the Original Issuance Date; provided, that the Corporation shall have the right, on no more than three (3) occasions during the life of the Series B Convertible Preferred Stock, by at least three (3) trading days' prior written notice to the holders, to refuse to honor any Exchange Notice delivered during any specified seven (7) calendar day period. (ii) In no event shall a holder be permitted to convert any shares of Series B Convertible Preferred Stock in excess of the number of such shares upon the conversion of which, (x) the number of shares of Common Stock owned by such holder (other than shares of Common Stock issuable upon conversion of shares of Series B Convertible Preferred Stock) plus (y) the number of shares of Common Stock issuable upon such conversion of such shares of Series B Convertible Preferred Stock, would be equal to or exceed 9.9% of the number of shares of Common Stock then issued and outstanding, including shares issuable upon conversion of the Series B Convertible Preferred Stock held by such holder after application of this Section 5(b)(ii). As used herein, beneficial ownership shall be determined in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder. To the extent that the limitation contained in this Section 5(b)(ii) applies, the determination of whether shares of Series B Convertible Preferred Stock are convertible (in relation to other securities owned by holder) and of which shares of Series B Convertible Preferred Stock are convertible shall be in the sole discretion of such holder, and the submission of shares of Series B Convertible Preferred Stock for conversion shall be deemed to be such holder's determination of whether such shares of Series B Convertible Preferred Stock are convertible (in relation to other securities owned by such holder) and of which shares of Series B Convertible Preferred Stock are convertible, in each case subject to such aggregate percentage limitation, and the Corporation shall have no obligation to verify or confirm the accuracy of such determination. Nothing contained herein shall be deemed to restrict the right of a holder to convert such shares of Series B Convertible Preferred Stock at such time as such conversion will not violate the provisions of this paragraph. The provisions of this Section 5(b)(ii) may be waived by a holder of Series B Convertible Preferred Stock as to itself (and solely as to itself) upon not less than 75 days' prior notice to the Corporation, and the provisions of this Section 5(b)(ii) shall continue to apply until such 75th day (or such later date as may be specified in such notice of waiver). No conversion in violation of this paragraph but otherwise in accordance with this Certificate of Designation shall affect the status of the Common Stock issued upon such conversion as validly issued, fully-paid and nonassessable. (c) NOTICE OF CONVERSION. The right of conversion shall be exercised by the holder thereof by giving written notice (the "Conversion Notice") to the Corporation, by facsimile or by registered mail or overnight delivery service, with a copy by facsimile to the Corporation's then transfer agent for its Common Stock, as designated by the Corporation from time to time, that the holder elects to convert a specified number of shares of Series B Convertible Preferred Stock representing a specified Stated Value thereof into Common Stock and, if such conversion will result in the conversion of all of such holder's shares of Series B Convertible Preferred Stock, by surrender of a certificate or certificates for the shares so to be converted to the Corporation at its principal office (or such other office or agency of the Corporation as the Corporation may designate by notice in writing to the holders of the Series B Convertible Preferred Stock) at any time during its usual business hours on the date set forth in the Conversion Notice, together with a statement of the name or names (with address) in which the certificate or certificates for shares of Common Stock shall be issued. The Conversion Notice shall include therein the Stated Value of shares of Series B Convertible Preferred Stock to be converted, and a calculation (i) of the Market Price, (ii) the Conversion Price, and (iii) the number of shares of Common Stock to be issued in connection with such conversion. (d) ISSUANCE OF CERTIFICATES; TIME CONVERSION EFFECTED. (i) Promptly, but in no event more than three business days, after the receipt of the Conversion Notice referred to in Section 5(c) and surrender of the certificate or certificates for the share or shares of Series B Convertible Preferred Stock to be converted (if required), the Corporation shall issue and deliver, or cause to be issued and delivered, to the holder, registered in such name or names as such holder may direct, a certificate or certificates for the number of whole shares of Common Stock into which such shares of Series B Convertible Preferred Stock are converted. To the extent permitted by law, such conversion shall be deemed to have been effected on the date on which such Conversion Notice shall have been received by the Corporation and at the time specified stated in such Conversion Notice, which must be during the calendar day of such notice, and at such time the rights of the holder of such share or shares of Series B Convertible Preferred Stock shall cease, and the person or persons in whose name or names any certificate or certificates for shares of Common Stock shall be issuable upon such conversion shall be deemed to have become the holder or holders of record of the shares represented thereby. Issuance of shares of Common Stock issuable upon conversion which are requested to be registered in a name other than that of the registered holder shall be subject to compliance with all applicable federal and state securities laws. (ii) The Corporation understands that a delay in the issuance of the shares of Common Stock beyond three business days could result in economic loss to the holder. As compensation to the holder for such loss, the Corporation agrees to pay late payments to the holder for late issuance of shares of Common Stock upon conversion in accordance with the following schedule (where "NO. BUSINESS DAYS LATE" is defined as the number of business days beyond three (3) business days from the date of receipt by the Corporation of the Conversion Notice):
Late Payment For Each $5,000 of Stated Value No. Business Days Late Amount Being Converted - ----------------------------- ---------------------------------------------- 1 $100 2 $200 3 $300 4 $400 5 $500 6 $600 7 $700 8 $800 9 $900 10 $1,000 >10 $1,000 + $200 for each Business Day Late beyond 10 days
The Corporation shall pay any payments incurred under this Section in immediately available funds upon demand. Nothing herein shall limit holder's right to pursue injunctive relief and/or actual damages for the Corporation's failure to issue and deliver Common Stock to the holder, including, without limitation, the holder's actual losses occasioned by any "buy-in" of Common Stock necessitated by such late delivery. Furthermore, in addition to any other remedies which may be available to the holder, in the event that the Corporation fails for any reason to effect delivery of such shares of Common Stock within five business days the date of receipt of the Conversion Notice, the holder will be entitled to revoke the relevant Conversion Notice by delivering a notice to such effect to the Corporation whereupon the Corporation and the holder shall each be restored to their respective positions immediately prior to delivery of such Conversion Notice. (iii) If, at any time (a) the Corporation challenges, disputes or denies the right of the holder to effect the conversion of the Series B Convertible Preferred Stock into Common Shares or otherwise dishonors or rejects any Conversion Notice delivered in accordance with this Section 5 or (b) any third party who is not and has never been an Affiliate (as defined in Rule 405 under the Securities Act of 1933, as amended) of the holder obtains a judgment or order from any court or public or governmental authority which denies, enjoins, limits, modifies, or delays the right of the holder hereof to effect the conversion of the Series B Convertible Preferred Stock into Common Shares, then the holder shall have the right, by written notice to the Corporation, to require the Corporation to promptly redeem the Series B Convertible Preferred Stock for cash at a redemption price equal to one hundred twenty percent (120%) of the Stated Value thereof (the "Mandatory Purchase Amount"). Under any of the circumstances set forth above, the Corporation shall indemnify and hold harmless the holder and be responsible for the payment of all costs and expenses of the holder, including its reasonable legal fees and expenses, as and when incurred in disputing any such action or pursuing its rights hereunder (in addition to any other rights of the holder). The Corporation shall not refuse to honor any Conversion Notice unless its has actually been enjoined by a court of competent jurisdiction from doing so, and if so enjoined, the Corporation shall post with such court a performance bond equal to 120% of the Stated Value of the shares sought to be converted by the holder which are the subject of such injunction. (iv) The holder shall be entitled to exercise its conversion privilege notwithstanding the commencement of any case under 11 U.S.C. Section 101 ET SEQ. (the "Bankruptcy Code"). In the event the Corporation is a debtor under the Bankruptcy Code, the Corporation hereby waives to the fullest extent permitted any rights to relief it may have under 11 U.S.C. Section 362 in respect of the holder's conversion privilege. The Corporation hereby waives to the fullest extent permitted any rights to relief it may have under 11 U.S.C. Section 362 in respect of the conversion of the Series B Convertible Preferred Stock. The Corporation agrees, without cost or expense the holder, to take or consent to any and all action necessary to effectuate relief under 11 U.S.C. Section 362. (e) FRACTIONAL SHARES. No fractional shares shall be issued upon conversion of Series B Convertible Preferred Stock into Common Stock. All fractional shares shall be rounded up to the nearest whole share. (f) REORGANIZATION OR RECLASSIFICATION. If any capital reorganization or reclassification of the capital stock of the Corporation shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, or, in the case of any consolidation, merger or mandatory share exchange of the Corporation into any other company, then, as a condition of such reorganization, reclassification or exchange, lawful and adequate provisions shall be made whereby each holder of a share or shares of Series B Convertible Preferred Stock shall thereupon have the right to receive, upon the basis and upon the terms and conditions specified herein and in lieu of the shares of Common Stock immediately theretofore receivable upon the conversion of such share or shares of Series B Convertible Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such Common Stock immediately theretofore receivable upon such conversion had such reorganization, reclassification or exchange not taken place, and in any such case appropriate provisions shall be made with respect to the rights and interests of such holder to the end that the provisions hereof (including without limitation provisions for adjustments of the conversion rights and the fixing of the Conversion Price) shall thereafter be applicable, as nearly as may be, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of such conversion rights. For clarity, it is the intention of the Corporation that the conversion rights of the holders of the Series B Convertible Preferred Stock shall survive any consolidation, merger or mandatory share exchange and that the conversion rights granted hereunder shall be exercisable against any such successor corporation, and shall not be terminated or fixed upon the consummation of any such transaction. (g) ADJUSTMENTS FOR SPLITS, COMBINATIONS, ETC. The Conversion Price and the number of shares of Common Stock into which the Series B Convertible Preferred Stock shall be convertible shall be adjusted for stock splits, stock dividends, combinations or other similar events. No adjustment to the Conversion Price will be made for dividends (other than stock dividends), if any, paid on the Common Stock or for securities issued pursuant to exercise for fair value of options, warrants or restricted stock. 6. MANDATORY CONVERSION. (a) MANDATORY CONVERSION DATE. If on or after March 31, 2002 (such date as selected by the Corporation being the "Mandatory Conversion Date"), there remain issued and outstanding any shares of Series B Convertible Preferred Stock, then the Corporation shall be entitled to require all (but not less than all) holders of shares of Series B Convertible Preferred Stock then outstanding to convert their shares of Series B Convertible Preferred Stock into shares of Common Stock or, at the option of the Corporation, to buy out all such holders in cash, at the then effective Conversion Price pursuant to Section 5(a). The Corporation shall provide written notice (the "Mandatory Conversion Notice") to the holders of shares of Series B Convertible Preferred Stock of such mandatory conversion or such mandatory buy-out. The Mandatory Conversion Notice shall include (i) the Stated Value of the shares of Series B Convertible Preferred Stock to be converted or bought out, (ii) the Conversion Price at the Mandatory Conversion Date (which may refer to a formula for determining such price), and (iii) the number of shares of the Corporation's Common Stock to be issued (or the amount of cash to be paid in the event of a buy-out) upon such mandatory conversion or such mandatory buy-out at the then applicable Conversion Price. Notwithstanding the foregoing, in no event shall the Corporation convert that portion of the Series B Convertible Preferred Stock to the extent that the issuance of Common Stock upon the conversion of such Series B Convertible Preferred Stock, when combined with shares of Common Stock received upon other conversions of Series B Convertible Preferred Stock by such holder and any other holders of Series B Convertible Preferred Stock or upon exercise of the Stock Purchase Warrants referred to in Section 5(a), would exceed 19.9% of the Common Stock outstanding on the Original Issuance Date (unless stockholder approval has been obtained as described in Section 5(a), if necessary) , or as to any individual holder, make such holder the beneficial owner of 9.9% or more of the Company's then-outstanding Common Stock. (b) SURRENDER OF CERTIFICATES. On or before the Mandatory Conversion Date, each holder of shares of Series B Convertible Preferred Stock shall surrender his or its certificate or certificates for all such shares to the Corporation at the place designated in such Mandatory Conversion Notice (or an affidavit of lost certificate in form and content reasonably satisfactory to the Corporation), and shall thereafter receive certificates for the number of shares of Common Stock to which such holder is entitled or, in the event of a buy-out by the Corporation, the amount of cash such holder is entitled within three business days. On the Mandatory Conversion Date, all rights with respect to the Series B Convertible Preferred Stock so converted, including the rights, if any, to receive notices and vote, will terminate. All certificates evidencing shares of Series B Convertible Preferred Stock that are required to be surrendered for conversion in accordance with the provisions hereof, from and after the Mandatory Conversion Date, shall be deemed to have been retired and cancelled, notwithstanding the failure of the holder or holders thereof to surrender such certificates on or prior to such date. The Corporation may thereafter take such appropriate action as may be necessary to reduce the authorized Series B Convertible Preferred Stock accordingly. 7. REDEMPTION OF SERIES B CONVERTIBLE PREFERRED STOCK. (a) RIGHT TO REDEEM SERIES B CONVERTIBLE PREFERRED STOCK. At any time after the earlier of (i) the closing of a firm-commitment underwritten public offering of its Common Stock or (ii) the date which is six months after the Original Issuance Date, the Corporation may, in its sole discretion, but shall not be obligated to, redeem, in whole but not in part, the then issued and outstanding shares of Series B Convertible Preferred Stock, at a price equal to 130% of the Stated Value, plus all accrued but unpaid dividends, provided that a registration statement permitting resale of any shares of Common Stock issuable upon conversion by the holder is then effective. Each holder shall have five (5) business days after receipt of the Redemption Notice to elect instead to convert such shares pursuant to Section 5 hereof, notwithstanding that less than 90 days may have elapsed from the Original Issuance Date or that the registration statement is not then effective. Any such conversions made pursuant to this Section 7 shall be made at the Conversion Price established pursuant to Section 5(a). (b) NOTICE OF REDEMPTION. The Corporation shall provide each holder of record of the Series B Convertible Preferred Stock being redeemed with written notice of redemption (the "Redemption Notice") not less than 10 days prior to any date stipulated by the Corporation for the redemption of the Series B Convertible Preferred Stock (the "Redemption Date"). The Redemption Notice shall contain (i) the Redemption Date, (ii) the number of shares of Series B Convertible Preferred Stock to be redeemed from the holder to whom the Redemption Notice is delivered, and (iii) instructions for surrender to the Corporation of the certificate or certificates representing the shares of Series B Convertible Preferred Stock to be redeemed. (c) SURRENDER OF CERTIFICATES; PAYMENT OF REDEMPTION PRICE. On or before the Redemption Date, each holder of the shares of Series B Convertible Preferred Stock to be redeemed shall surrender the required certificate or certificates representing such shares to the Corporation, in the manner and at the place designated in the Redemption Notice, and upon payment to the holder of the Redemption Price, each such surrendered certificate shall be cancelled and retired. If payment of such redemption price is not made in full by the Redemption Date the Holder shall again have the right to convert the Series B Convertible Preferred Stock as provided in Section 5 hereof, and the Company shall thereafter be precluded from exercising its rights under this Section 7. If a certificate is surrendered and all the shares evidenced thereby are not being redeemed, the Corporation shall issue new certificates to be registered in the names of the person(s) whose name(s) appear(s) as the owners on the respective surrendered certificates and deliver such certificate to such person(s). 8. NOTICES. In case at any time: (a) the Corporation shall declare any dividend upon its Common Stock payable in cash or stock or make any other pro rata distribution to the holders of its Common Stock; or (b) the Corporation shall offer for subscription PRO RATA to the holders of its Common Stock any additional shares of stock of any class or other rights; or (c) there shall be any capital reorganization or reclassification of the capital stock of the Corporation, or a consolidation or merger of the Corporation with or into, or a sale of all or substantially all its assets to, another entity or entities; or (d) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Corporation; then, in any one or more of said cases, the Corporation shall give, by first class mail, postage prepaid, or by telex or facsimile or by recognized overnight delivery service to non-U.S. residents, addressed to each holder of any shares of Series B Convertible Preferred Stock at the address of such holder as shown on the books of the Corporation, (i) at least twenty (20) business days' prior written notice of the date on which the books of the Corporation shall close or a record shall be taken for such dividend, distribution or subscription rights or for determining rights to vote in respect of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up and (ii) in the case of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, at least twenty (20) business days' prior written notice of the date when the same shall take place. Such notice in accordance with the foregoing clause (i) shall also specify, in the case of any such dividend, distribution or subscription rights, the date on which the holders of Common Stock shall be entitled thereto and (ii) shall also specify the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding up, as the case may be. 9. STOCK TO BE RESERVED. The Corporation, upon the effective date of this Certificate of Designations, has a sufficient number of shares of Common Stock available to reserve for issuance upon the conversion of all outstanding shares of Series B Convertible Preferred Stock, assuming immediate conversion. The Corporation will at all times reserve and keep available out of its authorized Common Stock, solely for the purpose of issuance upon the conversion of Series B Convertible Preferred Stock as herein provided, such number of shares of Common Stock as shall then be issuable upon the conversion of all outstanding shares of Series B Convertible Preferred. The Corporation covenants that all shares of Common Stock which shall be so issued shall be duly and validly issued, fully paid and non-assessable. The Corporation will take all such action as may be so taken without violation of any applicable law or regulation, or of any requirement of any national securities exchange upon which the Common Stock may be listed to have a sufficient number of authorized but unissued shares of Common Stock to issue upon conversion of the Series B Convertible Preferred Stock. The Corporation will not take any action which results in any adjustment of the conversion rights if the total number of shares of Common Stock issued and issuable after such action upon conversion of the Series B Convertible Preferred Stock would exceed the total number of shares of Common Stock then authorized by the Corporation's Certificate of Incorporation, as amended. 10. NO REISSUANCE OF SERIES B CONVERTIBLE PREFERRED STOCK. Shares of Series B Convertible Preferred Stock which are converted into shares of Common Stock as provided herein shall not be reissued. 11. ISSUE TAX. The issuance of certificates for shares of Common Stock upon conversion of Series B Convertible Preferred Stock shall be made without charge to the holder for any United States issuance tax in respect thereof, provided that the Corporation shall not be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of any certificate in a name other than that of the holder of the Series B Convertible Preferred Stock which is being converted. 12. CLOSING OF BOOKS. The Corporation will at no time close its transfer books against the transfer of any Series B Convertible Preferred Stock or of any shares of Common Stock issued or issuable upon the conversion of any shares of Series B Convertible Preferred Stock in any manner which interferes with the timely conversion of such Series B Convertible Preferred Stock, except as may otherwise be required to comply with applicable securities laws. 13. DEFINITIONS. As used in this Certificate of Designations, the term "Common Stock" shall mean and include the Corporation's authorized Common Stock, $0.01 par value, as constituted on the date of filing of these terms of the Series B Convertible Preferred Stock, and shall also include any capital stock of any class of the Corporation thereafter authorized which shall neither be limited to a fixed sum or percentage of par value in respect of the rights of the holders thereof to participate in dividends nor entitled to a preference in the distribution of assets upon the voluntary or involuntary liquidation, dissolution or winding up of the Corporation; provided that the shares of Common Stock receivable upon conversion of shares of Series B Convertible Preferred Stock shall include only shares designated as Common Stock of the Corporation on the date of filing of this instrument, or in case of any reorganization, reclassification, or stock split of the outstanding shares thereof, the stock, securities or assets provided for in Subparagraph 5(f) and (g). Any capitalized terms used in this Certificate of Designations but not defined herein shall have the meanings set forth in that certain Convertible Preferred Stock and Warrant Purchase Agreement dated as of April 5, 1999 among the Corporation and the other persons signatory thereto, a copy of which will be provided to any stockholder of the Corporation upon request to the Secretary of the Corporation, without charge. 14. LOSS, THEFT, DESTRUCTION OF PREFERRED STOCK. Upon receipt of evidence satisfactory to the Corporation of the loss, theft, destruction or mutilation of certificates representing shares of Series B Convertible Preferred Stock and, in the case of any such loss, theft or destruction, upon receipt of indemnity or security reasonably satisfactory to the Corporation, or, in the case of any such mutilation, upon surrender and cancellation of the Series B Convertible Preferred Stock certificate, the Corporation shall make, issue and deliver, in lieu of such lost, stolen, destroyed or mutilated certificates for Series B Convertible Preferred Stock, new certificates for Series B Convertible Preferred Stock of like tenor. The Series B Convertible Preferred Stock shall be held and owned upon the express condition that the provisions of this Section 14 are exclusive with respect to the replacement of mutilated, destroyed, lost or stolen shares of Series B Preferred Stock and shall preclude any and all other rights and remedies notwithstanding any law or statue existing or hereafter enacted to the contrary with respect to the replacement of negotiable instruments or other securities without the surrender thereof. 15. WHO DEEMED ABSOLUTE OWNER. The Corporation may deem the person in whose name the Series B Convertible Preferred Stock shall be registered upon the registry books of the Corporation to be, and may treat it as, the absolute owner of the Series B Convertible Preferred Stock for the purpose of conversion of the Series B Convertible Preferred Stock and for all other purposes, and the Corporation shall not be affected by any notice to the contrary. All such payments and such conversion shall be valid and effectual to satisfy and discharge the liability upon the Series B Convertible Preferred Stock to the extent of the sum or sums so paid or the conversion so made. 16. REGISTER. The Corporation shall maintain a transfer agent, which may be the transfer agent for the Common Stock or the Corporation itself, for the registration of the Series B Convertible Preferred Stock. Upon any transfer of the Series B Convertible Preferred Stock in accordance with the provisions hereof, the Corporation shall register or cause the transfer agent to register such transfer on the Series B Convertible Preferred Stock register. 17. WITHHOLDING. To the extent required by applicable law, the Corporation may withhold amounts for or on account of any taxes imposed or levied by or on behalf of any taxing authority in the United States having jurisdiction over the Corporation from any payments made pursuant to the Series B Convertible Preferred Stock. 18. HEADINGS. The headings of the Sections of this Certificate of Designations are inserted for convenience only and do not constitute a part of this Certificate of Designations. IN WITNESS WHEREOF, Anthony E. Papa, Chief Executive Officer of the Corporation, under penalties of perjury, does hereby declare and certify that this is the act and deed of the Corporation and the facts stated herein are true and accordingly has signed this Certificate of Designations as of this 13th day of April, 1999. AvTEL COMMUNICATIONS, INC. By: /S/ ANTHONY E. PAPA ------------------------ Anthony E. Papa, Chief Executive Officer EX-10.5 6 EXHIBIT 10.5 Exhibit 10.5 AVTEL COMMUNICATIONS, INC. FIRST AMENDMENT TO NEW BEST CONNECTIONS, INC. AMENDED AND RESTATED 1997 OPTION PLAN (NON-QUALIFIED) THIS FIRST AMENDMENT (the "Amendment") to the New Best Connections, Inc. Amended and Restated 1997 Option Plan (the "Plan") was approved effective January 1, 1999, by the Board of Directors (the "Board") of AvTel Communications, Inc. ("AvTel"), a Delaware corporation which has succeeded to and assumed the rights and obligations of New Best Connections, Inc. pursuant to Section 8.12 of the Plan. RECITALS A. Section 10 of the Plan states that the Plan may be amended or discontinued at any time or from time to time by the Board. So long as such amendment does not impair the rights of any holder of an option that has become exercisable under the terms of the Plan, such amendment does not require the consent of any holder. B. The Board desires to amend the Plan to provide certain additional incentives with respect to certain products and participants. AMENDMENT NOW, THEREFORE, the Plan is amended as follows: 1. ADDITIONAL DEFINITIONS. The following terms will have the meanings set forth below: 1.1 "Qualified Billings Average" will mean the average monthly Qualified Billings of a participant during the period commencing October 1, 1998, and ending December 31, 1998, excluding any bonus Qualified Billings. 1.2 "Special Qualifying Period" will mean the period commencing January 1, 1999, and ending September 30, 1999. 1.3 "SuperAchiever" will mean a participant who has earned Exercisable Options equal to the full amount of his or her Initial Options at or after the date of this Amendment. 1.4 Other capitalized terms used herein and not defined will have the respective meanings ascribed to them in the Plan. 2. INCLUSION OF MULTIPLE OF MATRIXINET-TM- IN CALCULATION OF QUALIFIED BILLINGS. For the purposes of Section 6.2 of the Plan, a participant's Qualified Billings for a Qualifying Period will include the actual monthly billing of each customer properly subscribed by the participant for AvTel's MatrixInet-TM- Internet access services multiplied by 200%. 3. SUPERACHIEVER COMPONENT. 3.1 DESIGNATION OF ADDITIONAL INITIAL OPTIONS. The Board may determine to designate additional Initial Options with respect to one or more SuperAchievers ("Additional Initial Options"), up to the maximum number of Initial Options fixed by Section 6.1 of the Plan. Any and all Additional Initial Options that have not become Exercisable Options as a result of Qualified Billings during the Special Qualifying Period will terminate as of the end of the Special Qualifying Period. 3.2 CONVERSION TO EXERCISABLE OPTIONS. A SuperAchiever's Additional Initial Options will become Exercisable Options in accordance with Section 6.2 of the Plan; provided, however, that for such purposes (i) only the SuperAchiever's Qualified Billings in excess of his or her Qualified Billings Average in each month will be included, (ii) all computations will use the Special Qualifying Period, rather than the Qualifying Periods specified in Section 6.2 of the Plan, and (iii) the respective conversion factors used will be one-third of the values set forth in Table 6.2.2(b) of the Plan. 4. EXTRA COMPONENT. 4.1 ELIGIBLE PARTICIPANTS. Participants in the Plan who are not SuperAchievers ("Extra participants") may be selected by the Board to participate in a separate mechanism to accelerate the conversion of their Initial Options to Exercisable Options. Extra participants will continue to earn Exercisable Options in accordance with Section 6.2 of the Plan, as well as the Exercisable Options contemplated by this Section. 4.2 CALCULATION OF EXTRA COMPONENT. If an Extra participant's Qualified Billings in any month during the Special Qualifying Period exceed his or her Qualified Billings Average, then an additional amount equal to the excess will be treated as separate and additional Qualified Billings for the purposes of Section 6.2 of the Plan, resulting in additional Initial Options becoming Exercisable Options. 5. EXAMPLES. Specific examples illustrating the amendments set forth in Sections 2, 3 and 4 are attached hereto as exhibits to aid in the interpretation of this Amendment. 6. EFFECTIVE DATE. This Amendment will be effective as of January 1, 1999. 7. CONFIRMATION. Except as modified hereby, the provisions of the Plan will remain unchanged and in full force and effect. All the provisions of the Plan will apply to this Amendment. EX-10.12 7 EXHIBIT 10.12 Exhibit 10.12 LICENSE AGREEMENT THIS LICENSE AGREEMENT (the "Agreement"), executed as of _March 1, 1999 (the "Effective Date"), is between MATRIX Telecom, Inc. a Texas corporation ("Licensee"), and Electronic Data Systems Corporation, a Delaware corporation ("EDS"). ARTICLE I - GRANT 1.1 GRANT OF LICENSE TO THE LICENSED PROGRAMS. Subject to the terms and conditions set forth in this Agreement, EDS grants to Licensee a non-exclusive, non-transferable license: (a) to use as provided in this ARTICLE I on the equipment designated by type, model and serial number in SCHEDULE 1.1 (the "Designated Equipment") and at the location designated in SCHEDULE 1.1 (the "Designated Location") one copy, in object code form, of EDS' proprietary computer software programs more specifically described in SCHEDULE 1.1 (such programs, including all new releases thereof and modifications thereto which are provided to Licensee under this Agreement, are referred to herein as the "Licensed Programs"); and (b) to use as provided in this ARTICLE I the documentation relating to the Licensed Programs, including user manuals, narrative descriptions, output reports, training materials and technical manuals setting forth specifications for the Licensed Programs, including all new releases thereof and modifications made thereto which are provided to Licensee under this Agreement (collectively, the "Documentation"). Such right of use will include Licensee's reproduction of that number of copies of the Documentation reasonably required in Licensee's operations. 1.2 DELIVERY AND TERM. EDS will deliver to Licensee the Licensed Programs and the Documentation at the Designated Location on or before June 1, 1999 or such other date agreed to by the parties in writing. The term of this License will begin on the earlier of (a) the date EDS completes installation of the Licensed Programs and furnishes Licensee written notification of such completion, or (b) the date the Licensed Programs first processes Licensee's Billable Messages to Licensee's reasonable satisfaction (the "Installation Date"), and will continue for sixty (60) months (the "License Term") unless earlier terminated pursuant to Article VII. For purposes of this Agreement, a "Billable Message" means records of those mutually agreed upon and legally permitted (i) telephone calls originated by end-users through Licensee, or (ii) other services provided by Licensee to Licensee's end-users. The original License Term will automatically extend for successive one-year periods thereafter unless either party notifies the other at least ninety days prior to the end of the original License Term or prior to the end of any such one-year extension period, as the case may be, that this Agreement will not be so extended. 1.3 OWNERSHIP. For purposes of Section 117 of the Copyright Act of 1976, as amended, and for all other purposes, EDS will be considered the owner of the Licensed Programs, the Documentation and any copies thereof and of all copyright, trade secret, patent and other intellectual or industrial property rights contained or evidenced therein. Physical copies of the Licensed Programs (in diskette, tape or other form provided by EDS) and the Documentation will remain the property of EDS, and all such copies will be deemed to be on loan to Licensee during the License Term. 1.4 RESTRICTIONS ON USE. Licensee will comply with the provisions set forth in this SECTION 1.4 during the License Term. (a) The Licensed Programs and the Documentation will be utilized only for the internal data processing requirements of Licensee and only as specified in the Documentation. (b) The Licensed Programs and the Documentation will be utilized (i) only by Licensee employees and/or Licensee agents who are directly involved in the use and operation of the Licensed Programs and who are bound by written agreement to comply with the confidentiality obligations set forth in this Agreement, and (ii) only on the Designated Equipment at the Designated Location. EDS reserves the right to prohibit such utilization by specific individuals to whom EDS has reasonable objection. (c) With thirty days prior written notification to EDS, Licensee may change the Designated Location or the composition or configuration of the Designated Equipment (including the manufacturer, description, model number or serial number of the Designated Equipment) during the License Term. (d) Licensee may transfer its use of the Licensed Programs to a backup system on a temporary basis for disaster recovery purposes. ARTICLES II and III will not apply to any such temporary backup system usage of the Licensed Programs. If the usage of the backup system must exceed a reasonable temporary period, the backup system will be considered the new Designated Equipment and the location of the backup system will be considered the new Designated Location, and Licensee will give EDS written notification thereof. (e) Licensee may not cause or permit disclosure, display, loan, publication, transfer of possession (whether by sale, exchange, gift, operation of law or otherwise), sublicensing or other dissemination of the Licensed Programs or the Documentation, in whole or in part, to any third party without the prior written consent of EDS. (f) Licensee will not, and will not permit any other person under Licensee's control to, disassemble, decompile, reverse engineer or otherwise recreate or modify the Licensed Programs. Licensee will not, and will not permit any other person under Licensee's control to, copy or reproduce the Licensed Programs or the Documentation, except as may be necessary for backup and disaster recovery purposes as specified in SECTION 1.4(D). (g) Licensee will not alter or remove any copyright, trade secret, patent, proprietary and/or other legal notices contained on or in any EDS provided copies of the Licensed Programs or the Documentation. Licensee will include on or in all copies authorized hereunder of the Licensed Programs and the Documentation designation(s) that EDS may reasonably require to indicate that such material is the proprietary property of EDS. (h) The Licensed Programs and the Documentation are being disclosed by EDS to Licensee in confidence. Licensee will implement and maintain precautions, no less rigorous than those Licensee uses to protect its own confidential information, to safeguard the Licensed Programs and the Documentation so that no unauthorized persons have access to the Licensed Programs or the Documentation and that no persons authorized to have such access will take any action which would violate the confidentiality obligations set forth in this Agreement if such action were taken by Licensee. Licensee will promptly report to EDS any violation of such confidentiality obligations. Licensee will, at its expense, take such steps as EDS may reasonably request to remedy any such violation, including retrieving any portion of the Licensed Programs or the Documentation that is being used or otherwise possessed in breach of this Agreement, and will pay or reimburse EDS for all reasonable expenses that EDS incurs which are related to the remedy of any such violation. (i) In using or possessing the Licensed Programs and the Documentation, Licensee will not, by any action or inaction, violate laws or regulations promulgated by governmental or quasi-governmental authorities or cause EDS or its affiliates to violate any such laws or regulations. 1.5 INJUNCTIVE RELIEF. Licensee acknowledges and agrees that the Licensed Programs and the Documentation are the valuable property and trade secrets of EDS, that any violation by Licensee of the confidentiality obligations set forth in this Agreement would cause EDS irreparable injury for which they would have no adequate remedy at law, and that, in addition to any other remedies which EDS may have, it will be entitled to preliminary and other injunctive relief against any such violation. 1.6 VERIFICATION. EDS may conduct, at EDS' expense, an investigation to determine Licensee's compliance with the terms of this Agreement. No more often than twice each year during the License Term, with reasonable notice to Licensee, EDS or its designated representative may have access to the Designated Location, the Designated Equipment and any records (in whatever form) related to this Agreement and Licensee's use of the Licensed Programs and the Documentation. Licensee will cooperate with EDS in any such investigation and, in particular, will take all commercially reasonable actions to assist EDS in accurately determining Licensee's compliance with the terms of this Agreement. ARTICLE II - INSTALLATION, TRAINING, MAINTENANCE AND ADDITIONAL SERVICES 2.1 INSTALLATION ASSISTANCE. EDS will provide to Licensee installation assistance at EDS' then current time and material rates as Additional Services in accordance with SECTION 2.4; provided, however, that EDS will be relieved of its obligation to provide installation assistance unless and until Licensee has fulfilled its obligation to acquire and install required hardware and software pursuant to SECTIONS 5.2 and 5.3. EDS estimates such assistance to take 1,600 hours. 2.2 TRAINING. EDS will provide to Licensee training with respect to the use and operation of the Licensed Programs at EDS' then current time and material rates as Additional Services in accordance with SECTION 2.4. EDS estimates such training to take 40 hours. 2.3 MAINTENANCE. (a) MAINTENANCE SERVICES. During the License Term, EDS will promptly repair or replace the then current release of the Licensed Programs if it is not performing in accordance with applicable Documentation in all material respects upon receiving notice of the nonperformance from Licensee as described below. The methods and techniques for resolving nonperformance will be at the reasonable discretion of EDS. If the Designated Equipment can be accessed remotely through dial-up capability or otherwise, Licensee will make such remote access capability available to EDS for use in performing maintenance services. EDS will have no obligation to repair or replace the Licensed Programs if the nonperformance is caused by computer equipment malfunction, Licensee's negligence or fault, Licensee's failure to follow instructions as set forth in the applicable Documentation, improper or unauthorized use of the Licensed Programs, hardware changes, changes in any software not provided by EDS or any other cause beyond the control of EDS; provided, however, that EDS will provide Licensee with assistance in resolving any nonperformance resulting from such causes as Additional Services pursuant to SECTION 2.4. As part of the maintenance to be provided by EDS, EDS also will support, in the manner described in this SECTION 2.3, one major release (such major releases to be made no more frequently than semi-annually) of the Licensed Programs previous to the then current major release of the Licensed Programs in anticipation of Licensee eventually using the then current release. Upgrades to a release will always be to the most recent release. EDS may provide maintenance services for releases of the Licensed Programs older than those described in the preceding sentence in accordance with SECTION 2.4 hereof, however Licensee will continue to be subject to the maintenance service fees specified in SECTION 4.2. (b) NOTICE; REMEDY. To obtain the maintenance services described above, Licensee must provide EDS with the following: (i) notice of the operating problem; (ii) a detailed description of the failure to perform in accordance with the applicable Documentation in all material respects; (iii) a detailed description of the operating conditions, including the specific hardware/software configuration, under which such failure to perform occurred; and (iv), if applicable, a representative sample of inputs and outputs for replicating and analyzing such failure to perform. If, after using commercially reasonable efforts to repair or replace the then current release of the Licensed Programs so that it performs in accordance with the Documentation in all material respects, EDS is unable to make such repairs or replacement, Licensee's sole remedy will be the refund of the maintenance service fees paid to EDS by Licensee for the twelve months immediately preceding EDS' determination that it is unable to so repair or replace, and this Agreement will terminate either, at Licensee's discretion, (i) in its entirety, or (ii) as it pertains to the nonoperable module(s) with an appropriate reduction in maintenance service fees, as applicable. Such choice by Licensee will be made within sixty (60) days of the determination that EDS is unable to so repair or replace. (c) NEW RELEASES. From time to time, EDS may, in its sole discretion, make updates, improvements or changes to the Licensed Programs in separate releases to the Licensed Programs which are designed to enhance the functionality of the Licensed Programs; provided, however, that EDS has no obligation to make any such updates, improvements or changes. During the License Term and at no additional charge, EDS will make all new releases available to Licensee which are generally made available by EDS at no additional charge to other licensees of the Licensed Programs. During the License Term, any data conversions or site specific code developed by EDS for Licensee that require retrofitting to any new releases to the Licensed Programs will be provided by EDS as Additional Services pursuant to SECTION 2.4. 2.4 ADDITIONAL SERVICES. Licensee may from time to time request that EDS provide support or services which are beyond the scope or amount of support or services required of EDS under this Agreement ("Additional Services"). EDS will provide to Licensee such Additional Services for which the parties have reached a written agreement regarding (a) the nature and scope of the Additional Services, (b) the time period during which EDS will provide the Additional Services, and (c) the basis upon which EDS will be compensated therefor based upon commercially reasonable rates. Any developments, improvements, modifications, additions or enhancements made by or for EDS to the Licensed Programs will be and will remain solely EDS' property. New software developed or created by EDS pursuant to this Agreement will be and will remain solely EDS' property unless the parties otherwise agree in writing prior to such development or creation being undertaken. ARTICLE III - WARRANTY 3.1 RIGHTS IN LICENSED PROGRAMS. EDS warrants that it has all right, title, ownership interest, marketing and/or sublicensing rights necessary to grant the rights and license to Licensee set forth herein. 3.2 NONPERFORMANCE OF LICENSED PROGRAMS. EDS warrants that on the Installation Date the Licensed Programs will be capable of performing in accordance with the Documentation in all material respects. EDS will resolve any failure of the Licensed Programs to perform in compliance with the Documentation in all material respects in accordance with the terms and conditions set forth in SECTION 2.3. 3.3 YEAR 2000. EDS represents that, when installed, the Licensed Programs will be Year 2000 Compliant and that the Maintenance Services as specified in SECTION 2.3 will include any updates, modifications or enhancements necessary so that the Licensed Programs will continue to be Year 2000 Compliant. For purposes of this Agreement, "Year 2000 Compliant" means that the Licensed Programs (i) will operate and produce data on and after January 1, 2000 (including taking into effect that such year is a leap year), accurately and without delay, interruption or error relating to the fact that the time at which and the date on which the Licensed Programs is operating is on or after 12:00 a.m. on January 1, 2000 (including taking into effect that such year is a leap year), or (ii) will accept, calculate, process, maintain, write and output, accurately and without delay, interruption or error, all times or dates, or both, whether before, on or after 12:00 a.m. on January 1, 2000 (including taking into effect that such year is a leap year), and any time periods determined or to be determined based on any such times or dates, or both. EDS will not be responsible or penalized for any adverse impact on Licensee, services performed hereunder or any service levels resulting from any software, systems, hardware and related equipment, data, interfaces or processes of Licensee or any third party not being Year 2000 compliant or from any inaccuracies, delays, interruptions or errors as a result of receiving data in two digit year date or other formats that are not Year 2000 Compliant from other software, systems, hardware and related equipment, interfaces or processes or from third parties. 3.4 DISCLAIMER. EDS does not warrant that the functions contained in the Licensed Programs will meet Licensee's requirements or, except as otherwise specified in this ARTICLE III, that the operation of the Licensed Programs will be uninterrupted or error free. Further, EDS will have no responsibility with respect to the accuracy of Licensee's data files. The remedy of Licensee under SECTION 2.3 is exclusive, and EDS' liability for all matters relating to this ARTICLE III will be limited as provided herein. EXCEPT AS OTHERWISE EXPRESSLY PROVIDED IN THIS ARTICLE III, EDS MAKES NO REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED, TO LICENSEE OR TO ANY OTHER PERSON, INCLUDING ANY WARRANTIES REGARDING TITLE, THE MERCHANTABILITY, SUITABILITY, ORIGINALITY, FITNESS FOR A PARTICULAR PURPOSE OR OTHERWISE (IRRESPECTIVE OF ANY PREVIOUS COURSE OF DEALINGS BETWEEN THE PARTIES OR CUSTOM OR USAGE OF TRADE) OF ANY SERVICES, SOFTWARE OR MATERIALS PROVIDED UNDER THIS AGREEMENT. ARTICLE IV - PAYMENTS TO EDS 4.1 LICENSE FEE. There will be no license fee payable by Licensee to EDS hereunder. 4.2 MAINTENANCE SERVICE FEE: For the maintenance services provided pursuant to Section 2.3, Licensee will pay to EDS monthly maintenance fees as follows: from the Installation Date through December 31, 1999, $15,000.00; for 2000, $18,000.00; for 2001, $20,700.00; for 2002, $23,805.00; after 2002 EDS may increase such monthly maintenance fee on an annual basis, but in an incremental amount not to exceed fifteen percent (15%). The foregoing notwithstanding, in the event that Licensee's monthly processing of Billable Messages exceed 150,000,000, EDS reserves the right to renegotiate subsequent annual maintenance fees. 4.3 OUT-OF-POCKET EXPENSES. Licensee will pay, or reimburse EDS for, all actual out-of-pocket costs and expenses incurred by EDS in connection with EDS' performance of its obligations under this Agreement with the prior written approval of Licensee, including the travel, meals and lodging expenses incurred by EDS personnel performing the installation assistance, training, maintenance services and any Additional Services hereunder. 4.4 TIME FOR PAYMENT. Except as otherwise expressly provided herein, any amount due EDS pursuant to this Agreement will be due and payable by Licensee within thirty days after the date of an invoice from EDS. Any amount owing to EDS pursuant to this Agreement that is not paid when due and payable will thereafter bear interest until paid at a rate of interest equal to four percent per annum more than the prime rate established from time to time by Citibank, N.A. in New York, New York; provided, however, that in no event will such interest rate exceed the maximum rate of interest allowed by applicable law. 4.5 TAXES. There will be added to any charges under this Agreement, or separately billed, and Licensee will either pay to EDS, or reimburse EDS for the payment of, any taxes, assessments, duties, permits, fees and other charges of any kind, however designated, assessed, charged or levied, with respect to or measured by (a) charges under this Agreement, (b) this Agreement, or (c) the services, software, equipment, materials or other property (tangible or intangible), or the use thereof or the resources used therefor, that are provided under this Agreement. Taxes payable under this Agreement include state and local sales taxes, use taxes, property taxes, telecommunications taxes, privilege taxes, excise taxes (including federal excise taxes), value added taxes and any taxes or amounts in lieu thereof paid or payable by EDS in respect of the foregoing, exclusive however, of taxes based on the net income of EDS. EDS and Licensee will cooperate to minimize and properly calculate any applicable taxes, and in connection therewith, Licensee will provide EDS any resale certificates, information regarding out-of-state use of materials, services or sales or other exemption certificates or information reasonably requested by EDS. EDS will have sole control over the response to and settlement of any claims for taxes that may be asserted by applicable taxing authorities. Licensee will be entitled to any refunds or rebates of taxes granted to the extent such refunds or rebates are of taxes that were paid by Licensee. ARTICLE V - OTHER LICENSEE OBLIGATIONS 5.1 SELECTION, USE AND RESULTS. Licensee accepts responsibility, financial and otherwise, for (i) the selection of the Licensed Programs to achieve the desired results, (ii) the installation of the Licensed Programs (with assistance from EDS as provided in SECTION 2.1), (iii) the use of the Licensed Programs, and (iv) the results obtained from the Licensed Programs. The foregoing will in no way limit warranties made by EDS in ARTICLE III. 5.2 Q-TEL 9000 SOFTWARE. Licensee will, at its expense, (i) acquire a license from United Communication Group for the Q-TEL 9000 software, (ii) install or cause to be installed such software prior to delivery of the Licensed Programs , and (iii) thereafter arrange for the maintenance of such software during the License Term or any extensions thereof. 5.3 OPERATING ENVIRONMENT. Licensee will, at its expense, (i) acquire hardware and associated operating system software specified by EDS to support the Licensed Programs, (ii) install or cause to be installed such hardware and software prior to the delivery of the Licensed Programs, and (iii) thereafter arrange for any required maintenance for such hardware and software during the License Term or any extensions thereof. 5.4 LICENSEE REPRESENTATIVE. Licensee will designate an officer or employee of Licensee (the "Licensee Representative") who will be authorized to act generally as the primary point of contact for EDS in dealing with Licensee with respect to the Licensed Programs and any services performed hereunder. If Licensee fails to expressly designate a Licensee Representative, the principal executive officer of Licensee will be the Licensee Representative. The Licensee Representative will be responsible for directing, insofar as EDS is concerned, all activities of Licensee affecting the provision by EDS of the Licensed Programs and related services, including working with EDS to establish Licensee's priorities for any services to be performed hereunder. 5.5 RELIANCE ON INSTRUCTIONS. In performing its obligations under this Agreement, EDS will be entitled to rely upon any routine instructions, authorizations, approvals or other information provided to EDS by the Licensee Representative or, as to areas of competency specifically identified by the Licensee Representative, by any other Licensee personnel identified by the Licensee Representative, from time to time, as having authority to provide the same on behalf of Licensee in such person's area of competency. Unless EDS knew of any error, incorrectness or inaccuracy in such instructions, authorizations, approvals or other information, EDS will incur no liability or responsibility of any kind in relying on or complying with any such instructions, authorizations, approvals or other information. 5.6 PRIORITIES AND COOPERATION. Licensee will cooperate with EDS in good faith in the performance of Licensee's activities contemplated by this Agreement through, but not limited to, (a) establishing priorities for the services to be provided to Licensee, and (b) making available, as reasonably requested by EDS, such information, facilities, management decisions, approvals, authorizations and acceptances so that EDS' provision of the Licensed Programs and related services may be accomplished in a proper, timely and efficient manner. 5.7 FACILITIES. Licensee will, at no cost to EDS, provide EDS personnel or agents who are performing implementation, training or Additional Services on-site at Licensee's facilities the following items or services to the extent reasonably required for EDS to effectively provide such services or Additional Services hereunder: space, office furnishings, janitorial service, parking, computer hardware, computer software, voice communication services, data communication services, utilities (including heat and air conditioning), office-related equipment (such as telephones, file cabinets and desks), supplies, duplicating and facsimile equipment, training facilities and premises security services. 5.8 OTHER FINANCIAL OBLIGATIONS. In addition to any other financial responsibilities of Licensee contemplated by this Agreement, Licensee will pay all costs and expenses related to each item that is to be provided by Licensee pursuant to this Agreement and for which the financial responsibility has not been expressly assigned to EDS. 5.9 LICENSEE SPECIFIC SOFTWARE MODIFICATIONS. The parties acknowledge and agree that Licensee will be responsible for (i) any retrofitting, recoding, reengineering and ongoing maintenance of any and all Licensee specific software modifications existing as of the Effective Date of this Agreement as well as any such modifications made by Licensee subsequent to the Effective Date of this Agreement, and (ii) any and all modifications required to make such Licensee specific software modifications Year 2000 Compliant. Such modifications and retrofitting, recoding and reengineering thereof will be done in such a way so as not to affect or impact the source code or operations of the Licensed Programs. ARTICLE VI - ARBITRATION 6.1 DISPUTE ESCALATION. In the event of any dispute, controversy or claim of any kind or nature arising under or in connection with this Agreement (including disputes as to the creation, validity, interpretation, breach or termination of this Agreement) (a "Dispute"), then upon the written request of either party, each of the parties will appoint a designated senior business executive whose task it will be to meet for the purpose of endeavoring to resolve the Dispute. The designated executives will meet as often as the parties reasonably deem necessary in order to gather and furnish to the other all information with respect to the matter in issue which the parties believe to be appropriate and germane in connection with its resolution. Such executives will discuss the Dispute and will negotiate in good faith in an effort to resolve the Dispute without the necessity of any formal proceeding relating thereto. The specific format for such discussions will be left to the discretion of the designated executives but may include the preparation of agreed upon statements of fact or written statements of position furnished to the other party. No formal proceedings for the resolution of the Dispute under SECTION 6.2 may be commenced until the earlier to occur of (a) a good faith conclusion by the designated executives that amicable resolution through continued negotiation of the matter in issue does not appear likely, or (b) the fifteenth day after the initial request to negotiate the Dispute. 6.2 ARBITRATION. Any Dispute that the parties are unable to resolve through escalation pursuant to SECTION 6.1 will be submitted to arbitration in accordance with the following procedures: (a) DEMAND FOR ARBITRATION; LOCATION. Either party may demand arbitration by giving the party written notice to such effect, which notice will describe, in reasonable detail, the facts and legal grounds forming the basis for the filing party's request for relief and will include a statement of the total amount of damages claimed, if any, and any other remedy sought by that party. The arbitration will be held before one neutral arbitrator in Plano, Texas if the proceedings are initiated by Licensee and in Fort Worth, Texas if the proceedings are initiated by EDS. (b) IDENTIFICATION OF ARBITRATOR. Within thirty days after the other party's receipt of such demand, the parties will mutually determine who the arbitrator will be. If the parties are unable to agree on the arbitrator within that time period, the arbitrator will be selected by the American Arbitration Association ("AAA"). In any event, the arbitrator will have a background in, and knowledge of, the information technology services industry and will be an appropriate person based on the nature of the Dispute. If a person with such industry experience is not available, the arbitrator will be chosen from the large and complex case panel or, if an appropriate person is not available from such panel, the retired federal judges pool. (c) CONDUCT OF ARBITRATION. The arbitration will be governed by the Commercial Arbitration Rules of the AAA, except as expressly provided in this SECTION 6.2 However, the arbitration will be administered by any organization mutually agreed to in writing by the parties. If the parties are unable to agree on the organization to administer the arbitration, it will be administered by the AAA. Pending the arbitrator's determination of the merits of the Dispute, either party may apply to any court of competent jurisdiction to seek injunctive or other extraordinary relief. (d) SCOPE OF DISCOVERY. Discovery will be limited to the request for and production of documents, depositions and interrogatories. Interrogatories will be allowed only as follows: a party may request the other party to identify by name, last known address and telephone number (i) all persons having knowledge of facts relevant to the Dispute and a brief description of that person's knowledge, (ii) any experts who may be called as an expert witness, the subject matter about which the expert is expected to testify, the mental impressions and opinions held by the expert and the facts known by the expert (regardless of when the factual information was acquired) which relate to or form the basis for the mental impressions and opinions held by the expert, and (iii) any experts who have been used for consultation, but who are not expected to be called as an expert witness, if such consulting expert's opinions or impressions have been reviewed by an expert witness. All discovery will be guided by the Federal Rules of Civil Procedure. All issues concerning discovery upon which the parties cannot agree will be submitted to the arbitrator for determination. (e) AUTHORITY OF ARBITRATOR. In rendering an award, the arbitrator will determine the rights and obligations of the parties according to the substantive and procedural laws of the State of Texas. The arbitrator will not have authority to award damages in excess of the amount or other than the types allowed by SECTION 8.2 and may not, in any event, make any ruling, finding or award that does not conform to the terms and conditions of this Agreement. (f) JOINDER OF PARTIES. Each of EDS and Licensee agree that it will use commercially reasonable efforts to join (and will allow the other party to join) any third party that the parties have agreed is indispensable to the arbitration. If any such third party does not agree to be joined, the arbitration will proceed nonetheless. (g) AWARD. The decision of, and award rendered by, the arbitrator will be final and binding on the parties. Upon the request of a party, the arbitrator's award will include written findings of fact and conclusions of law. Judgment on the award may be entered in and enforced by any court of competent jurisdiction. Each party will bear its own costs and expenses (including filing fees) with respect to the arbitration, including one-half of the fees and expenses of the arbitrator. 6.3 EXCLUSIVE REMEDY. Other than those matters involving injunctive or other extraordinary relief or any action necessary to enforce the award of the arbitrator, the parties agree that the provisions of this ARTICLE VI are a complete defense to any suit, action or other proceeding instituted in any court or before any administrative tribunal with respect to any Dispute or the provision of the Licensed Programs or related services by EDS. Nothing in this ARTICLE VI prevents the parties from exercising their rights to terminate this Agreement in accordance with ARTICLE VII. 6.4 CONTINUED PERFORMANCE. Unless (a) EDS has commenced a proceeding or has presented a claim pursuant to this ARTICLE VI for nonpayment by Licensee of amounts due under this Agreement, or (b) this Agreement has been terminated in accordance with ARTICLE VII, EDS will continue to provide services during any mediation or arbitration proceedings commenced pursuant to this ARTICLE VI and Licensee will continue to perform its obligations (including the making of payments to EDS) in accordance with this Agreement. ARTICLE VII - TERMINATION 7.1 TERMINATION FOR CAUSE. Subject to SECTION 9.12, if either party materially defaults in the performance of any of its duties or obligations under this Agreement (excluding a default in payments to be made to EDS, which will be governed by SECTION 7.2), which default is not substantially cured within fifteen days after written notice is given to the defaulting party specifying the default, or, with respect to those defaults that cannot reasonably be cured within fifteen days, if the defaulting party fails to proceed within fifteen days to commence curing said default and thereafter to proceed with all reasonable diligence substantially to cure the same, then the non-defaulting party may, by giving written notice thereof to the defaulting party, terminate this Agreement as of the date of receipt by the defaulting party of such notice or as of a future date specified in such notice of termination. 7.2 TERMINATION FOR NONPAYMENT. If Licensee defaults in the payment when due of any amount due to EDS pursuant to this Agreement and does not cure such default within fifteen days after being given written notice of such default, then EDS may, by giving written notice thereof to Licensee, terminate this Agreement as of the date of receipt by Licensee of such notice or as of a future date specified in such notice of termination. 7.3 TERMINATION FOR BANKRUPTCY AND RELATED EVENTS. Subject to Title 11, United States Code, if either party becomes or is declared insolvent or bankrupt, is the subject of any proceedings relating to its liquidation, insolvency or for the appointment of a receiver or similar officer for it, makes an assignment for the benefit of all or substantially all of its creditors or enters into an agreement for the composition, extension or readjustment of all or substantially of its obligations, then the other party may, by giving written notice thereof to such party, terminate this Agreement as of a date specified in such notice of termination. 7.4 TERMINATION FOR REGULATORY EVENT. Either party may terminate this Agreement if any statute, rule, regulation, interpretation, judgment, order or injunction will have been enacted, enforced, promulgated, amended, issued or deemed applicable to (a) either party or any of its affiliates or (b) this Agreement or the transactions contemplated by this Agreement, by any Governmental Authority that renders illegal, or materially inhibits the performance of this Agreement by EDS. To terminate this Agreement pursuant to this SECTION 7.4, the party seeking such termination will give written notice thereof to the other party at least thirty days prior to the date on which such party desires to terminate this Agreement. 7.5 Termination by Licensee Without Cause. At any time after the third anniversary of the Installation Date, Licensee may terminate this Agreement for any reason or no reason upon (i) ninety days prior written notice to EDS, and (ii) payment of fifty percent (50%) of the maintenance fees that would have been payable to EDS pursuant to Section 4.2 during the twelve month period immediately following the effective date of such termination. 7.6 RIGHTS UPON TERMINATION. Upon expiration or termination of the License Term for any reason, then, in addition to any other rights which either party may have, Licensee will promptly return to EDS all copies of the Licensed Programs and the Documentation in Licensee's possession and completely erase the Licensed Programs and all elements thereof from the Designated Equipment and any other Licensee computer system, and upon EDS' request, will execute and deliver to EDS a written certification that Licensee has complied with the provisions of this SECTION 7.6 and no longer retains any material relating to the Licensed Programs or the Documentation. In addition, Licensee will pay EDS for all services provided and expenses incurred through the date of such expiration or termination. Upon expiration or termination of this Agreement, Licensee will retain all Licensee's data. The expiration or termination of the License Term for any reason will not release either party from any liabilities or obligations set forth herein which (a) the parties have expressly agreed will survive any such expiration or termination, or (b) remain to be performed or by their nature would be intended to be applicable following any such expiration or termination. Should Licensee require access to the Licensed Programs post termination, EDS agrees to provide such access in good faith upon terms consistent with the terms of this Agreement; provided, however, that such commitment by EDS to provide such post termination access will is conditioned upon EDS' commercially reasonable capability to do so. ARTICLE VIII - INDEMNIFICATION, REMEDIES AND LIABILITY 8.1 INDEMNITIES. (a) CLAIMS RELATING TO PERSONAL INJURY AND PROPERTY DAMAGE. (i) GENERAL. EDS and Licensee each will be responsible for any and all claims, actions, damages, liabilities, costs and expenses, including reasonable attorneys' fees and expenses (collectively, "Losses"), to their respective tangible personal or real property (whether owned or leased), and each party agrees to look only to its own insuring arrangements (if any) with respect to such Losses. EDS and Licensee each will be responsible for Losses for the death of or personal injury to any person (including any employee of either party) and Losses for damages to any third party's tangible personal or real property (whether owned or leased), in accordance with the law of the jurisdiction in which such Loss is alleged to have occurred. Subject to SECTIONS 8.1(D) and 8.2, each party will indemnify and defend the other party and hold the other party harmless from any and all Losses arising out of, under or in connection with claims for which the indemnitor is responsible under the preceding sentence. (ii) WAIVER OF SUBROGATION. EDS and Licensee waive all rights to recover against each other for any Losses to their respective tangible personal property (whether owned or leased) from any cause covered by insurance maintained by each of them, including their respective deductibles or self-insured retentions. EDS and Licensee will cause their respective insurers to issue appropriate waivers of subrogation rights endorsements to all property insurance policies maintained by each party. Each party will give the other written notice if a waiver of subrogation is unobtainable or obtainable only at additional expense. If the party receiving such notice agrees to reimburse the other party for such additional expense, the other party will obtain such waiver of subrogation. If a waiver is unobtainable or if a party elects not to pay the additional expense of a waiver, then neither party nor their insurers will waive such subrogation rights. (b) INFRINGEMENT CLAIMS. (i) GENERAL. Subject to SECTIONS 8.1(D) and 8.2 and the limitations set forth below in this SECTION 8.1(B), EDS and Licensee each agree to defend the other party against any action to the extent that such action is based upon a claim that the software (other than third party software) or confidential information provided by the indemnitor, or any part thereof, (i) infringes a copyright perfected under United States statute, (ii) infringes a patent granted under United States law, or (iii) constitutes an unlawful disclosure, use or misappropriation of another party's trade secret. The indemnitor will bear the expense of such defense and pay any damages and attorneys' fees that are attributable to such claim finally awarded by a court of competent jurisdiction. (ii) EXCLUSIONS. Neither EDS nor Licensee will be liable to the other for claims of indirect or contributory infringement. In particular, the indemnitor will have no liability to the indemnitee hereunder if any claim of infringement is based upon the use of software provided by the indemnitor hereunder in a manner for which the software was not designed. Also, the indemnitor will have no liability if the indemnitee modifies any software provided by the indemnitor hereunder and such infringement would not have occurred but for such modification, or uses the software in the practice of a patented process and there would be no infringement in the absence of such practice, or such claim arises out of the indemnitor's compliance with specifications provided by the indemnitee and such infringement would not have occurred but for such compliance. (iii) ADDITIONAL REMEDY. If software or confidential information becomes the subject of a claim under this SECTION 8.1(B), or in the indemnitor's opinion is likely to become the subject of such a claim, then, in addition to defending the claim and paying any damages and attorneys' fees as required above in this SECTION 8.1(B), the indemnitor will either (A) replace or modify the software or confidential information to make it noninfringing or cure any claimed misuse of another's trade secret, or (B) procure for the indemnitee the right to continue using the software or confidential information pursuant to this Agreement. Any costs associated with implementing either of the above alternatives will be borne by the indemnitor but will be subject to SECTION 8.2. If neither option is available to the indemnitor through the use of reasonable, diligent efforts, (x) the indemnitee will return such software or confidential information to the indemnitor and (y) if requested by the indemnitee in good faith, the Parties will negotiate, pursuant to ARTICLE VI but subject to SECTION 8.2, to reach a written agreement on what, if any, monetary damages (in addition to the indemnitor's obligation to defend the claim and pay any damages and attorneys' fees as required above in this SECTION 8.1(B) are reasonably owed by the indemnitor to the indemnitee as a result of the indemnitee no longer having use of such software or confidential information. (c) THIRD PARTY INDEMNIFICATION OF EDS. Without limiting EDS' liability to Licensee under this Agreement, each of the parties acknowledge that by entering into and performing its obligations under this Agreement EDS will not assume and should not be exposed to the business and operational risks associated with Licensee's business, and Licensee therefore agrees, subject to SECTIONS 8.1(D), to indemnify and defend EDS and hold EDS harmless from any and all third party Losses arising out of the conduct of Licensee's business. (d) PROCEDURES. The indemnification obligations set forth in this SECTION 8.1 will not apply unless the party claiming indemnification (i) notifies the other promptly in writing of any matters in respect of which the indemnity may apply and of which the notifying party has knowledge in order to allow the indemnitor the opportunity to investigate and defend the matter; provided, however, that the failure to so notify will only relieve the indemnitor of its obligations under this SECTION 8.1 if and to the extent that the indemnitor is actually prejudiced thereby; and (ii) gives the other party full opportunity to control the response thereto and the defense thereof, including any agreement relating to the settlement thereof; provided, however, that the indemnitee will have the right to (i) participate in any legal proceeding to contest and defend a claim for indemnification involving a third party, (ii) to be represented by legal counsel of its choosing, and (iii) be party to any settlement agreement of such a claim, all at the indemnitee's cost and expense. However, if the indemnitor fails to promptly assume the defense of the claim, the party entitled to indemnification may assume the defense at the indemnitor's cost and expense. (e) The indemnitor will not be responsible for any settlement or compromise made without its consent, unless the indemnitee has tendered notice and the indemnitor has then refused to assume and defend the claim and it is later determined that the indemnitor was liable to assume and defend the claim. The indemnitee agrees to cooperate in good faith with the indemnitor at the request and expense of the indemnitor. 8.2 LIABILITY. (a) GENERAL LIMITATION. EDS' liability for all damages arising out of or related to this Agreement, regardless of the form of action that imposes liability, whether in contract, equity, negligence, intended conduct, tort or otherwise, will be limited to and will not exceed, in the aggregate for all claims, actions and causes of action of every kind and nature, an amount equal to the total amounts paid by Licensee to EDS in the twelve months immediately preceding the event giving rise to such damages, then divided by twelve, and then multiplied by three. (b) EXCLUSIONS. Except for EDS' loss of income or profits related to Licensee's breach of the provisions of SECTION 1.4, in no event will the measure of damages payable by a party include, nor will either party be liable for, any amounts for loss of income, profit or savings or indirect, incidental, consequential, exemplary, punitive or special damages of any party, including third parties, even if such party has been advised of the possibility of such damages in advance, and all such damages are expressly disclaimed. (c) EXCEPTIONS TO LIMITATIONS. The limitation set forth in SECTIONS 8.2 (A) will not apply to EDS's liability to the extent such liability results from a claim under SECTION 8.1(B), nor to amounts due Licensee pursuant to SECTION 2.3(B). (d) DUTY TO MITIGATE. Each party has a duty to mitigate the damages that would otherwise be recoverable from the other pursuant to this Agreement by taking appropriate and reasonable actions to reduce or limit the amount of such damages. (e) CONTRACTUAL STATUTE OF LIMITATIONS. No claim and demand for mediation or arbitration or cause of action which arose out of an event or events which occurred more than two years prior to the filing of a demand for mediation or arbitration or suit alleging a claim or cause of action may be asserted by either party against the other. (f) ACKNOWLEDGMENT. The Parties expressly acknowledge that the limitations and exclusions set forth in this SECTION 8.2 have been the subject of active and complete negotiation between the Parties and represent the Parties' agreement taking into account each party's level of risk associated with the performance or nonperformance of its obligations under this Agreement and the payments and other benefits to be derived by each party pursuant to this Agreement. The provisions of this SECTION 8.2 will survive the expiration or termination of this Agreement for any reason. ARTICLE IX - MISCELLANEOUS 9.1 OTHER CONFIDENTIAL INFORMATION. In addition to the terms and conditions of SECTION 1.4, the parties will comply with the confidentiality obligations set forth in this SECTION 9.1. (a) SCOPE OF OBLIGATION. Except as otherwise expressly provided in this Agreement, EDS and Licensee each agree that (i) all information communicated to it by the other and identified as confidential, whether before or after the date hereof, (ii) all information identified as confidential to which it has access in connection with this Agreement, whether before or after the date hereof, and (iii) this Agreement and the parties' rights and obligations hereunder, will be and will be deemed to have been received in confidence and will be used only for purposes of this Agreement, and each of EDS and Licensee agrees to use the same means as it uses to protect its own confidential information, but in no event less than reasonable means, to prevent the disclosure and to protect the confidentiality thereof. No such information will be disclosed by the recipient party without the prior written consent of the other party; provided, however, that each party may disclose this Agreement and the other party's confidential information to those of the recipient party's attorneys, auditors (including the Federal Communications Commission), insurers (if applicable), agents and full time employees who have a need to have access to such information in connection with their employment (or engagement, if applicable) by the recipient party, so long as the recipient party advises each such person of the confidentiality obligations set forth in this SECTION 9.1. In any event, compliance by each of the persons referenced in the preceding sentence with the confidentiality obligations set forth in this SECTION 9.1 will remain the responsibility of the party employing or engaging such persons. The foregoing will not restrict either party from disclosing this Agreement in a filing with the United States Securities and Exchange Commission, if required to do so. (b) EXCEPTIONS. The foregoing will not prevent either party from disclosing information that belongs to such party or (i) is already known by the recipient party without an obligation of confidentiality other than under this Agreement, (ii) is publicly known or becomes publicly known through no unauthorized act of the recipient party, (iii) is rightfully received from a third party, (iv) is independently developed without use of the other party's confidential information or (v) is disclosed without similar restrictions to a third party by the party owning the confidential information. If confidential information is required to be disclosed pursuant to a requirement of a governmental authority, such confidential information may be disclosed pursuant to such requirement so long as the party required to disclose the confidential information, to the extent possible, provides the other party with timely prior notice of such requirement and coordinates with such other party in an effort to limit the nature and scope of such required disclosure. If confidential information is required to be disclosed in connection with the conduct of any mediation or arbitration proceeding carried out pursuant to ARTICLE VI, such confidential information may be disclosed pursuant to and in accordance with the approval and at the direction of the mediator or arbitrator, as the case may be, conducting such proceeding. Upon written request at the expiration or termination of the License Term for any reason, all documented confidential information (and all copies thereof) owned by the requesting party will be returned to the requesting party or will be destroyed, with written certification thereof being given to the requesting party. The provisions of this SECTION 9.1 will survive the expiration or termination of the License Term for any reason. 9.2 RIGHT TO ENGAGE IN OTHER ACTIVITIES. Nothing in this Agreement will impair EDS' right to acquire, license, market, distribute, develop for itself or others or have others develop for EDS similar technology performing the same or similar functions as the technology and services contemplated by this Agreement. 9.3 INDEPENDENT CONTRACTORS. The parties are independent contractors, and this Agreement will not be construed as constituting either party as partner, joint venturer or fiduciary of the other or to create any other form of legal association that would impose liability on one party for the act or failure to act of the other or as providing either party with the right, power or authority (express or implied) to create any duty or obligation of the other. Except as otherwise expressly provided in this Agreement, each party has the sole right and obligation to supervise, manage, contract, direct, procure, perform or cause to be performed all work to be performed by it pursuant to this Agreement. 9.4 HIRING OF EMPLOYEES. During the License Term and for a period of twelve months thereafter, neither party will solicit, directly or indirectly, for employment nor employ any employee of the other party actively involved in the performance, consumption or evaluation of services under this Agreement without the prior written consent of the other party. 9.5 ENTIRE AGREEMENT. This Agreement (including the Schedules and Exhibits attached hereto, each of which is incorporated into this Agreement by this reference) constitutes the full and complete statement of the agreement of the parties with respect to the subject matter hereof and supersedes any previous agreements, understandings or communications, whether written or oral, relating to such subject matter. The foregoing notwithstanding, Licensee agrees to continue payment of monthly maintenance fees to EDS in accordance with the provisions of that certain IXPLUS License Agreement (as amended) between the parties dated April 23, 1991 until the Installation Date of the Licensed Programs hereunder. 9.6 AMENDMENTS; WAIVER. Changes or modifications to this Agreement may not be made orally, but only by a written amendment or revision signed by the parties. Any terms and conditions varying from this Agreement on any order, invoice or other notification from either party are not binding on the other unless specifically accepted by the other. Unless otherwise expressly provided in this Agreement, a delay or omission by either party to exercise any right or power under this Agreement will not be construed to be a waiver thereof. No waiver of any breach of any provision of this Agreement will constitute a waiver of any prior, concurrent or subsequent breach of the same or any other provision hereof. 9.7 BINDING NATURE; ASSIGNMENT. This Agreement will be binding on the parties and their successors and permitted assigns (it being understood and agreed that nothing contained in this Agreement is intended to confer upon any other person any rights, benefits or remedies of any kind or character whatsoever under or by reason of this Agreement). Except in the event of the sale or transfer of all or substantially all of a party's business or assets, neither party may, nor will it have the power to, assign this Agreement, or any part hereof, without the consent of the other. In the event of the sale or transfer of all or substantially all of a party's business or assets, the parties may mutually agree to terminate this Agreement. EDS may subcontract the performance of any portion of this Agreement to a third party so long as EDS remains responsible for such performance. 9.8 COMPLIANCE WITH LAWS. In performing its obligations under this Agreement, neither party will be required to undertake any activity that would conflict with the requirements of any applicable statute, rule, regulation, interpretation, judgment, order or injunction of any Governmental Authority. 9.9 EXPORT REGULATIONS. This Agreement is expressly made subject to any United States government laws, regulations, orders or other restrictions regarding export from the United States of computer hardware, software, technical data or derivatives of such hardware, software or technical data. Notwithstanding anything to the contrary in this Agreement, Licensee will not directly or indirectly export (or reexport) any computer hardware, software, technical data or derivatives of such hardware, software or technical data, or permit the shipment of same: (a) into (or to a national or resident of) Cuba, North Korea, Iran, Iraq, Libya, Syria or any other country to which the United States has embargoed goods; (b) to anyone on the U.S. Treasury Department's List of Specially Designated Nationals, List of Specially Designated Terrorists or List of Specially Designated Narcotics Traffickers, or the U.S. Commerce Department's Denied Parties List; or (c) to any country or destination for which the United States government or a United States governmental agency requires an export license or other approval for export without first having obtained such license or other approval. Each party will reasonably cooperate with the other and will provide to the other promptly upon request any end-user certificates, affidavits regarding reexport or other certificates or documents as are reasonably requested to obtain approvals, consents, licenses and/or permits required for any payment or any export or import of products or services under this Agreement. The provisions of this SECTION 9.9 will survive the expiration or termination of the License Term for any reason. 9.10 APPROVALS AND SIMILAR ACTIONS. Except as otherwise expressly provided in this Agreement, where agreement, approval, acceptance, consent or similar action is required of either party by any provision of this Agreement, such action will not be unreasonably withheld or delayed. An approval or consent given by a party under this Agreement will not relieve the other party from responsibility for complying with the requirements of this Agreement, nor will it be construed as a waiver of any rights under this Agreement, except as and to the extent otherwise expressly provided in such approval or consent. 9.11 NOTICES. Except as otherwise expressly provided in this Agreement, all notices under this Agreement will be in writing and will be deemed to have been duly given if delivered personally or by courier service, faxed or mailed by registered or certified mail, return receipt requested, postage prepaid, to the parties at the addresses set forth in SCHEDULE 9.11. All notices under this Agreement that are addressed as provided in this SECTION 9.11, (a) if delivered personally or by courier service, will be deemed given upon delivery, (b) if delivered by facsimile, will be deemed given when electronic confirmation is received by the sending party and (c) if delivered by mail in the manner described above, will be deemed given on the fifth business day after the day it is deposited in a regular depository of the United States mail. Either party from time to time may change its address or designee for notification purposes by giving the other party notice of the new address or designee and the date upon which such change will become effective. 9.12 EXCUSED PERFORMANCE. Neither party will be deemed to be in default hereunder, or will be liable to the other, for failure to perform any of its non-monetary obligations under this Agreement for any period and to the extent that such failure results from acts or omissions of the other party or third parties, natural disasters, riots, war, civil disorder, court order, labor dispute or any other causes beyond that party's reasonable control (including failures or fluctuations in electrical power, heat, light, air conditioning or telecommunications equipment or lines) and which it could not have prevented by reasonable precautions or could not have remedied by the exercise of reasonable efforts. 9.13 MEDIA RELEASES. Each party will coordinate with the other regarding any media release, public announcement or similar disclosure relating to this Agreement or its subject matter and will give the other party a reasonable opportunity to review and comment on the content of such release, announcement or disclosure prior to its release. This provision does not alter the restrictions on the disclosure of confidential information set forth in SECTION 9.1 and, subject to SECTION 9.1, will not be construed so as to delay or restrict either party from disclosing any information required to be disclosed in order to comply with any applicable law, rule or regulation. Notwithstanding the foregoing, EDS will have the right to make general references to Licensee and the type of services being provided by EDS to Licensee under this Agreement in EDS' promotional and marketing materials as well as in EDS' oral and visual presentations to prospects. 9.14 CONSTRUCTION RULES. The Article and Section headings used in this Agreement are for convenience of reference only and will not enter into the interpretation hereof. As used in this Agreement, unless otherwise expressly provided to the contrary, (a) any reference to a "Section", "Article" or "Schedule" is a reference to a Section or Article of this Agreement or a Schedule attached to this Agreement, and (b) all references to days, months or years are references to calendar days, months or years. To the extent that the provisions of this Agreement and the Schedules are inconsistent, to the extent possible such provisions will be interpreted so as to make them consistent, and if that is not possible, the provisions of the Schedules will prevail. If any provision of this Agreement is held to be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions will not in any way be affected or impaired, and such provision will be deemed to be restated to reflect the original intentions of the parties as nearly as possible in accordance with applicable law. The parties agree that this Agreement is an executory contract as contemplated by 11 U.S.C. Section 365. In performing its obligations under this Agreement, neither party will be required to undertake any activity that would conflict with the requirements of any applicable law, rule, regulation, interpretation, judgment, order or injunction of any governmental authority. The parties acknowledge and agree that each has been represented by legal counsel of its choice throughout the negotiation and drafting of this Agreement, that each has participated in the drafting hereof and that this Agreement will not be construed in favor of or against either party solely on the basis of a party's drafting or participation in the drafting of any portion of this Agreement. 9.15 COOPERATION. EDS will cooperate with Licensee in good faith in the performance of EDS' activities contemplated by this Agreement in a proper, timely and efficient manner. 9.16 GOVERNING LAW. This Agreement will be governed by and construed in accordance with the substantive laws of the State of Texas, without giving effect to any choice-of-law rules that may require the application of the laws of another jurisdiction. IN WITNESS WHEREOF, the parties hereto have each caused this Agreement to be signed and delivered by its duly authorized officer or representative as of the Effective Date. ELECTRONIC DATA SYSTEMS CORPORATION By: /S/WALTER SCHORTMANN Typed Name: Walter Schortmann Title: Vice President, Telecommunications Industry Date: March 11, 1999 MATRIX TELECOM, INC. By: /s/ JOE RENTERIA, JR. Typed Name: Joe Renteria, Jr. Title: Vice President, Information Services Date: March 8, 1999 EX-10.13 8 EXHIBIT 10.13 EXHIBIT 10.13 CONVERTIBLE PREFERRED STOCK AND WARRANTS PURCHASE AGREEMENT BETWEEN AVTEL COMMUNICATIONS, INC. AND THE INVESTORS SIGNATORY HERETO CONVERTIBLE PREFERRED STOCK AND WARRANTS PURCHASE AGREEMENT dated as of April 5, 1999 (the "Agreement"), between the Investors signatory hereto (each an "Investor" and together the "Investors"), and AvTel Communications, Inc., a corporation organized and existing under the laws of the State of Delaware (the "Company"). WHEREAS, the parties desire that, upon the terms and subject to the conditions contained herein, the Company shall issue and sell to the Investors, and the Investors shall purchase in the aggregate, (i) $1,500,000 liquidation preference of Convertible Preferred Stock (as defined below) and (ii) Warrants (as defined below) to purchase up to 20,000 shares of the Common Stock (as defined below) at 125% of the Closing Date closing bid price for such Common Stock. WHEREAS, such investments will be made in reliance upon the provisions of Section 4(2) ("Section 4(2)") and/or 4(6) of the United States Securities Act and/or Regulation D ("Regulation D") and the other rules and regulations promulgated thereunder (the "Securities Act"), and/or upon such other exemption from the registration requirements of the Securities Act as may be available with respect to any or all of the investments in securities to be made hereunder. NOW, THEREFORE, the parties hereto agree as follows: ARTICLE I CERTAIN DEFINITIONS Section 1.1. "CAPITAL SHARES" shall mean the Common Stock and any shares of any other class of common stock whether now or hereafter authorized, having the right to participate in the distribution of earnings and assets of the Company. Section 1.2. "CAPITAL SHARES EQUIVALENTS" shall mean any securities, rights, or obligations that are convertible into or exchangeable for or give any right to subscribe for any Capital Shares of the Company or any Warrants, options or other rights to subscribe for or purchase Capital Shares or any such convertible or exchangeable securities. Section 1.3. "CLOSING" shall mean the closing of the purchase and sale of the Convertible Preferred Stock and Warrants pursuant to Section 2.1. Section 1.4. "CLOSING DATE" shall mean the date on which all conditions to the Closing have been satisfied (as defined in Section 2.1 (b) hereto) and the Closing shall have occurred. Section 1.5. "COMMON STOCK" shall mean the Company's common stock, $0.01 par value per share. Section 1.6. "CONVERSION SHARES" shall mean the shares of Common Stock issuable upon conversion of the Convertible Preferred Stock and any shares of Common Stock issued as dividends upon the Convertible Preferred Stock. Section 1.7. "CONVERTIBLE PREFERRED STOCK" shall mean the $1,500,000 liquidation preference amount of Series B Convertible Preferred Stock, as described in the Certificate of Designations in the form of Exhibit A hereto, to be issued to the Investors pursuant to this Agreement. Section 1.8. "DAMAGES" shall mean any loss, claim, damage, judgment, penalty, deficiency, liability, costs and expenses (including, without limitation, reasonable attorney's fees and disbursements and reasonable costs and expenses of expert witnesses and investigation). Section 1.9. "EFFECTIVE DATE" shall mean the date on which the SEC first declares effective a Registration Statement registering the resale of the Registrable Securities as set forth in the Registration Rights Agreement. Section 1.10. "ESCROW AGENT" shall have the meaning set forth in the Escrow Agreement. Section 1.11. "ESCROW AGREEMENT" shall mean the Escrow Agreement in substantially the form of Exhibit D hereto executed and delivered contemporaneously with this Agreement. Section 1.12. "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. Section 1.13. "LEGEND" shall mean the legend set forth in Section 9.1. Section 1.14. "MARKET PRICE" on any given date shall mean the lowest closing bid price on the Principal Market (as reported by Bloomberg L.P.) of the Common Stock on any Trading Day during the five Trading Day period ending on the Trading Day immediately prior to the date for which the Market Price is to be determined. Section 1.15. "MATERIAL ADVERSE EFFECT" shall mean any effect on the business, operations, properties, prospects, or financial condition of the Company that is material and adverse to the Company and its subsidiaries and affiliates, taken as a whole, and/or any condition, circumstance, or situation that would prohibit or otherwise interfere with the ability of the Company to enter into and perform any of its obligations under this Agreement, the Registration Rights Agreement, the Escrow Agreement, the Convertible Preferred Stock or the Warrants in any material respect. Section 1.16. "OUTSTANDING" when used with reference to shares of Common Stock or Capital Shares (collectively the "Shares"), shall mean, at any date as of which the number of such Shares is to be determined, all issued and outstanding Shares, and shall include all such Shares issuable in respect of outstanding scrip or any certificates representing fractional interests in such Shares; PROVIDED, HOWEVER, that "Outstanding" shall not mean any such Shares then directly or indirectly owned or held by or for the account of the Company. Section 1.17. "PERSON" shall mean an individual, a corporation, a partnership, an association, a trust or other entity or organization, including a government or political subdivision or an agency or instrumentality thereof. 2 Section 1.18. "PRINCIPAL MARKET" shall mean the American Stock Exchange, the New York Stock Exchange, the NASDAQ National Market, or the NASDAQ Small-Cap Market, whichever is at the time the principal trading exchange or market for the Common Stock, based upon share volume. Section 1.19. "PURCHASE PRICE" shall mean one million five hundred thousand dollars ($1,500,000). Section 1.20. "REGISTRABLE SECURITIES" shall mean the Conversion Shares and the Warrant Shares until (i) the Registration Statement has been declared effective by the SEC, and all Conversion Shares and Warrant Shares have been disposed of pursuant to the Registration Statement, (ii) all Conversion Shares and Warrant Shares have been sold under circumstances under which all of the applicable conditions of Rule 144 (or any similar provision then in force) under the Securities Act ("Rule 144") are met, (iii) all Conversion Shares and Warrant Shares have been otherwise transferred to holders who may trade such shares without restriction under the Securities Act, and the Company has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend or (iv) such time as, in the opinion of counsel to the Company, all Conversion Shares and Warrant Shares may be sold without any time, volume or manner limitations pursuant to Rule 144(k) (or any similar provision then in effect) under the Securities Act. Section 1.21. "REGISTRATION RIGHTS AGREEMENT" shall mean the agreement regarding the filing of the Registration Statement for the resale of the Registrable Securities, entered into between the Company and the Investor as of the Closing Date in the form annexed hereto as Exhibit C. Section 1.22. "REGISTRATION STATEMENT" shall mean a registration statement on Form S-3 (if use of such form is then available to the Company pursuant to the rules of the SEC and, if not, on such other form promulgated by the SEC for which the Company then qualifies and which counsel for the Company shall deem appropriate, and which form shall be available for the resale of the Registrable Securities to be registered thereunder in accordance with the provisions of this Agreement, the Registration Rights Agreement and in accordance with the intended method of distribution of such securities), for the registration of the resale by the Investor of the Registrable Securities under the Securities Act. Section 1.23. "REGULATION D" shall have the meaning set forth in the recitals of this Agreement. Section 1.24. "SEC" shall mean the Securities and Exchange Commission. Section 1.25. "SECTION 4(2)" and "SECTION 4(6)" shall have the meanings set forth in the recitals of this Agreement. Section 1.26. "SECURITIES ACT" shall have the meaning set forth in the recitals of this Agreement. Section 1.27. "SEC DOCUMENTS" shall mean the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 and each report, proxy statement or registration statement filed by the Company with the SEC pursuant to the Exchange Act or the Securities Act since the filing of such Annual Report through the date hereof. Section 1.28. "SHARES" shall have the meaning set forth in Section 1.16. Section 1.29. "TRADING DAY" shall mean any day during which the Principal Market at such day shall be open for business. Section 1.30. "WARRANTS" shall mean the Warrants substantially in the form of Exhibit B to be issued to the Investors hereunder. Section 1.31. "WARRANT SHARES" shall mean all shares of Common Stock or other securities issued or issuable pursuant to exercise of the Warrants. 3 ARTICLE II PURCHASE AND SALE OF CONVERTIBLE PREFERRED STOCK AND WARRANTS Section 2.1. INVESTMENT. (a) Upon the terms and subject to the conditions set forth herein, the Company agrees to sell, and the Investors agree to purchase the Convertible Preferred Stock and the Warrants at the Purchase Price on the Closing Date as follows: (i) Upon execution and delivery of this Agreement, each Investor shall deliver to the Escrow Agent immediately available funds in their proportionate amount of the Purchase Price as set forth on the signature pages hereto, and the Company shall deliver the Convertible Preferred Stock certificates and the Warrants to the Escrow Agent, in each case to be held by the Escrow Agent pursuant to the Escrow Agreement. (ii) Upon satisfaction of the conditions set forth in Section 2.1(b), the Closing ("Closing") shall occur at the offices of the Escrow Agent at which the Escrow Agent (x) shall release the Convertible Preferred Stock and the Warrants to the Investor and (y) shall release the Purchase Price (after all fees have been paid as set forth in the Escrow Agreement), pursuant to the terms of the Escrow Agreement. (b) The Closing is subject to the satisfaction of the following conditions: (i) acceptance and execution by the Company and by the Investors, of this Agreement and all Exhibits hereto; (ii) delivery into escrow by each Investor of immediately available funds in the amount of the Purchase Price of the Convertible Preferred Stock and the Warrants, as more fully set forth in the Escrow Agreement; (iii) all representations and warranties of the Investors contained herein shall remain true and correct as of the Closing Date (as a condition to the Company's obligations); (iv) all representations and warranties of the Company contained herein shall remain true and correct as of the Closing Date (as a condition to the Investors' obligations); (v) the Company shall have obtained all permits and qualifications required by any state for the offer and sale of the Convertible Preferred Stock and Warrants, or shall have the availability of exemptions therefrom; (vi) the sale and issuance of the Convertible Preferred Stock and the Warrants hereunder, and the proposed issuance by the Company to the Investors of the Common Stock underlying the Convertible Preferred Stock and the Warrants upon the conversion or exercise thereof shall be legally permitted by all laws and regulations to which the Investors and the Company are subject and there shall be no ruling, judgment or writ of any court prohibiting the transactions contemplated by this Agreement; (vii) delivery of the original fully executed Convertible Preferred Stock certificates and Warrants certificates to the Escrow Agent; 4 (viii) delivery to the Escrow Agent of an opinion of Seed, Mackall & Cole LLP, counsel to the Company, in the form of Exhibit E hereto; (ix) delivery to the Escrow Agent of the Irrevocable Instructions to Transfer Agent in the form attached hereto as Exhibit F; and (x) delivery to the Escrow Agent of the Registration Rights Agreement. Section 2.2. Liquidated Damages. The parties hereto acknowledge and agree that the sums payable pursuant to the Registration Rights Agreement shall constitute liquidated damages and not penalties. The parties further acknowledge that (a) the amount of loss or damages likely to be incurred is incapable or is difficult to precisely estimate, (b) the amounts specified in such Sections bear a reasonable proportion and are not plainly or grossly disproportionate to the probable loss likely to be incurred by the Investors in connection with the failure by the Company to timely cause the registration of the Registrable Securities and (c) the parties are sophisticated business parties and have been represented by sophisticated and able legal and financial counsel and negotiated this Agreement at arm's length. ARTICLE III REPRESENTATIONS AND WARRANTIES OF INVESTOR Each Investor, severally and not jointly, represents and Warrants to the Company that: Section 3.1. INTENT. The Investor is entering into this Agreement for its own account and not with a view to or for sale in connection with any distribution of the Common Stock. The Investor has no present arrangement (whether or not legally binding) at any time to sell the Convertible Preferred Stock, the Warrants, any Conversion Shares or Warrant Shares to or through any person or entity; provided, however, that by making the representations herein, the Investor does not agree to hold such securities for any minimum or other specific term and reserves the right to dispose of the Conversion Shares and Warrant Shares at any time in accordance with federal and state securities laws applicable to such disposition. Section 3.2. SOPHISTICATED INVESTOR. The Investor is a sophisticated investor (as described in Rule 506(b)(2)(ii) of Regulation D) and an accredited investor (as defined in Rule 501 of Regulation D), and Investor has such experience in business and financial matters that it has the capacity to protect its own interests in connection with this transaction and is capable of evaluating the merits and risks of an investment in the Convertible Preferred Stock, the Warrants and the underlying Common Stock. The Investor acknowledges that an investment in the Convertible Preferred Stock, the Warrants and the underlying Common Stock is speculative and involves a high degree of risk. Section 3.3. AUTHORITY. This Agreement and each agreement attached as an Exhibit hereto which is required to be executed by Investor has been duly authorized and validly executed and delivered by the Investor and is a valid and binding agreement of the Investor enforceable against it in accordance with its terms, subject to applicable bankruptcy, insolvency, or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. Section 3.4. NOT AN AFFILIATE. The Investor is not an officer, director or "affiliate" (as that term is defined in Rule 405 of the Securities Act) of the Company. Section 3.5. ABSENCE OF CONFLICTS. The execution and delivery of this Agreement and the agreements the forms of which are attached as Exhibits hereto and executed in connection herewith, and the consummation of the transactions contemplated hereby and thereby, and compliance with the requirements hereof and 5 thereof, will not violate any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on Investor or (a) violate any provision of any indenture, instrument or agreement to which Investor is a party or is subject, or by which Investor or any of its assets is bound; (b) conflict with or constitute a material default thereunder; (c) result in the creation or imposition of any lien pursuant to the terms of any such indenture, instrument or agreement, or constitute a breach of any fiduciary duty owed by Investor to any third party; or (d) require the approval of any third-party (which has not been obtained) pursuant to any material contract, agreement, instrument, relationship or legal obligation to which Investor is subject or to which any of its assets, operations or management may be subject. Section 3.6. DISCLOSURE; ACCESS TO INFORMATION. The Investor has received all documents, records, books and other publicly available information pertaining to Investor's investment in the Company that have been requested by the Investor. The Company is subject to the periodic reporting requirements of the Exchange Act, and the Investor has reviewed copies of all SEC Documents deemed relevant by Investor. Section 3.7. MANNER OF SALE. At no time was Investor presented with or solicited by or through any leaflet, public promotional meeting, television advertisement or any other form of general solicitation or advertising. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and Warrants to the Investor that, except as set forth on the Disclosure Schedule attached hereto: Section 4.1. ORGANIZATION OF THE COMPANY. The Company is a corporation duly incorporated and existing in good standing under the laws of the State of Delaware and has all requisite corporate authority to own its properties and to carry on its business as now being conducted. The Company does not have any subsidiaries and does not own more that fifty percent (50%) of or control any other business entity except as set forth in the SEC Documents. The Company is duly qualified and is in good standing as a foreign corporation to do business in every jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, other than those in which the failure so to qualify would not have a Material Adverse Effect. Section 4.2. AUTHORITY. (i) The Company has the requisite corporate power and corporate authority to enter into and perform its obligations under this Agreement, the Registration Rights Agreement, the Escrow Agreement, and the Warrants and to issue the Convertible Preferred Stock, the Conversion Shares, the Warrants and the Warrant Shares pursuant to their respective terms, (ii) the execution, issuance and delivery of this Agreement, the Registration Rights Agreement, the Escrow Agreement, the Convertible Preferred Stock and the Warrants by the Company and the consummation by it of the transactions contemplated hereby have been duly authorized by all necessary corporate action and no further consent or authorization of the Company or its Board of Directors or stockholders is required, and (iii) this Agreement, the Registration Rights Agreement, the Escrow Agreement, the Convertible Preferred Stock and the Warrants have been duly executed and delivered by the Company and at the Closing shall constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, or similar laws relating to, or affecting generally the enforcement of, creditors' rights and remedies or by other equitable principles of general application. The Company has duly and validly authorized and reserved for issuance shares of Common Stock sufficient in number for the conversion of the Convertible Preferred Stock and for the exercise of the Warrants. The Company understands and acknowledges the potentially dilutive effect to the Common Stock of the issuance of the Conversion Shares and, upon any redemption of the Warrants, the Warrant Shares. The Company further acknowledges that its obligation to issue Conversion Shares upon conversion of the Convertible Preferred Stock and Warrant Shares upon exercise of the Warrants in accordance with this Agreement and the 6 Convertible Preferred Stock is absolute and unconditional regardless of the dilutive effect that such issuance may have on the ownership interests of other stockholders of the Company and notwithstanding the commencement of any case under 11 U.S.C. Section 101 et seq. (the "Bankruptcy Code"). The Company shall not seek judicial relief from its obligations hereunder except pursuant to the Bankruptcy Code. In the event the Company is a debtor under the Bankruptcy Code, the Company hereby waives to the fullest extent permitted any rights to relief it may have under 11 U.S.C. Section 362 in respect of the conversion of the Convertible Preferred Stock and the exercise of the Warrants. The Company agrees, without cost or expense to the Investor, to take or consent to any and all action necessary to effectuate relief under 11 U.S.C. Section 362. Section 4.3. CAPITALIZATION. The authorized capital stock of the Company consists of 20,000,000 shares of Common Stock, $0.01 par value per share, of which 10,503,278 shares are issued and outstanding as of March 15, 1999 and 1,000,000 shares of preferred stock, par value $0.01 per share, of which 250,000 have been designated as Series A Convertible Preferred Stock, 147,700 of which shares are issued and outstanding. The Company has duly designated 1,500 shares of its preferred stock as Series B Convertible Preferred Stock. Except for (i) the outstanding Series A Convertible Preferred Stock, (ii) outstanding options and Warrants as set forth in the SEC Documents, (iii) stock options awarded under the Company's 1998 Stock Incentive Plan after September 30, 1998, (iv) stock options awarded under the Company's New Best Connections, Inc. 1997 Stock Option Plan after September 30, 1998 and (v) as set forth in the Schedule of Exceptions, there are no outstanding Capital Shares Equivalents. All of the outstanding shares of Common Stock of the Company have been duly and validly authorized and issued and are fully paid and non-assessable. Section 4.4. COMMON STOCK. The Company has registered its Common Stock pursuant to Section 12(b) or (g) of the Exchange Act and is in full compliance with all reporting requirements of the Exchange Act, and the Company is in compliance with all requirements for the continued listing or quotation of its Common Stock, and such Common Stock is currently listed or quoted on the Principal Market. As of the date hereof, the Principal Market is the Nasdaq SmallCap Market and the Company has not received any notice regarding, and to its knowledge there is no threat, of the termination or discontinuance of the eligibility of the Common Stock for such listing. Section 4.5. SEC DOCUMENTS. The Company has delivered or made available to the Investors true and complete copies of the SEC Documents. The Company has not provided to the Investors any information that, according to applicable law, rule or regulation, should have been disclosed publicly prior to the date hereof by the Company, but which has not been so disclosed. As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Exchange Act, and rules and regulations of the SEC promulgated thereunder and the SEC Documents did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. The financial statements of the Company included in the SEC Documents complied in all material respects with applicable accounting requirements and the published rules and regulations of the SEC or other applicable rules and regulations with respect thereto at the time of such inclusion. Such financial statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis during the periods involved (except (i) as may be otherwise indicated in such financial statements or the notes thereto or (ii) in the case of unaudited interim statements, to the extent they exclude footnotes or may be condensed or summary statements) and fairly present in all material respects the financial position of the Company as of the dates thereof and the results of operations and cash flows for the periods then ended (subject, in the case of unaudited interim statements, to normal year-end audit adjustments). Neither the Company nor any of its subsidiaries has any material indebtedness, obligations or liabilities of any kind (whether accrued, absolute, contingent or otherwise, and whether due or to become due) that would have been required to be reflected in, reserved against or otherwise described in the financial statements or in the notes thereto in accordance with GAAP, which was not fully reflected in, reserved against or otherwise described 7 in the financial statements or the notes thereto included in the SEC Documents or was not incurred in the ordinary course of business consistent with the Company's past practices since the last date of such financial statements. Section 4.6. EXEMPTION FROM REGISTRATION; VALID ISSUANCES. Subject to the accuracy of the Investors' representations in Article III, the sale of the Convertible Preferred Stock, the Conversion Shares, the Warrants and the Warrant Shares will not require registration under the Securities Act and/or any applicable state securities law. When issued and paid for in accordance with the Warrants and validly converted in accordance with the terms of the Convertible Preferred Stock, the Conversion Shares and the Warrant Shares will be duly and validly issued, fully paid, and non-assessable. Neither the sales of the Convertible Preferred Stock, the Conversion Shares, the Warrants or the Warrant Shares pursuant to, nor the Company's performance of its obligations under, this Agreement, the Registration Rights Agreement, the Escrow Agreement, the certificate of designation for the Convertible Preferred Stock, or the Warrants will (i) result in the creation or imposition by the Company of any liens, charges, claims or other encumbrances upon the Convertible Preferred Stock, the Conversion Shares, the Warrants or the Warrant Shares or, except as contemplated herein, any of the assets of the Company, or (ii) entitle the holders of Outstanding Capital Shares to preemptive or other rights to subscribe to or acquire the Capital Shares or other securities of the Company. The Convertible Preferred Stock, the Conversion Shares, the Warrants and the Warrant Shares shall not subject the Investors to personal liability to the Company or its creditors by reason of the possession thereof. Section 4.7. NO GENERAL SOLICITATION OR ADVERTISING IN REGARD TO THIS TRANSACTION. Neither the Company nor any of its affiliates nor, to the knowledge of the Company, any person acting on its or their behalf (i) has conducted or will conduct any general solicitation (as that term is used in Rule 502(c) of Regulation D) or general advertising with respect to any of the Convertible Preferred Stock, the Conversion Shares, the Warrants or the Warrant Shares, or (ii) made any offers or sales of any security or solicited any offers to buy any security under any circumstances that would require registration of the Convertible Preferred Stock, the Conversion Shares, the Warrants or the Warrant Shares under the Securities Act. Section 4.8. NO CONFLICTS. The execution, delivery and performance of this Agreement by the Company and the consummation by the Company of the transactions contemplated hereby, including without limitation the issuance of the Convertible Preferred Stock, the Conversion Shares, the Warrants and the Warrant Shares, do not and will not (i) result in a violation of the Company's Certificate of Incorporation or By-Laws or (ii) conflict with, or constitute a material default (or an event that with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any material agreement, indenture or instrument, or any "lockup" or similar provision of any underwriting or similar agreement to which the Company is a party, or (iii) result in a violation of any federal, state or local law, rule, regulation, order, judgment or decree (including federal and state securities laws and regulations) applicable to the Company or by which any material property or asset of the Company is bound or affected, nor is the Company otherwise in violation of, conflict with or default under any of the foregoing (except in each case for such conflicts, defaults, terminations, amendments, accelerations, cancellations and violations as would not have, individually or in the aggregate, a Material Adverse Effect). The business of the Company is not being conducted in violation of any law, ordinance or regulation of any governmental entity, except for possible violations that either singly or in the aggregate would not have a Material Adverse Effect. The Company is not required under federal, state or local law, rule or regulation to obtain any consent, authorization or order of, or make any filing or registration with, any court or governmental agency in order for it to execute, deliver or perform any of its obligations under this Agreement or issue and sell the Convertible Preferred Stock or the Warrants in accordance with the terms hereof (other than any SEC, Nasdaq or state securities filings that may be required to be made by the Company subsequent to Closing, any registration statement that may be filed pursuant hereto, and any shareholder approval required by the rules applicable to companies whose common stock trades on the 8 Nasdaq Stock Market); provided that, for purposes of the representation made in this sentence, the Company is assuming and relying upon the accuracy of the relevant representations and agreements of the Investors herein. Section 4.9. NO MATERIAL ADVERSE CHANGE. Since September 30, 1998, no Material Adverse Effect has occurred or exists with respect to the Company, except as disclosed in the SEC Documents. Section 4.10. NO UNDISCLOSED EVENTS OR CIRCUMSTANCES. Since September 30, 1998, no event or circumstance has occurred or exists with respect to the Company or its businesses, properties, prospects, operations or financial condition, that, under applicable law, rule or regulation, requires public disclosure or announcement prior to the date hereof by the Company but which has not been so publicly announced or disclosed in the SEC Documents. Section 4.11. NO INTEGRATED OFFERING. Other than pursuant to an effective registration statement under the Securities Act, or pursuant to the issuance or exercise of employee stock options, or pursuant to its discussion with the Investors in connection with the transactions contemplated hereby, the Company has not issued, offered or sold the Convertible Preferred Stock, the Warrants or any shares of Common Stock (including for this purpose any securities of the same or a similar class as the Convertible Preferred Stock, the Warrants or Common Stock, or any securities convertible into a exchangeable or exercisable for the Convertible Preferred Stock or Common Stock or any such other securities) within the six-month period next preceding the date hereof, and the Company shall not permit any of its directors, officers or Affiliates directly or indirectly to take, any action (including, without limitation, any offering or sale to any person or entity of the Convertible Preferred, Warrants or shares of Common Stock), so as to make unavailable the exemption from Securities Act registration being relied upon by the Company for the offer and sale to Investors of the Convertible Preferred Stock (and the Conversion Shares) or the Warrants (and the Warrant Shares) as contemplated by this Agreement. Section 4.12. LITIGATION AND OTHER PROCEEDINGS. Except as disclosed in the SEC Documents, there are no lawsuits or proceedings pending or, to the knowledge of the Company, threatened, against the Company, nor has the Company received any written or oral notice of any such action, suit, proceeding or investigation, which could reasonably be expected to have a Material Adverse Effect. Except as set forth in the SEC Documents, no judgment, order, writ, injunction or decree or award has been issued by or, to the knowledge of the Company, requested of any court, arbitrator or governmental agency which could result in a Material Adverse Effect. Section 4.13. NO MISLEADING OR UNTRUE COMMUNICATION. The Company and, to the knowledge of the Company, any person representing the Company, or any other person selling or offering to sell the Convertible Preferred Stock or the Warrants in connection with the transaction contemplated by this Agreement, have not made, at any time, any oral communication in connection with the offer or sale of the same which contained any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading. Section 4.14. MATERIAL NON-PUBLIC INFORMATION. Except as set forth in the Disclosure Schedule, the Company has not disclosed to the Investors any material non-public information that (i) if disclosed, would reasonably be expected to have a material effect on the price of the Common Stock or (ii) according to applicable law, rule or regulation, should have been disclosed publicly by the Company prior to the date hereof but which has not been so disclosed. The Company has disclosed material non-public information to Trinity Capital Advisors, Inc. subject to a confidentiality agreement, and makes no representation as to Trinity's possible use or disclosure of any of such information. 9 Section 4.15. INSURANCE. The Company maintains property and casualty, general liability, workers' compensation, environmental hazard, personal injury and other similar types of insurance with financially sound and reputable insurers that is adequate, consistent with industry standards and the Company's historical claims experience. The Company has not received notice from, and has no knowledge of any threat by, any insurer (that has issued any insurance policy to the Company) that such insurer intends to deny coverage under or cancel, discontinue or not renew any insurance policy presently in force. Section 4.16. TAX MATTERS. (a) The Company has filed all Tax Returns which it is required to file under applicable laws; all such Tax Returns are true and accurate and have been prepared in compliance with all applicable laws; the Company has paid all Taxes due and owing by it (whether or not such Taxes are required to be shown on a Tax Return) and have withheld and paid over to the appropriate taxing authorities all Taxes which it is required to withhold from amounts paid or owing to any employee, stockholder, creditor or other third parties; and since December 31, 1997, the charges, accruals and reserves for Taxes with respect to the Company (including any provisions for deferred income taxes) reflected on the books of the Company are adequate to cover any Tax liabilities of the Company if its current tax year were treated as ending on the date hereof. (b) No claim has been made by a taxing authority in a jurisdiction where the Company does not file tax returns that such corporation is or may be subject to taxation by that jurisdiction. There are no foreign, federal, state or local tax audits or administrative or judicial proceedings pending or being conducted with respect to the Company; no information related to Tax matters has been requested by any foreign, federal, state or local taxing authority; and, except as disclosed above, no written notice indicating an intent to open an audit or other review has been received by the Company from any foreign, federal, state or local taxing authority. There are no material unresolved questions or claims concerning the Company's Tax liability. The Company (A) has not executed or entered into a closing agreement pursuant to Section 7121 of the Internal Revenue Code or any predecessor provision thereof or any similar provision of state, local or foreign law; or (B) has not agreed to or is required to make any adjustments pursuant to Section 481 (a) of the Internal Revenue Code or any similar provision of state, local or foreign law by reason of a change in accounting method initiated by the Company or any of its subsidiaries or has any knowledge that the IRS has proposed any such adjustment or change in accounting method, or has any application pending with any taxing authority requesting permission for any changes in accounting methods that relate to the business or operations of the Company. The Company has not been a United States real property holding corporation within the meaning of Section 897(c)(2) of the Internal Revenue Code during the applicable period specified in Section 897(c)(1)(A)(ii) of the Internal Revenue Code. (c) The Company has not made an election under Section 341(f) of the Internal Revenue Code. The Company is not liable for the Taxes of another person that is not a subsidiary of the Company under (A) Treas. Reg. Section 1.1502-6 (or comparable provisions of state, local or foreign law), (B) as a transferee or successor, (C) by contract or indemnity or (D) otherwise. The Company is not a party to any tax sharing agreement. The Company has not made any payments, is obligated to make payments or is a party to an agreement that could obligate it to make any payments that would not be deductible under Section 280G of the Internal Revenue Code. (d) For purposes of this Section 4.16: "IRS" means the United States Internal Revenue Service. "TAX" or "TAXES" means federal, state, county, local, foreign, or other income, gross receipts, ad valorem, franchise, profits, sales or use, transfer, registration, excise, utility, environmental, communications, real or personal property, capital stock, license, payroll, 10 wage or other withholding, employment, social security, severance, stamp, occupation, alternative or add-on minimum, estimated and other taxes of any kind whatsoever (including, without limitation, deficiencies, penalties, additions to tax, and interest attributable thereto) whether disputed or not. "TAX RETURN" means any return, information report or filing with respect to Taxes, including any schedules attached thereto and including any amendment thereof. Section 4.17. PROPERTY. Neither the Company nor any of its subsidiaries owns any real property. Each of the Company and its subsidiaries has good and marketable title to all personal property owned by it, free and clear of all liens, encumbrances and defects except such as do not materially affect the value of such property and do not materially interfere with the use made and proposed to be made of such property by the Company; and to the Company's knowledge any real property, mineral or water rights, and buildings held under lease by the Company as tenant are held by it under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and intended to be made of such property, mineral or water rights, and buildings by the Company. Section 4.18. INTELLECTUAL PROPERTY. Each of the Company and its subsidiaries owns or possesses adequate and enforceable rights to use all patents, patent applications, trademarks, trademark applications, trade names, service marks, copyrights, copyright applications, licenses, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures) and other similar rights and proprietary knowledge (collectively, "Intangibles") necessary for the conduct of its business as now being conducted. To the Company's knowledge, except as disclosed in the SEC Documents neither the Company nor any of its subsidiaries is infringing upon or in conflict with any right of any other person with respect to any Intangibles. Except as disclosed in the SEC Documents, no claims have been asserted by any person to the ownership or use of any Intangibles and the Company has no knowledge of any basis for such claim. Section 4.19. INTERNAL CONTROLS AND PROCEDURES. The Company maintains books and records and internal accounting controls which provide reasonable assurance that (i) all transactions to which the Company is a party or by which its properties are bound are executed with management's authorization; (ii) the recorded accounting of the Company's assets is compared with existing assets at regular intervals; (iii) access to the Company's assets is permitted only in accordance with management's authorization; and (iv) all transactions to which the Company is a party or by which its properties are bound are recorded as necessary to permit preparation of the financial statements of the Company in accordance with U.S. generally accepted accounting principles. Section 4.20. PAYMENTS AND CONTRIBUTIONS. Neither the Company nor any of its directors, officers or, to its knowledge, other employees has (i) used any Company funds for any unlawful contribution, endorsement, gift, entertainment or other unlawful expense relating to political activity; (ii) made any direct or indirect unlawful payment of Company funds to any foreign or domestic government official or employee; (iii) violated or is in violation of any provision of the Foreign Corrupt Practices Act of 1977, as amended; or (iv) made any bribe, rebate, payoff, influence payment, kickback or other similar payment to any person with respect to Company matters. Section 4.21. NO MISREPRESENTATION. Except as set forth in the Disclosure Schedule, the representations and warranties of the Company contained in this Agreement, any schedule, annex or exhibit hereto and any agreement, instrument or certificate furnished by the Company to the Investors pursuant to this Agreement, do not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. 11 ARTICLE V COVENANTS OF THE INVESTORS Section 5.1. COMPLIANCE WITH LAW. The Investor's trading activities with respect to shares of the Company's Common Stock will be in compliance with all applicable state and federal securities laws, rules and regulations and rules and regulations of the Principal Market on which the Company's Common Stock is listed. Section 5.2. SHORT SALES. The Investor and its affiliates shall not engage in short sales of the Company's Common Stock so long as the Investor holds any unconverted shares of Convertible Preferred Stock, except that the Investor may make short sales up to the amount of the number of shares of Common Stock to be received upon any particular conversion of Convertible Preferred Stock upon delivering the Notice of Conversion with respect thereto. ARTICLE VI COVENANTS OF THE COMPANY Section 6.1. REGISTRATION RIGHTS. The Company shall cause the Registration Rights Agreement to remain in full force and effect and the Company shall comply in all material respects with the terms thereof. Section 6.2. RESERVATION OF COMMON STOCK. As of the date hereof, the Company has reserved and the Company shall continue to reserve and keep available at all times, free of preemptive rights, shares of Common Stock for the purpose of enabling the Company to issue the Conversion Shares and the Warrant Shares pursuant to any conversion of the Convertible Preferred Stock or exercise of the Warrants; such amount of shares of Common Stock to be reserved shall initially be calculated based upon a Conversion Price for the Common Stock under the terms of the Convertible Preferred Stock of $2.00. The number of shares so reserved from time to time, as theretofore increased or reduced as hereinafter provided, may be reduced by the number of shares actually delivered pursuant to any conversion of the Convertible Preferred Stock or exercise of the Warrants and the number of shares so reserved shall be increased or decreased to reflect potential increases or decreases in the Common Stock that the Company may thereafter be obligated to issue by reason of adjustments to the Warrants. Section 6.3. LISTING OF COMMON STOCK. The Company hereby agrees to maintain the listing of the Common Stock on a Principal Market, and as soon as reasonably practicable following the Closing to list the Conversion Shares and the Warrant Shares on the Principal Market. The Company further agrees, if the Company applies to have the Common Stock traded on any other Principal Market, it will include in such application the Conversion Shares and the Warrant Shares, and will take such other action as is necessary or desirable in the opinion of the Investors to cause the Common Stock to be listed on such other Principal Market as promptly as possible. The Company will take all action to continue the listing and trading of its Common Stock on a Principal Market (including, without limitation, maintaining sufficient net tangible assets) and will comply in all respects with the Company's reporting, filing and other obligations under the bylaws or rules of the Principal Market and shall provide Investors with copies of any correspondence to or from such Principal Market which questions or threatens delisting of the Common Stock, within three (3) Trading Days of the Company's receipt thereof, until the Investors have disposed of all of their Registrable Securities. Section 6.4. EXCHANGE ACT REGISTRATION. The Company will cause its Common Stock to continue to be registered under Section 12(b) or (g) of the Exchange Act, will use its best efforts to comply in all respects 12 with its reporting and filing obligations under the Exchange Act, and will not take any action or file any document (whether or not permitted by the Exchange Act or the rules thereunder) to terminate or suspend such registration or to terminate or suspend its reporting and filing obligations under said Act until the Investors has disposed of all of its Registrable Securities. Section 6.5. LEGENDS. The certificates evidencing the Registrable Securities shall be free of legends, except as set forth in Article IX. Section 6.6. CORPORATE EXISTENCE. The Company will take all steps necessary to preserve and continue the corporate existence of the Company. Section 6.7. CONSOLIDATION; MERGER. The Company shall not, at any time after the date hereof, effect any merger or consolidation of the Company with or into, or a transfer of all or substantially all of the assets of the Company to, another entity (a "Consolidation Event") unless the resulting successor or acquiring entity (if not the Company) assumes by written instrument or by operation of law the obligation to deliver to the Investors such shares of stock and/or securities as the Investors are entitled to receive pursuant to this Agreement. Section 6.8. ISSUANCE OF CONVERTIBLE PREFERRED STOCK AND WARRANT SHARES. The sale of the Convertible Preferred Stock and the issuance of the Warrant Shares pursuant to exercise of the Warrants and the Conversion Shares upon conversion of the Convertible Preferred Stock shall be made in accordance with the provisions and requirements of Section 4(2), 4(6) or Regulation D and any applicable state securities law. The Company shall make any necessary SEC and "blue sky" filings required to be made by the Company in connection with the sale of the Securities to the Investors as required by all applicable Laws, and shall provide a copy thereof to the Investors promptly after such filing. Section 6.9. LIMITATION ON FUTURE FINANCING. The Company agrees that it will not enter into any sale of its securities for cash at a discount to Market Price until 90 days after the effective date of the Registration Statement without first offering such securities to the Investors on the same terms as are proposed to others, and the Investors shall severally and not jointly have five (5) Trading Days to accept such offer, except for any sales (i) pursuant to any presently existing employee benefit plan which plan has been approved by the Company's stockholders, (ii) pursuant to any compensatory plan for a full-time employee or key consultant, (iii) pursuant to any repricing of any existing Warrants or options outstanding on the Closing Date (but not to any exercise price below the closing bid price of the Common Stock on the Principal Market on the date of such repricing), (iv) with the prior approval of a majority in interest of the Investors, which will not be unreasonably withheld, in connection with a strategic partnership or other business transaction, the principal purpose of which is not simply to raise money or (v) with the prior approval of a majority in interest of the Investors, in connection with an equity line of credit transaction in an amount not to exceed $15,000,000 with a discount to market price not to exceed 15%. Section 6.10. PRO-RATA REDEMPTION. The Company agrees that if it shall redeem any of the Convertible Preferred Stock, that it shall make such redemption pro-rata among all Investors in proportion their respective initial purchases of such securities pursuant to this Agreement. ARTICLE VII SURVIVAL; INDEMNIFICATION Section 7.1. SURVIVAL. The representations, warranties and covenants made by each of the Company and each Investor in this Agreement, the annexes, schedules and exhibits hereto and in each instrument, agreement and certificate entered into and delivered by them pursuant to this Agreement, shall survive the 13 Closing and the consummation of the transactions contemplated hereby. In the event of a breach or violation of any of such representations, warranties or covenants, the party to whom such representations, warranties or covenants have been made shall have all rights and remedies for such breach or violation available to it under the provisions of this Agreement, irrespective of any investigation made by or on behalf of such party on or prior to the Closing Date. Section 7.2. INDEMNITY. (a) The Company hereby agrees to indemnify and hold harmless the Investors, their respective Affiliates and their respective officers, directors, partners and members (collectively, the "Investor Indemnitees"), from and against any and all Damages, and agrees to reimburse the Investor Indemnitees for all reasonable out-of-pocket expenses (including the reasonable fees and expenses of legal counsel), in each case promptly as incurred by the Investor Indemnitees and to the extent arising out of or in connection with: (i) any misrepresentation, omission of fact or breach of any of the Company's representations or warranties contained in this Agreement, the annexes, schedules or exhibits hereto or any instrument, agreement or certificate entered into or delivered by the Company pursuant to this Agreement; or (ii) any failure by the Company to perform in any material respect any of its covenants, agreements, undertakings or obligations set forth in this Agreement, the annexes, schedules or exhibits hereto or any instru ment, agreement or certificate entered into or delivered by the Company pursuant to this Agreement. (b) Each Investor, severally and not jointly hereby agrees to indemnify and hold harmless the Company, its Affiliates and their respective officers, directors, partners and members (collectively, the "Company Indemnitees"), from and against any and all Damages, and agrees to reimburse the Company Indemnitees for reasonable all out-of-pocket expenses (including the reasonable fees and expenses of legal counsel), in each case promptly as incurred by the Company Indemnitees and to the extent arising out of or in connection with: (i) any misrepresentation, omission of fact, or breach of any of the Investor's representations or warranties contained in this Agreement, the annexes, schedules or exhibits hereto or any instrument, agreement or certificate entered into or delivered by the Investor pursuant to this Agreement; or (ii) any failure by the Investor to perform in any material respect any of its covenants, agreements, undertakings or obligations set forth in this Agreement or any instrument, certificate or agreement entered into or delivered by the Investor pursuant to this Agreement. Section 7.3. NOTICE. Promptly after receipt by either party hereto seeking indemnification pursuant to Section 7.2 (an "Indemnified Party") of written notice of any investigation, claim, proceeding or other action in respect of which indemnification is being sought (each, a "Claim"), the Indemnified Party promptly shall notify the party against whom indemnification pursuant to Section 7.2 is being sought (the "Indemnifying Party") of the commencement thereof; but the omission to so notify the Indemnifying Party shall not relieve it from any liability that it otherwise may have to the Indemnified Party, except to the extent that the Indemnifying Party is actually prejudiced. In connection with any Claim as to which both the Indemnifying Party and the Indemnified Party are parties, the Indemnifying Party shall be entitled to assume the defense thereof. Notwithstanding the assumption of the defense of any Claim by the Indemnifying Party, the Indemnified Party shall have the right to employ separate legal counsel and to participate in the defense of such Claim, and the Indemnifying Party shall bear the reasonable fees, out-of-pocket costs and expenses of such separate legal counsel to the Indemnified Party if (and only if): (x) the Indemnifying Party shall have agreed to pay such fees, out-of-pocket costs and expenses, (y) the Indemnified Party and the Indemnifying 14 Party reasonably shall have concluded that representation of the Indemnified Party and the Indemnifying Party by the same legal counsel would not be appropriate due to actual or, as reasonably determined by legal counsel to the Indemnified Party, potentially differing interests between such parties in the conduct of the defense of such Claim, or if there may be legal defenses available to the Indemnified Party that are in addition to or disparate from those available to the Indemnifying Party, or (z) the Indemnifying Party shall have failed to employ legal counsel reasonably satisfactory to the Indemnified Party within a reasonable period of time after notice of the commencement of such Claim. If the Indemnified Party employs separate legal counsel in circumstances other than as described in clauses (x), (y) or (z) above, the fees, costs and expenses of such legal counsel shall be borne exclusively by the Indemnified Party. Except as provided above, the Indemnifying Party shall not, in connection with any Claim in the same jurisdiction, be liable for the fees and expenses of more than one firm of legal counsel for the Indemnified Party (together with appropriate local counsel). The Indemnifying Party shall not, without the prior written consent of the Indemnified Party (which consent shall not unreasonably be withheld), settle or compromise any Claim or consent to the entry of any judgment that does not include an unconditional release of the Indemnified Party from all liabilities with respect to such Claim or judgment. Section 7.4. DIRECT CLAIMS. In the event one party hereunder should have a claim for indemnification that does not involve a claim or demand being asserted by a third party, the Indemnified Party promptly shall deliver notice of such claim to the Indemnifying Party. If the Indemnified Party disputes the claim, such dispute shall be resolved by mutual agreement of the Indemnified Party and the Indemnifying Party or by binding arbitration conducted in accordance with the procedures and rules of the American Arbitration Association as set forth in Article X. Judgment upon any award rendered by any arbitrators may be entered in any court having competent jurisdiction thereof. ARTICLE VIII DUE DILIGENCE REVIEW; NON-DISCLOSURE OF NON-PUBLIC INFORMATION. Section 8.1. DUE DILIGENCE REVIEW. Subject to Section 8.2, the Company shall make available for inspection and review by the Investors, advisors to and representatives of the Investors (who may or may not be affiliated with the Investors and who are reasonably acceptable to the Company), any underwriter participating in any disposition of the Registrable Securities on behalf of the Investors pursuant to the Registration Statement, any such registration statement or amendment or supplement thereto or any blue sky, Nasdaq or other filing, all SEC Documents and other filings with the SEC, and all other publicly available corporate documents and properties of the Company as may be reasonably necessary for the purpose of such review, and cause the Company's officers, directors and employees to supply all such publicly available information reasonably requested by the Investors or any such representative, advisor or underwriter in connection with such Registration Statement (including, without limitation, in response to all questions and other inquiries reasonably made or submitted by any of them), prior to and from time to time after the filing and effectiveness of the Registration Statement for the sole purpose of enabling the Investors and such representatives, advisors and underwriters and their respective accountants and attorneys to conduct initial and ongoing due diligence with respect to the Company and the accuracy of the Registration Statement. Section 8.2. NON-DISCLOSURE OF NON-PUBLIC INFORMATION. (a) The Company shall not disclose material non-public information to the Investors, advisors to or representatives of the Investors unless prior to disclosure of such information the Company identifies such information as being non-public information and provides the Investors, such advisors and representatives with the opportunity to accept or refuse to accept such non-public information for review. Other than disclosure of any comment letters received from the SEC staff with respect to the Registration Statement, the Company may, as a condition to disclosing any non-public information hereunder, require the Investors' 15 advisors and representatives to enter into a confidentiality agreement in form reasonably satisfactory to the Company and the Investors. (b) Nothing herein shall require the Company to disclose material non-public information to the Investors or their advisors or representatives, and the Company represents that it does not disseminate material non-public information to any investors who purchase stock in the Company in a public offering, to money managers or to securities analysts, provided, however, that notwithstanding anything herein to the contrary, the Company will, as hereinabove provided, promptly notify the advisors and representatives of the Investors and, if any, underwriters, of any event or the existence of any circumstance (without any obligation to disclose the specific event or circumstance) of which it becomes aware, constituting material non-public information (whether or not requested of the Company specifically or generally during the course of due diligence by such persons or entities), which, if not disclosed in the prospectus included in the Registration Statement would cause such prospectus to include a material misstatement or to omit a material fact required to be stated therein in order to make the statements, therein in light of the circumstances in which they were made, not misleading. Nothing contained in this Section 8.2 shall be construed to mean that such persons or entities other than the Investors (without the written consent of the Investors prior to disclosure of such information as set forth in Section 8.2(a)) may not obtain non-public information in the course of conducting due diligence in accordance with the terms of this Agreement and nothing herein shall prevent any such persons or entities from notifying the Company of their opinion that based on such due diligence by such persons or entities, that the Registration Statement contains an untrue statement of a material fact or omits a material fact required to be stated in the Registration Statement or necessary to make the statements contained therein, in light of the circumstances in which they were made, not misleading. ARTICLE IX LEGENDS; TRANSFER AGENT INSTRUCTIONS Section 9.1. LEGENDS. Unless otherwise provided below, each certificate representing Registrable Securities will bear the following legend or equivalent (the "Legend"): THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY OTHER APPLICABLE SECURITIES LAWS AND HAVE BEEN ISSUED IN RELIANCE UPON AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND SUCH OTHER SECURITIES LAWS. NEITHER THIS SECURITY NOR ANY INTEREST OR PARTICIPATION HEREIN MAY BE REOFFERED, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED, HYPOTHECATED OR OTHERWISE DISPOSED OF, EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO A TRANSACTION THAT IS EXEMPT FROM, OR NOT SUBJECT TO, SUCH REGISTRATION. Section 9.2. TRANSFER AGENT INSTRUCTIONS. Upon the execution and delivery hereof, the Company is issuing to the transfer agent for its Common Stock (and to any substitute or replacement transfer agent for its Common Stock upon the Company's appointment of any such substitute or replacement transfer agent) instructions in substantially the form of Exhibit F hereto. Such instructions shall be irrevocable by the Company from and after the date hereof or from and after the issuance thereof to any such substitute or replacement transfer agent, as the case may be, except as otherwise expressly provided in the Registration Rights Agreement. 16 Section 9.3. NO OTHER LEGEND OR STOCK TRANSFER RESTRICTIONS. No legend other than the one specified in Section 9.1 has been or shall be placed on the share certificates representing the Registrable Securities and no instructions or "stop transfer orders," so called, "stock transfer restrictions," or other restrictions have been or shall be given to the Company's transfer agent with respect thereto other than as expressly set forth in this Article IX. Section 9.4. INVESTORS' Compliance. Nothing in this Article shall affect in any way each Investor's obligations under any agreement to comply with all applicable securities laws upon resale of the Common Stock. ARTICLE X CHOICE OF LAW Section 10.1. GOVERNING LAW/ARBITRATION. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made in New York by persons domiciled in New York City and without regard to its principles of conflicts of laws. Any dispute under this Agreement or any Exhibit attached hereto shall be submitted to arbitration under the American Arbitration Association (the "AAA") in New York City, New York, and shall be finally and conclusively determined by the decision of a board of arbitration consisting of three (3) members (hereinafter referred to as the "Board of Arbitration") selected as according to the rules governing the AAA. The Board of Arbitration shall meet on consecutive business days in New York City, New York, and shall reach and render a decision in writing (concurred in by a majority of the members of the Board of Arbitration) with respect to the amount, if any, which the losing party is required to pay to the other party in respect of a claim filed. In connection with rendering its decisions, the Board of Arbitration shall adopt and follow the laws of the State of New York. To the extent practical, decisions of the Board of Arbitration shall be rendered no more than thirty (30) calendar days following commencement of proceedings with respect thereto. The Board of Arbitration shall cause its written decision to be delivered to all parties involved in the dispute. Any decision made by the Board of Arbitration (either prior to or after the expiration of such thirty (30) calendar day period) shall be final, binding and conclusive on the parties to the dispute, and entitled to be enforced to the fullest extent permitted by law and entered in any court of competent jurisdiction. The Board of Arbitration shall be authorized and is hereby directed to enter a default judgment against any party failing to participate in any proceeding hereunder within the time periods set forth in the AAA rules. The non-prevailing party to any arbitration (as determined by the Board of Arbitration) shall pay the expenses of the prevailing party including reasonable attorney's fees, in connection with such arbitration. Any party shall be entitled to obtain injunctive relief from a court in any case where such relief is available. ARTICLE XI ASSIGNMENT Section 11.1. ASSIGNMENT. Neither this Agreement nor any rights of the Investors or the Company hereunder may be assigned by either party to any other person. Notwithstanding the foregoing, (a) the provisions of this Agreement shall inure to the benefit of, and be enforceable by, any permitted transferee of any of the Convertible Preferred Stock or Warrants purchased or acquired by any Investor hereunder with respect to the Convertible Preferred Stock or Warrants held by such person, and (b) upon the prior written consent of the Company, which consent shall not unreasonably be withheld or delayed, each Investor's interest in this Agreement may be assigned at any time, in whole or in part, to any other person or entity (including any affiliate of the Investor) who agrees to make the representations and Warranties contained in Article III and who agrees to be bound by the terms of this Agreement. 17 ARTICLE XII NOTICES Section 12.1. NOTICES. All notices, demands, requests, consents, approvals, and other communications required or permitted hereunder shall be in writing and, unless otherwise specified herein, shall be (i) personally served, (ii) deposited in the mail, registered or certified, return receipt requested, postage prepaid, (iii) delivered by reputable air courier service with charges prepaid, or (iv) transmitted by hand delivery, telegram, or facsimile, addressed as set forth below or to such other address as such party shall have specified most recently by written notice. Any notice or other communication required or permitted to be given hereunder shall be deemed effective (a) upon hand delivery or delivery by facsimile, with accurate confirmation generated by the transmitting facsimile machine, at the address or number designated below (if delivered on a business day during normal business hours where such notice is to be received), or the first business day following such delivery (if delivered other than on a business day during normal business hours where such notice is to be received) or (b) on the second business day following the date of mailing by reputable courier service, fully prepaid, addressed to such address, or upon actual receipt of such mailing, whichever shall first occur. The addresses for such communications shall be: If to the Company: AvTel Communications, Inc. 501 Bath Street Santa Barbara, CA 93101 Attention: Anthony E. Papa, C.E.O. Telephone: (805) 884-6300 Facsimile: (805) 884-6311 with a copy to (shall not constitute notice): Seed, Mackall & Cole LLP 1332 Anacapa Street, Suite 200 Santa Barbara, CA 93101 Attention: Thomas N. Harding, Esq. Telephone: (805) 963-0669 Facsimile: (805) 962-1404 if to the Investors: As set forth on the signature pages hereto with a copy to: Joseph A. Smith, Esq. (shall not constitute notice) Epstein Becker & Green, P.C. 250 Park Avenue New York, New York Telephone: (212) 351-4500 Facsimile: (212) 661-0989 Either party hereto may from time to time change its address or facsimile number for notices under this Section 12.1 by giving written notice of such changed address or facsimile number to the other party hereto as provided in this Section 12.1. 18 ARTICLE XIII MISCELLANEOUS Section 13.1. COUNTERPARTS/ FACSIMILE/ AMENDMENTS. This Agreement may be executed in multiple counterparts, each of which may be executed by less than all of the parties and shall be deemed to be an original instrument which shall be enforceable against the parties actually executing such counterparts and all of which together shall constitute one and the same instrument. Except as otherwise stated herein, in lieu of the original documents, a facsimile transmission or copy of the original documents shall be as effective and enforceable as the original. This Agreement may be amended only by a writing executed by all parties. Section 13.2. ENTIRE AGREEMENT. This Agreement, the agreements attached as Exhibits hereto, which include, but are not limited to the Convertible Preferred Stock, the Warrants, the Escrow Agreement, and the Registration Rights Agreement, set forth the entire agreement and understanding of the parties relating to the subject matter hereof and supersedes all prior and contemporaneous agreements, negotiations and understandings between the parties, both oral and written relating to the subject matter hereof. The terms and conditions of all Exhibits to this Agreement are incorporated herein by this reference and shall constitute part of this Agreement as is fully set forth herein. Section 13.3. SEVERABILITY. In the event that any provision of this Agreement becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement shall continue in full force and effect without said provision; provided that such severability shall be ineffective if it materially changes the economic benefit of this Agreement to any party. Section 13.4. HEADINGS. The headings used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. Section 13.5. REPORTING ENTITY FOR THE COMMON STOCK. The reporting entity relied upon for the determination of the trading price or trading volume of the Common Stock on any given Trading Day for the purposes of this Agreement shall be Bloomberg, L.P. or any successor thereto. The written mutual consent of the Investors and the Company shall be required to employ any other reporting entity. Section 13.6. REPLACEMENT OF CERTIFICATES. Upon (i) receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of a certificate representing the Convertible Preferred Stock or any Conversion Shares or Warrants or any Warrant Shares and (ii) in the case of any such loss, theft or destruction of such certificate, upon delivery of an indemnity agreement or security reasonably satisfactory in form and amount to the Company (which shall not exceed that required by the Company's transfer agent in the ordinary course) or (iii) in the case of any such mutilation, on surrender and cancellation of such certificate, the Company at its expense will execute and deliver, in lieu thereof, a new certificate of like tenor. Section 13.7. FEES AND EXPENSES. Each of the Company and the Investors agrees to pay its own expenses incident to the performance of its obligations hereunder, except that the Company shall pay the fees, expenses and disbursements of Epstein Becker & Green, P.C., counsel to the investors, in an amount equal to $15,000, all as set forth in the Escrow Agreement. 19 Section 13.8. BROKERAGE. Each of the parties hereto represents that it has had no dealings in connection with this transaction with any finder or broker who will demand payment of any fee or commission from the other party except for Trinity Capital Advisors, Inc., whose fee shall be paid by the Company. The Company on the one hand, and the Investors, on the other hand, agree to indemnify the other against and hold the other harmless from any and all liabilities to any person claiming brokerage commissions or finder's fees on account of services purported to have been rendered on behalf of the indemnifying party in connection with this Agreement or the transactions contemplated hereby. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by the undersigned, thereunto duly authorized, as of the date first set forth above. AVTEL COMMUNICATIONS, INC. By: /s/ ANTHONY E. PAPA ------------------- Anthony E. Papa Chief Executive Officer INVESTOR AMRO INTERNATIONAL, S.A. By: /s/ H.U. BACHOFEN ------------------- H.U. Bachofen, Director INVESTOR AUSTINVEST ANSTALT BALZERS By: /s/ W. GRILL ------------------- W. Grill, Director INVESTOR ESQUIRE TRADE & FINANCE INC. By: /s/ R. WINIGER ------------------- R. Winiger, Director [Exhibits and Schedules omitted] 20 EX-10.14 9 EXHIBIT 10.14 Exhibit 10.14 REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT, dated as of April 5, 1999, between the investors signatory hereto (each an "Investor"), and AVTEL COMMUNICATIONS, INC., a Delaware corporation (the "Company"). WHEREAS, simultaneously with the execution and delivery of this Agreement, the Investor is purchasing from the Company, pursuant to an Convertible Preferred Stock and Warrants Purchase Agreement dated the date hereof (the "Purchase Agreement"), $1,500,000 liquidation preference amount of Convertible Preferred Shares and Warrants to purchase up to 20,000 shares of the Company's Common Stock (terms not defined herein shall have the meanings ascribed to them in the Purchase Agreement); and WHEREAS, the Company desires to grant to the Investor the registration rights set forth herein with respect to the shares of Common Stock issuable upon conversion of the Convertible Preferred Shares purchased from time to time pursuant to the Purchase Agreement, shares of Common Stock issuable as dividends on the Convertible Preferred Shares and shares of Common Stock issuable upon exercise of the Warrants (hereinafter referred to as the "Stock" or "Securities" of the Company). NOW, THEREFORE, the parties hereto mutually agree as follows: Section 1. REGISTRABLE SECURITIES. As used herein the term "Registrable Security" means the Securities until (i) the Registration Statement has been declared effective by the Commission, and all Securities have been disposed of pursuant to the Registration Statement, (ii) all Securities have been sold under circumstances under which all of the applicable conditions of Rule 144 (or any similar provision then in force) under the Securities Act ("Rule 144") are met, (iii) all Securities have been otherwise transferred to holders who may trade such Securities without restriction under the Securities Act, and the Company has delivered a new certificate or other evidence of ownership for such Securities not bearing a restrictive legend or (iv) such time as, in the opinion of counsel to the Company, all Securities may be sold without any time, volume or manner limitations pursuant to Rule 144(k) (or any similar provision then in effect) under the Securities Act. The term "Registrable Securities" means any and/or all of the securities falling within the foregoing definition of a "Registrable Security." In the event of any merger, reorganization, consolidation, recapitalization or other change in corporate structure affecting the Common Stock, such adjustment shall be deemed to be made in the definition of "Registrable Security" as is appropriate in order to prevent any dilution or enlargement of the rights granted pursuant to this Agreement. Section 2. RESTRICTIONS ON TRANSFER. The Investor acknowledges and understands that prior to the registration of the Securities as provided herein, the Securities are "restricted securities" as defined in Rule 144 promulgated under the Act. The Investor understands that no disposition or transfer of the Securities may be made by Investor in the absence of (i) an opinion of counsel to the Investor, in form and substance reasonably satisfactory to the Company, that such transfer may be made without registration under the Securities Act or (ii) such registration. With a view to making available to the Investor the benefits of Rule 144 under the Securities Act or any other similar rule or regulation of the Commission that may at any time permit the Investor to sell securities of the Company to the public without registration ("Rule 144"), the Company agrees to: (a) comply with the provisions of paragraph (c)(1) of Rule 144; and (b) file with the Commission in a timely manner all reports and other documents required to be filed by the Company pursuant to Section 13 or 15(d) under the Conversion Act; and, if at any time it is not required to file such reports but in the past had been required to or did file such reports, it will, upon the request of any Investor, make available other information as required by, and so long as necessary to permit sales of, its Registrable Securities pursuant to Rule 144. Section 3. REGISTRATION RIGHTS WITH RESPECT TO THE SECURITIES. (a) The Company agrees that it will prepare and file with the Securities and Conversion Commission ("Commission"), within forty-five (45) days after the Closing Date a registration statement (on Form S-3, or other appropriate registration statement form) under the Securities Act (the "Registration Statement"), at the sole expense of the Company (except as provided in Section 3(c) hereof), in respect of Investor, so as to permit a public offering and resale of the Securities under the Act by the holders thereof as selling stockholders and not as underwriters. The Company shall use its best efforts to cause such Registration Statement to become effective within ninety (90) days from the Closing Date (or 120 days if the SEC makes a "full review" of the Registration Statement), or, if earlier, within five (5) days of SEC clearance to request acceleration of effectiveness. The number of shares designated in the Registration Statement to be registered shall include all the Warrant Shares, at least 750,000 shares issuable upon conversion of the Convertible Preferred Shares, and such number of shares as the Company deems prudent for the purpose of issuing shares of Common Stock as dividends on the Convertible Preferred Shares, and shall include appropriate language regarding reliance upon Rule 416 to the extent permitted by the Commission. The Company will notify Investor of the effectiveness of the Registration Statement within one Trading Day of such event. In the event that the number of shares so registered shall be insufficient to register the resale of all of the Securities, then the Company shall be obligated to file, within thirty (30) days of notice from any Investor, a further Registration Statement registering such remaining shares and shall use diligent best efforts to prosecute such additional Registration Statement to effectiveness. (b) The Company will maintain the Registration Statement or post-effective amendment filed under this Section 3 hereof effective under the Securities Act until the earlier of (i) the date that none of the Convertible Preferred Shares, the Warrant or the Securities covered by such Registration Statement are or may become issued and outstanding, (ii) the date that all of the Securities have been sold pursuant to such Registration Statement, (iii) the date the holders thereof receive an opinion of counsel to the Company, which counsel shall be reasonably acceptable to the Investor, that the Securities may be sold under the provisions of Rule 144 without limitation as to volume, (iv) all Securities have been otherwise transferred to Investors who may trade such shares without restriction under the Securities Act, and the Company has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend, or (v) all Securities may be sold without any time, volume or manner limitations pursuant to Rule 144(k) or any similar provision then in effect under the Securities Act in the opinion of counsel to the Company, which counsel shall be reasonably acceptable to the Investor (the "Effectiveness Period"). (c) All fees, disbursements and out-of-pocket expenses and costs incurred by the Company in connection with the preparation and filing of the Registration Statement under subparagraph 3(a) and in complying with applicable securities and Blue Sky laws (including, without limitation, all attorneys' fees of the Company) shall be borne by the Company. The Investor shall bear the cost of underwriting and/or brokerage discounts, fees and commissions, if any, applicable to the Securities being registered and the fees and expenses of its counsel. The Investor and its counsel shall have a reasonable period, not to exceed three (3) Trading Days, to review the proposed Registration Statement or any amendment thereto, prior to filing with the Commission, and the Company shall provide each Investor with copies of any comment letters received from the Commission with respect thereto within two (2) Trading Days of receipt thereof. The Company shall make reasonably available for inspection by Investor, any underwriter participating in any disposition pursuant to the Registration Statement, and any attorney, accountant or other agent retained by such Investor or any such underwriter all relevant financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, and cause the Company's officers, directors and employees to supply all information reasonably requested by such Investor or any such underwriter, attorney, accountant or agent in connection with the Registration Statement, in each case, as is customary for similar due diligence examinations; PROVIDED, HOWEVER, that all records, information and documents that are designated in writing by the Company, in good faith, as confidential, proprietary or containing any material non-public information shall be kept confidential by such Investor and any such underwriter, attorney, accountant or agent (pursuant to an appropriate confidentiality agreement in the case of any such Investor or agent), unless such disclosure is made pursuant to judicial process in a court proceeding (after first giving the Company an opportunity promptly to seek a protective order or otherwise limit the scope of the information sought to be disclosed) or is required by law, or such records, information or documents become available to the public generally or through a third party not in violation of an accompanying obligation of confidentiality; and PROVIDED FURTHER that, if the foregoing inspection and information gathering would otherwise disrupt the Company's conduct of its business, such inspection and information gathering shall, to the maximum extent possible, be coordinated on behalf of the Investors and the other parties entitled thereto by one firm of counsel designated by and on behalf of the majority in interest of Investors and other parties. The Company shall qualify any of the securities for sale in such states as any Investor reasonably designates and shall furnish indemnification in the manner provided in Section 6 hereof. However, the Company shall not be required to qualify in any state which will require an escrow or other restriction relating to the Company and/or the sellers, or which will require the Company to qualify to do business in such state or require the Company to file therein any general consent to service of process. The Company at its expense will supply the Investors with copies of the applicable Registration Statement and the prospectus included therein and other related documents in such quantities as may be reasonably requested by the Investors. (d) The Company shall not be required by this Section 3 to include a Investor's Securities in any Registration Statement which is to be filed if, in the opinion of counsel for both the Investor and the Company (or, should they not agree, in the opinion of another counsel experienced in securities law matters acceptable to counsel for the Investor and the Company) the proposed offering or other transfer as to which such registration is requested is exempt from applicable federal and state securities laws and would result in all purchasers or transferees obtaining securities which are not "restricted securities", as defined in Rule 144 under the Securities Act. (e) In the event that (i) the Registration Statement to be filed by the Company pursuant to Section 3(a) above is not filed with the Commission within forty-five (45) days from the Closing Date, (ii) such Registration Statement is not declared effective by the Commission within the earlier of ninety (90) days from the Closing Date (or 120 days if the Commission makes a "full review" of the Registration Statement) or five (5) days of clearance by the Commission to request effectiveness, or (iii) such Registration Statement is not maintained as effective by the Company for the period set forth in Section 3(b) above (each a "Registration Default") then the Company will pay Investor (pro rated on a daily basis), as liquidated damages for such failure and not as a penalty one percent (1%) of the aggregate market value of shares of Common Stock purchased from the Company (including the Conversion Shares which would be issuable upon conversion of the Convertible Preferred Shares on any date of determination, and whether or not the Convertible Preferred Shares are then Convertible pursuant to their terms) and held by the Investor for the first month and two percent (2%) for every month thereafter until such Registration Statement has been filed, and in the event of late effectiveness (in case of clause (ii) above) or lapsed effectiveness (in the case of clause (iii) above), one percent (1%) of the aggregate market value of shares of Common Stock purchased from the Company and held by the Investor (including the Conversion Shares which would be issuable upon conversion of the Convertible Preferred Shares on any date of determination, and whether or not the Convertible Preferred Shares are then Convertible pursuant to their terms) for the first month and two percent (2%) for every month thereafter (regardless of whether one or more such Registration Defaults are then in existence) until such Registration Statement has been declared effective. Such payment of the liquidated damages shall be made to the Investor in cash, within five (5) calendar days of demand, provided, however, that the payment of such liquidated damages shall not relieve the Company from its obligations to register the Securities pursuant to this Section. The market value of the Common Stock for this purpose shall be the closing price (or last trade, if so reported) on the Principal Market for each day during such Registration Default. Notwithstanding anything to the contrary contained herein, a failure to maintain the effectiveness of a filed Registration Statement or the ability of a Investor to use an otherwise effective Registration Statement to effect resales of Securities during the period after 45 days and within 90 days from the end of the Company's fiscal year resulting solely from the need to update the Company's financial statements contained or incorporated by reference in such Registration Statement shall not constitute a Registration Default and shall not trigger the accrual of liquidated damages hereunder. If the Company does not remit the payment to the Investor as set forth above, the Company will pay the Investor reasonable costs of collection, including attorneys' fees, in addition to the liquidated damages. The registration of the Securities pursuant to this provision shall not affect or limit Investor's other rights or remedies as set forth in this Agreement. (f) No provision contained herein shall preclude the Company from selling securities pursuant to any Registration Statement in which it is required to include Securities pursuant to this Section 3. (g) If at any time or from time to time after the effective date of any Registration Statement, the Company notifies the Investor in writing of the existence of a Potential Material Event (as defined in Section 3(h) below), the Investor shall not offer or sell any Securities or engage in any other transaction involving or relating to Securities, from the time of the giving of notice with respect to a Potential Material Event until such Investor receives written notice from the Company that such Potential Material Event either has been disclosed to the public or no longer constitutes a Potential Material Event; provided, however, that the Company may not so suspend the right to such holders of Securities for more than thirty (30) days in the aggregate during any twelve month period, during the periods any Registration Statement is required to be in effect, and if such period is exceeded, such event shall be a Registration Default. If a Potential Material Event shall occur prior to the date a Registration Statement is required to be filed, then the Company's obligation to file such Registration Statement shall be delayed without penalty for not more than thirty (30) days, and such delay or delays shall not constitute a Registration Default. The Company must, if lawful, give Investor notice in writing at least two (2) Trading Days prior to the first day of the blackout period. (h) "Potential Material Event" means any of the following: (a) the possession by the Company of material information not ripe for disclosure in a registration statement, as determined in good faith by the Chief Executive Officer, the Chief Financial Officer or the Board of Directors of the Company that disclosure of such information in a Registration Statement would be detrimental to the business and affairs of the Company; or (b) any material engagement or activity by the Company which would, in the good faith determination of the Chief Executive Officer, the Chief Financial Officer or the Board of Directors of the Company, be adversely affected by disclosure in a registration statement at such time, which determination shall be accompanied by a good faith determination by the Chief Executive Officer, the Chief Financial Officer or the Board of Directors of the Company that the applicable Registration Statement would be materially misleading absent the inclusion of such information. Section 4. COOPERATION WITH COMPANY. Investor will cooperate with the Company in all respects in connection with this Agreement, including timely supplying all information reasonably requested by the Company (which shall include all information regarding the Investor and proposed manner of sale of the Registrable Securities required to be disclosed in any Registration Statement) and executing and returning all documents reasonably requested in connection with the registration and sale of the Registrable Securities and entering into and performing its obligations under any underwriting agreement, if the offering is an underwritten offering, in usual and customary form, with the managing underwriter or underwriters of such underwritten offering. Nothing in this Agreement shall obligate the Investor to consent to be named as an underwriter in any Registration Statement. The obligation of the Company to register the Registrable Securities shall be absolute and unconditional as to those Securities which the Commission will permit to be registered without naming the Investor as an underwriter. Any delay or delays caused by the Investor by failure to cooperate as required hereunder shall not constitute a Registration Default. Section 5. REGISTRATION PROCEDURES. If and whenever the Company is required by any of the provisions of this Agreement to effect the registration of any of the Registrable Securities under the Act, the Company shall (except as otherwise provided in this Agreement), as expeditiously as possible, subject to the Investor's assistance and cooperation as reasonably required with respect to each Registration Statement: (a) (i) prepare and file with the Commission such amendments and supplements to the Registration Statement and the prospectus used in connection therewith as may be necessary to keep such Registration Statement effective and to comply with the provisions of the Act with respect to the sale or other disposition of all securities covered by such registration statement whenever the Investor of such Registrable Securities shall desire to sell or otherwise dispose of the same (including prospectus supplements with respect to the sales of securities from time to time in connection with a registration statement pursuant to Rule 415 promulgated under the Act) and (ii) take all lawful action such that each of (A) the Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading and (B) the Prospectus forming part of the Registration Statement, and any amendment or supplement thereto, does not at any time during the Registration Period include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (b) (i) prior to the filing with the Commission of any Registration Statement (including any amendments thereto) and the distribution or delivery of any prospectus (including any supplements thereto), provide draft copies thereof to the Investors as required by Section 3(c) and reflect in such documents all such comments as the Investors (and their counsel) reasonably may propose respecting the Selling Shareholders and Plan of Distribution sections (or equivalents) and (ii) furnish to each Investor such numbers of copies of a prospectus including a preliminary prospectus or any amendment or supplement to any prospectus, as applicable, in conformity with the requirements of the Act, and such other documents, as such Investor may reasonably request in order to facilitate the public sale or other disposition of the securities owned by such Investor; (c) register and qualify the Registrable Securities covered by the Registration Statement under such other securities or blue sky laws of such jurisdictions as the Investor shall reasonably request (subject to the limitations set forth in Section 3(d) above), and do any and all other acts and things which may be necessary or advisable to enable each Investor to consummate the public sale or other disposition in such jurisdiction of the securities owned by such Investor, except that the Company shall not for any such purpose be required to qualify to do business as a foreign corporation in any jurisdiction wherein it is not so qualified or to file therein any general consent to service of process; (d) list such Registrable Securities on the Principal Market, if the listing of such Registrable Securities is then permitted under the rules of such Principal Market; (e) notify each Investor at any time when a prospectus relating thereto covered by the Registration Statement is required to be delivered under the Act, of the happening of any event of which it has knowledge as a result of which the prospectus included in the Registration Statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing, and the Company shall prepare and file a curative amendment under Section 5(a) as quickly as commercially possible; (f) as promptly as practicable after becoming aware of such event, notify each Investor who holds Registrable Securities being sold (or, in the event of an underwritten offering, the managing underwriters) of the issuance by the Commission of any stop order or other suspension of the effectiveness of the Registration Statement at the earliest possible time and take all lawful action to effect the withdrawal, recession or removal of such stop order or other suspension; (g) cooperate with the Investors to facilitate the timely preparation and delivery of certificates for the Registrable Securities to be offered pursuant to the Registration Statement and enable such certificates for the Registrable Securities to be in such denominations or amounts, as the case may be, as the Investors reasonably may request and registered in such names as the Investor may request; and, within three business days after a Registration Statement which includes Registrable Securities is declared effective by the Commission, deliver and cause legal counsel selected by the Company to deliver to the transfer agent for the Registrable Securities (with copies to the Investors) an appropriate instruction and, to the extent necessary, an opinion of such counsel; (h) take all such other lawful actions reasonably necessary to expedite and facilitate the disposition by the Investors of their Registrable Securities in accordance with the intended methods therefor provided in the prospectus which are customary for issuers to perform under the circumstances; (i) in the event of an underwritten offering, promptly include or incorporate in a Prospectus supplement or post-effective amendment to the Registration Statement such information as the managers reasonably agree should be included therein and to which the Company does not reasonably object and make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after it is notified of the matters to be included or incorporated in such Prospectus supplement or post-effective amendment; and (j) maintain a transfer agent and registrar for its Common Stock. Section 6. INDEMNIFICATION. (a) To the maximum extent permitted by law, the Company agrees to indemnify and hold harmless the Investor and each person, if any, who controls the Investor within the meaning of the Securities Act ("Distributing Investor") against any losses, claims, damages or liabilities, joint or several (which shall, for all purposes of this Agreement, include, but not be limited to, all reasonable costs of defense and investigation and all reasonable attorneys' fees), to which the Distributing Investor may become subject, under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement, or any related preliminary prospectus, final prospectus or amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in such Registration Statement, preliminary prospectus, final prospectus or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by the Distributing Investor, its counsel, affiliates or any underwriter, specifically for use in the preparation thereof. This Section 6(a) shall not inure to the benefit of any Distributing Investor with respect to any person asserting such loss, claim, damage or liability who purchased the Registrable Securities which are the subject thereof if the Distributing Investor failed to send or give (in violation of the Securities Act or the rules and regulations promulgated thereunder) a copy of the prospectus contained in such Registration Statement to such person at or prior to the written confirmation to such person of the sale of such Registrable Securities, where the Distributing Investor was obligated to do so under the Securities Act or the rules and regulations promulgated thereunder. This indemnity agreement will be in addition to any liability which the Company may otherwise have. (b) To the maximum extent permitted by law, each Distributing Investor agrees that it will indemnify and hold harmless the Company, and each officer, director of the Company or person, if any, who controls the Company within the meaning of the Securities Act, against any losses, claims, damages or liabilities (which shall, for all purposes of this Agreement, include, but not be limited to, all reasonable costs of defense and investigation and all reasonable attorneys' fees) to which the Company or any such officer, director or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any Registration Statement, or any related preliminary prospectus, final prospectus or amendment or supplement thereto, or arise out of or are based upon the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but in each case only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission was made in such Registration Statement, preliminary prospectus, final prospectus or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by such Distributing Investor, its counsel, affiliates or any underwriter, specifically for use in the preparation thereof. This indemnity agreement will be in addition to any liability which the Distributing Investor may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 6 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 6, notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party will not relieve the indemnifying party from any liability which it may have to any indemnified party except to the extent the failure of the indemnified party to provide such written notification is prejudicial to the ability of the indemnifying party to defend such action. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, assume the defense thereof, subject to the provisions herein stated and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party will not be liable to such indemnified party under this Section 6 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation, unless the indemnifying party shall not pursue the action to its final conclusion. The indemnified parties as a group shall have the right to employ one separate counsel in any such action and to participate in the defense thereof, but the fees and expenses of such counsel shall not be at the expense of the indemnifying party if the indemnifying party has assumed the defense of the action with counsel reasonably satisfactory to the indemnified party unless (i) the employment of such counsel has been specifically authorized in writing by the indemnifying party, or (ii) the named parties to any such action (including any impleaded parties) include both the indemnified party and the indemnifying party and the indemnified party shall have been advised by its counsel that there may be one or more legal defenses available to the indemnifying party different from or in conflict with any legal defenses which may be available to the indemnified party or any other indemnified party (in which case the indemnifying party shall not have the right to assume the defense of such action on behalf of such indemnified party, it being understood, however, that the indemnifying party shall, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable only for the reasonable fees and expenses of one separate firm of attorneys for the indemnified party, which firm shall be designated in writing by the indemnified party). No settlement of any action against an indemnified party shall be made without the prior written consent of the indemnified party, which consent shall not be unreasonably withheld. Section 7. CONTRIBUTION. In order to provide for just and equitable contribution under the Securities Act in any case in which (i) the indemnified party makes a claim for indemnification pursuant to Section 6 hereof but is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of Section 6 hereof provide for indemnification in such case, or (ii) contribution under the Securities Act may be required on the part of any indemnified party, then the Company and the applicable Distributing Investor shall contribute to the aggregate losses, claims, damages or liabilities to which they may be subject (which shall, for all purposes of this Agreement, include, but not be limited to, all reasonable costs of defense and investigation and all reasonable attorneys' fees), in either such case (after contribution from others) on the basis of relative fault as well as any other relevant equitable considerations. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or the applicable Distributing Investor on the other hand, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Distributing Investor agree that it would not be just and equitable if contribution pursuant to this Section 7 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in this Section 7. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this Section 7 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Notwithstanding any other provision of this Section 7, in no event shall any (i) Investor be required to undertake liability to any person under this Section 7 for any amounts in excess of the dollar amount of the proceeds to be received by such Investor from the sale of such Investor's Registrable Securities (after deducting any fees, discounts and commissions applicable thereto) pursuant to any Registration Statement under which such Registrable Securities are to be registered under the Securities Act and (ii) underwriter be required to undertake liability to any person hereunder for any amounts in excess of the aggregate discount, commission or other compensation payable to such underwriter with respect to the Registrable Securities underwritten by it and distributed pursuant to such Registration Statement. Section 8. NOTICES. All notices, demands, requests, consents, approvals, and other communications required or permitted hereunder shall be in writing and, unless otherwise specified herein, shall be (i) personally served, (ii) deposited in the mail, registered or certified, return receipt requested, postage prepaid, (iii) delivered by reputable air courier service with charges prepaid, or (iv) transmitted by hand delivery, telegram, or facsimile, addressed as set forth below or to such other address as such party shall have specified most recently by written notice. Any notice or other communication required or permitted to be given hereunder shall be deemed effective (a) upon hand delivery or delivery by facsimile, with accurate confirmation generated by the transmitting facsimile machine, at the address or number designated below (if delivered on a business day during normal business hours where such notice is to be received), or the first business day following such delivery (if delivered other than on a business day during normal business hours where such notice is to be received) or (b) on the second business day following the date of mailing by reputable courier service, fully prepaid, addressed to such address, or upon actual receipt of such mailing, whichever shall first occur. The addresses for such communications shall be as set forth in the Purchase Agreement. Either party hereto may from time to time change its address or facsimile number for notices under this Section 8 by giving at least ten (10) days' prior written notice of such changed address or facsimile number to the other party hereto. Section 9. ASSIGNMENT. This Agreement is binding upon and inures to the benefit of the parties hereto and their respective heirs, successors and permitted assigns. THE RIGHTS GRANTED THE INVESTOR UNDER THIS AGREEMENT MAY BE ASSIGNED TO ANY PURCHASER OF SUBSTANTIALLY ALL OF THE REGISTRABLE SECURITIES (OR THE RIGHTS THERETO) FROM INVESTOR, AS OTHERWISE PERMITTED BY THE PURCHASE AGREEMENT. IN THE EVENT OF A TRANSFER OF THE RIGHTS GRANTED UNDER THIS AGREEMENT, THE INVESTOR AGREES THAT THE COMPANY MAY REQUIRE THAT THE TRANSFEREE COMPLY WITH REASONABLE CONDITIONS AS DETERMINED IN THE DISCRETION OF THE COMPANY. Section 10. ADDITIONAL COVENANTS OF THE COMPANY. The Company agrees that at such time as it meets all the requirements for the use of Securities Act Registration Statement on Form S-3 it shall file all reports and information required to be filed by it with the Commission in a timely manner and take all such other action so as to maintain such eligibility for the use of such form. Section 11. COUNTERPARTS/FACSIMILE. This Agreement may be executed in two or more counterparts, each of which shall constitute an original, but all of which, when together shall constitute but one and the same instrument, and shall become effective when one or more counterparts have been signed by each party hereto and delivered to the other party. In lieu of the original, a facsimile transmission or copy of the original shall be as effective and enforceable as the original. SECTION 12. REMEDIES. The remedies provided in this Agreement are cumulative and not exclusive of any remedies provided by law. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, illegal, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions set forth herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated, and the parties hereto shall use their best efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such term, provision, covenant or restriction. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions without including any of such that may be hereafter declared invalid, illegal, void or unenforceable. Section 13. CONFLICTING AGREEMENTS. The Company shall not enter into any agreement with respect to its securities that is inconsistent with the rights granted to the holders of Registrable Securities in this Agreement or otherwise prevents the Company from complying with all of its obligations hereunder. Section 14. HEADINGS. The headings in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. Section 15. GOVERNING LAW, ARBITRATION. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made in New York by persons domiciled in New York City and without regard to its principles of conflicts of laws. Any dispute under this Agreement shall be submitted to arbitration under the American Arbitration Association (the "AAA") in New York City, New York, and shall be finally and conclusively determined by the decision of a board of arbitration consisting of three (3) members (hereinafter referred to as the "Board of Arbitration") selected as according to the rules governing the AAA. The Board of Arbitration shall meet on consecutive business days in New York City, New York, and shall reach and render a decision in writing (concurred in by a majority of the members of the Board of Arbitration) with respect to the amount, if any, which the losing party is required to pay to the other party in respect of a claim filed. In connection with rendering its decisions, the Board of Arbitration shall adopt and follow the laws of the State of New York. To the extent practical, decisions of the Board of Arbitration shall be rendered no more than thirty (30) calendar days following commencement of proceedings with respect thereto. The Board of Arbitration shall cause its written decision to be delivered to all parties involved in the dispute. Any decision made by the Board of Arbitration (either prior to or after the expiration of such thirty (30) calendar day period) shall be final, binding and conclusive on the parties to the dispute, and entitled to be enforced to the fullest extent permitted by law and entered in any court of competent jurisdiction. The Board of Arbitration shall be authorized and is hereby directed to enter a default judgment against any party failing to participate in any proceeding hereunder within the time periods set forth in the AAA rules. The non-prevailing party to any arbitration (as determined by the Board of Arbitration) shall pay the expenses of the prevailing party, including reasonable attorneys' fees, in connection with such arbitration. Any party shall be entitled to obtain injunctive relief from a court in any case where such relief is available. Section 16. SEVERABILITY. If any provision of this Agreement shall for any reason be held invalid or unenforceable, such invalidity or unenforceablity shall not affect any other provision hereof and this Agreement shall be construed as if such invalid or unenforceable provision had never been contained herein. Section 17. CAPITALIZED TERMS. All capitalized terms not otherwise defined herein shall have the meaning assigned to them in the Purchase Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, on the day and year first above written. AVTEL COMMUNICATIONS, INC. By: /S/ ANTHONY E. PAPA -------------------- Anthony E. Papa Chief Executive Officer INVESTOR AMRO INTERNATIONAL, S.A. By: /S/ H.U. BACHOFEN -------------------- H.U. Bachofen, Director INVESTOR AUSTINVEST ANSTALT BALZERS By: /S/ W. GRILL -------------------- W. Grill, Director INVESTOR ESQUIRE TRADE & FINANCE INC. By: /S/ R. WINIGER -------------------- R. Winiger, Director EX-10.15 10 EXHIBIT 10.15 EXHIBIT 10.15 NEITHER THIS WARRANT NOR THE SHARES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED WITH THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") OR THE SECURITIES COMMISSION OF ANY STATE PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER REGULATION D PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"). NEITHER THIS WARRANT NOR THE SHARES ISSUABLE UPON EXERCISE HEREOF MAY BE SOLD, PLEDGED, TRANSFERRED OR ASSIGNED EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND UNDER APPLICABLE STATE SECURITIES LAWS, OR IN A TRANSACTION WHICH IS EXEMPT FROM REGISTRATION UNDER THE PROVISIONS OF THE SECURITIES ACT AND UNDER PROVISIONS OF APPLICABLE STATE SECURITIES LAWS; AND IN THE CASE OF AN EXEMPTION, ONLY IF THE COMPANY HAS RECEIVED AN OPINION OF COUNSEL THAT SUCH TRANSACTION DOES NOT REQUIRE REGISTRATION OF THE WARRANT OR SUCH SHARES, WHICH OPINION AND WHICH COUNSEL SHALL BE SATISFACTORY TO THE COMPANY IN ITS SOLE DISCRETION. STOCK PURCHASE WARRANT To Purchase 10,000 Shares of Common Stock of AVTEL COMMUNICATIONS, INC. THIS CERTIFIES that, for value received, AMRO International, S.A. (the "Holder"), is entitled, upon the terms and subject to the conditions hereinafter set forth, at any time on or after September 30, 1999 (the "Initial Exercise Date") and on or prior to the close of business on March 31, 2002 (the "Termination Date") but not thereafter, to subscribe for and purchase from AVTEL COMMUNICATION, INC., a corporation incorporated in Delaware (the "Company"), up to Ten Thousand (10,000) shares (the "Warrant Shares") of Common Stock, $.01 par value, of the Company (the "Common Stock"). The purchase price of one share of Common Stock (the "Exercise Price") under this Warrant shall be 125% of the closing bid price of the Common Stock on the Nasdaq SmallCap Market on the Closing Date of the Convertible Preferred Stock and Warrants Purchase Agreement dated as of April 5, 1999 pursuant to which this Warrant has been issued (the "Purchase Agreement"). The Exercise Price and the number of shares for which the Warrant is exercisable shall be subject to adjustment as provided herein. In the event of any conflict between the terms of this Warrant and the Purchase Agreement, the Purchase Agreement shall control. Capitalized terms used and not otherwise defined herein shall have the meanings set forth for such terms in the Purchase Agreement. 1. Title of Warrant. Prior to the expiration hereof and subject to compliance with applicable laws, this Warrant and all rights hereunder are transferable, in whole or in part, at the office or agency of the Company by the holder hereof in person or by duly authorized attorney, upon surrender of this Warrant together with the Assignment Form annexed hereto properly endorsed. 2. Authorization of Shares. The Company covenants that all shares of Common Stock which may be issued upon the exercise of rights represented by this Warrant will, upon exercise of the rights represented by this Warrant, be duly authorized, validly issued, fully paid and nonassessable and free from all taxes, liens and charges in respect of the issue thereof (other than taxes in respect of any transfer occurring contemporaneously with such issue). 3. Exercise of Warrant. Except as provided in Section 4 herein, exercise of the purchase rights represented by this Warrant may be made at any time or times on or after the Initial Exercise Date, and before the close of business on the Termination Date, or such earlier date on which this Warrant may terminate as provided elsewhere in this Warrant, by the surrender of this Warrant and the Notice of Exercise Form annexed hereto duly executed, at the office of the Company (or such other office or agency of the Company as it may designate by notice in writing to the registered holder hereof at the address of such holder appearing on the books of the Company) and upon payment of the Exercise Price of the shares thereby purchased by wire transfer or cashier's check drawn on a United States bank, the holder of this Warrant shall be entitled to receive a certificate for the number of shares of Common Stock so purchased. Certificates for shares purchased hereunder shall be delivered to the holder hereof within three (3) business days after the date on which this Warrant shall have been exercised as aforesaid. This Warrant shall be deemed to have been exercised and such certificate or certificates shall be deemed to have been issued, and Holder or any other person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the Warrant has been exercised by payment to the Company of the Exercise Price and all taxes required to be paid by Holder, if any, pursuant to Section 5 prior to the issuance of such shares, have been paid. If this Warrant shall have been exercised in part, the Company shall, at the time of delivery of the certificate or certificates representing Warrant Shares, deliver to Holder a new Warrant evidencing the rights of Holder to purchase the unpurchased shares of Common Stock called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant. 4. No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which Holder would otherwise be entitled to purchase upon such exercise, the Company shall pay a cash adjustment in respect of such final fraction in an amount equal to the Exercise Price. 5. Charges, Taxes and Expenses. Issuance of certificates for shares of Common Stock upon the exercise of this Warrant shall be made without charge to the holder hereof for any issue or transfer tax or other incidental expense in respect of the issuance of such certificate, all of which taxes and expenses shall be paid by the Company, and such certificates shall be issued in the name of the holder of this Warrant or in such name or names as may be directed by the holder of this Warrant; provided, however, that in the event certificates for shares of Common Stock are to be issued in a name other than the name of the holder of this Warrant, this Warrant when surrendered for exercise shall be accompanied by the Assignment Form attached hereto duly executed by the holder hereof; and provided further, that upon any transfer involving in the issuance or delivery of any certificates for shares of Common Stock, the Company may require, as a condition thereto, the payment of a sum sufficient to reimburse it for any transfer tax incidental thereto. 6. Closing of Books. The Company will not close its shareholder books or records in any manner which prevents the timely exercise of this Warrant. 7. Transfer, Division and Combination. (a) Subject to compliance with any applicable securities laws, transfer of this Warrant and all rights hereunder, in whole or in part, shall be registered on the books of the Company to be maintained for such purpose, upon surrender of this Warrant at the principal office of the Company, together with a written assignment of this Warrant substantially in the form attached hereto duly executed by Holder or its agent or attorney and funds sufficient to pay any transfer taxes payable upon the making of such transfer. Upon such surrender and, if required, such payment, the Company shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees and in the denomination specified in such instrument of assignment, and shall issue to the assignor a new Warrant evidencing the portion of this Warrant not so assigned, and this Warrant shall promptly be cancelled. A Warrant, if properly assigned, may be exercised by a new Holder for the purchase of shares of Common Stock without having a new Warrant issued. (b) This Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by Holder or its agent or attorney. Subject to compliance with Section 7(a), as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. (c) The Company shall prepare, issue and deliver at its own expense (other than transfer taxes) the new Warrant or Warrants under this Section 7. (d) The Company agrees to maintain, at its aforesaid office, books for the registration and the registration of transfer of the Warrants. 8. No Rights as Shareholder until Exercise. This Warrant does not entitle the holder hereof to any voting rights or other rights as a shareholder of the Company prior to the exercise hereof. Upon the surrender of this Warrant and the payment of the aggregate Exercise Price, the Warrant Shares so purchased shall be and be deemed to be issued to such holder as the record owner of such shares as of the close of business on the later of the date of such surrender or payment. 9. Loss, Theft, Destruction or Mutilation of Warrant. The Company represents and warrants that upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Warrant certificate or any stock certificate relating to the Warrant Shares, and in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it, and upon surrender and cancellation of such Warrant or stock certificate, if mutilated, the Company will make and deliver a new Warrant or stock certificate of like tenor and dated as of such cancellation, in lieu of such Warrant or stock certificate. 10. Saturdays, Sundays, Holidays, etc. If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall be a Saturday, Sunday or a legal holiday, then such action may be taken or such right may be exercised on the next succeeding day not a Saturday, Sunday or legal holiday. 11. Adjustments of Exercise Price and Number of Warrant Shares. (a) Stock Splits, etc. The number and kind of securities purchasable upon the exercise of this Warrant and the Exercise Price shall be subject to adjustment from time to time upon the happening of any of the following. In case the Company shall (i) pay a dividend in shares of Common Stock or make a distribution in shares of Common Stock to holders of its outstanding Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of shares of Common Stock, (iii) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock or (iv) issue any shares of its capital stock in a reclassification of the Common Stock, then the number of Warrant Shares purchasable upon exercise of this Warrant immediately prior thereto shall be adjusted so that the holder of this Warrant shall be entitled to receive the kind and number of Warrant Shares or other securities of the Company which he would have owned or have been entitled to receive had such Warrant been exercised in advance thereof. Upon each such adjustment of the kind and number of Warrant Shares or other securities of the Company which are purchasable hereunder, the holder of this Warrant shall thereafter be entitled to purchase the number of Warrant Shares or other securities resulting from such adjustment at an Exercise Price per such Warrant Share or other security obtained by multiplying the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares purchasable pursuant hereto immediately prior to such adjustment and dividing by the number of Warrant Shares or other securities of the Company resulting from such adjustment. An adjustment made pursuant to this paragraph shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. (b) Reorganization, Reclassification, Merger, Consolidation or Disposition of Assets. In case the Company shall reorganize its capital, reclassify its capital stock, consolidate or merge with or into another corporation (where the Company is not the surviving corporation or where there is a change in or distribution with respect to the Common Stock of the Company), or sell, transfer or otherwise dispose of all or substantially all its property, assets or business to another corporation and, pursuant to the terms of such reorganization, reclassification, merger, consolidation or disposition of assets, shares of common stock of the successor or acquiring corporation, or any cash, shares of stock or other securities or property of any nature whatsoever (including warrants or other subscription or purchase rights) in addition to or in lieu of common stock of the successor or acquiring corporation ("Other Property"), are to be received by or distributed to the holders of Common Stock of the Company, then Holder shall have the right thereafter to receive, upon exercise of this Warrant, the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and Other Property receivable upon or as a result of such reorganization, reclassification, merger, consolidation or disposition of assets by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such event. In case of any such reorganization, reclassification, merger, consolidation or disposition of assets, the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all the obligations and liabilities hereunder, subject to such modifications as may be deemed appropriate (as determined by resolution of the Board of Directors of the Company) in order to provide for adjustments of shares of Common Stock for which this Warrant is exercisable which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 11. For purposes of this Section 11, "common stock of the successor or acquiring corporation" shall include stock of such corporation of any class which is not preferred as to dividends or assets over any other class of stock of such corporation and which is not subject to redemption and shall also include any evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for any such stock, either immediately or upon the arrival of a specified date or the happening of a specified event and any warrants or other rights to subscribe for or purchase any such stock. The foregoing provisions of this Section 11 shall similarly apply to successive reorganizations, reclassifications, mergers, consolidations or disposition of assets. 12. Voluntary Adjustment by the Company. The Company may at any time during the term of this Warrant, reduce the then current Exercise Price to any amount and for any period of time deemed appropriate by the Board of Directors of the Company. 13. Notice of Adjustment. Whenever the number of Warrant Shares or number or kind of securities or other property purchasable upon the exercise of this Warrant or the Exercise Price is adjusted, as herein provided, the Company shall promptly mail by registered or certified mail, return receipt requested, to the holder of this Warrant notice of such adjustment or adjustments setting forth the number of Warrant Shares (and other securities or property) purchasable upon the exercise of this Warrant and the Exercise Price of such Warrant Shares (and other securities or property) after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. Such notice, in absence of manifest error, shall be conclusive evidence of the correctness of such adjustment. 14. Notice of Corporate Action. If at any time (a) the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or other distribution, or any right to subscribe for or purchase any evidences of its indebtedness, any shares of stock of any class or any other securities or property, or to receive any other right, or (b) there shall be any capital reorganization of the Company, any reclassification or recapitalization of the capital stock of the Company or any consolidation or merger of the Company with, or any sale, transfer or other disposition of all or substantially all the property, assets or business of the Company to, another corporation or, (c) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; then, in any one or more of such cases, the Company shall give to Holder (i) at least 30 days' prior written notice of the date on which a record date shall be selected for such dividend, distribution or right or for determining rights to vote in respect of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, liquidation or winding up, and (ii) in the case of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up, at least 30 days' prior written notice of the date when the same shall take place. Such notice in accordance with the foregoing clause also shall specify (i) the date on which any such record is to be taken for the purpose of such dividend, distribution or right, the date on which the holders of Common Stock shall be entitled to any such dividend, distribution or right, and the amount and character thereof, and (ii) the date on which any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up is to take place and the time, if any such time is to be fixed, as of which the holders of Common Stock shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such disposition, dissolution, liquidation or winding up. Each such written notice shall be sufficiently given if addressed to Holder at the last address of Holder appearing on the books of the Company and delivered in accordance with Section 16(d). 15. Authorized Shares. The Company covenants that during the period the Warrant is outstanding, it will reserve from its authorized and unissued Common Stock a sufficient number of shares to provide for the issuance of the Warrant Shares upon the exercise of any purchase rights under this Warrant. The Company further covenants that its issuance of this Warrant shall constitute full authority to its officers who are charged with the duty of executing stock certificates to execute and issue the necessary certificates for the Warrant Shares upon the exercise of the purchase rights under this Warrant. The Company will take all such reasonable action as may be necessary to assure that such Warrant Shares may be issued as provided herein without violation of any applicable law or regulation, or of any requirements of NASDAQ or any domestic securities exchange upon which the Common Stock may be listed. The Company shall not by any action, including, without limitation, amending its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of Holder against impairment. Without limiting the generality of the foregoing, the Company will (a) not increase the par value of any shares of Common Stock receivable upon the exercise of this Warrant above the amount payable therefor upon such exercise immediately prior to such increase in par value, (b) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock upon the exercise of this Warrant, and (c) use its best efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. Upon the request of Holder, the Company will at any time during the period this Warrant is outstanding acknowledge in writing, in form reasonably satisfactory to Holder, the continuing validity of this Warrant and the obligations of the Company hereunder. Before taking any action which would cause an adjustment reducing the current Exercise Price below the then par value, if any, of the shares of Common Stock issuable upon exercise of the Warrants, the Company shall take any corporate action which may be necessary in order that the Company may validly and legally issue fully paid and non-assessable shares of such Common Stock at such adjusted Exercise Price. Before taking any action which would result in an adjustment in the number of shares of Common Stock for which this Warrant is exercisable or in the Exercise Price, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. 16. Miscellaneous. (a) Jurisdiction. This Warrant shall be binding upon any successors or assigns of the Company. This Warrant shall constitute a contract under the laws of New York without regard to its conflict of law, principles or rules, and be subject to arbitration pursuant to the terms set forth in the Purchase Agreement. (b) Restrictions. The holder hereof acknowledges that the Warrant Shares acquired upon the exercise of this Warrant, if not registered, will have restrictions upon resale imposed by state and federal securities laws and by the Purchase Agreement. (c) Nonwaiver and Expenses. No course of dealing or any delay or failure to exercise any right hereunder on the part of Holder shall operate as a waiver of such right or otherwise prejudice Holder's rights, powers or remedies, notwithstanding all rights hereunder terminate on the Termination Date. If the Company fails to comply with any provision of this Warrant, the Company shall pay to Holder such amounts as shall be sufficient to cover any costs and expenses including, but not limited to, reasonable attorneys' fees, including those of appellate proceedings, incurred by Holder in collecting any amounts due pursuant hereto or in otherwise enforcing any of its rights, powers or remedies hereunder. (d) Notices. Any notice, request or other document required or permitted to be given or delivered to the holder hereof by the Company shall be delivered in accordance with the notice provisions of the Purchase Agreement. (e) Limitation of Liability. No provision hereof, in the absence of affirmative action by Holder to purchase shares of Common Stock, and no enumeration herein of the rights or privileges of Holder hereof, shall give rise to any liability of Holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company. (f) Remedies. Holder, in addition to being entitled to exercise all rights granted by law, including recovery of damages, will be entitled to specific performance of its rights under this Warrant. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Warrant and hereby agrees to waive the defense in any action for specific performance that a remedy at law would be adequate. (g) Successors and Assigns. Subject to applicable securities laws, this Warrant and the rights and obligations evidenced hereby shall inure to the benefit of and be binding upon the successors of the Company and the successors and permitted assigns of Holder. The provisions of this Warrant are intended to be for the benefit of all Holders from time to time of this Warrant and shall be enforceable by any such Holder or holder of Warrant Stock. (h) Cooperation. The Company shall cooperate with Holder in supplying such information as may be reasonably necessary for Holder to complete and file any information reporting forms presently or hereafter required by the SEC as a condition to the availability of an exemption from the Securities Act for the sale of any Warrant or Restricted Common Stock. (i) Indemnification. The Company agrees to indemnify and hold harmless Holder from and against any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, attorneys' fees, expenses and disbursements of any kind which may be imposed upon, incurred by or asserted against Holder in any manner relating to or arising out of any failure by the Company to perform or observe in any material respect any of its covenants, agreements, undertakings or obligations set forth in this Warrant; provided, however, that the Company will not be liable hereunder to the extent that any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, attorneys' fees, expenses or disbursements are found in a final non-appealable judgment by a court to have resulted from Holder's negligence, bad faith or willful misconduct in its capacity as a stockholder or warrantholder of the Company. (j) Amendment. This Warrant may be modified or amended or the provisions hereof waived with the written consent of the Company and the Holder. (k) Severability. Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provisions or the remaining provisions of this Warrant. (l) Headings. The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant. IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its officer thereunto duly authorized. Dated: April 13, 1999 AVTEL COMMUNICATIONS, INC. By: /s/ ANTHONY E. PAPA --------------------- Anthony E. Papa, Chief Executive Officer The Registrant has issued Stock Purchase Warrants identical in form to the following additional holders: Austinvest Anstalt Balzers 2,333 shares Esquire Trade & Finance Inc. 2,667 shares
EX-21 11 EXHIBIT 21 EXHIBIT 21 LIST OF SUBSIDIARIES
NAME JURISDICTION OF INCORPORATION - ---- ----------------------------- AvTel Holdings, Inc. California Best Connections, Inc. Texas Digital Media International, Inc. Pennsylvania Hi, Tiger, Inc. Utah Matrix Telecom, Inc Texas Remote Lojix/PCSI, Inc. New York Remote Lojix of Connecticut, Inc. Connecticut Remote Lojix Technology Partners, Inc. New York Silicon Beach Communications, Inc. California Westnet Communications, Inc. California
EX-23 12 EXHIBIT 23 EXHIBIT 23 Independent Auditors' Consent The Board of Directors AvTel Communications, Inc. We consent to incorporation by reference in the Registration Statements (No. 333-30725), (No. 333-53435), and (No. 333-64769) on Form S-8 of AvTel Communications, Inc. of our report dated April 14, 1999, relating to the consolidated balance sheets of AvTel Communications, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows and related schedule, for each of the years in the three-year period ended December 31, 1998, which report appears in the December 31, 1998 annual report on Form 10-K of AvTel Communications, Inc. /s/ KPMG LLP ------------- KPMG LLP Dallas, Texas April 14, 1999 EX-27 13 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES F-3 AND F-4 OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 911 0 4,805 0 0 7,139 1,685 0 14,634 10,162 1,113 0 1 103 0 14,634 0 44,013 0 31,849 19,588 0 86 (7,329) (202) (7,127) 0 0 0 (7,127) (0.74) (0.74)
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