<PAGE>
SCHEDULE 14C
(RULE 14c-101)
INFORMATION REQUIRED IN INFORMATION STATEMENT
SCHEDULE 14C INFORMATION
INFORMATION STATEMENT PURSUANT TO SECTION 14(c) OF
THE SECURITIES EXCHANGE ACT OF 1934
<TABLE>
<S> <C>
CHECK THE APPROPRIATE BOX:
/ / Preliminary Information Statement
/ / Confidential, for Use of the Commission Only (as permitted
by Rule 14c-5(d)(2))
/X/ Definitive Information Statement
</TABLE>
NETLOJIX COMMUNICATIONS, INC.
-------------------------------------------------------------
(Name of Registrant As Specified In Its Charter)
PAYMENT OF FILING FEE (CHECK THE APPROPRIATE BOX):
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<S> <C> <C>
/ / No fee required
/X/ Fee computed on table below per Exchange Act Rules 14c-5(g) and
0-11
(1) Title of each class of securities to which transaction
applies:
----------------------------------------------------------
(2) Aggregate number of securities to which transaction
applies:
----------------------------------------------------------
(3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11 (set forth the
amount on which the filing fee is calculated and state how
it was determined):
$7,052,529--maximum sale price
----------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
$7,052,529
----------------------------------------------------------
(5) Total fee paid:
$1,411
----------------------------------------------------------
/X/ Fee paid previously 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:
----------------------------------------------------------
</TABLE>
<PAGE>
[LOGO]
NETLOJIX COMMUNICATIONS, INC.
501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 884-6300
------------------------
November 8, 1999
To the Stockholders of NetLojix Communications, Inc.:
The enclosed Information Statement is being furnished to stockholders of
NetLojix Communications, Inc., a Delaware corporation formerly known as AvTel
Communications Inc. ("NetLojix"), in connection with action taken by written
consent of the stockholders (the "Written Consent") with respect to the sale of
Matrix Telecom, Inc. ("Matrix"), a wholly-owned subsidiary of NetLojix (the
"Sale").
We have made substantial changes lately, which we believe will provide our
stockholders and employees with greatly improved value. As you may know, we
agreed to sell all of the stock of Matrix to Matrix Acquisition Holdings Corp.
(the "Buyer"), a wholly-owned subsidiary of Platinum Equity Holdings, LLC
("Platinum"), pursuant to a Stock Purchase Agreement dated August 31, 1999, as
amended (the "Stock Purchase Agreement"), among NetLojix, Matrix and the Buyer
(as assignee of Energy TRACS Acquisition Corp., a wholly-owned subsidiary of
Platinum).
This decision was driven by our desire to maximize our focus on our core
competency of providing Enterprise Network Solutions to business customers. The
sale of Matrix is the result of our decision to exit the residential long
distance business. This area has become overwhelmingly competitive with
unprecedented downward pricing pressure and rising customer attrition rates. We
also believe that the challenges we experienced in this area overshadowed the
substantial growth we experienced in providing data communications services and
information technology support to businesses.
To mark this move and to better reflect our core mission of networking
services, on September 15, 1999 we changed our name to NetLojix
Communications, Inc. This move also created the opportunity for us to reorganize
the way we do business and service our customers. We have restructured our
operations into decentralized geographic regions putting us closer to our
customers. Each region contains the field management, sales, engineering and
service personnel necessary to design, build and manage our business customers'
data and voice networks.
Since this divestiture is a complete discontinuation of our operations in
the residential long distance marketplace, all of our future financial
statements will contain only the historical financial results of our core
businesses of providing Enterprise Network Solutions to business customers. This
should provide all stockholders with a clear picture of the progress we have
made to date.
We define an Enterprise Network Solution as the integration of technology,
people and a communications platform, which facilitate and enhance the
operations of our customers' business. Our primary objective is to provide our
customers with a solution, serve as their technology partner and grow with them
for the life cycle of their enterprise. Our services include the communications
network which accounts for approximately 60% of our revenue, information
technology support services and eBusiness solutions.
Our regional sales representatives are targeting mid-size businesses, which
generally employ between 50 and 500 people. This is a very large segment of
businesses in the United States. Our target customer within this segment
generally has multiple locations and an expanding workforce of remote and mobile
employees and is overwhelmed by the chaos and confusion of changing technology.
Its spending on enterprise-wide network services is primarily driven by the
deployment of new technology and applications that require increased bandwidth
and support. We believe that this spending will continue to increase as
<PAGE>
our customers' businesses grow and they require future upgrades and enhancements
to their existing network infrastructures.
We believe that we have a unique opportunity to capture our share of this
marketplace and build strong, long-term relationships with the management teams
of these businesses.
The enclosed Information Statement is being mailed on or about November 8,
1999, to all stockholders of record at the close of business on October 20,
1999. Holders of approximately 65.1% of NetLojix's common stock have executed
the Written Consent approving the Sale and the Stock Purchase Agreement as of
the date of the attached Information Statement. However, such transactions will
not be effected until at least 20 days after the Information Statement has first
been sent to stockholders. The consummation of the Sale is also subject to the
satisfaction of several conditions, including certain regulatory approvals.
Your Board of Directors has fully reviewed and considered the terms and
conditions of the Sale and determined that the Sale is fair and in the best
interests of NetLojix and its stockholders. Your Board of Directors has approved
the Sale and the Stock Purchase Agreement.
Thank you for your continued support. Please visit our new web site at
www.netlojix.com.
Sincerely,
NETLOJIX COMMUNICATIONS, INC.
[LOGO]
Anthony E. Papa
Chairman and Chief Executive Officer
WE ARE NOT ASKING YOU FOR A PROXY
AND YOU ARE REQUESTED NOT TO SEND US A PROXY
<PAGE>
[LOGO]
NETLOJIX COMMUNICATIONS, INC.
----------------
INFORMATION STATEMENT
CONSENT OF STOCKHOLDERS IN LIEU OF SPECIAL MEETING
---------------------
This Information Statement is being furnished to holders of the outstanding
shares of common stock of NetLojix Communications, Inc., a Delaware corporation
formerly known as AvTel Communications, Inc. ("NetLojix" or the "Company"), in
connection with action taken by written consent of the stockholders (the
"Written Consent") with respect to the sale of Matrix Telecom, Inc. ("Matrix"),
a wholly-owned subsidiary of NetLojix (the "Sale"). The Board of Directors has
fixed the close of business on October 20, 1999 as the record date (the "Record
Date") for determination of stockholders entitled to receive notice of the
Written Consent and this Information Statement.
NetLojix has agreed to sell all of the stock of Matrix to Matrix Acquisition
Holdings Corp. (the "Buyer"), a wholly-owned subsidiary of Platinum Equity
Holdings, LLC ("Platinum"), pursuant to a Stock Purchase Agreement dated
August 31, 1999, as amended (the "Stock Purchase Agreement"), among NetLojix,
Matrix and the Buyer (as assignee of Energy TRACS Acquisition Corp., a
wholly-owned subsidiary of Platinum; "ETAC"). A copy of the Stock Purchase
Agreement is attached hereto as Appendix A. Capitalized items used in this
Information Statement but not defined herein shall have the meaning ascribed to
such terms in the Stock Purchase Agreement.
The business, property and assets of Matrix account for a substantial
portion of the business, property and assets of the Company and its subsidiaries
considered as a whole. Section 271 of the Delaware General Corporation Law (the
"DGCL") requires that the holders of a majority of the outstanding shares of a
Delaware corporation must approve the sale of all or substantially all of the
corporation's property and assets. Although the Board of Directors does not
believe that the Sale constitutes a sale of all or substantially all of the
Company's property and assets, it has deemed it prudent to obtain the approval
of the holders of a majority of the outstanding shares of NetLojix common stock.
In any event, stockholders of NetLojix will not have dissenters' rights or
appraisal rights in connection with the Sale.
Directors and principal stockholders who, collectively, hold in excess of
65.1% of the Company's issued and outstanding shares of common stock as of the
Record Date have signed the Written Consent approving the Sale and the Stock
Purchase Agreement. Accordingly, no meeting of stockholders will be held to
consider the Sale.
THIS INFORMATION STATEMENT IS FURNISHED BY NETLOJIX FOR
INFORMATION PURPOSES ONLY.
This Information Statement is being provided to you pursuant to Rule 14c-2
under the Securities Exchange Act of 1934. This Information Statement is first
being mailed on or about November 8, 1999 to holders of record of common stock
as of the Record Date. As of the Record Date, 10,924,834 shares of common stock
were outstanding. The Company's principal offices are located at 501 Bath
Street, Santa Barbara, California 93101 and its telephone number is
(805) 884-6300.
WE ARE NOT ASKING YOU FOR A PROXY AND
YOU ARE REQUESTED NOT TO SEND US A PROXY.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Introduction................................................ 1
The Written Consent......................................... 1
The Sale.................................................... 2
Unaudited Pro Forma Condensed Consolidated Financial
Statements................................................ 11
Information With Respect to the Company..................... 13
Information With Respect to the Buyer and Platinum.......... 37
Index to Financial Statements............................... F-1
</TABLE>
ii
<PAGE>
INTRODUCTION
NetLojix is a provider of Enterprise Network Solutions integrating data,
voice and Internet services. The Company currently sells and markets advanced
network services and information technology support services through internal
direct sales professionals and independent value added resellers. See
"Information with Respect to the Company," below. On September 15, 1999, the
Company changed its name from AvTel Communications, Inc. to NetLojix
Communications, Inc.
Matrix is a wholly-owned subsidiary of NetLojix which is engaged primarily
in the business of providing residential long distance telephone services to
consumers through agents and affinity organizations. The Board of Directors of
NetLojix has determined that it is in the best interests of the Company and its
stockholders for the Company to exit the residential long distance telephone
service business by selling Matrix. See "The Sale--Background and Reasons for
Transaction," below. Accordingly, NetLojix has entered into the Stock Purchase
Agreement to effect the sale of Matrix to the Buyer.
THE WRITTEN CONSENT
RECORD DATE AND OUTSTANDING SHARES
The Board of Directors has fixed the close of business on October 20, 1999
as the record date (the "Record Date") for determination of stockholders
entitled to receive notice of the Written Consent and this Information
Statement. On the Record Date, there were 10,924,834 shares of common stock
outstanding held by approximately 588 stockholders of record.
REQUIRED VOTE
Section 271 of the DGCL requires that the holders of a majority of the
outstanding shares of a Delaware corporation must approve the sale of "all or
substantially all of the corporation's property and assets." The Board of
Directors believes that the Sale does not constitute a sale of all or
substantially all of the Company's property and assets and that, accordingly,
stockholder approval is not required under Section 271 of the DGCL. However, the
Board has deemed it prudent to obtain the approval of the Sale and the Stock
Purchase Agreement from the holders of a majority of the outstanding shares of
NetLojix common stock. Neither the holders of the Company's Series A Convertible
Preferred Stock nor its Series B Convertible Preferred Stock have any right to
vote with respect to the Sale.
ACTION BY WRITTEN CONSENT
Section 228 of the DGCL provides that any action required or permitted to be
taken at an annual or special meeting of the stockholders of a Delaware
corporation may be taken without a meeting, without prior notice, and without a
vote, if consents in writing setting forth the action so taken are signed by 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 were present and
voting. Section 228 requires a corporation to deliver prompt notices of the
taking of action by written consent to any stockholders who did not sign the
written consent, but who would have been entitled to vote on the action if a
meeting were held.
As of the Record Date, Directors Anthony E. Papa, James P. Pisani, John A.
Allen and Jeffrey J. Jensen owned an aggregate of 2,587,514 shares of common
stock, or approximately 23.7% of all outstanding shares of common stock on such
date. In addition, Thomas H. Patrick, as voting trustee under a voting trust
agreement dated May 18, 1999, for certain members of the Jensen family, held an
additional 4,526,583 shares of common stock, or approximately 41.4% of all
outstanding shares of common stock on such date. Collectively, this represents
approximately 65.1% of the outstanding shares of common stock on the Record
Date. Each of such stockholders has executed the Written Consent as of the
Record Date. Accordingly, no meeting or vote of any other stockholder is
necessary and stockholder votes are not being solicited.
1
<PAGE>
In accordance with Rule 14c-2 promulgated under the Securities Exchange Act
of 1934, as amended, the Company will not complete the Sale until at least
20 calendar days after this Information Statement has first been sent to
stockholders. The Information Statement is first being sent to stockholders on
or about November 8, 1999. The consummation of the Sale is subject to the
satisfaction of several conditions, including certain regulatory approvals. See
"The Sale," below.
NO SOLICITATION OF PROXIES
The Company will not hold a meeting of stockholders with respect to the
Sale. Stockholders are not being asked for a proxy, and are requested not to
send a proxy to the Company. The Company will bear all of the costs associated
with preparing this Information Statement and its mailing to stockholders.
THE SALE
THE TERMS AND CONDITIONS OF THE SALE ARE CONTAINED IN THE STOCK PURCHASE
AGREEMENT, A COPY OF WHICH IS ATTACHED TO THIS INFORMATION STATEMENT AS APPENDIX
A AND INCORPORATED HEREIN BY REFERENCE. The description in this Information
Statement of the terms and conditions of the Sale is qualified in its entirety
by, and made subject to, the more complete information set forth in the Stock
Purchase Agreement. Capitalized terms used in this Information Statement but not
defined herein shall have the meaning ascribed to such terms in the Stock
Purchase Agreement. STOCKHOLDERS OF NETLOJIX ARE URGED TO, AND SHOULD, CAREFULLY
READ THE STOCK PURCHASE AGREEMENT IN ITS ENTIRETY.
GENERAL
The Stock Purchase Agreement was executed and delivered by NetLojix, Matrix
and Energy TRACS Acquisition Corp. ("ETAC") on August 31, 1999. ETAC is a
wholly-owned subsidiary of Platinum. As permitted by the Stock Purchase
Agreement, on September 1, 1999 ETAC assigned its rights, duties and obligations
under the Stock Purchase Agreement to the Buyer, which is also a wholly-owned
subsidiary of Platinum. Platinum has guaranteed all of the payment obligations,
and potential payment obligations, of the Buyer under the Stock Purchase
Agreement. Platinum is a closely-held limited liability company with annual
revenues in excess of $800 million for the year ended December 31, 1998.
The Stock Purchase Agreement provides for the sale by NetLojix to the Buyer
of all of the capital stock of Matrix. In return, NetLojix will receive
consideration of up to $7,052,529, consisting of (i) up to $614,332 in credits
against long distance service usage, (ii) the elimination of $4,190,058 in
intercompany indebtedness owed to Matrix by NetLojix, (iii) the retention by
NetLojix of federal tax refunds to Matrix in the amount of $1,248,139, and
(iv) an incentive payment of up to $1 million based on additions to Matrix's
Internet service customer base. In addition, the Buyer will indemnify NetLojix
from certain amounts owing to Coast Business Credit, the secured lender to
NetLojix and Matrix.
BACKGROUND AND REASONS FOR TRANSACTION
On December 1, 1997, NetLojix acquired Matrix in a share-for-share exchange,
whereby all of the outstanding common stock of Matrix was exchanged for shares
of NetLojix common stock. For accounting purposes, the share exchange was
treated as a reverse acquisition of NetLojix by Matrix. NetLojix was the legal
acquirer and, accordingly, the share exchange was effected by the issuance of
NetLojix common stock in exchange for all the common stock then outstanding of
Matrix. Immediately after the share exchange, the former shareholders of Matrix
held over 80% of the issued and outstanding common stock of NetLojix.
At the time of the share exchange, Matrix was a provider of domestic and
international long distance telecommunication services primarily to residential
and small business customers in the United States. At the time, Matrix provided
long distance service in 49 states. Matrix's strategy was to compete as a
non-facilities based reseller, contracting with Sprint Corporation, Pacific
Gateway Exchange, Inc., and
2
<PAGE>
other carriers to provide switching and transmission of its customers' traffic.
Subsequent to the share exchange the Company made Matrix a part of the Company's
Channel Markets Group. The Channel Markets Group initially focused on selling
residential long distance service through telemarketing, direct mail and
distributors or agents. However, NetLojix quickly discontinued the telemarketing
and direct mail marketing channels as they were not cost-effective. During the
fourth quarter of 1998, the Channel Markets Group implemented a new strategy to
sell Internet access and additional voice services exclusively through affinity
groups, agents and distributors. However, the primary source of revenues of the
Channel Markets Group has continued to be through residential long distance
voice distribution channels.
Since the time of the share exchange, competitive pressures within the
residential long distance market have increased dramatically. Pricing pressures
have continued to reduce retail pricing of long distance products. These
factors, similar in nature to those affecting all resellers of long distance
telephone services, together with NetLojix's discontinuation of non-cost
effective telemarketing and direct mail marketing, resulted in significant
decreases in revenue. Channel Markets Group revenues decreased by approximately
$7.9 million, or 17%, in the year ended December 31, 1998, as compared with the
year ended December 31, 1997. More significantly, Channel Markets Group revenue
decreased by $8.5 million, or 40%, during the first six months of 1999, as
compared with the first six months of 1998.
The sharp decreases in revenues, together with the concomitant net losses
and decreases in cash flow, have put NetLojix in a precarious financial
position. NetLojix reported a net loss of $5,802,318 for the year ended
December 31, 1998, and had a working capital deficit of $1,697,959 at that date.
NetLojix reported a net loss of $5,186,732 for the six months ended June 30,
1999, and its working capital deficit worsened to $3,771,247 at that date. As of
June 30, 1999, NetLojix was in violation of one provision of its secured credit
agreement with Coast Business Credit that stipulates that NetLojix must maintain
a net worth equal to or greater than $2 million. NetLojix's net worth as of
June 30, 1999 was $1,055,876. Coast Business Credit has waived its right of
acceleration of the obligation as it relates to NetLojix's not meeting the net
worth covenant subject to the closing of the Sale. Substantially all of the debt
to Coast Business Credit has been incurred by Matrix.
In light of this rapidly worsening situation, management of NetLojix began
to investigate the possibility of selling NetLojix's residential long distance
telephone business. In May, 1999, Anthony E. Papa and James P. Pisani, Chief
Executive Officer and President, respectively, of the Company began preliminary
discussions with several parties to assess the level of interest in a possible
sale. Mr. Papa and Mr. Pisani made a presentation to the Board of Directors at
its meeting on May 27, 1999, regarding this possibility. After extensive
discussion and questions of management, the Board of Directors authorized and
directed management to continue reviewing the possibilities for a sale and
investigating potential purchasers, as well as other strategic alternatives for
the Company.
Throughout June and July, 1999, management continued to explore the possible
sale, and made contacts with numerous possible acquirers. These included certain
potential acquirers identified by members of the Board of Directors with
experience in the telecommunications industry. As part of this process,
management received a draft letter of intent from Platinum which it reviewed
with counsel. At the Board of Directors meeting on July 21, 1999, management
reported that it had received only one viable offer for the residential long
distance business, the offer from Platinum. At that meeting, the Board reviewed
the draft letter of intent with Platinum and determined to go forward subject to
certain additional points to be negotiated, while continuing to consider other
strategic alternatives. The Board also directed management to prepare a
financial analysis of the transaction and to obtain estimates of the costs of
retaining an outside financial advisor. Management and the Company's outside
counsel then engaged in additional negotiation of the Platinum letter of intent.
On July 26, 1999, the Board of Directors held a special meeting to review a
revised letter of intent with Platinum. After extensive discussion and review,
the Board of Directors authorized the Company to execute the non-binding letter
of intent with Platinum. Later that same day, the Company and Platinum
3
<PAGE>
entered into the letter of intent. NetLojix issued a press release to announce
the letter of intent publicly prior to the commencement of trading on July 27,
1999.
Management and the Company's outside counsel then began negotiating the
terms of the Stock Purchase Agreement and related documents with Platinum and
its counsel. Management circulated to the members of the Board of Directors
copies of preliminary drafts of the Stock Purchase Agreement and related
documents reflecting the negotiations with Platinum to date, together with
materials describing the remaining unresolved issues. During this process, the
Board of Directors continued to evaluate and consider other near-term and
long-term alternative strategies to address the Company's financial position.
The Board met again on August 30, 1999, at which time the Stock Purchase
Agreement and the fairness of the Platinum offer were again analyzed and
considered by the Board in detail. The Board reviewed with management and
counsel the points negotiated with Platinum and the resulting changes to the
Stock Purchase Agreement and related documents. The Board also discussed the
possibility of retaining an outside financial advisor to render a fairness
opinion in connection with the transaction. After reviewing the 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. After a full discussion of the proposed transaction
structure, the draft documentation, related financial, legal and tax issues, the
Company's other prospects for selling or keeping the residential long distance
business, and the Company's financial condition and operations, the Board of
Directors unanimously voted to approve the execution and delivery of the Stock
Purchase Agreement on behalf of the Company, subject to regulatory approvals and
the possibility of stockholder approval.
The Stock Purchase Agreement was executed by the parties on August 31, 1999.
The Company issued a press release announcing such execution on September 1,
1999, upon the assignment of the Stock Purchase Agreement from ETAC to the
Buyer. The Company, Matrix and Buyer amended the Stock Purchase Agreement on
September 16, 1999 to change and clarify the provision regarding the
post-execution adjustment of the purchase price and to document the waiver of
one of the Buyer's conditions to closing.
The Board of Directors concluded that the Sale as embodied in the Stock
Purchase Agreement provides the best opportunity for the Company to divest
itself of the residential long distance business with its concomitant financial
pressures. In connection with the execution of the Stock Purchase Agreement,
NetLojix, Matrix and the Buyer also entered into a Management Services Agreement
pursuant to which the Buyer has commenced managing the business of Matrix. As a
result, a significant amount of the financial pressure on the Company has been
relieved pending the closing of the Sale.
The Company did not engage an investment banking firm or financial advisor
to assist it in the negotiations with Platinum or the valuation of Matrix, nor
has it obtained a fairness or similar evaluation opinion with respect to the
Sale. The negotiations were conducted at arms' length and, in arriving at the
terms of the Sale, management considered, among other things, (a) NetLojix's and
Matrix's current and prospective business operations, revenues, profitability
and existing infrastructure; (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
and techniques. Management and the Board of Directors concluded that the
substantial and increasing net losses of the residential long distance business,
and the prospect for continuing long term losses, warranted approval of the
Sale.
Accordingly, on the basis of these considerations, the Board has unanimously
approved the Sale, the execution of the Stock Purchase Agreement and the
consummation of the transactions contemplated therein.
4
<PAGE>
TERMS OF THE SALE
STOCK TO BE SOLD.
The Stock Purchase Agreement provides that NetLojix will sell to the Buyer
all of the common stock of Matrix. No other assets of NetLojix are being sold.
NetLojix will retain certain business customers of Matrix, which will be
transferred from Matrix to another subsidiary of NetLojix upon receipt of
certain regulatory approvals.
PURCHASE PRICE.
The purchase price for the Matrix stock (the "Purchase Price") may be valued
at up to $7,052,529. There are four major components to the Purchase Price.
First, NetLojix will receive a credit against charges incurred for long distance
wholesale telephone traffic pursuant to its service contract with Matrix (the
"Long Distance Credit"). Second, the parties will eliminate $4,190,058 in
intercompany indebtedness owed to Matrix by NetLojix. Third, NetLojix retains
federal income tax refunds paid to or due Matrix in the total amount of
$1,248,139. Fourth, NetLojix will receive $50 for each additional Internet
service customer added to Matrix's aggregate customer base, net of one-half of
the customers lost from such base, within six months after August 31, 1999, up
to an aggregate of $1 million (the "ISP Payment"). In addition, the Company will
receive an indemnity against certain claims or liabilities arising under its
secured credit facility.
LONG DISTANCE CREDIT. NetLojix has an agreement with Matrix under which it
receives wholesale long distance services at rates equal to Matrix's current
wholesale cost. These rates will increase or decrease based upon subsequent
increases or decreases in Matrix's wholesale cost. Under the Stock Purchase
Agreement, as amended, the initial amount of the Long Distance Credit was
$2,039,057. However, the amount of the Purchase Price was subject to reduction
based upon a comparison of Matrix's adjusted stockholder's equity on August 31,
1999, compared to such adjusted stockholder's equity on May 31, 1999. NetLojix
has calculated that this adjustment will result in a reduction of the Purchase
Price by $1,424,725. The Buyer is currently reviewing NetLojix's calculation of
this adjustment and has until November 30, 1999, to object to such calculation.
If the Buyer does so object, and the parties are unable to resolve the matter,
the calculation will be submitted to an independent firm of accountants chosen
by the parties for final resolution. Accordingly, the amount of the Long
Distance Credit will not be more than $614,332, and may be less.
NetLojix may use up to $225,000 of the Long Distance Credit, if available,
during the period commencing on September 1, 1999 and ending on November 30,
1999. Thereafter the amount of the Long Distance Credit used may not exceed
$100,000 per month. NetLojix intends to use this Long Distance Credit to offset
its costs for long distance service which it will continue to provide to its
business customers. NetLojix is not obligated to continue to purchase long
distance services from Matrix.
INTERCOMPANY INDEBTEDNESS AND TAX REFUND. At August 31, 1999, NetLojix owed
Matrix $4,190,058 for telecommunications and other services provided. This
indebtedness will be eliminated upon the closing of the Sale. At August 31, 1999
Matrix had a Federal income tax refund due to Matrix in the amount of $1,248,139
relating to taxes paid in prior years. This amount has been transferred to, and
will be retained by, NetLojix. In September and October 1999 NetLojix received
payment of $1,037,385 of the refund.
ISP PAYMENT. The Buyer will pay NetLojix $50 for each Internet service
customer added to Matrix's aggregate customer base, less one-half of the
customers lost, between August 31, 1999 and February 29, 2000, up to a maximum
of $1 million. The ISP payment will be paid on the later of March 31, 2000 or
the closing of the Sale.
5
<PAGE>
COAST BUSINESS CREDIT INDEMNITY.
The Buyer has agreed to indemnify NetLojix from any claims, damages or
liabilities arising out of NetLojix's secured credit agreement with Coast
Business Credit in an amount not to exceed $2,750,000 plus any amount drawn on
such facility by Matrix after August 31, 1999. Substantially all of this
indebtedness is related to the business of Matrix.
NONCOMPETITION AGREEMENT.
NetLojix has agreed not to engage in the provision of residential long
distance telephone services within the United States prior to August 31, 2002.
NetLojix may continue to provide long distance service to its business
customers. The noncompetition covenant will not prohibit NetLojix from acquiring
a business that provides residential long distance telephone services in the
United States if such services constitute less than 35% of the value of the
acquired business and NetLojix fully divests itself of such services within six
months after the date of acquisition. NetLojix may not implement any new
marketing programs with respect to such services. For a similar time period,
NetLojix may not, directly or indirectly, solicit the employment of or hire
certain of the employees of Matrix.
GUARANTY OF PLATINUM.
As part of the execution of the Stock Purchase Agreement, Platinum signed a
guaranty pursuant to which it guarantees the obligations of Buyer under those
provisions of the Stock Purchase Agreement which require, or may require, Buyer
to make payments to NetLojix. These include the obligations of Buyer to (i) pay
the Purchase Price, (ii) to indemnify NetLojix with respect to Coast Business
Credit, (iii) to indemnify NetLojix for breaches of its representations,
warranties and covenants under the Stock Purchase Agreement, and (iv) to pay
NetLojix certain amounts upon a termination of the Stock Purchase Agreement as a
result of the Buyer's breach of its representations, warranties or covenants
under the Stock Purchase Agreement.
OPERATION OF REMAINING BUSINESS
NetLojix will continue to operate its remaining businesses after the closing
of the Sale. See "Information with Respect to the Company--Existing Business of
NetLojix," below. Its newly-formed subsidiary, NetLojix Telecom, Inc., has
applied for Section 214 operating authority from the Federal Communications
Commission and necessary approvals from the various state authorities to provide
telecommunication services after the closing. This will enable NetLojix to
continue to provide long distance services to its business customers.
Accordingly, the Stock Purchase Agreement provides that, upon receipt of such
regulatory approvals, the Buyer will transfer to NetLojix the existing business
customers of Matrix.
COMPARATIVE PER SHARE DATA
The following table sets forth certain historical per share data of NetLojix
and unaudited per share data on a pro forma basis, based on the assumption that
the Sale was effective at the beginning of the earliest period indicated. The
unaudited pro forma per share data provided below is not necessarily indicative
of the results of operations or the financial position which would have occurred
had the Sale 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 NetLojix and
the unaudited pro forma condensed financial statements, which are included in
this
6
<PAGE>
Information Statement. The unaudited pro forma per share data below is shown for
illustrative purposes only.
<TABLE>
<CAPTION>
AT OR FOR THE AT OR FOR THE
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 1999 DECEMBER 31, 1998
---------------- -----------------
<S> <C> <C>
NetLojix:
Book value per common share................ $ 0.10 $ 0.43
Cash dividends declared per common share... -- --
Earnings (loss) from continuing operations
per common share......................... (0.52) (0.61)
Pro Forma:
Book value per common share................ 0.65 0.64
Cash dividends declared per common share... -- --
Earnings (loss) from continuing operations
per common share......................... (0.26) (0.30)
</TABLE>
INTEREST OF CERTAIN PERSONS IN THE SALE
M. Scott Hall is currently the President of Matrix and, prior to
September 15, 1999, he was Senior Vice President of NetLojix's Channel Markets
Group. Mr. Hall is not a director or shareholder of NetLojix or Matrix. Upon the
closing, Mr. Hall will terminate his relationship with NetLojix, and will remain
as the President of Matrix under the Buyer's ownership. NetLojix is unaware of
any change in the terms of Mr. Hall's employment by Matrix contemplated to take
place after the closing of the Sale. Mr. Hall will retain the right to exercise
certain of his NetLojix stock options for a limited time after the closing. To
the best of NetLojix's knowledge, no other officer, director or holder of at
least 5% of NetLojix's common stock has an interest, financial or otherwise, in
the Sale different from any other holder of common stock of NetLojix.
REGULATORY APPROVAL
Matrix operates under Section 214 authority from the Federal Communications
Commission and is certified or registered in 49 states. Certain of these
jurisdictions require either the filing of notices or a formal approval process
in connection with the change in control of Matrix. The parties have filed all
such notices and applications for all such approvals. As of the date hereof, the
parties have received approval from a majority of such jurisdictions. With the
Buyer's permission, the closing of the Sale may occur prior to the receipt of
certain approvals if the Company agrees to indemnify the Buyer from any claims
or liabilities resulting therefrom. The Company does not foresee any substantial
difficulty or delay in completing the Sale as a result of the required
regulatory approvals.
The parties were required to notify the Federal Trade Commission and the
Department of Justice of the transaction pursuant to the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended, and the rules and regulations
promulgated thereunder (the "HSR Act"). The Federal Trade Commission granted
early termination of the notification period on October 19, 1999.
NO DISSENTERS' RIGHTS
Under the DGCL and NetLojix's Certificate of Incorporation, holders of
shares of NetLojix's common stock will not be entitled to dissenters' rights or
appraisal rights in connection with the Sale.
ACCOUNTING TREATMENT
The Sale will be accounted for as a sale of a subsidiary. Upon consummation
of the Sale, a gain will be recognized for financial reporting purposes equal to
the difference between the net proceeds and the
7
<PAGE>
closing net book value of the Matrix assets sold and liabilities assumed, less
expenses associated with the sale. NetLojix estimates such gain will be
approximately $5.8 million.
FEDERAL INCOME TAX CONSEQUENCES
The Sale will be a taxable transaction to NetLojix for United States Federal
and state income tax purposes. The Sale is structured as a sale of the common
stock of Matrix. However, the parties have agreed to make an election under
Section 338(h)(10) of the Internal Revenue Code of 1986, as amended, so that the
Sale will be taxed as though NetLojix had sold Matrix's assets and liabilities
to the Buyer. NetLojix will recognize a taxable gain on the Sale. It is
anticipated, however, that there will not be any material tax payable at the
corporate level because of the utilization of net operating loss carryforwards.
THE STOCK PURCHASE AGREEMENT
The following is a summary of certain provisions of the Stock Purchase
Agreement.
THE CLOSING.
It is anticipated that the closing of the Sale will take place at the
offices of Riordan & McKinzie, counsel to the Buyer and Platinum, on or about
November 30, 1999, or at such other place, time or date as may be mutually
agreed upon by the parties. The transfer of the Matrix stock to the Buyer will
be effective as of the close of business on such date.
CONDITIONS TO CLOSING.
Pursuant to the Stock Purchase Agreement, the obligations of the parties to
effect the Sale are subject to, among other things, (i) the accuracy of the
representations and warranties of, and the performance of the covenants of, the
other party contained in the Stock Purchase Agreement, (ii) the receipt of
regulatory approvals as described above, and (iii) the exchange of customary
closing documents.
REPRESENTATIONS AND WARRANTIES OF NETLOJIX.
NetLojix has made certain representations and warranties relating to, among
other things, (i) its title to the Matrix stock, (ii) its corporate organization
and the corporate organization of Matrix, (iii) corporate and third party
approvals, (iv) litigation, (v) Matrix's ownership and use of its tangible
assets and intellectual property, (vi) the financial statements of Matrix,
(vii) taxes, (viii) Matrix's contracts and other agreements, (ix) Matrix's
employees and employee benefits, (x) insurance, (xi) environmental matters,
(xii) regulatory matters, and (xiii) transactions with affiliates.
REPRESENTATIONS AND WARRANTIES OF BUYER.
The Buyer has made certain representations and warranties relating to, among
other things, (i) its corporate organization consents required and its financial
statements, (ii) corporate and third party approvals, (iii) litigation,
(iv) its financial statements, and (v) its investment intent and qualifications
with respect to the Matrix stock.
SURVIVAL OF REPRESENTATIONS AND WARRANTIES.
The representations and warranties of the parties will survive for a period
of twenty-four months following the Closing except that NetLojix's
representations and warranties as to taxes, litigation, environmental matters
and regulatory compliance shall survive until ninety days after the expiration
of the applicable statute of limitations, as will any representation by a party
which is known by that party to be false at the time made. The representations
of NetLojix regarding its organization, its ownership of Matrix stock, and its
required approvals of the Sale will survive indefinitely.
8
<PAGE>
INDEMNIFICATION.
NetLojix has agreed to indemnify the Buyer and Matrix for any losses,
liabilities or claims resulting from or arising out of any misrepresentation or
breach of any warranty made by NetLojix or any breach or default in any covenant
to be performed by NetLojix under the Stock Purchase Agreement or related
documents. NetLojix has also agreed to indemnify the Buyer and Matrix against
certain threatened litigation relating to Matrix's operations prior to the
closing. Except for claims as to fraudulent misrepresentation or for
misrepresentations relating to NetLojix's organization, its ownership of Matrix
stock, its required approvals of the Sale, and taxes owing by Matrix, NetLojix
shall not be required to indemnify the Buyer or Matrix unless the damages for
all such claims exceed $100,000 in the aggregate, but upon reaching that amount,
indemnification shall be from the first dollar of such damages. The maximum
amount of indemnification which NetLojix may be required to provide (other than
for fraudulent claims or for misrepresentations relating to NetLojix's
organization, its ownership of Matrix stock, its required approvals of the Sale,
litigation, taxes and environmental matters) may not exceed $5,575,000 plus any
amount of the ISP Payment received.
NO SOLICITATION.
Prior to the closing of the Sale or the earlier termination of the Stock
Purchase Agreement, NetLojix and its directors, officers, employees and
affiliates may not solicit, initiate, encourage or participate in any
discussions or negotiations relating to the sale of Matrix or its assets to any
person other than the Buyer, except to the extent that their fiduciary duties so
require. If NetLojix terminates the Stock Purchase Agreement in order to accept
a proposal to sell Matrix or its assets to any other person, NetLojix shall be
required to pay the Buyer $2 million, plus the net amount of money invested by
the Buyer in the operations of Matrix through the date of termination (the
"Investment").
TERMINATION.
The Stock Purchase Agreement may be terminated in certain circumstances,
including (i) by the mutual written consent of NetLojix and the Buyer, (ii) by
NetLojix or the Buyer if any court or governmental agency takes any action
restraining or otherwise prohibiting the transactions contemplated by the Stock
Purchase Agreement, or (iii) by NetLojix or the Buyer if the Closing shall not
have occurred on or before August 31, 2000, provided that a party may not
terminate the Stock Purchase Agreement as a result of its own breach of
representation or warranty or failure to perform or comply with its own
covenant.
In the event the Stock Purchase Agreement is terminated without fault by
either party (for example, because of the failure of a regulatory agency to
approve the transaction), then neither party will have liability to the other,
except that NetLojix will be required to return the amount of the Investment to
the Buyer. In the event of the termination of the Stock Purchase Agreement due
to NetLojix's breach of representation or warranty, NetLojix shall be required
to pay the Buyer the amount of the Investment. In the event of a termination due
to NetLojix's failure to perform or comply with a covenant under the Stock
Purchase Agreement, then NetLojix shall pay the Buyer the amount of the
Investment, and NetLojix and the Buyer shall make reasonable efforts to sell
Matrix to a third party. Upon such sale, if the purchase price actually obtained
for Matrix exceeds the Purchase Price set forth in the Stock Purchase Agreement,
then NetLojix shall pay Buyer the difference. If the Stock Purchase Agreement is
terminated due to Buyer's breach of representation or warranty or failure to
perform or comply with the covenant, then NetLojix and the Buyer will make
reasonable efforts to sell Matrix to a third party. Upon such sale, if the
purchase price actually obtained for Matrix is less than the Purchase Price set
forth in the Stock Purchase Agreement, Buyer shall pay NetLojix the difference,
net of the amount of the Investment.
9
<PAGE>
THE MANAGEMENT SERVICES AGREEMENT
Concurrently with the execution of the Stock Purchase Agreement, NetLojix,
Matrix and ETAC signed a Management Services Agreement relating to the
operations of Matrix (the "Management Services Agreement"). On September 1, 1999
ETAC assigned its rights, duties and obligations under the Management Services
Agreement to the Buyer.
Under the Management Services Agreement, NetLojix appointed the Buyer as the
sole and exclusive provider of all services necessary or appropriate for the
supervision and management of the operation of Matrix. Pursuant to the
Management Services Agreement, the Buyer has established and implemented the
operational policies of Matrix and now exercises supervision, direction and
control over the operations of Matrix. Although M. Scott Hall remains as the
President of Matrix, the other officers of Matrix have been appointed at the
designation of the Buyer.
The term of the Management Services Agreement will continue until the
earlier of the closing of the Sale or the termination of the Stock Purchase
Agreement. Under certain circumstances, the term of the Management Services
Agreement would continue after the termination of the Stock Purchase Agreement
while the parties sought another buyer for Matrix.
As compensation for rendering services under the Management Services
Agreement, the Buyer has the right to retain all net profits of Matrix during
the term of the Management Services Agreement. Matrix (and not NetLojix) bears
all costs and expenses related to such services. NetLojix has no obligation to
provide any additional capital or funding to Matrix. As a result, unless the
sale is terminated prior to closing, the Buyer has assumed the financial risks
and rewards of the operations of Matrix.
10
<PAGE>
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma financial statements give effect to the
sale of all of the issued and outstanding stock of Matrix to the Buyer. The
unaudited pro forma financial statements should be read in conjunction with the
historical financial statements of NetLojix and accompanying notes. This pro
forma information is presented for illustration purposes only and is not
necessarily indicative of the results which actually would have been achieved if
the Matrix sale had been effected on the pro forma dates, nor is it necessarily
indicative of future results.
The Unaudited Pro Forma Balance Sheet at June 30, 1999 assumes that the
Matrix sale was effected on that date. The Unaudited Pro Forma Statements of
Operations for the year ended December 31, 1998 and for the six months ended
June 30, 1999 assume the sale occurred January 1, 1998.
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 1999
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS BALANCE SHEET
----------- ----------- -------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................. $ 684,989 -- 684,989
Accounts receivable, net.................................. 4,004,945 (2,591,148)(a) 1,413,797
Federal and state income tax receivable................... 1,325,000 -- 1,325,000
Other current assets...................................... 1,088,655 (378,708)(a) 709,947
----------- ----------- -----------
Total current assets.................................... 7,103,589 (2,969,856) 4,133,733
Property and equipment, net............................... 1,963,581 (1,022,902)(a) 940,679
Goodwill, net............................................. 4,204,868 4,204,868
Other assets, net......................................... 1,158,710 (5,115)(a) 1,153,595
----------- ----------- -----------
Total assets............................................ $14,430,748 (3,997,873) 10,432,875
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and other accrued expenses............... $ 3,498,110 (2,010,067)(a) 1,488,043
Accrued network services costs............................ 4,500,953 (4,500,953)(a) --
Sales and excise tax payable.............................. 1,344,977 (724,555)(a) 620,422
Due to affiliates......................................... 98,332 (98,332)(a) --
Other current liabilities................................. 1,432,464 (267,125)(a) 1,165,339
----------- ----------- -----------
Total current liabilities............................... 10,874,836 (7,601,032) 3,273,804
Long-term borrowings........................................ 2,226,619 (2,226,619)(a) --
Common stock subject to put option.......................... 112,577 112,577
Long-term obligations under capital leases.................. 160,840 (1,300)(a) 159,540
----------- ----------- -----------
Total liabilities....................................... 13,374,872 (9,828,951) 3,545,921
----------- ----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, authorized 750,000 shares, $0.01 par
value................................................... -- -- --
Series A convertible preferred stock, authorized 250,000
shares, $0.01 par value, cumulative as to 8% dividends,
147,700 shares issued and outstanding. (Liquidation
preference of $704,032 including dividends
in arrears.)............................................ 1,477 -- 1,477
Series B convertible preferred stock, authorized 1,500
shares, $0.01 par value, annual dividends of $30 per
share, 1,500 shares issued and outstanding. (Liquidation
preference of $1,500,000.).............................. 15 -- 15
Common stock, authorized 20,000,000 shares, $0.01 par
value, issued 10,579,870 shares at June 30, 1999........ 105,048 -- 105,048
Additional paid in capital................................ 21,384,408 -- 21,384,408
Accumulated deficit....................................... (20,434,961) 5,831,078 (a) (14,603,883)
Treasury stock, $0.01 par value, 11,075 shares............ (111) -- (111)
----------- ----------- -----------
Total stockholders' equity.............................. 1,055,876 5,831,078 6,886,954
----------- ----------- -----------
Total liabilities and stockholders' equity.............. $14,430,748 (3,997,873) 10,432,875
=========== =========== ===========
</TABLE>
- ------------------------------
Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet
(a) To eliminate the Matrix subsidiary.
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<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 SIX MONTHS ENDED JUNE 30, 1999
--------------------------------------- ---------------------------------------
HISTORICAL ADJUSTMENTS PROFORMA HISTORICAL ADJUSTMENTS PROFORMA
----------- ----------- ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
REVENUES.............................. $44,013,498 (34,125,769)(a) 9,887,729 18,650,775 (10,781,366)(a) 7,869,409
COST OF REVENUES...................... 31,849,354 (25,796,234)(a) 6,053,120 12,644,779 (8,027,271)(a) 4,617,508
----------- ----------- ---------- ---------- ------------ ----------
GROSS MARGIN.......................... 12,164,144 (8,329,535) 3,834,609 6,005,996 (2,754,095) 3,251,901
Operating expenses
Selling, general and
administrative.................... 18,480,576 (13,978,781)(a) 10,239,790 (6,056,620)(a)
1,539,011 (b) 6,040,806 858,950 (b) 5,042,120
Depreciation and amortization....... 1,107,321 (487,794)(a) 753,345 (254,931)(a)
370 (b) 619,897 37,598 (b) 536,012
----------- ----------- ---------- ---------- ------------ ----------
Total operating expenses.......... 19,587,897 (12,927,194) 6,660,703 10,993,135 (5,415,003) 5,578,132
----------- ----------- ---------- ---------- ------------ ----------
OPERATING LOSS........................ (7,423,753) 4,597,659 (2,826,094) (4,987,139) 2,660,908 (2,326,231)
Interest expense...................... (86,251) 18,889 (c) (67,362) (212,692) 73,677 (c) (139,015)
Other income (expense), net........... 181,107 (88,770)(a) 92,337 13,099 (4,795)(a) 8,304
----------- ----------- ---------- ---------- ------------ ----------
Loss before income taxes.............. (7,328,897) 4,527,778 (2,801,119) (5,186,732) 2,729,790 (2,456,942)
Income tax benefit.................... 1,526,579 (1,526,579)(a) -- -- -- --
----------- ----------- ---------- ---------- ------------ ----------
EARNINGS (LOSS) FROM CONTINUING
OPERATIONS.......................... $(5,802,318) 3,001,199 (2,801,119) (5,186,732) 2,729,790 (2,456,942)
=========== =========== ========== ========== ============ ==========
Net earnings (loss) per share--basic
and diluted......................... $ (0.61) (0.30) (0.52) (0.26)
=========== ========== ========== ==========
Weighted average number of common
shares--basic and diluted........... 9,633,474 9,633,474 10,512,523 10,512,523
=========== ========== ========== ==========
</TABLE>
- ------------------------------
Notes to Unaudited Pro Forma Condensed Consolidated Statement of Operations
The Company expects to recognize a gain of approximately $5.8 million upon
closing of the sale which is not included in the pro forma statements of
operations.
(a) To record reduction in revenues, cost of sales and operating expenses
related to sale of Matrix.
(b) To reverse operating expenses that were previously allocated to Matrix, but
will remain after the sale.
(c) To reduce interest expense associated with Matrix borrowings.
12
<PAGE>
INFORMATION WITH RESPECT TO THE COMPANY
BACKGROUND
GENERAL
NetLojix is a provider of Enterprise Network Solutions integrating data,
voice and Internet services. The Company currently sells and markets advanced
network services and information technology support services ("IT Support")
through internal direct sales professionals and independent value added
resellers ("VAR's"). NetLojix targets its services primarily to mid-sized
businesses.
HISTORY
NetLojix was incorporated on October 31, 1981, but did not commence its
current business until February, 1995. Prior to October 23, 1996, NetLojix
conducted operations under the name "Hi, Tiger International, Inc." On
October 23, 1996, the Company changed its name to "AvTel Communications, Inc."
The name change was effected in connection with NetLojix's acquisition of AvTel
Holdings, Inc., a California corporation on that date. As a result of the
acquisition of AvTel Holdings, NetLojix 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 NetLojix as a telecommunications carrier
providing a comprehensive array of broadband voice and data network services.
The acquisition of AvTel Holdings was effected pursuant to the merger of a
wholly-owned subsidiary of NetLojix with and into AvTel Holdings, as a result of
which NetLojix acquired 100% of the issued and outstanding capital stock of
AvTel Holdings in exchange for 1,063,127 shares of NetLojix common stock,
representing approximately 61% of the issued and outstanding NetLojix common
stock after giving effect to the merger, and 250,000 shares of newly authorized
shares of NetLojix's series A convertible preferred stock. For accounting
purposes, the acquisition was treated as a reverse acquisition with AvTel
Holdings as the acquirer.
In November, 1996, NetLojix acquired Silicon Beach Communications, Inc., an
Internet service provider and provider of software development services. In
February, 1997, NetLojix acquired all of the issued and outstanding capital
stock of WestNet Communications, Inc., a Ventura, California Internet service
provider. Following completion of this acquisition, NetLojix began to integrate
the customer bases, network facilities and other operations of Silicon Beach
Communications and WestNet Communications in order to achieve desired
efficiencies and economies of scale.
On December 1, 1997, NetLojix acquired Matrix, a privately-held Texas
corporation by means of a share for share exchange. Matrix is a provider of long
distance telephone services. See "Background--Acquisition of Matrix" below.
On September 25, 1998, NetLojix acquired all of the issued and outstanding
capital stock of Digital Media International, Inc., a privately-held corporation
based in Santa Barbara, California, which develops software for educational,
entertainment and other applications.
In November, 1998, NetLojix acquired all of the issued and outstanding
capital stock of Remote Lojix/ PCSI, Inc., a privately-held corporation based in
New York, which is a provider of system integration and local area network
services to corporate customers in the eastern United States.
On September 15, 1999, the Company changed its name to NetLojix
Communications, Inc. This name change was effected by the short-form merger of a
wholly-owned subsidiary with and into the Company.
13
<PAGE>
ACQUISITION OF MATRIX
NetLojix and Matrix entered into a stock exchange agreement dated April 29,
1997, and subsequently amended, pursuant to which the persons or entities who
owned the issued and outstanding common stock of Matrix would transfer to
NetLojix all of their Matrix stock and, in exchange, NetLojix would issue to the
Matrix stockholders shares of NetLojix common stock. The share exchange was
completed pursuant to the terms of the stock exchange agreement on December 1,
1997. For accounting purposes, the acquisition was treated as a reverse
acquisition with Matrix as the acquirer.
In connection with the completion of the share exchange, the Matrix
stockholders and NetLojix entered into a registration rights and lockup
agreement dated December 1, 1997. Pursuant to the registration rights and lockup
agreement, certain persons and entities who held an aggregate of 85.2% of the
outstanding Matrix common stock agreed, for a two-year period commencing on the
closing of the share exchange, not to offer, pledge, sell, or otherwise dispose
of any shares of NetLojix issued to them pursuant to the terms of the stock
exchange agreement. As of June 30, 1999, this "lockup" provision relates to a
total of 6,457,123 shares of NetLojix stock held by the following shareholders:
Thomas H. Patrick, as voting trustee for shares held by Ronald L. Jensen, Gladys
Jensen, James J. Jensen, Jami J. Jensen, Janet Jensen Kreiger and Julie J.
Jensen (4,526,583 shares), Jeffrey J. Jensen (851,738 shares), The RJ & GJ
Foundation (329,692 shares), The Janet Foundation (24,124 shares), The OUI
Foundation (75,862 shares), The Chasdrew Foundation (24,124 shares), John E.
Allen (125,000 shares), Anthony E. Papa (250,000 shares) and James P. Pisani
(250,000 shares)(together, the "Lockup Stockholders").
The registration rights and lockup agreement requires that NetLojix use its
best efforts to file a shelf registration statement providing for the sale by
the Lockup Stockholders of all securities issued to them in connection with the
stock exchange agreement, subject to the two-year holding restriction imposed on
the Lockup Stockholders described above. Under the registration rights and
lockup agreement, NetLojix is obliged to use its reasonable efforts to keep the
shelf registration statement effective on a continuous basis until either
(1) all of the shares of common stock are sold or (2) all of the shares of
common stock could be sold in a single transaction pursuant to Rule 144 of the
Securities Act of 1933. The Lockup Stockholders may also require NetLojix to
undertake up to two additional demand registrations of their securities if the
shelf registration is not in place. All costs and expenses of both shelf and
demand registrations (excluding any underwriting discounts and fees of counsel
to the Lockup Stockholders) will be borne by NetLojix.
EXISTING BUSINESS OF NETLOJIX
NetLojix is a provider of Enterprise Network Solutions integrating data,
voice and Internet services, primarily to mid-sized businesses. The Company
currently sells and markets advanced network services and IT Support through
internal direct sales professionals and independent VAR's.
The Company had previously been organized into two primary business units:
the Business Markets Group and the Channel Markets Group. On September 15, 1999,
the Company executed an internal restructuring of its operations as a result of
its decision to exit the residential long distance business. As a result, after
that date the Channel Markets Group operated as Matrix. The remaining operations
of the Company, including the Business Markets Group have been integrated and
reorganized to support the Company's core mission of providing Enterprise
Network Solutions to businesses.
NETLOJIX--FORMERLY THE BUSINESS MARKETS GROUP
NetLojix targets mid-size corporate customers for their enterprise
networking needs. Following this sales strategy, NetLojix's objective is to
become the single-source provider of communications services, IT support and
eBusiness solutions. This includes the transport of data, voice and Internet
traffic; systems integration, service and technical support; and Web development
and hosting. Through a value-added sales process, NetLojix designs, installs and
manages its customers' networks. NetLojix will provide a host of
14
<PAGE>
additional value added services assisting its customers to create enhanced
intranet and extranet applications. NetLojix believes its strategy to focus on
the corporate customer for enterprise-wide network services offers significant
opportunity. NetLojix cross-markets to its customer base a variety of
traditional telecommunications products and services such as long distance
telephone service, executive calling cards and video/audio conferencing.
INDUSTRY. Information technology has fast become a driving force in
telecommunications. NetLojix's strategy is driven by corporate end users' needs
for network connectivity, integration and support as a result of new software
applications and technology advancements developed in the information technology
arena. This has become a critical element in the ability of businesses,
professional and other organizations to improve productivity and lower costs.
This can be accomplished through the use of a variety of communications
services, including branch office, remote office and telecommuter networking
("intranets") as well as providing network access to customers, vendors,
suppliers ("extranets") and the Internet. While management expects these factors
to continue to increase market demand for these services, there are no
assurances regarding the size of such demand or that NetLojix will be selected
to provide its services in response to such demand.
INTERNETWORKING. At an increasing rate, business, professional and other
organizations are seeking to inter-network their local area networks, wide area
networks and virtual private networks 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 wide area network 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 local area network
so users can work anywhere, any time. Users can access e-mail, databases and
servers as if they were in the corporate office. The recent availability of
reliable Internet protocol voice technology within an enterprise-wide data
network has created additional cost-saving incentives for businesses to
implement advanced network solutions.
NetLojix believes that, as a result of these shifts, internetworking, the
method used for interconnecting networks, will continue to grow. This is
reflected in the growth in sales and distribution of routers, remote access
servers, intranet software and other various components that enable
internetworking. As the computing paradigm continues to migrate to
network-centric architectures, enterprise-wide networks allow those technologies
to be implemented. NetLojix's strategy recognizes the opportunity to bridge the
gap between telecom and computer providers and simplify networking complexities
by becoming a single source for enterprise-wide services and support.
CONNECTIVITY AND BANDWIDTH. NetLojix believes that communications
requirements such as bandwidth availability and network design are replacing
computer requirements such as processor speed, memory or operating systems as
the delimiting factors for business applications. Video conferencing, remote
patient diagnostics with medical imaging and telecommuting are all business
applications in which the success of the deployment is defined by the available
bandwidth. The ultimate realization of this trend is the Web and applications
developed with Internet-specific tools. Web-based applications are computer
platform and operating system independent but depend entirely upon connectivity
and bandwidth for successful deployment and execution.
As a result, connectivity is becoming one of the most important factors in
enhancing business productivity and customer service. Large corporations have
historically created private wide area networks through leased dedicated data
lines. However, dedicated point-to-point facilities have several deficiencies:
leased lines are very expensive; remote offices and telecommuters are omitted;
and leased lines are not
15
<PAGE>
suited for unscheduled and asynchronous communications. Accordingly, small and
medium size companies that have sought the benefits of internetworking have been
required to use modems and dial-up telephone lines which are generally too slow
to handle today's applications.
Growing demands for high speed capabilities have given way to the emergence
of new carrier-based data communication services to overcome the deficiencies of
both dedicated leased and dial-up lines. Wide area network solutions vary
substantially depending on an organization's size and communications needs.
Traditionally, wideband digital transmission circuits (such as T1 and DS-1) were
leased from public carriers to provide voice, fax and data communications links
between larger offices and low speed leased lines (such as DS-O) for branch
office connectivity. For some applications, however, this has proven expensive
and inefficient because the entire bandwidth capacity is dedicated 24 hours per
day, whether or not it is used.
Packet-based services were developed to address the issue of allocation and
utilization. Today, "fast packet" networking technologies such as Frame Relay
and Asynchronous Transfer Mode have emerged as an integrated, cost-effective,
flexible wide area network solution. These networks allow for "bandwidth on
demand" between any two endpoints on a wide area network.
STRATEGY. The implementation of NetLojix's strategy involves the marketing
of products and services integrated into enterprise-wide network solutions for
business customers. These enterprise-wide solutions include network design,
system integration and technical support, wide area network connectivity, voice
connectivity, Internet access and Web development, hosting and co-location. The
Company's sales and marketing activities result in monthly, recurring revenues
from networking customers under multi-year term agreements. The Company's sales
strategy includes in-house direct sales professionals and an agent program
through which the Company distributes its services through VAR's of information
technology products. The Company leverages the existing customer relationships
of these VAR's gaining more immediate access to a wider group of prospective
customers and greater credibility in the sales process. Additionally, this VAR
channel becomes the service organization for NetLojix's business customers
requiring on-site repair and maintenance visits in remote markets.
MATRIX--FORMERLY THE CHANNEL MARKETS GROUP
On September 15, 1999, the Company executed an internal restructuring of its
operations as a result of its decision to exit the residential long distance
business. As a result, after that date the Channel Markets Group operated as
Matrix. Matrix markets domestic and international long distance telephone
services, Internet access and related services through distribution companies,
agents, resellers and affinity groups ("Channel Partners") that maintain access
to large groups of individuals and small businesses through affinity
relationships and niche marketing strategies. Channel Partners include
non-profit organizations and for-profit distribution groups. Matrix's Channel
Partners generally require account management, have a large and somewhat captive
audience of members/customers and distribute information and services.
Historically, telecommunications companies have leveraged third party
organizations to sell long distance telephone service to their member/customers
sharing a percentage of the revenues generated by the group. Substantially all
of the revenues for Matrix is generated by outside sales agents.
Matrix provides residential long distance telephone service to customers in
49 states. Matrix is fully certified or registered in all states where required
and operates under Section 214 authority from the Federal Communications
Commission. Matrix also has a national-deployed Carrier Identification Code. The
Carrier Identification Code provides Matrix greater network flexibility and
permits Matrix to market to subscribers of other carriers by having the customer
dial the Carrier Identification Code directly, a process, which is known in the
industry as "casual calling." Matrix has executed strategic agreements with
Sprint for its underlying voice carrier services.
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<PAGE>
In November, 1998, Matrix introduced its nationwide Internet access program
for dial-up connectivity. This program is provided to the public under the
MatrixInet-TM- brand, and is also available under a private label arrangement
for certain Channel Partners.
Channel Partners generally market to niche consumer segments such as
non-profit affinity membership groups, ethnic affinity groups and home based
business professionals. These independent distributor groups are provided with a
variety of value-added support services which include: an in-house multi-lingual
Customer Service department open 24 hours a day, 7 days a week; direct
electronic provisioning to local exchange carriers; and custom billing. The
Company believes that Matrix's agreements with Channel Partners provide
highly-leveraged access to large, loyal groups of individuals.
BUSINESS OF NETLOJIX AFTER THE SALE
As described above, in conjunction with its approval of the Stock Purchase
Agreement, the Board of Directors determined that the Company should divest
itself of its residential long distance telephone service business. This
business formed the core of the Channel Markets Group and Matrix, the Company's
wholly-owned subsidiary. As a result of the Sale, this business will be
transferred to the Buyer.
The Company intends to continue providing long distance telephone services
to its business customers. NetLojix Telecom, Inc., a wholly-owned subsidiary of
the Company, has applied for Section 214 authority from the Federal
Communications Commission and operating authority from all 49 states in which
Matrix is currently qualified or registered. Management believes that NetLojix
Telecom will have received such approval in all or substantially all of such
jurisdictions on or before the closing of the Sale. In the event that NetLojix
Telecom has not received approval in any given jurisdiction, then Matrix will
continue to provide service on behalf of the Company in such jurisdiction until
such approval is received.
REGULATION
The services which NetLojix provides, either directly or through its
subsidiaries, are subject to varying degrees of federal, state and local
regulation. The Federal Communications Commission 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 retain jurisdiction over jurisdictionally intrastate
communications. The Federal Communications Commission and relevant public
service commissions have the authority to regulate interstate and intrastate
rates, respectively, ownership of transmission facilities and the terms and
conditions under which NetLojix's services are provided.
In general, neither the Federal Communications Commission nor the relevant
state public service commissions exercise direct oversight over cost
justification for NetLojix's services or NetLojix's profit levels, but either or
both may do so in the future. However, NetLojix is required by federal and state
law and regulations to file tariffs listing the rates, terms and conditions of
services provided. NetLojix generally is also required to obtain certification
from the relevant state public service commission prior to the initiation of
certain intrastate service, and is required to maintain a certificate issued by
the Federal Communications Commission in connection with the provision of
certain 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 NetLojix.
COMPETITION
The telecommunications and information technology industries are highly
competitive and affected by rapid regulatory and technological change. NetLojix
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. NetLojix's future success will depend in
part upon its ability to compete with national and local telecommunications
providers, national and local Internet service providers, and small
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<PAGE>
and large network services providers, many of which have considerably greater
financial and other resources than NetLojix.
INTELLECTUAL PROPERTY
NetLojix has registered several trademarks for use in its marketing
materials. The Matrix name and logo, used by NetLojix to market long distance
service, calling card services and dial-up Internet access is a registered
trademark owned by Matrix. NetLojix also uses several unregistered trademarks,
including NetLojix-TM-, mPOP-TM-, Silicon Beach-TM-, WestNet Communications-TM-,
Remote Lojix-TM-, Addictive Media-TM- and Digital Meteor-TM-, which it may seek
to register. While NetLojix believes these trademarks are important to its
business, NetLojix does not believe that failure to register these trademarks
poses any material risk of infringement on its rights to use such trademarks.
EMPLOYEES
As of September 30, 1999, NetLojix, including its subsidiaries, had 180
full-time employees. Of this number, 19 are employees of Matrix who will no
longer be affiliated with NetLojix after the closing of the Sale. None of the
employees of NetLojix are represented by a union. NetLojix supplements its work
force from time to time with contractors, administrative personnel through
employment agencies, and part time employees. NetLojix believes that it has good
relations with its employees.
FACILITIES
NetLojix does not own any real property. The table below sets forth certain
information with respect to the material properties leased by NetLojix,
including the NetLojix's executive offices in Santa Barbara, California. All of
such properties consist of office space. NetLojix and its subsidiaries also
operate points-of-presence for the purpose of creating local access points to
its network backbone.
<TABLE>
<CAPTION>
LOCATION SQUARE FEET EXPIRATION DATE(2) CURRENT MONTHLY RENT(1)
- -------- ----------- ------------------ -----------------------
<S> <C> <C> <C>
501 Bath Street
Santa Barbara, CA............. 6,798 March 2003 $11,863
8721 Airport Freeway
Fort Worth, TX(3)............. 24,500 November 2000 $23,050
104 West Anapamu
Suites C&D
Santa Barbara, CA............. 3,441 November 2001 $ 4,800
70 West 36th St., Suite 605
New York, NY.................. 2,500 December 2002 $ 4,800
38 East 32nd St., 8th Floor
New York, NY.................. 4,400 February 2004 $ 4,416
1600 Parkwood Circle
Suite 603
Atlanta, GA................... 2,190 December 2001 $ 3,750
2333 Mill Creek Drive
Suite 120
Laguna Hills, CA.............. 1,446 February 2001 $ 3,370
</TABLE>
- ------------------------
(1) All amounts shown are on a "triple net" basis.
(2) Subject to certain renewal options held by NetLojix.
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<PAGE>
(3) Matrix is the lessee under this lease. NetLojix may continue to use a
portion of the facility after the closing of the Sale pursuant to an
agreement with the Buyer.
In addition, NetLojix has leases at six other facilities throughout the
United States. These facilities are used primarily for sales offices. The rent
on these facilities is less than $3,000 per month per facility.
LEGAL PROCEEDINGS
NetLojix is a defendant in a class action under the federal securities laws
(IN RE AVTEL SECURITIES LITIGATION, Case No. 98-9236) currently pending in the
United States District Court for the Central District of California.
This litigation is the consolidation of five separate class action suits
that were filed against NetLojix and certain of its officers, alleging
securities fraud. The plaintiffs are purported investors who purchased shares of
NetLojix common stock on November 12, 1998. On that day, the trading price for
the common stock on The Nasdaq SmallCap Market rose from $2.125 to $31 per
share, with more than 3 million shares trading. The plaintiffs allege that a
press release issued by NetLojix on November 12, 1998, announcing the launch of
its subsidiaries' DSLink Service for high speed Internet access, and an
interview with NetLojix Chief Executive Officer Anthony E. Papa concerning that
service, as reported by Bloomberg News, were misleading and defrauded the market
for NetLojix's publicly-traded securities.
This matter is still in the early stages of litigation. The plaintiffs filed
a consolidated and amended complaint on March 15, 1999. Discovery is under way,
with trial tentatively scheduled for October 2000. NetLojix contends that its
statements were not misleading, and intends to defend vigorously this securities
litigation. However, it is not possible to predict at this time the likely
outcome of this action or the costs NetLojix will incur in defending the action.
On May 28, 1999, Matrix was served with a complaint filed in the District
Court of Dallas County, Texas, by E. Craig Sanders. Mr. Sanders was an executive
of Matrix from late 1994 until he was terminated by Matrix in May 1995. In
addition to Matrix, the defendants in the action are Ronald L. Jensen, United
Group Association, Inc. (an entity affiliated with Mr. Jensen) and NetLojix. The
complaint alleges that Mr. Jensen wrongfully foreclosed on Matrix stock
allegedly owned by Mr. Sanders after Mr. Sanders failed to repay a debt to
Mr. Jensen. Matrix's stock records do not indicate that any shares were issued
in Mr. Sanders' name, and the shares in dispute, which had been issued in
Mr. Jensen's name, were subsequently repurchased from Mr. Jensen by Matrix. In
addition to his claims against Mr. Jensen, Mr. Sanders is apparently seeking
171,548 shares of NetLojix's common stock, or its monetary equivalent, from
NetLojix.
NetLojix and Matrix have filed an answer denying the allegations of this
complaint, and discovery in the matter is under way. Both NetLojix and Matrix
intend to defend this complaint vigorously.
NetLojix is not aware of any proceedings against it contemplated by any
governmental authority.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth, for the periods and dates indicated,
selected consolidated financial data for NetLojix. The selected consolidated
financial information for and as of the end of, each of the years in the
five-year period ended December 31, 1998 are derived from NetLojix's
consolidated financial statements, which statements have been audited by KPMG
LLP, independent certified public accountants. NetLojix's consolidated financial
statements as of December 31, 1998 and 1997 and for each of the years in the
three-year period ended December 31, 1998 and KPMG LLP's report with respect to
these financial statements are included elsewhere in this Information Statement.
The information for the six months ended June 30, 1999 and 1998 was not derived
from audited financial statements, but in the opinion of NetLojix's management
reflects all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the results of operations for such periods.
The financial data as of and for the six months ended June 30, 1999 is not
necessarily indicative of the results that can be expected for the year ending
December 31, 1999.
On December 1, 1997, NetLojix and Matrix completed a share exchange, whereby
all of the outstanding stock of Matrix was exchanged for shares of NetLojix
common stock. For accounting purposes, the share exchange was treated as a
reverse acquisition of NetLojix by Matrix. Accordingly, NetLojix's results of
operations reflect the operations of Matrix prior to December 1, 1997 and
reflect the combined operations of NetLojix and Matrix subsequent to
December 1, 1997. These selected financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and notes thereto included
elsewhere herein.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, YEARS ENDED DECEMBER 31,
------------------------- -------------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues........................ $18,650,775 $23,739,705 $44,013,498 $51,389,080 $71,558,295 $64,289,718 $59,551,307
Operating income (loss)......... (4,987,139) (3,833,578) (7,423,753) (10,757,960) 4,091,034 2,422,393 604,109
Net income (loss)............... (5,186,732) (3,067,985) (5,802,318) (10,191,720) 2,566,734 (2,440,493) 643,200
Net loss per common share-basic
and diluted(1)................ (0.52) (0.32) (0.61) (1.23) N/A N/A N/A
Cash dividends per common
share......................... -- -- -- -- -- -- --
</TABLE>
- ------------------------------
N/A--Not applicable
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
AS OF JUNE 30, AS OF DECEMBER 31,
------------------------- -------------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Working capital (deficit)....... $(3,771,247) $ 3,383,908 $(1,697,959) $ 5,570,657 $ 6,066,620 $ 206,071 $ (140,741)
Total assets.................... 14,430,748 15,625,779 15,959,354 18,724,850 20,338,404 17,580,694 14,957,279
Long term borrowings............ 2,226,619 -- 1,112,890 -- -- -- --
Stockholders' equity............ 1,055,876 5,373,605 4,510,253 7,809,048 7,861,883 3,539,522 2,372,333
</TABLE>
- ------------------------------
(1) Per share amounts are not reflected for 1996, 1995 and 1994 due to the
recapitalization of NetLojix as a result of the reverse acquisition in 1997.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF NETLOJIX'S FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH NETLOJIX'S FINANCIAL
STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE IN THIS INFORMATION
STATEMENT. ALL STATEMENTS, TREND ANALYSIS AND OTHER INFORMATION CONTAINED IN
THIS INFORMATION STATEMENT RELATIVE TO MARKETS FOR NETLOJIX'S SERVICES AND
TRENDS IN NETLOJIX'S OPERATIONS OR FINANCIAL RESULTS, AS WELL AS OTHER
STATEMENTS INCLUDING WORDS SUCH AS "ANTICIPATES," "BELIEVES," "ESTIMATES,"
"EXPECTS" AND "INTENDS" AND OTHER SIMILAR EXPRESSIONS, CONSTITUTE
FORWARD-LOOKING STATEMENTS AND ARE SUBJECT TO BUSINESS AND ECONOMIC RISKS,
INCLUDING BUT NOT LIMITED TO THOSE DISCUSSED IN "RISK FACTORS," AND ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY THE FORWARD-LOOKING
STATEMENTS.
BACKGROUND
SHARE EXCHANGE
On December 1, 1997, NetLojix and Matrix completed a share exchange, whereby
all of the outstanding common stock of Matrix was exchanged for shares of
NetLojix common stock. For accounting purposes, the share exchange was treated
as a reverse acquisition of NetLojix by Matrix. NetLojix was the legal acquirer
and accordingly, the share exchange was effected by the issuance of NetLojix
common stock in exchange for all of the common stock then outstanding of Matrix.
In addition, holders of Matrix outstanding stock options received non-qualified
stock options of NetLojix. The following discussion of results of operations
reflects the operations of Matrix prior to December 1, 1997 and reflects the
combined operations of NetLojix and Matrix subsequent to December 1, 1997.
Accordingly, references to NetLojix refer to operations of Matrix prior to the
share exchange and the combined operations of Matrix and NetLojix subsequent to
the share exchange.
The reverse acquisition of NetLojix by Matrix was accounted for using the
purchase method of accounting. In order to value the consideration given in the
share exchange, the market price of NetLojix common stock for a period
immediately preceding the announcement of the share exchange was used. As of the
date of acquisition, NetLojix determined the fair value of the net tangible and
intangible assets and liabilities acquired. The underlying fair value of
NetLojix's net assets was substantially less than the indicated market value of
NetLojix's common and preferred stock. Accordingly, NetLojix recorded a charge
to income of $9.1 million immediately subsequent to the reverse acquisition.
ACQUISITION OF NEW BEST CONNECTIONS, INC.
Effective July 1, 1997, Matrix acquired New Best Connections, Inc., an
affiliate of Matrix through substantially similar common ownership, by means of
a share-for-share exchange. Best Connections' primary assets were cash of
$211,000, ownership of shares of Matrix common stock, and Best Connections'
relationships with the field force of sales agents. The assets and liabilities
of Best Connections' were recorded at their historical cost, which approximated
the fair value of such assets as of July 1, 1997. Best Connections merged into
Matrix effective October 18, 1999.
ACQUISITION AND DISPOSITION OF DNS COMMUNICATIONS, INC.
In October 1995, Matrix issued shares of its common stock valued at
$3.6 million in exchange for all of the outstanding common stock of DNS
Communications, Inc., 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 Communications net assets was pushed down to DNS
Communications 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 Communications
generated substantial losses. DNS Communications' customer churn rate and bad
debts as well as projected cash flows were evaluated
21
<PAGE>
and as of December 31, 1995 it was determined that the remaining investment in
the DNS Communications acquired customer base totaling approximately
$4.4 million should be written off, and that amount was written off
In June 1996, Matrix sold the customer base acquired in the DNS
Communications 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 Communications for approximately $5.2 million.
Matrix recorded a gain on this sale of approximately $3.2 million.
Due to the timing of the acquisition and subsequent decision to sell the
operations of DNS Communications, Matrix has recorded its interest in DNS
Communications operations using the equity method of accounting.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1998
REVENUES
Revenues for the three months ended June 30, 1999 were $9.3 million, a
decline of 17.4% or $2.0 million from $11.3 million for the three months ended
June 30, 1998.
NetLojix's Business Markets Group revenue increased $2.0 million to
$3.2 million for the three months ended June 30, 1999 from $1.2 million for the
three months ended June 30, 1998. The acquisitions of Remote Lojix/PCSI, Inc.
and Digital Media International, Inc. during the fourth quarter of 1998
contributed $1.6 million of the increase. Data and voice products of the
Business Markets Group increased 29.5% for the three months ended June 30, 1999
over the same period in 1998. Data networking needs of the corporate customer
and the Internet have continued to drive and change the telecom industry. The
future focus of NetLojix and the Business Markets Group continues to move toward
incorporating voice and data networking solutions into the construction of
corporate Intranets and Wide Area Networks. Accordingly, the Business Markets
Group revenue as a percent of NetLojix's total revenue increased to 34.0% for
the three months ended June 30, 1999 from 10.7% for the three months ended
June 30, 1998.
NetLojix's Channel Markets Group revenue decreased $3.9 million. The Channel
Markets Group revenue from traditional voice products declined $4.0 million or
43.7%, while Internet revenue increased $75,000 or 8.2%. Historically, the
Channel Markets Group has focused on selling retail long distance service
through telemarketing, direct mail, and distributors or agents. During the
fourth quarter of 1998, the Channel Markets Group implemented a new strategy to
sell Internet access and additional voice services exclusively through affinity
groups, agents and distributors with the main thrust focused on Internet access.
The primary source of revenues of the Channel Markets Group during the
period continued to be voice distribution channels. Pricing pressures within the
industry continued to reduce retail pricing of long distance products. These
factors, similar in nature to those affecting all resellers of long distance,
have accounted for a 7.6% decline in revenues reducing the Channel Markets
Group's long distance revenue per minutes to $0.178 for the three months ended
June 30, 1999 compared to $0.214 for the three months ended June 30, 1998.
Decreases in the Channel Markets Group revenues were additionally affected by a
continued attrition of customer bases primarily in the areas of telemarketed and
direct mail customers, which were determined not to be cost effective. A decline
in minutes of use on these customer bases represented 36.1% of the decline in
traditional voice products.
Consistent with NetLojix's stated focus, in July 1999, NetLojix entered into
a non-binding Letter of Intent to sell its residential long distance customer
business to Platinum Equity Holdings. On August 31, 1999, NetLojix entered into
the Stock Purchase Agreement pursuant to which it will sell the stock of Matrix
to a subsidiary of Platinum.
22
<PAGE>
GROSS MARGIN
Gross margin as a percentage of revenues increased to 35.4% for the three
months ended June 30, 1999 from 26.0% for the three months ended June 30, 1998.
Gross margin increased $365,000 to $3.3 million for the three months ended
June 30, 1999 from $2.9 million for the three months ended June 30, 1998.
The Business Markets Group's gross margin as a percent of revenue increased
22.9 percentage points to 32.1% for the three months ended June 30, 1999 from
9.2% for the three months ended June 30, 1998. Two primary factors affected this
increase. First, significantly lower rates were negotiated with NetLojix's major
underlying carrier for dedicated traffic. These rates became effective
February 15, 1999 and represent an approximate cost reduction of 20% on
dedicated traffic. Secondly, with the acquisitions of Remote Lojix and Digital
Media, the Business Markets Group is able to sell and support higher margin
products.
The Channel Markets Group's gross margin as a percent of revenue increased
9.1 percentage points to 37.1% for the three months ended June 30, 1999 from
28.0% for the three months ended June 30, 1998. Significantly lower rates were
negotiated with NetLojix's major underlying carrier that increased the gross
margin on multiple products and geographical areas in which the Channel Markets
Group provides services. Internet service gross margin within the Channel
Markets Group for the three months ended June 30, 1999 increased by 8.6% from
the same period in 1998. Provision for bad debts decreased $118,000, which was
fully attributable to the decline in voice revenues.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
Selling, general, and administrative costs increased $148,000 to
$5.0 million for the three months ended June 30, 1999 from $4.8 million for the
three months ended June 30, 1998. As a percentage of revenues, selling, general
and administrative costs increased by 10.6 percentage points to 53.1% for the
three months ended June 30, 1999 from 42.5% for the three months ended June 30,
1998.
The Business Markets Group's selling, general, and administrative costs
increased $1.1 million to $1.7 million for the three months ended June 30, 1999
from $535,000 for the three months ended June 30, 1998. The increase was
attributable to the acquisition of Remote Lojix and Digital Media in the fourth
quarter of 1998 accounting for $862,000 of the increase. The remaining increase
in cost was associated with expanded sales force and related expenses including
general office expense, rent, utilities and travel expenditures.
The Channel Markets Group's selling, general, and administrative costs
decreased $1.0 million to $3.3 million for the three months ended June 30, 1999
from $4.3 million for the three months ended June 30, 1998. As a percent of
revenue, selling, general, and administrative costs increased 10.8 percentage
points to 53.1% for the three months ended June 30, 1999 from 42.3% for the
three months ended June 30, 1998. A principal reason for the decrease in costs
was attributable to the decline in commission expenses associated with the
decline in revenue accounting for $292,000 of the decrease. Stock compensation
expense for the three months ended June 30, 1999 was $76,000 compared to
$329,000 for the three months ended June 30, 1998, a decrease of $253,000.
Certain option and restricted stock plans were accelerated and completely
expensed during 1998. Reductions in the sales/marketing force and advertising
and promotions expenditures accounted for $360,000 of the decrease.
Certain overhead expenditures that are allocated to each business segment
increased by $129,000 which includes professional fees related to the class
action lawsuit and accounting fees.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $93,000 to $359,000 for the three
months ended June 30, 1999 from $265,000 for the three months ended June 30,
1998. The increase was primarily from the
23
<PAGE>
acquisition and consolidation of assets related to the purchase of Remote Lojix
and Digital Media during the fourth quarter of 1998.
INTEREST EXPENSE AND OTHER INCOME (EXPENSE), NET
Interest expense increased $96,000 to $114,000 for the three months ended
June 30, 1999 from $17,000 for the three months ended June 30, 1998. The Channel
Markets Group recognized $62,000 of interest expense from long-term borrowings
and $22,000 of accrued interest on deferred payments due to a major vendor. The
Business Markets Group recognized $14,000 of accrued interest on liabilities
acquired with the Remote Lojix purchase. Other income (expense), net decreased
$35,000 to $2,000 of other expenses for the three months ended June 30, 1999
from $33,000 of other income for the three months ended June 30, 1998. The
decrease was primarily attributable to the Channel Markets Group due to the
decrease of interest income from cash investments and recognition of a loss on
disposition of obsolete assets and liabilities.
INCOME TAX
The income tax benefit for the three months ended June 30, 1999 was $0
compared to $413,000 for the three months ended June 30, 1998. During 1998,
NetLojix recognized a benefit for the carryback of the 1997 and 1998 net
operating losses attributable to Matrix. The unutilized 1998 and 1999 net
operating losses may be utilized to offset future taxable income.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998
REVENUES
Revenues for the six months ended June 30, 1999 were $18.7 million, a
decline of 21.4% or $5.0 million from $23.7 million for the six months ended
June 30, 1998.
The Business Markets Group's revenue increased $3.3 million to $5.9 million
for the six months ended June 30, 1999 from $2.6 million for the six months
ended June 30, 1998. The acquisition of Remote Lojix and Digital Media during
the fourth quarter of 1998 contributed $2.9 million of the increase. The
Business Markets Group's revenue as a percent of NetLojix's total revenue
increased to 31.8% for the six months ended June 30, 1999 from 10.8% for the six
months ended June 30, 1998. The future focus of NetLojix and the Business
Markets Group continues to move toward incorporating voice and data networking
solutions into the construction of corporate Intranets and Wide Area Networks.
The Channel Markets Group's revenue decreased $8.5 million. The Channel
Markets Group's revenue from traditional voice products declined $8.7 million,
while Internet revenue increased $220,000 or 12.8%. Long distance revenue per
minutes decreased to $0.174 for the six months ended June 30, 1999 compared to
$0.205 for the six months ended June 30, 1998, accounting for a 10.0% decline in
revenues. The decline in minutes of use on customer bases primarily in the areas
of telemarketed and direct mail customers contributed 34.7% of the decline in
traditional voice products. See "Results of Operations--Three Months Ended
June 30, 1999 compared with Three Months Ended June 30, 1998." The decline in
revenues is fully described above in the section, Revenue. All of the reasons
discussed above are applicable for the six months ended June 30, 1999 compared
to the six months ended June 30, 1998.
GROSS MARGIN
Gross margin as a percentage of revenues increased to 32.2% for the six
months ended June 30, 1999 from 25.7% for the six months ended June 30, 1998.
Gross margin decreased $90,000 to $6.0 million for the six months ended
June 30, 1999 from $6.1 million for the six months ended June 30, 1998.
The Business Markets Group's gross margin as a percent of revenue increased
18.0 percentage points to 28.1% for the six months ended June 30, 1999 from
10.1% for the six months ended June 30, 1998. Two
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primary factors affected this increase. First, significantly lower rates were
negotiated with NetLojix's major underlying carrier for dedicated traffic. These
rates became effective February 15, 1999 and represent an approximate cost
reduction of 20% on dedicated traffic. Secondly, with the acquisitions of Remote
Lojix and Digital Media, the Business Markets Group is able to sell and support
higher margin products.
The Channel Markets Group's gross margin as a percent of revenue increased
6.5 percentage points to 34.1% for the six months ended June 30, 1999 from 27.6%
for the six months ended June 30, 1998. Significantly lower rates were
negotiated with NetLojix's major underlying carrier that increased the gross
margin on multiple products and in geographical areas that the Channel Markets
Group provides service. Internet service gross margin within the Channel Markets
Group for the six months ended June 30, 1999 increased by 19.0% from the same
period in 1998. Provision for bad debt decreased $355,000, which was fully
attributable to the decline in voice revenues.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
Selling, general, and administrative costs increased $855,000 to
$10.2 million for the six months ended June 30, 1999 from $9.4 million for the
six months ended June 30, 1998. As a percentage of revenues, selling, general
and administrative costs increased by 15.4 percentage points to 54.9% for the
six months ended June 30, 1999 from 39.5% for the six months ended June 30,
1998.
The Business Markets Group's selling, general, and administrative costs
increased $2.4 million to $3.4 million for the six months ended June 30, 1999
from $946,000 for the six months ended June 30, 1998. The primary reason for the
increase was attributable to the acquisition of Remote Lojix and Digital Media
in the fourth quarter of 1998, accounting for $1.7 million of the increase. The
remaining increase in cost was associated with expanded sales force and related
expenses including general office expense, rent, utilities and travel
expenditures.
The Channel Markets Group's selling, general, and administrative costs
decreased $1.6 million to $6.8 million for the six months ended June 30, 1999
from $8.4 million for the six months ended June 30, 1998. As a percent of
revenue, selling, general, and administrative costs increased 14.0 percentage
points to 53.8% for the six months ended June 30, 1999 from 39.8% for the six
months ended June 30, 1998. A principal reason for the decrease in costs was
attributable to the decline in commission expenses and billing and collection
fees associated with the decline in revenue accounting for $668,000 of the
decrease. Stock compensation expense for the six months ended June 30, 1999 was
$157,000 compared to $564,000 for the six months ended June 30, 1998, a decrease
of $407,000. Certain option and restricted stock plans were accelerated and
completely expensed during 1998. Reductions in the sales/marketing force and
advertising and promotions expenditures accounted for $290,000 of the decrease.
Additionally, expenses declined $221,000 for the six months ended June 30, 1999
due to the amortization of advanced commissions being fully realized during
1998.
Certain overhead expenditures that are allocated to each business segment
increased by $157,000 which include professional fees related to the class
action lawsuit and accounting fees.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $209,000 to $753,000 for the six
months ended June 30, 1999 from $544,000 for the six months ended June 30, 1998.
The increase was primarily from the acquisition and consolidation of assets
related to the purchase of Remote Lojix and Digital Media during the fourth
quarter of 1998.
INTEREST EXPENSE AND OTHER INCOME (EXPENSE), NET
Interest expense increased $183,000 to $213,000 for the six months ended
June 30, 1999 from $29,000 for the six months ended June 30, 1998. The Channel
Markets Group recognized $118,000 of interest
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expense from long-term borrowings and $22,000 of accrued interest on deferred
payments due to a major vendor. The Business Markets Group recognized $51,000 of
accrued interest on liabilities acquired with the Remote Lojix purchase. Other
income decreased $64,000 to $13,000 for the six months ended June 30, 1999 from
$77,000 for the six months ended June 30, 1998. The decrease was primarily
attributable to the decrease of interest income from cash investments and
recognition of a loss on disposition of obsolete assets and liabilities.
INCOME TAX
The income tax benefit for the six months ended June 30, 1999 was $0
compared to $717,000 for the six months ended June 30, 1998. During 1998
NetLojix recognized a benefit for the carryback of the 1997 and 1998 net
operating losses of Matrix. The unutilized 1998 and 1999 net operating losses
may be utilized to offset future taxable income.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
REVENUES
Revenues for the year ended December 31, 1998 decreased 14.4% or
$7.4 million to $44.0 million from $51.4 million for the year ended
December 31, 1997. The decrease in revenues resulted primarily from the
reorganization and repositioning of NetLojix's Channel Markets Group. NetLojix's
focus is to be a provider of broadband network services integrating voice, data
and Internet solutions to mid-size corporations, small-office and home-office
professionals and select residential market segments. Historically, the Channel
Markets Group has focused on selling residential long distance telephone service
through telemarketing, direct mail, and distributors or agents. During the
fourth quarter of 1998, the Channel Markets Group implemented a new strategy to
sell Internet access and additional voice services exclusively through affinity
groups, agents and distributors.
Voice distribution channels continued to be the primary source of NetLojix's
revenues during 1998. Factors similar in nature to those affecting all resellers
of long distance have continued to effect a decline in revenues. Due to pricing
pressures within the industry and the competitive reductions by the first tier
carriers, NetLojix similarly continued to reduce retail pricing of long distance
products to meet consumer expectations, terminated the direct marketing of
casual calling products and discontinued the telemarketing of residential
customers. Long distance revenue, excluding discontinued sales channels,
decreased 9.5% while the associated minutes of usage decreased only 3.8% for the
year ended December 31, 1998 compared to the year ended December 31, 1997. Long
distance revenue from affiliated companies was $4.6 million for the year ended
December 31, 1998 and $3.6 million for the year ended December 31, 1997.
Decreases in revenues were also affected by continued attrition of a
maturing customer base and price reductions. Management anticipates that the
revenue decrease will stabilize as the continued integration of and revenue from
the Business Markets Group targeting corporate data networking, voice and
Internet service needs continues to expand and grow.
Decreases in revenues following the share exchange of NetLojix and Matrix
effective December 1, 1997 were anticipated by NetLojix beginning in the first
quarter of 1998. At that time, the management team chose to discontinue and
reduce certain unprofitable distribution channels. Management continued
throughout 1998 to reduce NetLojix's dependence on low margin, high churn
segments and to focus its resources in the business markets with higher average
billing and retention rates, niche ethnic consumer markets, small office-home
office distributors and agents, and Internet service providers. For the year
ended December 31, 1998, revenues generated from discontinued sales channels
decreased 43.4% or $8.2 million to $10.7 million from $18.9 million for the year
ended December 31, 1997. Long distance revenue generated from agents increased
3.5% or $665,000 to $19.5 million for the year ended December 31, 1998 from
$18.9 million for the year ended December 31, 1997.
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Data networking needs of the corporate customer and the Internet have
continued to drive and change the telecom industry. NetLojix's focus continues
to move toward incorporating voice and data networking solutions into the
construction of corporate intranets and wide area networks which will decrease
NetLojix's dependence on traditional long distance services. NetLojix's primary
focus has been to move quickly and efficiently towards becoming a viable
resource to the corporate world having few options in this new wave of
technology. With the acquisition of Remote Lojix in November 1998, NetLojix
recognized $1.0 million in technology systems integration and repair service
revenues for the two months ended December 31, 1998.
GROSS MARGIN
Gross margin decreased $3.0 million to $12.2 million for the year ended
December 31, 1998 from $15.2 million for the year ended December 31, 1997. As a
percentage of revenues, gross margin decreased by 1.9 percentage points to 27.6%
for the year ended December 31, 1998 from 29.5% for the year ended December 31,
1997. The decrease in gross margin as a percentage of revenues primarily
resulted from an increase in bad debt expenses, which was partially offset by
decreases of network cost from renegotiated contracts and leased facilities, all
of which are included in cost of sales.
Network cost as a percentage of revenues decreased by 1.3 percentage points
to 65.2% for the year ended December 31, 1998 from 66.5% for year ended
December 31, 1997. The primary factor that effected this decrease was
significantly lower wholesale rates, which went into effect March and July of
1998, negotiated with NetLojix's major underlying carriers.
Bad debt expense as a percentage of revenues increased by 2.6 percentage
points to 6.2% for the year ended December 31, 1998 compared to 3.6% for the
year ended December 31, 1997. The increased bad debt expense primarily resulted
from decreased collection percentages from the local exchange carriers in
certain geographical regions, primarily the northeastern portion of the United
States. This related principally to NetLojix's now discontinued casual calling
business. The majority of NetLojix's revenues are billed by the local exchange
carriers and NetLojix's bad debt expense was affected by the lower collection
percentages of the local exchange carriers. Collection policies and
aggressiveness in collection procedures among the local exchange carriers vary.
A significant amount of casual calling was experienced in the northeastern
portion of the United States in which the local exchange carriers' collection
percentages were considerably lower, and NetLojix's bad debt expense as a
percentage of revenues increased. The majority of new products being sold by
NetLojix have been designed as direct billed or electronic Internet billed
products, and the bad debt percentages experienced by NetLojix's internal
collection staff are significantly lower than those of the local exchange
carriers. For the fourth quarter of 1998, NetLojix experienced an average bad
debt percentage of 3.8% on direct billed products and 9.1% on local exchange
carrier billed products. Therefore, as the number of customers being billed by
the local exchange carrier decreases, and NetLojix implements its policy of
moving away from the local exchange carrier billing services, bad debt expense
as a percentage of revenue is anticipated to decrease. As of December 31, 1998,
58% of NetLojix's revenue was direct billed compared to 23% as of December 31,
1997.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
Selling, general, and administrative costs increased $2.4 million to
$18.5 million for the year ended December 31, 1998 from $16.1 million for the
year ended December 31, 1997. As a percentage of revenues, selling, general, and
administrative costs increased by 10.6 percentage points to 42.0% for the year
ended December 31, 1998 from 31.4% for the year ended December 31, 1997.
The primary reason for the increase in selling, general, and administrative
costs was the expanded sales force and related expenses including general office
expense, rent, utilities and travel expenditures. The remaining increase in cost
was attributable to the purchase of Remote Lojix by NetLojix, effective
November 1, 1998. As of December 31, 1998, NetLojix had three primary business
locations, eight
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additional sales locations throughout the United States and 47 sales and
marketing related employees compared to two primary business locations, two
remote sales locations and 21 sales and marketing related employees as of
December 31, 1997.
The decrease in revenue as explained above resulted in a decrease in selling
expenses of $1.6 million for the year ended December 31, 1998. Stock
compensation expense for the year ended December 31, 1998 was $477,000 compared
to $749,000 for the year ended December 31, 1997. The change was due primarily
to two circumstances. First, during 1998, NetLojix caused certain options
previously granted to accelerate (and to expire if not exercised before
December 13, 1998). As a result, fewer of such options were exercised than
contemplated in 1997, and the stock price used to calculate stock compensation
expense for such options was considerably lower than in 1997. The resulting
decrease in stock compensation expense was partially offset by additional
expense recognized in connection with the early vesting of a restricted stock
grant to a departing director. Certain non-employee agents were granted options
for participation in the generation of new business for NetLojix. Accordingly,
stock compensation was expensed under the requirements of SFAS No. 123.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $427,000 to $1,107,000 for the year
ended December 31, 1998 from $680,000 for the year ended December 31, 1997. The
increase primarily resulted from amortization of the acquired customer base
associated with the share exchange of NetLojix and Matrix effective December 1,
1997. The customer base is amortized on a straight-line basis over five years.
Similarly, the acquisition and consolidation of assets related to the share
exchange resulted in some increases in depreciation expense. As a result of the
acquisitions of Digital Media and Remote Lojix in the fourth quarter of 1998,
NetLojix recognized goodwill in the amount of $4.5 million. Goodwill is
amortized on a straight-line basis over fifteen years. Remote Lojix comprised
$4.4 million of goodwill. Goodwill was determined by the purchase price in
excess of the fair value of the assets received.
INTEREST EXPENSE AND OTHER INCOME, NET
Interest expense and other income net of other expenses decreased $195,000
to $95,000 for the year ended December 31, 1998 from $290,000 for the year ended
December 31, 1997. Interest expense increased $74,000 to $86,000 for the year
ended December 31, 1998 from $12,000 for the year ended December 31, 1997 due to
interest on the Coast Business Credit line of credit and leased equipment
acquired as the result of the share exchange of NetLojix and Matrix. Other
income decreased $121,000 to $181,000 for the year ended December 31, 1998 from
$302,000 for the year ended December 31, 1997 primarily due to the decrease in
interest earned from cash investments. The decrease in interest earned resulted
from a decrease in the amount of cash invested.
INCOME TAXES
NetLojix recognized a current and deferred tax benefit of $1,527,000 for the
year ended December 31, 1998 compared to $276,000 for the year ended
December 31, 1997. The tax benefit in 1998 resulted from the loss from
operations and the current portion of the benefit is attributable to the
carryback of a portion of such loss to prior years. As of December 31, 1998,
NetLojix has net operating loss carryforwards for federal tax purposes of
approximately $4.9 million which are available on a limited basis to offset
future federal taxable income, if any, through 2018.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
REVENUE
Revenue for the year ended December 31, 1997, decreased 28.1% or
$20.2 million to $51.4 million from $71.6 million for the year ended
December 31, 1996. The decrease in revenue resulted primarily from
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decreases in sales from three significant sales channels, all of which were
affiliated with NetLojix through substantially common ownership prior to the
share exchange of NetLojix and Matrix effective December 1, 1997. These sales
channels were a distributor selling via telemarketing, a distributor focusing on
the casual or dial-around customer, and a DNS Communications distributor of long
distance services. The relationship with the DNS Communications distributor was
terminated as a result of the sale of the DNS Communications customer bases in
June of 1996.
NetLojix in 1997 reduced its focus on the promotion of the dial-around
customer due to the significant costs of direct mailing and bad debt associated
with this product. Reduced sales from the telemarketing distributor resulted
from the erosion of the retail pricing in the market for the residential
consumer. Pricing continued to decline during 1997, and attrition from a
maturing customer base resulted in losing customers on higher gross margin
products. Attrition rates associated with long distance products are a normal
industry occurrence; however, methods of calculation differ within the industry.
NetLojix sought to reduce its risk from reliance on a small group of
distributors, and refocused to obtain multiple revenue sources external to
NetLojix. New distributors significantly contributed to the mix in 1997. 1997
sales from sources other than NetLojix's primary 1996 distributors increased
more than 20%.
GROSS MARGIN
Gross margin decreased $8.7 million in 1997, to $15.2 million for the year
ended December 31, 1997 from $23.9 million for the year ended December 31, 1996.
As a percentage of net sales gross margin decreased 3.9 percentage points to
29.5% for the year ended December 31, 1997 from 33.4% for the year ended
December 31, 1996. Two primary factors contributed to the decrease in gross
margin in 1997.
First, due to increasing competitive market demands, NetLojix was forced to
continue decreasing its retail rates in 1997 to meet the competitive rate
reductions; however, the underlying carrier costs to NetLojix did not change due
to contractual commitments. Accordingly, network costs as a percentage of
revenue increased, reflecting a lower gross margin in 1997 over 1996.
Second, bad debt as a percentage of revenue increased approximately 2% in
1997, primarily resulting from increased bad debt associated with the casual or
dial-around product. The majority of NetLojix's revenues were billed and
collected from the local exchange carriers, with which NetLojix has agreements.
Collection policies and aggressiveness in collection procedures differ among the
local exchange carriers. NetLojix experienced significant sales growth in a
geographical location in which the local exchange carriers bad debt percentages
were significantly higher than other local exchange carriers.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
NetLojix's selling, general, and administrative costs decreased
$2.7 million in 1997 from 1996. As a percentage of revenue, such costs increased
5.1 percentage points to 31.4% for the year ended December 31, 1997 compared to
26.3% for the year ended December 31, 1996. This increase resulted primarily
from the decrease in revenues causing the expense as a percentage of revenue to
increase. Certain changes are more fully described below.
Certain selling, general, and administrative costs related to the addition
of NetLojix operations to Matrix subsequent to the effective date of the share
exchange, December 1, 1997, amounted to approximately $286,000, accounting for
.56% of the increase as a percentage of revenues in 1997 over 1996. Selling
costs related to direct mailing to the casual or dial-around customer (which
were absorbed by the sales distributor in 1996) were approximately $605,000 in
1997, accounting for 1.18% of the increase as a percentage of revenues in 1997
over 1996. Salary expenses increased approximately $651,000 between the years,
or 3.76% as a percentage of revenues in 1997 over 1996, resulting primarily from
integration of NetLojix employees subsequent to the share exchange and the
addition of certain sales and marketing personnel in 1997.
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Billing and collection fees and distributor commissions decreased
approximately $3.9 million, or 1.82% as a percentage of revenues. Most of the
new products sold in 1997 were direct billed. As the percentage of direct billed
customers increased, billing and collection fees have decreased. Similarly, as
sales of certain products having a higher commission structure have declined,
commission expense has also declined.
Certain regulatory and professional services increased approximately
$266,000, or 1.22% as a percentage of revenues in 1997 over 1996. Carrier fees
specific to telecommunication providers upon reaching certain thresholds of
customers were met in the last half of the year in 1996; therefore, increased
fees in 1997 resulted from being charged the lower volume based fees for a full
year. Professional fees increased in 1997 over 1996 for two primary reasons.
First, due to increased market demands for information systems programmers,
NetLojix was forced to secure external contractors. Second, certain
telemarketing and verification costs associated with the sales process increased
in 1997 primarily resulting from the sales distributor absorbing these costs in
1996. Other selling, general and administrative costs decreased approximately
$213,000 in 1997. As a percentage of revenue, these costs increased .81% in 1997
over 1996 due to decreasing revenues.
ACQUISITION-RELATED WRITEOFF
The $9.1 million write off relates to the share exchange and is discussed
under "Background" above.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense decreased approximately $314,000 for
the year ended December 31, 1997, compared to the year ended December 31, 1996,
resulting primarily from older assets becoming fully depreciated.
INTEREST EXPENSE AND OTHER INCOME, NET
Interest expense decreased $219,000 to $12,000 for the year ended
December 31, 1997 from $231,000 for the year ended December 31, 1996. The
decrease resulted from reduced borrowings in 1997 compared to 1996. NetLojix had
sufficient cash from operations to meet operating expenses and capital
expenditures. Other income net of other expenses increased more than 11% for
1997 over 1996 primarily resulting from increases in interest earned from cash
investments. The increase in interest earned resulted from an increase in the
amount of cash invested.
INCOME TAXES
NetLojix recognized a tax benefit of $276,000 for the year ended
December 31, 1997 compared to a tax expense of $1.7 million for the year ended
December 31, 1996. The tax benefit in 1997 resulted from the loss from
operations for the year 1997.
LIQUIDITY AND CAPITAL RESOURCES
NetLojix's consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. As shown in the consolidated
financial statements during the years ended December 31, 1998 and 1997, NetLojix
reported net losses of $5,802,318 and $10,191,720, respectively. In addition, as
of December 31, 1998, NetLojix had a working capital deficit of $1,697,959, and
for the year ended December 31, 1998, net cash used in operations totaled
$5,978,797. During the six months ended June 30, 1999 and 1998, NetLojix
reported net losses of $5,186,732 and $3,067,985, respectively. In addition, as
of June 30, 1999, NetLojix had a working capital deficit of $3,771,247, and for
the six months ended June 30, 1999, net cash used in operations totaled
$2,440,659.
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Based on the realization of the tax benefit of carrying back 1998 net
operating losses to reduce prior years' taxable income, in September and
October 1999 NetLojix received a refund of approximately $1,325,000 of taxes
paid in prior years, as reflected on the balance sheets as of June 30, 1999 and
December 31, 1998.
On October 2, 1998, NetLojix entered into a secured credit facility with
Coast Business Credit. This credit facility consists of a line of credit of up
to $7.5 million. Under the line of credit, NetLojix may borrow up to 75% of
eligible receivables (as defined). In addition, the line of credit may be used
in connection with certain acquisitions and equipment purchases as well as to
provide a facility for issuing letters of credit. Borrowings under the line of
credit bear interest, payable monthly, based upon the prime rate of Bank of
America NT & SA plus 2% (10.0% at June 30, 1999). As of December 31, 1998,
borrowing outstanding under the credit facility amounted to $1,113,000 with
approximately $1,634,000 available under the borrowing base calculation for
future borrowings. As of June 30, 1999, borrowings outstanding under the credit
facility amounted to $2,227,000 with approximately $371,000 available for future
borrowings. Borrowings under the credit facility are secured by substantially
all of the assets of NetLojix. The credit facility expires on October 31, 2000.
Net cash provided by financing activities was $2.7 million and $3,000 for the
six months ended June 30, 1999 and 1998, respectively.
On April 23, 1999, NetLojix entered into an equity line agreement with
Cambois Finance, Inc., through which it may sell or "put" NetLojix common stock
to Cambois Finance, Inc. subject to the satisfaction of several conditions. The
equity line agreement provides for Cambois Finance to purchase up to $13,500,000
of NetLojix common stock, subject to NetLojix filing and maintaining an
effective registration statement, trading price and volume minimums, and limits
on the amount and frequency on sales of common stock under the line. NetLojix
filed the registration statement, which was declared effective by the Securities
and Exchange Commission on August 25, 1999. On September 13, 1999, NetLojix put
104,521 shares of common stock to Cambois Finance for $250,000 pursuant to the
equity line agreement. However, NetLojix's stock price subsequently declined
below the minimum threshold of $2.25 per share required in the equity line
agreement. As a result, NetLojix is currently unable to draw on the equity line.
As of June 30, 1999, NetLojix was in violation of one provision of the loan
and security agreement with Coast Business Credit that stipulates that NetLojix
must maintain a net worth equal to or greater than $2 million. NetLojix's net
worth as of June 30, 1999 was $1,055,876. Coast Business Credit has waived its
right of acceleration of the obligation as it relates to NetLojix not meeting
the net worth covenant subject to the closing of the Sale, but otherwise retains
its right of acceleration if the closing does not occur.
On August 31, 1999, NetLojix entered into the Stock Purchase Agreement
pursuant to which it will sell 100% of the stock of Matrix to the Buyer. The
consideration to NetLojix is to consist of a combination of credits against long
distance service, elimination of indebtedness (including under the Coast
Business Credit loan described above), and certain contingent payments. The
closing of the transaction is subject to certain regulatory and other approvals.
NetLojix believes with the completion of the sale of its residential long
distance business or its ability to draw upon the equity line or other sources
of capital, NetLojix will be able to meet its working capital requirements for
the foreseeable future. If NetLojix does not complete the sale of its
residential long distance business and if it is unable to draw on the equity
line or obtain other financing in a timely manner and on acceptable terms, it
may be in default under its agreement with Coast Business Credit. In that event,
management has developed and intends to implement a plan that would allow
NetLojix to continue to operate through the second quarter of 2000. This plan
would include reducing NetLojix's workforce, eliminating marketing expenditures,
reducing professional services, reducing or eliminating other discretionary
expenditures and possibly the sale of the Matrix customer base and other assets.
The primary sources of operating cash flow for NetLojix are (1) revenues
derived from the sale of information technology and telecommunications services
to individuals and business, (2) its secured credit
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facility and (3) the equity line agreement. Minor sources of revenues are
received for the provision of back office support to affiliated and
non-affiliated companies and for earnings from investment income. The primary
uses of cash are payments to underlying network vendors for provisioning
telecommunications facilities, to sales distributors for soliciting long
distance sales, and to the major local exchange carriers for billing and
collecting directly from the end user. Net cash used in operations totaled
$6.0 million for the year ended December 31, 1998, and net cash provided by
operations was $1.7 million for the year ended December 31, 1997, and
$1.0 million for the year ended December 31, 1996. Net cash used in operating
activities is $2.4 million for the six months ended June 30, 1999, compared to
$2.6 million for the six months ended June 30, 1998.
An important component of NetLojix's past growth has been to develop its
business through acquisitions, including the share exchange and the acquisitions
of Remote Lojix and Digital Media. NetLojix intends to continue this strategy.
In appropriate circumstances, NetLojix may use its capital stock for
acquisitions in addition to debt and equity financing.
On April 13, 1999, NetLojix sold 1,500 shares of its newly-designated
series B convertible preferred stock to AMRO International, S.A., Austinvest
Anstalt Balzers and Esquire Trade & Finance Inc. for $1,500,000. The series B
convertible preferred stock has a liquidation preference of $1,000 per share.
The series B convertible preferred stock is entitled to an annual dividend of
$30 per share, payable in cash or common stock, at NetLojix's option. The annual
dividend will increase to $60 per share if NetLojix ever ceases to be listed on
The Nasdaq Stock Market or any national securities exchange. The series B
convertible preferred stock is convertible into common stock at the option of
the series B investors at any time. The number of shares of common stock to be
received by a series B investor upon conversion will equal the liquidation
preference of the amount converted, divided by the conversion price. The
conversion price will be the lesser of (1) $6.875 and (2) 89% of the lowest
closing bid price for the common stock on The Nasdaq SmallCap Market during the
five days immediately preceding the date of conversion.
There is no minimum conversion price for the series B convertible preferred
stock. The conversion price is determined by the formula set forth above,
subject to limitation on the total number of shares which can be issued upon
conversion of the series B convertible stock below. As a result of issuance of
the series B stock, NetLojix is required to record the benefit of the conversion
feature in a manner similar to a preferred stock dividend equal to the
difference between the market price of NetLojix common stock and the conversion
price, times the number of common shares issuable upon conversion. The preferred
stock dividends are recorded ratably over the period to the earliest conversion
date (90 days from the date of issuance). During the quarter ended June 30,
1999, NetLojix recorded preferred dividends on series B stock of $222,381.
As of the date of this Information Statement, holders have converted 580
shares of series B preferred stock into 191,760 shares of NetLojix common stock.
However, unless NetLojix has obtained the approval of its voting stockholders in
accordance with the rules of The Nasdaq Stock Market, NetLojix will not issue
shares of common stock upon conversion of any shares of series B convertible
preferred stock if the issuance of common stock, when added to the number of
shares of common stock previously issued by NetLojix upon conversion of or as
dividends on shares of the series B convertible preferred stock, would exceed
19.9% of the number of shares of common stock which were issued and outstanding
on the original issuance date of the series B convertible preferred stock.
NetLojix will pay converting series B investors in cash for any excess over such
amount.
NetLojix also issued the series B investors warrants to purchase up to
20,000 shares of common stock at a price of $8.60 per share. The warrants may be
exercised beginning September 30, 1999 and expire on March 31, 2002.
NetLojix and the series B investors entered into a Registration Rights
Agreement that requires NetLojix to file, and obtain and maintain the
effectiveness of, a registration statement with the Securities and Exchange
Commission in order to register the public resale of all shares of the common
stock acquired
32
<PAGE>
by the series B investors (a) upon conversion of the series B convertible
preferred stock, (b) in payment of dividends on the series B convertible
preferred stock, and (c) upon exercise of the warrants. NetLojix will be subject
to significant monetary penalties if it fails to obtain or maintain the
effectiveness of such registration statement. NetLojix filed the registration
statement on May 20, 1999 and it became effective on June 2, 1999. NetLojix paid
Trinity Capital Advisors, Inc. $60,000 as compensation for providing financial
advisory services relating to the series B stock.
MARKET RISK
NetLojix was not exposed to material future earnings or cash flow
fluctuations, from changes in interest rates on its long-term debt at
December 31, 1998, or June 30, 1999. A hypothetical increase of 100 basis points
in the interest rate (ten percent of NetLojix's overall borrowing rate) would
not result in a material fluctuation in future earnings or cash flow. NetLojix
has not entered into any derivative financial instruments to manage interest
rate risk or for speculative purposes and is currently not evaluating the future
use of such financial instruments.
YEAR 2000 COMPLIANCE
NetLojix recognizes the importance of Year 2000 compliance. The following is
an overview of NetLojix's Year 2000 efforts and NetLojix's progress to date.
Year 2000 compliance relates to the ability or inability of computer systems
and certain other equipment to properly recognize and process data that uses two
digits rather than four to designate particular years. In 1998, NetLojix
initiated a Year 2000 project plan and internal project team to assess whether
NetLojix's network systems that process date sensitive information will perform
satisfactorily leading up to and beyond January 1, 2000. The goal of the plan
and the team is to correct, prior to January 1, 2000, any Year 2000-related
problem with NetLojix's critical systems, the failure of which could have a
material adverse effect on NetLojix's operations and/or NetLojix's ability to
provide service to its existing and potential customers. NetLojix's senior
management team has also given the team its full support and backing. In
addition to sums already expended, NetLojix anticipates spending approximately
$50,000 during the remainder of 1999 on the plan. The plan includes steps to
(1) identify each critical systems element that requires data code remediation,
(2) establish a plan to remediate such systems, (3) implement all required
remediations, (4) test the remediated systems, and (5) develop a contingency
plans.
The Year 2000 challenge is not only a technical issue of computer hardware
and software correctly storing and manipulating dates but also a business issue
affecting external customers and suppliers. NetLojix receives critical services
from providers of utilities and other services. NetLojix is also critically
reliant upon the systems of other telecommunications providers on which it
depends to deliver services and invoices to its customers. NetLojix cannot
control nor be responsible for compliance by its vendors and suppliers; however,
NetLojix is encouraging their efforts to become compliant and is working to
receive the appropriate warranties and assurances that those third parties are,
or will be, compliant.
To date, although efforts are ongoing in all areas of the plan, the phases
for the awareness, assessment and renovation of NetLojix owned or licensed
systems have been materially completed. Testing and verification of NetLojix
owned or licensed systems continues and is projected to be completed during the
fourth quarter of 1999.
NetLojix has contacted all significant third-party vendors and other
telecommunications carriers. Thus far, the majority of those suppliers who have
responded have indicated that their systems and service delivery mechanisms are
Year 2000 compliant or will be made so through currently available modifications
before the end of 1999. NetLojix plans to continue monitoring all of its
third-party remediation efforts and to develop an ongoing contingency plan for
the delivery of such services as necessary.
33
<PAGE>
Contingency planning to maintain and restore service in the event of natural
disasters, power failures and systems-related problems is a routine part of
NetLojix's operations. NetLojix believes that such contingency plans will assist
it in responding to the failure by outside service providers to successfully
address Year 2000 issues. In addition, NetLojix is currently identifying and
considering various Year 2000-specific contingency plans, including
identification of alternate vendors and service providers and manual
alternatives to system operations. These Year 2000 specific contingency plans
are expected to be materially complete during the fourth quarter of 1999.
Because the impact of Year 2000 issues on NetLojix and its customers is
materially dependent on the mitigation efforts of parties outside NetLojix's
control, NetLojix cannot assess with certainty the magnitude of any such
potential adverse impact. However, based upon risk assessment work conducted
thus far, NetLojix believes that it will be able to continue to provide service
to its customers at current service levels on January 1, 2000 and beyond.
INFLATION
NetLojix does not believe that the relatively moderate rates of inflation
over the past three years have had a significant effect on its net sales or its
profitability.
RECENTLY-ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities. In July 1999, the Financial Accounting Standards Board
issued SFAS No. 137 which delayed the effective date of SFAS No. 133. SFAS
No. 133 is now effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. Management does not anticipate that this statement will
have a material impact on NetLojix's consolidated financial statements.
SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of October 20, 1999,
with respect to the beneficial ownership of NetLojix common stock by each person
known by NetLojix to be the beneficial owner of more than 5% of its outstanding
common stock, by each director, by each of NetLojix's executive officers whose
annual salary and bonus exceeded $100,000 for the fiscal year ended
December 31, 1998, and by all executive officers and directors as a group.
Except as indicated in the footnotes to the table, the persons named in the
table have sole voting and investment power with respect to all shares of common
stock beneficially owned by them.
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 common stock subject to options held by that person that are
exercisable within sixty (60) days following October 20, 1999 are deemed
outstanding. However, such shares of 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 person's name. The percentages of beneficial
ownership shares in this table are based upon 10,924,834 shares of the common
stock outstanding.
Effective as of May 18, 1999, certain shareholders of NetLojix entered into
a voting trust agreement with Thomas H. Patrick, an unrelated party, as the
voting trustee. Pursuant to the voting trust agreement, James J. Jensen, Jami J.
Jensen, Janet J. Jensen, Julie J. Jensen, Gladys J. Jensen and Ronald L. Jensen
conveyed legal title of a total of 4,526,583 shares of NetLojix common stock to
a voting trust, with each depositing shareholder retaining his or her beneficial
ownership of the deposited shares. Under the terms of the voting trust
agreement, the voting trustee will exercise sole voting authority for the
deposited shares.
34
<PAGE>
The voting trust agreement has an initial term of five years, which may be
terminated earlier by unanimous agreement of the depositing shareholders and may
be extended for successive three year terms by the depositing shareholders who
elect to do so. After December 1, 1999, any depositing shareholder may direct
the voting trustee to sell shares they deposited and distribute the proceeds to
them in partial or complete redemption of their voting trust certificates.
<TABLE>
<CAPTION>
AMOUNT BENEFICIALLY
NAME AND ADDRESS OWNED PERCENT OF CLASS
- ---------------- ------------------- ----------------
<S> <C> <C>
Janet J. Jensen(1)(2) ...................................... 961,939 8.8%
9003 Airport Freeway
Fort Worth, TX 76180
Jeffrey J. Jensen(1) ....................................... 851,738 7.8%
2121 Precinct Line Road
Hurst, TX 76054
James J. Jensen(1)(2) ...................................... 800,000 7.3%
6304 Alexandria Circle
Atlanta, GA 30326
Jami J. Jensen(1)(2) ....................................... 851,738 7.8%
1933 Swede Gulch
Golden, CO 80120
Julie J. Jensen(1)(2) ...................................... 851,738 7.8%
Box 540, Kenwood Station
5257 River Road
Bethesda, MD 20816
Anthony E. Papa(3).......................................... 778,588 7.1%
James P. Pisani(3).......................................... 772,188 7.1%
Gladys J. Jensen(1)(2) ..................................... 731,847 6.7%
c/o United Group Association, Inc.
4001 McEwen Drive, Suite 200
Dallas, TX 75244
John E. Allen(4)............................................ 185,000 1.7%
Anthony D. Martin........................................... -- *
All directors and executive officers as a group (8
persons)(5)................................................. 2,721,122 24.7%
</TABLE>
- ------------------------
* Represents less than 1%
(1) Information is derived from a Schedule 13D filed with the Securities and
Exchange Commission on December 11, 1997 and a Schedule 13D/A filed with the
Securities and Exchange Commission (by Gladys J. Jensen only) on July 10,
1998 (the "Schedule 13D's"). Pursuant to the terms of the registration
rights and lockup agreement dated December 1, 1997, these shares may not be
sold until December 1, 1999. The Schedule 13D's note that, because each of
these stockholders agreed to the restrictions contained in the registration
rights and lockup agreement, such persons may be considered to be a "group"
within the meaning of Section 13 of the Securities Exchange Act of 1934, as
amended. However, the Schedule 13D's state that each of such persons
disclaims beneficial ownership of the shares held by any other person.
35
<PAGE>
(2) Shares are held by Thomas H. Patrick, as voting trustee under a voting trust
agreement dated May 18, 1999. Mr. Patrick has sole voting authority over
such shares.
(3) As to each of Mr. Papa and Mr. Pisani, includes 15,625 shares of common
stock that may be acquired under options that were exercisable within
60 days of October 20, 1999. Pursuant to the terms of the registration
rights and lockup agreement, 250,000 of the shares of common stock held by
each of Mr. Papa and Mr. Pisani may not be sold until December 1, 1999. The
address of these stockholders is c/o NetLojix Communications, Inc., 501 Bath
Street, Santa Barbara, CA 93101.
(4) Includes 60,000 shares of restricted stock awarded to Mr. Allen under
NetLojix's 1997 Stock Incentive Plan. Pursuant to the terms of the
registration rights and lockup agreement, 125,000 of the shares of common
stock held by Mr. Allen may not be sold until December 1, 1999.
(5) Includes 111,250 shares of common stock that may be acquired under options
that were exercisable within 60 days of October 20, 1999. Only includes
shares for the current directors and executive officers of NetLojix.
PRICE RANGE OF NETLOJIX COMMON STOCK AND RELATED MATTERS
NetLojix common stock is currently listed on the Nasdaq SmallCap Market
under the symbol "NETX." Prior to May 28, 1998, the common stock was traded on
the Electronic Bulletin Board. Prior to September 15, 1999, the common stock was
listed under the symbol "AVCO." For each quarter since the beginning of 1997,
the high and low bid quotations for NetLojix common stock, as reported by
Nasdaq, were as follows:
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
1997
First Quarter............................................... $ 3.50 $2.00
Second Quarter.............................................. 18.00 3.13
Third Quarter............................................... 19.00 9.75
Fourth Quarter.............................................. 19.00 7.00
1998
First Quarter............................................... 8.63 4.94
Second Quarter.............................................. 15.88 7.67
Third Quarter............................................... 8.00 1.75
Fourth Quarter.............................................. 31.00 2.00
1999
First Quarter............................................... 12.50 4.00
Second Quarter.............................................. 8.75 3.75
Third Quarter............................................... 4.88 1.63
Fourth Quarter (through November 5, 1999)................... 2.03 1.63
</TABLE>
The foregoing bid quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commissions and may not necessarily represent actual
transactions.
On July 26, 1999, the date preceding the public announcement of the letter
of intent with respect to the Sale between NetLojix and Platinum, the high and
low sales prices for the common stock were $4.00 and $3.75. The last reported
sales price of NetLojix common stock on November 5, 1999 was $1.88. As of
October 20, 1999, there were 588 record holders of NetLojix common stock.
NetLojix has never declared or paid any dividends on its common stock.
Further, NetLojix does not anticipate paying any dividends on the common stock
in the foreseeable future and intends to retain all available funds for use in
the operation and development of its business including future acquisitions. The
36
<PAGE>
Board of Directors intends to review NetLojix's dividend policy from time to
time. Under its secured credit facility with Coast Business Credit, NetLojix is
prohibited from paying cash dividends unless approved by Coast Business Credit.
In addition, NetLojix cannot pay a cash dividend on its common stock while any
Series A Preferred Stock is outstanding without the approval of at least 50% of
the outstanding shares of the Series A Preferred Stock. Even if NetLojix
receives this approval, the holders of the outstanding Series A and Series B
Preferred Stock are entitled to be paid any unpaid dividends on their preferred
shares for previous periods and to have a sufficient amount of money set aside
for payment of dividends in respect of the then current dividend period, prior
to the holders of the common stock receiving any dividend.
INFORMATION WITH RESPECT TO THE BUYER AND PLATINUM
The Buyer was incorporated in the State of Delaware on September 1, 1999,
specifically for the acquisition of Matrix. All of the capital stock of the
Buyer is owned by Platinum. Its principal executive offices are located at 2049
Century Park East, Suite 2710, Los Angeles, California 90067, and its telephone
number is (310) 712-1850.
Platinum is a limited liability company organized under the laws of the
State of Delaware. Its principal executive offices are located at 2049 Century
Park East, Suite 2710, Los Angeles, California 90067, and its telephone number
is (310) 712-1850.
Platinum is a holding company engaged in acquiring and operating technology
businesses that support Fortune 1000 companies and other major organizations
worldwide. Its subsidiaries include: Manac Solutions, Inc., which engages in
software engineering, distribution, consulting and support services to the legal
profession; Foresight Software, Inc., a provider of customer interaction
software, services management systems and enterprise resource planning
applications; David Corporation, which develops, markets and supports risk
management software for workers compensation and liability claims management;
DCA Services, Inc., a provider of long distance billing software applications
and solutions and other telecommunication services; Pilot Software, Inc., a
global supplier of customer and market analysis software for mission critical
business decisions; StarNine Technologies, Inc., an Internet software solutions
company that develops web server and e-mail client/server software for the
Macintosh as well as e-mail gateway, directory synchronization, and list server
products; ProfitKey International, LLC, which develops, markets and supports
manufacturing resource planning software products; Ins-Site Insurance Solutions,
which develops and supports an interactive suite of applications linking
insurance carriers and agents via the Internet; Synertech Health Systems
Solutions, Inc., which markets a managed care information system, support
software and data warehouse, as well as administrative support services, to
managed care organizations; Milgo Solutions, Inc., a provider of mission
critical networking solutions, including a line of telecommunications products
and services, WAN and remote office connectivity products, network consulting,
design, repair, service and management; Tesseract Corporation, a provider of
mainframe-based human resources, payroll and benefits software for large
companies; TeleService Resources, Inc., which provides call center management
services; and TimePlex, Inc., a developer of voice and data networks.
BY ORDER OF THE BOARD OF DIRECTORS
[LOGO]
James P. Pisani
President
November 8, 1999
37
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets, June 30, 1999
(Unaudited) and December 31, 1998......................... F-2
Condensed Consolidated Statements of Operations, Three Month
and Six Month Periods ended June 30, 1999 and 1998
(Unaudited)............................................... F-3
Condensed Consolidated Statements of Cash Flows, Six Month
Periods ended June 30, 1999 and 1998 (Unaudited).......... F-4
Notes to Condensed Consolidated Financial Statements
(Unaudited)............................................... F-5
CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report................................ F-13
Consolidated Balance Sheets, December 31, 1998 and 1997..... F-14
Consolidated Statements of Operations, Years ended
December 31, 1998, 1997 and 1996.......................... F-15
Consolidated Statements of Stockholders' Equity,Years ended
December 31, 1998, 1997 and 1996.......................... F-16
Consolidated Statements of Cash Flows,Years ended
December 31, 1998, 1997 and 1996.......................... F-17
Notes to Consolidated Financial Statements.................. F-18
Schedule II--Valuation of Qualifying Accounts............... S-1
</TABLE>
F-1
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 684,989 $ 911,179
Accounts receivable, net.................................. 4,004,945 4,804,532
Due from affiliates....................................... 474,638 501,858
Federal and state income tax receivable................... 1,325,000 1,325,000
Other current assets...................................... 614,017 921,435
----------- -----------
Total current assets.................................... 7,103,589 8,464,004
Property and equipment, net................................. 1,963,581 1,684,707
Goodwill, net............................................... 4,204,868 4,463,747
Other assets, net........................................... 1,158,710 1,346,896
----------- -----------
Total assets............................................ $14,430,748 $15,959,354
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and other accrued expenses............... $ 3,498,110 $ 2,643,761
Accrued network services costs............................ 4,500,953 4,217,206
Sales and excise tax payable.............................. 1,344,977 1,433,483
Due to affiliates......................................... 98,332 324,020
Other current liabilities................................. 1,432,464 1,543,493
----------- -----------
Total current liabilities............................... 10,874,836 10,161,963
Long-term borrowings........................................ 2,226,619 1,112,890
Common stock subject to put option.......................... 112,577 168,867
Other liabilities........................................... 160,840 5,381
----------- -----------
Total liabilities....................................... 13,374,872 11,449,101
----------- -----------
Stockholders' Equity:
Preferred stock, authorized 750,000 shares, $0.01 par
value................................................... -- --
Series A convertible preferred stock, authorized 250,000
shares, $0.01 par value, cumulative as to 8% dividends,
147,700 shares issued and outstanding. (Liquidation
preference of $704,032 including dividends in
arrears.)............................................... 1,477 1,477
Series B convertible preferred stock, authorized 1,500
shares, $0.01 par value, annual dividends of $30 per
share, 1,500 shares issued and outstanding. (Liquidation
preference of $1,500,000.).............................. 15 --
Common stock, authorized 20,000,000 shares, $0.01 par
value, issued 10,579,870 and 10,409,473 shares at June
30, 1999 and December 31, 1998 respectively............. 105,048 102,969
Additional paid in capital................................ 21,384,408 19,630,404
Accumulated deficit....................................... (20,434,961) 15,224,597)
Treasury stock, $0.01 par value, 11,075 at June 30, 1999
and none at December 31, 1998........................... (111) --
----------- -----------
Total stockholders' equity.............................. 1,055,876 4,510,253
Commitments and contingencies............................... -- --
----------- -----------
Total liabilities and stockholders' equity.............. $14,430,748 $15,959,354
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
(unaudited).
F-2
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues.................................. $ 9,328,361 $11,294,866 $18,650,775 23,739,705
Cost of revenues.......................... 6,024,066 8,356,018 12,644,779 17,644,013
----------- ----------- ----------- -----------
Gross margin.......................... 3,304,295 2,938,848 6,005,996 6,095,692
Operating expenses:
Selling, general and administrative..... 4,950,477 4,802,586 10,239,790 9,385,032
Depreciation and amortization........... 358,766 265,370 753,345 544,238
----------- ----------- ----------- -----------
Total operating expenses.............. 5,309,243 5,067,956 10,993,135 9,929,270
----------- ----------- ----------- -----------
Operating loss............................ (2,004,948) (2,129,108) (4,987,139) (3,833,578)
Interest expense.......................... (113,548) (17,327) (212,692) (29,302)
Other income, net......................... (2,104) 33,488 13,099 77,443
----------- ----------- ----------- -----------
Loss before income taxes.................. (2,120,600) (2,112,947) (5,186,732) (3,785,437)
Income tax benefit........................ -- 413,004 -- 717,452
----------- ----------- ----------- -----------
Net loss.................................. $(2,120,600) $(1,699,943) $(5,186,732) $(3,067,985)
=========== =========== =========== ===========
Net loss per share--basic and diluted..... $ (0.22) $ (0.18) $ (0.52) $ (0.32)
=========== =========== =========== ===========
Weighted average number of common shares--
basic and diluted....................... 10,549,170 9,549,958 10,512,523 9,513,924
=========== =========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
(unaudited).
F-3
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE 30,
--------------------------
1999 1998
------------ -----------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss.................................................. $ (5,186,732) $(3,067,985)
Adjustments to reconcile net loss to net to net cash used
in operating activities:
Depreciation and amortization........................... 753,345 544,238
Loss on disposition of assets........................... 66,421 --
Amortization of advanced commissions.................... -- 220,928
Provision for bad debts................................. 1,084,812 1,468,143
Stock compensation earned............................... 157,324 563,509
Changes in certain operating assets and liabilities:
Accounts receivable................................... (285,224) (1,415,826)
Due from affiliates................................... 27,220 (137,213)
Federal and state income tax receivable............... -- (228,821)
Other current assets.................................. 307,418 90,793
Accounts payable and accrued liabilities.............. 860,446 (561,458)
Due to affiliate...................................... (225,688) (36,036)
------------ -----------
Net cash used in operating activities............... (2,440,659) (2,559,728)
Cash Flows from Investing Activities:
Additions of property and equipment....................... (479,395) (226,327)
Payments received on loans to affiliates.................. -- 437,424
Proceeds from sale of property and equipment.............. 7,650 --
------------ -----------
Net cash provided by (used in) investing
activities........................................ (471,745) 211,097
Cash Flows from Financing Activities:
Principal payments on capital leases...................... (27,846) (28,881)
Issuance of common stock for exercise of options.......... 294,038 31,780
Issuance of Series B preferred stock...................... 1,407,325 --
Preferred stock dividend payments......................... (23,632) --
Borrowing on line of credit............................... 17,525,162 --
Amounts paid on line of credit............................ (16,411,433) --
Purchase of common stock for treasury..................... (77,400) --
------------ -----------
Net cash provided by financing activities........... 2,686,214 2,899
------------ -----------
Net decrease in cash and cash equivalents........... (226,190) (2,345,732)
Cash and cash equivalents at beginning of period............ 911,179 4,807,441
------------ -----------
Cash and cash equivalents at end of period.................. $ 684,989 $ 2,461,709
============ ===========
Cash paid during the period for interest.................... $ 152,885 $ 29,072
============ ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
(unaudited).
F-4
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 1999 AND 1998
(1) BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of NetLojix
Communications, Inc. and Subsidiaries (the "Company") as of June 30, 1999 and
for the three month and six month periods ended June 30, 1999 and 1998 have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting. Accordingly, they do not include all of the disclosures
required by generally accepted accounting principles for complete financial
statements and should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Form 10-K and
10-K/A for the year ended December 31, 1998. All significant intercompany
balances and transactions have been eliminated in consolidation. In the opinion
of management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of the interim financial
information have been included. The results of operations for any interim period
are not necessarily indicative of the results of operations for the entire year.
The Company's condensed consolidated financial statements for the three
month and six month periods ended June 30, 1998 have been restated to give
effect to the recognition of an income tax benefit of $413,004 and $717,452,
respectively. As a result of this restatement, net loss for the three month and
six month periods ended June 30, 1998 have been decreased by $413,004 ($0.04 per
common share--basic and diluted), and $717,452 ($0.08 per common share--basic
and diluted), respectively, from amounts previously reported.
(2) EARNINGS PER COMMON SHARE
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, EARNINGS PER SHARE ("SFAS 128"), in the fourth quarter of
1997, which required companies to present basic earnings per share and diluted
earnings per share.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Numerator:
Net loss................................. $(2,120,600) $(1,699,943) $(5,186,732) $(3,067,985)
Less preferred dividends................. 234,197 11,816 246,013 23,632
----------- ----------- ----------- -----------
Loss applicable to common
shareholders......................... $(2,354,797) $(1,711,759) $(5,432,745) $(3,091,617)
=========== =========== =========== ===========
Denominator:
Weighted average number of common shares
used in basic and diluted loss per
common share........................... 10,549,170 9,549,958 10,512,523 9,513,924
----------- ----------- ----------- -----------
Basic and diluted loss per common share.... $ (0.22) $ (0.18) $ (0.52) $ (0.32)
=========== =========== =========== ===========
</TABLE>
As of June 30, 1999, there are 2,638,893 potential common shares excluded
from the diluted per common share calculation because the effect was determined
to be antidilutive.
F-5
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(3) STOCKHOLDERS' EQUITY
In 1996, approximately 482,000 shares of common stock were issued to
officers of the Company at $1.50 per share. Such shares can be put or called at
a price of $1.50 per share plus the earnings per share or minus the losses per
share of the Company from the period July 1, 1996 to the end of the month prior
to the date of notification of termination of employment by the employee or the
Company. There were 75,051 and 112,578 shares outstanding subject to put options
as of June 30, 1999 and December 31, 1998, respectively.
During February 1999, the Company purchased 11,075 shares of its common
stock at prices ranging from $5.875 to $7.41 in the open market pursuant to the
Company's 1999 GO Plan. The 1999 GO Plan was established to provide the
Company's employees with cash bonuses for up to four years to promote longevity
of employment.
On April 1, 1999 the Company granted nonstatutory stock options to two board
members to purchase a total of 50,000 shares of the Company's common stock at an
exercise price of $4.88 per share (fair market value at date of grant) vesting
at a rate of 50% per year over two years. The Company also granted incentive
stock options to three executive officers to purchase a total of 300,000 shares
of the Company's common stock at an exercise price of $4.88 per share (fair
market value at date of grant) vesting at a rate of 25% per year over four
years. These options were granted pursuant to the Company's 1998 Stock Incentive
Plan.
On April 6, 1999 a former employee of the Company relinquished 36,262 shares
of the Company's common stock to settle an employee receivable. The shares where
subsequently canceled and retired.
On April 9, 1999 the Company granted nonstatutory stock options to a new
board member to purchase 25,000 shares of the Company's common stock at an
exercise price of $4.6875 per share (fair market value at date of grant). The
options were granted pursuant to the Company's 1998 Stock Incentive Plan and
vest at the rate of 50% per year over two years.
On April 13, 1999, the Company sold 1,500 shares of its newly-designated
Series B Convertible Preferred Stock (the "Series B Stock") to AMRO
International, S.A., an entity organized under the laws of Panama, Austinvest
Anstalt Balzers, an entity organized under the laws of Liechtenstein, and
Esquire Trade & Finance Inc., an entity organized under the laws of the British
Virgin Islands (the "Series B Investors") for $1,500,000. The Series B Stock has
a liquidation preference of $1,000 per share. The Series B Stock will be
entitled to an annual dividend of $30 per share, payable in cash or Common
Stock, at the Company's option. The annual dividend will increase to $60 per
share if the Company ever ceases to be listed on The NASDAQ Stock Market or any
national securities exchange. The Series B Stock is convertible into Common
Stock at the option of the Series B Investors at any time. The number of shares
of Common Stock to be received by a Series B Investor upon conversion will equal
the liquidation preference of the amount converted, divided by the conversion
price. The conversion price will be the lesser of (1) $6.875, or (2) 89% of the
lowest closing bid price for the Common Stock on The NASDAQ SmallCap Market
during the five trading day period prior to the date of conversion. The
conversion price will not be less than $3.00 for 180 days after the date of
issuance of the Series B Stock. As a result of issuance of the Series B stock,
the Company is required to record the benefit of the conversion feature in a
manner similar to a preferred stock dividend equal to the difference between the
market price of the
F-6
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(3) STOCKHOLDERS' EQUITY (CONTINUED)
Company's common stock and the conversion price, times the number of common
shares issuable upon conversion. The preferred stock dividends are recorded
ratably over the term of the minimum conversion period (90 days from date of
issuance). During the quarter ended June 30, 1999, the Company recorded
preferred dividends on Series B stock of $222,381. As of July 12, 1999,
Series B Investors had converted 520 shares of Series B Stock into 155,804
shares of NetLojix common stock at a conversion price of $3.3375 per share.
Unless the Company shall have obtained the approval of its voting stockholders
in accordance with the rules of The NASDAQ Stock Market, the Company will not
issue shares of Common Stock upon conversion of any shares of Series B Stock if
such issuance of Common Stock, when added to the number of shares of Common
Stock previously issued by the Company upon conversion of or as dividends on
shares of the Series B Stock, would exceed 19.9% of the number of shares of
Common Stock which were issued and outstanding on the original issuance date of
the Series B Stock. The Company will pay converting series B Investors in cash
for any excess over such amount.
The Company also issued the Series B Investors warrants to purchase up to
20,000 shares of Common Stock at a price of $8.60 per share. The warrants may be
exercised beginning September 30, 1999, and terminate on March 31, 2002.
The Company and the Series B Investors entered into a Registration Rights
Agreement that requires the Company to file, and obtain and maintain the
effectiveness of, a Registration Statement with the Securities and Exchange
Commission (the "Commission") in order to register the public resale of all
shares of the Common Stock acquired by the Series B Investors (a) upon
conversion of the Series B Stock, (b) in payment of dividends on the Series B
Stock, and (c) upon exercise of the warrants. The Company will be subject to
significant monetary penalties if it fails to maintain the effectiveness of such
Registration Statement.
The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation for
financial advisory services in connection with the placement of the Series B
Stock.
On April 23, 1999, the Company entered into a Private Equity Line with
Cambois Finance, Inc., a British Virgin Islands corporation (the "Investor").
Pursuant to the Private Equity Line, the Investor, subject to the Company filing
and maintaining an effective registration statement, trading price and volume
minimums, and limits on the amount and frequency on sales of common stock under
the line, agreed to purchase up to $13,500,000 of the Company's Common Stock
(the "Common Stock") over three years, as, when and if shares are put to the
Investor by the Company. The actual number of shares that may be issued by the
Company under the Private Equity Line is limited to 2,103,939 shares, unless and
until the Company obtains approval of the Private Equity Line from its
stockholders pursuant to the applicable corporate governance rules of The NASDAQ
Stock Market.
The Company's ability to require the Investor to purchase Common Stock is
subject to a number of significant conditions, including the continued
effectiveness of the Registration Statement described below. There can be no
assurance that the Investor will be able to purchase Common Stock when and as
required by the Company under the Private Equity Line.
F-7
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(3) STOCKHOLDERS' EQUITY (CONTINUED)
The Company may put shares to the Investor in amounts ranging from $75,000
up to $2,000,000 (varying with the Common Stock's trading price and volume)
every 15 trading days. The purchase price for the shares put to the investor
will be 89% of the lowest closing bid price for the Common Stock on The NASDAQ
SmallCap Market during the five trading day period consisting of the two trading
days preceding the delivery of the put notice to the Investor by the Company,
the day of such delivery, and the two trading days after such delivery. The
Company may not put shares to the Investor unless the lowest closing bid price
during such five trading day period is in excess of $2.25 per share. The closing
bid price for the Common Stock on August 9, 1999, was $3.375 per share.
In connection with the Private Equity Line, the Company and the Investor
entered into a Registration Rights Agreement that requires the Company to file,
and obtain and maintain the effectiveness of, a Registration Statement on
Form S-1 with the Commission in order to register the sale and public resale of
shares of the Common Stock acquired by the Investor under the Private Equity
Line (the "Registration Statement"). The Investor will be named as an
underwriter in such Registration Statement. The Investor will also be subject to
certain restrictions on short selling of the Common Stock and certain "blackout"
periods on its ability to resell Common Stock under the Registration Statement.
If the Registration Statement has not been declared effective by October 30,
1999, the Investor's obligation to purchase Common Stock under the Private
Equity Line shall terminate, and the Company will be required to pay the
Investor $25,000 in liquidated damages. The registration statement has been
filed with the Commission and is expected to be declared effective once the
Commission has completed its review process to its satisfaction.
The Company has issued 3,000 shares of Common Stock to Trinity Capital
Advisors, Inc. as compensation for financial advisory services in connection
with the transactions set forth in the Private Equity Line.
On May 3, 1999 the Company granted incentive stock options to an executive
officer to purchase 50,000 shares of the Company's common stock at an exercise
price of $5.625 per share (fair market value at date of grant) vesting at a rate
of 25% per year over four years. These options were granted pursuant to the
Company's 1998 Stock Incentive Plan.
(4) LIQUIDITY
For the three months and six months ended June 30, 1999, the Company
reported net losses of $2,120,600 and $5,186,732, respectively. In addition as
of June 30, 1999, the Company had a working capital deficit of $3,771,247, and
for the six months ended June 30, 1999, net cash used in operations totaled
$2,440,659.
As of June 30, 1999, the Company was in violation of one provision of the
Loan and Security Agreement with Coast Business Credit that stipulates that the
Company must maintain a net worth equal to or greater than $2 million. Coast
Business Credit has waived its right of acceleration of the obligation as it
relates to the Company not meeting the net worth covenant through September 30,
1999, but retains its right of acceleration if the Company is in violation of
the net worth covenant in any month after September 1999.
F-8
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(4) LIQUIDITY (CONTINUED)
In July 1999, the Company entered into discussions with a major vendor to
defer approximately $4.4 million in invoice payments. The Company expects to
finalize such agreements in late August.
On July 26, 1999, the Company entered into a non-binding Letter of Intent to
sell its residential long distance business to Platinum Equity Holdings through
the sale of 100% of the stock of its wholly owned subsidiary, Matrix, Inc.
("Matrix") (see Note 6). The consideration to the Company would consist of a
combination of cash, assumption of indebtedness (including the Coast Business
Credit loan described above), certain contingent payments and future services.
As of April 23, 1999, the Company entered into a Private Equity Line of
Credit which provides for investors to purchase up to $13,500,000 of the
Company's common stock, subject to the Company filing and maintaining an
effective registration statement, trading price and volume minimums, and limits
on the amount and frequency on sales of common stock under the line (see
Note 6).
The Company believes that, if it completes the sale of its residential long
distance business or if it becomes able to draw upon the Private Equity Line or
other sources of capital, the Company will be able to meet its working capital
requirements in the foreseeable future.
If the Company does not complete the sale of its residential long distance
business or if it is unable to draw on the Private Equity Line or obtain other
financing in a timely manner and on acceptable terms, it may be in default under
its agreement with Coast Business Credit. In that event, management has
developed and intends to implement a plan that would allow the Company to
continue to operate through the second quarter of 2000. This plan would include
reducing the Company's workforce, eliminating advertising expenditures, reducing
professional services, reducing or eliminating other discretionary expenditures
and possibly the sale of assets.
(5) SEGMENT REPORTING
The Company's primary business segments are Business Markets Group ("BMG"),
and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data, voice and
Internet networking needs. Through a value-added sales process, the Company
designs, provisions and manages its customers' networks. The Company provides a
host of additional value-added services assisting its customers to create
enhanced intranet and extranet applications. Additionally, BMG markets to its
customer base a variety of traditional communications products and services such
as Internet access, long distance telephone service, executive calling cards and
audio/video conferencing.
CMG targets and markets to distribution companies, agents, resellers and
affinity groups ("Channel Partners") that maintain access to large groups of
individuals and small businesses through affinity relationships and niche
marketing strategies. Channel Partners include non-profit organizations and
for-profit distribution groups. CMG provides Internet access, long distance
telephone and other services to customers in 49 states.
F-9
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(5) SEGMENT REPORTING (CONTINUED)
The Company measures the performance of BMG, and CMG based on revenues,
gross margin and earnings before interest, taxes, depreciation and amortization
("EBITDA"). EBITDA is not a measure of financial performance under generally
accepted accounting principles and should not be considered as an alternative to
net income or cash flows from operations, as a measure of performance.
The results for the three months ended June 30, 1999 and 1998 are as
follows:
THREE MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenues................................................ $3,174,251 $ 6,154,110 $ 9,328,361
Gross margin............................................ 1,019,451 2,284,844 3,304,295
Selling, general and administrative..................... 1,682,513 3,267,964 4,950,477
Depreciation and amortization........................... 183,271 175,495 358,766
Interest expense........................................ (14,530) (99,018) (113,548)
Other income (expense).................................. 1,260 (3,364) (2,104)
Income tax benefit...................................... -- -- --
---------- ----------- -----------
Net loss................................................ $ (859,603) $(1,260,997) $(1,648,286)
========== =========== ===========
EBITDA.................................................. $ (661,802) $ (986,484) $(1,648,286)
Total assets............................................ $9,672,238 $ 4,758,510 $14,430,748
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenues............................................... $1,203,154 $10,091,712 $11,294,866
Gross margin........................................... 111,045 2,827,803 2,938,848
Selling, general and administrative.................... 534,505 4,268,081 4,802,586
Depreciation and amortization.......................... 89,805 175,565 265,370
Interest expense....................................... -- (17,327) (17,327)
Other income (expense)................................. 78 33,410 33,488
Income tax benefit..................................... -- 413,004 413,004
---------- ----------- -----------
Net loss............................................... $ (513,187) $(1,186,756) $(1,699,943)
========== =========== ===========
EBITDA................................................. $ (423,382) $(1,406,868) $(1,830,250)
Total assets........................................... $2,484,748 $13,141,031 $15,625,779
</TABLE>
F-10
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(5) SEGMENT REPORTING (CONTINUED)
The results for the six months ended June 30, 1999 and 1998 are as follows:
SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
BMG CMG TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
Revenues............................................... $ 5,936,208 $12,714,567 $18,650,775
Gross margin........................................... 1,666,310 4,339,666 6,005,996
Selling, general and administrative.................... 3,395,721 6,844,069 10,239,790
Depreciation and amortization.......................... 395,654 357,691 753,345
Interest expense....................................... (51,769) (160,923) (212,692)
Other income (expense)................................. 17,860 (4,761) 13,099
Income tax benefit..................................... -- -- --
----------- ----------- -----------
Net loss............................................... $(2,158,954) $(3,027,778) $(5,186,732)
=========== =========== ===========
EBITDA................................................. $(1,711,531) $(2,509,164) $(4,220,695)
</TABLE>
SIX MONTHS ENDED JUNE 30, 1998
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenues............................................... $2,553,000 $21,186,705 $23,739,705
Gross margin........................................... 257,930 5,837,762 6,095,692
Selling, general and administrative.................... 945,898 8,439,134 9,385,032
Depreciation and amortization.......................... 195,063 349,175 544,238
Interest expense....................................... (6,068) (23,234) (29,302)
Other income (expense)................................. 3,403 74,040 77,443
Income tax benefit..................................... -- 717,452 717,452
---------- ----------- -----------
Net loss............................................... $ (885,696) $(2,182,289) $(3,067,985)
========== =========== ===========
EBITDA................................................. $ (684,565) $(2,527,332) $(3,211,897)
</TABLE>
F-11
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
JUNE 30, 1999 AND 1998
(6) SUBSEQUENT EVENTS
On July 12, 1999, Series B Investors converted 520 shares of Series B Stock
into 155,804 shares of NetLojix common stock at a conversion price of $3.3375
per share.
On July 26, 1999, the Company entered into a non-binding Letter of Intent
with Platinum Equity Holdings, LLC ("PEH") to sell its residential long distance
business to PEH. The Company's residential long distance business unit, the
principal component of the CMG segment, contributed approximately $10,781,000 in
revenues for the six months ended June 30, 1999. For the six months ended
June 30, 1999 the unit represented approximately 58% of the Company's total
revenues and 72% of its total losses.
The Letter of Intent contemplates that PEH will acquire 100% of the stock of
NetLojix's wholly owned subsidiary, Matrix. The consideration to the Company
from the transaction is valued at approximately $7.9 million, and will consist
of a combination of cash, assumption of indebtedness, certain contingent
payments and future services. The value of the transaction could be affected by
the future performance of the unit being transferred. The closing of the
transaction is subject to negotiation and execution of a definitive agreement,
as well as regulatory and other approvals. The Company expects to record a gain
on the transaction.
F-12
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NetLojix Communications, Inc. (formerly known as AvTel Communications, Inc.):
We have audited the accompanying consolidated balance sheets of NetLojix
Communications, Inc. and subsidiaries (formerly known as AvTel
Communications, Inc.) as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1998. In
connection with our audits of the consolidated financial statements, we also
have audited the accompanying financial statement schedule. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NetLojix
Communications, Inc. and subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles, after restatement for the income tax refund receivable
discussed in Note 5. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG LLP
Dallas, Texas
April 14, 1999, except as to Note 5,
which is as of July 2, 1999
F-13
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 911,179 $ 4,807,441
Accounts receivable, net.................................. 4,804,532 6,961,953
Due from affiliates....................................... 501,858 2,127,771
Federal and state income tax receivable................... 1,325,000 598,970
Other current assets...................................... 921,435 861,950
----------- -----------
Total current assets.................................... 8,464,004 15,358,085
Property and equipment, net................................. 1,684,707 1,791,682
Goodwill, net............................................... 4,463,747 --
Other assets, net........................................... 1,346,896 1,575,083
----------- -----------
Total assets............................................ $15,959,354 $18,724,850
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued expenses............... $ 2,643,761 $ 1,546,762
Accrued network service costs............................. 4,217,206 4,319,198
Sales and excise taxes payable............................ 1,433,483 736,012
Unearned revenue.......................................... 954,101 --
Due to affiliates......................................... 324,020 2,719,417
Other current liabilities................................. 589,392 466,039
----------- -----------
Total current liabilities............................... 10,161,963 9,787,428
Deferred income taxes....................................... -- 498,712
Long term borrowings........................................ 1,112,890 --
Other liabilities........................................... 5,381 50,782
Common stock subject to put option (note 4)................. 168,867 578,880
----------- -----------
Total liabilities....................................... 11,449,101 10,915,802
----------- -----------
Stockholders' equity:
Preferred stock, authorized 750,000 shares, $0.01 par
value................................................... -- --
Series A convertible preferred stock, authorized 250,000
shares, $0.01 par value, cumulative asset of 8%
dividends, 147,700 and 207,700 shares issued and
outstanding at December 31, 1998 and 1997 respectively.
(Liquidation preference of $704,032 December 31, 1998
including dividends in arrears.......................... 1,477 2,077
Common stock, Authorized 20,000,000 shares, $0.01 par
value; issued 10,408,473 and 11,473,056 shares at
December 31, 1998 and 1997 respectively, including
112,578 and 385,920 shares subject to put options on
December 31, 1998 and 1997 respectively................. 102,969 110,511
Additional paid in capital................................ 19,630,404 17,138,739
Accumulated deficit....................................... (15,224,597) (9,422,279)
Treasury stock, none at December 31, 1998 and 1,999,997
common shares at December 31, 1997...................... -- (20,000)
----------- -----------
Total stockholders' equity.............................. 4,510,253 7,809,048
----------- -----------
Commitments and contingencies
Total liabilities and stockholders' equity................ $15,959,354 $18,724,850
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ -----------
<S> <C> <C> <C>
Revenues (note 6)..................................... $44,013,498 $ 51,389,080 $71,558,295
Cost of revenues (note 6)............................. 31,849,354 36,227,507 47,674,396
----------- ------------ -----------
Gross margin........................................ 12,164,144 15,161,573 23,883,899
----------- ------------ -----------
Operating expenses:
Selling, general and administrative (note 6)........ 18,480,576 16,141,132 18,798,925
Acquisition related write off (note 2).............. -- 9,098,545 --
Depreciation and amortization....................... 1,107,321 679,856 993,940
----------- ------------ -----------
19,587,897 25,919,533 19,792,865
----------- ------------ -----------
Operating income (loss)........................... (7,423,753) (10,757,960) 4,091,034
Interest expense (note 6)............................. (86,251) (11,692) (230,922)
Other income, net..................................... 181,107 301,580 393,498
----------- ------------ -----------
Income (loss) before income tax expense........... (7,328,897) (10,468,072) 4,253,610
Income tax expense (benefit).......................... (1,526,579) (276,352) 1,686,876
----------- ------------ -----------
Net income (loss)................................. $(5,802,318) $(10,191,720) $ 2,566,734
=========== ============ ===========
Net loss per common share--basic and diluted (note
6).................................................. $ (0.61) $ (1.23)
=========== ============
Weighted average number of common shares.............. 9,633,474 8,267,296
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-15
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
RETAINED
PREFERRED STOCK COMMON STOCK ADDITIONAL EARNINGS TREASURY STOCK
------------------- ------------------------- PAID IN (ACCUMULATED ------------------------
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) SHARES AMOUNT
-------- -------- ---------- ------------ ----------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
December 31, 1995.. -- $ -- 6,872,883 $ 5,336,815 $ -- $(1,797,293) -- $ --
Purchase of common
stock............ -- -- -- -- -- -- (171,548) (439,584)
Issuance of common
stock............ -- -- 1,463,771 2,195,211 -- -- -- --
Net income......... -- -- -- -- -- 2,566,734 -- --
------- ------ ---------- ------------ ----------- ------------ ---------- -----------
Balances at
December 31, 1996.. -- $ -- 8,336,654 $ 7,532,026 -- $ 769,441 (171,548) $ (439,584)
Acquisition of Best
(note 2)......... -- -- 934,987 3,361,208 -- -- (1,999,997) (3,317,940)
Share for share
exchange between
NetLojix and
Matrix (note 2):
Reverse
acquisition of
NetLojix....... 207,700 2,077 1,839,563 18,396 9,129,040 -- -- --
Reflect new
capitalization
of Company..... -- -- (171,548) (10,802,234) (7,064,710) -- 171,548 3,737,524
Issuance of common
stock for
exercise of
options.......... -- -- 15,000 150 52,350 -- -- --
Expired put options
(note 4)......... -- -- 96,480 965 143,755 -- -- --
Stock compensation
earned (note
7)............... -- -- -- -- 748,884 -- -- --
Net loss........... -- -- -- -- -- (10,191,720) -- --
------- ------ ---------- ------------ ----------- ------------ ---------- -----------
Balances at
December 31, 1997.. 207,700 $2,077 11,051,136 $ 110,511 $17,138,739 $(9,422,279) (1,999,997) $ (20,000)
Conversion of
preferred stock
(note 4)......... (60,000) (600) 60,000 600 -- -- -- --
Issuance of common
stock for
exercise of
options and
restricted common
stock............ -- -- 473,326 4,733 512,879 -- -- --
Issuance of common
stock for
acquisitions
(note 2)......... -- -- 680,000 6,800 1,526,950 -- -- --
Expired put options
(note 4)......... -- -- 48,187 482 36,770 -- -- --
Exercised put
options (note
6)............... -- -- 185,847 1,859 372,918 -- (207,604) (2,016)
Purchase of officer
notes receivable
(note 6)......... -- -- -- -- (435,000) -- -- --
Stock compensation
earned (note
7)............... -- -- -- -- 477,148 -- -- --
Retirement of
treasury stock... -- -- (2,201,601) (22,016) -- -- 2,201,601 22,016
Net loss........... -- -- -- -- -- (5,802,318) -- --
------- ------ ---------- ------------ ----------- ------------ ---------- -----------
Balances at
December 31, 1998.. 147,700 $1,477 10,296,895 $ 102,969 $19,630,404 $(15,224,597) -- $ --
======= ====== ========== ============ =========== ============ ========== ===========
<CAPTION>
TOTAL
------------
<S> <C>
Balances at
December 31, 1995.. $ 3,539,522
Purchase of common
stock............ (439,584)
Issuance of common
stock............ 2,195,211
Net income......... 2,566,734
------------
Balances at
December 31, 1996.. $ 7,861,883
Acquisition of Best
(note 2)......... 43,268
Share for share
exchange between
NetLojix and
Matrix (note 2):
Reverse
acquisition of
NetLojix....... 9,149,513
Reflect new
capitalization
of Company..... --
Issuance of common
stock for
exercise of
options.......... 52,500
Expired put options
(note 4)......... 144,720
Stock compensation
earned (note
7)............... 748,884
Net loss........... (10,191,720)
------------
Balances at
December 31, 1997.. $ 7,809,048
Conversion of
preferred stock
(note 4)......... --
Issuance of common
stock for
exercise of
options and
restricted common
stock............ 517,612
Issuance of common
stock for
acquisitions
(note 2)......... 1,533,750
Expired put options
(note 4)......... 37,252
Exercised put
options (note
6)............... 372,761
Purchase of officer
notes receivable
(note 6)......... (435,000)
Stock compensation
earned (note
7)............... 477,148
Retirement of
treasury stock... --
Net loss........... (5,802,318)
------------
Balances at
December 31, 1998.. $ 4,510,253
============
</TABLE>
See accompanying notes to consolidated financial statements.
F-16
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $(5,802,318) $(10,191,720) $2,566,734
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 1,107,321 679,856 993,940
Amortization of advanced commissions.................... 220,928 1,355,492 618,791
Acquisition related write off........................... -- 9,098,545 --
Gain on disposition of assets........................... (83,139) -- --
Provision for bad debts................................. 2,727,803 1,829,770 1,461,471
Deferred income taxes................................... (498,712) (80,377) (321,678)
Stock compensation earned............................... 477,148 748,884 --
Equity in income of DNS................................. -- -- (122,327)
Changes in certain operating assets and liabilities:
Accounts receivable................................... 374,477 1,969,332 (1,971,970)
Due from affiliates................................... (106,071) (915,357) 345,336
Federal and state income tax receivable............... (741,094) (598,970) --
Other current assets.................................. (224,820) 1,787,672 (393,781)
Accounts payable and accrued liabilities.............. (1,034,923) (2,876,789) (1,397,160)
Due to affiliates..................................... (2,395,397) (1,138,568) (742,663)
----------- ------------ ----------
Net cash provided by (used in) operating
activities........................................ (5,978,797) 1,667,770 1,036,693
----------- ------------ ----------
Cash flows from investing activities:
Cash received (paid) in acquisitions (note 2)............. (474,082) 477,643 --
Loans to affiliate........................................ -- (2,000,000) --
Payments received on loans to affiliates.................. 1,798,889 201,111 --
Purchase of property and equipment........................ (473,089) (212,421) (701,718)
Repayments from DNS, net.................................. -- -- 1,577,432
Proceeds from sale of property and equipment.............. 94,370 2,749 (14,482)
----------- ------------ ----------
Net cash provided by (used in) investing activities... 946,088 (1,530,918) 861,232
----------- ------------ ----------
Cash flows from financing activities:
Principal payments on capital leases...................... (59,055) (4,306) --
Issuance of common stock for exercise of options.......... 517,612 52,500 --
Borrowings on line of credit.............................. 9,753,467 -- --
Amounts paid on line of credit............................ (8,640,577) -- --
Purchase of officer notes receivable...................... (435,000) -- --
Purchase of common stock for treasury..................... -- -- (439,583)
----------- ------------ ----------
Net cash provided by (used in) financing activities... 1,136,447 48,194 (439,583)
----------- ------------ ----------
Net increase (decrease) in cash and cash equivalents........ (3,896,262) 185,046 1,458,342
Cash and cash equivalents at beginning of year.............. 4,807,441 4,622,395 3,164,053
----------- ------------ ----------
Cash and cash equivalents at end of year.................... $ 911,179 $ 4,807,441 $4,622,395
=========== ============ ==========
Cash paid (received) during the year for:
Interest.................................................. $ 86,121 $ 11,594 $ 212,404
=========== ============ ==========
Income taxes, net of refunds.............................. $ (487,007) $ 925,161 $1,482,103
=========== ============ ==========
Noncash financing activities:
Common stock issued for advanced commissions.............. $ -- $ -- $2,195,211
=========== ============ ==========
Common stock issued for receivable from major
shareholder............................................. $ -- $ -- $ 723,600
=========== ============ ==========
Common stock for Best acquisition......................... $ -- $ 3,361,208 $ --
=========== ============ ==========
Treasury stock acquired with Best acquisition............. $ -- $ (3,317,940) $ --
=========== ============ ==========
Common and preferred stock issued in NetLojix reverse
acquisition............................................. $ -- $ 9,149,513 $ --
=========== ============ ==========
Common stock issued for DMI acquisition................... $ 30,000 $ -- $ --
=========== ============ ==========
Common stock issued for RLI acquisition................... $ 650,000 $ -- $ --
=========== ============ ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-17
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BUSINESS AND BACKGROUND
On December 1, 1997, NetLojix Communications, Inc. ("NetLojix") and Matrix
Telecom, Inc. ("Matrix") completed a share for share exchange pursuant to a
stock exchange agreement dated April 29, 1997 as subsequently amended ("Share
Exchange"). For accounting purposes, the Share Exchange was treated as a reverse
acquisition of NetLojix by Matrix. NetLojix was the legal acquirer and
accordingly, the Share Exchange was effected by the issuance by NetLojix of
9,582,493 shares of common stock in exchange for all of the common stock then
outstanding of Matrix. In addition, holders of outstanding Matrix stock options
received 22,338 non-qualified stock options of NetLojix. The purchase method of
accounting was used, with Matrix being treated as the acquirer for accounting
purposes. The results of operations reported in the accompanying consolidated
financial statements reflect the operations of Matrix prior to December 1, 1997
and the combined operations of NetLojix and Matrix subsequent to December 1,
1997. References to the "Company" refer to operations of Matrix prior to the
Share Exchange and the combined operations of Matrix and NetLojix subsequent to
the Share Exchange. As a result of the Share Exchange, Matrix became a wholly
owned subsidiary of NetLojix. (See note 2).
The Share Exchange provided that each Matrix shareholder would receive
2.4819 NetLojix common shares for each common share of Matrix then issued
including treasury shares held by Matrix. For periods prior to the December 1,
1997 Share Exchange, all share amounts have been restated to reflect the Share
Exchange as a 2.4819 for one stock split. In addition, on March 10, 1997 Matrix
declared an 18 for one stock split. All share amounts have also been restated to
reflect this stock split.
NetLojix was formed to be a provider of broadband network services
integrating voice, data and Internet solutions for individuals and corporate
customers. The Company sells and markets a broad range of telecommunications and
advanced network services through independent value added resellers, third party
marketing organizations and internal direct sales professionals. The Company
targets mid-size corporations, small-office home-office professionals and select
residential market segments through two primary business units, its Business
Markets Group ("BMG") and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data, voice and
Internet networking needs. Following this sales strategy, the Company's
objective is to become the underlying telecommunications carrier for the
transport of data, voice and Internet traffic. Through a value-added sales
process, the Company designs, provisions and manages its customers' networks.
The Company will provide a host of additional value-added services assisting its
customers to create enhanced intranet and extranet applications. Additionally,
BMG markets to its customer base a variety of traditional communications
products and services such as long distance telephone service, executive calling
cards and video/audio conferencing.
CMG targets and markets to distribution companies, agents, resellers and
affinity groups that maintain access to large groups of individuals and small
businesses through affinity relationships and niche marketing strategies. CMG
provides Internet access, long distance telephone and other services to
customers in 49 states. The Company is fully certified or registered in all
states where required and operates under Section 214 authority from the Federal
Communications Commission ("FCC"). The Company, through a wholly owned
subsidiary, has a national-deployed Carrier Identification Code ("CIC"). The
Company maintains its own convergent billing platform, rating system and
monitoring center.
F-18
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(b) LIQUIDITY
The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
consolidated financial statements during the years ended December 31, 1998 and
1997, the Company reported net losses of $5,802,318 and $10,191,720,
respectively. In addition, as of December 31, 1998, the Company had a working
capital deficit of $1,697,959, and for the year ended December 31, 1998, net
cash used in operations totaled $5,978,797.
As a result, as of December 31, 1998, unless the Company effects substantial
changes in its operating methods, the Company does not have sufficient resources
to meet its anticipated operating requirements during 1999 without obtaining
additional financing. The Company is actively pursuing an equity line through
discussion with potential investors. If the Company is unable to obtain
financing in a timely manner and on acceptable terms, management is developing
and intends to implement a plan that would allow the Company to continue to
operate through 1999. This plan would include significantly reducing the
Company's workforce, eliminating advertising expenditures, reducing professional
services and reducing or eliminating other discretionary expenditures.
(c) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(d) CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all
demand deposits, time deposits, and other highly liquid investments with a
remaining maturity at date of purchase of less than ninety days to be cash
equivalents.
(e) COMMISSIONS
Commissions to sales agents are paid and expensed based on a percentage of
billings as incurred.
Commissions paid in advance of $221,000 as of December 31, 1997, included in
other current assets, were expensed over a period of eighteen months based on
estimated billings of the customers for which the commissions were paid. The
above advances were fully expensed during 1998 and no additional advance
commission payments were made.
(f) REVENUE RECOGNITION
Long distance, frame relay, Internet, systems integration and repair service
revenues are recognized as service is provided. Amounts paid in advance are
recorded as unearned revenue and recognized as services are provided.
(g) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Maintenance and repairs are
charged against income as incurred, while renewals and major replacements are
capitalized. The cost and related accumulated depreciation of assets sold or
retired are removed from the accounts, and any resulting gain or loss is
F-19
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reflected in operations. The Company provides depreciation on fixed assets using
the straight-line method over the estimated useful lives of the respective
assets.
(h) GOODWILL
Goodwill of $4.5 million, which is net of amortization of $19,000 as of
December 31, 1998, represents the excess of purchase price over fair value of
net assets acquired in the Digital Media, Inc. and Remote Lojix/PCSI, Inc.
acquisitions and is amortized on a straight-line basis over fifteen years. The
Company assesses the recoverability of this intangible asset by determining
whether the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future cash flows of the acquired operation. The
amount of goodwill impairment, if any, is measured based on expected
undiscounted future operating cash flows expected to be generated by the
acquired business. The assessment of the recoverability of goodwill will be
impacted if estimated future operating cash flows are not achieved.
(i) INCOME TAXES
The Company utilizes the asset and liability method for accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(j) USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period to prepare these consolidated financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
(k) CONCENTRATIONS OF CREDIT RISK
The Company's subscribers are primarily small business owners and
residential subscribers and are not concentrated in any specific geographic
region of the United States. The Company has agreements with Local Exchange
Companies, which provide billing and collection services to the majority of the
Company's subscribers. A significant portion of the Company's accounts
receivable is due from these companies.
(l) ACCOUNTS RECEIVABLE
Accounts receivable are net of allowances for doubtful accounts and other
provisions of $935,000 and $982,000 as of December 31, 1998 and 1997,
respectively. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of subscribers, historical trends and
other information.
F-20
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(m) FINANCIAL INSTRUMENTS
The Company's financial instruments include cash, receivables, payables, and
accrued expenses. The carrying amount of such financial instruments approximates
fair value because of the short maturity of these instruments.
(n) ACQUIRED CUSTOMER BASE
Acquired customer base of $1,240,000, which is net of accumulated
amortization of $343,000 at December 31, 1998, included in other assets, is
being amortized on a straight-line basis over five years. The Company assesses
the recoverability of this intangible asset by determining whether the acquired
customer base balance can be recovered through undiscounted future operating
cash flows of the acquired operations. The amount of impairment, if any, is
measured based on projected discounted cash flows. The assessment of the
recoverability of the acquired customer base will be impacted if estimated
future operating cash flows are not achieved.
(o) IMPAIRMENT OF LONG-LIVED ASSETS
In January, 1996, the Company adopted Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of "("SFAS No. 121"). SFAS No. 121 requires
that long-lived assets and certain intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the future net
cash flows expected to be generated by the asset. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the net asset exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or
fair value less costs to sell.
(p) COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes net income and other comprehensive income, which is generally composed
of changes in the fair value of available-for-sale marketable securities,
foreign currency translation adjustments and adjustments to recognize additional
minimum pension liabilities. The statement requires additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations. Comprehensive income (loss) for the
years ended December 31, 1998, 1997 and 1996 is equal to net income (loss)
reported for such periods.
(q) SEGMENT REPORTING
In 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS No. 131"). SFAS No. 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected
F-21
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. (See Note 11).
(r) RECLASSIFICATIONS
Certain reclassifications have been made to prior period amounts in order to
conform to current year presentation.
(2) ACQUISITIONS
MATRIX TELECOM, INC.--On December 1, 1997, NetLojix and Matrix completed the
Share Exchange. For accounting purposes the Share Exchange was treated as a
reverse acquisition of NetLojix by Matrix. NetLojix was the legal acquirer and,
accordingly, the Share Exchange was effected by the issuance of NetLojix common
stock in exchange for all of the common stock then outstanding of Matrix. In
addition, holders of outstanding Matrix stock options received non-qualified
stock options of the Company. Immediately after the Share Exchange the former
shareholders of Matrix held approximately 84% of the then outstanding common
stock of the Company.
The consummation of the Share Exchange was subject to the satisfaction of
several conditions by NetLojix. These included the reincorporation of NetLojix
(then a Utah corporation; "NetLojix Utah") in Delaware by way of a merger (the
"Reincorporation Merger") with and into NetLojix Communications, Inc., a
Delaware corporation, a wholly-owned subsidiary formed for the sole purpose of
this merger. As part of the merger, NetLojix (the surviving Delaware
corporation) issued to its stockholders one share of new Delaware Common Stock
for each four shares of NetLojix-Utah's Common Stock outstanding immediately
prior to the Reincorporation Merger. NetLojix's Series A Convertible Preferred
Stock and its outstanding options were similarly adjusted. Accordingly, the
Reincorporation Merger essentially effected a one for four reverse stock split
of NetLojix's shares.
The reverse acquisition of NetLojix by Matrix was accounted for using the
purchase method of accounting. In order to value the consideration given in the
Share Exchange the market price of NetLojix common stock for a period
immediately preceding the announcement of the Share Exchange was used. As of the
date of acquisition, the Company determined the fair value of the net tangible
and intangible assets acquired and liabilities assumed. Concurrently, the
Company determined that the carrying amount of recorded goodwill was not
recoverable. Accordingly, the Company recorded a charge to income of $9,098,545
immediately subsequent to the reverse acquisition.
In connection with the completion of the Share Exchange, the Company entered
into a Registration Rights and Lockup Agreement dated December 1, 1997 (the
"Registration Rights and Lockup Agreement"). The Registration Rights and Lockup
Agreement requires that the Company use its best efforts to file a shelf
registration statement providing for the sale by certain stockholders of all
securities issued to them in connection with the Exchange Agreement, subject to
a two-year holding restriction imposed on such stockholders. Under the
Registration Rights and Lockup Agreement, the Company is obliged to use its
reasonable efforts to keep the shelf registration statement effective on a
continuous basis for a period described in the Registration Rights and Lockup
Agreement. Such stockholders may also require the Company to undertake up to two
additional demand registrations of their securities if the shelf registration
F-22
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(2) ACQUISITIONS (CONTINUED)
is not in place. As of April 14, 1999, this registration obligation related to
6,457,123 shares held by 14 stockholders.
BEST CONNECTIONS, INC. ("BEST")--Effective July 1, 1997, shareholders of
Best, an affiliate of Matrix through substantially common ownership, contributed
their ownership of Best to Matrix in exchange for 934,987 shares of Matrix
common stock. Best's primary assets were 1,999,997 shares of Matrix common stock
and cash of $211,000. The assets and liabilities of Best were recorded at their
historical cost which approximated the fair value of such assets as of July 1,
1997. As a result of the combination, Matrix assumed the obligation to grant up
to 1,999,997 stock options to agents of Best and certain employees of affiliated
companies. Such option grants relate to services, including sales promotion
activities, to be performed by the recipients on behalf of the Company.
Accordingly, the fair value of such options is being charged to expense by the
Company as the related services are provided.
DIGITAL MEDIA, INC. ("DMI")--Effective September 25, 1998, the Company
acquired all of the capital stock of DMI, a California based developer of
multimedia software. The Company exchanged 30,000 shares of its common stock
valued at $71,250 for all of the outstanding common stock of DMI. The
transaction was accounted for under the purchase method of accounting. The
assets and liabilities of DMI were recorded at their historical cost which
approximated their fair value at September 25, 1998. The Company recorded
goodwill of approximately $117,000, which represents the excess of the purchase
price over the fair value of the net assets received. The goodwill is being
amortized on a straight-line basis over fifteen years.
REMOTE LOJIX/PCSI, INC. ("RLI")--Effective November 1, 1998, the Company
acquired all of the capital stock of RLI, a New York based provider of
information technology services to corporate customers. The Company exchanged
650,000 shares of its common stock valued at $1,462,500 and the outstanding
balance of a $500,000 loan from the Company for all of the outstanding common
stock of RLI. The transaction was accounted for under the purchase method of
accounting. The assets and liabilities of RLI were recorded at their historical
cost which approximated the fair value at November 1, 1998. The Company recorded
goodwill of approximately $4.4 million, which represents the excess of the
purchase price over the fair value of the assets received. The goodwill is being
amortized on a straight-line basis over fifteen years.
Unaudited pro forma results of operations of the Company as if the share
exchange of Matrix and the acquisitions of Best, DMI and RLI had occurred as of
the beginning of the periods presented is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------
1998 1999
----------- ------------
<S> <C> <C>
Revenue........................................... $49,711,440 $ 58,967,268
Loss from operations.............................. (8,909,490) (12,749,469)
Net loss.......................................... (7,799,180) (12,378,014)
Proforma net loss per share....................... $ (0.76) $ (1.02)
</TABLE>
The pro forma financial information has been prepared for comparative
purposes only and does not purport to indicate the results of operations that
would have occurred had the acquisition been made at the beginning of the period
indicated, or which may occur in the future.
F-23
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(2) ACQUISITIONS (CONTINUED)
As of the date of acquisitions, the fair market value of the assets acquired
and liabilities assumed included the following:
<TABLE>
<CAPTION>
1998
-------------------------------------
DMI RLI TOTAL
--------- ----------- -----------
<S> <C> <C> <C>
Current assets other than cash........... $ 50,105 $ 1,034,803 $ 1,084,908
Property and equipment................... 44,313 132,169 176,482
Goodwill................................. 117,169 4,375,191 4,492,360
Current liabilities...................... (166,255) (3,579,663) (3,745,918)
Common stock issued...................... (71,250) (1,462,500) (1,533,750)
--------- ----------- -----------
Cash acquired (paid)..................... $ 25,918 $ (500,000) $ (474,082)
========= =========== ===========
</TABLE>
<TABLE>
<CAPTION>
1997
----------------------------------------
MATRIX BEST TOTAL
----------- ----------- ------------
<S> <C> <C> <C>
Current assets other than cash........ $ 258,041 $ -- $ 258,041
Property and equipment................ 577,836 15,137 592,973
Customer base......................... 1,583,000 -- 1,583,000
Goodwill.............................. 9,098,545 -- 9,098,545
Current liabilities................... (1,945,526) (183,041) (2,128,567)
Long-term liabilities................. (688,854) -- (688,854)
Common and preferred stock issued..... (9,149,513) (3,361,208) (12,510,721)
Treasury stock acquired............... -- 3,317,940 3,317,940
----------- ----------- ------------
Cash acquired......................... $ 266,471 $ 211,172 $ 477,643
=========== =========== ============
</TABLE>
(3) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31
ESTIMATED -------------------------
USEFUL LIFE 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Communications system................... 2-5 years $ 1,318,326 $ 1,318,326
Office furniture and equipment.......... 1-7 years 3,420,773 2,945,795
Leasehold improvements.................. lease term 521,319 416,220
----------- -----------
Total property and equipment............ 5,260,418 4,680,341
Accumulated depreciation and
amortization.......................... (3,575,711) (2,888,659)
=========== ===========
Property and equipment, net............. $ 1,684,707 $ 1,791,682
=========== ===========
</TABLE>
Depreciation expense was $737,000, $632,000 and $877,000 for 1998, 1997 and
1996, respectively.
F-24
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(4) STOCKHOLDERS' EQUITY
The Series A convertible preferred shareholders are entitled to receive
cumulative annual dividends at a rate of 8% and are entitled to a preference in
liquidation in the amount of $4 per share plus unpaid dividends. There were
$137,000 cumulative Series A convertible preferred stock dividends in arrears at
December 31, 1998. The Series A preferred stock is convertible, on a one-for-one
basis, into shares of Company common stock. During 1998, a total of 60,000
shares of the Company's Series A convertible preferred stock was converted to
60,000 shares of the Company's common stock.
In December 1998, the Company retired all of its outstanding treasury stock.
In December 1996, the Company issued 1,463,771 shares of common stock for
future commissions due to affiliates as of October 31, 1996. A value of $1.50
per share was used in determining the number of shares to issue in settlement of
the $2,195,211 obligation. Of this amount, $221,000, $1,355,000 and $619,000 was
expensed as commission expense in 1998, 1997 and 1996, respectively.
During 1996, the Company sold to certain employees 482,400 shares of common
stock at $1.50 per share. As of December 31, 1996, the Company had recorded a
$723,600 receivable for such shares, which was subsequently collected. Proceeds
used to repay the $723,600 receivable were loaned to the employees by a major
shareholder of the Company. As of December 31, 1998 and 1997, the shares subject
to this agreement could be put to the Company at the option of the employee at
approximately $1.50 per share ($168,867 and $578,880), respectively. Such
amounts have been included in other liabilities. Under certain circumstances
(e.g. employee termination) the Company has a call at the same amounts. The call
and put rights vest over a period of five years. As of December 31, 1998, these
rights were forty percent vested. Activity in common stock outstanding related
to shares subject to put follows:
<TABLE>
<CAPTION>
SHARES AMOUNT
--------- ---------
<S> <C> <C>
Sale of common shares subject to put.................. $ 482,400 $ 723,600
Increase in share value subject to put charged to
expense............................................. -- 172,400
--------- ---------
Balance, December 31,1996........................... 482,400 896,000
Decrease in share value subject to put recorded as a
reduction to expense................................ -- (172,400)
Vested shares no longer subject to put................ (96,480) (144,720)
--------- ---------
Balance, December 31, 1997.......................... 385,920 578,880
Vested shares no longer subject to put................ (48,187) (37,253)
Called shares subject to put.......................... (225,155) (372,760)
--------- ---------
Balance, December 31, 1998.......................... $ 112,578 $ 168,867
========= =========
</TABLE>
During May 1996, the Company purchased 171,548 shares of its common stock as
treasury stock for $439,584. As further discussed in note 8 in connection with
the Best and Matrix combination effective July 1, 1997, Matrix acquired an
additional 1,999,997 shares of its common stock as treasury stock. As a part of
the recapitalization done in connection with the NetLojix reverse acquisition,
Matrix retired the 171,548 shares of its common stock discussed above and the
Company recorded the remaining treasury stock at par value.
F-25
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(5) FEDERAL AND STATE INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- -----------
<S> <C> <C> <C>
Current tax expense (benefit):
Federal................................ $(1,325,000) $(234,899) $ 1,751,047
State and local........................ 7,531 (41,453) 257,507
----------- --------- -----------
(1,317,469) (276,352) 2,008,554
----------- --------- -----------
Deferred tax expense (benefit):
Federal................................ (209,110) -- (254,350)
State and local........................ -- -- (67,328)
----------- --------- -----------
(209,110) -- (321,678)
----------- --------- -----------
$(1,526,579) $(276,352) $(1,686,876)
=========== ========= ===========
</TABLE>
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>
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Computed "expected" tax expense
(benefit)............................. $(2,491,825) $(3,559,144) $1,404,637
State and local taxes, net of federal
income tax effect..................... (135,961) (27,359) 125,518
Other nondeductible items............... 22,539 3,093,522 --
Losses not providing tax benefit........ 1,269,289 330,190 --
Other................................... (190,621) (113,561) 156,721
----------- ----------- ----------
$(1,526,579) $ (276,352) $1,686,876
=========== =========== ==========
</TABLE>
Deferred income taxes as of December 31, 1998 and 1997 reflect the impact of
temporary differences between financial statement carrying amounts and tax bases
of assets and liabilities. The tax effects of
F-26
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(5) FEDERAL AND STATE INCOME TAXES (CONTINUED)
temporary differences that give rise to significant portions of the net deferred
tax assets at December 31, 1998 and 1997 are presented below:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Deferred tax assets
Net operating loss and alternative minimum tax
credit carryovers.............................. $ 2,169,634 $ 814,425
Compensation related items....................... 480,137 299,554
Contingent liabilities and other................. 268,340 204,978
----------- -----------
Gross deferred tax asset......................... 2,918,111 1,318,957
Less valuation allowance......................... (2,453,958) (1,184,669)
----------- -----------
Net deferred tax asset........................... 464,153 134,288
Deferred tax liabilities:
Customer base intangible......................... (464,153) (633,000)
----------- -----------
Net deferred tax liability..................... $ -- $ (498,712)
=========== ===========
</TABLE>
The valuation allowance for deferred tax assets increased $1,269,289 and
$1,184,669 during 1998 and 1997, respectively.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and prior taxes paid in making this assessment. Based upon its evaluation of
these factors, management believes that it is more likely than not that the
Company will realize the benefits of these deductible differences, net of the
valuation allowance, at December 31, 1998. At December 31, 1998, the Company has
net operating loss carryforwards for federal tax purposes of approximately
$4,860,000 which are available on a limited basis to offset future federal
taxable income, if any, through 2018. When realized, such benefit will first be
utilized to reduce intangible assets recorded in the reverse acquisition of
NetLojix by Matrix.
In accordance with the Internal Revenue Code of 1986, as amended, the
Company may carryback the 1998 net operating loss, subject to certain
limitations, up to two (2) years to reduce prior years' taxable income. Any
unused portion may be carried forward up to twenty (20) years. The Company
expects to utilize $4,294,000 of the net operating loss to offset prior years'
taxable income resulting in a refund of approximately $1,325,000 of taxes
previously paid.
The Company's 1998 consolidated financial statements have been restated to
give effect to the recognition of the income tax receivable discussed in the
preceding paragraph. As a result of this restatement, net loss for the year
ended December 31, 1998 has been decreased by $1,325,000 ($0.13 per common
share--basic and diluted) from amounts previously reported.
F-27
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(6) RELATED PARTY TRANSACTIONS
The Company has had transactions in the normal course of business with
various companies which are affiliated with shareholders of the Company. Pacific
Gateway Exchange, Inc. ("PGE") provides the Company with significant domestic
and international transmission services. As of January 1, 1998, PGE was no
longer affiliated with the Company. During 1998, a director and several
significant holders of the Company's common stock divested themselves of a
substantial portion of their holdings of PGE common stock; they have advised the
Company that they no longer could be deemed to be in control of PGE. A
significant number of the Company's employees were leased from United Group
Service Center, an affiliate, which provides such services to a number of
affiliated companies. This lease agreement was terminated on December 31, 1998,
at which time these individuals became employees of the Company. The Company
provides long distance and data network service to a number of affiliated
companies. Balances with affiliates related to operating activities are settled
monthly. In addition, the Company has made both interest bearing and
non-interest bearing advances to affiliated companies.
Due from affiliates consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1998 1997
-------- ----------
<S> <C> <C>
Core Marketing--note receivable due September 1,
1998................................................ $ -- $1,798,889
UICI Administrators (long distance services).......... 308,346 94,417
Interactive Media Works (IMW) (long distance
services)........................................... 6,214 25,263
Core Marketing (long distance services)............... 82,695 111,280
AMLI Management Co. (long distance services).......... 10,695 --
Other receivables from various affiliates............. 93,908 97,922
-------- ----------
$501,858 $2,127,771
======== ==========
</TABLE>
Due to affiliates consists of the following:
<TABLE>
<CAPTION>
1998 1997
-------- ----------
<S> <C> <C>
PGE (not considered an affiliate in 1998)............. $ -- $2,335,787
Group Association (UGA) and Core Marketing
(commissions)....................................... 5,339 134,618
Other payables to various affiliates.................. 318,681 249,012
-------- ----------
$324,020 $2,719,417
======== ==========
</TABLE>
F-28
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
Significant services and transactions incurred in the normal course of
operations with affiliated companies are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ----------- -----------
<S> <C> <C> <C>
Revenues include the following:
U.S. Telco-billing and collection services, customer
service and accounting services.................... $ -- $ 200,370 $ --
Long distance revenues from affiliates: UGA, UICI, IMW,
Core Marketing, and AMLI............................. 4,592,040 3,351,375 5,445,903
---------- ----------- -----------
$4,592,040 $ 3,551,745 $ 5,445,903
========== =========== ===========
Cost of revenues includes the following:
Network transmission services--PGE (not considered an
affiliate in 1998)................................. $ -- $15,917,688 $20,527,236
========== =========== ===========
Selling, general and administrative expenses includethe
following:
Expenses paid on behalf of PGE (not considered an
affiliate in 1998) for access services, for which
the Company was reimbursed......................... $ -- $ 3,534,154 $ 5,040,051
Expenses incurred for leasing employees from United
Group Service Center............................... 5,581,428 4,395,820 4,542,007
Sales commissions to affiliates:
Core Marketing, UICI, UGA, Best Connections and
AMLI............................................. 140,187 990,533 5,335,233
Overhead expenses reimbursed to/from UGA Divisions... 241,810 110,761 77,231
Core Marketing--casual mailings and telemarketing.... 21,425 603,742 --
---------- ----------- -----------
$5,984,850 $ 9,635,010 $14,994,522
========== =========== ===========
Interest expense includes the following:
Interest paid to shareholder......................... $ -- $ -- $ 173,380
========== =========== ===========
</TABLE>
During 1997, the Company loaned $2,000,000 to an affiliated company, Core
Marketing, LLC. Of such amount, $201,000 was repaid in 1997 and the remainder
was repaid in 1998.
In July 1998, the Company purchased notes receivable from one of the
Company's significant shareholders at a discount. The notes receivable evidenced
loans made by the significant shareholder in 1996 to Matrix employees to finance
their purchases of Matrix common stock (which was subsequently converted to
shares of the Company's common stock). Each of the employees who delivered a
note receivable also entered into a Buyback Agreement dated October 6, 1996 (the
"Buyback Agreement"), pursuant to which the Company has the option (but no
obligation) to repurchase a portion of such employee's stock upon the
termination of his or her employment. The original notes, plus accrued interest,
at the date of purchase by the Company was $573,000. The Company purchased these
notes for $435,000.
F-29
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
In connection with the purchase of the notes receivable above, the Company
repurchased 240,912 shares of its common stock subject to the Buyback Agreement
from terminated employees. The Company exercised its right to repurchase 225,154
of such shares at a price range of $1.51 to $1.70 per share, and the former
employees used the $373,081 in proceeds to reduce the amount of their notes. The
Company repurchased an additional 15,758 shares in satisfaction of the remaining
balance of $116,085 on the former employees' notes.
(7) STOCK COMPENSATION
NETLOJIX OPTIONS--Prior to the Share Exchange NetLojix adopted a 1997
Incentive Stock Option Plan (the "NetLojix 1997 Plan") for option grants to
officers and key employees. The NetLojix 1997 Plan authorizes grants of options
to purchase up to 250,000 shares of authorized but unissued common stock and
125,000 shares of restricted common stock. Stock options are to be granted with
an exercise price greater than or equal to the stock's fair market value at the
date of grant. Options generally vest 25% after one year and 25% each year
thereafter until fully vested. Such options typically expire after ten years. In
addition, NetLojix had other options which had been granted prior to the
adoption of the NetLojix 1997 Plan. After the Share Exchange all outstanding
options became obligations of the Company.
On January 1, 1998, the Company granted options to purchase 75,000 shares of
the Company's common stock at an exercise price of $1.50 per share. On March 1,
1998 the Company granted options to purchase 100,000 shares of the Company's
common stock at an exercise price of $1.50 per share. These options become
exercisable based on qualified billings of long distance customers generated by
the optionees from the respective dates of grant through December 31, 2000. As
of December 31, 1998, 27,316 options are exercisable.
On February 24, 1998, the Company's Board of Directors approved the grant of
a total of 120,000 shares of restricted common stock to two board members
pursuant to the Company's 1997 Stock Incentive Plan. The restricted stock
provisions will lapse over four years or fully lapse in the event of death or
permanent disability of the grantees. During 1998 one of the board members
resigned from the board and his 60,000 shares were vested immediately. As of
December 31, 1998, only those 60,000 shares of restricted common stock are
vested.
During 1998, the Company adopted the 1998 Stock Incentive Plan (the
"NetLojix 1998 Plan"), which provides for the issuance of up to 1,500,000 shares
of NetLojix common stock pursuant to stock options and issuances of restricted
stock, as well as for the grant of stock appreciation rights. Stock options are
to be granted with an exercise price greater than or equal to the stock's fair
market value at the date of grant. Options generally vest 25% after one year and
25% each year thereafter until fully vested. Such options typically expire after
ten years. As of December 31, 1998, the Company granted 671,000 options under
the NetLojix 1998 Plan. Exercise prices range from $2.375 to $4.00 per share.
MATRIX OPTIONS--Prior to the Share Exchange, the Board of Directors of
Matrix approved stock options for certain officers and employees. Stock option
transactions of Matrix are included in the table below. At the time of the Share
Exchange, Matrix had 22,338 options outstanding to purchase its common stock. In
connection with the Share Exchange, the Company reissued these stock options and
they vested immediately. These reissued options expire in December 2002.
F-30
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(7) STOCK COMPENSATION (CONTINUED)
The Company applies APB Opinion No. 25 in accounting for the NetLojix 1997
Plan, 1998 Stock Incentive Plan and the Matrix options discussed above; and,
accordingly, no compensation cost has been recognized for its stock options
issued to employees in the financial statements. For stock options granted to
non-employees, the Company accounts for such options in accordance with the
requirements of SFAS No. 123. Had the Company determined compensation cost based
on the fair value at the grant date for stock options issued to employees under
SFAS No. 123, the Company's net loss in 1998 and 1997 would not have materially
changed.
BEST CONNECTIONS, INC. OPTIONS--As discussed in Note 2, as a result of the
Matrix combination with Best, Matrix assumed the obligation to issue stock
options to Best's agents under Best's 1997 Option Plan. Effective as of the date
of combination, July 1, 1997, 1,292,000 options to purchase Matrix common shares
were granted to Best agents at $1.50 per share, which will result in aggregate
commission expense of approximately $764,000 over the vesting period. The option
price per share was $1.50. The agents' options become exercisable no later than
December 31, 1999 and may be exercised earlier based on qualified billings of
long distance customers generated by the agents during six month measurement
periods. After the Share Exchange such options became obligations of the
Company. As of December 31, 1998, 641,532 options have been earned and 172,120
exercised under the Plan and the Company recorded expense totaling approximately
$132,000 and $249,000 related to such options based on qualified billings for
1998 and 1997, respectively. Options generally expire two years from the date
they become exercisable or sixty days subsequent to termination of employment.
The per share weighted average fair value of stock options granted on
July 1, 1997 was $.59 on the date of the grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: expected
volatility of 30%, risk-free interest rate of 6.0%, and an expected life of
3.5 years.
BEST CONNECTIONS, INC. OPTIONS AND RESTRICTED STOCK AGREEMENTS--As discussed
in Note 2 as a result of the Matrix combination with Best, Matrix assumed the
obligation to issue stock options, consisting of Matrix common shares owned by
Best, to employees of affiliated companies. Effective July 15, 1997, the Company
issued 247,500 options to purchase an equal number of shares of its common
stock, at $1.50 per share subject to the provisions of a Restricted Stock
Agreement. The Restricted Stock Agreement includes a call provision by the
Company that lapses 10 percent each six months beginning December 15, 1997
through June 15, 2002 or fully lapses in the event of death or permanent
disability of the option holder. The call price is equal to the initial purchase
price of $1.50 plus the aggregate amount of net income or less the aggregate
amount of net losses per share for each fiscal quarter beginning after
December 15, 1997; provided that the call price could not be less than $1.50 per
share. During 1998 NetLojix relinquished its right to call the shares which
caused the options to vest immediately and to expire if not exercised before
December 13, 1998. NetLojix provided the holders the option of a "cashless"
exercise by purchasing up to one half the shares issuable at $3.00 The Company
recognized expense over the life of the options in accordance with the
provisions of SFAS No. 123 and recorded expense of $500,000 in 1997 and a
reduction of expense of $170,000 in 1998. At December 31, 1998, 107,250 options
had been exercised, 67,250 were used for the cashless exercise, 45,500 expired,
and 27,500 were canceled.
F-31
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(7) STOCK COMPENSATION (CONTINUED)
Stock option activity is as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Outstanding at December 31, 1995................... 53,607 $2.24
Canceled......................................... (31,269) 2.24
Outstanding at December 31, 1996................... 22,338 2.24
NetLojix options outstanding at time of Share
Exchange....................................... 255,109 4.52
Granted.......................................... 1,539,500 1.50
Exercised........................................ (15,000) 3.50
---------
Outstanding at December 31, 1997................... 1,801,947 1.78
Granted.......................................... 1,024,500 3.31
Expired.......................................... (46,750) 1.54
Forfeited........................................ (106,999) 1.91
Exercised........................................ (353,327) 1.81
--------- -----
Outstanding at December 31, 1998................... 2,319,371 $2.45
========= =====
Exercisable at December 31, 1995................. -- $ --
Exercisable at December 31, 1996................. 3,574 2.24
Exercisable at December 31, 1997................. 349,972 2.21
Exercisable at December 31, 1998................. 524,849 2.16
</TABLE>
Total expense recorded for stock based awards during 1998 and 1997 was
$477,148 and $748,884, respectively.
The following table summarizes certain information about the Company's stock
options at December 31, 1998.
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVERAGE ------------------------------------
RANGE OF NUMBER OF REMAINING WEIGHTED AVERAGE NUMBER OF OPTIONS WEIGHTED AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------------- --------- ---------------- ---------------- ----------------- ----------------
<C> <C> <S> <C> <C> <C>
$ 1.50 - 2.25 1,427,218 2.5 years $ 1.57 462,334 $ 1.54
2.38 - 3.30 303,749 8.5 2.92 26,736 2.93
4.00 - 6.00 555,112 9.9 4.02 2,487 4.00
6.75 - 8.00 17,093 8.9 7.47 17,093 7.47
12.00 - 14.00 16,199 8.1 12.77 16,199 12.77
--------- -------
2,319,371 5.1 2.45 524,849 2.16
========= =======
</TABLE>
F-32
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(8) EARNINGS PER COMMON SHARE
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, EARNINGS PER SHARE ("SFAS 128") in the fourth quarter of
1997, which required companies to present basic earnings per share and diluted
earnings per share.
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Numerator:
Net loss........................................ $(5,802,318) $(10,191,720)
Less preferred dividends........................ 47,264 5,540
----------- ------------
Loss applicable to common shareholders........ $(5,849,582) $(10,197,260)
=========== ============
Denominator:
Weighted average number of common shares used in
basic and diluted loss per common share....... 9,633,474 8,267,296
=========== ============
Basic and diluted loss per common share......... $ (0.61) $ (1.23)
=========== ============
</TABLE>
Per share amounts are not reflected for 1996 due to the recapitalization of
the Company as a result of the reverse acquisition in 1997.
(9) LEASING ACTIVITIES AND OTHER COMMITMENTS
The Company leases office space and various equipment under operating leases
expiring in various years through 2004. In the normal course of business,
operating leases are generally renewed or replaced by other leases. Total rental
expenses were $546,000 in 1998, $245,000 in 1997, and $325,000 in 1996. Future
minimum lease payments under non-cancelable operating leases (with initial or
remaining lease terms in excess of one year) and future minimum capital lease
payments as of December 31, 1998 are: 1999--$731,000; 2000--$688,000;
2001--$426,000; 2002--$307,000; and 2003--$101,224.
Substantially all of the Company's switching and transmission facilities
have been provided by two suppliers under negotiated contractual agreements. The
Company purchases long distance services at certain per-minute rates, which vary
depending on the time and type of call. At December 31, 1998, there are
outstanding contractual agreements committing the Company to $18,570,000 minimum
usage through February 15, 2000.
(10) REVOLVING LINE OF CREDIT
In 1998, the Company entered into a Loan and Security Agreement with a bank,
which provides for an asset-based revolving credit line with a floating interest
rate of prime plus 2% (9.75% at December 31, 1998), payable monthly. The credit
limit is the lesser of $7,500,000 or a percentage of the amount of the Company's
eligible receivables and other items. Borrowings are secured by substantially
all of the assets of the Company. The agreement also calls for a minimum
borrowing of $1,500,000 with a two-year term. At December 31, 1998, there was
$1,112,890 outstanding under the agreement, and an additional $1,655,000 was
eligible for borrowing under the revolving credit line.
F-33
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(10) REVOLVING LINE OF CREDIT (CONTINUED)
The Loan and Security Agreement contains restrictions on net worth, future
acquisitions and other transactions.
(11) SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION,
which the Company adopted in 1998. The Company identifies such segments based on
management responsibility. The Company's two primary business segments are
Business Markets Group ("BMG") and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data, voice and
Internet networking needs. Through a value-added sales process, the Company
designs, provisions and manages its customers' networks. The Company provides a
host of additional value-added services assisting its customers to create
enhanced intranet and extranet applications. Additionally, BMG markets to its
customer base a variety of traditional communications products and services such
as long distance telephone service, executive calling cards and wireless paging.
CMG targets and markets to distribution companies, agents, resellers and
affinity groups ("Channel Partners") that maintain access to large groups of
individuals and small businesses through affinity relationships and niche
marketing strategies. Channel Partners include non-profit organizations and
for-profit distribution groups. CMG provides Internet access, long distance
telephone and other services to customers in 49 states.
During 1998, the Company measured and monitored the progress of BMG and CMG
based on revenues from external customers and gross margin. The results for the
year ended December 31, 1998 are as follows:
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenue from external customers........ $6,338,114 $37,675,384 $44,013,498
Gross margin........................... 1,846,895 10,317,249 12,164,144
Total assets........................... 8,079,998 7,879,356 15,959,354
</TABLE>
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenue from external customers........ $5,791,993 $45,597,087 $51,389,080
Gross margin........................... 1,715,205 13,446,368 15,161,573
Total assets........................... 2,241,825 16,483,025 18,724,850
</TABLE>
F-34
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(11) SEGMENT REPORTING (CONTINUED)
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenue from external customers........ $6,368,460 $65,189,835 $71,558,295
Gross margin........................... 2,135,461 21,748,438 23,883,899
Total assets........................... 705,964 19,632,440 20,338,404
</TABLE>
(12) CONTINGENCIES
The Company's common stock has been traded on The Nasdaq SmallCap Market
since May 28, 1998. Trading in the Company's stock was halted by Nasdaq after
the close of trading on November 12, 1998, through the close of trading on
November 13, 1998, as a result of an unusual upsurge in its stock price and
trading volume. This unusual event has triggered the initiation of class action
litigation under the federal securities laws. The Company believes that these
claims are without merit and intends to defend vigorously this litigation.
However, it is not possible at this time for the Company to predict with
certainty the outcome of this litigation. Even if the Company prevails in the
litigation, the expenses of the defense could have a material adverse effect on
the Company's operating results and financial condition.
The Company presently has other contingent liabilities relating to various
lawsuits and other matters related to the conduct of its business. On the basis
of information furnished by counsel and others, management believes these
contingencies upon resolution will not materially affect the financial condition
or results of operations of the Company.
(13) SUBSEQUENT EVENTS
On April 13, 1999, the Company sold 1,500 shares of its newly-designated
Series B Convertible Preferred Stock (the "Series B Stock") to AMRO
International, S.A., an entity organized under the laws of Panama, Austinvest
Anstalt Balzers, an entity organized under the laws of Liechtenstein, and
Esquire Trade & Finance Inc., an entity organized under the laws of the British
Virgin Islands (the "Series B Investors") for $1,500,000. The Series B Stock has
a liquidation preference of $1,000 per share. The Series B Stock will be
entitled to an annual dividend of $30 per share, payable in cash or Common
Stock, at the Company's option. The annual dividend will increase to $60 per
share if the Company ever ceases to be listed on The Nasdaq Stock Market or any
national securities exchange. The Series B Stock is convertible into Common
Stock at the option of the Series B Investors at any time. The number of shares
of Common Stock to be received by a Series B Investor upon conversion will equal
the liquidation preference of the amount converted, divided by the conversion
price. The conversion price will be the lesser of (1) $6.875, or (2) 89% of the
low closing bid price for the Common Stock on The Nasdaq SmallCap Market at the
time of conversion. The conversion price will not be less than $3.00 for
180 days after the date of issuance of the Series B Stock. Thereafter the
conversion price will not be less than $2.00 as long as certain revenue and
EBITDA requirements are met. As a result, the Company could issue up to 750,000
shares of Common Stock upon conversion if all of the Series B Stock were
converted at the lowest possible conversion price (assuming such revenue and
EBITDA requirements continue to be met). Unless the Company shall have obtained
the approval of its voting stockholders in accordance with the rules of The
Nasdaq Stock Market, the Company will not issue shares of Common Stock upon
conversion of any
F-35
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS AVTEL COMMUNICATIONS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(13) SUBSEQUENT EVENTS (CONTINUED)
shares of Series B Stock if such issuance of Common Stock, when added to the
number of shares of Common Stock previously issued by the Company upon
conversion of or as dividends on shares of the Series B Stock, would exceed
19.9% of the number of shares of Common Stock which were issued and outstanding
on the original issuance date of the Series B Stock. The Company will pay
converting Series B Investors in cash for any excess over such amount.
The Company also issued the Series B Investors warrants to purchase up to
20,000 shares of Common Stock at a price of $8.60 per share. The warrants may be
exercised beginning September 30, 1999, and terminate on March 31, 2002.
The Company and the Series B Investors entered into a Registration Rights
Agreement that requires the Company to file, and obtain and maintain the
effectiveness of, a Registration Statement with the Securities and Exchange
Commission (the "Commission") in order to register the public resale of all
shares of the Common Stock acquired by the Series B Investors (a) upon
conversion of the Series B Stock, (b) in payment of dividends on the Series B
Stock, and (c) upon exercise of the warrants. The Company will be subject to
significant monetary penalties if it fails to obtain or maintain the
effectiveness of such Registration Statement.
The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation for
advising it with respect to the placement of the Series B Stock.
(14) QUARTERLY FINANCIAL DATA (UNAUDITED)
1998
<TABLE>
<CAPTION>
1ST QTR 2ND QTR 3RD QTR 4TH QTR TOTAL
---------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Revenues....................... 12,444,839 11,294,866 10,589,137 9,684,656 44,013,498
Gross Margins.................. 3,156,844 2,938,848 3,336,290 2,732,162 12,164,144
Net loss as previously
reported..................... (1,672,490) (2,112,947) (1,208,539) (2,133,342) (7,127,318)
Tax benefit from NOL carryback
(note 5)..................... 304,448 413,004 156,006 451,542 1,325,000
Adjusted net loss.............. (1,368,042) (1,699,943) (1,052,533) (1,681,800) (5,802,318)
Net loss per common share--
basic and diluted as
previously reported.......... (0.18) (0.22) (0.13) (0.22) (0.74)
Net loss per common
share--basic and diluted
adjusted for tax benefit from
NOL carryback................ (0.15) (0.18) (0.11) (0.17) (0.61)
</TABLE>
During each of the quarters in 1998 the Company incurred a net operating
loss for federal income tax purposes. Approximately $4,294,000 of the NOL may be
carried back to reduce taxable income in prior years. The 1998 quarterly
information has been adjusted to reflect the tax benefit of the carryback of the
tax NOL in each quarter.
F-36
<PAGE>
NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END OF
DESCRIPTION OF PERIOD ADDITIONS DEDUCTIONS PERIOD
- ----------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful
Accounts and other
Provisions--years ended:
December 31, 1998......................... $ 982,000 2,728,000(a) 2,775,000(b) 935,000
========== ========= ========= =========
December 31, 1997......................... $ 627,000 1,830,000(a) 1,475,000(b) 982,000
========== ========= ========= =========
December 31, 1996......................... $ 730,000 1,461,000(a) 1,564,000(b) 627,000
========== ========= ========= =========
Valuation allowance for deferred tax assets:
December 31, 1998......................... $1,185,000 1,269,000(c) -- 2,454,000
========== ========= ========= =========
December 31, 1997......................... $ -- 1,185,000(c) -- 1,185,000
========== ========= ========= =========
December 31, 1996......................... $ -- -- -- --
========== ========= ========= =========
</TABLE>
- ------------------------
(a) Charged to cost of revenues.
(b) Amounts written off.
(c) Recognized as a component of deferred tax assets.
S-1
<PAGE>
APPENDIX A
STOCK PURCHASE AGREEMENT
BY AND AMONG
AVTEL COMMUNICATIONS, INC.,
ENERGY TRACS ACQUISITION CORP.
AND
MATRIX TELECOM, INC.
AUGUST 31, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C> <C> <C>
ARTICLE 1 PURCHASE AND SALE OF THE COMMON STOCK.................................. A-1
1.1. Purchase of the Common Stock........................................... A-1
1.2. Purchase Price......................................................... A-1
1.3. Payment of Purchase Price.............................................. A-1
1.4. Purchase Price Adjustment.............................................. A-1
ARTICLE 2 CONDITIONS PRECEDENT TO THE CLOSING.................................... A-2
2.1. Conditions Precedent to the Buyer's Obligation......................... A-2
2.2. Conditions Precedent to the Company's and the Seller's Obligation...... A-4
ARTICLE 3 CLOSING................................................................ A-5
3.1. Time and Place of Closing.............................................. A-5
3.2. Deliveries of the Buyer................................................ A-5
3.3. Deliveries of the Company and the Seller............................... A-5
ARTICLE 4 WARRANTIES AND REPRESENTATIONS OF THE SELLER........................... A-6
4.1. Warranties and Representations of the Seller with respect to the
Seller................................................................. A-6
4.1.1. Title to Common Stock....................................... A-6
4.1.2. Due Authorization and Execution............................. A-6
4.1.3. Organization................................................ A-6
4.1.4. Consents, Violations and Authorizations..................... A-6
4.1.5. Regulatory Compliance....................................... A-7
4.2. Warranties and Representations of the Seller with respect to the
Company................................................................ A-7
4.2.1. Organization and Standing................................... A-7
4.2.2. Capitalization.............................................. A-7
4.2.3. Consents, Violations and Authorizations..................... A-7
4.2.4. Litigation and Compliance with Laws......................... A-8
4.2.5. Subsidiaries, Investments................................... A-8
4.2.6. Ownership and Use of Tangible Assets........................ A-9
4.2.7. Patents, Trademarks, and Other Intellectual Property........ A-9
4.2.8. Financial Statements........................................ A-11
4.2.9. Conduct Out of Ordinary Course.............................. A-11
4.2.10. Taxes....................................................... A-12
4.2.11. Contracts and Other Agreements.............................. A-13
4.2.12. Employee Benefit Matters.................................... A-15
4.2.13. Labor Practices............................................. A-16
4.2.14. Brokers; Agents............................................. A-16
4.2.15. Permits and Licenses........................................ A-16
4.2.16. Material Suppliers.......................................... A-16
4.2.17. Insurance................................................... A-17
4.2.18. Environmental Matters....................................... A-17
4.2.19. Transactions with Related Parties........................... A-18
4.2.20. Accounts Receivable......................................... A-18
4.2.21. Banks....................................................... A-18
4.2.22. Conflicts of Interest....................................... A-19
4.2.23. Letters of Agency........................................... A-19
4.2.24. No Undisclosed Liabilities.................................. A-19
4.2.25. Business Practices.......................................... A-19
4.2.26. Year 2000................................................... A-19
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C> <C> <C>
4.2.27. Regulatory Compliance....................................... A-19
4.2.28. AvTel Stock Options......................................... A-20
4.2.29. Disclosure.................................................. A-20
4.3. Warranties Survive Closing............................................. A-20
ARTICLE 5 WARRANTIES AND REPRESENTATIONS OF THE BUYER............................ A-20
5.1. Warranties and Representations......................................... A-20
5.1.1. Due Authorization and Execution............................. A-20
5.1.2. Organization................................................ A-21
5.1.3. Consents, Violations and Authorizations..................... A-21
5.1.4. Investment Representations.................................. A-21
5.1.5. Brokers; Agents............................................. A-21
5.1.6. Financial Statements........................................ A-21
5.2. Warranties Survive Closing............................................. A-21
ARTICLE 6 COVENANTS.............................................................. A-22
6.1. Covenants of the Seller with respect to Itself and the Company......... A-22
6.1.1. Access...................................................... A-22
6.1.2. Records..................................................... A-22
6.1.3. Conduct of the Business of the Company...................... A-22
6.1.4. Acquisition Proposals....................................... A-24
6.1.5. Notice of Proceedings....................................... A-24
6.1.6. Noncompetition and Nonsolicitation.......................... A-25
6.1.7. AvTel Stock Options......................................... A-26
6.1.8. "Toll Free" Telephone Numbers............................... A-26
6.1.9. MCI WorldCom Inc............................................ A-26
6.1.10. Matrix Communications Corporation........................... A-27
6.2. Covenants of the Buyer................................................. A-27
6.2.1. Coast Indemnity............................................. A-27
6.2.2. Business Markets Customers.................................. A-27
6.2.3. Field Force Plan............................................ A-27
6.3. Mutual Covenants....................................................... A-27
6.3.1. Cooperation................................................. A-27
6.3.2. Records..................................................... A-27
6.3.3. Regulatory Filings.......................................... A-27
6.3.4. Contract Assignments........................................ A-27
6.3.5. Reasonable Efforts.......................................... A-28
6.3.6. Closing..................................................... A-28
ARTICLE 7 DISCLOSURE SCHEDULE.................................................... A-28
7.1. General................................................................ A-28
7.2. Disclosure Schedule.................................................... A-28
ARTICLE 8 NON-DISCLOSURE......................................................... A-28
8.1. Non-Disclosure of Confidential Information............................. A-28
8.2. Exceptions............................................................. A-29
8.3. Enforcement............................................................ A-29
8.4. Ratification of Non-Disclosure Agreement............................... A-29
ARTICLE 9 INDEMNIFICATION........................................................ A-29
9.1. Indemnification of the Buyer........................................... A-29
9.2. Indemnification of the Seller.......................................... A-29
9.3. Procedure Relative to Indemnification.................................. A-29
</TABLE>
ii
<PAGE>
<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C> <C> <C>
9.4. Limits on Indemnification Claims....................................... A-30
9.4.1. Basket...................................................... A-30
9.4.2. Maximum Amount of Indemnification........................... A-30
9.5. Sole Remedy; Termination............................................... A-30
ARTICLE 10 TAX MATTERS............................................................ A-31
10.1. Section 338 Election................................................... A-31
10.2. Tax Indemnification.................................................... A-32
10.3. Preparation of Tax Returns; Payment of Taxes........................... A-32
10.4. Tax Proceedings........................................................ A-33
10.5. Payment of Indemnification............................................. A-33
10.6. Assistance and Cooperation............................................. A-33
10.7. Tax Sharing Agreements................................................. A-34
10.8. Transfer Taxes......................................................... A-34
10.9. Survival of Obligations................................................ A-34
10.10. Tax Refund............................................................. A-34
10.11. Provisions of this Article to Control.................................. A-34
ARTICLE 11 TERMINATION............................................................ A-34
11.1. Termination............................................................ A-34
11.2. Effect of Termination.................................................. A-34
ARTICLE 12 MISCELLANEOUS.......................................................... A-35
12.1. Expenses............................................................... A-35
12.2. Notices................................................................ A-35
12.3. Entire Agreement....................................................... A-36
12.4. Assignment............................................................. A-36
12.5. Binding Effect......................................................... A-36
12.6. Section Headings....................................................... A-36
12.7. Severability........................................................... A-36
12.8. Applicable Law......................................................... A-36
12.9. Counterparts........................................................... A-36
12.10. Passage of Title....................................................... A-36
12.11. Use of Terms........................................................... A-36
12.12. Facsimile Copy......................................................... A-37
</TABLE>
iii
<PAGE>
EXHIBITS
Exhibit 2.1(e)--Opinion of the Seller
Exhibit 6.1.6(b)--Nonsolicitation
Exhibit 6.3.4(i)--Assignment from the Company to the Seller
Exhibit 6.3.4(ii)--Assignment from the Seller to the Company
iv
<PAGE>
STOCK PURCHASE AGREEMENT
THIS STOCK PURCHASE AGREEMENT (this "Agreement") is made and entered into
this August 31, 1999, by and among AvTel Communications, Inc., a Delaware
corporation (the "Seller"), Energy TRACS Acquisition Corp., a Delaware
corporation (the "Buyer"), and Matrix Telecom, Inc., a Texas corporation
(including its subsidiaries, the "Company").
BACKGROUND
WHEREAS, the Seller owns 100% of the outstanding common stock of the
Company; and
WHEREAS, the Buyer desires to acquire from the Seller and the Seller desires
to sell to the Buyer, 100% of the common stock of the Company (the "Common
Stock"), on the terms and subject to the conditions set forth herein.
NOW, THEREFORE, the Buyer, the Seller and the Company, in consideration of
the mutual promises hereinafter set forth, do hereby promise and agree as
follows:
ARTICLE 1
PURCHASE AND SALE OF THE COMMON STOCK
1.1. PURCHASE OF THE COMMON STOCK. Subject to the terms and conditions set
forth in this Agreement, the Seller shall sell to the Buyer, and the Buyer shall
purchase from the Seller at the Closing (as defined below), all of the Common
Stock.
1.2. PURCHASE PRICE. The Buyer shall pay or provide, as appropriate, to
the Seller, as consideration for the Common Stock, the following (collectively,
the "Purchase Price"):
(a) A credit in favor of the Seller (the "Credit") against amounts that
become due after the date hereof for long distance wholesale traffic to be
provided by the Company to the Seller (the "Long Distance Services")
pursuant to a rebiller service contract between the Company and the Seller
of even date herewith; provided, however, that the amount of the Credit will
not exceed Seventy-Five Thousand Dollars ($75,000) per month for a period
not to exceed twenty-six (26) months commencing with the Closing Date, not
to exceed an aggregate of One Million Six Hundred Fifty Thousand Dollars
($1,650,000); and
(b) Fifty Dollars ($50) per each additional Internet service customer
added to the Company's aggregate customer base, net of one-half of the
customers lost from the date hereof, within six (6) months of the date
hereof, up to an aggregate of One Million Dollars ($1,000,000) (the "ISP
Payment").
1.3. PAYMENT OF PURCHASE PRICE. On the later of (i) the Closing Date or
(ii) the seven-month anniversary of the date hereof, the Buyer shall pay to the
Seller the ISP Payment portion of the Purchase Price by wire transfer of
immediately available funds and pursuant to the wire transfer instructions set
forth on SCHEDULE 1.3.
1.4. PURCHASE PRICE ADJUSTMENT.
(a) Within thirty (30) days following the date hereof, the Seller shall
prepare, in accordance with generally accepted accounting principles
consistently applied ("GAAP") except as set forth on SCHEDULE 4.2.8(II), a
balance sheet of the Company as of the date hereof (the "Execution Date
Balance Sheet"), together with a detailed analysis of each balance sheet
item, and including a computation of stockholder's equity net of (i) the
intercompany receivables identified in SECTION 2.1(G) and (ii) the tax
refund identified in SECTION 10.10, as of the date hereof (the
"Stockholder's Equity"), and provide a copy thereof to the Buyer.
A-1
<PAGE>
(b) The Buyer shall have the right to review the books and records of
the Company for a period of sixty (60) days after receiving the Execution
Date Balance Sheet to verify and confirm the accuracy thereof. If, after
such review, the Buyer agrees with the Execution Date Balance Sheet, the
Buyer shall promptly (and in any event within sixty (60) days after
receiving the Execution Date Balance Sheet) notify the Seller of its
agreement. If, after such review, the Buyer objects to the Execution Date
Balance Sheet, the Buyer shall promptly (and in any event within sixty
(60) days after receiving the Execution Date Balance Sheet) provide the
Seller with a detailed statement indicating the basis for its objections,
and the Buyer and the Seller shall meet and confer in an effort to resolve
such disagreement in good faith.
(c) In the event that the Buyer and the Seller are unable to resolve a
disagreement with respect to the Execution Date Balance Sheet within sixty
(60) days following the date of the Buyer's objection (or such longer period
as the Buyer and the Seller may agree), the Stockholder's Equity shall be
determined by an independent firm of certified public accountants (the
"Accountants") as the Seller and the Buyer may agree. If issues in dispute
are submitted to the Accountants for resolution, (i) each party will furnish
to the Accountants such work papers and other documents and information
relating to the disputed issues as the Accountants may request and are
available to that party, and will be afforded the opportunity to present to
the Accountants any material relating to the determination and to discuss
the determination with the Accountants; (ii) the determination by the
Accountants of the Stockholder's Equity, as set forth in a notice delivered
to both parties by the Accountants, will be binding and conclusive on the
parties; and (iii) the fees of the Accountants for such determination shall
be paid equally by the parties.
(d) Within five (5) days after the determination of the Stockholder's
Equity pursuant to either the agreement of the parties or the determination
of the Accountants, the parties shall calculate the amount, if any, by which
the Stockholder's Equity is a larger negative number than negative
$4,356,078 (the "Purchase Price Reduction") or the amount, if any, by which
the Stockholder's Equity is a smaller negative number than negative
$4,356,078 (the "Purchase Price Increase"). The aggregate amount of the
Credit (but not the monthly limit thereon) that may be taken by the Seller
against the costs of the Long Distance Services shall be reduced by the
amount of the Purchase Price Reduction, with any residual amount due paid by
the Seller to the Buyer by wire transfer of immediately available funds and
pursuant to the wire transfer instructions set forth on SCHEDULE 1.3. The
aggregate amount of the Credit (but not the monthly limit thereon) that may
be taken by the Seller against the costs of the Long Distance Services shall
be increased by the amount of the Purchase Price Increase.
ARTICLE 2
CONDITIONS PRECEDENT TO THE CLOSING
2.1. CONDITIONS PRECEDENT TO THE BUYER'S OBLIGATION. The obligation of the
Buyer to consummate the transactions contemplated herein is subject to the
satisfaction as of the Closing of each of the following conditions:
(a) Except with regard to events that result from the actions of any
person or entity other than the Seller after the date hereof, each of the
representations and warranties of the Seller and the representations and
warranties of the Company made in this Agreement and the statements
contained in the Disclosure Schedule (as defined below) and exhibits thereto
shall be complete and correct in all material respects on and as of the date
hereof and on and as of the Closing Date; the Company and the Seller shall
have performed in all material respects the respective covenants, agreements
or obligations of the Company and the Seller contained in this Agreement
required to be performed on or prior to the Closing Date; and the Seller
shall have delivered to the Buyer a certificate dated as of the Closing Date
and signed by an authorized officer of the Seller confirming the foregoing
in a form reasonably satisfactory to the Buyer.
A-2
<PAGE>
(b) The Seller (or its ultimate parent entity) shall have filed, if
required by law, proper pre-merger notification forms with the United States
Federal Trade Commission (the "FTC") and the Antitrust Division of the
United States Department of Justice (the "DOJ") under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended, and the rules and
regulations promulgated thereunder (the "HSR Act"), and the waiting period
following the filing of proper pre-merger notification forms by the Buyer
(or its ultimate parent entity) and the Seller (or its ultimate parent
entity) shall have expired, whether pursuant to early termination or by
passage of time.
(c) All consents, licenses, permits, authorizations or approvals from,
filings with and notifications to any federal, state, local or other
governmental or regulatory body required to be made or obtained by the
Company and the Seller in connection with the consummation of the
transactions contemplated by this Agreement or necessary to operate the
Company shall have been made or obtained including, without limitation,
requirements under the HSR Act, and of the Federal Communications Commission
(the "FCC") or any state public utility commission ("PUC"). All approvals,
consents and waivers of third parties required to be obtained by the Company
and the Seller shall have been obtained. None of the approvals, consents,
permits, licenses, certificates, and authorizations given by any state or
local regulatory authority to provide the telecommunications services
currently provided by the Company and to conduct its business as it is
currently conducted (the "PUC Authorizations") and none of the Company's
approvals, consents, permits, licenses, certificates, and authorizations
given by the FCC or similar federal governmental agency to provide the
telecommunications services currently provided by the Company and to conduct
its business as it is currently conducted (the "FCC Authorizations") shall
have been modified, amended, or otherwise altered, and each shall remain
legal, valid, binding, and in full force and effect.
(d) No injunction or order of any court or administrative agency of
competent jurisdiction shall be in effect as of the Closing Date which
restrains or prohibits the consummation of the transactions contemplated by
this Agreement nor shall any action, suit or proceeding requesting such an
injunction or order have been commenced or threatened in writing by a party
other than the Buyer.
(e) The Buyer shall have received from Seed, Mackall & Cole, LLP,
counsel for the Seller and the Company, an opinion, dated the Closing Date,
substantially in the form set forth as EXHIBIT 2.1(E).
(f) Except with regard to events that result from the actions of any
person or entity other than the Seller after the date hereof, the Company
shall not have suffered or incurred the loss, termination, suspension or
adverse modification to, or been threatened with any such loss, termination
suspension or adverse modification to, any contract, certificate, license or
permit necessary or required for the Company to continue, both before and
after the Closing Date, to operate and conduct its business in the manner,
and in the geographic areas, currently conducted by it as of the date of
this Agreement, except such as would not have a Material Adverse Effect (as
defined below).
(g) All intercompany receivables have been eliminated.
(h) The Company and the Seller shall have delivered to the Buyer the
documents, certificates, agreements and instruments required under
SECTION 3.3, each in a form reasonably acceptable to Buyer.
(i) The Seller and the Company shall have delivered all customer letters
of agency ("LOAs"), carrier selection authorizations ("PIC Change
Authorization") and third party verifications ("TPV") of the Company since
1996 in their possession to the Buyer.
(j) The Seller and the Company shall have delivered all Tax Returns (as
defined below) of the Company since 1992 to the Buyer, including all work
papers and backup used to prepare and support such Tax Returns.
A-3
<PAGE>
(k) The Buyer shall have entered into a reasonably acceptable
arrangement with Sprint Communications Company L.P. within thirty (30) days
of the date hereof that addresses the outstanding balances due as of this
date and future rates for long distance telephone services.
In the event that any of the foregoing conditions to the Closing shall
not have been satisfied prior to one (1) year from the date hereof, the
Buyer may elect to (i) terminate this Agreement without liability to the
Buyer, the Company or the Seller, provided that any such termination shall
be without prejudice to any claims by the Buyer for intentional breach of
this Agreement by the Company or the Seller or (ii) waive all such
unsatisfied conditions and consummate the transactions contemplated herein
despite such failure.
2.2. CONDITIONS PRECEDENT TO THE COMPANY'S AND THE SELLER'S
OBLIGATION. The obligation of the Company and the Seller to consummate the
transactions contemplated herein is subject to the satisfaction as of the
Closing of each of the following conditions:
(a) Each of the representations and warranties of the Buyer made in this
Agreement shall be complete and correct in all material respects as of the
date hereof and on and as of the Closing Date, as though made on and as of
the Closing Date; the Buyer shall have performed in all material respects
the covenants, agreements and obligations of the Buyer contained in this
Agreement required to be performed on or prior to the Closing; and the Buyer
shall have delivered to the Seller a certificate dated as of the Closing
Date and signed by an authorized officer of the Buyer confirming the
foregoing in a form reasonably satisfactory to the Seller.
(b) The Buyer shall have caused its ultimate parent entity to file, if
required by law, proper pre-merger notification forms with the FTC and the
DOJ under the HSR Act, and the waiting period following the filing of proper
pre-merger notification forms by the Buyer and the Seller (or its ultimate
parent entity) shall have expired, whether pursuant to early termination or
by passage of time.
(c) All consents, licenses, permits, authorizations, approvals from,
filings with and notifications to any federal, state, local or other
governmental or regulatory body required to be made or obtained by the Buyer
in connection with the consummation of the transactions contemplated by this
Agreement shall have been made or obtained including, without limitation,
requirements under the HSR Act, and of the FCC or any PUC. All approvals,
consents and waivers of third parties required to be obtained by the Buyer
in connection with the consummation of such transactions shall have been
obtained.
(d) No injunction or order of any court or administrative agency of
competent jurisdiction shall be in effect as of the Closing which restrains
or prohibits the consummation of the transactions contemplated under this
Agreement nor shall any action, suit or proceeding requesting such an
injunction or order have been commenced by a party other than the Seller or
the Company.
(e) The stockholders of the Seller shall have approved this Agreement
and the transactions contemplated hereby in accordance with the Delaware
General Corporation Law (the "DGCL") and Regulation 14A or Regulation 14C
promulgated under the Securities Exchange Act of 1934, as amended. In the
event that such approval is by the written consent of stockholders, the
Seller shall have been permitted by the Securities and Exchange Commission
to provide non-consenting stockholders with an Information Statement on
Schedule 14C at least twenty (20) days prior to the Closing. All costs
associated with this SECTION 2.2(e) shall be borne by the Seller.
(f) The Seller shall have received on or prior to the Closing Date a
full release from Coast Business Credit, a division of Southern Pacific
Bank, a California corporation ("Coast"), of those obligations of the Seller
to Coast under the Loan and Security Agreement, dated as of September 30,
1998, between the Seller, the Company and Coast (the "Coast Loan Agreement")
which are secured by assets of the Seller and the Company.
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(g) The Buyer shall have delivered to the Seller the documents,
certificates, agreements and instruments required under SECTION 3.2, each in
a form reasonably acceptable to the Seller.
(h) The Seller shall have received from Riordan & McKinzie, counsel for
the Buyer, an opinion, dated the Closing Date, in a form reasonably
satisfactory to the Seller.
In the event that any of the foregoing conditions to the Closing shall
not have been satisfied prior to one (1) year from the date hereof, the
Seller may elect to (i) terminate this Agreement without liability to the
Seller, the Company or the Buyer, provided that any such termination shall
be without prejudice to any claims by the Company or the Seller for
intentional breach of this Agreement by the Buyer or (ii) waive any such
unsatisfied conditions and consummate the transactions contemplated herein
despite such failure.
ARTICLE 3
CLOSING
3.1. TIME AND PLACE OF CLOSING. The closing of the purchase and sale
contemplated herein (the "Closing") shall be held at the offices of Riordan &
McKinzie, 695 Town Center Drive, Suite 1500, Costa Mesa, California, at
10:00 a.m. (Los Angeles time), on the fifth (5th) business day following the
date on which all the conditions precedent to the Closing set forth in
ARTICLE 2 have been satisfied or waived, or at such other time or place as the
Seller and the Buyer shall mutually agree, provided, that on that day, there
shall not be in effect any injunction, temporary restraining order, or other
order of a court or governmental or regulatory authority of competent
jurisdiction directing that the purchase and sale of the Common Stock pursuant
to this Agreement not be consummated. If such an injunction or order is in
effect on that day, the Closing shall take place as soon as practicable after it
is no longer in effect. The date on which the Closing shall occur is hereinafter
referred to as the "Closing Date."
3.2. DELIVERIES OF THE BUYER. At the Closing, the Buyer shall deliver to
the Seller the following:
(a) The payment of the Purchase Price in the manner specified in
SECTION 1.3.
(b) A certificate from the Secretary of the Buyer, in a form reasonably
satisfactory to the Seller and its counsel, setting forth the resolutions of
the Board of Directors of the Buyer authorizing the execution of this
Agreement and all agreements, documents and instruments to be executed and
delivered by the Buyer in connection herewith (the "Buyer Ancillary
Documents") and the taking of any and all actions deemed necessary or
advisable to consummate the transactions contemplated herein or therein.
(c) The certificate of the Buyer required to be delivered pursuant to
SECTION 2.2(a).
(d) Copies of the consents, approvals and other documentation required
pursuant to SECTION 2.2(c).
3.3. DELIVERIES OF THE COMPANY AND THE SELLER. At the Closing, the Company
and the Seller shall deliver to the Buyer the following:
(a) Certificates representing the Common Stock, duly endorsed in blank
or accompanied by an assignment duly executed in blank by the Seller.
(b) The certificate of the Company and the Seller required to be
delivered pursuant to SECTION 2.1(a).
(c) Resignations of all of the officers and directors of the Company and
each person who is a trustee, custodian, or authorized signatory under any
employee benefit plan, bank account, depository account or safe deposit box
of the Company, effective as of the Closing.
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(d) Constructive possession of the complete books and records relating
to the business of the Company including, without limitation, minute books,
stock ledgers, all keys or articles required for access thereto and the
combinations for all safes, vaults and other places of safekeeping or
storage of the Company.
(e) A certificate of the Secretary of the Company, in a form reasonably
satisfactory to the Buyer and its counsel, setting forth the resolutions of
the Board of Directors of the Company authorizing the execution of this
Agreement and all agreements, documents and instruments to be executed and
delivered by the Company or the Seller hereunder (collectively, the "Seller
Ancillary Documents") and the taking by the Company of any and all actions
deemed necessary or advisable to consummate the transactions contemplated
herein or therein.
(f) Copies of the consents, approvals and other documentation required
pursuant to SECTION 2.1(c).
(g) The Disclosure Schedule, pursuant to ARTICLE 7.
(h) Such other documents or instruments as the Buyer may reasonably
request.
ARTICLE 4
WARRANTIES AND REPRESENTATIONS OF THE SELLER
4.1. WARRANTIES AND REPRESENTATIONS OF THE SELLER WITH RESPECT TO THE
SELLER. The Seller hereby warrants and represents to the Buyer, which
warranties and representations shall survive the Closing for the period set
forth in SECTION 4.3, that, except as set forth in the disclosure schedule
attached hereto (the "Disclosure Schedule"), which exceptions shall specify the
Sections to which they relate and be in reasonable detail, the following
statements are true on and as of the date hereof and will be true on and as of
the Closing Date with respect to the Seller:
4.1.1. TITLE TO COMMON STOCK. The Seller is the record owner of and
has good, valid and marketable (except due to applicable federal and state
law) title to the Common Stock free and clear of any and all claims, liens,
pledges, options, charges, security interests, restrictions (except due to
applicable federal and state law), encumbrances or other rights of third
parties of any kind or nature whatsoever affecting its ability to transfer
such Common Stock to the Buyer.
4.1.2. DUE AUTHORIZATION AND EXECUTION. The Seller has the necessary
corporate power and authority to enter into this Agreement and the Seller
Ancillary Documents and to consummate the transactions contemplated hereby
and thereby. The Board of Directors of the Seller has duly authorized and
approved the execution and delivery of this Agreement and the Seller
Ancillary Documents and the consummation of the transactions contemplated
hereby and thereby. No other corporate proceedings are necessary to
authorize this Agreement and the Seller Ancillary Documents and the
consummation of such transactions, except that the consummation of the
transactions contemplated by this Agreement require the approval of the
stockholders of the Seller pursuant to the DGCL. This Agreement has been
duly and validly executed and delivered by the Seller and, assuming due
execution and delivery by the Buyer, constitutes a valid and binding
obligation of the Seller enforceable against it in accordance with its
terms, except as limited by (a) bankruptcy, insolvency, reorganization,
moratorium or similar laws relating to creditors' rights generally or
(b) equitable principles (whether considered in an action at law or in
equity).
4.1.3. ORGANIZATION. The Seller is a corporation duly incorporated,
validly existing and in good standing under the laws of the State of
Delaware and has all requisite corporate power and authority to own, operate
and lease its properties and assets and carry on its business as now
conducted.
4.1.4. CONSENTS, VIOLATIONS AND AUTHORIZATIONS. Except as set forth on
SCHEDULE 4.1.4, the Seller is not party to or bound by any lien, lease,
permit, concession, franchise, license, instrument,
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mortgage, indenture or other agreement, or any judgment, order, decree,
statute, law, ordinance, rule or regulation of any court or governmental
entity applicable to it which would require it to obtain the authorization,
consent or approval of another (including the authorization, consent or
approval of governmental authorities) to the execution of this Agreement,
the Seller Ancillary Documents or the transactions contemplated hereby or
thereby. Neither the execution and delivery of this Agreement or the Seller
Ancillary Documents nor the consummation of the transactions contemplated
hereby or thereby shall violate any provision of the Certificate of
Incorporation or Bylaws of the Seller.
4.1.5. REGULATORY COMPLIANCE. The Seller (i) is operating in
compliance in all material respects with all applicable federal and state
tariffs, laws, regulations and orders relating to the telecommunications
industry and (ii) has not received notice of any violations of any tariffs
or of laws, regulations and orders from any governmental entity having
authority to enforce such tariffs, laws, regulations and orders, including
but not limited to, (a) the Communications Act of 1934, as amended by the
Telecommunications Act of 1996 and (b) the Telephone Consumer Protection Act
of 1991. The Seller has no PUC Authorizations or FCC Authorizations.
4.2. WARRANTIES AND REPRESENTATIONS OF THE SELLER WITH RESPECT TO THE
COMPANY. The Seller hereby warrants and represents to the Buyer, which
warranties and representations shall survive the Closing for the period set
forth in SECTION 4.3, that, except as set forth in the Disclosure Schedule,
which exceptions shall specify the Sections to which they relate and be in
reasonable detail, the following statements are true on and as of the date
hereof with respect to the Company:
4.2.1. ORGANIZATION AND STANDING. The Company is a corporation duly
formed, validly existing and in good standing under the laws of the State of
Texas. The Company has the corporate power and authority to own or lease its
properties and to carry on all business activities which it now conducts.
The Company is duly qualified and is in good standing in each state and
jurisdiction where such qualification is necessary or required for the
Company to conduct its business and offer communications services, except
for any state or jurisdiction where the failure to be so qualified and in
good standing could not reasonably be expected to have a "material adverse
effect." For the purposes of this Agreement, a "Material Adverse Effect"
shall mean any material adverse effect on the financial condition,
prospects, results of operations, properties, assets or liabilities
(absolute, accrued, contingent or otherwise) of the business of the Company
as currently conducted or of the Company and its subsidiaries.
SCHEDULE 4.2.1 contains a complete and correct list of all states in which
the Company is qualified to do business as a foreign corporation. The
minutes of the meetings of the Board of Directors of the Company and its
shareholders (complete and correct copies of which have been provided to the
Buyer) are complete and correct in all material respects. The Articles of
Incorporation and Bylaws of the Company (complete and correct copies of
which have been provided to the Buyer) are complete and correct and are in
full force and effect without amendment or modification.
4.2.2. CAPITALIZATION. SCHEDULE 4.2.2 sets forth the capitalization of
the Company. All of the issued and outstanding Common Stock (or other equity
interests) of the Company are owned beneficially and of record as set forth
on SCHEDULE 4.2.2. All of the Common Stock is duly authorized, validly
issued and outstanding, fully paid and nonassessable. The Common Stock has
not been issued in violation of, and is not subject to, any preemptive or
subscription rights. There are no outstanding warrants, options, puts,
agreements, subscriptions, convertible or exchangeable securities or other
commitments or rights pursuant to which the Company is or may become
obligated to issue, sell, purchase, return or redeem any of its securities.
All of the Common Stock has been issued in compliance with all applicable
federal and state securities laws or in accordance with exemptions
therefrom, except where the failure to so comply would not have a Material
Adverse Effect.
4.2.3. CONSENTS, VIOLATIONS AND AUTHORIZATIONS. Except as set forth on
SCHEDULE 4.2.3, the Company is not a party to or bound by any contract,
encumbrance, lease, permit, concession, franchise, license, instrument,
mortgage, indenture or other agreement or any judgment, order,
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decree, statute, law, ordinance, rule or regulation of any court or
governmental entity applicable to it which would require it to obtain the
authorization, consent or approval of another (including the authorization,
consent or approval of governmental authorities) to the execution of this
Agreement and the Seller Ancillary Documents or the transactions
contemplated hereby or thereby. Neither the execution and delivery of this
Agreement or the Seller Ancillary Documents, nor the consummation of the
transactions contemplated hereby or thereby shall (a) violate any provision
of the Articles of Incorporation or Bylaws of the Company or (b) conflict
with, or result (immediately or upon the giving of notice or the passage of
time or both) in any violation of or default under, or give rise to a right
of modification, termination, cancellation or acceleration of any obligation
or to a loss of a benefit under, or result in the creation of any claims,
liens, pledges, options, charges, easements, security interests, deeds of
trust, mortgages, rights of way, easements, encumbrances or rights of third
parties of any kind or nature whatsoever (collectively, an "Encumbrance")
upon the Company or its assets under any contract, lease, permit,
concession, franchise, license, instrument, mortgage, indenture or other
agreement which the Company is party to, beneficiary of, or bound by, or
result in the violation or creation of any Encumbrance upon the Company or
its assets under any judgment, order, decree, statute, law, ordinance, rule
or regulation applicable to the Company. None of the execution, delivery or
performance of this Agreement or any of the Seller Ancillary Documents, or
the consummation of the transactions contemplated hereby or thereby requires
any filing with or the consent or approval of any third party, including but
not limited to any governmental body or entity other than (a) compliance
with applicable securities laws, (b) applications to the FCC and the state
utility regulatory commissions in states in which the Company offers
services (such commissions together with the FCC constitute a "Commission"
or the "Commissions"), (c) notifications to the FTC and the DOJ under the
HSR Act, and (d) approval of the Seller's stockholders.
4.2.4. LITIGATION AND COMPLIANCE WITH LAWS. Except as set forth on
SCHEDULE 4.2.4, there is no claim, suit, action, investigation, litigation,
complaint proceeding (including, without limitation, arbitral proceedings)
or other legal or administrative proceeding pending or, to the best
knowledge of the Company and the Seller, threatened against the Company and
there are no complaints or reviews by any court, governmental department,
commission, agency, instrumentality or authority or any arbitrator pending
or, to the best knowledge of the Company and the Seller, threatened against,
relating to or affecting, the Company. There is no judgment, order, writ,
garnishment, levy, injunction, decree or award (whether issued by a court,
an arbitrator, a governmental body or agency thereof or otherwise) to which
the Company is party, or involving the properties, assets or business of the
Company, which is unsatisfied or which requires continuing compliance
therewith by the Company. During the past five (5) years, there has not been
nor is there now pending, any claim(s) against any person in his or her
capacity as either a director or officer of the Company. The Company has
complied with all existing foreign and domestic laws, statutes, ordinances,
codes, rules, regulations, judgments, orders, writs or decrees of any
federal, state, local or foreign court or governmental or regulatory body or
agency thereof (collectively, "Laws") now applicable to its business, as
presently conducted, including, without limitation, (a) all environmental
laws, and (b) all provisions of Laws relating to labor relations, equal
employment practices, fair employment practices, entitlement, prohibited
discrimination, terms and conditions of employment, wages and hours, or
other similar employment practices or acts, except where the failure to
comply with any such Laws would not have a Material Adverse Effect. Neither
the Seller nor the Company has received any written notice that the Company
has not complied in all material respects with all applicable Laws to which
the Company may be subject or which are applicable to the operations,
businesses or assets of the Company.
4.2.5. SUBSIDIARIES, INVESTMENTS. Except as set forth on
SCHEDULE 4.2.5, the Company has no subsidiaries and does not own, directly
or indirectly, any stock, partnership interest, joint venture interest or
other security, investment or interest in any other corporation,
organization or entity. SCHEDULE 4.2.5 sets forth the state of
incorporation, foreign qualification and capital structure of each
subsidiary.
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4.2.6. OWNERSHIP AND USE OF TANGIBLE ASSETS.
(a) The Company has good title to or a valid leasehold interest in
all tangible personal property and assets which are material to the
operation of the Company as currently conducted free and clear of all
Encumbrances except those which would not have a Material Adverse Effect
on the Company's ability to use or enjoy beneficial ownership of the
personal property or assets. Such tangible personal property and assets
are set forth on SCHEDULE 4.2.6(a).
(b) The Company does not own any real property. SCHEDULE 4.2.6(b)
contains a complete list and description of all real property leased by
the Company or used by the Company in its operations (collectively, the
"Leased Real Property"), in each case indicating the entity leasing or
using such property and the persons or entities from whom such property
is being leased. The Leased Real Property constitutes all of the real
property interests leased or used in the operations of the Company as
currently conducted. With respect to all of the Leased Real Property, the
Company has good and valid leasehold title thereto free and clear of all
Encumbrances. The structures, plants, improvements, systems (including,
without limitation, heating, ventilation, air conditioning, electrical,
plumbing, fire sprinkler, lighting, elevator and other mechanical
systems) and fixtures located in or about the Leased Real Property have
been maintained in accordance with reasonable maintenance standards
generally followed in the industry. All other assets and property used in
the business of the Company, and all assets and property reflected in the
balance sheet of the Company dated May 31, 1999 (the "Interim Balance
Sheet") or acquired after the date of the Interim Balance Sheet (other
than assets or property sold or otherwise disposed of by the Company in
the ordinary course of its business subsequent to such date) are in each
case free and clear of all Encumbrances. The buildings, machinery and
equipment of the Company are in good and serviceable condition,
reasonable wear and tear excepted. The Leased Real Property is being used
by the Company in compliance with the terms of its applicable lease or
occupancy agreement.
(c) All tangible personal property of the Company which is material
to the Company's operations has been maintained in accordance with
reasonable maintenance standards generally followed in the industry and
is physically located at or about the places of business of the Company.
None of such tangible personal property is subject to any agreement,
arrangement or understanding for its use by any person other than the
Company, the presence of which would have a Material Adverse Effect.
(d) SCHEDULE 4.2.6(d) sets forth a complete and correct list of all
tangible personal property leases to which the Company is a party which
involve annual lease payments of more than $3,000. Each such lease is in
full force and effect against the Company. All lease payments due to date
on any such lease have been paid, and the Company is not in default under
any such lease. There are no disputes or disagreements between the
Company, on the one hand, and any other party with respect to any such
lease.
(e) SCHEDULE 4.2.6(e) sets forth a complete and correct list of all
"toll free" telephone numbers used in connection with the business of the
Company.
4.2.7. PATENTS, TRADEMARKS, AND OTHER INTELLECTUAL PROPERTY.
(a) INTELLECTUAL PROPERTIES. Except for Third-Party Software (as
defined below) and license agreements included in shrink-wrapped software
packages ("Shrink-Wrapped Licenses"), SCHEDULE 4.2.7(a) contains a list
of all issued patents, registered and unregistered trademarks, trade
names and/or copyrights which are owned or used in the operation of the
Company's business by the Company and all applications therefor in which
the Company has an interest (collectively, the "Intellectual
Properties"). The Company has the sole right to use the Intellectual
Properties as they are currently being used by the Company, free and
clear of all Encumbrances, except for the
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Third-Party Software (as defined below) and as set forth on
SCHEDULE 4.2.7(a). No claims have been asserted or threatened in writing
by any person challenging the Company's ownership or use of any of the
Intellectual Properties which if successful, would have a Material
Adverse Effect. The conduct of the Company's business does not infringe
or otherwise violate the intellectual property rights of others. To the
best of the Company's and the Seller's knowledge, none of the
Intellectual Properties is being infringed by others. Each of the
Intellectual Properties is fully valid, subsisting, and enforceable, and
there are no restrictions and/or limitations on the transfer of any of
the Intellectual Properties as contemplated by this Agreement. The
Company does not license intellectual property from any third party,
except for Third-Party Software and Shrink-Wrapped Licenses.
(b) COMPANY SOFTWARE PRODUCTS. The computer software owned or
developed by the Company (the "Company Software Products") is not
licensed or sold by the Company.
(c) THIRD-PARTY SOFTWARE. SCHEDULE 4.2.7(c) contains a list of all
computer software licensed to the Company (the "Third-Party Software")
under which any rights to use or distribute Third-Party Software have
been granted to the Company other than Shrink-Wrapped Licenses. All such
license agreements are enforceable in accordance with their terms against
the licensors (subject, as to the enforcement of remedies, to applicable
bankruptcy, reorganization, insolvency, moratorium, and similar laws
affecting creditors' rights, and, with respect to the remedy of specific
performance, equitable doctrines applicable thereto). SCHEDULE 4.2.7(c)
also sets forth the amount of royalties payable, if any, by the Company
with respect to such Third-Party Software. All such royalties have been
paid by the Company when and as due and there are no royalty payments
outstanding.
(d) SOURCE CODE ESCROW. The Company has not delivered source code
for any Company Software Product to be held in escrow.
(e) DISCLOSURES.
(i) The Company has the right to possess, use and modify all
Company Software Products and to use Third-Party Software products in
all jurisdictions in which any Company Software Product (or such
Third-Party Software) is in use. The Company does not manufacture,
reproduce (except for internal use), license or sell the Company
Software Products. The Company has neither done anything nor, with
respect to the United States, permitted anything to be done to cause
such rights to be owned or possessed by any third party. The Company
has not received nor is otherwise aware of any claim that any Company
Software Product or any Third-Party Software infringes the rights of
others.
(ii) There is no pending claim or litigation and to the best of
the Company's and the Seller's knowledge, there is no threatened
claim or litigation contesting the right to use, sell, license or
dispose of any Company Software Product nor, to the best of the
Company's and the Seller's knowledge, is there any fact or alleged
fact which would reasonably serve as a basis for any such claim.
(iii) The Company is in material compliance with the terms and
conditions of all license agreements governing the use and
distribution of Third-Party Software.
(iv) All Third-Party Software used by the Company for its
internal business operations (including product development and
testing) is licensed for use only on computer equipment located at
the Company's sites or on computers under control of the Company's
employees.
(v) The Company has taken commercially reasonable steps to
safeguard and maintain the secrecy and confidentiality of all trade
secrets and proprietary or confidential business and technical
information included in the Intellectual Property Rights.
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(vi) All documents and materials containing trade secrets or
proprietary or confidential business or technical information of the
Company (including without limitation unpublished source code for the
Company Software Products) are presently located at one of the
premises identified as Leased Real Property on SCHEDULE 4.2.6(b) and,
to the best of the Company's and the Seller's knowledge, have not
been used, divulged or appropriated for the benefit of any person
other than the Company, or to the detriment of the Company.
4.2.8. FINANCIAL STATEMENTS. SCHEDULE 4.2.8(i) contains complete and
correct copies of the consolidated financial statements of the Company for
the fiscal periods ended December 31, 1997 and December 31, 1998 (the
"Historical Financial Statements") and the balance sheet and statement of
operations of the Company at and for the period ended May 31, 1999 (the
"Interim Financial Statements" and, collectively with the Historical
Financial Statements, the "Financial Statements"). The Financial Statements
are prepared in accordance with the books and records of the Company. Except
as set forth on SCHEDULE 4.2.8(ii), the balance sheet contained in the
Interim Financial Statements is complete and correct, was prepared in
accordance with GAAP, was consistently prepared and fairly presents the
financial condition of the Company on such date. The Historical Financial
Statements were consolidated into the audited consolidated financial
statements of the Seller, which financial statements were prepared in
accordance with GAAP. There has been no material adverse change in the
capitalization, assets or liabilities of the Company since the date of the
Interim Financial Statements, other than changes in the ordinary course of
business consistent with past practice and changes for which the Purchase
Price has been adjusted pursuant to SECTION 1.4.
4.2.9. CONDUCT OUT OF ORDINARY COURSE. Except as set forth on
SCHEDULE 4.2.9, the Company has, since the date of the Interim Balance
Sheet, conducted its business in the normal and ordinary course and has not
since such date: (i) other than in the ordinary course of business,
mortgaged, pledged or subjected to, or agreed to mortgage, pledge or subject
to, any lien, any of the assets or business of the Company, except as
contemplated in this Agreement, (ii) sold, transferred, leased to others or
otherwise disposed of or agreed to sell, transfer, lease or otherwise
dispose of any of the assets of the Company having an aggregate value of
more than $10,000; (iii) suffered any damage, destruction or loss (whether
or not covered by insurance) which would have a Material Adverse Effect;
(iv) other than in the ordinary course of business, borrowed, or agreed to
borrow, funds in excess of $10,000; (v) directly or indirectly paid, or
agreed to pay, any severance or termination pay to any employee or otherwise
granted any general or specific increase in the salary, commission rate or
other compensation payable to any employee, director, independent
contractor, governor or officer which was not accrued at such date;
(vi) issued, or agreed to issue, any securities of the Company;
(vii) declared, paid, made or agreed to declare, pay or make any dividends,
distributions, redemptions, equity repurchases or other transactions with
respect to any securities of the Company; (viii) had any change in its
accounting principles, methods or practices or any change in its
depreciation or amortization policies or rates or any change in any
assumption underlying or methods of calculating any bad debt, contingency or
other reserves related to the business of the Company; (ix) had any change
in the relationship or course of dealing with any of its suppliers,
customers, distributors, lenders or creditors that has had or could
reasonably be expected to have a Material Adverse Effect; (x) had any labor
disputes or disturbances, other than grievances, or attempts to organize the
employees of the Company for the purpose of collective bargaining, which
have had or could reasonably be expected to have a Material Adverse Effect;
(xi) amended or terminated any contract, permit or other agreement related
to its assets or business, or by which it or any of its assets or properties
used or useable in connection with its business is subject, except as
expressly required by this Agreement provided that the Company may have
amended or terminated any contracts, permits or other agreements which have
a value in the aggregate of less than $10,000; (xii) cancelled any
indebtedness or waived or released any right or claim of the Company related
in any way to the Company's business with an aggregate value in excess of
$10,000; (xiii) made any capital expenditure or incurred any obligation to
make any capital expenditure in connection with the conduct of the
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Company's business in excess of an aggregate of $10,000 or other than in the
ordinary course consistent with past practices; (xiv) failed to pay or
satisfy when due any material obligation of the Company, except where such
failure would not have a Material Adverse Effect on the Company;
(xv) assigned, sold or transferred any of its Intellectual Properties or
other intangible assets; (xvi) satisfied or discharged any material lien or
paid any material obligation or liability, other than obligations or
liabilities incurred in the ordinary course of business, an obligation or
liability included in the Interim Balance Sheet, current liabilities
incurred since such date in the ordinary course of business, liabilities
incurred in carrying out the transactions contemplated by this Agreement and
obligations and liabilities under, and pursuant to the terms of, the
contracts and agreements listed in the Disclosure Schedule; (xvii) made any
loan to any person or entity other than loans to its employees; or
(xviii) had any other change or taken any other action not in the ordinary
course of business which has had or could reasonably be expected to have a
Material Adverse Effect.
4.2.10. TAXES.
(a) DEFINITIONS. For purposes of this SECTION 4.2.10, the following
terms shall have the following meanings:
The terms "Tax" and "Taxes" shall mean and include any and all
United States, state, local, foreign income, alternative, minimum,
accumulated earnings, personal holding company, franchise, capital
stock, profits, windfall profits, gross receipts, sales, use,
utility, value added, transfer, registration, stamp, premium, excise,
customs duties, severance, environmental (including taxes under
Section 59A of the Internal Revenue Code of 1986, as amended (the
"Code"), real property, personal property, escheat, ad valorem,
occupancy, license, occupation, employment, payroll, social security,
disability, unemployment, workers' compensation, withholding, or
other taxes, assessments, surcharges, social security obligations,
deficiencies, fees, customs duties or other governmental charges from
time to time imposed by or required to be paid to any governmental
authority or quasi-governmental authority in support of statutory or
regulatory programs (including penalties and additions to tax
thereon, penalties for failure to file a return or report, and
interest on any of the foregoing).
The term "Tax Return" shall mean and include any return,
declaration, report, claim for refund, or information return or
statement filed relating to Taxes, including any schedule or
attachment thereto, and any amendment thereof.
(b) WARRANTIES AND REPRESENTATIONS. Except as set forth on
SCHEDULE 4.2.10(b):
(i) All Tax Returns which the Company was required to file or in
which the Company was required to have been included for any period
ending on or before the Closing Date (including, without limitation,
sales, payroll, employee withholding, social security and
unemployment Tax Returns) have been, or will be, filed when due and
when filed were or will be complete and correct in all material
respects.
(ii) All Taxes due and owing by the Company (whether or not shown
on any Tax Return) have been paid and any Taxes that become due and
owing by the Company before the Closing Date (whether or not shown on
any Tax Return) will be paid, other than Taxes which are not
delinquent and subject to a late payment penalty.
(iii) All Taxes that the Company is required by law to withhold or
to collect for payment have been duly withheld and collected, and
have been paid or accrued, reserved against and entered on the books
of the Company.
(iv) There are no liens on any of the assets of the Company as a
result of any Tax liabilities except for Taxes not yet due and
payable.
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(v) There is no claim or issue (other than a claim or issue that
has been finally settled) concerning any liability for Taxes of the
Company pending or threatened by any taxing authority.
(vi) There are no agreements or applications by the Company for
an extension of time for the assessment or payment of any Taxes or
for the filing of any Tax Return, or waivers of a statute of
limitations by the Company in respect of Taxes.
(vii) There are no Tax sharing, Tax indemnity or Tax allocation
agreements or other similar arrangements with respect to or involving
the Company.
(viii) The Company is taxed as a corporation for federal, state and
local income tax purposes.
(ix) The Company is not a party to any agreement, contract, other
arrangement that would result, separately or in the aggregate, in the
requirement to pay any "excess parachute payment" within the meaning
of Section 280G of the Code which will be in effect following the
Closing.
(x) No Tax assessment or deficiency which has not been paid has
been made or proposed against the Company, nor are any of the Tax
Returns now being or, to the best knowledge of the Company and the
Seller, threatened to be examined or audited, and no consents waiving
or extending any applicable statutes of limitations for the Tax
Returns, or any Taxes required to be paid thereunder, have been
filed. The Company shall promptly notify the Seller of any notice of
pending action or proceeding involving Taxes relating to the Seller
between the date of this Agreement and the Closing Date. All Tax
deficiencies determined as a result of any past completed audit have
been satisfied. The Seller has delivered to the Buyer complete and
correct copies of all audit reports and statements of deficiencies
with respect to any tax assessed against or agreed to by the Company
for the three (3) most recent taxable periods for which such audit
reports and statements of deficiencies have been received by the
Company.
(xi) To the best knowledge of the Company and the Seller, there
is no proposal for increasing the assessed value of any of the
Company's properties for tax purposes, and there are no pending
proceedings or public improvements which would result in the levy of
any special tax or assessment against any of the Company's
properties.
(xii) The Company has delivered to the Buyer complete and correct
copies of all state, local and foreign income or franchise Tax
Returns filed by the Company for the three most recent taxable years
for which such Tax Returns have been filed immediately preceding the
date of this Agreement. Other than with respect to Taxes shown on Tax
Returns described in this subsection, the Company is not subject to
any Tax imposed on net income in any jurisdiction or by any Taxing
Authority.
(xiii) No powers of attorney or other authorizations are in effect
that grant to any person the authority to represent the Company in
connection with any Tax matter or proceeding, and any such powers of
attorney or other authorizations shall be revoked as of the Closing
Date.
4.2.11. CONTRACTS AND OTHER AGREEMENTS.
(a) SCHEDULE 4.2.11(a) sets forth a complete and correct list of all
of the following to which the Company is a party or by which it is bound
(collectively, the "Contracts"):
(i) any lease, license or right to use, real or personal
property;
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(ii) any license agreement or other agreements of the Company
providing in whole or in part for the use of any patents, trademarks,
trade names, service marks, copyrights, inventions, trade secrets or
other proprietary know-how or other intellectual property, whether
the Company is the licensor or the licensee thereunder, and all
settlements, consents or forbearance to sue agreements relating
thereto;
(iii) any contract, arrangement or understanding which is material
to the business of the Company;
(iv) any note, bond, indenture, credit facility, mortgage,
security agreement or other instrument or document relating to or
evidencing indebtedness for money borrowed by, or extensions of
credit to, or a security interest or mortgage in the assets of, the
Company;
(v) any indemnity or guaranty issued by the Company during the
past three years (other than customary product warranties provided by
the Company in the ordinary course of business);
(vi) any contract, arrangement or understanding materially
restricting the right, or limiting the freedom of the Company to
engage in any business activity or compete with any business or in
any geographical area;
(vii) any material contract, arrangement or understanding by the
Company with customers or distributors, other than standard LOAs that
provide for basic service authorization.
(viii) any power of attorney given by the Company, which is
currently in effect, to any person, firm or corporation for any
purpose whatsoever;
(ix) any collective bargaining agreements with any unions,
guilds, shop committees or collective bargaining groups;
(x) any contracts or agreements with current officers, other
employees, consultants or advisors other than contracts which by
their terms are cancelable by the Company with notice of not more
than ninety (90) days;
(xi) each material contract for the future purchase of materials,
services, supplies or equipment;
(xii) each contract and agreement with Affiliates (as defined
below);
(xiii) partnership, joint venture or other similar arrangements or
agreements to which the Company is a party; or
(xiv) agreements pursuant to which the Company acquired (by
merger, consolidation or acquisition of stock or assets or otherwise)
any corporation, partnership or other business organization, entity
or division thereof.
(b) Except as set forth on SCHEDULE 4.2.11(b), with respect to the
Contracts, (i) each Contract is in full force and effect against the
Company; (ii) the Company is not in default under any Contract which
would have a Material Adverse Effect; and (iii) there are no disputes or
disagreements between the Company and any other party with respect to any
such Contract which would have a Material Adverse Effect.
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(c) For the purposes of this Agreement, the term "Affiliate" means,
with respect to any person, any of the following:
(i) any person directly or indirectly controlling, controlled by
or under common control with such Person,
(ii) any officer, director, general partner, member or trustee of
such person or
(iii) any person who is an officer, director, general partner,
member or trustee of any person described in clauses (i) or (ii) of
this sentence. For purposes of this definition, the terms
"controlling," "controlled by" or "under common control with" shall
mean the possession, direct or indirect, of the power to direct or
cause the direction of the management and policies of a person or
entity, whether through the ownership of voting securities, by
contract or otherwise or the power to elect at least fifty percent
(50%) of the directors, managers, general partners or persons
exercising similar authority with respect to such person or entities.
4.2.12. EMPLOYEE BENEFIT MATTERS. The Company has no employees, but
obtains the services of the Seller's employees pursuant to an informal
agreement whereby the cost of such employees is reflected on the Company's
statement of operations through the intercompany account. SCHEDULE 4.2.12
sets forth all of the employment or consulting contracts, bonus, deferred or
incentive compensation, profit sharing, retirement, vacation, sick leave,
medical, dental, vision, accidental death and dismemberment insurance,
disability, sick pay, holiday pay, stock purchase, stock bonus, restricted
stock, or other stock-based plans or severance plans, programs, arrangements
and policies, as well as all "employee pension benefit plans" (as defined in
Section 3(2) of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA")) and "employee welfare benefit plans" (as defined in
Section 3(1) of ERISA) (collectively, the "Plans") sponsored or contributed
to by the Company or by any trade or business, whether or not incorporated
(an "ERISA Affiliate") that together with the Company would be deemed a
"single employer" within the meaning of Section 414 of the Code for the
benefit of an employee or former employee of the Company or any ERISA
Affiliate or an independent contractor or consultant with respect to any
such entity. Each such Plan is in compliance, and has been administered in
accordance with the applicable provisions of ERISA and the Code and all
other applicable laws, rules and regulations and the terms of the Plan, in
all material respects. None of the Plans are subject to Title IV of ERISA.
All contributions required to be made with respect to all Plans and the
payment of all costs of administering those Plans required to be paid on or
prior to the date hereof have been timely made. All amounts properly accrued
to date as liabilities of the Company or an ERISA Affiliate under or with
respect to each Plan (including administrative expenses and incurred but not
reported claims) for the current plan year of the Plan have been recorded on
the books of the Company or an ERISA Affiliate (whichever is applicable).
The Company has delivered to the Buyer a complete and correct copy of:
(a) each Plan and any related funding agreements (E.G., trust agreements or
insurance contracts), including all amendments (and the Disclosure Schedule
includes a description of any such amendment that is not in writing);
(b) the current draft of the Summary Plan Description and Summary of
Material Modifications (if applicable) of each Plan; (c) the most recent
Internal Revenue Service determination letter (if applicable) for each Plan,
which determination letter reflects all amendments that have been made to
the Plan; and (d) the two (2) most recent Form 5500s that were filed on
behalf of the Plan, including the actuarial report (if applicable). The
Internal Revenue Service has issued a favorable determination letter with
respect to each Plan that is intended to qualify under Code Section 401(a),
and no event has occurred (either before or after the date of the letter)
that would disqualify the Plan. Neither the Company nor any ERISA Affiliate
maintains any Plan that provides (or will provide) medical or death benefits
to one or more former employees (including retirees), other than benefits
that are required to be provided pursuant to Code Section 4980B or state law
continuation coverage or conversion rights. There are no investigations,
proceedings, or lawsuits, either currently in progress or, to the best
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knowledge of the Company and the Seller, threatened, relating to any Plan,
by any administrative agency, whether local, state or federal. There are no
pending or threatened lawsuits or other claims (other than routine claims
for benefits under the Plan and those relating to qualified domestic
relations orders) against or involving (i) any Plan, or (ii) any Fiduciary
of such Plan (within the meaning of Section 3(21)(A) of ERISA) brought on
behalf of any participant, beneficiary, or Fiduciary thereunder nor is there
any reasonable basis for any such claim. Neither the Company nor any ERISA
Affiliate has any intention or commitment, whether legally binding or not,
to create any additional Plan, or to modify or change any existing Plan so
as to materially increase benefits to participants or the cost of
maintaining the Plan. No statement, either oral or written, has been made by
the Company or an ERISA Affiliate (or by any agent of the Company or ERISA
Affiliate) to any Person regarding any Plan that is not in accordance with
the Plan that could have adverse economic consequences to the Buyer. The
benefits under all Plans are as represented, and have not been, and will not
be, materially increased subsequent to the date documents are provided to
the Buyer. Except as provided in the Disclosure Schedule, none of the Plans
provide any benefits that become payable or vested solely as a result of the
consummation of this transaction. None of the persons performing services
for the Company or any ERISA Affiliate have been improperly classified as
independent contractors, leased employees, or as being exempt from the
payment of wages for overtime.
4.2.13. LABOR PRACTICES. The Company's operations are not unionized.
Within the last three (3) years the Company has not experienced any labor
disputes, union organizational attempts or any work stoppage due to labor
disagreements in connection with its business. The Company is in compliance
with all applicable laws respecting employment and employment practices,
terms and conditions of employment and wages and hours, the non- compliance
with which would not have a Material Adverse Effect. The Company is not
engaged in any unfair labor practices. There is no unfair labor practice
charge or complaint pending against the Company. There is no labor strike,
dispute, request for representation, petition for certification of
representative, slowdown or stoppage pending against or affecting the
Company. No grievance which might have a Material Adverse Effect on the
Company, nor any arbitration proceeding arising out of or under collective
bargaining agreements, is pending against the Company. There are no
administrative charges or court complaints against the Company concerning
alleged employment discrimination, breach of contract, wrongful termination,
fraudulent inducement, infliction of emotional distress or other employment
related matters pending before the U.S. Equal Employment Opportunity
Commission or any state or federal court or agency.
4.2.14. BROKERS; AGENTS. Neither the Seller nor the Company has dealt
with, retained, employed or used any agent, finder, broker or other
representative in any manner which could result in the Company or the Buyer
being liable for any fee or commission in the nature of a finder's fee or
originator's fee in connection with the subject matter of this Agreement.
4.2.15. PERMITS AND LICENSES. Neither the Seller nor the Company has
received any written notice of, and neither the Seller nor the Company has
any knowledge of, any intention on the part of any government authority to
cancel, revoke or modify any permit, license, exemption, franchise,
qualification, rights-of-way, easement, municipal and other approval,
authorization, order, consent and other right from, and filing with, any
government authority of any jurisdiction worldwide relating to the conduct
of the Company's business (collectively, "Permits"), which cancellation,
revocation or modification would have a Material Adverse Effect. All Permits
are in full force and effect. SCHEDULE 4.2.15(a) contains a complete and
correct list of all Permits which are necessary for the lawful operation of
the business of the Company. SCHEDULE 4.2.15(b) contains a complete and
correct list of all carrier identification codes used in connection with the
business of the Company and the ownership thereof.
4.2.16. MATERIAL SUPPLIERS. SCHEDULE 4.2.16 sets forth a complete and
correct list of all written supply contracts between the Company and each
supplier of goods and services to the Company who provided goods and
services to the Company which involved an aggregate value of $10,000 or more
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during the year ended December 31, 1998 with such supplier. The Disclosure
Schedule also correctly identifies all currently outstanding purchase orders
of the Company for goods or services with an aggregate value per supplier of
$10,000 or more. No supplier identified in the Disclosure Schedule has given
the Company any notice terminating, suspending or reducing in any material
respect, or specifying an intention to terminate, suspend or reduce in any
material respect, or otherwise reflecting a material adverse change in, the
business relationship between such supplier and the Company.
4.2.17. INSURANCE. SCHEDULE 4.2.17 contains a complete and correct
list of all material insurance policies carried by, or covering, the Company
with respect to its businesses, together with, in respect of each such
policy, the name of the insurer, the policy number, the expiration date
thereof and each pending claim. Complete and correct copies of each such
policy have previously been provided to the Buyer. No written notice of
cancellation has been received by the Company with respect to any such
policy. All premiums due thereon have been paid in a timely manner and the
Company has complied in all material respects with the terms and provisions
of such policies. The Company has not been refused any insurance with
respect to any aspect of the operations of the business nor has its coverage
been limited by any insurance carrier to which it has applied for insurance
or with which it has carried insurance during the last three years. There is
no claim by the Company pending under any such policies as to which coverage
has been questioned, denied or disputed by the underwriters of such
policies.
4.2.18. ENVIRONMENTAL MATTERS.
(a) For purposes of this SECTION 4.2.18, "Environmental Laws" shall
mean (i) all Federal, state or local statutes, regulations, ordinances,
orders or decrees regulating or otherwise affecting the environment
and/or the disposal of Hazardous Materials (as defined below) and
(ii) The Comprehensive Environmental Response, Compensation and Liability
Act of 1980, as amended by the Superfund Amendments and Reauthorization
Act of 1986; the Emergency Planning and Community Right-to-Know Act; the
Resource Conservation and Recovery Act; the Hazardous Materials
Transportation Act of 1974; the Federal Water Pollution Control Act; the
Clean Air Act; the Federal Insecticide, Fungicide and Rodenticide Act;
the Safe Drinking Water Act; the Toxic Substances Control Act; the Oil
Pollution Act of 1990; any laws regulating the use of health, safety, the
environment, biological agents or substances including medical or
infectious wastes, each as amended or supplemented.
(b) Operations of the Company or any of its subsidiaries conducted at
the Leased Real Property, any of the Company's or its subsidiaries'
previously owned real property and any real property previously leased,
licensed or otherwise operated by the Company or any of its subsidiaries
(each, a "Site") at all times during such ownership, lease, license or
operation complied with all Environmental Laws, except for noncompliance
that would not, individually or in the aggregate, reasonably be expected
to have a Material Adverse Effect. The Company and each Site are in
compliance with all, and the Company has no liability under any,
Environmental Laws, except where the failure to comply or any such
liability would not, individually or in the aggregate, reasonably be
expected to have a Material Adverse Effect. No Site is subject to
(i) any federal, state, or local investigation, (ii) any judicial or
administrative proceeding alleging the violation of or liability under
any Environmental Law, or (iii) any outstanding written order or
agreement with any governmental authority or private party relating to
any Environmental Law. As used in this SECTION 4.2.18, the term
"Hazardous Materials" means any hazardous or toxic substances, materials
and wastes listed in the United States Department of Transportation
Hazardous Materials Table (49 C.F.R. 172.101) or by the United States
Environmental Protection Agency (the "EPA") as a hazardous substance (40
C.F.R. Part 302) and amendments thereto, or such substances, materials
and wastes which are regulated under any applicable local, state or
Federal law, including without limitation, any material waste or
substance which is: (i) petroleum; (ii) asbestos; (iii) polychlorinated
biphenyls; (iv) defined as a "hazardous waste," "extremely
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hazardous waste," "restricted hazardous waste" or "hazardous material"
under applicable state laws and regulations; (v) designated as a
"hazardous substance" pursuant to Section 311 of the Clean Water Act, 33
U.S.C. Section 1251, ET SEQ. (33 U.S.C. Section 1321) or U.S.C. Section
1317; (vi) defined as a "hazardous waste" pursuant to Section 1004 of the
Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, ET SEQ.
(42 U.S.C. Section 6903); or (vii) defined as a "hazardous substance"
pursuant to Section 101 of the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA"), 42 U.S.C. Section 9601, ET
SEQ. (42 U.S.C. Section 9601).
(c) No Hazardous Materials have been generated, stored, released,
discharged, used, treated, or transported from any Leased Real Property,
except in compliance with applicable Environmental Laws.
(d) Neither the Seller nor the Company has received notice from any
third party including, without limitation, any Federal, state or local
governmental authority: (a) that the Company has been identified by the
EPA as a potentially responsible party under CERCLA with respect to a
site listed on the National Priorities List, 40 C.F.R. Part 300
Appendix B (1986); (b) that any Hazardous Materials which the Company has
generated, transported or disposed of has been found at any site at which
a Federal, state or local agency or other third party has conducted or
has ordered that the Company conduct a remedial investigation, removal or
other response action pursuant to any Environmental Law; or (c) that the
Company is or shall be named a party to any claim, action, cause of
action, complaint (contingent or otherwise), legal or administrative
proceeding arising out of any third party's incurrence of costs,
expenses, losses or damages of any kind whatsoever in connection with the
release of Hazardous Materials.
(e) The Company has been issued, and has maintained through the date
hereof, all required Federal, state and local permits, licenses,
certificates and approvals with respect to the Leased Real Property
and/or its operations thereat relating to (a) air emissions;
(b) discharges to surface water or groundwater; (c) noise emissions;
(d) solid or liquid waste disposal; and (e) the use, generation, storage,
transportation or disposal of Hazardous Materials, except where the
failure to obtain or maintain any such permits, licenses, certificates
and approvals would not, either individually or in the aggregate,
reasonably be expected to have a Material Adverse Effect.
4.2.19. TRANSACTIONS WITH RELATED PARTIES. Set forth on
SCHEDULE 4.2.19 is a complete and correct list and description of all
transactions with an aggregate value of $1,000 per individual engaged in
since December 1, 1997 between the Company and any director, manager,
officer, employee or stockholder of the Company, or any of their respective
spouses or children, any trust of which any such person is the grantor,
trustee or beneficiary, any corporation of which any such person or party is
a stockholder, employee, manager, officer or director, or any partnership or
other person in which any such person or party owns an interest.
4.2.20. ACCOUNTS RECEIVABLE. All accounts receivable of the Company
reflected in the Interim Balance Sheet or existing at the date hereof (the
"Accounts") represent amounts due for services performed or sales actually
made in the ordinary course of business and properly reflect the amounts
due. The bad debt reserves, allowances and anticipated customer discounts
and credits reflected in the Interim Balance Sheet are adequate as of the
date thereof. All material Accounts existing and remaining unpaid on the
effective date of this Agreement will be collectible by the Buyer in the
ordinary course of business consistent with past practice.
4.2.21. BANKS. SCHEDULE 4.2.21 contains a complete and correct list
setting forth the name of each bank in which any Company has an account,
line of credit, credit facility or safe deposit box, the names of all
persons authorized to draw thereon or to have access thereto, and the name
of each person holding a power of attorney from the Company.
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4.2.22. CONFLICTS OF INTEREST. Except as set forth on
SCHEDULE 4.2.22, since December 1, 1997 none of the Seller nor any director,
officer or employee of the Company or any relative of any of them has
(a) loaned to or guaranteed the loan of a third party to the Company or
borrowed any money from the Company or (b) any interest in any property,
real or personal whether owned or leased, tangible or intangible, including
but not limited to, software, inventions, patents, trade names or trademarks
used in connection with or pertaining to the business of the Company or any
lender, supplier, customer, sales representatives or distributor of the
Company; provided, however, that such director, officer or employee or
relative thereof shall not be deemed to have such interest solely by virtue
of the ownership of less than five percent of any stock or indebtedness of
any publicly held company, the stock or indebtedness of which is traded on a
recognized stock exchange.
4.2.23. LETTERS OF AGENCY.
(a) The Company has obtained a valid LOA, PIC Change Authorization or
TPV from each end user whose automatic number identification the Company
services.
(b) All LOAs, PIC Change Authorizations and TPVs of the Company as of
the date hereof were obtained in accordance with applicable law and were
valid as of such date. No LOA, PIC Change Authorization or TPV is
carrier-specific.
4.2.24. NO UNDISCLOSED LIABILITIES. As of the date of the Interim
Balance Sheet, the Company has not had any material liabilities or
obligations (absolute, accrued, contingent or otherwise and known or
unknown), that are not shown on the Interim Financial Statements. Since the
date of the Interim Balance Sheet, the Company has not assumed, incurred or
received notice of any liabilities or obligations (absolute, accrued,
contingent or otherwise and known or unknown), except liabilities or
obligations (absolute, accrued, contingent or otherwise and known or
unknown) assumed or incurred in the ordinary course of business and
consistent with prior practice not otherwise reflected in any adjustment to
the Purchase Price pursuant to SECTION 1.4.
4.2.25. BUSINESS PRACTICES. The Company has not engaged in
(i) cramming, or the unauthorized addition of services or charges
(including, but not limited to, voicemail, Internet service or 900 number
charges) to a phone bill, (ii) slamming, or the changing of a customer's
designated long-distance provider without permission, (iii) sliding, or the
changing of a customer's designated local toll carrier without permission,
or (iv) any other type or practice of phone-related fraud.
4.2.26. YEAR 2000. Except as set forth on SCHEDULE 4.2.26, all
computer hardware and software that is currently used by the Company is Year
2000 compliant. "Year 2000 compliant" means that such computer hardware and
software is designed to accurately receive, provide and process date/time
data from, into and between the years 1999 and 2000, to the extent that the
computer hardware, software and related systems of others, used in
combination with the Company's computer hardware and software, properly
exchanges date/time data with it. As to any computer hardware or software
acquired from third parties, the representation set forth above is to the
best knowledge of the Company and the Seller, which knowledge is based
solely on the representations of such third parties to the Company or the
Seller. Set forth on SCHEDULE 4.2.26 is a summary description of the
Company's Year 2000 compliance program and a statement of the Company's
progress in meeting such program's compliance schedule and goals as of the
date hereof.
4.2.27. REGULATORY COMPLIANCE. The Company (i) is operating in
compliance in all material respects with all applicable federal and state
tariffs, laws, regulations and orders relating to the telecommunications
industry (ii) has not received notice of any violations of its tariffs or of
laws, regulations and orders from any governmental entity having authority
to enforce such tariffs, laws, regulations and orders, including but not
limited to, (a) the Communications Act of 1934, as amended by the
Telecommunications Act of 1996 and (b) the Telephone Consumer Protection Act
of 1991; and (iii) has complied in all material respects with all applicable
rules and regulations, including those of
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the local exchange carriers providing it with access services, in
determining and designating the percentage of interstate usage in ordering
interstate and intrastate access services. SCHEDULE 4.2.27 sets forth each
of the Company's PUC Authorizations and each of the Company's FCC
Authorizations. None of the PUC Authorizations or FCC Authorizations has
been modified, amended, or otherwise altered, and each remains legal, valid,
binding, and in full force and effect.
4.2.28. AVTEL STOCK OPTIONS. Except pursuant to SECTION 6.1.7, the
Company has no obligation, financial or otherwise, with respect to the
grant, vesting or exercise of any option or options to purchase the capital
stock of AvTel, any of its Affiliates or any third party.
4.2.29. DISCLOSURE. No representation or warranty of the Seller herein
and no statement, information or certificate furnished or to be furnished by
the Seller or its counsel, accountants or other agents pursuant hereto or in
connection with the transactions contemplated hereby contains or will
contain any untrue statement of a material fact or omits or will omit to
state a material fact necessary to make the statements contained herein or
therein, in light of the circumstances under which they were made, not
misleading.
4.3. WARRANTIES SURVIVE CLOSING. The warranties and representations of the
Seller herein contained shall be complete and correct on the date hereof and on
the Closing Date, and shall survive the Closing for a twenty-four (24) month
period following the Closing Date except (i) all representations and warranties
with respect to SECTION 4.2.10 (Taxes) shall survive the Closing Date until
ninety (90) days after the later of: (A) the final settlement of any alleged tax
deficiencies, or (B) the expiration of the applicable statute of limitations,
together with any extensions or waivers thereof approved by the Seller, (a
"Survival Date") (ii) all representations and warranties with respect to
SECTION 4.2.10 (Litigation), SECTION 4.2.18 (Environmental Matters) and
SECTION 4.2.27 (Regulatory Compliance) shall survive the Closing Date until
ninety (90) days after the expiration of the applicable statute of limitations,
together with any extensions or waivers thereof approved by the Seller (each, a
"Survival Date") and (iii) any claim based on an inaccuracy of a representation
or the breach of a warranty which is known by the Seller to be false at the time
such representation or warranty is made (a "Fraud Claim") shall survive the
Closing Date until ninety (90) days after the expiration of the applicable
statute of limitations, together with any extensions or waivers thereof approved
by the Seller (a "Survival Date"); provided, however, that if the Buyer provides
written notice to the Seller as specified in SECTION 9.3 of any claim for which
the Buyer seeks indemnification pursuant to ARTICLE 9, prior to the applicable
Survival Date, the claim so made shall survive the Closing until resolved. Any
claim not so made in writing prior to the applicable Survival Date shall be
deemed to have been waived by the Buyer and no other party shall have further
liability therefor. Notwithstanding the above, there shall be no time limit on
claims or actions brought for breach of any warranty or representation made in
SECTION 4.1.
ARTICLE 5
WARRANTIES AND REPRESENTATIONS OF THE BUYER
5.1. WARRANTIES AND REPRESENTATIONS. The Buyer hereby warrants and
represents to the Seller, which warranties and representations shall survive the
Closing for the period set forth in SECTION 5.2, that the following statements
are true on and as of the date hereof and will be true on and as of the Closing
Date:
5.1.1. DUE AUTHORIZATION AND EXECUTION. The Buyer has the necessary
corporate power and authority to enter into this Agreement and the Buyer
Ancillary Documents and to consummate the transactions contemplated hereby
and thereby. The Board of Directors of the Buyer and, if required, the
stockholders of the Buyer, have duly authorized and approved the execution
and delivery of this Agreement and the Buyer Ancillary Documents and the
consummation of the transactions contemplated hereby and thereby. No other
corporate proceedings are necessary to authorize this Agreement and the
Buyer Ancillary Documents and the consummation of such transactions. This
Agreement has been duly and validly executed and delivered by the Buyer and,
assuming due execution and delivery
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by the Seller, constitutes a valid and binding obligation of the Buyer
enforceable against it in accordance with its terms, except as limited by
(a) bankruptcy, insolvency, reorganization, moratorium or similar laws
relating to creditors' rights generally or (b) equitable principles (whether
considered in an action at law or in equity).
5.1.2. ORGANIZATION. The Buyer is a corporation duly incorporated,
validly existing and in good standing under the laws of the State of
Delaware and has all requisite corporate power and authority to own, operate
and lease its properties and assets and carry on its business as now
conducted.
5.1.3. CONSENTS, VIOLATIONS AND AUTHORIZATIONS. The Buyer is not party
to or bound by any lien, lease, permit, concession, franchise, license,
instrument, mortgage, indenture or other agreement, or any judgment, order,
decree, statute, law, ordinance, rule or regulation of any court or
governmental entity applicable to it which would require it to obtain the
authorization, consent or approval of another (including the authorization,
consent or approval of governmental authorities) to the execution of this
Agreement, the Buyer Ancillary Documents or the transactions contemplated
hereby or thereby. Neither the execution and delivery of this Agreement or
the Buyer Ancillary Documents nor the consummation of the transactions
contemplated hereby or thereby shall violate any provision of the
Certificate of Incorporation or Bylaws of the Buyer.
5.1.4. INVESTMENT REPRESENTATIONS. The Common Stock to be purchased by
the Buyer pursuant to this Agreement is being acquired by the Buyer for
investment only, for its own account, and not with a view to any public
distribution thereof. The Buyer has such knowledge and experience in
business matters as to be capable of evaluating the merits and risks in
purchasing the Common Stock. The Buyer is an "accredited investor" as
defined in Rule 501(a) under the Securities Act of 1933, as amended (the
"Securities Act"). The Buyer acknowledges that the Common Stock has not been
registered under the Securities Act or the securities laws of any state
(collectively, the "Securities Laws"), and has been issued in reliance upon
exemptions from the registration requirements of the Securities Laws. The
Buyer understands that any transfer or disposition of the Common Stock may
only be made pursuant to an effective registration under applicable
Securities Laws or pursuant to an exemption from the registration
requirements of the Securities Laws. The Buyer further acknowledges that
neither the Seller nor the Company has any obligation to register the Common
Stock. The Buyer understands that any certificates representing the Common
Stock may bear an appropriate legend consistent with the foregoing.
5.1.5. BROKERS; AGENTS. The Buyer has not dealt with any agent,
finder, broker or other representative in any manner which could result in
the Seller being liable for any fee or commission in the nature of a
finder's or originator's fee in connection with the subject matter of this
Agreement or the Buyer Ancillary Documents.
5.1.6. FINANCIAL STATEMENTS. The Buyer has delivered to the Seller
complete and correct copies of the balance sheet and income statement of the
Buyer for the fiscal period ended December 31, 1998 (the "Buyer Historical
Financial Statements") and the balance sheet and income statement of the
Buyer for the period ended June 30, 1999 (the "Buyer Interim Financial
Statements" and, collectively with the Buyer Historical Financial
Statements, the "Buyer Financial Statements"). The Buyer Financial
Statements are prepared in accordance with the books and records of the
Buyer. The balance sheet contained in the Buyer Interim Financial Statements
is complete and correct, was consistently prepared and fairly presents the
financial condition of the Buyer on such date. The Buyer Historical
Financial Statements were consolidated into the audited consolidated
financial statements of Platinum Equity Holdings, LLC ("PEH"), which
financial statements were prepared in accordance with GAAP.
5.2. WARRANTIES SURVIVE CLOSING. The warranties and representations of
the Buyer herein contained shall be complete and correct on the date hereof
and on the Closing Date and shall survive the Closing for a twenty-four
(24) month period following the Closing Date, except any claim based on an
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inaccuracy of a representation or the breach of a warranty which is known by
the Buyer to be false at the time such representation or warranty is made
shall survive the Closing Date until ninety (90) days after the expiration
of the applicable statute of limitations; provided, however, that if the
Seller provides written notice to the Buyer as specified in SECTION 9.3 of
any claim for which the Seller seeks indemnification pursuant to ARTICLE 9,
prior to the expiration of such twenty-four (24) month period, the claims so
made shall survive the Closing until resolved. Any claim not so made in
writing prior to twenty-four (24) months subsequent to the Closing Date
shall be deemed to have been waived by the Seller and no other parties shall
have further liability therefor.
ARTICLE 6
COVENANTS
6.1. COVENANTS OF THE SELLER WITH RESPECT TO ITSELF AND THE COMPANY. The
Seller covenants and agrees with respect to itself and the Company as follows:
6.1.1. ACCESS. Prior to the Closing, the Company will (i) give the
Buyer and its representatives, employees, counsel and accountants reasonable
access to the properties, books and records of the Company, (ii) furnish the
Buyer and its designated representatives with financial and operating data
and other information with respect to the Company for the purpose of
permitting the Buyer, among other things, to (a) conduct its due diligence
review, (b) review the financial statements of the Company and (c) prepare
for the consummation of the transactions contemplated by this Agreement, and
(iii) provide to Buyer complete and correct copies of each written Contract
(and any amendments thereto). Without limiting the foregoing, the Seller and
the Company will permit the Buyer and its counsel and accountants to have
access during normal business hours to examine and make copies of all work
papers and schedules of the Company and its accountants. In connection
therewith, the Buyer shall be permitted to discuss the business affairs and
financial statements of the Company with the Company's counsel and
accountants, to review the work papers of such accountants regarding the
Company, and in the presence of management of the Company and after prior
consultation with such management, to interview the employees of the Company
regarding continued employment and to discuss with the appropriate employees
of the Company such matters regarding the business and assets of the Company
as the Buyer may deem necessary or appropriate. The Buyer and the Seller
agree that nothing in this Agreement shall be interpreted or construed as
limiting, waiving, terminating or otherwise affecting that Non-Disclosure
Agreement between the Buyer and the Seller dated June 9, 1999. The Buyer and
the Seller acknowledge that the terms of such Non-Disclosure Agreement
remain in full force and effect. In the event, at any time prior to Closing,
the Buyer receives notice from a third party of information that the Buyer
believes indicates that the Seller is in breach of any representation or
warranty in this Agreement, the Buyer shall give immediate notice to the
Seller, who shall then have the opportunity to cure any such breach prior to
Closing. Notwithstanding any failure by the Buyer to provide such notice, or
anything herein to the contrary, any information learned or deemed to be
learned by the Buyer in its due diligence or pursuant to this SECTION 6.1.1
shall not limit or reduce its right to the indemnity of ARTICLE 9 with
respect to the breach of any of the representations and/or warranties of the
Seller or the Company in this Agreement.
6.1.2. RECORDS. On the Closing Date, the Company will deliver to the
Buyer all original records relating to the Company, including such records
that are in the possession of the Seller, provided that the Seller shall
have the right to make copies of any and all materials which it may deem
necessary and shall have the continual right to have access to such records
in accordance with SECTION 6.2.3.
6.1.3. CONDUCT OF THE BUSINESS OF THE COMPANY. The Seller covenants
and agrees that, between the date hereof and the Closing Date (except as
otherwise agreed in writing by the Buyer):
(a) the business of the Company will be conducted in the ordinary
course consistent with past practice;
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(b) no amendment will be made to the Articles of Incorporation or
Bylaws of the Company;
(c) the Company will use reasonable efforts to keep available the
services of its employees and to preserve the goodwill of the customers,
suppliers and others having business relationships with the Company;
(d) the Company shall promptly advise the Buyer in writing of the
commencement or threat of any suit, proceeding or investigation against,
relating to or involving the Company or which could otherwise affect the
assets or the businesses of the Company and which in each case would, if
not covered by insurance and if determined adversely to the Company, have
a Material Adverse Effect;
(e) the Company shall advise the Buyer of (i) any material adverse
change in the assets, liabilities or financial condition of the Company
and (ii) in any event, any condition or state of facts which results in
the failure to satisfy any of the conditions of the Buyer's obligations
hereunder;
(f) the Company shall not create or permit to become effective any
Encumbrance on the assets of the Company other than Encumbrances created
in the ordinary course of business;
(g) the Company will maintain its current liability, casualty,
property and other insurance coverage in full force and effect;
(h) the Company will not issue any debt securities or any additional
shares of capital stock or any options, warrants or other rights to
purchase, or securities convertible into or exchangeable for, shares of
capital stock of the Company;
(i) the Company will not declare or pay any dividends on or make any
distributions (however characterized) in respect of its Common Stock;
(j) the Company will not repurchase, redeem, retire or otherwise
acquire any shares of its Common Stock or split, combine or reclassify
its outstanding shares of its Common Stock;
(k) the Company will not make any change in the accounting principles
or practices reflected in the Interim Financial Statements other than as
required by GAAP or in the Company's methods of applying such principles
or processes;
(l) the Company shall not, directly or indirectly, (i) incur any
indebtedness for borrowed money, (ii) waive, release, grant or transfer
any rights of material value, except in the ordinary course of business,
(iii) transfer, lease, License, sell, mortgage, pledge, dispose of, or
encumber any asset of the Company with a value exceeding $1,000
individually, and/or $5,000 in the aggregate, (iv) purchase or acquire
any material interest in any business or any securities or assets of a
business, (v) enter into any joint venture or partnership, (vi) settle
any material litigation, or (vii) accelerate payments on any
indebtedness;
(m) the Company will not, directly or indirectly, (i) increase the
compensation payable or to become payable by it to any of its employees,
officers, directors, managers or consultants, (ii) adopt any additional,
or make any payment or provision with respect to any, or otherwise amend
any, other than as required by existing plans or agreements in the
ordinary course of business and consistent with past practice, stock
option, bonus, profit sharing, pension, group insurance, severance pay,
deferred compensation or other payment or employee compensation plan for
the benefit of employees of the Company, (iii) grant any stock options or
stock appreciation rights, (iv) enter into any new, or alter or amend any
employment severance, consulting or other compensation agreement with any
director, manager, officer, employee or Affiliate of the Company,
(v) make any loan or advance to, or enter into any written contract,
lease or commitment with, any officer, manager, employee or director of
the Company, or
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(vi) enter into any transactions with any Affiliate of the Company other
than as contemplated by this Agreement;
(n) capital expenditures (or commitments to make such expenditures
which are not terminable at the option of the Company) shall be incurred
by the Company in the ordinary course of business in accordance with past
practices but shall in no event exceed an aggregate of $5,000;
(o) the Seller and the Company will promptly advise the Buyer in
writing of any facts or circumstances that could give rise to a Material
Adverse Effect or any breach of the representations or warranties with
respect to the Seller or the Company, or any breach of a covenant
contained herein;
(p) the Company shall not, directly or indirectly, guaranty or
otherwise become responsible for any obligation or liability of any third
party;
(q) the Company shall not enter into any material contracts (or
modify in a material way any such existing contracts) for the purchase or
sale of communication services unless such contracts are first approved
by the Buyer;
(r) the Company shall not, without the Buyer's written consent,
change any of its rate plans for its existing customers; and
(s) the Company will not enter into any agreement or commitment to do
any of the foregoing.
6.1.4. ACQUISITION PROPOSALS.
(a) Following the execution of this Agreement and prior to the
earliest to occur of (i) the termination of this Agreement under
ARTICLE 10 or (ii) the Closing Date, the Company, the Seller and/or any
of their respective managers, directors, partners, officers, employees or
other representatives or agents shall not, directly or indirectly,
communicate, solicit, initiate, encourage or participate (including
furnishing non-public information concerning the Company's business,
properties or assets) in any discussions or negotiations with regard to
any proposal to acquire, directly or indirectly, any shares of the
capital stock or Common Stock of the Company, to invest any funds in the
Company, whether such proposal, acquisition, investment or other
transaction involves a stock sale, a tender offer, exchange offer, merger
or other business combination involving the Company, or for the
acquisition of a substantial portion of the assets of the Company (an
"Acquisition Proposal"); provided, however, that the Seller and its
directors and officers may participate in any discussions or negotiations
regarding, furnish any information with respect to, assist or participate
in, or facilitate in any other manner any effort or attempt by any person
to do or seek any of the foregoing to the extent that their fiduciary
duties so require. The Company will immediately communicate to the Buyer
the identity of such other party and the initial terms of any proposal it
may receive from any other party in respect of an Acquisition Proposal.
(b) If the Seller shall terminate this Agreement in connection with
its acceptance of an Acquisition Proposal, the Seller shall pay to the
Buyer Two Million Dollars ($2,000,000), plus the net amount of money
invested by the Buyer in the operations of the Company through the date
of termination plus the amount of the Purchase Price paid through the
date of termination (the "Investment") by wire transfer of immediately
available funds and pursuant to the wire transfer instructions set forth
on SCHEDULE 1.3.
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(c) The Seller shall have the right to review the books and records
of the Buyer and the Company for a period of thirty (30) days after
notification of the amount of the Investment to verify and confirm the
accuracy thereof. If, after such review, the Seller agrees with the
amount of the Investment, the Seller shall promptly pay the Buyer
pursuant to SECTION 6.1.4(b). If, after such review, the Seller objects
to the amount of the Investment, the Seller shall promptly (and in any
event within forty-five (45) days after notification of the amount of the
Investment) provide the Buyer with a detailed statement indicating the
basis for its objections, and the Buyer and the Seller shall meet and
confer in an effort to resolve such disagreement in good faith.
(d) In the event that the Buyer and the Seller are unable to resolve
a disagreement with respect to the amount of the Investment within sixty
(60) days following the date of the Seller's objection (or such longer
period as the Buyer and the Seller may agree), the amount of the
Investment shall be determined by the Accountants as the Buyer and the
Seller may agree. If issues in dispute are submitted to the Accountants
for resolution, (i) each party will furnish to the Accountants such work
papers and other documents and information relating to the disputed
issues as the Accountants may request and are available to that party,
and will be afforded the opportunity to present to the Accountants any
material relating to the determination and to discuss the determination
with the Accountants; (ii) the determination by the Accountants of the
amount of the Investment, as set forth in a notice delivered to both
parties by the Accountants, will be binding and conclusive on the
parties; and (iii) the fees of the Accountants for such determination
shall be paid equally by the parties.
6.1.5. NOTICE OF PROCEEDINGS. The Company will, upon becoming aware of
any order or decree or any complaint praying for an order or decree
restraining or enjoining the consummation of this Agreement or the
transactions contemplated hereunder, or upon receiving any notice from any
governmental department, court, agency or commission of its intention to
institute an investigation into, or institute a suit or proceeding to
restrain or enjoin the consummation of this Agreement or such transactions,
or to nullify or render ineffective this Agreement or such transactions if
consummated, promptly notify the Buyer in writing of such order, decree,
complaint or notice.
6.1.6. NONCOMPETITION AND NONSOLICITATION.
(a) NONCOMPETITION. For a period commencing on the date hereof and
continuing through the third anniversary of the date hereof, the Seller
shall not, directly or indirectly, and shall not permit any officer,
employee or subsidiary (other than the Company) of the Seller to,
(i) engage in; (ii) own or control any interest in (except as a passive
investor of less than two percent (2%) of the capital stock or publicly
traded notes or debentures of a publicly held company); (iii) act as an
officer, director, partner, member, or joint venturer of; (iv) lend
credit or money for the purpose of establishing or operating; or
(v) allow such entity's name or reputation to be used by any firm,
corporation, partnership, limited liability company, trust or business
enterprise (a "Competitor") that is engaged in, directly or indirectly,
the provision of residential long distance telephone services within the
Territory (as defined below). Notwithstanding the foregoing, the Seller
may acquire a business which provides residential long distance telephone
services in the Territory if: (i) such services constitute less than
thirty-five percent (35%) of the value of the acquired business,
(ii) the Seller fully divests itself of such services within six
(6) months of the date of acquisition; provided, however, that the Buyer
shall have a thirty (30) day right of first refusal with regard to such
services and (iii) the Seller does not implement any new marketing
programs with regard to such services. In addition, the Seller shall not,
directly or indirectly, and shall not permit any officer, employee,
controlling person or subsidiary (other than the Company) of the Seller
to, influence or attempt to influence any person who is a contracting
party with the Company as of the date of this Agreement to terminate or
amend any existing written or oral agreement of them that relates to the
residential long distance telephone services business of the Company,
except with regard to mass-market advertising campaigns and to customers
whose long
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distance telephone services will be provided by the Company. The
covenants and agreements contained in this paragraph shall extend
geographically throughout the United States (the "Territory").
(b) NONSOLICITATION. For a period commencing on the date hereof and
continuing through the third anniversary of the date hereof, the Seller
shall not, directly or indirectly, and shall not permit any officer,
employee or Affiliate (other than the Company) of the Seller to, without
the prior written consent of the Buyer, solicit the employment of, or
hire any person set forth in EXHIBIT 6.1.6(B).
(c) COVENANTS REASONABLE AS TO TIME AND TERRITORY. The Seller has
carefully considered the nature and extent of the restrictions upon it
under this SECTION 6.1.6, and hereby acknowledges and agrees that the
same are reasonable in time and territory.
(d) INJUNCTION FOR BREACH. The Seller acknowledges and agrees that a
monetary remedy for any breach of the covenants in this SECTION 6.1.6
will be inadequate, and that the Buyer shall be entitled to temporary and
permanent injunctive relief against the Seller, in addition to any other
relief the Buyer may be entitled to, without the necessity of proving
actual damages.
(e) UNENFORCEABILITY. It is the desire and intent of the Buyer and
the Seller that the provisions of this SECTION 6.1.6 be enforced to the
fullest extent permissible under the laws and public policies of each
jurisdiction in which enforcement is sought. Accordingly, if any
provision of this SECTION 6.1.6 shall be adjudicated to be invalid or
unenforceable, such provision, without any action on the part of any
party hereto, shall be deemed amended to delete or to modify or to
restrict (including, without limitation, a reduction in duration,
geographical area or prohibited business activities) the portion
adjudicated to be invalid or unenforceable, such deletion or modification
to apply only with respect to the operation of such provision in the
particular jurisdiction in which such adjudication is made, and such
deletion or modification to be made only to the extent necessary to cause
the provision as amended to be valid and enforceable.
6.1.7. AVTEL STOCK OPTIONS. The Seller shall continue to grant options
to purchase the Seller's common stock pursuant to the New Best
Connections, Inc. Amended and Restated 1997 Option Plan (the "Field Force
Plan") to the Company's field force of independent sales agents and to
permit such options to vest. Such grants and vesting shall be in accordance
with the terms of the Field Force Plan and consistent with past practice and
shall continue until all Exercisable Options and Kickoff Options (as those
terms are defined in the Field Force Plan) have been granted and vested. In
consideration of the continued grants and vesting of such options, and
commencing on the date hereof, the Company shall pay the Seller $15,000 per
month through December 31, 1999. The Seller shall not amend the Field Force
Plan without the written consent of the Buyer other than to ensure the
continuing compliance of the Field Force Plan and the awards thereunder with
all laws, rules and regulations applicable thereto; provided, however, that
the Buyer shall cease to make any payments related to the Field Force Plan
upon any amendment of the Field Force Plan that precludes the grant and/or
the vesting of such options.
6.1.8. "TOLL FREE" TELEPHONE NUMBERS. Following the execution of this
Agreement, the Seller covenants and agrees that the Company shall have the
sole and exclusive right to use the "toll free" telephone numbers set forth
on SCHEDULE 4.2.6(e).
6.1.9. MCI WORLDCOM INC. The Seller shall indemnify the Buyer and the
Company and hold them harmless from and against any and all damages, losses,
deficiencies, actions, judgments, costs, expenses, debts, liabilities and
obligations (including reasonable attorneys' and accountants' fees)
(collectively, "Claims") of or against the Buyer or the Company resulting
from or arising out of the relationship between DNS Communications, Inc.,
formerly a subsidiary of the Company, and MCI WorldCom Inc. (or any
successor thereto).
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6.1.10. MATRIX COMMUNICATIONS CORPORATION. The Seller shall indemnify
the Buyer and the Company and hold them harmless from and against any and
all Claims of or against the Buyer or the Company resulting from or arising
out of the dispute between the Company and Matrix Communications Corporation
(or any successor thereto).
6.2. COVENANTS OF THE BUYER. The Buyer covenants and agrees as follows:
6.2.1. COAST INDEMNITY. Except with regard to actions of the Seller
following August 30, 1999, and subject to the limitations, restrictions and
conditions set forth in this Agreement, the Buyer shall indemnify the Seller
and hold it harmless from and against any and all Claims of or against the
Seller resulting from or arising out of the Coast Loan Agreement in an
amount not to exceed $2,750,000 plus any amount drawn after the date hereof.
6.2.2. BUSINESS MARKETS CUSTOMERS. Upon the Seller obtaining
regulatory approval, including, but not limited to, a waiver from the FCC of
its carrier selection rules with respect to customers whose preselected
carrier changes as a result of the transactions contemplated hereby, and
without additional consideration therefor, the Buyer shall transfer to the
Seller the Business Markets customers listed on the schedule previously
delivered by the Seller to the Buyer, plus all additional Business Markets
customers acquired between the date hereof and the date such regulatory
approval is obtained.
6.2.3. FIELD FORCE PLAN. The Buyer shall provide to the Seller all
documentation reasonably required by the Seller to operate the Field Force
Plan.
6.3. MUTUAL COVENANTS. Each of the Company, the Seller and the Buyer
covenants and agrees as follows:
6.3.1. COOPERATION. The Buyer, the Company and the Seller shall
cooperate with each other and shall cause their respective directors,
officers, managers, employees, agents, accountants and representatives to
cooperate with each other after the Closing to ensure the orderly transition
of the ownership of the Company and its business from the Seller to the
Buyer and to minimize any disruption to the business of the Company that
might result from the transactions contemplated hereby. At any time prior to
Closing, in the event that either party receives notice from a third party
of information that such party believes indicates that the other party is in
breach of any representation or warranty in this Agreement, such party shall
give prompt notice to the other party.
6.3.2. RECORDS. For a period of six (6) years after the Closing, upon
reasonable written notice, the Buyer and the Seller agree to furnish or
cause to be furnished to each other and their respective representatives,
counsel and accountants access, during normal business hours, such
information (including records pertinent to the Company) relating to the
Company as is reasonably necessary for financial reporting, regulatory, tax
and accounting matters, assistance in the preparation and filing of any
returns, reports or forms or the defense of any tax claim or assessment;
provided, however, that such access does not unreasonably disrupt the normal
operations of the Company. Without limiting the foregoing, the Seller shall
have access to and the right, at the Seller's expense, to copy any books or
records of the Company which relate to matters or events prior to the
Closing. The Seller shall be entitled, at reasonable times and upon
reasonable notice, to inspect and receive copies of all accounting and sales
records relating to the calculation of the ISP Payment, whether maintained
by the Company or the Buyer.
6.3.3. REGULATORY FILINGS. The Buyer, the Company and the Seller shall
make reasonable efforts to ensure that all regulatory filings associated
with the transactions contemplated hereby shall be filed by the appropriate
party or parties within two (2) weeks of the date hereof.
6.3.4. CONTRACT ASSIGNMENTS. The Buyer, the Company and the Seller
shall make reasonable efforts to ensure that (i) the contracts set forth on
EXHIBIT 6.3.4(i) are assigned from the Seller to the
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Company and (ii) the contracts set forth on EXHIBIT 6.3.4(ii) are assigned
from the Company to the Seller. From the date hereof and until such time as
the assignment of a contract set forth on EXHIBIT 6.3.4(i) or
EXHIBIT 6.3.4(ii) is completed, the intended assignee shall be responsible
for all obligations and duties under such contract, and shall receive any
profits or losses associated with such contract.
6.3.5. REASONABLE EFFORTS. Each party hereto agrees that, from the
date hereof to the Closing Date, it shall use reasonable efforts to satisfy
the conditions precedent to the Closing (including but not limited to, any
obligation to obtain regulatory approvals in connection with the
transactions contemplated hereby) to the extent that such conditions are to
be satisfied by such party. From time to time, as and when requested by a
party hereto, each party hereto shall execute and deliver, or cause to be
executed and delivered, all such documents and instruments and shall take,
or cause to be taken, all such further or other actions as such other
parties may reasonably deem necessary or desirable to consummate the
transactions contemplated by this Agreement or the agreements, documents or
instruments associated herewith.
6.3.6. CLOSING.
(a) The Buyer, the Company and the Seller shall make reasonable
efforts to ensure that the Closing shall occur on or before December 31,
1999; provided, however, that to the extent that any regulatory approval
associated with the transactions contemplated hereby has not been
obtained by such date that would, together with all such regulatory
approvals that have not been obtained by such date, have a Material
Adverse Effect on the Company or the Buyer, the Closing shall not occur
until such regulatory approvals have been obtained, such determination to
be made by the Buyer in its sole and reasonable discretion.
(b) If the Buyer determines that the Closing shall occur prior to
obtaining all regulatory approvals associated with the transactions
contemplated hereby, the Seller shall indemnify the Buyer and the Company
and hold them harmless from and against any and all Claims resulting
therefrom.
ARTICLE 7
DISCLOSURE SCHEDULE
7.1. GENERAL. The schedules and information set forth in the Disclosure
Schedule shall specifically refer to the section of this Agreement to which such
schedule and information is responsive. Terms used in the Disclosure Schedule
and not otherwise defined therein shall have the same meanings as are ascribed
to such terms in this Agreement. Any documents attached to the Disclosure
Schedule are incorporated in their entirety into the Disclosure Schedule.
7.2. DISCLOSURE SCHEDULE. The Seller shall deliver the Disclosure Schedule
to the Buyer on or prior to the date hereof.
ARTICLE 8
NON-DISCLOSURE
8.1. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION. Except as may be agreed
to in writing by the Buyer, the Seller acknowledges and agrees that the Seller
shall not, and shall indemnify the Buyer and the Company in the event that any
of the Seller's Affiliates shall, at any time during the five (5) year period
following the Closing Date, make use of or disclose any Confidential Information
(as defined below) to anyone other than to employees and representatives of the
Buyer. For purposes of this SECTION 8.1, the term "Confidential Information"
shall mean all proprietary information of the Company relating to the Company,
its customers, products and services including, without limitation, the
following: (i) all technical information relating to the provision of goods or
services by the Company; (ii) information concerning
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pricing policies of the Company, prices charged by the Company to its customers,
the volume of orders of such customers and all other information concerning the
transactions of the Company with its customers or proposed customers; (iii) the
customer lists of the Company; (iv) information concerning the marketing
programs or strategies of the Company; (v) financial information concerning the
Company; and (vi) information concerning salaries or wages paid to, the work
records of and other personal information relating to employees of the Company.
8.2. EXCEPTIONS. The provisions of SECTION 8.1 shall not apply to any
information that (i) becomes available to the Seller without restriction on
disclosure by the Seller from a source other than the Company who received the
information not in violation of any confidentiality restriction; (ii) is or
becomes available on an unrestricted basis to a third party from the Company or
someone acting under its control; (iii) is publicly known or becomes publicly
known through no fault of the Seller or (iv) is revealed pursuant to a statute,
regulation, or order of a court of competent jurisdiction requiring such
disclosure, provided the Seller promptly notifies the Buyer to allow the Buyer
to take appropriate protective measures. Section 8.1 shall not limit the ability
of the Seller or the Company to file tax returns or similar documents or to
produce financial statements and make filings with the Securities and Exchange
Commission as required without the consent of the Buyer.
8.3. ENFORCEMENT. In addition to all other legal remedies available to the
Buyer for the enforcement of the covenants of this ARTICLE 8, the Seller hereby
agrees that the Buyer shall be entitled to an injunction by any court of
competent jurisdiction to prevent or restrain any breach or threatened breach
hereof. The Seller further agrees that if any of the covenants set forth herein
shall at any time be adjudged invalid to any extent by any court of competent
jurisdiction, such covenant shall be deemed modified to the extent necessary to
render it enforceable.
8.4. RATIFICATION OF NON-DISCLOSURE AGREEMENT. The Buyer and the Seller
agree that nothing in this Agreement shall be interpreted or construed as
limiting, waiving, terminating or otherwise affecting that Non-Disclosure
Agreement between PEH and the Seller dated June 9, 1999. The Buyer, the Seller
and PEH each acknowledge and agree that the terms of such Non-Disclosure
Agreement remain in full force and effect and shall govern all parties to this
Agreement.
ARTICLE 9
INDEMNIFICATION
9.1. INDEMNIFICATION OF THE BUYER. Subject to the limitations,
restrictions and conditions set forth in this Agreement, the Seller shall
indemnify the Buyer and the Company and hold them harmless from and against any
and all Claims of or against the Buyer or the Company resulting from or arising
out of (i) any misrepresentation or breach of any warranty made by the Seller
herein or in any Seller Ancillary Document not otherwise reflected in any
adjustment to the Purchase Price pursuant to SECTION 1.4 or (ii) any breach,
default in performance or nonfulfillment of any covenant or agreement which is
to be performed by the Seller under this Agreement or any of the Seller
Ancillary Documents.
9.2. INDEMNIFICATION OF THE SELLER. The Buyer shall indemnify the Seller
and hold it harmless from and against any and all Claims of or against the
Seller resulting from or arising out of (i) any misrepresentation or breach of
warranty of the Buyer contained herein or in any Buyer Ancillary Document, or
(ii) any breach, default in performance or nonfulfillment of any covenant or
agreement which is to be performed by the Buyer under this Agreement or any of
the Buyer Ancillary Documents.
9.3. PROCEDURE RELATIVE TO INDEMNIFICATION.
(a) In the event that any party hereto shall claim that it is entitled
to be indemnified pursuant to the terms of this ARTICLE 9, it (the "Claiming
Party") shall so notify the party against which the claim is made (the
"Indemnifying Party") in writing of such claim promptly (i) after discovery
of the facts supporting the claim or (ii) receipt of a written notice of any
claim of a third party (a "Third-Party
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Claim") that may reasonably be expected to result in a claim by such party
against the party to which such notice is given, as the case may be. Such
notice shall specify the breach of representation, warranty, covenant or
agreement claimed by the Claiming Party and the liability, loss, cost or
expense incurred by or imposed upon or expected to be incurred by or imposed
upon the Claiming Party on account thereof. If such liability, loss, cost or
expense is liquidated in amount, the notice shall so state. If the amount is
not liquidated, the notice shall so state and in such event a claim shall be
deemed asserted against the Indemnifying Party on behalf of the Claiming
Party, but no payment shall be made on account thereof until the amount of
such claim is liquidated and the claim is finally determined.
(b) The Indemnifying Party may, upon receipt of written notice of a
Third-Party Claim and at its expense, defend such claim in its own name or,
if necessary, in the name of the Claiming Party, unless the aggregate
potential liability of the Claiming Party exceeds the aggregate potential
liability of the Indemnifying Party (calculated assuming indemnification by
the Indemnifying Party with reference to the limitations set forth in
SECTION 9.4), in which event the Indemnifying Party shall only have the
right to defend the Third-Party Claim with the consent of the Claiming
Party, but shall have the right to participate at its expense in the defense
thereof. The Claiming Party will cooperate with and make available to the
Indemnifying Party such assistance and materials as may be reasonably
requested of it, and the Claiming Party shall have the right, at its
expense, to participate in the defense. The Indemnifying Party shall have
the right to settle and compromise such claim only with the consent of the
Claiming Party which consent shall not be unreasonably withheld.
(c) In the event the Indemnifying Party shall fail or not have the right
to assume the defense under SECTION 9.3(b), or shall notify the Claiming
Party that it shall refuse to conduct a defense against a Third-Party Claim,
then the Claiming Party shall have the right to conduct a defense against
such claim and shall have the right to settle and compromise such claim.
Once the amount of such claim is liquidated and the claim is finally
determined, the Claiming Party shall be entitled to pursue each and every
remedy available to it at law or in equity to enforce the indemnification
provisions of this ARTICLE 9 and, in the event such amount is determined, or
the Indemnifying Party agrees, that it is obligated to indemnify the
Claiming Party for such claim, the Indemnifying Party agrees to pay all
costs, expenses and fees, including all reasonable attorneys' fees which may
be incurred by the Claiming Party in defending such claim and in attempting
to enforce indemnification under this ARTICLE 9, whether the same shall be
enforced by suit or otherwise.
9.4. LIMITS ON INDEMNIFICATION CLAIMS.
9.4.1. BASKET. Except with respect to Claims for breaches of
representations or warranties contained in SECTION 4.1, SECTION 4.2.10
(Taxes), SECTION 6.3.5 (Closing) or a Fraud Claim, the Seller shall not be
required to provide indemnification under SECTION 9.1 unless the damages for
all such Claim(s) of indemnification shall exceed in the aggregate $100,000
(the "Basket Amount"), but upon reaching such amount, indemnification shall
be from the first dollar to the full extent of all damages.
9.4.2. MAXIMUM AMOUNT OF INDEMNIFICATION. Except with respect to
claims for breaches of representations or warranties which arise as a result
of a Fraud Claim or those representations or warranties contained in
SECTION 4.1, SECTION 4.2.4 (Litigation), SECTION 4.2.10 (Taxes) and
SECTION 4.2.18 (Environmental Matters) for which there shall be no limit, in
no event shall the aggregate liability of the Seller with respect to all
claims of indemnification by the Buyer exceed the aggregate amount of Eight
Million Dollars ($8,000,000), plus or minus any Purchase Price Increase or
Purchase Price Decrease, as appropriate, pursuant to SECTION 1.4, and minus
any amount of the ISP Payment not received by the Seller (the "Cap Amount").
9.5. SOLE REMEDY; TERMINATION. The sole and exclusive monetary remedy of
the parties for any and all claims with respect to the transactions contemplated
herein, whether under or as a result of this Agreement or otherwise, shall be
the indemnity set forth in this ARTICLE 9, as limited by the provisions set
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forth in this ARTICLE 9. Any Claim or request for indemnification not submitted
in writing prior to the expiration of the applicable survival period of the
warranty, representation or covenant on which such Claim or request is based
shall be deemed to have been waived and no party shall have any further
liability with respect thereto.
ARTICLE 10
TAX MATTERS
10.1. SECTION 338 ELECTION.
(a) The Buyer, in its sole discretion, shall determine whether an
election shall be made under Sections 338(g) and 338(h)(10) of the Code and
the Treasury Regulations promulgated under the Code (the "Treasury
Regulations") and any corresponding or similar elections under state, local
or foreign Tax law (collectively, a "Section 338(h)(10) Election") with
respect to the purchase and sale of the shares of the Company hereunder. If
the Buyer so determines that a Section 338(h)(10) Election shall be made
with respect to these shares, the Buyer shall notify the Seller in writing
on or before at any time prior to ninety (90) days following the Closing of
its determination and the Seller shall join with the Buyer in making the
Section 338(h)(10) Election in accordance with the provisions of
SECTION 10.1(b) through SECTION 10.1(d) below.
(b) If the Section 338(h)(10) Election will be made, the Seller and the
Buyer shall report, in connection with the determination of income,
franchise or other Taxes measured by net income, the transactions being
undertaken pursuant to this Agreement in a manner consistent with the
Section 338(h)(10) Election and this Agreement. The Buyer shall be
responsible for the preparation of two (2) copies of all forms and documents
required in connection with the Section 338(h)(10) Election (including
Internal Revenue Service Form 8023). Once the Buyer properly prepares
documents and forms as may be required by applicable Tax laws to complete
and make properly the Section 338(h)(10) Election and timely delivers two
(2) copies of such forms and documents to the Seller, the Seller shall
execute both copies no later than thirty (30) days following receipt of such
forms and timely file one copy of such forms and documents with its
appropriate income tax return with the Internal Revenue Service and return
the other copy to Buyer for timely filing with the Internal Revenue Service
District Director.
(c) If the Section 338(h)(10) Election will be made, the Buyer shall
provide the Seller with a valuation statement reflecting, as of the Closing
Date, the fair market values of all of the assets and the liabilities and
obligations of the Company. The Seller shall file, and/or shall cause to
file, all Tax Returns and statements in connection therewith in a manner
consistent with such valuations and shall take no position contrary thereto
unless required to do so by applicable Tax laws. The Seller shall have the
right to review and approve (which approval shall not be unreasonably
withheld) any appraisal upon which such valuations are based and any such
forms and schedules relating to such valuations, prior to the filing
thereof. Any disputes regarding the valuation statement or the preparation,
execution or filing of the forms and documents required in connection with
making the Section 338(h)(10) Election shall be resolved in an arbitration
to be conducted by a Big Five accounting firm jointly selected by the Buyer
and the Seller (the "Selected Accounting Firm"), whose fees shall be borne
equally by the parties. Each of the parties to this Agreement shall be bound
by the decision of the Selected Accounting Firm rendered in such
arbitration.
(d) To the extent permitted by state, local or foreign Tax laws, the
principles and procedures of this SECTION 10.1 shall also apply with respect
to a Section 338(h)(10) Election under state, local or foreign law. The
Seller shall join with the Buyer in making any election similar to the
Section 338(h)(10) Election which is optional under any state, local or
foreign law, and shall cooperate and join in any election made by the Buyer
or the Company to effect such an election so as to treat the
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transactions contemplated herein as a sale of assets for state, local and
foreign income Tax purposes, if so determined by the Buyer.
10.2. TAX INDEMNIFICATION. The Seller shall be liable for, shall pay or
cause to be paid and shall indemnify and hold the Buyer and its Affiliates,
including, after the date hereof, the Company, and all of their officers,
directors and agents, harmless from and against any and all losses, claims,
damages, liabilities, costs, expenses (including reasonable attorneys' fees and
the cost and expenses of enforcing such indemnification against the Seller),
interest and penalties, if any, arising out of or based upon or for or in
respect of each of the following: any and all income Taxes (or franchise or
other Taxes measured by net income) with respect to the Company for any taxable
period (or any partial period) ending on or before the date hereof; any and all
income Taxes (or franchise or other Taxes measured by net income) resulting
solely from the Company having been included in any consolidated, combined or
unitary tax return that included the Company for any taxable period (or portion
thereof) ending on or before the Closing Date pursuant to Treasury Regulation
Section 1.1502-6(a) or any analogous or similar state, local or foreign law or
regulations (other than any liability arising under such Treasury Regulation or
analogous law by reason of the Company becoming a member of the consolidated,
combined or unitary group of which the Buyer is a member); any and all other
Taxes with respect to the Company for any Tax period ending on or prior to the
date hereof or with respect to periods beginning before the Closing Date and
ending after the date hereof to the extent allocated to the Company or to the
Seller pursuant to SECTION 10.3(C) hereof and not previously paid; any breach of
representations in SECTION 4.2.10; and any income or franchise taxes incurred by
the Company in connection with a Section 338(h)(10) Election.
10.3. PREPARATION OF TAX RETURNS; PAYMENT OF TAXES.
(a) The Seller shall prepare or cause to be prepared and file or cause
to be filed all federal, state and local Tax Returns of the Company required
to be filed (taking into account any extensions) for periods ending on or
before the date hereof. The Seller shall pay the amount of any Taxes shown
due thereon to the appropriate Tax authorities and shall provide the Buyer
with adequate proof of such filing and payment and with written confirmation
that such Tax Returns have been prepared in a manner that is consistent with
the past income Tax practices and consistent with the past Tax Returns of
the Company. Following the date hereof, the Buyer shall be responsible for
properly and consistently preparing or causing to be prepared all other
federal, state and local income Tax Returns required to be filed by the
Company for periods which include the date hereof and any such income Tax
Returns will not be filed without the Seller's approval, which approval will
not be unreasonably withheld; provided, however, that the Seller shall
prepare and file or cause to be filed federal and state income or franchise
tax returns that would include the Company in any consolidated, combined or
unitary Tax Return of the Seller.
(b) For federal income Tax purposes, the taxable year of the Company
ends as of the close of the Closing Date and, with respect to all other
Taxes, the Buyer and the Seller will, unless prohibited by applicable law,
close the taxable period of the Company as of the date hereof. Neither the
Buyer nor the Seller shall take any position inconsistent with the preceding
sentence on any Tax Return.
(c) In any case in which a Tax with respect to the Company is assessed
with respect to a taxable period which begins before the date hereof and
ends after the date hereof, the resulting Tax obligation shall be allocated
(i) to the Seller for the period up to and including the date hereof, and
(ii) to the Buyer for the period subsequent to the date hereof. Any
allocation of Taxes attributable to any period beginning before and ending
after the date hereof shall be made by means of a closing of the books and
records of the Company as of the close of the date hereof, provided that
exemptions, allowances, deductions (including, but not limited to,
depreciation and amortization deductions) or any Taxes (such as property or
similar Taxes) that are calculated on an annual basis shall be allocated
between the period ending on the date hereof and the period after the date
hereof in proportion to the number of days in each such period. Any
disagreements regarding the allocations shall be promptly resolved in
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an arbitration conducted by the Selected Accounting Firm whose decision
shall be binding on the parties.
10.4. TAX PROCEEDINGS. In the event of a contest with a Taxing Authority
over Taxes for which indemnifying party is liable pursuant to SECTION 10.2, the
indemnifying party will be entitled to control, at its expense, the proceedings
with respect to such Taxes, but only if the indemnifying party submits to the
claiming party an executed acknowledgment that it is liable for all Taxes
(including interest and penalties) resulting from such contest. Notwithstanding
the preceding sentence, the claiming party will in any event be entitled to
control the proceedings which relate to a consolidated or combined return filed
by the claiming party and its subsidiaries, as the case may be. If the claiming
party is not entitled to control the proceedings under the foregoing provisions,
the indemnifying party will provide, or cause to be provided, to the claiming
party copies of all correspondence received from the taxing authority in
connection with such proceedings. The party in control of the proceeding under
this SECTION 10.4 shall not enter into any agreement or compromise or settlement
of such contest that could affect a period that is the responsibility of the
noncontrolling party without the written consent of the non-controlling party
(which consent shall not be unreasonably withheld). The party which is not
entitled to control any such proceeding shall be afforded a reasonable
opportunity to participate in the defense thereof at its own expense and shall
reimburse the party entitled to control such proceedings for any additional
expenses incurred by such controlling party as a result of the noncontrolling
party's participation in such proceeding.
10.5. PAYMENT OF INDEMNIFICATION. Upon payment of any Taxes with respect
to which a party is entitled to receive indemnification hereunder, such party
shall submit an invoice to the indemnifying party stating that such Taxes have
been paid and giving in reasonable detail the particulars relating thereto. The
indemnifying party shall remit payment for such Taxes promptly upon receipt of
such invoice.
10.6. ASSISTANCE AND COOPERATION. The Seller and the Buyer shall:
(a) Assist (and cause its respective Affiliates to assist) the other
party in preparing any Tax Returns which such other party is responsible for
preparing and filing in accordance with SECTION 10.3 hereof;
(b) Cooperate fully in preparing for any audits of, or disputes,
contests or proceedings with, taxing authorities regarding any Tax Returns
which relate to the Company;
(c) Make available to the other and to any taxing authority as
reasonably requested all information, records and documents relating to Tax
liabilities which are attributable to the Company;
(d) Preserve all such information, records and documents until the
expiration of any applicable statutes of limitations or extensions thereof
and as otherwise required by law;
(e) Make available to the other, as reasonably requested, personnel
responsible for preparing or maintaining information, records and documents
in connection with Tax matters;
(f) Provide timely notice to the other in writing upon receipt of notice
of any pending or threatened Tax audits or assessments relating to the
Company for any period beginning prior to the Closing Date;
(g) Furnish the other with copies of all correspondence received from
any Taxing authority in connection with any Tax audit or information request
with respect to any period beginning prior to the Closing Date;
(h) Keep confidential any information obtained pursuant to this
SECTION 10.6, except as may otherwise be necessary in connection with the
filing of Tax Returns or claims for refund or in conducting any audit or
other Tax proceeding; and
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(i) Furnish the other with adequate information which would enable the
other party to determine its entitlement to, and the amount of, any refund
or credit to which either party reasonably believes the other party may be
entitled.
10.7. TAX SHARING AGREEMENTS. All Tax sharing and similar agreements
(other than the provisions of this Agreement) between the Company and the Seller
or any other corporation or corporations shall be terminated as of the date
hereof, and the Company shall not have any liability from and after the date
hereof under any such agreement.
10.8. TRANSFER TAXES. The Seller shall be liable for and shall pay all
excise, sales, use, transfer (including real property transfer or gains), stamp,
documentary, filing, recordation and other similar Taxes which may be imposed in
connection with the transactions contemplated by this Agreement, together with
any interest, additions or penalties with respect thereto ("Transfer Taxes").
Each party hereto hereby agrees to file all necessary documentation in
connection with the payment and reporting of Transfer Taxes.
10.9. SURVIVAL OF OBLIGATIONS. The obligations of the parties set forth in
this ARTICLE 10 shall be unconditional and absolute and shall remain in effect
without limitation as to time.
10.10. TAX REFUND. Within three (3) business days of receipt thereof, the
Company shall promptly transfer to the Seller the tax refund due to the Company
in connection with the Seller's consolidated tax return for 1998.
10.11. PROVISIONS OF THIS ARTICLE TO CONTROL. In the event of a conflict
between the provisions of this ARTICLE 10 and any other provisions of this
Agreement, the provisions of this ARTICLE 10 shall control.
ARTICLE 11
TERMINATION
11.1. TERMINATION. This Agreement may be terminated at any time prior to
the Closing Date:
(a) by the mutual written consent of the Buyer and the Seller;
(b) by the Buyer, or the Seller;
(i) if any court or governmental body or agency thereof shall have
enacted, promulgated or issued any statute, rule, regulation, ruling,
writ or injunction, or taken any other action, restraining, enjoining or
otherwise prohibiting the transactions contemplated hereby; or
(ii) if the Closing shall not have occurred on or before one
(1) year from the date hereof; provided, however, that the right to
terminate this Agreement pursuant to this SECTION 11.1(b)(ii) shall not
be available to any party whose breach of any representation or warranty
or failure to perform or comply with any covenant or obligation under
this Agreement has been the cause of, or resulted in, the failure of the
Closing to occur on or before such date.
11.2. EFFECT OF TERMINATION.
(a) Except as provided in SECTION 6.1.4, SECTION 11.2(b),
SECTION 11.2(c), SECTION 11.2(d), or SECTION 11.2(e) in the event of
termination of this Agreement, this Agreement shall forthwith become null
and void and there shall be no liability on the part of any party hereto,
except for the return of the amount of the Investment by the Seller to the
Buyer, SECTION 6.1.4, SECTION 12.1, SECTION 12.2 and SECTION 12.9 and this
SECTION 11.2, which shall remain in full force and effect and which shall
survive such termination, and provided that no such termination shall
relieve any party hereto from liability for any breach by such party of this
Agreement.
(b) In the event of termination of this Agreement due to the Seller's
breach of a warranty or representation under this Agreement, the Seller
shall pay to the Buyer the amount of the Investment by wire transfer of
immediately available funds.
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(c) In the event of termination of this Agreement due to the Seller's
failure to perform or comply with a covenant or obligation under this
Agreement, the Seller shall pay to the Buyer the amount of the Investment by
wire transfer of immediately available funds, and the Seller and the Buyer
shall make reasonable efforts to sell the Company to a third party. Upon
such sale, if the purchase price actually obtained for the Company (the "New
Purchase Price") exceeds the Purchase Price set forth herein, the Seller
shall pay to the Buyer the difference between the New Purchase Price and the
Purchase Price by wire transfer of immediately available funds.
(d) In the event of termination of this Agreement due to the Buyer's
breach of a warranty or representation or failure to perform or comply with
a covenant or obligation under this Agreement, the Seller and the Buyer
shall make reasonable efforts to sell the Company to a third party. Upon
such sale, if the Purchase Price exceeds the New Purchase Price, the Buyer
shall pay to the Seller the difference between the Purchase Price and the
New Purchase price, net of the amount of the Investment.
(e) In the event of termination of this Agreement due to the failure to
satisfy the condition set forth in Section 2.1(k), the Seller shall pay to
the Buyer the amount of the Investment by wire transfer of immediately
available funds, and the Seller and the Buyer shall make reasonable efforts
to sell the Company to a third party. Upon such sale, if the New Purchase
Price exceeds the Purchase Price set forth herein, the Seller shall retain
the difference thereof.
ARTICLE 12
MISCELLANEOUS
12.1. EXPENSES. Except as may be otherwise specifically provided herein,
the parties hereto shall pay their own legal fees and expenses incurred in
connection with the negotiation and consummation of the transactions
contemplated by this Agreement.
12.2. NOTICES. All notices or other communications required or permitted
to be given hereunder shall be in writing and shall be considered to be given
and received in all respects when hand delivered, when sent one (1) business day
after it is sent by prepaid express or courier delivery service, when sent by
facsimile transmission actually received by the receiving equipment, or five
(5) days after it is deposited in the United States mail, certified mail,
postage prepaid, return receipt requested (or international equivalents
thereof), in each case addressed as follows, or to such other address as shall
be designated by notice duly given:
<TABLE>
<S> <C>
If to the Buyer: Energy TRACS Acquisition Corp.
c/o Platinum Equity Holdings, LLC
Suite 2710
2049 Century Park East
Los Angeles, CA 90067
Facsimile: (310) 712-1848
Attention: William Bricking
With a copy to: Riordan & McKinzie
Suite 1500
695 Town Center Drive
Costa Mesa, CA 92626
Facsimile: (714) 549-3244
Attention: James H. Shnell
</TABLE>
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<TABLE>
<S> <C>
If to the Seller: AvTel Communications, Inc.
501 Bath Street
Santa Barbara, CA 93101
Facsimile: (805) 884-6311
Attention: Anthony E. Papa
With a copy to: Seed Mackall & Cole, LLP
Suite 200
1332 Anacapa Street
Santa Barbara, CA 93101
Facsimile: (805) 962-1404
Attention: Thomas N. Harding
</TABLE>
12.3. ENTIRE AGREEMENT. This Agreement, the Disclosure Schedule, the
exhibits attached hereto and any agreements between or among the parties hereto
of even date herewith constitute the entire agreement among the parties hereto
relating to the subject matter hereof, and all prior agreements, correspondence,
discussions and understandings of the parties (whether oral or written) are
merged herein and superseded hereby, it being the intention of the parties
hereto that this Agreement and the instruments and agreements contemplated
hereby shall serve as the complete and exclusive statement of the terms of their
agreement together. No amendment, waiver or modification hereto or hereunder
shall be valid unless in writing signed by an authorized signatory of the party
or parties to be affected thereby.
12.4. ASSIGNMENT. This Agreement and the rights hereunder shall not be
assignable or transferable (i) by the Buyer without the prior written consent of
the Seller, except to an Affiliate of the Buyer or to a financial institution in
connection with a financing related to this Agreement, or (ii) by the Seller
without the prior written consent of the Buyer. The duties and obligations of a
party hereunder shall not be delegable without the prior written consent of the
other parties hereto.
12.5. BINDING EFFECT. This Agreement shall be binding upon the parties
hereto and their respective successors and permitted assigns.
12.6. SECTION HEADINGS. The headings in this Agreement are for purposes of
convenience and ease of reference only and shall not be construed to limit or
otherwise affect the meaning of any part of this Agreement.
12.7. SEVERABILITY. The parties agree that if any provision of this
Agreement shall under any circumstances be deemed invalid or inoperative, this
Agreement shall be construed with the invalid or inoperative provision deleted,
and the rights and obligations of the parties shall be construed and enforced
accordingly.
12.8. APPLICABLE LAW. This Agreement and all questions arising in
connection herewith shall be governed by and construed in accordance with the
internal laws of the State of California without regard to the principles of
conflicts of laws thereunder.
12.9. COUNTERPARTS. This Agreement may be executed in one or more original
or facsimile counterparts, all of which shall be considered but one and the same
agreement, and shall become effective when one or more such counterparts have
been executed by each of the parties and delivered to the other parties.
12.10. PASSAGE OF TITLE. Legal title, equitable title and risk of loss
with respect to the Common Stock will not pass to the Buyer until the Common
Stock is transferred at the Closing, which transfer, once it has occurred, will
be deemed effective as of the close of business in Los Angeles on the Closing
Date for all purposes.
12.11. USE OF TERMS. In this Agreement, (i) the words "hereof," "herein,"
"hereto," "hereunder" and words of similar import mean and refer to this
Agreement as a whole and not merely to the specific
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<PAGE>
section or clause in which the respective word appears, (ii) words importing
gender include the other genders as appropriate and (iii) any terms defined in
this Agreement may, unless the context otherwise requires, be used in the
singular or the plural depending on the reference. As used in this Agreement,
the terms "knowledge of the Company and the Seller" or "the Company's and
Seller's best knowledge," or words of similar import, shall mean both actual
knowledge and information that should have been known after reasonable inquiry.
Except as otherwise provided herein, terms used in this Agreement with generally
understood meanings in the telecommunications industry shall have the meanings
given to such terms in the telecommunications industry.
12.12. FACSIMILE COPY. This Agreement may be executed in facsimile copy
with the same binding effect as an original.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day,
month and year first above written.
<TABLE>
<S> <C> <C>
SELLER
AVTEL COMMUNICATIONS, INC.
By: /s/ ANTHONY E. PAPA
--------------------------------------
Name: Anthony E. Papa
Title: CHIEF EXECUTIVE OFFICER
BUYER
ENERGY TRACS ACQUISITION CORP.
By: /s/ WILLIAM C. BRICKING
--------------------------------------
Name: William C. Bricking
Title: PRESIDENT
COMPANY
MATRIX TELECOM, INC.
By: /s/ ANTHONY E. PAPA
--------------------------------------
Name: Anthony E. Papa
Title: CHIEF EXECUTIVE OFFICER
</TABLE>
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<PAGE>
GUARANTY OF PLATINUM EQUITY HOLDINGS, LLC
Platinum Equity Holdings, LLC hereby (i) agrees to the provisions set forth
in SECTION 8.4 and (ii) guarantees the obligations of the Buyer (including any
assignee of the Buyer) under ARTICLE 1, SECTION 6.2.1, ARTICLE 9 and
SECTION 11.2(D) and agrees that it will not cause the Buyer to take any actions
that would cause the Buyer to violate the terms of ARTICLE 1, SECTION 6.2.1,
ARTICLE 9 or SECTION 11.2(D).
<TABLE>
<S> <C> <C>
By: /s/ WILLIAM C. BRICKING
--------------------------------------
Name: William C. Bricking
Title: VICE PRESIDENT, OPERATIONS
</TABLE>
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<PAGE>
FIRST AMENDMENT
TO
STOCK PURCHASE AGREEMENT
THIS FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT (this "Amendment") is
entered into as of September 16, 1999, between NetLojix Communications, Inc., a
Delaware corporation (the "Seller"), Matrix Acquisition Holdings Corp., a
Delaware corporation (the "Buyer"), and Matrix Telecom, Inc., a Texas
corporation (the "Company").
BACKGROUND
A. The Seller, the Company and Energy TRACS Acquisition Corp., a Delaware
corporation ("ETAC") have entered into that certain Stock Purchase Agreement
dated August 31, 1999 (the "Stock Purchase Agreement") pursuant to which ETAC
was to acquire all of the common stock of the Company.
B. Pursuant to Section 12.4 of the Stock Purchase Agreement, ETAC assigned
its rights, duties and obligations under the Stock Purchase Agreement to the
Buyer on August 31, 1999.
C. On September 15, 1999, the Seller changed its corporate name from "AvTel
Communications, Inc." to "NetLojix Communications, Inc."
D. The parties hereto have determined to amend the Stock Purchase Agreement
as set forth herein.
AGREEMENT
NOW, THEREFORE, the Buyer, the Seller and the Company, in consideration of
the mutual promises hereinafter set forth, and intending to be legally bound, do
hereby promise and agree as follows:
1. AMENDMENT OF SECTION 1.2(a)
Section 1.2(a) is hereby amended to read in its entirety as follows:
"(a) A credit in favor of the Seller (the "Credit") in the aggregate amount
of Two Million Thirty-Nine Thousand Fifty-Seven Dollars ($2,039,057) against
amounts that become due after the date hereof for long distance wholesale
traffic to be provided by the Company to the Seller (the "Long Distance
Services") pursuant to a rebiller service contract between the Company and the
Seller of even date herewith; provided, however, that the amount of the Credit
taken by the Seller will not exceed Two Hundred Twenty-Five Thousand Dollars
($225,000) for the period commencing on September 1, 1999 and ending on
November 30, 1999, and will not exceed One Hundred Thousand Dollars ($100,000)
per month for a period not to exceed twenty-five (25) months thereafter."
2. DELETION OF SECTION 2.1(k).
Section 2.1(k) is hereby deleted in its entirety.
3. PAYMENT OF CERTAIN ACCOUNTS PAYABLE.
The Seller hereby agrees to pay currently those accounts payable of the
Company set forth on Exhibit A attached hereto and incorporated herein by this
reference.
4. NO OTHER MODIFICATION.
Except as specifically amended hereby, the Stock Purchase Agreement shall
continue unchanged and in full force and effect. All of the provisions contained
in Section 12 of the Stock Purchase Agreement shall apply to this Amendment.
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<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day,
month and year first above written.
<TABLE>
<S> <C> <C>
SELLER
NETLOJIX COMMUNICATIONS, INC.
By: /s/ ANTHONY E. PAPA
--------------------------------------
Name: Anthony E. Papa
Title: CHIEF EXECUTIVE OFFICER
BUYER
MATRIX ACQUISITION HOLDINGS CORP.
By: /s/ WILLIAM M. FOLTZ, JR.
--------------------------------------
Name: William M. Foltz, Jr.
Title: VICE PRESIDENT
COMPANY
MATRIX TELECOM, INC.
By: /s/ ANTHONY E. PAPA
--------------------------------------
Name: Anthony E. Papa
Title: CHIEF EXECUTIVE OFFICER
</TABLE>
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<PAGE>
GUARANTY OF PLATINUM EQUITY HOLDINGS, LLC
Platinum Equity Holdings, LLC hereby guarantees the obligations of the Buyer
(including any assignee of the Buyer) under SECTION 1 hereof and agrees that it
will not cause the Buyer to take any actions that would cause the Buyer to
violate the terms of SECTION 1.
<TABLE>
<S> <C> <C>
By: /s/ WILLIAM C. BRICKING
--------------------------------------
Name: William C. Bricking
Title: VICE PRESIDENT, OPERATIONS
</TABLE>
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