<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
---------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27580
---------
AVTEL COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT SPECIFIED IN ITS CHARTER)
---------
DELAWARE 87-0378021
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(805) 884-6300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
As of July 30, 1999, there were 10,732,124 shares of the Registrant's Common
Stock, par value $0.01 per share, issued and outstanding, excluding treasury
stock.
1
<PAGE>
AVTEL COMMUNICATIONS, INC.
QUARTER ENDED JUNE 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June
30, 1999 (Unaudited) and December 31, 1998 3
Condensed Consolidated Statements of Operations for
the Three Month and Six Month Periods Ended June 30,
1999 and 1998 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for
the Three Month and Six Month Periods Ended June 30,
1999 and 1998 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements
(Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 22
Signature Page 23
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
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
Long-term obligations under capital leases 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 shares 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.
3
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
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 (expense), 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.
4
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
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 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 (285,225) (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 to 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.
5
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 1999 and 1998
(1) BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of AvTel
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 months
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 Six Months
Ended June 30, Ended 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)
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.
(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
6
<PAGE>
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 a preferred
stock dividend equal to the difference between the market price of the
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 $143,000. As of July 12, 1999,
Series B Investors had converted 520 shares of Series B Stock into 155,804
shares of AvTel 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.
7
<PAGE>
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.
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.
8
<PAGE>
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.
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 Telecom, 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.
9
<PAGE>
(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.
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:
<TABLE>
<CAPTION>
Three Months Ended June 30, 1999
--------------------------------
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 & administration 1,682,513 3,267,964 4,950,477
Depreciation & 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) (2,120,600)
---------------- ------------ ------------
---------------- ------------ ------------
EBITDA $ (661,802) (986,484) (1,648,286)
Total assets $ 9,672,238 4,758,510 14,430,748
<CAPTION>
Three Months Ended June 30, 1998
--------------------------------
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 & administration 534,505 4,268,081 4,802,586
Depreciation & amortization 89,805 175,565 265,370
Interest expense -- (17,327) (17,327)
Other income 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>
10
<PAGE>
The results for the six months ended June 30, 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
Six Months Ended June 30, 1999
------------------------------
BMG CMG Total
--- --- -----
<S> <C> <C> <C>
Revenues $ 5,936,208 12,714,567 18,650,775
Gross margin 1,666,330 4,339,666 6,005,996
Selling, general & administration 3,395,721 6,844,069 10,239,790
Depreciation & 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)
<CAPTION>
Six Months Ended June 30, 1998
------------------------------
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 & administration 945,898 8,439,134 9,385,032
Depreciation & amortization 195,063 349,175 544,238
Interest expense (6,068) (23,234) (29,302)
Other income 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>
(6) SUBSEQUENT EVENTS
On July 12, 1999, Series B Investors converted 520 shares of Series B
Stock into 155,804 shares of AvTel 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 AvTel'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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS DOCUMENT
THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, INCLUDING WITHOUT LIMITATION STATEMENTS
REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES
REGARDING THE FUTURE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS
QUARTERLY REPORT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE
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DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH
FORWARD-LOOKING STATEMENTS. ACTUAL EVENTS AND OUTCOMES COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY
FACTORS, INCLUDING THOSE DESCRIBED HEREIN AND THOSE SET FORTH IN THE RISK
FACTORS DESCRIBED IN ITEM 1 OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K AND
10-K/A FOR THE YEAR ENDED DECEMBER 31, 1998.
The following discussion and analysis should be read in connection with the
unaudited condensed consolidated financial statements for the three month and
six month periods ended June 30, 1999 and 1998 of the Registrant and related
notes included elsewhere in this report and the consolidated financial
statements and related management discussion and analysis included in the
Registrant's Annual Report on Form 10-K, as amended by Form 10-K/A, for the year
ended December 31, 1998.
OVERVIEW
AvTel Communications, Inc. (the "Company") is a provider of broadband
network services integrating voice, data and Internet solutions. The Company
sells and markets a broad range of telecommunications and advanced network
services through independent value added resellers, Affinity and agent
organizations, and internal direct sales professionals. The Company targets
mid-size corporations, small-office home-office professionals and select
residential market segments through two primary business units; the Business
Markets Group ("BMG") and the Channel Markets Group ("CMG").
On December 1, 1997, the Company acquired Matrix Telecom, Inc., a
privately-held Texas corporation ("Matrix") by means of a share for share
exchange. For a accounting purposes, the acquisition was treated as a reverse
acquisition with Matrix as the acquirer. Matrix was a provider of long
distance telephone services and subsequently provides a bundled service
including Internet access.
On September 25, 1998, the Company acquired all of the issued and
outstanding capital stock of Digital Media International, Inc. ("DMI"), a
privately-held corporation based in Santa Barbara, California, which develops
software for educational, entertainment and other applications.
On November 19, 1998, the Company acquired all of the issued and
outstanding capital stock of Remote Lojix/PCSI, Inc. ("RLI"), a
privately-held corporation based in New York, which is a provider of system
integration and local area network ("LAN") services to corporate customers.
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RESULTS OF OPERATIONS
Condensed Consolidated Statements of Operations as a Percent of Revenue
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues 100.00% 100.00% 100.00% 100.00%
Cost of revenues 64.58% 73.98% 67.80% 74.32%
Gross margin 35.42% 26.02% 32.20% 25.68%
Operating expenses
Selling, general & administrative 53.07% 42.52% 54.90% 39.54%
Depreciation & amortization 3.84% 2.35% 4.04% 2.29%
------ ------ ------ ------
Total operating expenses 56.91% 44.87% 58.94% 41.83%
------ ------ ------ ------
Operating loss (21.49%) (18.85%) (26.74%) (16.15%)
Interest expense (1.22%) (0.15%) (1.14%) (0.12%)
Other income (expense), net (0.02%) 0.29% 0.07% 0.33%
------ ------ ------ ------
Loss before income tax benefit (22.73%) (18.71%) (27.81%) (15.94%)
Income tax benefit 0.00% 3.66% 0.00% 3.02%
------ ------ ------ ------
Net loss (22.73%) (15.05%) (27.81%) (12.92%)
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
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.
BMG 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 acquisition of RLI and DMI during the fourth quarter of 1998
contributed $1.6 million of the increase. Data & voice products of BMG
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
the Company and BMG continues to move toward incorporating voice and data
networking solutions into the construction of corporate Intranets and Wide
Area Networks. Accordingly, BMG revenue as a percent of the Company'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.
CMG revenue decreased $3.9 million. CMG revenue from traditional voice
products declined $4.0 million or 43.7%, while Internet revenue increased
$75,000 or 8.2%. Historically, CMG has focused on selling retail long
distance service through telemarketing, direct mail, and distributors or
agents. During the fourth quarter of 1998, CMG implemented a new strategy to
sell Internet access and additional voice services exclusively through
affinity groups, agents and distributors with the main thrust focused on
Internet access.
The primary source of revenues of CMG 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 CMG's long distance revenue per minutes
to $0.178 for the three months ended June 30, 1999 compared to $0.214 for the
three
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months ended June 30, 1998. Decreases in CMG 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 the Company's stated focus, in July 1999, the Company
entered into a non-binding Letter of Intent to sell its residential long
distance customer business (see Note 6 of Notes to Condensed Consolidated
Financial Statements).
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.
BMG 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 the Company's major
underlying carrier for dedicated traffic. These rates became effective
February 15, 1999 and represent an approximate cost reduction of 20% on
dedicated traffic. Secondly, with the acquisitions of RLI and DMI, BMG is
able to sell and support higher margin products.
CMG gross margin as a percent of revenue increased 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
the Company's major underlying carrier that increased the gross margin on
multiple products and geographical areas in which CMG provides services.
Internet service gross margin within CMG 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.
BMG 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 RLI and DMI 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.
CMG 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.
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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 June 30, 1998. The
increase was primarily from the acquisition and consolidation of assets related
to the purchase of RLI and DMI 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. CMG
recognized $62,000 of interest expense from long-term borrowings and $22,000 of
accrued interest on deferred payments due to a major vendor. BMG recognized
$14,000 of accrued interest on liabilities acquired with the RLI 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 CMG 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
the Company 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.
BMG 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 RLI and DMI during the fourth quarter of 1998 contributed
$2.9 million of the increase. BMG revenue as a percent of the Company'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 the Company and
BMG continues to move toward incorporating voice and data networking
solutions into the construction of corporate Intranets and Wide Area Networks.
CMG revenue decreased $8.5 million. CMG 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 attributed 34.7% of the decline in traditional voice products.
See Results of Operations for the 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.
BMG 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 primary factors affected this increase. First,
significantly lower rates were negotiated with the Company's major underlying
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<PAGE>
carrier for dedicated traffic. These rates became effective February 15, 1999
and represent an approximate cost reduction of 20% on dedicated traffic.
Secondly, with the acquisitions of RLI and DMI, BMG is able to sell and
support higher margin products.
CMG gross margin as a percent of revenue increased 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. Significant lower rates were negotiated with the Company's major
underlying carrier that increased the gross margin on multiple products and
geographical areas that CMG provides services. Internet service gross margin
within CMG 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.
BMG 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 RLI and DMI 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.
CMG 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 June 30, 1998. The
increase was primarily from the acquisition and consolidation of assets related
to the purchase of RLI and DMI 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. CMG
recognized $118,000 of interest expense from long-term borrowings and $22,000 of
accrued interest on deferred payments due to a major vendor. BMG recognized
$51,000 of accrued interest on liabilities acquired with the RLI 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.
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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 the
Company 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.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended June 30, 1999, the Company reported a net
loss of $2,120,600. In addition, as of June 30, 1999, the Company had a
working capital deficit of $3,771,247, and for the three 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 indefinitely 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.
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 PEH. The Letter of
Intent contemplates that PEH will acquire 100% of the stock of AvTel's wholly
owned subsidiary, Matrix (see Note 6 to Notes to Condensed Consolidated
Financial Statements). The consideration to the Company will consist of a
combination of cash, assumption of indebtedness (including the Coast Business
Credit loan described above), certain contingent payments and future
services. The closing of the transaction is subject to negotiation and
execution of a definitive agreement, as well as regulatory and other
approvals.
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 of Notes to Consolidated Financial Statements). In addition, on
April 13, 1999, the Company sold 1,500 shares of its newly designated Series
B Convertible Preferred Stock for $1,500,000 (see Note 6 of Notes to
Consolidated Financial Statements).
The Company believes with the sale of its residential long distance
business or its ability 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 and 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.
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The primary sources of operating cash flow for the Company are revenues
derived from the sale of information technology and telecommunications
services to individuals and business, and its secured credit facility. The
primary uses of cash are payments to underlying network vendors for
provisioning telecommunications facilities, to sales distributors for
soliciting long distance sales, and to the major LECs for directly billing to
and collecting from the end user. Net cash used in operating activities is
$2.4 million for the six months ended June 30, 1999, compared to $2.6 million
for the six months ended June 30, 1998.
Net cash used in investing activities was $472,000 for the six months
ended June 30, 1999, and net cash provided by investing activities was
$211,000 for the six months ended June 30, 1998. The Company loaned $2.0
million to an affiliated company during 1997. Of such amount, $201,000 was
repaid during 1997, $437,000 was repaid during the first six months of 1998
and the remainder was repaid in subsequent months of 1998.
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 October 2,
1998, the Company entered into a secured credit facility with Coast Business
Credit. This credit facility consists of a line of credit of up to $7.5
million. Under the line of credit, the Company may borrow up to 75% of
eligible receivables (as defined). In addition, the line of credit may be
utilized in connection with certain acquisitions and equipment purchases as
well as to provide a facility for issuing letters of credit. Borrowings under
the line of credit bear interest, payable monthly, based upon the prime rate
of Bank of America NT & SA plus 2% (10.0% at June 30, 1999). As of June 30,
1999, borrowing 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 the
Company. The credit facility expires on October 31, 2000.
The Company anticipates that future operations and growth strategies
(including possible acquisitions) of the Company will require funding from
other sources. The Company entered into the Private Equity Line to help meet
this need, as well as operating and capital expenditure needs, for the
foreseeable future.
YEAR 2000
The Company recognizes the importance of Year 2000 Date ("Y2K")
Compliance to our customers, as well as our global community, and it is a top
corporate priority. In order to assist our customers in their preparations
related to Y2K Compliance for January 1, 2000 and beyond, the following is an
overview of the Company's Y2K efforts and our progress to date.
Y2K Compliance is the inability of computer systems and certain other
equipment to properly recognize and process data that uses two digits rather
than four to designate particular years. In 1998, the Company initiated a Y2K
Project Plan ("the Plan") and Internal Project Team ("the Team") to assess
whether our 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 our critical systems, the failure of which could
have a material or adverse effect on the Company's operations and/or our
ability to provide service to our existing and potential customers. The
Company's senior management team has also given the Team its full support and
backing. In addition to sums already expended, the Company anticipates
spending approximately $200,000 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.
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The Y2K 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. The Company receives critical
services from providers of utilities and other services. The Company is also
critically reliant upon the systems of other telecommunications providers on
which the Company depends to deliver services and invoices to its customers.
The Company cannot control nor be responsible for compliance by our vendors
and suppliers; however, we are encouraging their efforts to become compliant
and are working to receive the appropriate warranties and assurances that
those third parties are, or will be, compliant.
The identification and planning phases of the Plan are materially
complete as they relate to Company-owned systems. As they relate to
third-party vendors and other telecommunications carriers, the identification
and planning phases are on going and are expected to be materially complete
during the third quarter of 1999.
With respect to Company-owned systems, the process of remediation of Y2K
issues, identified in the identification and planning phases, are ongoing.
Testing and verification of such changes is expected to be complete in early
fourth quarter of 1999.
Based on work completed under the Plan to date, the Company is currently
pursuing the following steps under the Plan with respect to third-party
vendors and other telecommunications carriers: the Company has or is in the
process of contacting all such suppliers. Thus far, the majority of those
suppliers who have responded have indicated that their systems and service
delivery mechanisms are Y2K compliant or will be made so through currently
available modifications before the end of the year. The Company plans to
continue monitoring all of our third-party remediation efforts and to develop
an ongoing contingency plan for the delivery of such services as necessary.
Contingency planning to maintain and restore service in the event of
natural disasters, power failures and systems-related problems is a routine
part of the Company's operations. The Company believes that such contingency
plans will assist the Company in responding to the failure by outside service
providers to successfully address Y2K issues. In addition, the Company is
currently identifying and considering various Y2K-specific contingency plans,
including identification of alternate vendors and service providers and
manual alternatives to system operations. These Y2K specific contingency
plans are expected to be materially complete early in the fourth quarter of
1999.
Because the impact of Y2K issues on the Company and its customers is
materially dependent on the mitigation efforts of parties outside the
Company's control, the Company cannot access with certainty the magnitude of
any such potential adverse impact. However, based upon risk assessment work
conducted thus far, the Company believes that it will be able to continue to
provide service to our customers at current service levels on January 1, 2000
and beyond.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not exposed to material future earnings or cash flow
fluctuations, from changes in interest rates on its long-term debt at June
30, 1999. A hypothetical increase of 100 basis points in interest rate (ten
percent of the Company's overall borrowing rate) would not result in a
material fluctuation in future earnings or cash flow. The Company had not
entered into any derivative financial instruments to manage interest rate
risk or for speculative purposes and is currently not evaluating the future
use of such financial instruments.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company 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 the Company and certain of its
officers, alleging securities fraud. The plaintiffs are purported investors
who purchased shares of AvTel common stock on November 12, 1998. On that date
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 AvTel on November 12, 1998,
announcing the launch of its subsidiaries' DSLink Service for high speed
Internet access, and an interview with AvTel Chief Executive Officer Anthony
E. Papa concerning that service, as reported by Bloomberg News, were
misleading and defrauded the market for AvTel'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. The Company's
initial motion to dismiss the matter was denied; however, its motion to
reconsider this denial in light of a recent appellant decision under the
Private Securities Litigation Reform Act is currently pending. The plaintiffs
have yet to state the amount of damages they seek.
The Company contends that its statements were not misleading, and
intends to defend vigorously this securities litigation. However, it is not
possible to predict at this time the likely outcome of this action or the
costs AvTel 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 Telecom from late 1994 until he was terminated by
Matrix Telecom 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 AvTel. The complaint alleges that Mr. Jensen
wrongfully foreclosed on Matrix Telecom stock owned by Mr. Sanders after Mr.
Sanders failed to repay a debt to Mr. Jensen. Matrix Telecom then repurchased
the stock from Mr. Jensen pursuant to an existing buy/sell agreement with Mr.
Sanders. In addition to his claim against Mr. Jensen, Mr. Sanders is
apparently seeking 171,548 shares of AvTel's common stock, or its monetary
equivalent, from AvTel.
The parties are currently beginning the discovery process. AvTel and
Matrix Telecom intend to defend this complaint vigorously.
On June 28, 1999, the Company was served with a complaint filed in the
District Court of Garfield County, Oklahoma. The complaint is styled as a
class action with Alexander B. McNaughton as representative of the class. The
suit alleges that members of the class received unsolicited facsimile
transmissions from an agent of the Company in violation of the Telephone
Consumer Privacy Act. The Company has filed an answer denying the
allegations. The parties are currently beginning the discovery process. The
Company intends to defend this complaint vigorously.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 13, 1999, the Company issued 1,500 shares of its Series B
Convertible Preferred Stock and 20,000 common stock purchase warrants, which
were not registered under the Securities Act, to three private investors. No
underwriters were used in this transaction and none of such shares were
issued publicly. The Company relied on the exemptions from registration
provided by Sections 4(2) and 4(6) of the Securities Act and Rule 506 of
Regulation D promulgated thereunder. The persons receiving securities are
believed by the
20
<PAGE>
Company to possess the requisite level of financial sophistication and
experience in order to qualify for such exemptions. The Company made available
to the investors all material information with respect to the Company. The
investors signed a preferred stock and warrants purchase agreement containing
appropriate investment representations and covenants.
On April 23, 1999, the Company issued 3,000 shares of common stock to
Trinity Capital Advisors, Inc. in compensation for financial advisory
services in connection with the Private Equity Line described in Note 3 to
the Notes to Condensed Consolidated Financial Statements. Trinity Capital
Advisors, in its role as financial advisor, conducted a financial analysis of
the Company and presented it with a private placement structure. Trinity also
provided the Company with several contacts with investors known to invest in
the type of structure proposed. No underwriters were used in this transaction
and none of such shares were issued publicly. The Company relied on the
exemptions from registration provided by Sections 4(2) and 4(6) of the
Securities Act and Rule 506 of Regulation D promulgated thereunder. Trinity
is believed by the Company to possess the requisite level of financial
sophistication and experience in order to qualify for such exemptions. The
Company made available to Trinity all material information with respect to
the Company. Trinity signed an agreement containing appropriate investment
representations and covenants.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
As of June 30, 1999, the Company was in violation of one provision of
its 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. There has been no default in the payment of principal,
interest, sinking fund or purchase fund installments under this obligation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Registrant held its annual meeting of stockholders on May 27,
1999.
(b) The following individuals were elected as all of the directors of
the Registrant: Anthony E. Papa, James P. Pisani, John E. Allen,
Jeffrey J. Jensen and Anthony D. Martin.
(c) The following matters were presented to the stockholders for
approval:
1. Election of directors.
The voting for the election of directors was as follows:
<TABLE>
<CAPTION>
Directors For Against Abstain Total
<S> <C> <C> <C> <C>
Anthony E. Papa 7,268,489 4,076 0 7,272,565
James P. Pisani 7,268,489 4,076 0 7,272,565
John E. Allen 7,232,489 40,076 0 7,272,565
Jeffery J. Jensen 7,268,489 4,076 0 7,272,565
Anthony D. Martin 7,268,489 4,076 0 7,272,565
</TABLE>
There were no broker non-votes.
21
<PAGE>
2. Ratification of Auditors.
The stockholders of Registrant ratified the appointment of KPMG LLP
as the Company's independent auditors for 1999. The voting was as
follows:
<TABLE>
<CAPTION>
For Against Abstain Total
<S> <C> <C> <C>
7,227,359 34,492 10,714 7,272,565
</TABLE>
There were no broker non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule - Six Months Ended June 30, 1999
27.2 Restated Financial Data Schedule - Six Months Ended
June 30, 1998
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on April 23,
1999 with respect to the Private Equity Line of Credit Agreement and
the Registration Rights Agreement dated April 23, 1999, between the
Company and Cambois Finance, Inc. The Company also announced the
appointment of its new Chief Financial Officer.
The Company filed no other reports on Form 8-K during the
quarter ended June 30, 1999.
22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVTEL COMMUNICATIONS, INC.,
a Delaware corporation
By: /S/ MICHAEL J. USSERY
------------------------------------
Michael J. Ussery
CHIEF FINANCIAL OFFICER
(Duly Authorized Officer and Principal
Financial Officer, and Principal
Accounting Officer)
August 18, 1999
23
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
- ------- -------------------
<S> <C>
27.1 Financial Data Schedule - Six Months Ended June 30, 1999
27.2 Restated Financial Data Schedule - Six Months Ended June 30, 1998
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF
JUNE 30, 1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX
MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 685
<SECURITIES> 0
<RECEIVABLES> 4,005
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,104
<PP&E> 1,964
<DEPRECIATION> 0
<TOTAL-ASSETS> 14,431
<CURRENT-LIABILITIES> 10,875
<BONDS> 2,227
0
1
<COMMON> 105
<OTHER-SE> 949
<TOTAL-LIABILITY-AND-EQUITY> 14,431
<SALES> 0
<TOTAL-REVENUES> 18,651
<CGS> 0
<TOTAL-COSTS> 12,645
<OTHER-EXPENSES> 10,993
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 213
<INCOME-PRETAX> (5,187)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,187)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,187)
<EPS-BASIC> (0.52)
<EPS-DILUTED> (0.52)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF
JUNE 30, 1998 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH
FLOWS FOR THE SIX MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 2,462
<SECURITIES> 0
<RECEIVABLES> 6,910
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 12,577
<PP&E> 1,661
<DEPRECIATION> 0
<TOTAL-ASSETS> 15,626
<CURRENT-LIABILITIES> 9,193
<BONDS> 0
0
1
<COMMON> 113
<OTHER-SE> 5,259
<TOTAL-LIABILITY-AND-EQUITY> 15,626
<SALES> 0
<TOTAL-REVENUES> 23,740
<CGS> 0
<TOTAL-COSTS> 17,644
<OTHER-EXPENSES> 9,929
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 29
<INCOME-PRETAX> (3,785)
<INCOME-TAX> (717)
<INCOME-CONTINUING> (3,068)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,068)
<EPS-BASIC> (.32)
<EPS-DILUTED> (.32)
</TABLE>
