<PAGE>
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934
AMENDMENT NO. 1
Filed by the Registrant [X]
Filed by a party other than the Registrant [_]
Check the appropriate box:
[X] Preliminary Proxy Statement
[_] Confidential For Use of the Commission Only [as permitted by Rule
14a-6(e)(2)]
[_] Definitive Proxy Statement
[_] Definitive Additional Materials
[_] Soliciting Material Pursuant to (S)240.14a-11(c) or (S)240.14a-12
AVTEL COMMUNICATIONS, INC.
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Payment of filing fee (Check the appropriate box):
[_] No fee required.
[X] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies: Common
Stock
(2) Aggregate number of securities to which transaction applies: 38,330,056
(3) Per unit price or their underlying value of transaction computed pursuant
to Exchange Act
Rule 0-11: (*) $2.56
(4) Proposed maximum aggregate value of transaction: $98,124,943
(5) Total fee paid: $19,625
[X] Fee previously paid with preliminary materials.
[_] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the form or schedule and the date of its filing.
(1) Amount previously paid: _____________________
(2) Form, Schedule or Registration Statement no.: ________________
(3) Filing party: __________________________________________
(4) Date filed: _____________________________________________
(*) Based on the average of the bid and asked prices reported on the NASDAQ
Electronic Bulletin Board on August 22, 1997.
<PAGE>
REVISED PRELIMINARY COPY
AVTEL
COMMUNICATIONS, INC.
--------------------
October 31, 1997
To the Shareholders of AvTel Communications, Inc.:
You are cordially invited to attend a Special Meeting of Shareholders of
AvTel Communications, Inc. (the "Company" or "AvTel"), to be held at 10:00 a.m.,
local time, on November 20, 1997, at the Company's offices at 130 Cremona
Drive, Suite C, Santa Barbara, California (the "Special Meeting"). Copies of
the Notice of Special Meeting of Stockholders, Proxy Statement and Proxy are
enclosed.
At the Special Meeting you will be asked to approve two proposals that will
materially change the Company. As described in the enclosed Proxy Statement, you
will be asked to approve a Stock Exchange Agreement dated April 29, 1997, as
amended (the "Exchange Agreement"), between the Company and Matrix Telecom,
Inc., a Texas corporation ("Matrix"). The Exchange Agreement provides for
the acquisition by the Company, by way of a stock for stock exchange (the "Share
Exchange"), of all of the issued and outstanding capital stock of Matrix in
exchange for shares of the Company's Common Stock. After giving effect to the
Share Exchange, the former shareholders of Matrix will hold approximately 84% of
the issued and outstanding Common Stock of the Company which would allow such
shareholders, if acting in concert, to control the election of directors and
other matters which are subject to a vote of the Company's shareholders.
The consummation of the Share Exchange is subject to the satisfaction of
several conditions. These include the approval of the Company's common and
preferred shareholders of a change in the Company's state of incorporation from
Utah to Delaware. To effect this reincorporation in Delaware, the Company will
be merged (the "Reincorporation Merger") with and into AvTel Communications,
Inc., a Delaware corporation ("AvTel Delaware"). AvTel Delaware is a newly-
formed, wholly-owned subsidiary of the Company formed for the sole purpose of
the Reincorporation Merger. AvTel Delaware will be the surviving corporation in
the Reincorporation Merger. The Reincorporation Merger will occur immediately
before or concurrently with the Share Exchange.
The Agreement and Plan of Merger relating to the Reincorporation Merger
will provide that AvTel Delaware will issue to the Company's shareholders one
share of AvTel Delaware Common Stock for each four shares of the Company's
Common Stock outstanding immediately prior to the Reincorporation Merger. The
Company's Series A Convertible Preferred Stock and its outstanding options will
be similarly adjusted. Accordingly, by approving the Reincorporation Merger,
the shareholders of the Company will also be approving, in effect, a four to one
reverse stock split of their shares. Shareholders will receive cash in lieu of
any fractional shares that would otherwise be issued as part of the
Reincorporation Merger.
Approval of the Reincorporation Merger will also constitute approval of the
Certificate of Incorporation and Bylaws of AvTel Delaware as the surviving
entity in the Reincorporation Merger. In addition, two of the Company's four
current directors, Frank Dziuba and Barry A. Peters, have indicated to the
Company that, concurrently with the Share Exchange, they will resign. In
accordance with the Exchange Agreement, they will be replaced by three nominees
of Matrix. These proposals and related matters are described in greater detail
in the enclosed Notice of Special Meeting of Shareholders and Proxy Statement.
130 CREMONA DRIVE, SUITE C, SANTA BARBARA, CALIFORNIA 93117
TELEPHONE: (805) 685-0355 FAX: (805) 685-9685
<PAGE>
The Company's management believes that the combination of AvTel and Matrix
will benefit AvTel by, among other things, expanding AvTel's product offerings
and customer base, improving AvTel's access to capital sources, thus reducing
the cost of capital to the Company, and allowing AvTel to benefit from Matrix's
established corporate infrastructure. Matrix has a much more developed
administrative and billing infrastructure, and has regulatory authorizations as
a long-distance provider in place in 49 states. Other reasons for the Share
Exchange are set forth in the Proxy Statement in greater detail. Although the
Board of Directors believes that the Share Exchange is in the best interests of
the shareholders of AvTel, no fairness opinion has been sought from an
investment bank that the transaction is fair from a financial point of view to
AvTel's shareholders. Nor has an opinion or private letter ruling been obtained
with respect to the tax treatment of the Share Exchange or the Reincorporation
Merger.
The Board of Directors of the Company has unanimously approved the Share
Exchange, the Reincorporation Merger and all related transactions. The
affirmative vote of the holders of a majority of the outstanding shares of each
of the Company's Common Stock and the Company's Preferred Stock is needed to
approve and adopt the proposals outlined above.
Certain shareholders, including the Company's current Directors, who own
shares representing approximately 61% of the issued and outstanding shares of
the Company's Common Stock have indicated that they will vote their shares in
favor of the proposals contemplated by the attached Proxy Statement. In
addition, the holders of all shares of the Company's Preferred Stock have
indicated that they will vote their shares in favor of the proposals.
Accordingly, without the affirmative vote of any other shareholder, there will
be sufficient votes for approval and adoption of the proposals submitted in the
Proxy Statement.
THE BOARD OF DIRECTORS BELIEVES THAT THE SHARE EXCHANGE AND REINCORPORATION
MERGER ARE ADVANTAGEOUS TO AND IN THE BEST INTERESTS OF THE COMPANY AND ITS
SHAREHOLDERS AND HAS UNANIMOUSLY RECOMMENDED APPROVAL THEREOF BY THE
SHAREHOLDERS.
APPROVAL OF THE PROPOSED SHARE EXCHANGE WITH MATRIX IS CONDITIONED UPON
APPROVAL OF THE PROPOSAL TO REINCORPORATE IN DELAWARE. AS A CONSEQUENCE, A VOTE
AGAINST THE PROPOSAL TO APPROVE THE REINCORPORATION MERGER, WILL CONSTITUTE A
VOTE AGAINST THE SHARE EXCHANGE. WHETHER YOU PLAN TO ATTEND THE SPECIAL MEETING
OR NOT, YOU ARE REQUESTED TO SIGN, DATE AND RETURN THE ENCLOSED PROXY IN THE
ENCLOSED ENVELOPE IN ORDER THAT AS MANY SHARES AS POSSIBLE MAY BE REPRESENTED AT
THE SPECIAL MEETING.
Sincerely,
AVTEL COMMUNICATIONS, INC.
/s/ ANTHONY E. PAPA
Anthony E. Papa
President & Chief Executive Officer
<PAGE>
REVISED PRELIMINARY COPY
AVTEL
COMMUNICATIONS, INC.
--------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD NOVEMBER 20, 1997
Notice is hereby given that a Special Meeting of Shareholders of AvTel
Communications, Inc. (the "Company" or "AvTel") will be held at 130 Cremona
Drive, Suite C, Santa Barbara, California, on November 20, 1997, at 10:00 a.m.,
local time (the "Special Meeting").
The items of business to be conducted at the Special Meeting are:
1. The ratification and approval of a Stock Exchange Agreement dated
April 29, 1997, as amended, in the form attached to the Proxy Statement as
Exhibit A (the "Exchange Agreement") between the Company and Matrix Telecom,
Inc., a Texas corporation ("Matrix"), pursuant to which:
A. The Company will acquire Matrix by way of a stock for stock
exchange (the "Share Exchange") with the shareholders of Matrix (the
"Matrix Shareholders");
B. The Matrix Shareholders, after giving effect to the Share
Exchange, will own approximately 84% of the issued and outstanding Common
Stock of the Company;
C. Holders of outstanding Matrix stock options would receive non-
qualified stock options of the Company; and
D. The Company will enter into a Registration Rights and Lockup
Agreement in the form attached as Exhibit B to the Exchange Agreement which
will provide certain registration rights for, and restrictions on, the
Matrix Shareholders.
2. The ratification and approval of an Agreement and Plan of Merger
between the Company and AvTel Communications, Inc., a Delaware corporation
("AvTel Delaware") substantially in the form attached to the Proxy Statement as
Exhibit B, pursuant to which:
A. Concurrently with, or immediately prior to, the Share Exchange,
the Company will change its state of incorporation from Utah to Delaware by
merging with and into AvTel Delaware, a newly-formed, wholly-owned
subsidiary of the Company (the "Reincorporation Merger");
B. AvTel Delaware shall succeed to all the rights, benefits, duties
and obligations of the Company (including its rights, benefits, duties and
obligations under the Exchange Agreement described in the proposal above);
C. Outstanding shares of the Company's Common Stock and Preferred
Stock (and outstanding options to purchase Common Stock) will be converted
into shares of AvTel Delaware (or options, as the case may be) on a four to
one basis, with cash to be paid in lieu of any fractional shares;
<PAGE>
D. The Certificate of Incorporation of AvTel Delaware, as the
surviving corporation, will be in substantially the form attached to the
Proxy Statement as Exhibit C; and
E. The Bylaws of AvTel Delaware, as the surviving corporation, will
be in substantially the form attached to the Proxy Statement as Exhibit D.
All as described more fully in the accompanying Proxy Statement.
3. Such other matters as may properly come before the Special Meeting or
any adjournment or postponement thereof.
The approval of the Reincorporation Merger by the Company's shareholders is
a condition precedent to the consummation of the transactions contemplated by
the Share Exchange. Therefore, a vote against the Reincorporation Merger
proposal is a vote against both the Share Exchange and the Reincorporation
Merger.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE "FOR" THE PROPOSALS TO
CONSUMMATE THE SHARE EXCHANGE, AND TO REINCORPORATE IN DELAWARE, WHICH PROPOSALS
ARE DESCRIBED IN MORE DETAIL IN THE ACCOMPANYING PROXY STATEMENT
Any action may be taken on the foregoing proposals at the Special Meeting
on the date specified above, or on any date or dates to which the Special
Meeting may be adjourned. Common and preferred shareholders of record at the
close of business on October 3, 1997, are entitled to vote at the Special
Meeting and at any adjournments thereof.
It is not anticipated that any other business will come before the Special
Meeting. If, however, such matters are presented, proxies will be voted thereon
as determined by a majority of the Board of Directors.
AVTEL COMMUNICATIONS, INC.
/s/ JAMES P. PISANI
James P. Pisani
Executive Vice President.
Chief Operating Officer & Secretary
Santa Barbara, California
October 31, 1997
YOUR VOTE IS IMPORTANT
Please immediately date, sign and return your proxy in the enclosed
envelope. If you attend the meeting, you may withdraw your proxy and vote in
person.
THANK YOU FOR ACTING PROMPTLY
<PAGE>
REVISED PRELIMINARY COPY
AVTEL
COMMUNICATIONS, INC.
-------------------
PROXY STATEMENT
This Proxy Statement and the attached Form of Proxy are being furnished to the
common shareholders and preferred shareholders of AvTel Communications, Inc., a
Utah corporation (the "Company" or "AvTel") on behalf of the Board of Directors
of the Company in connection with a special meeting (the "Special Meeting") of
Shareholders to be held November 20, 1997, at the Company's principal offices,
at 10:00 a.m., local time, and at any adjournments thereof. The Company's
principal offices are located at 130 Cremona Drive, Suite C, Santa Barbara,
California 93117 and its telephone number is (805) 685-0355.
These proxy solicitation materials are first being mailed to shareholders on
or about October 31, 1997. The specific proposals to be considered and acted
upon at the Special Meeting include (i) the approval of the Stock Exchange
Agreement dated April 29, 1997, as amended (the "Exchange Agreement"), between
the Company and Matrix Telecom, Inc., a Texas corporation ("Matrix"), pursuant
to which the Company will acquire, by way of a stock for stock exchange (the
"Share Exchange"), all of the issued and outstanding capital stock of Matrix
(and options to acquire Common Stock of Matrix) in exchange for shares of the
Company's Common Stock (and options to acquire the Company's Common Stock) to be
issued to the shareholders of Matrix (the "Matrix Shareholders"); and (ii) a
proposal to change the Company's state of incorporation from Utah to Delaware by
way of merger by the Company with and into AvTel Communications, Inc., a
Delaware corporation ("AvTel Delaware"), a wholly-owned subsidiary of the
Company (hereinafter referred to as the "Reincorporation Merger"), and, as part
of the conversion of shares in the Reincorporation Merger, to effect a four for
one reverse stock split of the Company's shares of Common Stock (the "Reverse
Stock Split"). The Reincorporation Merger and the Reverse Stock Split are
conditions to the completion of the Share Exchange. These proposals are
described in greater detail in this Proxy Statement.
Approval of these proposals will also constitute shareholder approval of
certain other matters, including (i) approval of a Registration Rights and
Lockup Agreement with the Matrix Shareholders in substantially the form of
Exhibit B to the Exchange Agreement attached as Exhibit A hereto (the
"Registration Rights and Lockup Agreement"), (ii) approval of the Merger
Agreement between the Company and AvTel Delaware in substantially the form of
Exhibit B hereto, (iii) approval of the Certificate of Incorporation of AvTel
Delaware in substantially the form of Exhibit C hereto, and (iv) approval of the
Bylaws of AvTel Delaware in substantially the form of Exhibit D hereto.
-1-
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
THE SPECIAL MEETING; INFORMATION CONCERNING
VOTING AND PROXY SOLICITATION............................................. 4
Record Date and Outstanding Shares...................................... 4
Voting and Solicitation................................................. 4
Revocability............................................................ 4
Dissenters' Rights...................................................... 4
THE SHARE EXCHANGE........................................................ 5
Background and Reasons for Transaction.................................. 5
Terms of the Share Exchange............................................. 7
Comparative Per Share Data.............................................. 9
Management of AvTel Delaware After the Share Exchange................... 10
Relationship with Matrix................................................ 12
Dissenters' Rights...................................................... 13
Accounting Treatment.................................................... 13
Federal Income Tax Consequences; No Legal Opinions or Tax Rulings....... 13
Regulatory Approval..................................................... 14
Impact on Holders of Company Preferred Stock............................ 14
Vote Required........................................................... 15
Recommendation of Management............................................ 15
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS......................... 16
Balance Sheets, June 30, 1997........................................... 17
Statement of Operations For the Six Month Period Ended June 30, 1997.... 20
Statement of Operations For the Year Ended December 31, 1996............ 21
Notes to Unaudited Pro Forma Condensed Financial Information............ 22
THE REINCORPORATION MERGER................................................ 24
General................................................................. 24
Principal Reasons for the Reincorporation Merger........................ 25
Regulatory Approval..................................................... 27
Comparison of Shareholder Rights under Utah and Delaware
Corporate Law and Charter Documents................................ 27
Dissenters' Rights as a Result of the Reincorporation Merger............ 34
Federal Income Tax Consequences......................................... 35
Impact on Holders of Company Preferred Stock............................ 36
Vote Required........................................................... 36
Recommendation of Management............................................ 36
DESCRIPTION OF THE COMPANY................................................ 37
Background.............................................................. 37
Business of the Company................................................. 37
Management's Discussion and Analysis of Financial
Condition and Results of Operation................................. 39
Properties.............................................................. 41
Litigation.............................................................. 41
Market for Common Equity and Related Stockholder Matters................ 41
Security Ownership of Certain Beneficial Owners in Management........... 42
DESCRIPTION OF MATRIX..................................................... 46
Background.............................................................. 46
Business of Matrix...................................................... 46
Selected Financial Data................................................. 48
Statement of Operations Data............................................ 49
</TABLE>
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<PAGE>
<TABLE>
<S> <C>
Management's Discussion and Analysis of Financial
Condition and Results of Operation............................... 51
Transactions with Affiliates.......................................... 55
Regulation............................................................ 56
Intellectual Property................................................. 56
Employees............................................................. 56
Properties............................................................ 57
Litigation............................................................ 57
Capitalization and Related Matters.................................... 57
SHAREHOLDER PROPOSALS................................................... 57
OTHER MATTERS........................................................... 57
INDEX TO FINANCIAL STATEMENT OF THE COMPANY AND MATRIX.................. 58
</TABLE>
EXHIBITS
Exhibit A - Stock Exchange Agreement
Exhibit B - Agreement and Plan of Merger
Exhibit C - Certificate of Incorporation of AvTel Delaware
Exhibit D - Bylaws of AvTel Delaware
Exhibit E - Utah Revised Business Corporations Act
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<PAGE>
THE SPECIAL MEETING
INFORMATION CONCERNING VOTING AND PROXY SOLICITATION
RECORD DATE AND OUTSTANDING SHARES
As of October 3, 1997 (the "Record Date"'), the outstanding securities of the
Company consisted of 7,144,327 shares of voting common stock ("Company Common
Stock"), and 1,000,000 shares of Series A Convertible Preferred Stock ("Company
Preferred Stock"). The presence in person or by proxy of holders of a majority
of the issued and outstanding shares of Company Common Stock and a majority of
the issued and outstanding shares of Company Preferred Stock will constitute a
quorum for the transaction of such business as shall properly come before the
meeting.
VOTING AND SOLICITATION
Each share of Company Common Stock has one vote on all matters. Even though
the shares of the Company Preferred Stock have no voting rights on most matters,
the Utah Revised Business Corporations Act ("URBCA") provides that the Share
Exchange and the Reincorporation Merger must be approved by a majority of the
shares of the Company Preferred Stock, voting separately as a class.
Accordingly, the affirmative vote of a majority of the outstanding shares of
Company Common Stock and a majority of the outstanding shares of Company
Preferred Stock is needed to approve the matters submitted for approval pursuant
to this Proxy Statement.
The cost of soliciting proxies will be borne by the Company. The Company
expects to reimburse brokerage firms and other persons representing beneficial
owners of shares for their expenses in forwarding solicitation material to such
beneficial owners. Proxies may be solicited by certain of the Company's
directors, officers and regular employees, without additional compensation, in
person or by telephone or telegram. Anthony E. Papa, James P. Pisani and Frank
Dziuba, directors and executive officers of the Company, and Barry A. Peters, a
director, own, collectively, an aggregate of 4,383,108 shares, representing 61%
of the issued and outstanding Common Stock of the Company as of the Record Date.
As directors, Messrs. Papa, Pisani, Dziuba and Peters have unanimously
recommended approval by the shareholders of the proposals set forth in this
Proxy Statement and have indicated their intentions to vote in favor of the
adoption and approval of such proposals. All of the holders of the Company
Preferred Stock have indicated their intentions to vote in favor of the adoption
and approval of the proposals. Accordingly, there will be sufficient votes for
approval and adoption of the proposals submitted for approval pursuant to this
Proxy Statement without the affirmative vote of any other shareholders besides
Messrs. Papa, Pisani, Dziuba, Peters and the holders of the Company Preferred
Stock. To the knowledge of the Company's Board of Directors, as of the Record
Date, none of AvTel's directors or executive officers held any shares of the
capital stock of Matrix.
The Board of Directors is not aware of any business to be acted upon at the
Special Meeting other than as described herein. If, however, other matters are
properly brought before the Special Meeting, including any adjournment or
postponement thereof, the persons appointed as proxies will have discretion to
vote or act thereon according to their best judgment.
REVOCABILITY
A shareholder giving a proxy has the power to revoke it at any time before it
is exercised by filing with the Secretary of the Company an instrument revoking
it or a duly executed proxy bearing a later date or by personal attendance and
voting at the Special Meeting. Subject to such revocation, all shares
represented by each properly executed proxy received by the Company will be
voted in accordance with the instructions indicated thereon, and if instructions
are not indicated, will be voted in favor of all proposals.
-4-
<PAGE>
DISSENTERS' RIGHTS
Shareholders will not have dissenters' rights as a result of the Share
Exchange. However, shareholders will have dissenters' rights under the URBCA in
connection with the Reincorporation Merger. Such dissenters' rights will be
available only to those shareholders of the Company who (i) object to the
proposed Reincorporation Merger in writing prior to or at the Special Meeting (a
negative vote will not itself constitute such a written objection); (ii) do not
vote any of their shares in favor of the proposed Reincorporation Merger at the
Special Meeting; (iii) file a written demand with the Company within a specified
time after the completion of the Reincorporation Merger requesting payment of
the fair value of their shares; and (iv) meet the other requirements of the
governing Utah statutes. For a summary of the procedures governing the exercise
of dissenters' rights, please see "The Reincorporation Merger -Dissenters'
Rights as a Result of the Reincorporation Merger," below.
THE SHARE EXCHANGE
BACKGROUND AND REASONS FOR TRANSACTION
In October 1996, the Company, which was then known as Hi, Tiger
International, Inc. ("HTI"), completed a transaction in which it acquired all of
the issued and outstanding capital stock of AvTel Holdings, Inc., a California
corporation ("A.I."), in exchange for 4,252,508 shares of Company Common Stock.
Upon consummation of this acquisition, the Company adopted its current name.
After giving effect to this transaction, among other things, (i) the
shareholders of A.I. acquired approximately 61% of the issued and outstanding
Company Common Stock, (ii) the Company's Board of Directors and executive
management was replaced by that of A.I., (iii) the Company had access, directly
or indirectly, to the increased capital resources available to A.I., and (iv)
the Company began to implement a strategy to expand and grow its business as a
non-facilities based telecommunications carrier providing a comprehensive array
of broadband voice and data network services. This business development
strategy involved, among other things, selected acquisitions and strategic
alliances and pursuit of capital resources necessary for the Company to
implement this strategy and to finance the anticipated expansion and growth.
In November 1996 and February 1997, respectively, the Company acquired all
the issued and outstanding capital stock of Silicon Beach Communications, Inc.,
an Internet Service Provider ("ISP") and software development firm based in
Santa Barbara, California and of WestNet Communications, Inc., an ISP based in
Ventura, California.
In early March, 1997, Anthony E. Papa, and James P. Pisani, President and
Chief Executive Officer and Executive Vice President, Chief Operating Officer,
respectively, of the Company began preliminary discussions with several
representatives of Matrix concerning a possible transaction in which the
businesses of AvTel and Matrix would be combined. These discussions resulted,
primarily, from the Company's perception of Matrix's attractiveness as an
acquisition candidate based on product and marketing synergies, the availability
of capital resources and the existence of a management and administrative
infrastructure. (See "Description of Matrix")
At its April 3, 1997 meeting, the Board of Directors reviewed the potential
Matrix transaction and authorized Mr. Papa and Mr. Pisani to enter into
negotiations with Matrix in an effort to determine whether the terms of a
proposed transaction could be agreed upon. At that meeting, the Board of
Directors also authorized management to retain legal counsel in connection with
the transaction. The Board discussed the possibility of retaining an outside
financial advisor to render a fairness opinion in connection with the
transaction. After reviewing the extensive financial analysis prepared by the
Company's management and accountants, and the estimated costs of retaining an
outside financial advisor, the Board determined that any value that might be
provided by such a financial advisor would not be worth the cost to the Company.
The Company's management, assisted by legal counsel, entered into negotiations
with Matrix and its counsel with respect to the provisions of the proposed
agreement and related documents. On April 14, 1997, the Company announced
publicly its intention to enter into a business combination with Matrix.
During this period, management circulated to the members of the Board
copies of preliminary drafts of the Exchange Agreement and related documents
reflecting negotiations with Matrix to date, together with materials describing
the remaining unresolved issues. Thereafter, extensive review and negotiation
of the provisions of the draft Exchange Agreement and related documents by
representatives of both sides ensued. During this process, the Board of
Directors continued to evaluate and consider other near- and short-term
alternative strategies to implement its growth and expansion plans and related
corporate financing objectives, including the private placement of its debt and
equity securities and obtaining credit facilities from private and institutional
sources.
The Board met again on April 25, 1997, at which time the Exchange Agreement
and the fairness of the Matrix offer were again analyzed and considered by the
Board in detail. The Board reviewed with legal counsel and management the
points negotiated with Matrix and the resulting changes to the Exchange
Agreement and related documents. After a full discussion of the proposed
transaction structure, the draft documentation, related financial and legal
issues, the Company's other prospects for acquisition partners, and the
Company's financial condition and operations, the Board of Directors unanimously
voted to approve the execution and delivery of the Exchange Agreement on behalf
of the Company, subject to the receipt of required shareholder and regulatory
approvals. The Exchange Agreement was executed by the parties on April 29,
1997, at which time they issued a joint press release announcing such execution
to the public. The Company and Matrix amended the Exchange Agreement as of
August
-5-
<PAGE>
25, 1997, to extend the time for closing, to adjust the number of shares
of Matrix Common Stock and the number of options to be converted in the Share
Exchange, to finalize the terms of the Reverse Stock Split, to update the
related disclosure schedules and to make other modifications to the transaction.
The Board of Directors concluded that the terms of the Exchange Agreement
would provide greater advantages for the Company in accomplishing these
strategies than other alternatives then being considered for a number of
reasons. Matrix's business focus is primarily that of a long distance telephone
provider, a business in which the Company is not presently engaged but one which
the Company had planned to develop or acquire because of the opportunities for
revenue growth and market expansion and because of the cross marketing
opportunities for the Company's ISP and other operations. (See "Description of
Matrix"). Matrix also has an established and larger corporate infrastructure
than that of the Company, including sales, billing, accounting and
administrative functions. In addition, Matrix has access to over 6,000
independent sales agents pursuant to long-term distribution agreements.
These existing resources will provide opportunities for the Company to improve
efficiencies and consolidate various similar functions that are either in an
incubation stage or are being performed using specialized resources (e.g.,
executive management, sales, etc.) that could more effectively be used
elsewhere.
Matrix also has available to it significantly greater capital resources,
including working capital, than those presently available to the Company. The
Company has pursued various financing opportunities and has received expressions
of interest from several sources of capital including venture capital firms,
institutional lenders and other private sources. However, by virtue of the
Exchange Agreement, the Company will have the opportunity to avail itself of
capital resources on an intercompany basis and without the distraction, delay
and expense of other capital funding alternatives. Moreover, the availability
of this capital in this manner will likely be on terms, including interest
rates, maturity, debt covenants and the like, that are more favorable to the
Company than those which would generally be available from outside sources.
Also, the combination of the Company's and Matrix's operations, asset and
business base and financial condition are likely to provide greater
opportunities for outside financing for the Company in the future.
The Share Exchange was also perceived by the Board of Directors to be in
the best interest of the Company and its shareholders because it should allow
AvTel to meet the applicable listing criteria of the National Market System of
NASDAQ. Promptly following the completion of the Share Exchange, the Company
intends to seek a listing on the National Market System. Because certain
investors will not trade in stocks unless they are listed on an exchange or the
NASDAQ National Market System, the Company believes that such qualification will
improve the liquidity of the Company Common Stock and as a result will be
beneficial to shareholder value.
The Company did not engage an investment banking firm or financial advisor
to assist it in the negotiations with or for the valuation of the Share Exchange
nor has it obtained a fairness or similar valuation opinion with respect to the
Share Exchange. The negotiations were conducted at arms-length and, in arriving
at the exchange ratio for the shares of the Company Common Stock that will,
subject to shareholder approval, be exchanged for common stock of Matrix, the
Company's management considered, among other things, (a) Matrix's current and
prospective business operations, revenues, profitability, existing
infrastructure (including established sales, billing, accounting and other
functions); (b) comparable values ascribed to other similar enterprises in the
same business as that in which Matrix is engaged (including other enterprises
whose financial statements and results of operation are publicly available); and
(c) customary financial valuation and analysis methods including net book
values, multiples of earnings and revenues and similar valuation techniques.
The Company utilized a discounted cash flow analysis using management's internal
financial projections for the next five years to determine its likely value.
Management believes this method of valuation to be fair since the majority of
the Company's value was in the future, as a result of management's expected
contribution to the business. Management then valued Matrix based on a multiple
of its net monthly revenue, using a multiple in the range applied in other
recent sales of switchless resellers. Management believed that this valuation
methodology for Matrix was appropriate given that Matrix is a very capable
reseller with a strong back office, but declining revenues and no specific plans
nor projections for the future.
When Matrix acquired Best Connections, Inc. in July 1997, management
revalued Matrix using the same methodology, but a higher multiple, applied to
the pro forma combined average monthly revenue for Matrix and Best for the six
month period ending June 30, 1997. As a result, the Company adjusted the
exchange ratio accordingly when the Exchange Agreement was amended in August
1997.
Accordingly, on the basis of these considerations, the Board unanimously
approved the execution of the Exchange Agreement and, subject to shareholder
approval, the consummation of the transactions contemplated therein.
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TERMS OF THE SHARE EXCHANGE.
Set forth below is a summary of the material features of the Share
Exchange. A copy of the Exchange Agreement, as amended, is attached as Exhibit
A to this Proxy Statement. To the extent that the following discussion relates
to the terms of the Exchange Agreement, it is qualified by reference to the full
text of the Exchange Agreement and the exhibits thereto.
CONVERSION OF SHARES. Pursuant to the terms of the Exchange Agreement, at
the Closing, as defined therein, all of the issued and outstanding shares of
Matrix Common Stock will be exchanged for 9,681,775 shares of AvTel Delaware
Common Stock (after adjustment for the Reverse Stock Split discussed below),
representing an exchange ratio of 2.482 shares of AvTel Delaware Common Stock to
one share of Matrix Common Stock (the "Exchange Ratio"). The Exchange Ratio was
negotiated at arms-length by the parties and was based on a number of factors.
(See "Background and Reasons for Transaction", above.) AvTel Delaware will not
issue any fractional shares or interests in the AvTel Delaware Common Stock in
the Share Exchange. If any holder of Matrix Common Stock would otherwise be
entitled to a fractional share upon exchange thereof, AvTel Delaware will round
the number of shares of AvTel Delaware Common Stock to be issued to such
shareholder to the nearest whole share. Matrix will become a wholly-owned
subsidiary of AvTel Delaware as a result of the Share Exchange.
The 9,681,775 shares to be issued by AvTel Delaware will represent
approximately 84% of the issued and outstanding AvTel Delaware Common Stock.
Of the 9,681,775 shares to be issued by AvTel Delaware, 1,999,997 will be issued
to Best Connections, Inc. ("Best"), a wholly-owned subsidiary of Matrix. These
shares are held by Best subject to options to purchase such shares awarded
pursuant to an option plan for Matrix's outside sales agents. Under Delaware
law, these shares may not be voted or counted in determining a quorum for the
purpose of taking any corporate action so long as they are held by Best. (See
"Best Option Plan", below). The remaining 7,681,778 shares to be held by Matrix
Shareholders after the Share Exchange will represent approximately 81% of the
outstanding AvTel Delaware Common Stock (excluding the shares held by Best). As
a result, the Matrix Shareholders, if acting in concert, will be able to control
the election of Directors of AvTel Delaware and other matters which are subject
to a vote of the shareholders of AvTel Delaware. (See "Description of Matrix -
Capitalization and Related Matters").
CONVERSION OF STOCK OPTIONS. Matrix currently has outstanding non-
qualified stock options to purchase 9,000 shares of Matrix Common Stock, all of
which are held by three former employees of Matrix. The current exercise price
of each of these options is $5.56 per share. Pursuant to the Exchange
Agreement, these options will be converted into options to purchase 22,338
shares of AvTel Delaware Common Stock, at an exercise price of $2.24 per share.
These options will be fully vested and exercisable in full by their holders as a
result of the Share Exchange. These options will be in addition to the options
to purchase 276,787 shares of the Company Common Stock currently outstanding
(after adjustment for the Reverse Stock Split).
BEST OPTION PLAN. Best markets Matrix's telephone services through
approximately 6,000 outside sales agents pursuant to distribution agreements.
In February 1997, Best, in cooperation with Matrix, established its 1997 Stock
Option Plan (the "Best Option Plan") in order to benefit and provide increased
incentives to this outside sales force. In connection with the establishment of
the Best Option Plan, shareholders of Matrix transferred 805,840 shares of
Matrix Common Stock to Best. Best has awarded (or committed to award) options to
purchase these shares to members of the outside sales force pursuant to the
terms of the Best Option Plan. In connection with the Share Exchange, these
Matrix shares will be converted into 1,999,997 shares of AvTel Delaware Common
Stock. Options to purchase AvTel Delaware Common Stock under the Best Option
Plan (to the extent they become exercisable) will have an exercise price of
$1.50 per share (after adjustment for the transactions contemplated hereby).
REPRESENTATIONS AND WARRANTIES. Pursuant to the Exchange Agreement each
of AvTel and Matrix have made certain representations and warranties to the
other concerning, among other things, (i) their respective capitalization and
capital structure, (ii) their respective corporate organization and status,
(iii) their authority to execute the Exchange Agreement and to perform their
respective obligations thereunder, (iv) the accuracy of their respective
financial statements and the lack of any material adverse events since the date
of the last of such financial statements, (v) the existence of contracts with
their respective affiliates, (vi) the existence of employee benefit plans,
(vii) the existence of litigation, actual or threatened, (viii) the accuracy of
tax returns previously filed by each party and (ix) the need for third party
consents in connection with the transactions contemplated by the Exchange
Agreement. Pursuant to the Exchange Agreement, the accuracy of the
representations and warranties of each of AvTel and Matrix is a condition
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to the other party's obligation to complete the transactions contemplated
thereby. Further, the representations and warranties of the parties will survive
the closing of the Exchange Agreement for a period of one year. The Matrix
Shareholders are third party beneficiaries of the representations and warranties
made by AvTel.
CONDITIONS TO CLOSING. The obligation of Matrix to complete the Exchange
Agreement is subject to and conditional upon, among other things, (i) approval
by the shareholders of the Company of the Exchange Agreement and the
transactions contemplated thereby, including the Reincorporation Merger and the
Reverse Stock Split, (ii) the receipt of any and all governmental or other third
party consents required to effect the transactions contemplated by the Exchange
Agreement, (iii) the execution by Matrix Shareholders holding at least 90% of
the Matrix Common Stock of an Exchange Statement in the form attached as Exhibit
A to the Exchange Agreement, (iv) the execution by AvTel of the Registration
Rights and Lockup Agreement, and (v) the accuracy of the representations and
warranties of AvTel in the Exchange Agreement as of the date thereof and as of
the closing date of the Exchange Agreement and the performance by AvTel of its
obligations under the Exchange Agreement as of the closing date of the Exchange
Agreement.
The obligation of AvTel to complete the Exchange Agreement is subject to
and conditional upon, among other things, (i) the approval by the shareholders
of the Company of the Exchange Agreement and the transactions contemplated
thereby, including the Reincorporation Merger, (ii) the receipt of any and all
governmental or other third party consents required to effect the transactions
contemplated by the Exchange Agreement, (iii) the execution by Matrix
Shareholders holding at least 90% of the Matrix Common Stock of an Exchange
Statement, (iv) the execution by Matrix and Matrix Shareholders holding at least
90% of the Matrix Common Stock of the Registration Rights and Lockup Agreement,
and (v) the accuracy of the representations and warranties of Matrix in the
Exchange Agreement as of the date thereof and as to the closing date of the
Exchange Agreement and the performance by Matrix of its obligations under the
Exchange Agreement as of the closing date of the Exchange Agreement.
After the Closing, each holder of shares of Matrix Common Stock shall, upon
the surrender of the certificate or certificates representing such shares to
AvTel Delaware's registrar and transfer agent, be entitled to receive a
certificate or certificates evidencing shares of the AvTel Delaware Common
Stock. On the effective date of the Share Exchange (the "Effective Date"), (i)
each share of Matrix Common Stock so surrendered prior to the Effective Date
will be canceled and extinguished and automatically converted into the right to
receive that number of shares of AvTel Delaware Common Stock required by the
Exchange Ratio; and (ii) all outstanding stock options of Matrix immediately
prior to the Closing will be canceled and extinguished and automatically
converted into options to purchase that number of shares of AvTel Delaware Stock
required by the Exchange Ratio.
As a condition precedent to the consummation of the transactions
contemplated by the Exchange Agreement, the Company's shareholders are to adopt
and approve all required or necessary resolutions providing for the
reincorporation of the Company in Delaware and the Reverse Stock Split. (See
"The Reincorporation Merger").
REGISTRATION RIGHTS AND LOCKUP AGREEMENT . Pursuant to the terms of the
Exchange Agreement, the Company, Matrix and the Matrix Shareholders will enter
into the Registration Rights and Lockup Agreement effective as of the Closing of
the Share Exchange. Set forth below is a summary of the material features of
the Registration Rights and Lockup Agreement. A copy of the Registration Rights
and Lockup Agreement is included in the Exchange Agreement, which is attached as
Exhibit A to this Proxy Statement. The following discussions of the terms of
the Registration Rights and Lockup Agreement is qualified by reference to the
full text of the Registration Rights and Lockup Agreement.
Pursuant to the Registration Rights and Lockup Agreement, certain persons
and entities who hold an aggregate of 67.7% of the outstanding Matrix Common
Stock (85.4% of the outstanding Matrix Common Stock, excluding the shares held
by Best) will agree, for a two-year period commencing on the closing of the
transactions contemplated by the Exchange Agreement, not to offer, pledge, sell,
or otherwise dispose of any shares of AvTel Delaware issued to them pursuant to
the terms of the Exchange Agreement. The Matrix Shareholders who have agreed
to this two-year lockup period are Ronald L. Jensen, his adult children (James
J. Jensen, Jami J. Jensen, Janet Jensen Krieger, Jeffrey J. Jensen, and Julie J.
Jensen), and United Group Association, Inc. and UA Plus, Inc. (which are
controlled by Mr. Jensen and his adult children).
The Registration Rights and Lockup Agreement will require that AvTel
Delaware use its best efforts to become listed on the NASDAQ Small Cap System or
the NASDAQ National Market System and to file a shelf registration statement
providing for the sale by the Matrix Shareholders of all securities issued to
them in connection with the Exchange Agreement, subject to the two-year holding
restriction imposed on certain of the Matrix Shareholders described above.
Under the Registration Rights and Lockup Agreement, AvTel Delaware 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. If AvTel Delaware securities are not listed on the NASDAQ
Small Cap System or the NASDAQ NMS within six months following the Closing or if
AvTel is unable to qualify for use of a shelf registration statement within such
period, the Matrix Shareholders (other than those subject to the two-year
restriction) are entitled to
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demand that the Company register the AvTel Delaware Common Stock received by
them in connection with the Share Exchange or any registration statement from
them available to the Company. The Matrix Shareholders may also require AvTel
Delaware to undertake up to two additional demand registrations of their
securities. All costs and expenses of both shelf and demand registrations
(excluding any underwriting discounts and fees of counsel to the Matrix
Shareholders) will be borne by AvTel Delaware.
COMPARATIVE PER SHARE DATA
The following table sets forth certain historical per share data of Avtel
and Matrix and per share data on a pro forma combined basis, based on the
assumptions that (i) the Share Exchange was effective at the beginning of the
periods indicated and was accounted for using the purchase method of accounting,
and (ii) the Reorganization Merger was effective at the beginning of the periods
indicated. The unaudited pro forma combined per share data provided below is not
necessarily indicative of the results of operations or the financial position
which would have occurred had the transactions been consummated on the indicated
dates or which may be attained in the future. This data should be read in
conjunction with the historical consolidated financial statements and the
related notes thereto of Avtel and Matrix and the unaudited pro forma condensed
combined financial statements, which are included in this Proxy Statement. The
unaudited pro forma combined per share data below is shown for illustrative
purposes only.
<TABLE>
<CAPTION>
AT OR FOR THE SIX AT OR FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, 1997 DECEMBER 31, 1996
AVTEL (1):
<S> <C> <C>
Book value per common share $(0.24) $(0.10)
Cash dividends declared per common share - -
Net loss per common share (0.15) (0.37)
MATRIX:
Book value per common share 2.44 2.39
Cash dividends declared per common share - -
Net income per common share 0.05 0.88
PRO FORMA:
Book value per common share 0.94 N/A
Cash dividends declared per common share - -
Net income per common share - 0.24
AVTEL EQUIVALENTS(2):
Book value per common share 0.38 N/A
Cash dividends declared per common share - -
Net income per common share - 0.10
</TABLE>
N/A - Not applicable.
(1) Reflects the impact of the Reverse Stock Split as contemplated by the
Reincorporation Merger.
(2) Represents pro forma amounts based upon the Exchange Ratio of 2.482 shares
of AvTel Delaware Common Stock for each share of Matrix Common Stock.
MANAGEMENT OF AVTEL DELAWARE AFTER THE SHARE EXCHANGE.
BOARD OF DIRECTORS OF AVTEL DELAWARE. Frank Dziuba and Barry A. Peters,
who are currently Directors of the Company, have indicated that they will resign
as directors immediately prior to the Closing of the Share Exchange, as
contemplated by the Exchange Agreement. There is currently one vacancy on the
Board. In accordance with the Exchange Agreement, the Directors of the Company
will appoint John E. Allen, Ronald W. Howard and Gregory T. Mutz, nominees of
Matrix, to fill the vacancies on the Board of AvTel Delaware. Accordingly, if
all of the
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conditions to the completion of the Share Exchange are satisfied, including
approval by the shareholders of AvTel, the composition of the Board of Directors
of AvTel Delaware will be as follows:
<TABLE>
<CAPTION>
NAME POSITION WITH AVTEL UTAH POSITION WITH AVTEL DELAWARE
---- ------------------------ ----------------------------
<S> <C> <C>
Anthony E. Papa President, Chief Executive Officer Chairman of the Board, President,
and Director Chief Executive Officer and
Director
James P. Pisani Executive Vice President, Chief Executive Vice President, Chief
Operating Officer, Chief Financial Operating Officer, Chief Financial
Officer, Secretary and Director Officer, Secretary and Director
John E. Allen None Director
Ronald W. Howard None Director
Gregory T. Mutz None Director
</TABLE>
Certain biographical information with respect to each of the persons named
above is set forth below.
ANTHONY E. PAPA, age 35, is Chairman of the Board, President and Chief
Executive Officer of the Company, and will continue to hold those offices with
AvTel Delaware. Mr. Papa is also one of the principal shareholders of the
Company. Before being elected a Director in 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 33, is Executive Vice-President, Chief Operating Officer,
Chief Financial Officer and Secretary of the Company, and will continue to hold
those offices with AvTel Delaware. Mr. Pisani is also a principal shareholder
of the Company and, prior to being elected a Director of the Company in 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.
JOHN E. ALLEN, age 61, is Vice Chairman of the Board of Amli Residential
Properties Trust and President of Amli Realty Co. ("AMLI"), a commercial real
estate firm, which he co-founded in 1980. Prior to co-founding AMLI, he was a
partner at the Chicago law firm of Mayer, Brown & Platt, with which he had been
associated since 1964. Mr. Allen is a member of the Board of Directors of UICI,
an insurance and financial services company. Mr. Allen received a B.S. in
Business from Indiana University in 1961 and a J.D. from Indiana University
School of Law in 1964.
RONALD W. HOWARD, age 49, has been employed by United Group Association, Inc.,
a management company ("UGA"), since July 1, 1997, and prior to that date served
as a consultant to UGA in a financial and management advisory capacity since
November, 1996. Prior to his consulting with UGA, Mr. Howard was Executive Vice
President of Associates First Capital Corporation, a financial services company,
from August 1990 to July 1996. Additionally, from 1993 to 1996, Mr. Howard
served as Chairman of Associates Investment Corporation, an industrial loan
chartered bank located in Salt Lake City, Utah. Mr. Howard also serves as a
member of the Board of Directors of U.S. Metroline Services, Inc., U.S. Telco,
Inc. and as an executive officer of Sun Network Technologies, LLC. Mr. Howard
earned a B.S. in Marketing from Sacred Heart University, in Fairfield,
Connecticut.
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GREGORY T. MUTZ, age 51, is chairman of the Board of Amli Residential
Properties Trust and Chairman of the Board of AMLI, which he co-founded in 1980.
Mr. Mutz is also a Director of Baldwin & Lyons, Inc., a Director of the Illinois
Chapter of The Nature Conservancy and a member of the Board of Visitors at
DePauw University. Prior to co-founding AMLI, he was an officer with White,
Weld & Co., Incorporated (1976-78) and associated with the law firm of Mayer,
Brown & Platt (1973-76). He received a B.A. from DePauw University in 1967 and
a J.D. from the University of Michigan law School in 1973. He is also a member
of the Urban Land Institute.
Messrs. Mutz and Allen are the Chairman of the Board and Vice Chairman and
President, respectively, of AMLI, which is a wholly-owned subsidiary of UICI.
UICI is a NASDAQ National Market System - traded holding company with interests
in insurance, financial services and technology. Mr. Ronald L. Jensen is the
Chairman of the Board of UICI and he and his adult children own approximately
35% of UICI's outstanding stock. Mr. Allen is also a director of UICI. Mr.
Jensen, his adult children and certain entities controlled by them hold a
majority of the outstanding Matrix Common Stock, and will own a majority of the
AvTel Delaware Common Stock after the Share Exchange. (See "Control by Jensen
Holders" below.)
Mr. Howard has been an employee or consultant of UGA since November of 1996.
UGA is wholly-owned by Mr. Jensen. See " Description of Matrix - Transaction
with Affiliates" for a description of certain transactions among Matrix, UICI,
UGA and certain other affiliated entities.
CONTROL BY JENSEN HOLDERS. Following completion of the Share Exchange, Mr.
Ronald L. Jensen, various adult children of Mr. Jensen and several corporations
controlled by Mr. Jensen and members of his family (collectively, the "Jensen
Holders") will hold approximately 69% of the outstanding AvTel Delaware Common
Stock (excluding the shares to be held by Best) and will constitute AvTel
Delaware's largest single stockholding group. Accordingly, the Jensen Holders
can be expected to have the ability to control the direction of the Company.
(See "Description of the Company - Security Ownership of Certain Beneficial
Owners and Management" below.)
EXECUTIVE COMPENSATION/EMPLOYMENT AGREEMENTS. The Company currently has
employment agreements in place with each of Messrs. Papa and Pisani. Under
these employment agreements, generally, each executive is employed for a term
commencing in August 1996 and expiring July 31, 1999. However, as described
below, these employment agreements will be terminated effective upon the Closing
of the Share Exchange.
In connection with the execution of the Exchange Agreement, Messrs. Papa and
Pisani have agreed that, upon closing of the transactions contemplated thereby,
their respective employment agreements shall be terminated and will no longer be
of any force and effect. Thereafter, their employment relationship with AvTel
Delaware will be on an at-will basis. Mr. Papa will continue to serve as
Chairman of the Board, President and Chief Executive Officer of the Company and
Mr. Pisani will continue to serve as Executive Vice President and Chief
Operating Officer, Chief Financial Officer and Secretary. Both Mr. Papa and Mr.
Pisani will continue to serve as directors of the Company and will continue to
serve as officers and employees of the Company (at the pleasure of the Board)
at their current salaries. Messrs. Papa and Pisani have already waived their
rights to receive guaranteed bonuses of $50,000 each under their employment
agreements with the Company and have also waived their rights to performance
bonuses for the fiscal year ending September 30, 1997, in the amount of 75% of
their respective base salaries, which are called for by their current employment
agreements. Upon consummation of the Share Exchange, neither of Messrs. Papa or
Pisani will be entitled to guaranteed bonuses, but may receive bonuses from time
to time at the discretion of the Board of Directors.
Frank Dziuba will continue to be employed as the Company's Senior Vice
President - Software Development, and D. Stephen DeWindt will continue to be
employed as the Presdient of the Company's Business Network Services Division
pursuant to the terms of their existing employment agreements with the Company.
RELATIONSHIP WITH MATRIX
The Matrix Loan. Under the terms of the Exchange Agreement, Matrix was
required to provide to the Company an unsecured loan (the "Matrix Loan") in the
maximum aggregate amount of $500,000. When the Exchange Agreement was amended
on August 25, 1997, the maximum aggregate amount of the Matrix Loan was
increased to $750,000. The loan is in the form of a revolving credit facility
under which the Company is permitted to draw down up to three increments of
$250,000 each. As of August 31, 1997, the Company has borrowed the full
$750,000 permitted under the Matrix Loan.
The Matrix Loan bears interest at a rate equal to 8% per annum until October
31, 1997. Thereafter, the interest rate increases to a rate equal to 12% per
annum until maturity. If the loan is not paid at maturity, the interest rate
increases to 15% per annum. Interest is payable monthly, and all principal and
accrued interest outstanding under the Matrix Loan are due and payable on
December 1, 1997. If the Share Exchange is not consummated, the Company will
have to attempt to access some other source of funds in order to repay the
Matrix Loan. See "Description of the Company - Management's Discussion and
Analysis of Financial Condition and Results of Operation - Liquidity and Capital
Resources."
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<PAGE>
Current Operational Transactions with Matrix. AvTel currently sells Matrix's
long distance telephone services to its customers. Because these sales have
only very recently commenced, this business has not yet accounted for any
significant revenues of the Company.
DISSENTERS' RIGHTS
Shareholders will not have dissenters' rights as a result of the Share
Exchange. However, shareholders will have dissenters' rights under the URBCA in
connection with the Reincorporation Merger. (See "The Reincorporation Merger -
Dissenters' Rights as a Result of the Reincorporation Merger," below.)
ACCOUNTING TREATMENT.
The Share Exchange will be treated for accounting purposes as a reverse
acquisition of AvTel by Matrix. After the Share Exchange, the Matrix
Shareholders will own approximately 81% of the outstanding AvTel Delaware Common
Stock (excluding the shares held by Best). The acquisition will be accounted
for using the purchase method and the results of operations of AvTel will be
recorded by Matrix from the date of acquisition forward. In addition, it is
anticipated that AvTel Delaware's fiscal year end will become December 31.
FEDERAL INCOME TAX CONSEQUENCES; NO LEGAL OPINIONS OR TAX RULINGS.
The following discussion summarizes the material federal income tax
considerations relevant to the Share Exchange. This discussion is based on
currently existing provisions of the Internal Revenue Code of 1986, as amended
(the "Code"), existing Treasury Regulations thereunder and current
administrative rulings and court decisions, all of which are subject to change.
Any such change, which may or may not be retroactive, could alter the tax
consequences to the Company, Matrix or the shareholders of such corporations.
This discussion does not deal with all federal income tax considerations that
may be relevant to particular shareholders in light of their particular
circumstances. For a description of the tax consequences of the Reincorporation
Merger, see "The Reincorporation Merger - Federal Income Tax Consequences."
Pursuant to Section 1032 of the Code, the issuance of stock by AvTel Delaware
in the Share Exchange does not create any taxable gain or loss on the part of
AvTel Delaware. Holders of Company Common Stock and Company Preferred Stock
prior to the Share Exchange will also not experience any taxable event as a
result of the Share Exchange, because they are not transferring their shares or
receiving any property for them.
With respect to the Matrix Shareholders, the Share Exchange, as a "stock for
stock exchange," is intended to qualify as a tax-free reorganization under
Section 368(a)(1)(B) of the Code. Assuming the Share Exchange is treated as a
reorganization within the meaning of that section, then the Share Exchange
should result in the following federal income tax consequences to the Matrix
Shareholders:
(i) No gain or loss should be recognized by holders of Matrix Common Stock
solely upon their receipt in the Share Exchange of AvTel Delaware Common
Stock in exchange therefor (except to the extent of cash received in lieu
of a fractional share of AvTel Delaware Common Stock).
(ii) The aggregate tax basis of the AvTel Delaware Common Stock received by
Matrix Shareholders in the Share Exchange (including any fractional share
of AvTel Delaware Common Stock not actually received) should be the same as
the aggregate tax basis of the Matrix Common Stock surrendered in exchange
therefor.
(iii) The holding period of the AvTel Delaware Common Stock received by each
Matrix Shareholder in the Share Exchange should include the period for
which the Matrix Common Stock surrendered in exchange therefor was
considered to be held, provided that the Matrix Common Stock so surrendered
is held as a capital asset at the time of the Share Exchange.
(iv) Cash payments received by holders of Matrix Common Stock in lieu of a
fractional share of AvTel Delaware Common Stock should be treated as if
such fractional share of AvTel Delaware Common Stock had been issued in the
Share Exchange and then redeemed by AvTel Delaware. Depending upon the
relative level of ownership of Matrix Common Stock compared to AvTel
Delaware Common Stock subject to the exchange, a holder of Matrix Common
Stock will either (a) be treated as having received dividends for receipt
of cash payments received in lieu of fractional shares, or (b) recognize
gain or loss upon such payment, measured by the difference (if any) between
the amount of cash received and the basis in such fractional share.
If the Internal Revenue Service were to challenge successfully the
reorganization status of the Share Exchange, Matrix Shareholders would recognize
taxable gain or loss with respect to each share of Matrix Common Stock
surrendered equal to the difference between the shareholder's basis in such
share and the fair market value, as of the effective time of the Share Exchange,
of the AvTel Delaware Common Stock received in exchange therefor. In such
event, a shareholder's aggregate basis in the AvTel Delaware Common Stock so
received would equal its fair market value as of such effective time, and the
shareholder's holding period for such stock would begin the day after the Share
Exchange. The tax treatment of the Company and the existing holders of Company
Common Stock and Company Preferred Stock would not be affected by such a
challenge.
Neither the Company nor Matrix has requested a tax ruling from the Internal
Revenue Service or an opinion of legal counsel with respect to the acquisition.
Accordingly, no assurance can be given that the acquisition will qualify as a
tax-free reorganization to the Matrix Shareholders as outlined above.
THE FOREGOING IS ONLY A SUMMARY OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES.
SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISERS REGARDING THE SPECIFIC TAX
CONSEQUENCES TO THEM OF THE SHARE EXCHANGE, INCLUDING THE APPLICABILITY OF THE
LAWS OF ANY STATE OR OTHER JURISDICTION.
REGULATORY APPROVAL.
The shares of the AvTel Delaware Common Stock to be issued to the Matrix
Shareholders will not be registered under the Securities Act of 1933, as amended
(the "Act") in reliance on the exemption from such registration requirements
provided by Section 4(2) of the Act for transactions not involving any public
offering. In order to claim the availability of such exemptions, the Matrix
Shareholders will make representations with respect to their acquisition of
shares of AvTel Delaware's Common Stock, such shares will be restricted
securities, and the certificates will bear legends restricting their subsequent
resale in the absence of registration under the Securities Act or the
availability of an exemption therefrom. The representations and warranties to
be made by the Matrix Shareholders at the closing of the Share Exchange are
included in the Exchange Statement to be executed and delivered by each Matrix
Shareholder at the Closing.
The acquisition of Matrix is also subject to regulatory approval by the
Federal Communications Commission ("FCC") and the corresponding state
telecommunications regulatory authorities of certain states in which Matrix
operates. The Company has been advised by Matrix that most of these regulators
require only the filing of a prior notice of the Share Exchange, and that those
states that require a formal approval process will not delay the closing of the
Share Exchange if an appropriate application has been filed. Accordingly, the
Company does not foresee any substantial difficulty or delay in completing the
Share Exchange as a result of the required regulatory approvals.
IMPACT ON HOLDERS OF COMPANY PREFERRED STOCK.
As a result of the Share Exchange, there will be significantly more shares of
the Company Common Stock outstanding. However, the shares of the Company
Preferred Stock will maintain their existing rights, preferences and privileges,
including their liquidation preference over the shares of Company Common Stock;
shares of the Company Preferred Stock will continue to be convertible, on a
one-for-one basis, into shares of the Company Common Stock.
The Share Exchange will cause an increase in the total assets, total
liabilities and the shareholders equity of the Company and its subsidiaries on a
consolidated basis. See "Pro Forma Condensed Combined Financial Statements,"
below. The bulk of the consolidated entity's assets will be held by Matrix (as
a subsidiary of the Company) and will be subject to the liabilities of Matrix.
Accordingly, if Matrix were liquidated by the Company, the liquidation
preference of the Company Preferred Stock would not be triggered unless and
until the Company was also liquidated.
VOTE REQUIRED.
Under Utah law, the affirmative vote of a majority of the outstanding shares
of Company Common Stock and a majority of the outstanding shares of Company
Preferred Stock, each voting as a class, is required for approval of the
proposed Share Exchange. If approved by the Company's shareholders, it is
anticipated that the Share Exchange would be completed within thirty (30) days
of such approval, concurrently with or immediately after consummation of the
Reincorporation Merger. However, consummation of the Share Exchange is subject
to the satisfaction or waiver of various conditions precedent, including the
delivery of an executed Exchange Statement by each of the Matrix Shareholders
and optionholders.
Certain shareholders, including the Company's current Directors, who own
shares representing approximately 61% of the issued and outstanding shares of
the Company Common Stock have indicated that they will vote their shares in
favor of the Share Exchange. In addition, the holders of all shares of the
Company's Preferred Stock have indicated that they will vote their shares in
favor of the Share Exchange. Accordingly, without the affirmative vote of any
other shareholder, there will be sufficient votes for approval and adoption of
the Share Exchange.
-12-
<PAGE>
RECOMMENDATION OF MANAGEMENT.
FOR THE REASONS STATED ABOVE, THE BOARD OF DIRECTORS OF THE COMPANY BELIEVES
THAT THE TRANSACTIONS CONTEMPLATED BY THE PROPOSED SHARE EXCHANGE ARE DESIRABLE
AND IN THE BEST INTERESTS OF THE COMPANY'S SHAREHOLDERS AND UNANIMOUSLY
RECOMMENDS THAT THE SHAREHOLDERS VOTE "FOR" SUCH PROPOSAL. MANAGEMENT BELIEVES
THAT THE SHAREHOLDERS WILL BENEFIT THROUGH MATRIX'S EXISTING BUSINESS BASE,
OPERATIONS, FINANCIAL AND OTHER RESOURCES AVAILABLE TO MATRIX. (SEE
"DESCRIPTION OF MATRIX").
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The unaudited pro forma condensed combined financial statements present (i)
the transactions contemplated by the Exchange Agreement as a reverse acquisition
of the Company by Matrix using the purchase method of accounting, (ii) the
combination of Best, an affiliated company of Matrix, and Matrix in a share
exchange accounted for as entities under common control using historical costs,
and (iii) the combined acquisitions of Hi, Tiger International, Inc. ("HTI"),
WestNet Communications, Inc. ("WNI") and Silicon Beach Communications, Inc.
("SBC") by AvTel using the purchase method of accounting, all as if these
transactions had been consummated, with respect to the statements of operations,
at the beginning of the earliest period presented, or, with respect to the
balance sheet, as of the date presented. Such information is derived from and
should be read in conjunction with, the separate historical financial statements
of the Company and Matrix and other financial information appearing elsewhere in
this Proxy Statement. The unaudited pro forma condensed combined financial
statements have been included for comparative purposes only and do not purport
to be indicative of the results of operations or financial position which
actually would have been obtained if the transaction contemplated by the
Exchange Agreement had been consummated at the beginning of the earliest period
presented or as of the date presented or of the results of operations or
financial position which may be obtained in the future.
In connection with the reverse acquisition, AvTel will change its fiscal year
end from September 30 to December 31. For purposes of these pro forma financial
statements, the financial information of AvTel has been presented based on a
fiscal year end of December 31 by combining appropriate historical periods of
AvTel.
Because the purchase price is determined based on the trading price of AvTel
shares immediately prior to the public announcement of the Share Exchange, which
results in a significantly higher value than the total value of the underlying
tangible and intangible net assets, a significant amount of goodwill results.
The operations of AvTel do not support the carrying value of such goodwill.
Accordingly, immediately following the transaction, and as a result of the
transaction, such goodwill will be written off to operations.
-13-
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED
BALANCE SHEET
JUNE 30, 1997
<TABLE>
<CAPTION>
Matrix/Best
Pro Forma Pro Forma Pro Forma
Assets Matrix Best Adjustments Combined AvTel Adjustments Combined
- ------------------------ ------------- -------- ----------------- ------------ ---------- ---------------- ----------
(Note B) (Note C)
Current assets
<S> <C> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 4,240,644 211,169 -- 4,451,813 431,405 -- 4,883,218
Accounts receivable, net 8,465,520 -- -- 8,465,520 206,871 -- 8,672,391
Due from affiliates 964,300 -- -- 964,300 86,000 (500,000)/(6)/ 550,300
Other current assets 1,570,087 -- -- 1,570,087 18,869 -- 1,588,956
----------- --------- ---------------- ---------- --------- ---------------- ----------
15,240,551 211,169 -- 15,451,720 743,145 (500,000) 15,694,865
----------------
Property and equipment, net 1,418,196 15,137 -- 1,433,333 523,805 -- 1,957,138
Loans to affiliates 1,924,303 -- -- 1,924,303 -- -- 1,924,303
Investments -- 3,317,940 (3,317,940)/(2)/ -- -- -- --
Goodwill, net -- -- -- -- 567,614 7,557,588/(2)/ --
(8,125,202)/(5)/
Other assets, net 3,369 -- -- 3,369 5,499 -- 8,868
Deferred income taxes 134,288 -- -- 134,288 -- -- 134,288
----------- --------- ---------------- ---------- --------- ---------------- ----------
$18,720,707 3,544,246 (3,317,940) 18,947,013 1,840,063 (1,067,614) 19,719,462
=========== ========= ================ ========== ========= ================ ==========
</TABLE>
See accompanying notes to unaudited pro forma condensed financial information.
14
<PAGE>
<TABLE>
<CAPTION>
Matrix/Best
Liabilities and Pro Forma Pro Forma Pro Forma
Stockholders' Equity Matrix Best Adjustments Combined AvTel Adjustments Combined
- ---------------------------- ------------ --------- ---------------- ----------- --------- ---------------- -----------
(Note B) (Note C)
<S> <C> <C> <C> <C> <C> <C> <C>
Current liabilities
Accounts payable and other
accrued expenses $ 1,891,342 -- -- 1,891,342 201,434 2,092,776
Accrued network services
costs 4,328,597 -- -- 4,328,597 -- -- 4,328,597
Deferred revenue -- -- -- -- 123,013 -- 123,013
Sales and excise tax
payable 1,341,572 -- -- 1,341,572 -- -- 1,341,572
Due to affiliates 2,207,665 177,008 -- 2,384,673 199,041 -- 2,583,714
Income tax payable 20,447 -- -- 20,447 -- -- 20,447
Lease obligations -
current portion -- -- -- 32,368 -- 32,368
Note payable -- -- -- 628,099 (500,000)(6) 128,099
Other liabilities 896,000 -- -- 896,000 -- -- 896,000
----------- --------- ------------- ---------- ---------- -------- ----------
10,685,623 177,008 -- 10,862,631 1,183,955 (500,000) 11,546,586
Lease obligation, less
current portion -- -- -- -- 77,889 -- 77,889
Stockholders' Equity
Preferred stock -- -- -- -- 1,000,000 -- 1,000,000
Common stock 7,532,026 -- 3,367,238(2) 10,899,264 7,136 (5,352)(1) 11,367
(10,889,681)(4)
Paid in capital in excess
of par value -- 3,209,779 (3,209,779)(2) -- 135,475 5,352(1) 14,989,781
6,993,196(2)
7,855,758(4)
Retained earnings
(accumulated deficit) 942,641 157,459 (157,459)(2) 942,641 (564,392) 564,392(2) (7,182,561)
(8,125,202)(5)
Treasury Stock (439,583) -- (3,317,940) (3,757,523) -- 3,757,523(4)
----------- --------- --------------- ---------- --------- --------- ---------
8,035,084 3,367,238 (3,317,940) 8,084,382 578,219 (567,614) 8,094,987
----------- --------- ---------------- ---------- --------- --------- ---------
$18,720,707 3,544,246 (3,317,940) 18,947,013 1,840,063 (1,067,614) 19,719,462
=========== ========= =============== ========== ========= ========== ==========
</TABLE>
See accompanying notes to unaudited pro forma condensed financial
information.
15
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
Matrix/Best
Pro Forma Pro Forma Combined
Matrix Best Adjustments Combined AvTel HTI/WNI/SBC
----------- ------- --------------- ------------ --------- ----------
(Note D)
<S> <C> <C> <C> <C> <C> <C>
Revenues $26,829,063 497,300 (497,300)(2) 26,829,063 1,346,084 108,583
Cost of revenues 18,314,213 -- -- 18,314,213 314,560 18,526
----------- ------- -------------- ---------- --------- -------
Gross margins 8,514,850 497,300 (497,300)(2) 8,514,850 1,031,524 90,057
Operating expenses
Selling, general and
administrative 7,800,920 471,542 (497,300) 7,775,162 1,268,338 84,726
Depreciation and
amortization 364,200 2,890 367,090 59,845 7,000
----------- ------- -------------- ---------- --------- -------
Total operating expenses 8,165,120 474,432 (497,300) 8,142,252 1,328,183 91,726
----------- ------- -------------- ---------- --------- -------
Operating income (loss) 349,730 22,868 -- 372,598 (296,659) (1,669)
Interest expense (6,864) -- -- (6,864) (3,481) --
Other income, net (44,238) 35 -- (44,203) 30,290 (8,990)
----------- ------- -------------- ---------- --------- -------
Income (loss) before
income taxes 298,628 22,903 -- 321,531 (269,850) (10,659)
Income tax expense (benefit) 125,426 -- 9,619(3) 135,045 -- --
----------- ------- -------------- ---------- --------- -------
173,202 22,903 (9,619) 186,486 (269,850) (10,659)
Net income (loss) $ 173,202 22,903 (9,619) 186,486 (269,850) (10,659)
=========== ======= ============== ========== ========= ========
Net income (loss) per common
share $0.05 0.06 (0.04)
=========== ========== =========
Weighted average shares
outstanding 3,484,260 3,055,147 7,129,779
=========== ========== =========
</TABLE>
16
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
AvTel/HTI
Pro Forma WNI/SEC Pro Forma
Adjustments Pro Forma Adjust- Pro Forma
Combined ments Combined
----------- ---------- --------------------- ---------
(Note E) ( Note F)
<S> <C> <C> <C> <C>
Revenues -- 1,454,667 -- 28,283,730
Cost of revenues -- 333,086 -- 18,647,299
------ --------- -------------- ----------
Gross margins -- 1,121,581 -- 9,636,431
Operating expenses
Selling, general and
administrative -- 1,353,064 -- 9,128,226
Depreciation and
amortization 6,400(2) 73,245 (8,683)(2) 431,652
------ --------- -------------- ----------
Total operating expenses 6,400 1,426,309 (8,683) 9,559,878
------ --------- -------------- ----------
Operating income (loss) (6,400) (304,728) 8,683 76,553
Interest expense -- (3,481) -- (10,345)
Other income, net -- 21,300 -- (22,903)
------ --------- -------------- ----------
Income (loss) before
income taxes (6,400) (286,909) 8,683 43,305
Income tax expense (benefit) -- -- (116,857)(3) 18,188
------ --------- -------------- ----------
Net income (loss) (6,400) (286,909) 125,540 25,117
======= ========= ============== ==========
Net income (loss) per
common share (0.04) --
======== ==========
Weighted average shares
outstanding 7,135,612 9,366,420
========= ==========
</TABLE>
See accompanying notes to unaudited pro forma condensed financial information.
17
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
Matrix/Best
Pro Forma Pro Forma
Matrix Best Adjustments Combined AvTel
-------------- --------- ----------------- ------------ ----------
(Note D)
<S> <C> <C> <C> <C> <C>
Revenues $71,558,295 1,280,273 (1,280,273)(2) 71,558,295 263,139
Cost of revenues 47,674,396 -- -- 47,674,396 89,121
----------- --------- ---------------- ---------- ---------
Gross margins 23,883,899 1,280,273 (1,280,273) 23,882,899 174,018
Operating expenses
Selling, general and
administrative 18,798,926 1,193,332 (1,280,273)(2) 18,711,985 504,991
Depreciation and
amortization 993,940 10,021 -- 1,003,961 --
----------- --------- ---------------- ---------- ---------
Total operating expenses 19,792,866 1,203,353 (1,280,273) 19,715,946 504,991
----------- --------- ---------------- ---------- ---------
Operating income (loss) 4,091,033 76,920 -- 4,167,953 (330,973)
Interest expense (230,922) -- -- (230,922) (945)
Other Income, net 271,172 18,619 -- 289,871 21,268
----------- --------- ---------------- ---------- ---------
Income (loss) before
income taxes 4,131,283 95,619 -- 4,226,902 (310,650)
Income tax expense (benefit) 1,686,878 -- 40,160(3) 1,727,038 --
----------- --------- ---------------- ---------- ---------
2,444,405 95,619 (40,160) 2,499,864 (310,650)
Equity in net income (loss)
of DNS 122,327 -- -- 122,327 --
Net income (loss) $ 2,566,732 95,619 (40,160) 2,622,191 (310,650)
=========== ========= ================ ========== =========
Net income (loss) per
common share $0.88 1.05 (0.09)
=========== ========== =========
Weighted average shares
outstanding 2,919,978 2,490,865 3,362,017
=========== ========== =========
</TABLE>
See accompanying notes to unaudited pro forma condensed financial information.
18
<PAGE>
<TABLE>
<CAPTION>
AvTel/HTI
WNI/SBC
Combined Pro Forma Pro Forma Pro Forma Pro Forma
HTI/WNI/SBC Adjustments Combined Adjustments Combined
------------ ------------ --------- ------------ ------------
(Note E) (Note F)
<S> <C> <C> <C> <C> <C>
Revenues 1,691,520 -- 1,954,659 -- 73,512,954
Cost of revenues 329,861 -- 418,982 -- 48,093,378
--------- ----------- --------- ------- ----------
Gross margins 1,361,659 -- 1,535,677 -- 25,419,576
Operating expenses
Selling, general and
administrative 1,155,561 -- 1,660,552 20,372,537
Depreciation and
amortization 96,687 178,627(2) 275,314 1,279,275
--------- ----------- --------- ------- ----------
Total operating expenses 1,252,248 178,627 1,935,866 21,651,812
--------- ----------- --------- ------- ----------
Operating income (loss) 109,411 (178,627) (400,189) -- 3,767,764
Interest expense (11,870) -- (12,815) -- (243,737)
Other Income, net 63,819 -- 85,087 -- 374,958
--------- ----------- --------- ----------
Income (loss) before
income taxes 161,360 (178,627) (327,917) -- 3,898,981
Income tax expense (benefit) (6,594) -- (6,594) (40,187)(3) 1,712,597
--------- ----------- --------- ------- ----------
167,954 (178,627) (321,323) 40,187 2,186,388
Equity in net income (loss)
of DNS -- -- -- 122,327
Net income (loss) 167,954 (178,627) (321,323) 40,187 2,308,715
========= =========== ========= ======= ==========
Net income (loss) per
common share (0.05) 0.24
========= ==========
Weighted average shares
outstanding 7,046,190 9,344,064
========= ==========
</TABLE>
See accompanying notes to unaudited pro forma condensed financial information.
19
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION
(A) Basis of Presentation
The unaudited pro forma condensed financial information reflects the exchange
of 376,727 shares of Matrix stock for 100% of the outstanding shares of Best
Connections, Inc.("Best"), an affiliated company. Due to the existence of the
common control of Matrix and Best, their share exchange was accounted for as a
combination of entities under common control with the assets of Best being
recorded at their historical cost basis. The unaudited pro forma condensed
financial information also reflects the exchange of 35,000 shares of AvTel
common stock, $100,000 cash and secured promissory notes of $177,000 for 100%
of the outstanding shares of WestNet Communications, Inc. ("WNI"), the
exchange of 115,000 shares of Company Common Stock for 100% of the outstanding
shares of Silicon Beach Communications, Inc. ("SBC") and 4,252,508 shares of
Company Common Stock and 1,000,000 shares of Company Preferred Stock issued in
connection with the HTI/A.I. transaction (which is treated as the reverse
acquisition of HTI by A.I. for financial accounting purposes). The
transactions were accounted for as purchaseS. Additionally, the unaudited
pro forma condensed financial information also reflects the exchange of AvTel
common stock for all of the outstanding common stock of Matrix pursuant to the
Share Exchange. Although AvTel common stock is being used in the Share
Exchange, for accounting purposes the Share Exchange is being treated as a
reverse acquisition of AvTel by Matrix. After the Share Exchange, the former
shareholders of Matrix will own 81% of AvTel. This transaction will be
accounted for using the purchase method of accounting.
June 30, 1997 Pro Forma Balance Sheet Adjustments
- -------------------------------------------------
(B) Matrix/Best - The pro forma adjustments applicable to the June 30, 1997
balance sheet assume the Best share exchange took place as of June 30, 1997.
(1) Matrix issues 376,727 shares of Matrix stock for 100% of the outstanding
shares of Best. Best's primary asset consists of 805,840 shares of Matrix
common stock. As part of the Best/ Matrix merger, Matrix assumes the Best
obligation related to 805,840 outstanding options to purchase Matrix
common shares at $3.75 per share (1,999,997 post-split AvTel shares at
$1.50 per share). Such outstanding options will result in compensation
expense in the future for AvTel as such options vest.
.
(2) To eliminate Best's investment in Matrix common stock and reflect issuance
of Matrix common shares for Best.
(C) Matrix/AvTel - The pro forma adjustments applicable to the June 30, 1997
balance sheet assume the AvTel Share Exchange took place as of June 30, 1997
and reflect a preliminary purchase price allocation.
(1) Reflects 1 for 4 reverse split of AvTel's common stock.
(2) This adjustment reflects recording of the purchase price of AvTel by
Matrix using the trading value of the AvTel shares immediately prior to
the public announcement of the Share Exchange as required for a reverse
acquisition.
The preliminary allocation of the purchase price is as follows:
<TABLE>
<CAPTION>
Carrying Fair Pro Forma
Value Value Adjustment
------------ ------------ -----------
<S> <C> <C> <C>
Current Assets $ 743,145 743,145 -
Property and equipment 523,805 523,805 -
Goodwill 567,614 8,125,202 (7,557,588)
Other assets 5,499 5,499 -
Current liabilities (1,183,955) (1,183,955) -
Lease obligation, less current portion (77,889) (77,889) -
-----------
$ 8,135,807
===========
</TABLE>
The purchase price is comprised of the following:
Preferred stock $1,000,000
Common stock 7,135,807
----------
$8,135,807
==========
(3) For purposes of the determination of the purchase price, the trading value
of AvTel common shares for a period immediately prior to the public
announcement of the Share Exchange was used. This resulted in a price per
share of $1.00 pre-Reverse Stock Split and a total purchase price of
$8,135,807.
(4) This adjustment recapitalizes Matrix based on par value of AvTel common
stock.
(5) Goodwill recorded in the acquisition results from recording the reverse
purchase acquisition utilizing the market trading price of AvTel common stock
which significantly exceeds the fair value of the underlying net tangible and
intangible assets of AvTel. Accordingly, immediately following the Share
Exchange the resulting goodwill in the amount of $8,125,202 will be charged to
operations of AvTel.
(6) To eliminate $500,000 advance to AvTel by Matrix.
(D) Matrix and Best six months ended June 30, 1997 and year ended December 31,
1996 pro forma statements of operations adjustments.
(1) For purposes of the Unaudited Pro Forma Condensed statements of operations
presented the acquisition of Best is assumed to have been completed as of
January 1, 1996.
(2) To eliminate commission revenue at Best and commission expense at Matrix.
(3) This adjustment reflects the tax impact of Best's income at 42% (the
combined federal and state rate). Best was a limited liability company prior to
June 30, 1997.
(E) AvTel, HTI, WNI and SBC's six months ended June 30, 1997 and year ended
December 31, 1996 pro forma statements of operations adjustments.
(1) For purposes of the Unaudited Pro Forma Condensed Statements of Operations
presented the acquisitions of HTI, WNI and SBC, which were as of October 1996,
February 1997 and November 1996, are assumed to have been completed as of
January 1, 1996. The acquisition by AvTel of the 20% minority interest of the
Friendly Net, LLC in March 1997 has not been included in these pro forma
financial statements due to its not being material for these purposes.
(2) To amortize goodwill at AvTel related to the combined acquisitions over 36
months.
(F) Matrix and AvTel's six months ended June 30, 1997 and year ended December
31, 1996 pro forma statements of operations adjustments.
(1) For purposes of the Unaudited Pro Forma Condensed Statements of Operations
presented the Share Exchange is assumed to have been completed as of January
1, 1996.
(2) To eliminate $8,683 amortization of goodwill at AvTel for the six month
period ended June 30, 1997. There was no goodwill amortization for the year
ended December 31, 1996.
(3) To adjust income tax expense to reflect utilization of AvTel losses at a
combined federal and state rate of 42%.
(4) For purposes of determining the purchase price, the trading value of AvTel
shares was used for a period immediately preceding the announcement of the
Share Exchange. However, the net asset values of AvTel including goodwill
cannot be supported by the operations of AvTel. Accordingly, immediately
following the Share Exchange, the resulting goodwill in the amount of
$8,125,202 will be charged to operations. Since this is a one time charge
resulting from the Share Exchange, it is not reflected in the pro forma
statements of operations.
20
<PAGE>
THE REINCORPORATION MERGER
GENERAL.
The proposed Reincorporation Merger would be effected by a merger of the
Company with and into its wholly-owned subsidiary, AvTel Delaware, which was
formed solely for purposes of the Reincorporation Merger and has no operating
history. The proposed Reincorporation Merger would be accomplished under the
terms of an Agreement and Plan of Merger between the Company and AvTel Delaware
in substantially the form annexed hereto as Exhibit B (the "Merger Agreement").
Set forth below is a summary of the material features of the Merger Agreement.
To the extent that the following discussion relates to the terms of the Merger
Agreement, it is qualified by reference to the full text of the Merger
Agreement. Upon effectiveness of the Reincorporation Merger, the separate
existence of the Company will cease, AvTel Delaware will survive, all the
properties, rights, privileges, powers and franchises of the Company will vest
in AvTel Delaware and all debts, liabilities and duties of the Company shall
become the debts, liabilities and duties of AvTel Delaware.
Upon effectiveness of the Reincorporation Merger, the shares of the Company
Common Stock will automatically be converted into shares of common stock of
AvTel Delaware ("AvTel Delaware Common Stock"), on a four to one basis.
Accordingly, the 7,144,327 shares of Company Common Stock currently outstanding
would be converted into approximately 1,786,081 shares of AvTel Delaware Common
Stock (less a nominal number of shares reflecting cash paid for fractional
shares). The 1,000,000 outstanding shares of the Company Preferred Stock will
be converted into 250,000 shares of AvTel Delaware's Series A Preferred
Convertible Stock ("AvTel Delaware Preferred Stock"), having substantially the
same rights, preferences and privileges as the Company Preferred Stock. In
addition, all options to purchase Company Common Stock outstanding on the
effective date of the Reincorporation Merger will become options to purchase
that number of shares of AvTel Delaware Common Stock equal to one quarter of the
number of shares of Company Common Stock specified in the relevant option
agreement. The exercise price per share for such options will be increased to
four times the exercise price per share set forth in the relevant option
agreement.
AvTel Delaware will be governed, as to corporate matters, by the Delaware
General Corporation Law and by a new Certificate of Incorporation (the "Delaware
Certificate") and new Bylaws (the "Delaware Bylaws"), copies of which are
attached hereto as Exhibits C and D, respectively, which will result in certain
fundamental changes in the rights of shareholders. For a description of these
and other changes in shareholders' rights, see "Comparison of Shareholder Rights
under Utah and Delaware Corporation Laws and Charter Documents". All
references in this Proxy Statement to the Delaware Certificate and the Delaware
Bylaws are qualified in their entireties by reference to the full text of these
documents.
The Reincorporation Merger will effect only a change in the legal domicile of
the Company and other changes of a legal nature, certain of which are described
in this Proxy Statement. The Reincorporation Merger will NOT result in any
change in the business, management, assets or liabilities or location of the
principal facilities of the Company. However, all of such items will be changed
materially by the Share Exchange. See "The Share Exchange", above. Shareholders
should note that their approval of the Reincorporation Merger also will
constitute their approval of the assumption by AvTel Delaware of the Company's
obligations. After the Reincorporation Merger, the shares of Common Stock of
AvTel Delaware will continue to be traded on the NASDAQ Electronic Bulletin
Board or if the Company's application thereto is accepted, on the NASDAQ
National Market System. If the Company for any reason fails to qualify for
trading on the NASDAQ National Market System, management intends to apply for
trading on the NASDAQ Small Cap System. Trading in shares of AvTel Delaware
Common Stock will continue to be quoted under the symbol "AVCO".
Anthony E. Papa and James P. Pisani, Frank Dziuba and Barry A. Peters, the
persons who currently serve as directors of the Company, will serve as
directors of AvTel Delaware immediately upon the effectiveness of the
Reincorporation Merger for the same term as they would otherwise serve as
directors of the Company. However, upon the closing of the Share Exchange,
Messrs. Dziuba and Peters have indicated that they expect to resign. The
remaining directors of the Company intend to appoint John E. Allen, Ronald W.
Howard and Gregory T. Mutz, persons designated by Matrix, to fill the vacancies
on the Board of AvTel Delaware (See "The Share Exchange - Management of AvTel
Delaware After the Share Exchange").
21
<PAGE>
The Company will continue to maintain its executive offices in Santa Barbara,
California. Certificates for Company Common Stock will be deemed to represent
shares of AvTel Delaware Common Stock as adjusted by the Reverse Stock Split.
Following the Reincorporation Merger, previously outstanding stock certificates
for Company Common Stock will constitute "good delivery" in connection with
sales through a broker, or otherwise, of shares of AvTel Delaware Common Stock.
Following the Reincorporation Merger and the Share Exchange, the Company will
cause Letters of Transmittal to be delivered to shareholders requesting that
stock certificates in the Company be delivered to the Company's transfer agent,
American Registrar and Transfer Company, for replacement by stock certificates
of AvTel Delaware. It will not be necessary for shareholders to exchange their
Company stock certificates for AvTel Delaware stock certificates, although
shareholders may exchange their certificates if they wish.
PRINCIPAL REASONS FOR THE REINCORPORATION MERGER.
The Reincorporation Merger is a condition precedent to the transaction
contemplated by the Exchange Agreement which the Board of Directors believes is
in the best interests of the Company and its shareholders. See "The Share
Exchange". Other reasons for the proposed reincorporation are summarized below.
ABILITY TO ATTRACT AND RETAIN DIRECTORS. The Company believes that the more
favorable corporate environment afforded by Delaware will enable it to compete
more effectively with other public companies, most of which are incorporated in
Delaware, to attract new directors and to retain its current directors.
Reincorporation in Delaware will allow the Company the increased flexibility and
predictability afforded by Delaware law.
ADVANTAGES OF DELAWARE CORPORATION LAW. For many years, Delaware has followed
a policy of encouraging incorporation under its jurisdiction. In furtherance of
that policy, Delaware has long been the leading state in adopting, construing
and implementing comprehensive and flexible corporate laws responsive to the
legal and business needs of corporations. As a result, Delaware's General
Corporation Law ("Delaware Law" or "DGCL") has become widely regarded as the
most extensive and well-defined body of corporate law in the United States.
Because of Delaware's prominence as the state of incorporation for many major
corporations, both the legislature and courts in Delaware have demonstrated an
ability and a willingness to act quickly and effectively to meet changing
business needs. Moreover, the Delaware courts have rendered a substantial
number of decisions interpreting and explaining Delaware Law. The
Reincorporation Merger accordingly will be beneficial to AvTel Delaware in that
it will provide (i) a greater degree of predictability and certainty regarding
how AvTel Delaware affairs should be conducted in order to comply with
applicable laws (such predictability and certainty resulting from a large body
of case law decided under those laws) and (ii) the comfort and security
resulting from the responsiveness of Delaware's legislature and courts to the
needs of corporations organized under Delaware's jurisdiction. For these
reasons, many U.S. corporations have initially chosen Delaware as their home
state for their state of incorporation or have subsequently changed their
corporate domicile to Delaware in a manner similar to the proposed
Reincorporation Merger.
ANTITAKEOVER IMPLICATIONS. Certain aspects of the Reincorporation Merger,
including the application of DGCL (S)203 to the Company, the limitations to be
included in the Delaware Bylaws on a shareholder's ability to make proposals at
an annual or special meeting of the Company, and various other provisions of the
Delaware Certificate and Delaware Bylaws, none of which previously applied to
the Company, may have the effect of deterring hostile takeover attempts. DGCL
(S)203, for example, from which AvTel Delaware does NOT intend to opt out,
restricts certain "business combinations" with "interested shareholders" for
three (3) years following the date on which a person becomes an interested
shareholder, unless the Board of Directors approves the business combination.
The Utah Revised Business Corporation Act ("URBCA") does not contain comparable
provisions with respect to business combinations. A hostile takeover attempt may
have a positive or a negative effect on the Company and its shareholders,
depending on the circumstances surrounding a particular takeover attempt.
Takeover attempts that have not been negotiated or approved by the board of
directors of a corporation can seriously disrupt the business and management of
a corporation and, generally, present to the shareholders the risk of terms
which may be less than favorable to all of the shareholders
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than would be in a board-approved transaction. Board approved transactions may
be carefully planned and undertaken at an opportune time in order to obtain
maximum value for the corporation and all of its shareholders with due
consideration to matters such as the recognition or postponement of gain or loss
for tax purposes, the management and business of the acquiring corporation and
maximum strategic deployment of corporate assets.
Unsolicited takeover attempts may be unfair or disadvantageous to a
corporation and its shareholders for other reasons. A non-negotiated takeover
bid may be timed to take advantage of temporarily depressed stock prices.
Further, a non-negotiated takeover bid may be designed to foreclose or minimize
the possibility of more favorable competing bids or may involve the acquisition
of only a controlling interest in the corporation's stock, without affording all
shareholders the opportunity to receive the same economic benefits.
By contrast, in a transaction in which an acquirer must negotiate with an
independent board of directors, such board of directors can and should take into
account the underlying and long-term values of the corporation's assets, the
possibilities for alternative transactions on more favorable terms, the possible
advantages of a tax-free reorganization, the anticipated favorable developments
in the corporation's business not yet reflected in the stock price and the
equality of treatment of all the corporation's shareholders.
The Board of Directors recognizes that hostile takeover attempts do not always
have the unfavorable consequences or effects described above and may frequently
be beneficial to the shareholders, providing all of the shareholders with
considerable value for their shares. However, for the reasons stated above, the
Board of Directors believes that the potential steps to reduce the likelihood of
such takeover attempts are in the best interests of the Company and its
shareholders.
Notwithstanding the belief of the board of directors as to the benefits to
shareholders of the changes, shareholders should recognize that one of the
effects of such changes may be to discourage a future attempt to acquire control
of the Company which is not presented to and approved by the Board of Directors,
but which a substantial number and perhaps even a majority of the Company's
shareholders might believe to be in their best interests or in which
shareholders might receive a substantial premium for their shares over the
current market prices. As a result, shareholders who might desire to
participate in such a transaction may not have an opportunity to do so.
Although the Reincorporation Merger is required as a condition to the
consummation of the Share Exchange, pursuant to which the Matrix Shareholders
will acquire 84% of the outstanding capital stock of the Company's successor,
AvTel Delaware, the Reincorporation Merger is not being proposed in order to
prevent any known attempt to acquire control of the Company (or such successor),
obtain representation on the Board of Directors or take any significant action
affecting the Company (or such successor).
DIRECTORS' LIABILITY AND INDEMNIFICATION. Over the past decade, the frequency
and magnitude of claims and litigation against directors and officers of
corporations have increased. Over the same period, the cost of directors' and
officers' insurance policies has increased substantially, with the amount of
risk covered by such policies having significantly decreased. As a result, and
because potential personal liability associated with service as a director or
officer of a corporation can be significant, it has become increasingly
difficult for corporations to find and retain talented and experienced directors
and officers. Although, as more particularly described below, the URBCA and the
Company's existing Amendment and Restated Articles of Incorporation and Bylaws
allow the corporation to reduce or eliminate a director's personal liability to
the corporation and to indemnify directors, officers and agents of the
corporation, the Reincorporation Merger should enable the corporation to more
effectively reduce the potential personal liability of members of the Board of
Directors associated with their service as directors and to expand the scope of
the Company's indemnification of its directors and officers. This should enable
the Company to continue finding and retaining talented and experienced directors
and officers.
In 1986, Delaware amended its corporate law to allow corporations to limit the
personal monetary liability of its directors for their conduct as directors
under certain circumstances. The Directors have elected to adopt such a
provision in the Delaware Certificate. It should be noted that Delaware Law
does not permit a Delaware corporation to limit or eliminate the liability of
its directors for intentional misconduct, bad faith conduct or any transaction
from which the director derives an improper personal benefit or for violations
of federal laws. The benefit of Delaware Law should enhance the Company's
ability to recruit and retain directors in the
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future; however, the shareholders should be aware that such a provision inures
to the benefit of the directors, and the interest of the Board of Directors in
recommending the Reincorporation Merger may, therefore, be in conflict with the
interests of the shareholders.
POSSIBLE DISADVANTAGES. Despite the unanimous belief of the Board of
Directors that the Reincorporation Merger is in the best interests of the
Company and its shareholders, it should be noted that Delaware Law has been
criticized by some commentators on the grounds that it does not afford minority
shareholders the same substantive rights and protections as are available in a
number of other states by, for example, making it more difficult for minority
shareholders to elect directors and influence corporate policies. See
"Comparison of Shareholder Rights under Utah and Delaware Corporate Laws and
Charter Documents".
Despite the unanimous belief of the Board of Directors as to the benefits to
shareholders of the Reincorporation Merger, the Reincorporation Merger may be
disadvantageous to the extent that it has the effect of discouraging a future
takeover attempt that is not approved by the Board of Directors but may be
deemed by a majority of the shareholders to be in their best interests (because,
for example, the possible takeover could cause shareholders to receive a
substantial premium for their shares over their then current market value or
over the shareholders' cost basis in such shares). As a result of such effects
of the Reincorporation Merger, shareholders who might wish to participate in a
tender offer may not have an opportunity to do so.
REGULATORY APPROVAL.
The change of domicile of the Company to Delaware may be deemed to constitute
the issuance and sale of securities within the meaning of the U.S. Securities
Act of 1933, as amended (the "Securities Act"). The deemed issuance of
securities will not be registered under the Securities Act and will be effected
in reliance upon the exemptions provided by Section 3(a)(9) of the Securities
Act and Rule 145 promulgated under the Securities Act. However, the issuance of
the shares of AvTel Delaware Common Stock pursuant to the Reincorporation Merger
will require the Company to file applications, notices or obtain permits from
various states in which the Company's shareholders are domiciled and, before
mailing this Proxy Statement, the Company obtained a permit authorizing the sale
and issuance of such securities from the California Department of Corporations,
and has filed notices with the states of Iowa, Minnesota, Nevada and New
Mexico.
COMPARISON OF SHAREHOLDER RIGHTS UNDER DELAWARE AND UTAH CORPORATE LAW AND
CHARTER DOCUMENTS
GENERAL. Subject to shareholder approval prior to the effective time (the
"Effective Time") of the Reincorporation Merger, the Company will change its
domicile to Delaware and shall thereafter be governed by the DGCL and by the
Delaware Certificate and the Delaware Bylaws ("Delaware Charter Documents").
Upon the filing with and acceptance by the Secretary of State of Delaware of a
Certificate of Merger in Delaware, the Company will become AvTel Delaware and
the outstanding shares of Company Common Stock will be deemed for all purposes
to evidence ownership of, and to represent, shares of AvTel Delaware Common
Stock.
The Delaware Charter Documents effectively replace the Company's current
Amended and Restated Articles of Incorporation ("Utah Articles") and Amended and
Restated Bylaws ("Utah Bylaws") (together, the "Utah Charter Documents") by (i)
changing the authorized capital (See "Authorized Capital Stock"), (ii) setting a
range of 5 - 9 persons as the authorized number of directors and authorizing the
Board to fix the number of directors within that range by resolution (the Utah
Bylaws set a range of 3-5 persons and authorize the Board to amend the bylaws to
fix the number within that range), and (iii) providing officers, directors and
agents of AvTel Delaware with certain indemnification rights in addition to
those currently provided for the Company.
If the Reincorporation Merger is consummated, holders of Company Common Stock
and Company Preferred Stock (and holders of options, warrants or other
securities exchangeable for or convertible into Company Common Stock) will
become holders of AvTel Delaware Common Stock, which will result in their rights
as shareholders being governed by the laws of the State of Delaware. In
addition, their rights as shareholders will be governed by the Delaware Charter
Documents. It is not practical to describe all of the differences between the
Delaware Articles and the Utah Articles and the Delaware Bylaws and the Utah
Bylaws or all of the differences between the laws of the States
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of Delaware and Utah. The following is a summary of some of the significant
rights of the shareholders under Utah and Delaware law and under the Utah and
Delaware Charter Documents. This summary is qualified in its entirety by
reference to the full text of such documents and laws. See the Delaware
Certificate and the Delaware Bylaws, copies of which are attached to the Proxy
Statement as Exhibits C and D, respectively.
AUTHORIZED CAPITAL STOCK. The authorized capital stock of the Company
consists of 50,000,000 shares of Common Stock, and 5,000,000 shares of Preferred
Stock. The authorized capital stock of AvTel Delaware will be 20,000,000 shares
of AvTel Delaware's Common Stock $.01 par value and 1,000,000 shares of AvTel
Delaware's Preferred Stock, $.01 par value. The Company has issued and
outstanding 1,000,000 shares of Series A Convertible Preferred Stock which will
be converted into an aggregate of 250,000 shares of AvTel Delaware Series A
Convertible Preferred Stock having substantially the same rights, preferences
and privileges, including certain rights to convert such AvTel Delaware Series A
Convertible Preferred Stock into the AvTel Delaware Common Stock. (For details
with respect to the Series A Convertible Preferred Stock, see the Certificate of
Incorporation of AvTel Delaware attached as Exhibit C.) The conversion ratio of
one to one will remain the same. No holder of Company Common Stock has
preemptive rights with respect to any class of stock of AvTel Utah and no such
preemptive rights will be afforded the holders of AvTel Delaware Common Stock
under the Delaware Charter Documents. Upon consummation of the Reincorporation
Merger and the Share Exchange, there will be issued and outstanding: (a)
approximately 11,467,856 shares of AvTel Delaware Common Stock, of which
9,681,775 shares or 84% of the total issued and outstanding will be held by the
Matrix Shareholders; (b) 250,000 shares of Series A Convertible Preferred Stock
of AvTel Delaware (convertible into 250,000 shares of AvTel Delaware Common
Stock); (c) 276,787 shares of AvTel Delaware Common Stock reserved for issuance
pursuant to outstanding stock options, including those granted under the
Company's 1997 Stock Incentive Plan (the "1997 Plan") which will be assumed by
AvTel Delaware pursuant to the Reincorporation Merger, and the outstanding
options of Matrix, which will be assumed by AvTel Delaware after the Share
Exchange; and (d) 34,823 shares of AvTel Delaware Common Stock reserved for
issuance in connection with the possible grant of stock options in the future
under the 1997 Plan. The 11,467,856 shares of AvTel Delaware Common Stock to be
outstanding (and the 9,681,775 shares to be held by the Matrix Shareholders)
include 1,999,997 shares that will be held by Best. Under Delaware law, these
shares may not be voted or considered in determining the presence of a quorum
for shareholder action.
VOTING RIGHTS WITH RESPECT TO EXTRAORDINARY CORPORATE TRANSACTIONS
DELAWARE. Approval of mergers and consolidations and sales, leases or
exchanges of all or substantially all of the property or assets of a
corporation, requires the affirmative vote or consent of the holders of a
majority of the outstanding shares entitled to vote, except that, unless
required by the certificate of incorporation, no vote of shareholders of the
corporation surviving a merger is necessary if: (i) the merger does not amend
the certificate of incorporation of the corporation; (ii) each outstanding share
immediately prior to the merger is to be an identical share after the merger and
(iii) either no common stock of the corporation and no securities or obligations
convertible into common stock are to be issued in the merger, or the common
stock to be issued in the merger plus that initially issuable on conversion of
other securities issued in the merger does not exceed 20% of the common stock of
the corporation outstanding immediately before the merger.
UTAH. A merger, share exchange or sale of all or substantially all of the
assets of a corporation (other than a sale in the ordinary course of the
corporation's business) requires the approval of a majority (unless the articles
of incorporation, the Bylaws or a resolution of the board of directors requires
a greater number) of the outstanding shares of the corporation (voting in
separate voting groups, if applicable). No vote of the shareholders of the
surviving corporation in a merger is required if: (i) the articles of
incorporation of the surviving corporation will not be changed; (ii) each
shareholder of the surviving corporation whose shares were outstanding
immediately before the effective date of the merger will hold the same number of
shares, with identical designations, preferences, limitations and relative
rights, immediately after the merger; (iii) the number of voting shares
outstanding immediately after the merger, plus the number of voting shares
issuable as a result of the merger (either by the conversion of securities
issued pursuant to the merger or the exercise of rights and warrants issued
pursuant to the merger), will not exceed by more than 20% of the total number of
voting shares of the surviving corporation outstanding immediately before the
merger; and (iv) the number of participating shares (shares that entitle their
holder to participate without limitation in distributions) outstanding
immediately after the merger, plus the number of participating shares issuable
as a result of the merger
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(either by the conversion of securities issued pursuant to the merger or the
exercise of rights and warrants issued pursuant to the merger), will not exceed
by more than 20% the total number of participating shares of the surviving
corporation outstanding immediately before the merger.
SHAREHOLDERS CONSENT WITHOUT A MEETING
DELAWARE. Unless otherwise provided in the certificate of incorporation,
action requiring the vote of shareholders, including the removal and election of
directors, may be taken without a meeting, without prior notice and without a
vote, by the written consent of shareholders having not less than the minimum
number of votes that would be necessary to take such action at a meeting at
which all shares entitled to vote thereon were present and acted. As a result,
the Jensen Holders, acting together, will be able to elect directors and to take
many other significant corporate actions by written consent. Delaware law will
require AvTel Delaware to notify non-consenting shareholders promptly of any
such action.
UTAH. Unless otherwise provided in the articles of incorporation, action
requiring the vote of shareholders may be taken without a meeting and without
prior notice by one or more written consents of the shareholders having not less
than the minimum number of votes that would be necessary to take such action at
a meeting at which all shares entitled to vote thereon were present and voted
(if shareholder action is by less than unanimous written consent, notice shall
be provided to the shareholders who did not consent at least ten (10) days
before the consummation of the transaction, action or event authorized by the
shareholders). However, any written consent for the election of directors must
be unanimous and the shareholders of any corporation in existence prior to July
1, 1992, are required to adopt a resolution permitting action by less than
unanimous written consent otherwise, the shareholders are only permitted to act
by unanimous written consent.
DISSENTERS' RIGHTS
DELAWARE. Shareholders are entitled to demand appraisal of their shares in
the case of mergers or consolidations, except where (i) they are shareholders of
the surviving corporation and the merger did not require their approval under
the DGCL; (ii) the corporation's shares are either listed on a national
securities exchange or designated as a national market system security on an
interdealer quotation system by The National Association of Securities Dealers,
Inc.; or (iii) the corporation's shares are held of record by more than 2,000
shareholders. Appraisal rights are available in either (i), (ii) or (iii)
above, however, if the shareholders are required by the terms of the merger or
consolidation to accept any consideration other than (a) stock of the
corporation surviving or resulting from the merger or consolidation, (b) shares
of stock of another corporation which are either listed on a national securities
exchange or designated as a national market system security on an interdealer
quotation system by the National Association of Securities Dealers, Inc. Or held
of record by more than 2,000 shareholders, (c) cash in lieu of fractional
shares, or (d) any combination of the foregoing Appraisal rights are not
available in the case of a sale, lease, exchange or other disposition by a
corporation of all or substantially all of its property and assets.
UTAH. In connection with a merger, share exchange or sale, lease, exchange or
other disposition of all or substantially all of the assets of a corporation
(other than in the ordinary course of the corporation's business), a dissenting
shareholder, after complying with certain procedures, is entitled to payment
from the corporation of the fair value of the shareholder's shares. The fair
value is estimated by the corporation. However, if the shareholder is unwilling
to accept the corporation's estimate, the shareholder may provide the
corporation with an estimate of the fair value and demand payment of that
amount. If the corporation is unwilling to pay that amount, the corporation
shall apply for judicial determination of the fair value. Unless the articles
of incorporation, Bylaws or a resolution of the Board of Directors provide
otherwise, shareholders are not entitled to dissenters' rights when the shares
are listed on a national securities exchange or the National Market System of
NASDAQ, or are held of record by more than 2,000 holders. However, this
exception does not apply if, pursuant to the corporate action, the shareholder
will receive anything except (i) shares of the surviving corporation, (ii)
shares of a corporation that is or will be listed on a national securities
exchange, the National Market System of NASDAQ, or held of record by more than
2,000 holders, (iii) cash in lieu of fractional shares or (iv) any combination
of the foregoing.
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DIVIDENDS
DELAWARE. Dividends may be paid either (i) out of surplus (the excess at any
time of the net assets of the corporation over the amount of its capital), or
(ii) in case there is no surplus, out of the corporation's net profits for the
fiscal year in which the dividend is declared and/or its net profits for the
preceding fiscal year.
UTAH. A corporation is prohibited from making a distribution to its
shareholders if, after giving effect to the distribution, the corporation would
not be able to pay its debts as they become due in the usual course of business
or the corporation's total assets would be less than its total liabilities (plus
any amounts necessary to satisfy any preferential rights).
ANTI-TAKEOVER STATUTES
DELAWARE. Except under certain circumstances, the Delaware Law prohibits a
"business combination" between the corporation and an "interested shareholder"
within three (3) years of the shareholder becoming an "interested shareholder".
Generally, an "interested shareholder" is a person or group that directly or
indirectly, controls fifteen percent (15%) or more of the outstanding voting
stock or is an affiliate or associate of the corporation and was the owner of
fifteen percent (15%) or more of such voting stock at any time within the
previous three (3) years. A "business combination" includes a merger,
consolidation, sale or other disposition of assets having an aggregate value in
excess of ten percent (10%) of the aggregate market value of the consolidated
assets of the corporation or its outstanding stock, and certain transactions
that would increase the interested shareholders' proportionate share ownership
in the board of directors prior to the date the interested shareholder became an
interested shareholder under the DGCL, such business combinations between a
corporation and an interested shareholder are prohibited unless (a) prior to the
date the person became an interested director the Board of Directors approved
either the business combination or the transaction which resulted in the person
becoming an interested shareholder; (b) the interested shareholder acquired at
least eighty-five percent (85%) of the outstanding voting stock of the
corporation in the transaction in which the shareholder became an interested
shareholder excluding, for purposes of determining the number of shares
outstanding, shares held by persons who are directors and also officers and by
employee stock plans in which participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered; (c) the
business combination is approved by a majority of the board of directors and by
the affirmative vote of two thirds of the votes entitled to be cast by
disinterested shareholders at an annual or special meeting, (d) the corporation
does not have a class of voting stock that is listed on a national securities
exchange, authorized for quotation on an interdealer quotation system of a
registered national securities association, or held by more than two thousand
(2,000) shareholders unless any of the foregoing results from action taken,
directly or indirectly, by an interested shareholder or (e) the corporation has
opted out of this provision. AvTel Delaware has not opted out of these
provisions governing business combinations as permitted under the Delaware Law.
UTAH. The Utah Control Share Acquisitions Act, set forth in Sections 61-6-1
through 61-6-12 of the Utah Code Annotated, provides, among other things, that,
when any person obtains shares (or the power to direct the voting shares) of "an
issuing public corporation" such that the person's voting power equals or
exceeds any of three levels (20%, 33 1/3% or 50%), the ability to vote (or to
direct the voting of) the "control shares" is conditioned on approval by a
majority of the corporation's shares (voting in voting groups, if applicable),
excluding the "interested shares". Shareholder approval may occur at the next
annual meeting of the shareholders, or, if the acquiring person requests and
agrees to pay the associated costs of the corporation, at a special meeting of
the shareholders (to be held within fifty (50) days of the corporation's receipt
of the request by the acquiring person). If authorized by the articles of
incorporation or the Bylaws, the corporation may redeem "control shares" at the
fair market value if the acquiring person fails to file an "acquiring person
statement" or if the shareholders do not grant voting rights to control shares.
If the shareholders grant voting rights to the control shares, and if the
acquiring person obtained a majority of the voting power, shareholders may be
entitled to dissenters' rights under the URBCA. An acquisition of shares does
not constitute a control share acquisition if (i) the corporation's articles of
incorporation or Bylaws provide that this Act does not apply, (ii) the
acquisition is consummated pursuant to a merger in accordance with the URBCA or
(iii) under certain other specified circumstances.
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QUORUM OF DIRECTORS
DELAWARE. Unless a greater or lesser number is required for a quorum by the
certificate of incorporation or Bylaws (but in no event less than one-third of
the votes of the entire board or committee), a majority of the directors then in
office shall constitute a quorum.
UTAH. A quorum of the board of directors consists of a majority of the fixed
number of directors if the corporation has a fixed board size, or if the
corporation's Bylaws provide for a variable board size, a majority of the number
of directors prescribed, or if no number is prescribed, the number in office.
However, the articles of incorporation or the Bylaws may establish a higher or
lower number of directors to constitute a quorum, but in no event may the number
be less than one-third of the number of directors.
DERIVATIVE SUITS
DELAWARE. The plaintiff must have been a shareholder of the corporation at
the time of the transaction of which he complains or his stock thereafter must
have devolved upon him by operation of law.
UTAH. A person may not commence a derivative action unless the person was a
shareholder of the corporation at the time when the transactions complained of
occurred (unless the person became a shareholder through transfer by operation
of law from a person who was a shareholder at the time). The complaint must be
verified and allege with particularity (i) the demand made on the board of
directors and that either the demand was refused or ignored by the board of
directors, or (ii) if no demand was made on the board of directors, why the
person did not make the demand. If a court finds that the proceeding was
commenced without reasonable cause, the court may require the plaintiff to pay
the defendant's reasonable expenses, including counsel fees.
SPECIAL MEETINGS OF SHAREHOLDERS
DELAWARE. Shareholders generally do not have the right to call meetings of
shareholders unless such right is granted in the certificate of incorporation or
Bylaws. However, if a corporation fails to hold its annual meeting within a
period of 30 days after the date designated therefor, or if no date has been
designated for a period of 13 months after its last annual meeting, the Delaware
court of Chancery may order a meeting to be held upon the application of a
shareholder.
UTAH. Special meetings of the shareholders may be called by: (i) the board of
directors (ii) the person or persons authorized by the Bylaws to call a special
meeting, or (iii) the holders of shares representing at least 10% of all votes
entitled to be cast on any issue proposed to be considered at the special
meeting. The corporation shall give notice of the date, time and place of the
meeting no fewer than ten (10) and no more than sixty (60) days before the
meeting. Notice of a special meeting must include a description of the purposes
for which the special meeting is called.
AMENDMENTS TO CHARTER
DELAWARE. Amendments to the certificate of incorporation require the
affirmative vote of the holders of a majority of the outstanding shares entitled
to vote thereon, except that if the certificate of incorporation requires the
vote of a greater number of proportion of the directors or of the holders of any
class of stock than is required by Delaware Law with respect to any matter, the
provision of the certificate of incorporation may not be amended, altered or
repealed except by such greater vote.
UTAH. The board of directors may propose amendments to the articles of
incorporation for submission to the shareholders. For an amendment to be
adopted, (i) the board of directors must recommend the amendment to the
shareholders (unless the board determines that because of a conflict of interest
or other special circumstances it should not make a recommendation and
communicates the basis for its determination to the shareholders), and (ii)
unless the articles of incorporation, the Bylaws (if authorized by the articles
of incorporation) or a resolution of the board of directors require a greater
number, the amendment must be approved by (a) a majority of the votes entitled
to be cast
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on the amendment by any voting group as to which the amendment would create
dissenters' rights, (b) a majority of the votes entitled to be cast on the
amendment by any voting group as to which the amendment would materially and
adversely affect the voting group's rights in shares (including preferential
rights, rights in redemption, preemptive rights, voting rights or rights in
certain reverse splits), and (c) a majority of the votes cast for all other
voting groups (voting separately, as applicable, with shares constituting a
quorum present for each voting group).
NOTICE, ADJOURNMENT AND PLACE OF STOCKHOLDERS' MEETINGS.
DELAWARE. There is no specific statutory requirement under Delaware law with
regard to advance notice of director nominations and shareholder proposals.
Absent a bylaw restriction, director nominations and shareholder proposals may
be made without advance notice at the annual meeting. However, federal
securities laws generally provide that shareholder proposals that the proponent
wishes to include in the Company's proxy materials must be received not less
than 120 days in advance of the date stated in the proxy statement released in
connection with the previous year's annual meeting.
The Delaware Bylaws provide that, in order for director nominations or
shareholder proposals to be properly brought before the annual meeting, the
shareholder must have delivered timely notice to the Secretary of the
Corporation. To be timely under the Delaware Bylaws, notice must be received by
the Secretary of the Company not later than the following dates: (i) with
respect to a meeting of stockholders, 60 days in advance of such meeting if such
meeting is to be held on a day which is within 30 days preceding the anniversary
of the previous year's meeting, or 90 days in advance of such meeting if such
meeting is to be held on or after the anniversary of the previous year's
meeting; and (ii) with respect to any other meeting of stockholders or a special
meeting of stockholders, the close of business on the tenth day following the
date of public disclosure of the date of such meeting. These notice
requirements help ensure that shareholders are aware of all proposals to be
voted on at the annual meeting and have the opportunity to consider each
proposal in advance of the annual meeting.
UTAH. The Utah Law and Utah Charter Documents require that notice of
stockholders' meetings be given between ten (10) and sixty (60) days before a
meeting unless the stockholders waive or reduce the notice period by unanimous
consent in writing.
Both Utah and Delaware law provide for adjournments of stockholders' meetings.
The Utah Charter Documents require notice of the adjournment if the adjournment
is for thirty (30) days or more. Delaware Law and the Delaware Charter
Documents require that if the adjournment is for more than thirty (30) days or
if a new record date is fixed, notice must be given to the stockholders as for
an original meeting.
Both the Delaware law and Utah law permit meetings of stockholders to be held
at such place as is designated by or in the manner provided in the Bylaws. If
not so designated, Delaware law requires that the meeting be held at the
registered office of the Delaware corporation, while Utah law provides for the
principal office of the corporation.
DIRECTORS
DELAWARE. The Delaware Bylaws provide that the number of members of the Board
of Directors shall not be less than five (5), nor more than nine (9), with the
actual number being determined by a resolution of the Board of Directors or by
the holders of AvTel Delaware Common Stock at an annual meeting. A majority of
the number of directors then in office constitutes a quorum for the transaction
of business. The Delaware Bylaws provide that a vacancy among the
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directors may be filled for the unexpired term by the vote of a majority of the
remaining directors in office, although less than a quorum.
UTAH. The Utah Bylaws provide that the Board of Directors of the Company
consists of not less than three (3), nor more than five (5) directors with
actual number being determined by resolutions adopted by the Board of Directors
or the holders of Company Common Stock. A majority of the number of directors
constitutes a quorum for the transaction of business. The AvTel Utah Bylaws
provide that a vacancy among the directors may be filled for the unexpired term
by the affirmative vote of a majority of the remaining directors in office,
though less than a quorum.
ELECTION AND REMOVAL OF DIRECTORS
DELAWARE. The Delaware Bylaws provide that Directors shall hold office until
the next annual meeting of shareholders following their election. Any director,
or the entire Board of Directors, may be removed only for cause, and only by the
vote of a majority of the voting power of the Company. Vacancies on the board
may be filled by the directors or the shareholders.
UTAH. The Utah Bylaws provide that each Director shall hold office until the
next annual meeting of shareholders and until his or her successor shall have
been elected and qualified. Under the Utah law and the Utah Charter Documents,
directors may be removed by a majority vote of shareholders, with or without
cause. Vacancies on the board may be filled by the directors or the
shareholders.
INSPECTION OF BOOKS AND RECORDS
DELAWARE. Any shareholder of record, upon written demand under oath stating
the purpose thereof, has the right during the usual hours for business to
inspect for any proper purpose, the corporation's stock ledger, a list of its
shareholders and its other books and records and to make copies or extract
therefrom.
UTAH. Upon providing the corporation with a written demand at least five (5)
business days before the date the shareholder wishes to make an inspection, a
shareholder and his agent and attorneys are entitled to inspect and copy ,
during regular business hours, (i) the articles of incorporation, Bylaws,
minutes of shareholders meetings for the previous three (3) years, written
communications to shareholders for the previous three (3) years, names and
business addresses of the officers and directors, the most recent annual report
delivered to the State of Utah, and financial statements for the previous three
(3) years and (ii) if the shareholder is acting in good faith and for a proper
purpose, excerpts from the records of the board of directors and shareholders
(including minutes of meetings, written consents and waivers of notices),
accounting records and shareholder lists.
TRANSACTIONS WITH OFFICERS AND DIRECTORS.
DELAWARE. Under the DGCL, contracts or transactions in which a director or
officer is financially interested are not automatically void or voidable, if
approved by the shareholders or the directors under substantially the same
circumstances as in Utah. Approval by the shareholders, however, requires only
a simple majority. Board approval
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must be by a majority of the disinterested directors, but interested directors
may be counted for purposes of establishing a quorum.
UTAH. The Utah Law provides that every director who is in any way, directly
or indirectly, interested in a proposed contract or transaction with the Company
is liable to account to the Company for any profit made as a consequence of the
Company entering into such transaction unless such person (a) disclosed his or
her interest at the meeting of directors where the proposed transaction was
first considered, and, after his or her disclosure, the transaction was approved
by the a majority of the disinterested directors; (b) disclosed his or her
interest prior to a meeting or written consent of shareholders and, after his or
her disclosure, the transaction was approved by the a majority of the
disinterested shares; or (c) can show that the contract or transaction was fair
and reasonable to the Company.
LIMITATION ON LIABILITY OF DIRECTORS; INDEMNIFICATION OF OFFICERS AND
DIRECTORS.
DELAWARE. The Delaware Law permits a corporation to adopt provisions in its
certificate of incorporation eliminating or limiting the personal liability of a
director to the corporation or its shareholders for monetary damages for breach
of fiduciary duty as a director, with the following exceptions: (a) a breach of
the director's duty of loyalty; (b) payment of an unlawful stock dividend or
making an unlawful stock repurchase or redemption; (c) acts or omissions not in
good faith or involving intentional misconduct or a knowing violation of law; or
(d) in any transaction in which the director derived an improper personal
benefit. The Delaware Certificate eliminates the liability of directors of the
corporation for monetary damages to the fullest extent permissible under
Delaware Law.
The Delaware Law permits a corporation to indemnify its current and former
directors, officers, employees and other agents under circumstances similar to
those for which the Utah Charter Documents provide. The Delaware Charter
Documents require AvTel Delaware to indemnify all such persons whom it has the
power to indemnify to the fullest extent legally permissible by the Delaware
Law. The Delaware Bylaws permit AvTel Delaware to advance expenses to a
director or officer, provided that the director or executive officer undertakes
to repay amounts advanced if it is ultimately determined that such person is not
entitled to indemnification, and subject to such other conditions as the Board
may impose.
Indemnification rights conferred on a person by the Delaware Bylaws are deemed
to be contractual, in that their repeal or modification shall have prospective
effect only and shall not affect rights in effect under the bylaws at the time
of an alleged occurrence, act or omission that is the basis of a proceeding
against the person or the corporation. Indemnification rights to which a person
becomes entitled under the Delaware Bylaws continue after the person ceases to
be a director, officer, employee or other agent of AvTel Delaware.
Indemnification rights under the Delaware Law are not exclusive. Accordingly,
AvTel Delaware's Bylaws specifically permit AvTel Delaware to indemnify its
directors, officers, employees and other agents pursuant to an agreement, bylaw
provision, shareholder vote or vote of disinterested directors or otherwise, any
or all of which may provide indemnification rights broader than those currently
available under the Utah or Delaware indemnification statutes.
UTAH. The URBCA permits a corporation, if so provided in its articles of
incorporation, its bylaws or in a shareholder resolution, to eliminate or limit
the personal liability of a director to the corporation or its shareholders for
monetary damages due to any action taken or any failure to take action as a
director, except liability for: (a) improper financial benefits receive by a
director; (b) intentional inflictions of harm on the corporation or its
shareholders; (c) payment of dividends to shareholders making the corporation
insolvent; and (d) intentional violations of criminal law. The Utah Charter
Documents eliminate the liability of directors of the corporation for monetary
damages to the fullest extent permissible under URBCA.
Under the URBCA, a corporation may indemnify its current and former directors,
officers, employees and other agents made party to any proceeding because of
their relationship to the corporation against expenses, judgments, fines,
settlements and other amounts actually and reasonably incurred in connection
with such proceeding if that person acted in good faith and reasonably believed
his or her conduct to be in the corporation's best interests, and, in the case
of a criminal proceeding, had no reasonable cause to believe his or her conduct
was unlawful. The URBCA also permits a corporation to
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indemnify its directors, officers, employees and other agents in connection with
a proceeding by or in the right of the corporation to procure a judgment in its
favor by reason of the fact that the person is such an agent of the corporation,
against expenses actually and reasonably incurred by such person in connection
with the proceeding. The URBCA prohibits the indemnification of an agent in
connection with a proceeding by or in the right of the corporation in which the
director, officer, employee or agent was adjudged liable to the corporation, or
in connection with any other proceeding in which the agent is adjudged liable on
the basis that the agent derived an improper personal benefit. The Utah Charter
Documents permit indemnification of all such persons whom it has the power to
indemnify to the fullest extent legally permissible under the URBCA. The URBCA
permits a corporation to advance expenses incurred by a director, officer,
employee or agent who is a party to a proceeding in advance of final disposition
of the proceeding if that person provides (a) a written affirmation of his good
faith belief that he acted in good faith, in the corporation's best interests
and, in the case of a criminal proceeding, had no reasonable cause to believe
his conduct was unlawful; (b) a written undertaking by or on behalf of that
person to repay the advance if it is ultimately determined that such person's
conduct did not meet the statutory standard required for indemnification; and
(c) the corporation determines under the facts then known that indemnification
would not be precluded. The Utah Charter Documents permit such advances.
Both the Delaware Charter Documents and Utah Documents provide that AvTel
Delaware and the Company, respectively, may purchase insurance on behalf of
those persons entitled to be indemnified by the Company.
DISSENTERS' RIGHTS AS A RESULT OF THE REINCORPORATION MERGER.
Shareholders have dissenters' rights in Utah as a result of the proposed
Reincorporation Merger. Shareholders who oppose the Reincorporation Merger will
have the right to receive payment for the value of their shares as set forth in
sections 16-10(a)-1301 et .seq. of the URBCA. A copy of these sections is
attached hereto as Exhibit E to this Proxy Statement. The material requirements
for a shareholder to properly exercise his or her rights are summarized below.
However, these provisions are very technical in nature, and the following
summary is qualified in its entirety by the actual statutory provisions which
should be carefully reviewed by any shareholder wishing to assert such rights.
Under the URBCA, such dissenters' rights will be available only to those
common or preferred shareholders of the Company who (i) object to the proposed
Reincorporation Merger in writing prior to or at the Special Meeting before the
vote on the matter is taken (a negative vote will not itself constitute such a
written objection); and (ii) do not vote any of their shares in favor of the
proposed Reincorporation Merger at the Special Meeting.
Within ten days after the effective date of the Reincorporation Merger, AvTel
Delaware will send to each shareholder who has satisfied both of the foregoing
conditions a written notice in which AvTel Delaware will notify such
shareholders of their right to demand payment for their shares and will supply a
form for dissenting shareholders to demand payment. Shareholders will have 30
days to make their payment demands or lose such rights. If required in the
notice sent by AvTel Delaware, each dissenting shareholder must also certify
whether or not he or she acquired beneficial ownership of such shares before or
after the date of the first announcement to the news media of the proposed
transaction.
Upon receipt of each demand for payment, AvTel Delaware will pay each
dissenting shareholder the amount that AvTel Delaware estimates to be the fair
value of such shareholder's shares, plus interest from the date of the
completion of the Reincorporation Merger to the date of payment. With respect
to any dissenting shareholder who does not certify that he or she acquired
beneficial ownership of the shares prior to the first public announcement of the
transaction, AvTel Delaware may, instead of making payment, offer such payment
if the dissenter agrees to accept it in full satisfaction of his or her demand.
"Fair value" with respect to a dissenter's shares, means the value of the shares
immediately before the effectuation of the Reincorporation Merger and the Share
Exchange, excluding any appreciation or depreciation in anticipation of such
events.
Any dissenter who does not wish to accept the payment or offer made by AvTel
Delaware must notify AvTel Delaware in writing of his or her own estimate of the
fair value of the shares within 30 days after the date AvTel Delaware makes or
offers payment. If the dissenting shareholder and AvTel Delaware are unable to
agree on the fair value of the shares, then AvTel Delaware will commence a
proceeding with the Utah courts within 60 days after receiving the dissenter's
notice of his or her own estimate of fair value. If AvTel Delaware does not
commence such a proceeding within the 60-day period, it must pay each dissenter
whose demand remains unresolved the amount demanded by such dissenter. If a
proceeding is commenced, the court will determine the fair value of the shares
and may appoint one or more appraisers to help determine such value.
All dissenting shareholders must be a party to the proceeding, and all such
shareholders will be entitled to judgment against AvTel Delaware for the amount
of the fair value of their shares, to be paid on surrender of the certificates
representing such shares. The judgment will include an allowance for interest
(at a rate determined by the court) to the date of payment. The costs of the
court proceeding, including the fees and expenses of any appraisers, will be
assessed against AvTel Delaware unless the court finds that the dissenters acted
arbitrarily, vexatiously or not in good faith in demanding payment at a higher
amount than that offered by AvTel Delaware. Each of AvTel Delaware and the
dissenters must bear their own respective legal fees and expenses, unless the
court requires one party to pay such legal fees and expenses because of the
conduct of such party.
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The loss or forfeiture of appraisal rights simply means the loss of the
right to receive a cash payment from AvTel Delaware in exchange for shares. In
such event the shareholder would still hold the appropriate number of shares of
AvTel Delaware.
FEDERAL INCOME TAX CONSEQUENCES
The Reincorporation Merger is intended to be a tax free reorganization under
Section 368(a)(1)(F) of the Code. Assuming the Reincorporation Merger qualifies
as a reorganization, no gain or loss will be recognized to the holders of
capital stock of the Company as a result of consummation of the Reincorporation
Merger, and no gain or loss will be recognized by the Company or AvTel Delaware.
Each former holder of capital stock of the Company will have the same basis in
the capital stock of the AvTel Delaware received by such holder pursuant to the
Reincorporation Merger as such holder has in the capital stock of the Company
held by such holder at the time of consummation of the Reincorporation Merger.
Each shareholder's holding period with respect to the AvTel Delaware capital
stock will include the period during which such holder held the corresponding
Company capital stock, provided the latter was held by such holder as a capital
asset at the time of consummation of the Reincorporation Merger. The Company
has not obtained a ruling from the Internal Revenue Service or an opinion of
legal or tax counsel with respect to the consequences of the Reincorporation
Merger.
A successful IRS challenge to the reorganization status of the Reincorporation
Merger would result in shareholders recognizing taxable gain or loss with
respect to each share of Company Common Stock surrendered equal to the
difference between the shareholder's basis in such share and the fair market
value, as of the Effective Time, of the AvTel Delaware Common Stock received in
exchange therefor. In such event, a shareholder's aggregate basis in the AvTel
Delaware Common Stock so received would equal its fair market value as of the
Effective Time, and the shareholder's holding period for such stock would begin
the day after the Share Exchange.
THE FOREGOING IS ONLY A SUMMARY OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES.
SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISERS REGARDING THE SPECIFIC TAX
CONSEQUENCES TO THEM OF THE PROPOSAL TO REINCORPORATE IN DELAWARE INCLUDING THE
APPLICABILITY OF THE LAWS OF ANY STATE OR OTHER JURISDICTION.
IMPACT ON HOLDERS OF COMPANY PREFERRED STOCK
The AvTel Delaware Preferred Stock will have substantially the same rights,
preferences and privileges as the Company Preferred Stock. Shares of the AvTel
Delaware Preferred Stock will be convertible, on a one-for-one basis, into
shares of the AvTel Delaware Common Stock. For a general comparison of the
rights of stockholders under Delaware and Utah law, see "Comparison of
Shareholder Rights under Utah and Delaware Corporate Law and Charter Documents,"
above.
VOTE REQUIRED.
Under Utah law, the affirmative vote of a majority of the outstanding shares
of Company Common Stock and a majority of the outstanding shares of Company
Preferred Stock, each voting as a class, is needed to approve the proposed
Reincorporation Merger. If approved by the Company's shareholders, it is
anticipated that the Reincorporation Merger would be completed within thirty
(30) days of such approval and that consummation of the Share Exchange would
follow promptly thereafter. However, consummation of the Share Exchange is
subject to the satisfaction or waiver of various conditions precedent, including
the delivery of an executed Exchange Statement by each of the Matrix
Shareholders and optionholders.
Certain shareholders, including the Company's current Directors, who own
shares representing approximately 61% of the issued and outstanding shares of
the Company Common Stock have indicated that they will vote their shares in
favor of the Reincorporation Merger. In addition, the holders of all shares of
the Company's Preferred Stock have indicated that they will vote their shares in
favor of the Reincorporation Merger. Accordingly, without the affirmative vote
of any other shareholder, there will be sufficient votes for approval and
adoption of the Reincorporation Merger.
Although the Board of Directors has recommended that the foregoing proposal be
adopted, shareholders should be aware that the continuing Directors may have a
personal interest in the Reincorporation Merger because it broadens the scope of
indemnification available to Directors. The broader scope of indemnification
available under Delaware Law could result in increased costs and expenses to the
Company to the potential indirect detriment of the shareholders. See "Comparison
of Shareholder Rights under Utah and Delaware Corporation Laws and Charter
Documents".
RECOMMENDATION OF MANAGEMENT
FOR THE REASONS STATED ABOVE, THE BOARD OF DIRECTORS OF THE COMPANY BELIEVES
THAT THE TRANSACTIONS CONTEMPLATED BY THE PROPOSED REINCORPORATION MERGER ARE
DESIRABLE AND IN THE BEST INTERESTS OF THE COMPANY'S SHAREHOLDERS AND
UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE "FOR" SUCH PROPOSAL.
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DESCRIPTION OF THE COMPANY
BACKGROUND.
The Company is a non-facilities based telecommunications carrier providing
a comprehensive array of broadband voice and data network services. The Company
was incorporated on October 31, 1981, but did not commence its current business
until February, 1995 when it acquired, through a subsidiary, The Friendly Net,
LLC ("TFN") a Utah limited liability company.
The acquisition of TFN, a Utah-based Internet Service Provider ("ISP") was
part of a general strategy to evaluate and acquire business enterprises in the
telecommunications industry which, in the opinion of management, represented
opportunities for revenue growth and profitability. The TFN acquisition was
accomplished through an agreement with the Company's wholly owned subsidiary,
Hi, Tiger, Inc., pursuant to which 260,000 shares of Company Common Stock,
options to purchase 75,000 shares of Company Common Stock and $21,000 in cash
were exchanged for an 80% interest in TFN. The remaining 20% interest was
acquired in March 1997 from Tree of Stars, Inc., a Nevada corporation ("TOSI"),
whose President and principal shareholder is Paul G. Begum, a significant
shareholder of the Company and its former President and Chairman.
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
("A.I.") on that date. As a result of the acquisition of A.I., 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 non-facilities based telecommunications carrier providing a comprehensive
array of broadband voice and data network services.
The acquisition of A.I. was effected pursuant to the merger of a wholly-
owned subsidiary of the Company with and into A.I. (the "AI Merger") as a result
of which the Company acquired 100% of the issued and outstanding capital stock
of A.I. in exchange for 4,252,508 shares of the Company Common Stock,
representing approximately 61% of the issued and outstanding Company Common
Stock after giving effect to the AI Merger, and 1,000,000 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
A.I. as the acquirer.
Since the AI Merger, the Company has, under its current management team,
aggressively pursued selective acquisitions, strategic alliances and the
development and implementation of sales and marketing efforts.
BUSINESS OF THE COMPANY
ACQUISITIONS AND STRATEGIC ALLIANCES. In November, 1996, the Company
acquired Silicon Beach Communications, Inc. ("SBC"), a privately held California
corporation that serves as an ISP and provides software development services.
The acquisition was structured as a stock for stock transaction in which the
Company issued an aggregate of 115,000 shares of Company Common Stock in
exchange for all the issued and outstanding capital stock of SBC.
In February, 1997, the Company acquired all the issued and outstanding
capital stock of WestNet Communications, Inc. ("WNI"), a Ventura, California
ISP. Following completion of this acquisition, the Company
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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.
SALES AND OPERATIONAL STRATEGY. Prior to the AI Merger, the Company's
sales and operational strategy was directed, primarily, at increasing revenues
through expansion of the customer base for the TFN ISP operations.
Following the AI Merger, the Company's new executive management team also
began to develop and implement a comprehensive sales and marketing strategy
designed to position the Company as a leading provider of broadband network
services, providing complete internetworking solutions for small- and mid-size
business and professional offices and certain personal applications.
This strategy is based on the assumption that network connectivity for
these market applications is becoming a critical element in the ability of these
business, professional and other organizations to improve productivity and lower
costs through the use of a variety of telecommunications services, including
branch office, remote office and telecommuter networking as well as network
access to customers, vendors, financial institutions and the Internet. While
management expects that these factors will result in an increased 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.
The implementation of this strategy involves the creation and marketing of
products and services designed for both business and personal applications,
namely Business Network Services and Personal Network Services, respectively.
The Company is developing and implementing sales and marketing strategies which,
it believes, will result in monthly, recurring revenues from networking
customers under multi-year term agreements. However, this strategy is in its
formative stages and the Company is recruiting, hiring, training and developing
the personnel resources necessary to manage and staff the sales and marketing
efforts. Delays or other difficulties in these recruitment and other activities
could adversely affect the Company's ability to timely and effectively implement
these revenue-generating objectives.
INTERNETWORKING. At an increasing rate, business, professional and other
organizations are seeking to internetwork their Local Area Networks ("LANs") and
Wide Area Networks ("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 Company believes that, as a result of these shifts, internetworking,
the method used for interconnecting networks, has been undergoing rapid growth
over the past ten years as reflected in the significant growth in sales and
distribution of routers, remote access servers, intranet software and other
various components that enable internetworking. As the computing paradigm
migrates to client-server 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 point of contact.
NETWORK PROVISIONING. 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 World-Wide Web ("WWW")
and WWW applications developed with Internet-specific tools such as SUN
Microsystems' Java. These Web applications are
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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
. Leased lines are not suited for unscheduled and asynchronous
communications
As a result, 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.
The birth of "packet" based services such as X.25 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. While ATM
is not generally available through public carriers, Frame Relay services are now
widely offered throughout the United States and are increasing in demand.
COMPANY STRATEGY. The Company intends to be a leading provider of
broadband network services, providing complete internetworking solutions for
small to mid-size offices. The Company's services are sold through a network of
value added resellers and a direct sales force focused on select vertical
markets.
Wide Area Network connectivity for small to medium size offices is fast
becoming a critical element in each organizations' infrastructure. These
enterprises require branch office, remote office and telecommuter networking as
well as network access to customers, vendors and the Internet. As a result,
management believes that market demand has been created for flexible, cost-
effective internetworking solutions representing the following primary market
trends:
. Demand for WAN connectivity for small to medium size offices is
increasing
. Capabilities of server integrated internetworking are increasing
. Outsourcing of network services is increasing
Management believes that there are significant opportunities created by all
three trends in becoming an affordable, single source provider of integrated
voice and data internetworking solutions. The Company intends to market a
variety of products and services tailored around its PointStream point-to-point
facilities, FrameLink Frame Relay facilities, and Internet service through its
subsidiaries, TFN, SBC and WNI, providing customers with access through 1+, 0+,
800#, PPP, SLIP, frame relay, T1, T3, ISDN and virtual network sharing.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
NINE MONTHS ENDED JUNE 30, 1997
The decrease in total current assets at June 30, 1997, as compared with
September 30, 1996, relates, primarily, to the use of cash for operating
activities relating to the integration of the Company
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and AI following their merger, the integration of SBC and WNC, and increased
selling and general administrative expenses.
The increase in net fixed assets over the period resulted primarily from
the acquisitions of SBC and WNC in November, 1996 and February, 1997
respectively. The increase in notes receivable-related party is due to a short
term loan to the Company's Senior Vice President of Software Development and
Business Network Services Division President, which has since been repaid.
The increase in total liabilities at June 30, 1997, from September 30,
1996, arose, primarily, from the increase in trade payables arising from the AI
Merger and the acquisition of SBC and WNC; the increase in deferred revenue
associated with the acquisition of SBC and WNC which, in the course of its
business, is paid in advance by certain customers for ISP services; the increase
in notes payable relating to certain promissory notes issued in connection with
the AI Merger and acquisitions of SBC and WNC; a promissory note issued in
connection with the Exchange Agreement with Matrix; and certain deferred
compensation arrangements and accounts payable with certain officers and
directors.
Stockholders' equity decreased at June 30, 1997, from September 30, 1996,
as a result of the operating losses experienced during the period due,
primarily, to substantial costs and expenses incurred in connection with the AI
Merger, the acquisitions of SBC and WNC, and increased management and other
costs relating to the development and implementation of the Company's marketing
strategies. The AI Merger is treated, for accounting purposes, as a reverse
acquisition whereby the holders of AI's Common Stock acquired, after giving
effect to the AI Merger, a controlling interest in the Company. For financial
reporting purposes, comparative data for periods prior to the quarter ended June
30, 1997, reflects the financial condition and results of operation of AI only.
Since AI did not begin operations until August, 1996, no comparative financial
analysis is available for AI, with respect to the quarter ended June 30, 1996,
as compared to similar data for the Company, for the same quarter in 1997, as to
revenues, operating income and expenses, net income, cash and other topics that
would normally be addressed in statements of operations and cash flows.
TWELVE MONTHS ENDED SEPTEMBER 30, 1996
As of September 30, 1996, the Company (for financial accounting purposes,
meaning AI) had only been in operation for two months. Since AI did not begin
operations until August, 1996, no comparative financial analysis is available
for AI, with respect to the year ended September 30, 1996, or prior periods, as
to revenues, operating income and expenses, net income, cash and other topics
that would normally be addressed in statements of operations and cash
flows.
LIQUIDITY AND CAPITAL RESOURCES
Consistent with management's intentions to develop and execute the
Company's business sales and marketing strategies, it is anticipated that the
Company's needs for capital will in the near term exceed funds generated from
operations. The Company has, as a result of the AI Merger, acquired access to
the capital resources of AI. While these funds have been employed to support
the recent implementation of the Company's business and other strategies, other
capital resources will continue to be explored. Accordingly, management has
evaluated a number of alternative solutions to the Company's capital needs,
including secured and unsecured debt, capital equipment leases to facilitate the
anticipated growth of sales, marketing and technical development, issuance of
debt or equity securities, strategic alliances, or any combination of the
foregoing.
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Prior to the quarter ended June 30, 1997 and pursuant to the terms of the
Exchange Agreement, the Company has availed itself of an aggregate of $500,000
under the Matrix Loan. The Company has subsequently borrowed another $250,000
under the Matrix Loan. All amounts of principal and interest outstanding under
the Matrix Loan are due and payable on the earlier to occur of one hundred
eighty (180) days after termination of the Exchange Agreement or December 1,
1997. Management expects that, following consummation of the transactions
contemplated by the Exchange Agreement, the Company will be able to avail itself
of the additional capital resources of Matrix. While these additional resources
should be sufficient to support the near term business development and other
strategies of the combined companies, other capital resources may from time to
time be required by the Company.
There are no assurances that such other capital resources will be available
to implement management's objectives with respect to the combined companies
assuming that the transactions contemplated by the Exchange Agreement are
consummated. Further, if for some reason the transactions contemplated by the
Exchange Agreement are not consummated, the amounts outstanding under the Matrix
Loan would become due and payable as early as December 1, 1997. In such a case,
management would be required to explore alternative solutions to fulfill the
Company's capital requirements, including, payment of the indebtedness under the
Matrix Loan.
Under the circumstances, there are no assurances that the additional funds
necessary to satisfy the Company's repayment obligations and future capital
needs will be available, or, if available, that they will be in sufficient
amounts and under terms and conditions acceptable to the Company. If these
additional funds are not available in sufficient amounts or at the times and
under term acceptable to the Company, the Company may not be able to repay its
obligations, including the Matrix Loan. In that event, management may be
required to significantly curtail, restrict or delay the execution of some parts
of the Company's business strategy and such actions could have a material
adverse effect on the Company's ability to execute its business plan and
strategy.
INFLATION, COMPETITION AND REGULATION
The Company's operations have not been, and in the near term are not
expected to be, materially affected by inflation or changing prices. The
Company encounters competition from a variety of firms offering Internet
services in its market area. Many of these firms have long standing customer
relationships and are well-staffed and well financed. The Company believes that
competition in the Internet service industry is based on competitive pricing,
although the ability, reputation and technical support of a concern is also
significant. The Company does not believe that any recently enacted or
presently pending proposed legislation will have a material adverse effect on
its results of operations.
PROPERTIES
The Company leases facilities in three locations. The Company's corporate
location is approximately 1,500 square feet and is located at 130 Cremona Drive,
Suite C, Santa Barbara, CA 93117. The Company leases these facilities on a
month-to-month basis for a monthly rent of $1.65 per square foot. TFN's office
location is approximately 1,100 square feet and is located at 350 West
Broadway, Suite 111, Salt Lake City, UT 84101. TFN's office lease is rented on
a month-to-month basis at a monthly rate of $1,000. SBC's office location is
approximately 3,441 square feet and is located at 104 West Anapamu, Suite C,
Santa Barbara 93101. SBC leases this space under a 5 year lease at a monthly
rate of $4,645. In addition, the Company and its subsidiaries operate points-
of-presence for the purpose of creating local access points to its network
backbone. Only one of these locations, Provo, Utah, requires monthly rent in
addition to what is listed above, with 20 square feet of space at a monthly
rate of $100.00.
LITIGATION
There is no pending legal proceeding to which the Company is party that in
the opinion of management of the Company is likely to have a material adverse
effect on the Company's business, financial condition or results of operations.
-38-
<PAGE>
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company Common Stock is traded over-the-counter on the NASDAQ Electronic
Bulletin Board under the trading symbol "AVCO" (formerly "HITI"). There is no
established public trading market for the Company Preferred Stock. The
following high and low bid information for the Company Common Stock was provided
by the NASDAQ Electronic Bulletin Board. The quotations provided reflect inter-
dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions. On April 11, 1997, (the trading day prior to the
public announcement of the Company's intent to enter into the Matrix
transaction) the high and low sales prices for the Company Common Stock were
$2.00 and $1.12.
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30, 1996 HIGH BID LOW BID
<S> <C> <C>
First Quarter $0.5000 $0.5000
Second Quarter $0.8750 $0.5000
Third Quarter $1.4370 $0.7500
Fourth Quarter $1.0000 $1.0000
YEAR ENDING SEPTEMBER 30, 1997 HIGH BID LOW BID
First Quarter $1.3750 $0.5000
Second Quarter $0.8750 $0.5000
Third Quarter $4.5000 $0.7813
Fourth Quarter $3.7813 $2.4375
YEAR ENDING SEPTEMBER 30, 1998 HIGH BID LOW BID
First Quarter
(through October 25, 1997)
</TABLE>
On October 25, 1997, the bid and asked quotations for the Company Common
Stock as quoted on the NASDAQ Electronic Bulletin Board were $____ and
$_____.
The number of shareholders of record of the Company Common Stock as of
October 3, 1997, was approximately 172. At that date there were two record
holders of the Company Preferred Stock.
Following the closing of the transactions contemplated by Exchange
Agreement and subject to shareholder approval thereof, management intends to
submit an application to allow trading of AvTel Delaware Common Stock on the
NASDAQ National Market System ("NMS") or, if such application is for any reason
rejected, on the NASDAQ Small Cap System ("SCS"). While management believes
that the Company size, shareholder base and other factors will, following
completion of the Exchange Agreement, enable it to obtain trading on NASDAQ NMS
or NASDAQ SCS, there are no assurances that this will occur, in which event the
trading in AvTel Delaware Common Stock will continue to be reported on NASDAQ
Electronic Bulletin Board.
The Company has not paid any cash dividends 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 Common Stock unless (i) all
cumulative dividends on the Series A Convertible Preferred Stock have been fully
paid, and (ii) the holders of at 50% of the outstanding shares of the Series A
Convertible Preferred Stock have approved such dividend.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Existing Ownership of Company Common Stock
The following table sets forth certain information regarding beneficial
ownership of the Company Common Stock as of September 30, 1997, by (i) each
person who is known by the Company to own beneficially five percent or more of
the Company Common Stock, (ii) each of the Company's directors and executive
officers, and (iii) all current directors and executive officers as a
group.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF NUMBER OF SHARES
BENEFICIAL OWNER BENEFICIALLY OWNED /(1)/ PERCENT OF CLASS /(1)/
---------------- ------------------------ --------------------
<S> <C> <C>
Tree of Stars, Inc./(2)/ 830,278 11.3%
350 West 300 South
Salt Lake City, UT 84101
Paul G. Begum/(2)/ 830,278 11.3%
350 West 300 South
Salt Lake City, UT 84101
Peter D. Olsen 597,163 8.4%
521 North Arden Drive
Beverly Hills, CA 90210
Tommy Lin /(3)/ 600,000 7.8%
921 North Roxbury
Beverly Hills, CA 90210
Patrick Lin/(3)/ 400,000 5.3%
921 North Roxbury
Beverly Hills, CA 90210
Anthony E. Papa 2,051,854 28.7%
James P. Pisani 2,026,254 28.4%
Barry A. Peters 200,000 2.8%
Frank Dziuba/(4)/ 154,896 2.2%
D. Stephen Dewindt -- *
All directors and executive officers
as a group (5 persons)/(4)/ 4,433,004 61.7%
</TABLE>
* Represents less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Company Common Stock subject to options held by that person that
are currently exercisable or become exercisable within sixty (60) days
following September 30, 1997 are deemed outstanding. Shares of the Company
Common Stock into which the Company Preferred Stock may be converted, are
also deemed outstanding. In both cases, however, such shares of Company
Common Stock are not deemed outstanding for the purpose of computing the
percentage ownership of any other person. Unless otherwise indicated in
the footnotes to this table, the persons and entities named in the table
have sole voting and sole investment power with respect to the shares set
forth opposite such shareholder's name. On September 30, 1997, there were
7,138,327 shares of the Company Common Stock outstanding.
(2) Includes 561,667 shares held by Tree of Stars, Inc., a Utah corporation,
73,667 shares held by Paul G. Begum, the president and principal
shareholder of Tree of Stars, Inc., 50,000 shares that may be acquired
under options held by Tree of Stars, Inc. that were exercisable within 60
days of September 30, 1997, 144,444 shares that may be acquired upon
exercise of options held by Paul G. Begum that were exercisable within 60
days of September 30, 1997, and 500 shares owned by Paul G. Begum, as
custodian for Gibran Paul Begum.
(3) Tommy Lin's holdings consist of 600,000 shares of the Company Preferred
Stock, which were convertible at September 30, 1997 into 600,000 shares of
the Company Common Stock. Patrick Lin's holdings consist of 400,000 shares
of the Company Preferred Stock, which were convertible at September 30,
1997 into 400,000 shares of the Company Common Stock. Tommy Lin and
Patrick Lin, who are brothers, are the sole shareholders of all outstanding
shares of the Company Preferred Stock.
(4) Includes 49,896 shares that may be acquired under options that were
exercisable within 60 days of September 30, 1997.
Ownership of AvTel Delaware Common Stock After Proposed Transactions
The following table sets forth certain information regarding the expected
beneficial ownership of the AvTel Delaware Common Stock (based on the share
ownership of the Company Common Stock as of September 30, 1997) assuming the
completion of the Reincorporation Merger, the Reverse Stock Split and the Share
Exchange as contemplated by this Proxy Statement. This information is set forth
for (i) each person who is expected by the Company to own beneficially more than
five percent (5%) of the AvTel Delaware Common Stock, (ii) each of the AvTel
Delaware directors and executive officers, and (iii) the executive officers and
directors of AvTel Delaware as a group.
<TABLE>
<CAPTION>
Name and Address of Number of Shares
Beneficial Owner Beneficially Owned/(1)/ Percent of Class/(1)/
---------------- ----------------------- ---------------------
<S> <C> <C>
Ronald L. Jensen/(2)(3)/................................. 2,088,232 22.1%
4001 McEwen, Suite 200
Dallas, TX 75244
United Group Association, Inc./(2)(3)/................... 2,088,232 22.1%
4001 McEwen, Suite 200
Dallas, TX 75244
UA Plus, Inc./(2)(3)/.................................... 2,088,232 22.1%
4001 McEwen, Suite 200
Dallas, TX 75244
Janet Jensen Krieger/(3)/................................. 961,938 10.2%
9003 Airport Freeway
Fort Worth, TX 76180
Jeffrey J. Jensen/(3)/.................................... 951,013 10.0%
2121 Precinct Line Road
Hurst, TX 76054
James J. Jensen/(3)/..................................... 851,738 9.0%
6304 Alexandria Circle
Atlanta, GA 30326
Jami J. Jensen/(3)/...................................... 851,738 9.0%
1933 Swede Gulch
Golden, CO 80120
Julie J. Jensen/(3)/..................................... 851,738 9.0%
1023 15/th/ Street N.W
Washington, D.C. 20005
Anthony E. Papa.......................................... 512,963 5.4%
James P. Pisani.......................................... 506,563 5.4%
John E. Allen............................................ -- *
Ronald W. Howard......................................... -- *
Gregory T. Mutz.......................................... -- *
Frank Dziuba/(4)/........................................ 38,724 *
D. Stephen Dewindt....................................... -- *
All directors and executive officers
as a group (7 persons)/(4)/..................... 1,058,250 11.2%
</TABLE>
* Represents less than 1%
(1) Beneficial ownership is determined in accordance with the same rules
applied in the preceding table. Assuming completion of the Reincorporation
Merger, the Reverse Stock Split and the Share Exchange, there would have
been 11,467,856 shares of AvTel Delaware Common Stock outstanding as of
September 30, 1997. However, 1,999,997 of such shares would have been held
by Best, a wholly-owned subsidiary of Matrix subject to the terms of the
Best Option Plan. Under Delaware law, these shares may not vote.
Accordingly, the percentages of beneficial ownership shares in this table
are based upon 9,467,859 shares of AvTel Delaware Common Stock
outstanding.
(2) Includes 1,463,693 shares to be held by United Group Association, Inc.,
222,475 shares to be held by Ronald L. Jensen and 402,064 shares to be held
by UA Plus, Inc. UGA is wholly-owned by Mr. Jensen. Mr. Jensen is the
majority shareholder in UA Plus, Inc. Excludes shares held by Mr. Jensen's
adult children, Janet Jensen Krieger, Julie J. Jensen, James J. Jensen,
Jami J. Jensen and Jeffrey J. Jensen, and certain employees of companies
associated with Mr. Jensen, as to all of which Mr. Jensen disclaims
beneficial ownership.
(3) Pursuant to the terms of the Registration Rights and Lockup Agreement,
these shares may not be sold for two years after the completion of the
Share Exchange.
(4) Includes 12,474 shares that may be acquired under options that were
exercisable within 60 days of September 30, 1997.
-39-
<PAGE>
DESCRIPTION OF MATRIX
MATRIX IS A PRIVATELY-HELD CORPORATION AND, PRIOR THE CONSUMMATION OF THE
SHARE EXCHANGE, HAS NOT BEEN SUBJECT TO THE REPORTING REQUIREMENTS OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THE FOLLOWING INFORMATION
CONCERNING MATRIX HAS BEEN PROVIDED TO THE COMPANY BY THE MANAGEMENT OF MATRIX
FOR INCLUSION IN THIS PROXY STATEMENT.
BACKGROUND.
Matrix is a provider of domestic and international long distance
telecommunication services primarily to residential and small business customers
in the United States. Matrix began operations in 1990. The majority of
Matrix's sales and marketing is produced by three affiliated companies, each of
which generate a substantial portion of Matrix's revenue. One of these
affiliated companies is Best, which Matrix acquired by means of a share exchange
effective July 1, 1997.
The address of Matrix's principal place of business is 8721 Airport
Freeway, Fort Worth, Texas 76180 and its phone number is (817) 581-9380.
BUSINESS OF MATRIX
Matrix provides long distance service to over 200,000 customers in 49
states. Matrix's current strategy is to compete as a reseller, contracting with
Sprint Corporation ("Sprint"), Pacific Gateway Exchange, Inc. ("PGE"),
Cincinnati Bell Long Distance ("CBLD") and other quality carriers to provide
switching and transmission of its customer's traffic. Matrix is fully certified
or registered in all states where required and operates under Section 214
authority from Federal Communications Commission ("FCC"). Matrix has a national
Carrier Identification Code ("CIC") which enables Matrix to manage and control
its customer base more effectively. The CIC also permits Matrix 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."
Matrix has invested in call rating, billing, and customer service
infrastructure. In addition, Matrix has entered into billing and collection
agreements with local exchange carriers ("LECs"), including all of the Regional
Bell Operating Companies ("RBOCs"), General Telephone Operating Companies
("GTOCs") and Sprint local telephone companies. These billing agreements permit
Matrix to include its billing on the customer's local telephone bill. Matrix
believes that these LEC billing agreements are the most effective mechanism for
billing its residential customers, because of the convenience to its customers
of receiving one bill for both local and long distance service and the benefits
derived from the LECs' extensive collections infrastructure. Matrix's billing
information systems and services also allows it to provide direct bills to its
larger commercial customers, a market segment which Matrix is currently
expanding.
Matrix markets its services primarily through direct mail, outbound
telemarketing and a network of over 6,000 independent agents. Approximately 25%
of revenue is derived from casual calling. Although casual calling has been in
existence since the mid-1980s, only recently have companies such as Matrix begun
to aggressively pursue this market opportunity.
MARKETING AND SERVICES. Since it commenced operations in May 1990,
Matrix's primary focus has been on sales to the small business customer, defined
as businesses with ten employees or less, and residential customers. The
majority of sales have been generated through telemarketing, a network of about
6,000 independent agents, and casual calling derived from marketing by direct
mail. Matrix further intends to expand its customer base by adding medium sized
business customers (with billings up to $5,000 per month) through its Commercial
Division. A discussion of Matrix's service offerings and residential and
commercial marketing follows.
-40-
<PAGE>
Residential Services. Matrix markets its residential services under the
--------------------
Matrix brand name. Sales consist of both "1 plus" calling, for which the
customer must select Matrix as its long distance carrier, and casual calling.
Products consist of those indexed to AT&T's basic tariffed rate ("AT&T rate"),
whereby the customer is offered a defined percentage discount off the AT&T rate.
This satisfies the particular subscriber who prefers to be guaranteed a certain
discount rather than pay a fixed cost per minute. As AT&T rates change, Matrix
rates for these services change commensurably. The "1 plus" customer may also
choose services which have fixed charges for either "peak" and "off peak"
periods, or a "flat rate" which is the same 24 hours a day, 7 days a week.
Products which follow the "peak-off peak" structure generally have slightly
higher charges during the day, and lower charges during the nights and weekends,
than "flat rate" products, and are often more attractive to residential
subscribers who place the majority of their long distance calls during "off
peak" periods.
Casual calling represents about 25% of Matrix's revenue base and has the
potential to grow faster than the basic residential market. A prerequisite to
growing casual calling revenues is expansion of Matrix's leased facilities into
additional equal access areas. This presently requires the connection of
dedicated facilities known as Feature Group Ds ("FG-Ds") between LEC switching
facilities and those of Matrix's underlying network provider. Matrix markets
its residential services primarily through direct mail pieces that seek to
educate potential customers regarding casual calling and its benefits. Direct
mail is targeted towards residential customers within a specified geographic
region and includes a service explanation and dialing instructions, a general
pricing comparison, and a set of reminder stickers highlighting Matrix's CICs
for customers to keep near their telephone. Matrix has periodically conducted
subsequent mailings into its existing territory to stimulate incremental usage
by new and existing customers, and to build brand awareness. Matrix's
experience indicates that subsequent mailings into its geographic markets have
generated incremental new customer usage, in some cases with response rates
equal to initial mailings into such markets. Approximately 130 such areas are
served today, and Matrix plans to expand its coverage to include approximately
70% of the U.S. domestic market by the end of 1997.
Whether a residential customer dials Matrix's access codes or is
presubscribed, their calls will appear on the customer's regular monthly local
telephone bill.
Matrix's inbound customer service department is designed to complement
Matrix's "1 plus" and casual calling marketing strategies. Customer Service
Representatives ("CSRs") are available 24 hours a day, 7 days a week in order to
answer inquiries generated by Matrix'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.
Commercial Services. In order to provide an additional distribution
-------------------
channel for Matrix's telecommunications products and services, Matrix has
developed and begun to implement a plan to build a direct commercial sales
force. Matrix intends to open regional sales offices throughout the country in
order to market these services. Matrix's commercial sales agents will market
Matrix's services through personal contacts which will emphasize customer
service, network quality, value-added services, reporting, rating and
promotional discounts.
In addition to competitive rates and a wide variety of products, Matrix 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.
Other Value-Added Services. Matrix has introduced and is developing
--------------------------
additional value-added services to extend features available to its existing
customer base and to attract additional customers. Matrix currently offers 800
service, calling cards, and paging services as well as its basic long distance
services. In addition, Matrix expects to introduce other enhanced products, and
may decide to provide additional services, including the resale of local
telecommunications services, cellular and other wireless products and services,
Internet access, and other enhanced long distance products such as packet
switching, video conferencing and conference calling.
CUSTOMER SERVICES. To ensure that in-bound telemarketing and customer
service are always available, Matrix's customer service department operates 24
hours a day, 7 days a week to provide full-service support for its residential
and commercial customer base and to handle marketing inquiries from potential
and existing customers.
-41-
<PAGE>
Matrix's call centers 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 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 DATA PROCESSING. Matrix has dedicated substantial resources
to its management information systems. Matrix's information systems enable
Matrix to (i) monitor and respond to the evolving needs of its customers by
developing new and customized services; (ii) provide sophisticated billing
information that can be tailored to meet the requirements of its customer base;
(iii) provide high quality customer service; (iv) detect and minimize fraud; (v)
verify payables to suppliers; and (vi) integrate additions to its customer base.
In addition, Matrix has complete facilities for rating, formatting and
distributing direct bills to its larger commercial subscribers. Small business
customers may receive either a direct or a LEC bill, depending upon the services
provided to the customer.
COMPETITION. The telecommunications industry is highly competitive and
affected by rapid regulatory and technological change. Matrix 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. Matrix's future success will depend upon its ability to
compete with AT&T, MCI, Sprint and other carriers (including the RBOCs when
approved to enter the long distance market) and other long distance providers,
many of which have considerably greater financial and other resources than
Matrix.
Matrix believes it competes favorably in its targeted markets, due to its
effective sales channels, competitive pricing and customer service
infrastructure. Matrix also believes that its success will depend increasingly
on its ability to offer on a timely basis new services based on evolving
technologies and industry standards.
SELECTED FINANCIAL DATA
The following selected operations data of Matrix for the years ended December
31, 1996, 1995 and 1994 and balance sheet data as of December 31, 1996 and 1995
have been derived from Matrix's audited financial statements included herein.
The selected operations data of Matrix for the years ended December 31, 1993 and
1992, and balance sheet data as of December 31, 1994, 1993 and 1992 have been
derived from unaudited financial statements of Matrix. The selected financial
data as of June 30, 1997 and for the six months ended June 30, 1997 and 1996
have been derived from unaudited interim financial statements of Matrix. The
results of operations for the first six months of the year are not necessarily
indicative of the results for the full year. These selected financial data
should be read in conjunction with Matrix's "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Matrix's
financial statements and notes thereto included elsewhere herein.
-42-
<PAGE>
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
Six months ended June 30, Years ended December 31,
-------------------------- ------------------------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues $26,829,063 37,579,184 71,558,295 64,289,718 59,551,307 40,568,307 24,088,039
Operating income (loss) 349,730 2,176,360 4,091,034 2,422,393 604,109 (397,804) (365,051)
Net income (loss) 173,202 (261,215) 2,566,734 (2,440,493) 643,200 (474,797) 16,684
Net income (loss) per common
share (0.05) (0.09) 0.88 (1.19) 0.36 N/A N/A
Cash dividends per common
share - - - - - N/A N/A
Weighted average common
shares outstanding 3,484,260 2,754,037 2,919,978 2,044,296 1,800,000 N/A N/A
BALANCE SHEET DATA:
<CAPTION>
As of
June 30, As of December 31,
-------- ------------------------------------------------------------
1997 1996 1995 1994 1993 1992
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Working capital (deficit) $ 4,554,928 6,066,620 206,071 (140,741) (326,746) (418,851)
Total assets 18,720,707 20,338,404 17,580,694 14,957,279 11,167,630 11,253,619
Long term debt - - - - - -
Stockholders' equity 8,035,084 7,861,883 3,539,522 2,372,333 1,729,133 1,427,979
</TABLE>
N/A - not applicable
-43-
<PAGE>
Notes to Selected Financial Data of Matrix
(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 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, a 18 for 1 stock split was declared resulting in 3,484,260 shares being
then outstanding. All share amounts have been restated to reflect the stock
splits and share exchanges.
(3) In October 1995, Matrix issued 969,228 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 and as
of December 31, 1995 it was determined that the remaining investment in the DNS
acquired customer base totaling approximately $4,462,000 should be written off.
See note 7 to Matrix's financial statements for the three years ended December
31, 1996 included elsewhere herein.
-44-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The following table sets forth statement of operations data as a percentage of
revenues for the period indicated.
<TABLE>
<CAPTION>
-------------------------- ---------------------------------------
Six months ending June 30, Years ending December 31,
1997 1996 1996 1995 1994
-------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues 100.00% 100.00% 100.00% 100.00% 100.00%
Cost of revenues 68.26% 67.32% 66.62% 66.85% 67.29%
------- --------- ---------------------------------------
Gross margin 31.74% 32.68% 33.38% 33.15% 32.71%
Selling, general, and
administrative expenses 29.08% 25.46% 26.27% 27.83% 30.32%
Depreciation and amortization 1.36% 1.43% 1.39% 1.55% 1.37%
------- --------- ---------------------------------------
Total operating
expenses 30.43% 26.89% 27.66% 29.38% 31.69%
Operating income 1.30% 5.79% 5.72% 3.77% 1.01%
Interest Expense (0.03)% (0.47)% (0.32)% (0.01)% (0.30)%
Other income, net 0.09% 0.15% 0.38% 0.26% 0.15%
------- --------- ---------------------------------------
Income before
income taxes 1.37% 5.47% 5.77% 4.02% 0.87%
Income tax expense (benefit) 0.72% 2.41% 3.42% 1.68% (0.21)%
------- --------- ---------------------------------------
Income before equity in net
income (loss) of subsidiary 0.65% 3.07% 2.36% 2.33% 1.08%
Equity in net income (loss) of
subsidiary --- (3.76)% 0.17% (6.13)% ---
------- --------- ---------------------------------------
Net income (loss) 0.65% (0.70)% 2.53% (3.80)% (1.08)%
======= ========= =======================================
</TABLE>
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
Revenues: Total revenues for the six months ended June 30, 1997 decreased
28.6% or $10.8 million from $37.6 million for the six months ended June 30,
1996. The decrease was primarily the result of a reduction in sales by
affiliated distributors for Matrix. Matrix is dependent upon sales generated by
affiliated companies which represent 73.7% and 63.6% of total sales for the six
months ended June 30, 1996 and 1997 respectively. Total sales for affiliated
distributors for the six months ended June 30, 1996 were $28.2 million and
decreased to $17.3 million for the six months ended June 30, 1997.
Additionally, the resale of certain AT&T long distance products was discontinued
in June 1996. The customer base associated with these products continues to
decline through normal attrition. Sales from this channel decreased from $2.6
million sales for the first six months in 1996 to $847,000 for the first six
months in 1997. Matrix's strategy is to reduce its dependency upon a small
number of sales distributors, ultimately decreasing the associated risk
involved. Accordingly, revenues associated with non-affiliated sales channels
(excluding the AT&T base) increased 22.8% or $1.7 million to $9.1 million for
the six months ended June 30, 1997 from $7.4 million for the six months ended
June 30, 1996. Sales generated by these non-affiliated channels represent 33.3%
of total revenues for the six months ended June 30, 1997, compared to 19.3% for
the same period in 1996.
-45-
<PAGE>
Gross margin: Gross margin decreased 30.7% to $8.5 million for the six
months ended June 30, 1997 from$12.3 million for six months ended June 30,
1996. As a percentage of revenue, gross margin decreased 1.0% from 32.7% to
31.7% for the six months ended June 30, 1996 and 1997 respectively. The decrease
primarily resulted from an increase in the cost of long distance services which
includes network and bad debt. Matrix realized a reduction in network cost for
the six months ended June 30, 1996 from credits received from a major network
vendor. The first six months of 1997 reflect lower rates by the same vendor due
to a re-negotiated contract in the fourth quarter of 1996; however, the effect
is negated by the significant revenue decreases related to a major sales
distributor whose product line carried high gross margins. Additionally, overall
retail rates have been lowered to meet competitive industry demands;
accordingly, Matrix is experiencing decreasing product margins. Bad debt as a
percentage of revenue increased insignificantly to 2.8% for the six months ended
June 30, 1997 from 2.4% for the six months ended June 30, 1996. Actual bad debt
dollars decreased for the first six months in 1997 compared to the first six
months in 1996 due to decreased revenues.
Selling, general and administrative expenses: As a percentage of revenues,
selling, general and administrative expenses increased 3.6 % the first six
months of 1997 compared to the first six months of 1996, and actual expenses
decreased $1.8 million from $9.6 million for the six months ended June 30, 1996
to $7.8 million for the same period in 1997. The primary reason for the decrease
in actual expenses is that commissions paid to the sales distributors and
billing and collections fees paid to the local exchange carriers decreased $2.5
million. Both commissions and billing and collection fees are variable with
changes in revenues. Billing and collection fees did not change as a percentage
of revenue significantly and its' decrease in actual dollars in the first six
months of 1997 was primarily due to decreased revenues. Likewise, commissions
decreased as revenues dropped; however, as a percentage of revenue, commissions
decreased 2.4% compared to the first six months of 1996, primarily resulting
from the prepayment of future commissions to CoreMarketing, LLC, a distributor
affiliated with Matrix. The resulting prepaid commission expense is being
amortized over the estimated eighteen month life of the customer base. Certain
other selling, general and administrative expenses not necessarily variable with
revenues increased approximately $1.0 million or 6.5% in the first six months of
1997 over the same period in 1996. First, salary expense increased approximately
$68,000 primarily due to an increase in the number of employees in the call and
provisioning centers to accommodate certain affiliates with their back office
support, and to normal compensatory increases. Second, advertising expense of
approximately $604,000 was expended in the 1997 period incurred for direct
mailing to potential dial around casual customers. Third, professional and
legal services and certain regulatory fees associated with doing business as a
carrier increased a net amount of approximately $336,000 in the first six months
of 1997 compared to the first six months of 1996. Professional and legal
services increased $90,000 in the first six months of 1997, representing an
increase in professional services of $183,000 and a decrease in legal expense of
$93,000. Increases in professional services were primarily due to $84,000 to out
source special programming projects, $72 ,000 to out source telemarketing
services, and $17 ,000 to out source third party verification. Legal expenses
decreased in 1996 primarily from bringing in house certain tariff, state and FCC
reporting and filing requirements. Carrier fees specific to providing
telecommunication service increased $246,000 in the first six months of 1997 as
compared with the comparable period of 1996. This increase resulted from a new
fee payable by Matrix for having reached a certain threshold of customers.
Certain other overhead expenses decreased about $251,000 during the first six
months of 1997 compared to the same period for 1996. Office, equipment, travel
and rent expenses represented the greatest decrease.
Depreciation and amortization: Depreciation and amortization decreased 32.2%
or $173,000 to $364,000 for the six months ended June 30, 1997 from $537,000 for
the six months ended June 30,1996, primarily as a result of older assets of
Matrix being fully depreciated. As a percentage of sales, depreciation and
amortization decreased in the first six months of 1997 compared to the same
period in 1996 by a de minimis amount.
Interest expense and other income: For the six months ended June 30, 1997,
interest expense decreased 96.1% or $170,000 to $67,000 from $177,000 for the
six months ended June 30, 1996. Actual dollars decreased in 1997 from a
reduction in borrowing by Matrix for operations. As a percentage of revenues,
both periods represent insignificant amounts. Other income decreased 57.3% for
the period ended June 30, 1997 to $24,500 from $57,500 for the six months ended
June 30,1996. Actual dollars earned from interest on cash investments changed
insignificantly.
Income tax: Income taxes decreased $711,000 to $194 ,000 from $905,000
primarily due to decreased operating income. The effective tax rate was 42.0%
for the six months ended June 30, 1997 and 43.9% for the six months ended June
30, 1996.
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<PAGE>
Equity in net income (loss) of DNS: For the six months ended June 30, 1996,
Matrix's equity in the loss of a 100% owned subsidiary, DNS was ($1.4) million,
and cash advances to DNS were $3.9 million. In July 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 $5.3
million. Matrix recorded a gain on this sale of approximately $3.2 million
during the third quarter of 1996. The gain is recorded in equity in net income
(loss) of DNS in the statement of operations for the year ended December 31,
1996.
TWELVE MONTHS ENDED DECEMBER 31, 1996 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1995.
Revenues: Total revenues for the year ended December 31, 1996 increased 11.3%
or $7.3 to $71.6 million from $64.3 million for the year ended December 31,
1995. This increase was due primarily to increases in revenues from a major
affiliated distributor of the casual calling product. Prior to 1996, casual
calling services were limited to the state of California; however, in 1996
direct mail marketing of casual calling services was expanded to eleven
additional states increasing total revenues in 1996 over 1995 by greater than
$2.8 million. Additional revenues were from the resale of certain AT&T long
distance products. This sales program was implemented at the end of 1995 and
increased total sales over 1995 by approximately $3.0 million. Finally, new
distributors not actively selling Matrix products in 1995 increased total
revenues in 1996 by $1.5 million. Attrition rates associated with long distance
products are a normal industry occurrence; however, methods of calculation
differ within the industry. Matrix calculates its attrition at approximately
6.0% per month.
Gross margin: Gross margin increased 12.1% or $2.5 million, from $21.3
million for the year ended December 31, 1995 to $23.8 million for the year ended
December 31, 1996. As a percentage of revenue, gross margin increased from
33.2% in 1995 to 33.4% in 1996. Changes in gross margin were affected by two
factors accounted for in cost of long distance services. First, actual network
cost for the year ended December 31, 1996 increased $5.5 million from $40.6
million for the year ended December 31, 1995 to $46.1 million for the year ended
December 31, 1996. The majority of the actual dollars was due to increased
revenues. As a percentage of revenue, network cost increased 1.3% in 1996
compared to 1995. The primary reason for the increase was increased revenues
from distributors whose products are being sold at lower retail rates than in
the prior year in response to the competitive demand of the industry; thus,
decreasing Matrix's product margins. Second, bad debt expense decreased
$821,000 or 1.5% for the year ended December 31, 1996 from 3.7% for the year
ended December 31, 1995. Approximately $494 ,000 of the reduction in actual bad
debt resulted from revised estimates to reflect actual amounts received through
the local exchange carriers, Matrix's billing and collection agents.
Additionally, $327,000 of the reduction was related to travel card fraud.
Matrix changed its network vendor for its travel card services due to the new
vendor's ability to provide real time fraud monitoring. Travel card fraud was
less than $100,000 in 1996. Overall, the percentage decrease in bad debt was
greater than the percentage increase in the cost of network accounting resulting
in a small change in gross margin.
Selling, general and administrative expenses: Selling, general and
administrative expenses increased 5.1% or $910,000 to $18.8 million for the year
ended December 31, 1996 from $17.9 million for the year ended December 31, 1995.
As a percentage of revenues, these expenses decreased 1.5% from 27.8% in 1995 to
26.3% in 1996. Billing and collection expense reacts as variable expense and
fluctuates with changes in revenues. Billing and collection fees for the year
ended December 31, 1996 increased approximately $737,000 from $3.4 million for
the year ended December 31, 1995. As a percentage of revenue, billing and
collection fees changed insignificantly; therefore, its change was consistent
with the increase in revenues. Salary expense increased $742 ,000 in 1996 for
several reasons: $257,000 was paid for four new key employee positions in 1996,
and $178 ,000 was paid in salary and commissions related to two new sales
distributors in 1996. Additionally, $43 ,000 was paid in relocation and
recruitment expense, $121,000 was paid in salaries for six new employees among
several function areas, and $117,000 was paid in fees to temporary employment
agencies. The remaining increases were primarily compensatory in nature.
Commissions and professional and legal expense decreased by $454,000 and
$267,000 respectively for the year ended December 31, 1996. Actual commission
as a function of revenue normally changes in the same direction as changes in
revenues; however, commissions in 1996 decreased, but revenues increased. As a
percentage of revenues, commissions decreased 1.7% from 11.0% to 9.3% in 1996.
The change is due to in an increasing revenue base in 1996 for which commissions
are not paid; therefore commission as a percentage of revenues continues to
decline as these particular revenue bases grow. Professional and legal expenses
decreased $267,000 for the year ending December 31, 1996 compared to 1995. The
decrease relates primarily to expending $240,000 for various lawsuits and other
matters related to the conduct of its business. Management believes these
contingencies upon resolution will not materially affect the financial condition
of Matrix. Other net miscellaneous selling, general and administrative expenses
increased approximately $153,000
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<PAGE>
in 1996 over the prior year. Matrix moved its corporate offices due to space
constraints to a more suitable location and experienced approximately $81,000 in
additional costs in holdover penalties related to the prior location.
Interest expense and other income: Interest expense increased $225,000 from
$6,300 in 1995 to $231,000 in 1996. Matrix increased its borrowing from a
majority stockholder for use in operations. The note was extinguished by the
end of second quarter in 1996. Other income increased $106,000 in 1996 from
$166,000 in 1995. The increase was primarily from interest earned on cash
investments in the third and fourth quarters of 1996 and income earned from
affiliates from providing certain back office support.
Income taxes: Income taxes increased $605 ,000 from $1.1 million for the year
ended December 31,1995 to $1.7 million for the year ended December 31, 1996 due
to increased operating income. The effective tax rate was 40.8% and 41.8% for
the year ended December 31, 1996 and 1995 respectively.
Equity in net income (loss) of DNS: In October 1995, Matrix issued 53,846
shares of its common stock valued at $3.6 million in exchange for all of the
outstanding common stock of DNS Communications, Inc., a Houston based long
distance reseller. The transaction was accounted for under the purchase method
of accounting. The purchase price paid 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 should be written off. In July 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 $5.3
million. Matrix recorded a gain on this sale of approximately $3.2 million.
This gain is recorded in equity in net income (loss) of DNS in the 1996
statement of operations.
TWELVE MONTHS ENDED DECEMBER 31, 1995 COMPARED TO TWELVE MONTHS ENDED DECEMBER
31, 1994
Revenues: Total revenues for the year ended December 31, 1995 increased 7.9%
or $4.7 million from $59.5 million for the year ended December 31, 1994. The
increase primarily resulted from an increase in billed minutes of use from
casual calling customers. Matrix's major distributor of the casual product
significantly increased marketing activities to the international consumer.
Gross margin: Gross margin for the year ended December 31, 1995 increased 9.4%
or $1.8 million from $19.5 million for the year ended December 31, 1994. As a
percentage of revenues, gross margin increased .44% from 32.7% for the year
ended December 31, 1994 to 33.2% for the year ended December 31, 1995. The
increase in gross margin resulted primarily from a net reduction of
approximately $2.9 million in cost of long distance services which includes
network cost and bad debt. Actual network cost increased $2.6 million from
$38.1 million for the year ended December 31, 1994 primarily from increased
revenues in 1995; however, network cost as a percentage of revenues decreased
.73% for the year ended December 31, 1995 from 63.9% for the year ended December
31, 1994. The decrease resulted primarily from moving travel card traffic to a
new network provider resulting in savings of .08 cents per minute. Bad debt
expense for the year ended December 31, 1995 increased as a percentage of
revenue .29% or $348,000 from 3.37% for the year ended December 31, 1994.
Matrix was able to significantly reduce its travel card abuse by moving its
traffic to a vendor capable of providing real time monitoring of travel card
use. Other significant increases in bad debt expense were consistent with
increases in revenue.
Selling, general and administrative expenses: Selling, general and
administrative expenses decreased $168,000 or .93% for the year ended December
31, 1995 from $18.1 million for the year ended December 31, 1994. For the year
ended December 31, 1994, Matrix expended $1.1 million to deploy its nationwide
Carrier Identification Code ("CIC"). The CIC allows the end user in equal access
areas the opportunity to select a long distance carrier other than their primary
carrier. Other selling, general and administrative expenses increased for the
year ended December 31, 1995 compared to the year ended December 31, 1994.
First, salaries increased $383,000 primarily from an increase in the number of
employees during 1995. Second, Matrix expended $240,000 in 1995 for various
lawsuits and other matters related to the conduct of its business. Third,
carrier costs related to doing business within the telecommunications
environment increased $241,000 primarily as a result of a change in estimates to
reflect the actual costs. Finally, actual commissions increased $267,000 due to
increased sales in 1995; however, as a percent of revenue, commissions decreased
.42% as a result of an increase in billable minutes from a non commissioned
product.
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<PAGE>
Interest expense and other income: Interest expense decreased $171,000 or
96.4% for the year ended December 31, 1995 from $177,000 for the year ended
December 31, 1994. The decrease resulted from Matrix decreasing its borrowing
requirements. Matrix financed operations including its capital expenditures
from operating cash in 1995. Interest income increased $77,000 for the year
ended December 31, 1995 from $89,000 for the year ended December 31, 1994. The
increase was primarily a result of earned income on cash investments.
Income taxes: Income taxes increased $1.2 million to $1.1 million for the year
ended December 31, 1995 from a tax benefit of approximately $127,000 for the
year ended December 31, 1994. The increase was primarily due to increased
operating income in 1995. The effective tax rate was 41.8% for the year ended
December 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of operating cash flow for Matrix are revenues derived
from the resale of domestic and international long distance services to the
public. Minor sources of revenues are received for provision of back office
support to affiliated and non affiliated companies and for earnings from
investment income. The primary uses of cash are payments for the underlying
network vendors for provisioning long distance services, for commissions paid to
sales distributors and agents for solicitation of long distance services from
business and residential customers, and for billing and collections services
from the major local exchange carriers for billing and collecting directly from
the end user of long distance services. Matrix has financed its growth,
including its capital expenditures, through funds provided by operations. Net
cash provided from operations totaled $2.2 million for the six months ended June
30, 1997 and $1.8 million for the year ended December 31, 1996.
Matrix's accounts receivable decreased to $8.5 million at June 30, 1997 from
$10.5 million as of December 31, 1996, a decrease of $2.0 million. The decrease
is due to a corresponding decrease in sales generated for the six months ended
June 30, 1997.
Matrix loaned $2.4 million to affiliates (including, for these purposes,
AvTel) in 1997. $1.9 million was loaned to Core Marketing, LLC for the quarter
ended March 31, 1997, and $500,000 was loaned to AvTel for the quarter ended
June 30, 1997. For the six months ended June 30, 1996, Matrix had loans
outstanding from a wholly owned subsidiary, DNS for $3.9 million which were paid
in July 1996.
Current liabilities decreased to $10.3 million at June 30, 1997 from $11.7
million as of December 31, 1996, a decrease of $1.4 million. The decrease in
current liabilities is due to a corresponding decrease in sales generated for
the six months ended June 30, 1997.
Matrix financed its capital expenditures for purchases of furniture and
equipment from funds generated from operations for the six months ended June 30,
1997 and the year ended December 31, 1996 in the amounts of $127,000 and
$716,000 respectively. During recent years, Matrix has generated sufficient
cash flow from operations to fund its investing activities and repayment of
previous financing needs.
TRANSACTIONS WITH AFFILIATES
Dependence on Jensen-Controlled Companies for Marketing Services. Mr. Ronald
L. Jensen and his adult children own approximately 35% of UICI, a publicly-
traded insurance and financial services company. Among other things, UICI's
marketing organizations sell Matrix long distance products to their customers.
The adult Jensen children own approximately 80% of Core Marketing, LLC ("Core").
Core sells Matrix long distance services using its direct mail facilities and
its telemarketing facilities. United Group Association, Inc. ("UGA"), a company
owned 100% by Ronald L. Jensen, has provided sales and marketing services to the
Company. Effective December 31, 1996, UGA sold its agency force to UICI and its
telemarketing and direct mail operations to Core. Matrix paid sales commissions
and related payments to UICI, Core and UGA, together with certain other
affiliated entities (including Best Connections, which has subsequently been
acquired by Matrix) of $5,335,233 in 1996 and $6,314,878 and $5,108,123 in 1995
and 1994, respectively. For the six months ending June 30, 1997, such payments
totaled $782,661.
Network Services From Affiliate of Shareholders. Certain shareholders of
Matrix including Mr. Jensen, his adult children, Howard Neckowitz, Gail Granton,
Ron Anderson and Chuck Taylor, own in the aggregate in excess of 60% of the
outstanding shares of Pacific Gateway Exchange, Inc. ("PGE"), a public company.
PGE is a provider of international and domestic long distance telephone
services. Matrix purchases long distance services from PGE for
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<PAGE>
resale to its customers. Matrix paid PGE $20,527,236 for such services in 1996,
and $17,195,182 and $9,259,150 in 1995 and 1994, respectively. For the six
months ending June 30, 1997, such payments totaled $5,859,692.
Loans to Affiliates. During the first six months of 1997, Matrix made a loan
to Core in the total amount of $1,924,303. The loan is due September 1, 1998,
and is interest-free. Also during this period, an outstanding receivable from a
major shareholder for shares purchase was paid in the aggregate principal amount
of $723,600.
Employee Leasing. Matrix leases substantially all of its employees from
United Group Service Center, which is affiliated with other entities in which
the Jensen Holders have controlling interests. Matrix paid United Group Service
Center $4,542,007 for such leased employees' services in 1996, and $3,655,712
and $2,442,442 in 1995 and 1994, respectively.
For additional information on the above transactions, see Note 3 to the Matrix
Financial Statements for the year ending December 31, 1996, and Note 3 of the
Matrix Financial Statements for the six months ending June 30, 1997.
Conflicts of Interest. As noted above, the Company depends on certain
relationships with UICI and Core. The interests of UICI, Core and other
companies in which Mr. Jensen or other Matrix Shareholders own an interest may
conflict with the interest of the Company, including with respect to the amount
of compensation payable by the Company and the freedom of Mr. Jensen, such other
shareholders and such companies to engage in other activities, and with respect
to any negotiations of, disputes under, or breaches of any such agreements or
arrangements.
Pursuant to Delaware law, the Board of Directors of the Company will adopt a
policy that all material transactions in which there may be a conflict of
interest between the Company and Mr. Jensen or any other Matrix Shareholder (or
any entity affiliated or controlled by any of them) are reviewed and approved by
a majority of the independent members of the Board.
REGULATION
The services which Matrix provides 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 Matrix's services are
provided. In general, neither the FCC nor the relevant state PSCs exercise
direct oversight over cost justification for Matrix's services or Matrix's
profit levels, but either or both may do so in the future. However, Matrix is
required by federal and state law and regulations to file tariffs listing the
rates, terms and conditions of services provided. Matrix generally is also
required to obtain certification from the relevant state PSC prior to the
initiation of intrastate service, and is required to maintain a certificate
issued by the FCC in connection with the provision of international services.
Any 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 Matrix.
INTELLECTUAL PROPERTY
Matrix has registered several trademarks for use in its marketing materials.
The logo used by Matrix to market its long distance service is a registered
trademark of Matrix. While Matrix believes its registered trademarks are
important to its business in terms of further protecting its existing common law
right to use such trademarks, Matrix does not believe that failure to register
its trademarks poses any material risk of infringement on its rights to use such
trademarks.
EMPLOYEES
As of July 31, 1997, Matrix utilized approximately 110 full-time employees,
including employees of Best, its wholly-owned subsidiary. The majority of
these employees were leased from United Group Service Center. See "Transaction
with Affiliates - Employee Leasing." above. None of these employees are
represented by a union. Matrix supplements its work force from time to time
with contractors, administrative personnel through employment agencies, and part
time employees. Matrix believes that it has good relations with its
employees.
PROPERTIES
Matrix currently leases approximately 24,050 square feet of space for its
corporate headquarters at 8721 Airport Freeway in Fort Worth, Texas, pursuant to
a lease agreement expiring on June 30, 2000. The monthly rent (not including
electricity) as of June 30, 1997 is approximately $19,888.
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<PAGE>
LITIGATION
Matrix is a party from time to time to litigation or proceedings incident to
its business, including but not limited to, informal complaints before the FCC
and state agencies regarding certain marketing and billing issues. There is no
pending legal proceeding to which Matrix is party that in the opinion of
management of Matrix is likely to have a material adverse effect on Matrix's
business, financial condition or results of operations.
CAPITALIZATION AND RELATED MATTERS
The authorized capital stock of Matrix consists of 10,000,000 shares of Common
Stock ("Matrix Common Stock") of which 3,900,987 shares are issued and
outstanding and held, as of September 30, 1997, by 25 persons and entities. Of
such shares, 805,840 shares are held by Best, a wholly-owned subsidiary of
Matrix, and are the subject of options awarded or to be awarded by Best to
outside sales agents. These shares may not be voted or counted in determining a
quorum for shareholder action so long as they are held by Best. Of the
remaining 3,095,147 shares, 2,641,709, representing approximately 85% of such
remaining outstanding shares of Matrix, are held by the Jensen Holders. The
remainder of the shares of Matrix Common Stock are held by employees or former
employees of Matrix or other companies affiliated with Mr. Jensen. The Company
has been informed by Matrix that no formal agreements exist among the
shareholders of Matrix with respect to the voting of their common stock in
Matrix or AvTel Delaware.
There is currently no established public trading market for Matrix Common
Stock. Matrix has not paid any cash dividends on the Matrix Common Stock.
SHAREHOLDER PROPOSALS
No proposals have been submitted by shareholders of the Company for
consideration at the Special Meeting. It is anticipated that the next annual
meeting of shareholders will be held in February, 1998. Shareholders may present
proposals for inclusion in the Proxy Statement to be mailed in connection with
the next annual meeting of shareholders of the Company, provided such proposals
were received by the Company no later than September 12, 1997, and are otherwise
in compliance with applicable laws and regulations and the governing provisions
of the articles of incorporation and bylaws of the Company.
OTHER MATTERS
Management does not know of any business other than referred to in the Notice
which may be considered at the meeting. If any other matters should properly
come before the Special Meeting, such matters will be properly addressed and
resolved and those in attendance will vote on such matters in accordance with
their best judgment.
AVTEL COMMUNICATIONS, INC.
BY ORDER OF THE BOARD OF DIRECTORS
/S/ ANTHONY E. PAPA
SANTA BARBARA, CALIFORNIA
OCTOBER 31, 1997
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<PAGE>
INDEX TO FINANCIAL STATEMENTS
-----------------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
AvTel Communications, Inc. (Formerly AvTel Holdings, Inc.)
- ----------------------------------------------------------
Independent Auditors' Report F-1
Balance Sheet, September 30, 1996 F-2
Statement of Operations and Accumulated Deficit
For the Period from Inception to September 30, 1996 F-3
Statement of Changes in Shareholders' Equity
For the Period from Inception to September 30, 1996 F-4
Statement of Cash Flows for the Period
From Inception to September 30, 1996 F-5
Notes to Financial Statements F-6
Consolidated Balance Sheets September 30, 1996
and June 30, 1997 (Unaudited) F-9
Consolidated Statements of Operations For The
Three Months and Nine Months Ending June 30, 1997
and 1996 (Unaudited) F-11
Consolidated Statements of Cash Flows For The Nine
Months Ending June 30, 1997 and 1996 (Unaudited) F-12
Notes to Consolidated Financial Statements (Unaudited) F-14
Matrix Telecom, Inc.:
- ---------------------
Independent Auditors' Report F-16
Balance Sheets, December 31, 1996 and 1995 F-17
Statements of Operations
Years ended December 31, 1996, 1995 and 1994 F-18
</TABLE>
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<PAGE>
INDEX TO FINANCIAL STATEMENTS
-----------------------------
(Continued)
-----------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Statements of Stockholders' Equity
Years ended December 31, 1996, 1995 and 1994 F-19
Statements of Cash Flows
Years ended December 31, 1996, 1995 and 1994 F-20
Notes to Financial Statements
December 31, 1996, 1995 and 1994 F-22
Balance Sheets (Unaudited)
June 30, 1997 and December 31, 1996 F-30
Statements of Operations
For the Six Month Periods Ended June 30, 1997 and 1996 (Unaudited) F-31
Statements of Cash Flows
For the Six Month Periods Ended June 30, 1997 and 1996 (Unaudited) F-32
Notes to Financial Statements
June 30, 1997 and 1996 (Unaudited) F-33
</TABLE>
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<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
AvTel Holdings, Inc.
(Formerly AvTel Communications, Inc.)
We have audited the Balance Sheet of AvTel Holdings, Inc. (formerly AvTel
Communications, Inc.) (a California corporation) as of September 30, 1996 and
the related Statements of Operations and Accumulated Deficit, Changes in
Shareholders' Equity and Cash Flows from inception to September 30, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of AvTel Holdings, Inc.
(Formerly AvTel Communications, Inc.) as of September 30, 1996, and the results
of its operations and its cash flows for the period then ended, in conformity
with generally accepted accounting principles.
/s/ MACFARLANE, FALETTI & CO. LLP
MACFARLANE, FALETTI & CO. LLP
Santa Barbara, California
October 14, 1997
F-1
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
BALANCE SHEET
September 30, 1996
<TABLE>
<S> <C>
ASSETS
- ------
Cash and cash equivalents $ 985,237
----------
Total Assets $ 985,237
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Liabilities
- -----------
Accounts payable $ 51,381
Accounts payable - officers 40,683
Payroll taxes payable 6,024
----------
Total Liabilities 98,088
----------
Shareholders' Equity
- --------------------
Preferred Stock (5,000,000 shares authorized,
1,000,000 8% cumulative preferred shares issued
and outstanding, $1 par value) 1,000,000
Common Stock (10,000,000 shares authorized,
4,000,000 shares issued and outstanding, no par value) 3,000
Deficit accumulated during development stage (115,851)
----------
Total Shareholders' Equity 887,149
----------
Total Liabilities and Shareholders' Equity $ 985,237
==========
</TABLE>
See accompanying notes.
F-2
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
STATEMENT OF OPERATIONS AND ACCUMULATED DEFICIT
For the Period from Inception to September 30, 1996
<TABLE>
<S> <C> <C>
Income
Interest $ 4,813
Operating Expenses
Payroll $ 31,250
Employee benefits 1,316
Consultants 10,491
Telephone 3,902
Legal 55,095
Insurance 116
Rent 650
Travel and Meals 13,410
Computer supplies 2,488
Office supplies 1,591
Other expenses 355
--------
Total Expenses 120,664
----------
Accumulated deficit during development stage $ (115,851)
==========
</TABLE>
See accompanying notes.
F-3
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For The Period From Inception to September 30, 1996
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------- ------------
Amount Amount Retained
Shares Received Shares Received Deficit
------ -------- ------ -------- -------
<S> <C> <C> <C> <C> <C>
Balance at July 1, 1996 - $ - - $ - $ -
July 31, 1996: Shares of Series A
preferred stock issued to two
individuals for cash at 1.00 per share 1,000,000 1,000,000
July 31, 1996: Shares of common
stock issued to an individual
for cash and labor performed 1,499,950 1,000
July 31, 1996: Shares of common
stock issued to an individual
for cash and labor performed 1,499,950 1,000
July 31, 1996: Shares of common
stock issued to an individual
for cash and labor performed 1,000,100 1,000
Accumulated deficit during
development stage (115,851)
---------
Balance at September 30, 1996 1,000,000 $1,000,000 4,000,000 $ 3,000 $(115,851)
========= ========== ========= ======= =========
</TABLE>
See accompanying notes.
F-4
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
STATEMENT OF CASH FLOWS
For The Period From Inception to September 30, 1996
<TABLE>
<S> <C>
Cash flows from operating activities:
Net Loss $ (115,851)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Increase/(decrease) in:
Accounts payable 51,381
Accounts payable - officers 40,683
Accrued expenses 6,024
----------
Net cash used by operating activities (17,763)
----------
Cash flows from financing activities:
Issuance of preferred stock 1,000,000
Issuance of common stock 3,000
----------
Net cash provided by financing activities 1,003,000
----------
Increase in cash 985,237
Cash at beginning of period -
----------
Cash at end of period $ 985,237
==========
</TABLE>
See accompanying notes.
F-5
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
NOTES TO FINANCIAL STATEMENTS
NOTE 1: ORGANIZATION
AvTel Communications, Inc., (the Company) was formed July 16, 1996 under the
laws of the State of California. After September 30, 1996, the Company changed
its name to AvTel Holdings, Inc. The Company is in its development stages. The
Company is intended to be a holding company of non-facilities based
telecommunications carriers, providing a comprehensive array of broadband
network services, focused primarily on the business customer.
The Company's current management consists of key executives from the
telecommunications industry who are developing and implementing a business
strategy to integrate voice, data and video internetworking solutions for
small and mid-size offices and select vertical markets.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and cash equivalents:
All cash on hand and in bank checking accounts and certificates of deposits with
maturities of 90 days or less are considered to be cash and cash equivalents.
Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses during the
reporting period.
NOTE 3: CASH AND CASH EQUIVALENTS
Cash and cash equivalents consists of the following:
<TABLE>
<S> <C>
Demand deposit accounts $ 181,555
30 day certificate of deposit 203,682
60 day certificate of deposit 400,000
90 day certificate of deposit 200,000
---------
Total $ 985,237
=========
</TABLE>
F-6
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
NOTES TO FINANCIAL STATEMENTS
NOTE 4: AUDIT PERIOD
This audit covers the time period from inception (July 16, 1996) to September
30, 1996.
NOTE 5: PREFERRED STOCK
The preferred shareholders are entitled to receive preferred and cumulative
annual dividends at a rate of $.08 per share and are entitled to a preference,
in liquidation, in the amount of $1 per share plus accrued and unpaid dividends
declared. As of September 30, 1996 there were no cumulative preferred stock
dividends in arrears.
NOTE 6: INCOME TAXES
The Company has a net operating loss carryforward of approximately $118,000
which will expire in 15 years.
Income tax benefit / expense consists of the following:
<TABLE>
<S> <C>
Deferred tax benefit arising
from net operating loss carryforward $ 18,400
Less valuation allowance (18,400)
--------
$ 0
========
</TABLE>
NOTE 7: RELATED PARTY TRANSACTIONS
The Company is indebted to two shareholder/officers of the Company for the
reimbursement of operating expenses and accrued wages totaling $40,683.
Another shareholder in the Company paid for operating expenses for the company
for which the Company owes the shareholder $1,858.
F-7
<PAGE>
AVTEL HOLDINGS, INC.
(formerly AvTel Communications, Inc.)
A Development Stage Company
NOTES TO FINANCIAL STATEMENTS
NOTE 8: CONCENTRATION OF CREDIT RISK
During the current period, the Company had more than $100,000 on deposit with
one financial institution. The Federal Deposit Insurance Corporation (FDIC)
insures only the first $100,000 on deposit at any one financial institution.
NOTE 9: CONTRACTS
The Company has executed employment agreements with its two executive officers.
The term of employment is from August 1, 1996 to July 31, 1999 and may be
extended at that time. The agreements set forth the executives' compensation
packages and incentive packages.
NOTE 10: SUBSEQUENT EVENTS
On October 23, 1996, the Company completed a merger transaction (the "Merger")
in which it was acquired by Hi,Tiger International, Inc., a Utah corporation.
(Hi, Tiger was then renamed AvTel Communications Inc.) The transaction included
the cancellation of the 4,000,000 outstanding shares of common stock and
1,000,000 Series A preferred shares. The shares were exchanged for 4,252,508
shares of the Hi, Tiger (AvTel Communications Inc.) $.001 par value common
stock, comprising approximately 61% of the issued and outstanding common stock
after giving effect to the Merger, and 1,000,000 shares of newly authorized
shares of the AvTel Communications' Inc. Series A Convertible Preferred Stock.
F-8
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and June 30, 1997 - (Unaudited)
<TABLE>
<CAPTION>
ASSETS
- ------
As of As of
June 30, 1997 September 30, 1996
-------------- ------------------
<S> <C> <C>
Current Assets
Cash $ 431,405 $ 985,237
Other Current Assets 18,869 -
Notes Receivable - Related Parties 86,000 -
Accounts Receivable (Net of Allowance
for Doubtful Accounts of ($-0-) 206,871 -
---------- ----------
Total Current Assets 743,145 985,237
---------- ----------
Fixed Assets
Equipment 575,468 -
Furniture and Fixtures 22,479 -
Less Accumulated Depreciation (74,142) -
---------- ----------
Net Fixed Assets 523,805 -
---------- ----------
Intangible Assets
Goodwill 575,087 -
Organization Costs 6,709 -
Less Accumulated Amortization (8,683) -
---------- ----------
Total Intangible Assets 573,113 -
---------- ----------
Total Assets $1,840,063 985,237
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and June 30, 1997 - (Unaudited)
(Continued)
LIABILITIES AND STOCKHOLDERS EQUITY
- -----------------------------------
<TABLE>
<CAPTION>
As of As of
June 30,1997 September 30, 1996
------------ -------------------
<S> <C> <C>
Current Liabilities
Accounts Payable - Trade $ 198,397 $ 51,381
Accounts Payable - Officers 49,041 40,683
Accrued Liabilities 3,037 6,024
Deferred Revenue 123,013 -
Line of Credit - -
Notes Payable- Matrix 500,000 -
Notes Payable - WestNet Acquisition 128,099 -
Notes Payable - Employee 150,000 -
Lease Obligations-Current Portion 32,368 -
---------- ----------
Total Current Liabilities 1,183,955 98,088
---------- ----------
Long Term Liabilities
Lease Obligation 77,889 -
---------- ----------
Total Long Term Liabilities 1,261,844 -
---------- ----------
Total Liabilities $1,261,844 $ 78,652
---------- ----------
Stockholders Equity
Preferred Stock
(Par Value $1.00, Series A Convertible) 1,000,000 1,000,000
5,000,000 shares authorized
Common Stock (Par Value $.001) 7,136 3,000
50,000,000 shares authorized
7,135,807 and 4,000,000 shares issued and
outstanding 06/30/97 and 09/30/96.
Paid in Capital in Excess of Par Value 135,475 -
Retained Earnings/(Deficit) (564,219) (115,851)
Total Stockholders Equity 578,219 887,149
---------- ----------
Total Liabilities and
Stockholders Equity $1,840,063 $ 985,237
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-10
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months and Nine Months Ending June 30, 1997 and 1996 -
(Unaudited)
<TABLE>
<CAPTION>
Predecessor Company
For The Three For The Nine For The Three For The Nine
Months Ended Months Ended Months Ended Months Ended
June 30, 1997 June 30, 1997 June 30, 1996 June 30, 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES
- --------
Sales $ 734,567 $1,600,439 $ 84,104 $ 216,645
Cost of Sales 173,725 401,044 16,099 48,977
---------- ---------- ---------- ----------
Gross Margin 560,842 1,199,395 68,005 167,688
EXPENSES
- --------
General and Admin. 666,384 1,722,940 60,104 194,623
Bad Debt Expense - 2,235 2,576 4,362
---------- ---------- ---------- ----------
Total Operating Exp. 666,384 1,725,175 62,680 198,985
----------
Income (Loss) from Oper. (105,542) (525,780) 5,325 (31,317)
---------- ---------- ---------- ----------
Other Income/(Expense)
Interest Income 526 13,975 - 1,196
Miscellaneous Income 25,633 32,907 - 867
Interest Expense (694) (4,426) (773) (4,510)
---------- ---------- ---------- ----------
Net Other Income (Exp) 25,465 42,456 (773) (2,447)
---------- ---------- ---------- ----------
Income/(Loss) Before Taxes (80,077) (483,324) 4,552 (33,764)
Income Taxes - - - -
Minority Interest - (137) (4,611) (2,847)
---------- ---------- ---------- ----------
Net Income (Loss) (80,077) (483,461) (59) (36,611)
========== ========== ========== ==========
Weighted Average
Shares Outstanding 7,135,807 6,719,124 2,333,300 2,312,800
Earnings / (Loss)
Per Common Share $ (0.01) $ (0.07) $ (0.00) $(0.02)
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-11
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Nine Months Ending June 30, 1997 and 1996 - Unaudited
<TABLE>
<CAPTION>
Predecessor
Company
For The Nine For The Nine
Months Ended Months Ended
June 30, 1997 June 30, 1996
------------- --------------
<S> <C> <C>
Cash Flows From Operating Activities:
- -------------------------------------
Net Loss $(483,461) $(36,611)
Adjustments to reconcile net loss net cash:
Minority Interest - 2,847
Depreciation Expense 74,142 31,658
Amortization Expense 8,683 -
Forgiveness of Debts (40,900) -
(Increase)/decrease in:
Accounts Receivable (88,081) (3,837)
Other Assets - -
Interest Receivable - 9,309
Increase/(Decrease) in:
Accounts Payable (58,068) 24,518
Accounts Payable - Officers 8,358 -
Accrued Expenses (56,927) -
Deferred Income 36,288 -
Interest Payable - (41,892)
--------- --------
Net Cash Used in Operating Activities: (580,171) (14,008)
--------- --------
Cash Flows From Investing Activities
- ------------------------------------
Cash Received from acquisition of subsidiaries 57,094 -
Purchase of fixed assets (85,142) (18,776)
Purchase of intangible assets (177,500) -
--------- --------
Net Cash Provided (Used) By Investing Activities (205,548) (18,776)
--------- --------
Cash Flows From Financing Activities:
- -------------------------------------
Cash paid for short term loan receivable (86,000) -
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-12
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Nine Months Ending June 30, 1997 and 1996 - Unaudited
(Continued)
Supplemental Disclosures of Cash Flow Information
- -------------------------------------------------
<TABLE>
<CAPTION>
Predecessor Company
For The Nine For The Nine
Months Ended Months Ended
June 30, 1997 June 30, 1996
------------- ------------------
<S> <C> <C>
Cash paid on capital lease (39,991) (3,200)
Borrowing on notes payable 500,000 46,000
Cash payments on notes payable (142,122) (26,900)
Issuance of common stock - 24,500
--------- --------
Net Cash Provided (Used) By Financing Activities 231,887 40,400
--------- --------
Increase/(Decrease) in cash and cash equivalents (553,832) 7,616
Cash and Cash Equivalents at Beginning of Period 431,405 17,267
--------- --------
Cash and Cash Equivalents at End of Period $ 431,405 $ 24,883
========= ========
Cash paid for:
Interest expense $ 6,199 $ 46,402
Income taxes - 200
Non-cash transactions:
Issuance of 115,000 shares Common Stock
and $225,000 in contingent consideration
in Exchange for Interest in Silicon Beach
Issuance of 4,452,508 Shares of Common Stock
and 1,000,000 Shares of $1.00
par value Series A Convertible
Preferred Stock for acquisition
of AvTel Holdings, Inc.
Issuance of 35,000 Shares of Common Stock
and $188,325 in debt for the acquisition of WestNet Communications, Inc.
</TABLE>
F-13
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - INTERIM REPORTING
- ----------------------------
The unaudited consolidated financial statements included herein have been
prepared by AvTel Communications, Inc. and its subsidiaries (the "Company") in
accordance with generally accepted accounting principles and pursuant to the
rules and regulations of the Securities and Exchange Commission. Accordingly,
certain information and footnote disclosures normally included in complete
financial statements prepared in accordance with generally accepted accounting
principles have been omitted. The unaudited consolidated financial statements
and selected notes included herein should be read in conjunction with the
audited consolidated financial statements and the notes hereto included herein
and in the Company's Annual Report on Form 10-KSB for the year ended September
30, 1996. Operating results for the three month and nine month period ended
June 30, 1997, are not necessarily indicative of the results that may be
expected for the year ended September 30, 1997.
The foregoing unaudited consolidated financial statements reflect all
adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position and results of operations for the
periods presented. The financial statements have been presented reflecting the
effects of the reverse acquisition for accounting purposes (see Note 2). The
statements therefore reflect those of the subsidiary as if it were the parent
company. Accordingly, the balance sheet shown is therefore that of AvTel
Holdings, Inc. ("AHI"). The statement of operations has been presented with the
operating results of AHI and the historical operating results of Hi, Tiger
International, Inc. ("HITI"), the predecessor company, a Utah corporation,
since AHI has only been in existence since July, 1996 and did not commence
operations until August 1996. Accordingly, the cash flow statement is presented
reflecting the current changes of AHI as the parent company and the historical
information for HITI.
Note 2 - ACQUISITIONS
- -----------------------
In connection with its acquisition of all the issued and outstanding
capital stock of AHI, on October 23, 1996, the Company amended and restated its
Articles of Incorporation to, among other things, authorize 5,000,000 shares of
preferred stock. The Company's Board of Directors is authorized to designate
one or more series of such preferred stock and to designate the rights,
preferences and privileges of each such series. The AHI acquisition was
completed in accordance with an Acquisition Agreement dated August 30, 1996
("Acquisition Agreement"). The transaction was accomplished by way of a merger
(the "Merger") in which a wholly owned subsidiary of the Company was merged with
and into AHI which was the surviving entity and became a wholly owned subsidiary
of the Company. Pursuant to the Merger, the Company authorized and issued
1,000,000 shares of Series A Convertible Preferred Stock which have certain
liquidation preferences, bear a cumulative dividend, payable semi-annually, at
8% and are convertible, upon the happening of certain events, into shares of the
Company's $.001 par value common stock. The Merger has been accounted for as a
reverse purchase by AHI of the Company whereby the holders of AHI's Common Stock
acquired, after giving effect to the Merger, a controlling interest in the
Company. Accordingly, the assets and liabilities of the Company and its
subsidiary, The Friendly Net, LLC ("TFN"), are reflected at their fair market
values, as are the assets and liabilities of Silicon Beach Communications, Inc.,
which was acquired in November, 1996. The foregoing unaudited financial
statements reflect, for the previous periods noted, comparative data as to AHI
only. AHI began operations in August, 1996.
In November, 1996, the Company, through a subsidiary, acquired all the
issued and outstanding capital stock of Silicon Beach Communications, Inc., a
California corporation ("SBC") that serves as an Internet Service Provider
("ISP") and provides software development services.
In February, 1997, the Company, through a subsidiary, acquired all of the
issued and outstanding shares of stock of WestNet Communications, Inc., a
California corporation ("WNC") that serves as an ISP in certain regions of
southern California.
F-14
<PAGE>
In March , 1997, the Company, acquired the 20% minority interest in TFN, a
Utah limited liability company held by Tree of Stars, Inc. (TOSI), a Nevada
corporation of which Paul G. Begum is President and a principal shareholder.
Mr. Begum is the former president and Chief Executive Officer of the Company
who, together with TOSI owns directly or indirectly approximately 9.8% of the
issued and outstanding common stock of the Company. The acquisition was
facilitated through a payment of cash in the amount of $10,000 and the issuance
of $20,000 of short term loans. In addition, a loan payable to Mr. Begum has
been discounted from $40, 900 to zero. The note payable was in consideration of
consulting services performed by Mr. Begum prior to the Merger. Prior to
realizing a gain, the Company set this amount aside in a reserve account
intended be used to offset any unexpected expenses that might arise relating to
the Company's operation prior to the Merger (see Note 4).
Note 3 - RECENT DEVELOPMENTS
- ------------------------------
In March 1997, the Company's Board of Directors granted, pursuant to the
Company's 1997 Incentive Stock Option Plan (the "1997 Plan") a total of
849,900 stock options which are exercisable at $0.62 - $3.00 per share. Of the
total, 92,000 qualified stock options were issued to SBC employees in
conjunction with the terms of the acquisition of SBC, 50,0000 non-qualified
stock options to a non-employee in conjunction with the Merger and 43,000 non-
qualified stock options to consultants for services rendered. A total of 46,000
qualified stock options issued to SBC employees, the 50,000 non-qualified stock
options issued to the non-employee and the 43,000 non-qualified stock options
issued to consultants have vested as of June 30, 1997.
In April, 1997, the Company entered into a Stock Exchange Agreement (as
subsequently amended in August 1997, the "Exchange Agreement") with Matrix
Telecom, Inc., a Texas corporation ("Matrix") pursuant to which the Company will
issue to persons who own 100% of the issued and outstanding common stock of
Matrix (the "Matrix Stockholders") an aggregate of 38,330,056 of the Company's
$.001 par value common stock in exchange for 100% of the issued and outstanding
capital stock of Matrix. As a result of the transaction, the Matrix
Stockholders will, after giving effect to the exchange, acquire and hold
approximately 84% of the issued and outstanding common stock of the Company.
The consummation of the transaction under the Exchange Agreement is subject to
the satisfaction of a number of the terms and conditions, including a condition
that prior to the exchange, the Company's shareholders shall have approved the
transaction as well as a proposal to reincorporate the Company in the state of
Delaware. The Exchange Agreement also provides for the Company to effect
either a four to one reverse stock split. The Exchange Agreement additionally
provides for Matrix to provide to the Company a secured loan in the maximum
aggregate amount of $750,000, and that the transaction is intended to be a tax
free reorganization.
Note 4 - OTHER
- -----------------
In June 1997, the Company recognized a gain on the forgiveness of debt of
$40,900 as a result of eliminated its indebtedness to Paul Begum, former CEO and
Chairmen of the Board as part of an agreement to acquire the remaining 20%
minority interest in TFN. The agreement was executed in February, 1997, and the
forgiveness of debt was set aside in a reserve account intended be used to
offset any unexpected expenses that might arise relating to the Company's
operation prior to the Merger. Concurrently with recognizing this gain, the
Company recorded $12,500 in telecommunications expenses related to TFN's
business which had been previously in dispute with US West Communications.
These expenses had not been recorded by TFN in the periods for which they were
incurred and were therefore recognized as an expense in the current period. As
of June 30, 1997, it is believed that all expenses have been captured and the
remaining deferred revenue to Mr. Begum was recorded as income.
The Company additionally recognized a decrease in payroll expense in the
current period due to the elimination of the accrued liability for payroll and
payroll taxes for TFN and WNC in the amount of $46,000. The Company switched
its payroll services to outside company and in doing so changed the timing of
payroll payments to the fifteenth and last day of the month from the first and
fifteenth of the month. The Company, therefore , now recognizes all payroll
expenses in the month they are incurred.
F-15
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Matrix Telecom, Inc.:
We have audited the accompanying balance sheets of Matrix Telecom, Inc. as of
December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Matrix Telecom, Inc. at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 1996, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Dallas, Texas
January 24, 1997, except as to the first paragraph
of note 4 which is as of March 10, 1997.
F-16
<PAGE>
MATRIX TELECOM, INC.
BALANCE SHEETS
December 31, 1996 and 1995
<TABLE>
<CAPTION>
Assets 1996 1995
------ ------------ -----------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 4,622,395 3,164,053
Accounts receivable, net 10,507,580 9,997,081
Due from affiliates 1,212,414 834,150
Other current assets 2,200,751 251,960
----------- ----------
Total current assets 18,543,140 14,247,244
Investment and advances to DNS Communications, Inc. - 1,244,637
Property and equipment, net 1,621,355 1,796,398
Other assets, net 39,621 142,318
Deferred income taxes 134,288 150,097
----------- ----------
Total assets $20,338,404 17,580,694
=========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable and other accrued expenses $ 1,888,026 1,872,373
Accrued network service costs 4,863,663 6,419,260
Sales and excise taxes payable 1,676,677 1,694,367
Due to affiliates 2,597,559 3,340,222
Income taxes payable 554,596 377,463
Deferred income taxes - 337,487
Other liabilities 896,000 -
----------- ----------
Total current liabilities 12,476,521 14,041,173
----------- ----------
Stockholders' equity:
Common stock, no par value; authorized 10,000,000 shares,
3,484,260 and 2,769,228 shares issued at December 31,
1996 and 1995, respectively 7,532,026 5,336,815
Retained earnings (accumulated deficit) 769,441 (1,797,293)
Treasury stock, 69,120 common shares, at cost (439,584) -
----------- ----------
Total stockholders' equity 7,861,883 3,539,522
Commitments and contingencies
-----------
Total liabilities and stockholders' equity $20,338,404 17,580,694
=========== ==========
</TABLE>
See accompanying notes to financial statements.
F-17
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF OPERATIONS
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------- ----------- -----------
<S> <C> <C> <C>
Revenues $71,558,295 64,289,718 59,551,307
Cost of revenues 47,674,396 42,980,127 40,074,801
----------- ---------- ----------
Gross margin 23,883,899 21,309,591 19,476,506
----------- ---------- ----------
Operating expenses:
Selling, general and administrative 18,798,925 17,888,856 18,057,296
Depreciation and amortization 993,940 998,342 815,101
----------- ---------- ----------
19,792,865 18,887,198 18,872,397
----------- ---------- ----------
Operating income 4,091,034 2,422,393 604,109
Interest expense (230,922) (6,299) (176,922)
Other income, net 271,171 165,616 88,514
----------- ---------- ----------
Income before income tax expense 4,131,283 2,581,710 515,701
Income tax expense (benefit) 1,686,876 1,081,726 (127,499)
----------- ---------- ----------
2,444,407 1,499,984 643,200
----------- ---------- ----------
Equity in net income (loss) of DNS 122,327 (3,940,477) -
----------- ---------- ----------
Net income (loss) $ 2,566,734 (2,440,493) 643,200
=========== ========== ==========
Net income (loss) per share $.88 (1.19) .36
=========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
F-18
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Retained
earnings Total
Partners' Common (accumulated Treasury stockholders'
capital stock deficit) stock equity
------------ --------- ------------- --------- -------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1993 $ 1,729,133 - - - 1,729,133
Dissolution of partnership
and contribution of assets -
to a corporation (1,729,133) 1,729,133 - -
Net income - - 643,200 - 643,200
----------- --------- ---------- -------- ----------
Balance at December 31, 1994 - 1,729,133 643,200 - 2,372,333
Purchase of DNS
Communications, Inc.
(969,228 common shares) - 3,607,682 - - 3,607,682
Net (loss) - - (2,440,493) - (2,440,493)
----------- --------- ---------- -------- ----------
Balances at December 31, 1995 - 5,336,815 (1,797,293) - 3,539,522
Purchase of 69,120
common shares - - - (439,584) (439,584)
Issuance of 589,752
common shares - 2,195,211 - - 2,195,211
Net income - - 2,566,734 - 2,566,734
----------- --------- ---------- -------- ----------
Balances at December 31, 1996 $ 7,532,026 769,441 (439,584) 7,861,883
========= ========== ========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
F-19
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF CASH FLOWS
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
------------ ----------- -----------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) $ 2,566,734 (2,440,493) 643,200
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization 993,940 998,342 815,101
Amortization of advanced commissions 618,791 - -
Provision for bad debts 1,461,471 1,955,842 1,974,903
Loss on disposition of assets - - 14,365
Deferred income taxes (321,678) 530,885 (343,494)
Equity in (income) loss of DNS (122,327) 3,940,477 -
Changes in assets and liabilities:
Accounts receivable (1,971,970) (2,170,807) (2,994,971)
Due from affiliate 345,336 630,395 (1,452,481)
Federal and state income tax receivable - 631,183 (631,183)
Other current assets (393,781) (96,791) 161,967
Accounts payable, accrued and other liabilities (1,397,160) 526,850 5,051,696
Due to affiliate (742,663) 591,889 1,293,631
----------- ---------- ----------
Net cash provided by
operating activities 1,036,693 5,097,772 4,532,734
----------- ---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (701,718) (529,805) (1,125,444)
Payments for billing and collection agreements (14,482) - (17,600)
Purchase of acquired customer bases - (103,970) (32,723)
Repayments (advances) to DNS, net 1,577,432 (1,577,432) -
Proceeds from sale of property and equipment - 52,173 77,967
----------- ---------- ----------
Net cash provided by (used in)
investing activities 861,232 (2,159,034) (1,097,800)
----------- ---------- ---------
Cash flows from financing activities:
Net change in notes payable - - (3,230,121)
Purchase of common stock for treasury (439,583) - -
----------- ---------- ----------
Net cash used in financing activities (439,583) - (3,230,121)
----------- ----------
Net increase in cash and cash equivalents 1,458,342 2,938,738 204,813
Cash and cash equivalents at beginning of year 3,164,053 225,315 20,502
----------- ---------- ----------
Cash and cash equivalents at end of year $ 4,622,395 3,164,053 225,315
=========== ========== ==========
</TABLE>
F-20
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF CASH FLOWS
(Continued)
<TABLE>
<CAPTION>
1996 1995 1994
----------- ---------- -------
Cash paid (received) during the year for:
<S> <C> <C> <C>
Interest $ 212,404 6,300 175,134
========== ========= =======
Income taxes, net of refunds $1,482,103 (475,177) 847,179
========== ========= =======
Noncash financing activities:
Common stock issued for DNS acquisition $ - 3,607,682 -
========== ========== =======
Common stock issued for advanced commissions $2,195,211 - -
========== ========== =======
Common stock issued for receivable from
major shareholder subject to put options $ 723,600 - -
========== ========== =======
</TABLE>
See accompanying notes to financial statements.
F-21
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
(1) Summary of Significant Accounting Policies
------------------------------------------
(a) Business and Background
-----------------------
All references to the "Company" or "Matrix Telecom" refer to
Matrix Telecom, Inc. and its predecessors. The Company provides
long distance telephone service to its customers in forty-nine
states over intercity facilities provided by fully certified
dominant domestic and international carriers. Matrix resells to
both residential and commercial customers; however, the primary
focus is to the small business owner with five or fewer employees
whose usage resembles that of the residential customer. The
Company is fully certified by the Federal Communications
Commission and certified to operate in all states requiring such
certification. The Company holds billing and collection agreements
with all regional bell operating companies, GTE, and other
independent telephone companies.
The Company 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 (see note 4). 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 the
Company then owned by MCL were transferred to Matrix Telecom,
Inc., a Texas corporation. The transfer was a tax free transaction
and significant controlling interest in the company did not
change. Effective June 30, 1995, MCL was liquidated and its sole
asset (Matrix Telecom capital stock) was distributed to MCL's
partners in proportion to their ownership interests.
(b) Basis of Presentation
---------------------
The Company includes the operations of DNS Communications, Inc. in
its financial statements using the equity method of accounting.
The Company utilized the equity method due to the temporary period
of time that its investment in the operations of DNS was retained
(see note 7).
(c) Cash and Cash Equivalents
-------------------------
For purposes of the statement of cash flows, the Company considers
all demand deposits, time deposits, and other investments with a
remaining maturity at date of purchase of less than ninety days to
be cash equivalents.
(d) Commissions
-----------
Commissions to sales agents are paid and expensed based on a
percentage of billings as incurred.
Commissions paid in advance of $1,576,000 as of December 31, 1996,
included in other current assets, are being expensed over a period
of eighteen months based on estimated billings of the customers
for which the commissions were paid. (See note 4).
(e) Revenue Recognition
-------------------
Long distance revenues are recognized as service is provided to
customers.
(f) 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
F-22
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
depreciation of assets sold or retired are removed from the
accounts, and any resulting gain or loss is reflected in
operations. The Company provides depreciation on fixed assets
using the straight-line method over the estimated useful lives of
the respective assets.
(g) Income Taxes
------------
Effective January 1, 1994 the Company began accounting for income
taxes under the asset and liability 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.
Prior to January 1, 1994, the Company operated as a partnership.
Accordingly, the Company was not a taxable entity. Income taxes
were the responsibility of the individual partners.
(h) 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 financial statements and the reported amounts of
revenues and expenses during the reporting period to prepare these
financial statements in conformity with generally accepted
accounting principles. Actual results could differ from those
estimates.
(i) 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 LECs, 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.
(j) Accounts Receivable
-------------------
Accounts receivable are net of allowances for doubtful accounts
and other provisions of $626,790 and $730,354 as of December 31,
1996 and 1995, respectively. The Company establishes an allowance
for doubtful accounts based upon factors surrounding the credit
risk of subscribers, historical trends and other information.
(k) 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.
(l) Earnings (loss) per share
-------------------------
Earnings (loss) per share are computed based on average common
shares outstanding which were 2,919,978, 2,044,296, and 1,800,000
in 1996, 1995 and 1994, respectively.
F-23
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
(2) Property and Equipment
----------------------
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
Estimated ------------
useful life 1996 1995
----------- ------------ -----------
<S> <C> <C> <C> <C>
Communications system 2-5 years $ 1,328,679 1,328,679
Office furniture and equipment software 1-7 years 2,815,451 2,449,746
Leasehold improvements lease term 416,220 256,412
---------- ----------
4,560,350 4,034,837
(2,938,995) (2,238,439)
---------- ----------
$ 1,621,355 1,796,398
========== ==========
</TABLE>
Depreciation expense was $877,000, $882,000 and $683,000 for 1996, 1995 and
1994, respectively.
(3) 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"), an affiliated company, provides the Company with
significant domestic and international transmission services. Common
shareholders hold an interest in both PGE and the Company. Affiliates of the
Company also act as agents for the Company in the solicitation of new customers.
In addition, the Company's employees are leased from United Group Service
Center, an affiliate, who provides such services to a number of affiliated
companies. The Company provides long distance service to a number of affiliated
companies. Balances with affiliates are settled monthly.
Due from affiliates consists of the following:
<TABLE>
<CAPTION>
December 31
-----------
1996 1995
----------- -----------
<S> <C> <C>
Excell Agent Services (long distance services) $ 193,285 129,007
Interactive Media Works (IMW) 525 336,345
(long distance services)
Core Marketing (long distance services) 134,652 -
Other transactions with various affiliates 160,352 368,798
Receivable from major shareholder for 723,600 -
stock issued ---------- ----------
$1,212,414 $ 834,150
========== ==========
The due to affiliates consists of the following: 1996 1995
---------- ----------
PGE (network transmission services) $2,244,411 2,559,031
Group Association (UGA) and
Core Marketing (commission) 144,612 294,484
Other transactions with various affiliates 208,536 486,707
---------- ----------
$2,597,559 3,340,222
========== ==========
</TABLE>
F-24
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
Significant services and transactions incurred in the normal course of
operations with affiliated companies are summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ---------- ---------
<S> <C> <C> <C>
Network transmission services - PGE $20,527,236 17,195,182 9,259,150
Expenses paid on behalf of PGE for access services, for
which the Company was reimbursed 5,040,051 3,142,222 853,060
Expenses incurred for leasing employees from United
Group Service Center 4,542,007 3,655,712 2,442,442
Consulting fees to United Group Association ("UGA") - - 313,294
Sales commissions to affiliates: TravelCom 800, Core
Marketing, UICI, UGA and Best Connections 5,335,233 6,314,878 5,108,123
Long distance revenues from affiliates: UGA, UICI IMW,
and Core Marketing 5,445,903 3,180,302 1,240,203
Advances to TravelCom 800 - 126,500 468,609
Overhead expenses reimbursed to/from UGA Divisions 77,231 105,007 151,038
Interest paid to shareholder 173,380 6,299 175,134
</TABLE>
During 1996, the Company obtained loans from a significant shareholder for
working capital and other purposes of $4,900,000. Such amount was repaid
during 1996.
(4) Stockholders' Equity
--------------------
Matrix Telecom 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, the Company's then outstanding
1,000 shares of common stock were cancelled and 100,000 shares were distributed
to the prior MCL partners in proportion to their ownership interest in MCL. In
addition, effective March 10, 1997, an 18 for 1 stock split was declared. All
share amounts have been restated to reflect the stock splits and share exchange.
In October 1995, the Company issued 969,228 shares of its no par value common
stock valued at $3,607,682 for 100% of the outstanding shares of DNS
Communications, Inc. ("DNS"), a Houston based long distance reseller. Matrix
Telecom is a private company and accordingly, its stock does not have a readily
determinable market value. For purposes of determining the cost of DNS, the
stock consideration of $3.72 per share was valued based on the price paid by a
shareholder of the Company to purchase the Company's common stock issued to the
former owners of DNS in the acquisition of DNS (see note 7).
F-25
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
In December 1996, the Company issued 589,752 shares of its no par value common
stock to its majority shareholder in settlement of future commissions due to
affiliates also owned by this majority shareholder as of October 31, 1996. A
value of $3.72 per share was used in determining the number of shares to issue
in settlement of the $2,195,211 obligation. Of this amount, $619,000 was
expensed as commission expense in 1996.
Periodically the Board approves stock options for certain officers and
employees. Stock option transactions during 1995 and 1996 were as follows:
<TABLE>
<CAPTION>
Weighted-average
Exercise
Options Price
------- ----------------
<S> <C> <C>
Outstanding at December 31, 1994 - -
Granted 21,600 $5.56
-------
Outstanding at December 31, 1995 21,600 5.56
Granted 217,800 5.56
Cancelled 230,400 5.56
-------
Outstanding at December 31, 1996 9,000 5.56
=======
</TABLE>
As of December 31, 1996 and 1995 all outstanding options were exercisable.
Outstanding options do not expire. The Company accounts for its stock options in
accordance with the provisions of APB Opinion No. 25 as allowed by SFAS No. 123
"Accounting for Stock Based Compensation." Options granted in 1996 were
cancelled shortly after grant and accordingly no value has been attributed to
such options. The fair value of options granted in 1995 is not material based
on the minimum value method.
In connection with the cancellation of 194,400 of the above options during 1996,
the Company sold to such employees 194,400 shares of common stock at $3.72 per
share. As of December 31, 1996, the Company has recorded a $723,600 receivable
for such shares, which was subsequently collected. Proceeds used to pay for
these shares were loaned to the employees by a major shareholder of the Company.
Also as a part of this transaction, the Company and the employees entered into
agreements whereby such shares could be put or called, as applicable, under
certain conditions. As of December 31, 1996, the shares subject to this
agreement could be put or called at a price per share of approximately $4.61
totaling $896,000. Such amount has been included in other liabilities as of
December 31, 1996.
During May 1996 the Company purchased 69,120 shares of treasury stock for
$439,583.
F-26
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
(5) Leasing Activities and Other Commitments
----------------------------------------
The Company has no significant capital lease liabilities; however, the Company
leases office space and various equipment under operating leases expiring in
various years through 2000. In the normal course of business, operating leases
are generally renewed or replaced by other leases. Total rental expenses were
$325,000 in 1996, $239,000 in 1995 and $156,000 in 1994. Minimum future rental
payments at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997 $ 253,587
1998 265,552
1999 276,575
2000 253,527
---------
$ 1,049,241
=========
</TABLE>
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, 1996, there are
outstanding contractual agreements committing the Company to minimum usage
requirements for the duration of the contracts as set forth below:
<TABLE>
<S> <C>
1997 $14,925,000
1998 1,050,000
-----------
$15,975,000
===========
</TABLE>
(6) Federal and State Income Taxes
------------------------------
The Company was originally organized as a partnership and continued to operate
as a partnership until December 31, 1993. Effective January 1, 1994, the
Company became a C corporation for federal income tax purposes.
Deferred income taxes for 1996 and 1995 reflect the impact of temporary
differences between financial statement carrying amounts and tax bases of assets
and liabilities. The tax effects of temporary differences that give rise to
significant portions of the net deferred tax assets at December 31, 1996 and
1995 are presented below:
<TABLE>
<CAPTION>
December 31
---------
1996 1995
--------- ---------
Deferred tax assets:
<S> <C> <C>
Financial over tax amortization of purchased
customer base $134,288 150,097
Less valuation allowance - -
-------- --------
Net deferred tax asset 134,288 150,097
Deferred tax liabilities:
Tax versus financial recognition of expenses - (337,487)
-------- --------
Net deferred tax asset (liability) $134,288 (187,390)
======== ========
</TABLE>
F-27
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
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 the deferred tax asset is realizable.
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:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Computed "expected" tax expense (benefit) $ 1,404,637 870,502 175,338
State and local taxes, net of federal income
tax benefit 125,518 116,346 43,835
Deferred tax asset recorded at conversion
of partnership - - (346,672)
Other differences 156,721 94,878 -
--------- --------- --------
$ 1,686,876 1,081,726 (127,499)
========= ========= ========
The provision for income taxes consisted of the following:
1996 1995 1994
---------- ---------- -------
Current tax expense:
Federal $ 1,751,047 480,736 172,770
State and local 257,507 70,105 43,225
--------- --------- --------
2,008,554 550,841 215,995
Deferred tax expense (benefit):
Federal (254,350) 424,708 (274,794)
State and local (67,328) 106,177 (68,700)
--------- --------- --------
(321,678) 530,885 (343,494)
--------- --------- --------
$ 1,686,876 1,081,726 (127,499)
========= ========= ========
</TABLE>
The difference between the tax and book bases of the assets and liabilities of
the partnership upon dissolution and contribution to Matrix Telecom was recorded
as a deferred tax benefit as of January 1, 1994, the effective date of the
dissolution of the partnership.
(7) Acquisition
-----------
In October 1995, the Company issued 969,228 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. 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 and included the following:
<TABLE>
<CAPTION>
<S> <C>
Current assets $ 1,978,262
Acquired customer base 6,351,131
Other noncurrent assets 114,384
</TABLE>
F-28
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
(Continued)
<TABLE>
<S> <C>
Accounts payable and accrued expenses (2,346,102)
Deferred tax liability (2,489,993)
----------
Value assigned to common stock issued $ 3,607,682
==========
Summarized financial information related to DNS is as follows:
December 31, 1995
-----------------
Current assets $ 2,461,961
Noncurrent assets 555,739
------------
$ 3,017,700
============
Current liabilities (includes $1,577,432 payable to Matrix) $ 3,350,495
Shareholder's deficit (332,795)
------------
$ 3,017,700
============
</TABLE>
<TABLE>
<CAPTION>
Period from
Year Ended October 1, 1995 to
December 31, 1996 December 31, 1995
----------------- ------------------
<S> <C> <C>
Revenue $ 11,027,000 $ 4,277,000
Gain on sale of acquired customer bases 3,221,000 -
Net income (loss) 122,000 (3,940,000)
</TABLE>
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 $4,462,000
should be written off. Such amount net of related deferred taxes is included in
the loss of DNS reflected above for 1995.
In June 1996, the Company 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 the Company and a former
shareholder of DNS for approximately $5,270,000. The Company recorded a gain on
this sale of approximately $3,221,000. This gain is recorded in equity in net
income (loss) of DNS in the 1996 statement of operations.
(8) Contingencies
-------------
The Company presently has 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
of the Company.
F-29
<PAGE>
MATRIX TELECOM, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1997 1996
------------- -----------
(unaudited)
Assets
- ------
<S> <C> <C>
Current assets
Cash and cash equivalents $4,240,644 4,622,396
Accounts receivable, net 8,465,520 10,507,580
Due from affiliates 964,300 1,212,414
Other current assets 1,570,087 2,200,751
----------- ----------
15,240,551 18,543,141
Property and equipment, net 1,418,196 1,621,355
Loans to affiliates 1,924,303 -
Other assets, net 137,657 173,909
---------- ----------
$18,720,707 20,388,405
=========== ==========
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities
Accounts payable and other accrued expenses $1,891,342 1,888,026
Accrued network services costs 4,328,597 4,863,663
Sales and excise tax payable 1,341,572 1,676,680
Due to affiliates 2,207,665 2,597,559
Income tax payable 20,447 554,596
Other liabilities 896,000 896,000
----------- ----------
10,685,623 12,476,521
----------- ----------
Stockholders' Equity
Common stock 7,532,026 7,532,026
Retained earnings (accumulated deficit) 942,641 769,439
Treasury stock, 69,120 common shares, at cost (439,583) (439,583)
---------- ---------
8,035,084 7,861,883
----------- ----------
$18,720,707 20,338,405
=========== ==========
</TABLE>
See accompanying notes to financial statements.
F-30
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF OPERATIONS
For the Six Month Periods Ended June 30, 1997 and 1996
(Unaudited)
<TABLE>
<CAPTION>
1997 1996
------------- -----------
<S> <C> <C>
Revenues $26,829,063 37,579,184
Cost of Revenues 18,314,213 25,298,873
----------- ----------
Gross Margin 8,514,850 12,280,311
Operating expenses
Selling, general and administrative 7,800,920 9,566,846
Depreciation and amortization 364,200 537,105
----------- ----------
Total operating expenses 8,165,120 10,103,951
----------- ----------
Operating income (loss) 349,730 2,176,360
Interest expense (6,864) (176,689)
Other income, net (44,238) 57,525
----------- ----------
Income (loss) before income taxes 298,628 2,057,196
Income tax expense (benefit) 125,426 905,166
----------- ----------
173,202 1,152,030
Equity in net income (loss) of DNS - (1,413,245)
----------- ----------
Net income (loss) 173,202 (261,215)
=========== ==========
Net income (loss) per share 0.05 (0.09)
=========== ==========
Weighted average shares outstanding 3,484,260 2,754,037
=========== ==========
</TABLE>
See accompanying notes to financial statements.
F-31
<PAGE>
MATRIX TELECOM, INC.
STATEMENTS OF CASH FLOWS
For the Six Month Periods Ended June 30, 1997 and 1996
(unaudited)
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income (loss) $ 173,202 (261,215)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities
Depreciation and amortization 364,200 537,105
Amortization of advanced commissions 832,094 -
Provision for bad debts 668,948 842,918
Loss on disposition of assets 2,748 -
Equity in loss of DNS - 1,413,245
Changes in assets and liabilities:
Accounts receivable 1,373,111 (2,318,204)
Due from affiliates 24,514 (436,418)
Other current assets (201,430) (252,247)
Accounts payable, accrued and other
liabilities (1,401,002) 1,753,254
Due to affiliate (389,894) 507,665
----------- ----------
Net cash provided by operating activities 1,446,491 1,786,103
Cash Flows from Investing Activities:
Purchase of property and equipment (127,540) (574,729)
Advance to AvTel (500,000) -
Loans made to affiliates (1,924,303) -
Repayments (advances) to DNS, net - (3,978,905)
----------- ----------
Net cash used in investing activities (2,551,843) (4,553,634)
Cash Flows from Financing Activities:
Net change in notes payable - 2,896,000
Purchase of common stock for treasury - (439,583)
Repayment of affilate loans 723,600 -
----------- ----------
Net cash provided by financing activities 723,600 2,456,417
Net decrease in cash and cash equivalents (381,752) (311,114)
Cash and cash equivalents at beginning of period 4,622,396 3,164,053
----------- ----------
Cash and cash equivalents at end of period 4,240,644 2,852,939
----------- ----------
Cash paid during the period for:
Interest $ 11 173,380
=========== ==========
Income taxes, net of refunds $ 871,150 827,936
=========== ==========
</TABLE>
See accompanying notes to financial statements.
F-32
<PAGE>
MATRIX TELECOM, INC.
NOTES TO FINANCIAL STATEMENTS
June 30, 1997 and 1996
(Unaudited)
(1) Basis of Financial Reporting
----------------------------
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to rules and regulations
of the Securities and Exchange Commission; however, Matrix Telecom believes
the disclosures which are made are adequate to make the information
presented not misleading. These financial statements and footnotes should be
read in conjunction with the financial statements and notes thereto of
Matrix Telecom for the three year period ended December 31, 1996 included
elsewhere herein.
The unaudited financial information for the six months ended June 30, 1997 and
1996 has not been audited by independent public accountants; however, in the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the results of operations for the
six-month periods have been included therein. The results of operations for
the first six months of the year are not necessarily indicative of the
results of operations which might be expected for the entire year.
The balance sheet as of December 31, 1996, has been taken from the audited
financial statements as of that date.
(2) Proposed Merger
---------------
On April 29, 1997, Matrix Telecom entered into a Stock Exchange Agreement with
AvTel Communications, Inc. whereby AvTel would issue shares of its common
stock for all of the outstanding common stock of Matrix Telecom. After the
share exchange, the former shareholders of Matrix Telecom will hold
approximately 81% of the then-outstanding common stock of AvTel. The share
exchange is subject to AvTel shareholders' approval and various other
conditions to closing. The transaction will be accounted for as a reverse
acquisition of AvTel by Matrix Telecom using the purchase method of
accounting.
(3) Loans made to affiliates
------------------------
In March 1997, Matrix Telecom loaned approximately $1,924,000 to Core Marketing,
L.L.C., an affiliated company, with no interest, due September 1998. In June
1997, Matrix Telecom loaned AvTel Communications, Inc. $500,000 at rates
ranging from eight to fifteen percent, due by December 1997 or 180 days
after the termination of the Exchange Agreement. In February 1997, a major
shareholder repaid Matrix Telecom the $723,600 outstanding balance due for
the purchase of common stock.
(4) Sale of DNS
-----------
In July 1996, Matrix Telecom 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
Telecom and a former shareholder of DNS for approximately $5,270,000. Matrix
Telecom recorded a gain on this sale of approximately $3,221,000. This gain
is recorded in the equity in net income (loss) of DNS in the July 1996
statement of operations.
F-33
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REVISED PRELIMINARY COPY
AVTEL COMMUNICATIONS, INC.
REVOCABLE PROXY
FOR SPECIAL MEETING OF SHAREHOLDERS
NOVEMBER 20, 1997
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned shareholder of AvTel Communications, Inc., a Utah corporation
(the ''Company''), hereby appoints Anthony E. Papa and James P. Pisani and each
of them, with full power of substitution, as proxies for the undersigned to
vote, as designated below, and otherwise represent all the shares registered in
the name of the undersigned at the Special Meeting of Shareholders of the
Company to be held on November 20, 1997, at 10:00 a.m. at 130-B Cremona Drive,
Santa Barbara, California, and at any adjournment thereof, with the same effect
as if the undersigned were present and voting such shares, on the following
matters as set forth in the accompanying Proxy Statement. Either of such
proxies or their substitutes, as shall be present and shall act at said meeting
or any adjournment or adjournments thereof shall have and may exercise all the
powers of said proxies hereunder.
(1) APPROVAL OF SHARE EXCHANGE
_____ FOR ______ AGAINST _____ ABSTAIN
The ratification and approval of the Stock Exchange Agreement dated April
29, 1997, as amended, (the "Exchange Agreement") between the Company and Matrix
Telecom, Inc., a Texas corporation ("Matrix"), pursuant to which: (i) the
Company will acquire Matrix by way of a stock for stock exchange (the "Share
Exchange") with the shareholders of Matrix (the "Matrix Shareholders"); (ii) the
Matrix Shareholders, after giving effect to the Share Exchange, will own
approximately 84% of the issued and outstanding Common Stock of the Company;
(iii) holders of outstanding Matrix stock options would receive non-qualified
stock options of the Company; and (iv) the Company will enter into a
Registration Rights and Lockup Agreement which will provide certain registration
rights for, and restrictions on, certain of the Matrix Shareholders.
(2) APPROVAL OF REINCORPORATION MERGER
_____ FOR ______ AGAINST _____ ABSTAIN
The ratification and approval of an Agreement and Plan of Merger between
the Company and AvTel Communications, Inc., a Delaware corporation ("AvTel
Delaware") pursuant to which: (i) concurrently with, or immediately prior to,
the Share Exchange, the Company will change its state of incorporation from Utah
to Delaware by merging with and into AvTel Delaware, a newly-formed, wholly-
owned subsidiary of the Company (the "Reincorporation Merger"); (ii) AvTel
Delaware shall succeed to all the rights, benefits, duties and obligations of
the Company (including its rights, benefits, duties and obligations under the
Exchange Agreement described in the proposal above); (iii) outstanding shares of
the Company's Common Stock and Preferred Stock (and outstanding options to
purchase Common Stock) will be converted into shares of AvTel Delaware (or
options, as the case may be) on a four to one basis, with cash to be paid in
lieu of any fractional shares; (iv) the Certificate of Incorporation of AvTel
Delaware, as the surviving corporation, will be in substantially the form
attached to the Proxy Statement; and (v) the Bylaws of AvTel Delaware, as the
surviving corporation, will be in substantially the form attached to the Proxy
Statement .
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(2) OTHER MATTERS
As determined by a majority of the Board of Directors of the Company on
such other business, if any, as may properly come before the meeting or any
adjournments thereof.
The undersigned acknowledges receipt of the Notice of Special Meeting of
Shareholders and Proxy Statement dated October 31, 1997, together with the
Exhibits attached thereto.
PLEASE SIGN, DATE AND RETURN THIS PROXY PROMPTLY.
THIS PROXY WILL BE VOTED IN ACCORDANCE WITH INSTRUCTIONS INDICATED; HOWEVER, IF
NO INSTRUCTIONS ARE GIVEN, this Proxy will be voted FOR ratification and
approval of the Share Exchange and the Reincorporation Merger, and as determined
by a majority of the Board of Directors of the Company upon any other matter
properly presented to the meeting or at any adjournments thereof.
If the shares are held jointly, each holder should
sign. If signing for estates, trusts, partnerships
or corporations, title or capacity should be
stated. Sign exactly as the name(s) appear on the
stock certificate(s).
Dated: _________________________, 1997
(Signature) _______________________________
(Signature) ______________________________
SIGNATURES MUST CORRESPOND EXACTLY WITH THE NAME(S) APPEARING ON THIS PROXY.
EACH JOINT OWNER MUST SIGN. HOWEVER, WHERE SHARES ARE HELD IN JOINT TENANCY,
THE SIGNATURE OF ONE JOINT TENANT IS SUFFICIENT.
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
