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As filed with the Securities and Exchange Commission on June 4, 1999
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
______________________
AVTEL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 4813 87-0378021
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification
incorporation or organization) Classification Code Number) No.)
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501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 884-6300
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
ANTHONY E. PAPA
AVTEL COMMUNICATIONS, INC.
501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(805) 884-6300
(Name, address, including zip code, and telephone
number, including area code, of agent for service)
Copies to:
PHILIP J. NIEHOFF THOMAS N. HARDING
MAYER, BROWN & PLATT SEED, MACKALL & COLE LLP
190 SOUTH LASALLE STREET 1332 ANACAPA STREET, SUITE 200
CHICAGO, ILLINOIS 60603 SANTA BARBARA, CALIFORNIA 93101
(312) 782-0600 (805) 963-0669
______________________
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon
as practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. /X/
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /______________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /______________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /______________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
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CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED (1) SHARE (2) PRICE (2) REGISTRATION FEE
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Common Stock ($0.01 par value) 2,103,939 shares $4.81 $10,119,946.59 $2,813.35
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(1) In the event of a stock split, stock dividend or other transaction
involving AvTel common stock, in order to prevent dilution, the number of
shares registered shall automatically be increased to cover the additional
shares in accordance with Rule 416(a) under the Securities Act of 1933.
(2) Estimated solely for purposes of determining the registration fee.
____________________________
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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<PAGE>
SUBJECT TO COMPLETION, DATED JUNE 4, 1999
PROSPECTUS
2,103,939 SHARES
AVTEL COMMUNICATIONS, INC.
COMMON STOCK
_____________________
This prospectus may be used in connection with the resale by Cambois
Finance, Inc., from time to time, of up to 2,103,939 shares of common stock
of AvTel. AvTel will not receive any of the proceeds from the sale of the
shares by Cambois Finance. However, AvTel will receive the sale price of any
common stock that it sells to Cambois Finance pursuant to an equity line
agreement. AvTel has agreed to pay the costs of registering the shares under
this prospectus, including legal fees, commissions and other expenses of
resale of the common stock.
Cambois Finance may offer, pursuant to this prospectus, shares of common
stock to purchasers from time to time in transactions on the Nasdaq SmallCap
Market, in negotiated transactions, or otherwise, or by a combination of
these methods, at fixed prices that may be changed, at market prices
prevailing at the time of sale, at prices related to such market prices or at
negotiated prices. Sales of the shares may be effected through
broker-dealers, who may receive compensation from Cambois Finance in the form
of discounts or commissions. Cambois Finance is an "underwriter" within the
meaning of the Securities Act of 1933 in connection with such sales.
AvTel common stock is listed on the Nasdaq SmallCap Market under the
symbol "AVCO." The last reported sales price for AvTel common stock on the
Nasdaq SmallCap Market on June 3, 1999 was $4.875 per share.
INVESTING IN THE COMMON STOCK INVOLVES CERTAIN RISKS WHICH ARE DESCRIBED
IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 3.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or accurate. Any representation to the contrary
is a criminal offense.
AvTel's principal executive offices are located at 501 Bath Street,
Santa Barbara, California 93101, telephone number: (805) 884-6300.
________________________
The date of this prospectus is ______, 1999.
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TABLE OF CONTENTS
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AvTel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
The Equity Line Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Price Range of AvTel Common Stock. . . . . . . . . . . . . . . . . . . . . . . . . .8
Dividend Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . 10
Management's Discussion and Analysis of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . 37
Security Ownership of Beneficial Owners and Management . . . . . . . . . . . . . . 38
Description of Capital Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Selling Stockholder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Plan of Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Where You Can Find More Information. . . . . . . . . . . . . . . . . . . . . . . . 45
Legal Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Experts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Index to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . .F-1
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_____________________________________
No dealer, salesman or other person has been authorized to give any
information or to make any representation not contained in this prospectus
and, if given or made, such information or representation must not be relied
upon as having been authorized by AvTel or Cambois Finance. This prospectus
does not constitute an offer to sell or a solicitation of an offer to buy of
the securities offered hereby in any jurisdiction to any person to whom it is
unlawful to make such an offer in such jurisdiction. Neither the delivery of
this prospectus nor any sale made hereunder shall, under any circumstances,
create any implication that the information contained in this prospectus is
correct as of any time subsequent to the date of this prospectus or that
there has been no change in the affairs of AvTel since such date.
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AVTEL
AvTel is a provider of broadband network services integrating voice,
data and Internet solutions. AvTel 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.
RISK FACTORS
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS,
TOGETHER WITH OTHER INFORMATION IN THIS PROSPECTUS, IN EVALUATING AN
INVESTMENT IN THE COMMON STOCK. ALL STATEMENTS, TREND ANALYSIS AND OTHER
INFORMATION CONTAINED IN THIS PROSPECTUS RELATIVE TO MARKETS FOR AVTEL'S
PRODUCTS AND TRENDS IN AVTEL'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. THESE FORWARD-LOOKING STATEMENTS ARE
SUBJECT TO BUSINESS AND ECONOMIC RISKS, INCLUDING BUT NOT LIMITED TO THOSE
SET FORTH IN THE FOLLOWING "RISK FACTORS," AND ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE CONTEMPLATED BY THE FORWARD-LOOKING STATEMENTS.
AVTEL HAS EXPERIENCED SIGNIFICANT LOSSES IN EACH OF THE LAST FOUR FISCAL
QUARTERS AND EXPECTS TO CONTINUE TO EXPERIENCE LOSSES FOR THE FORESEEABLE
FUTURE
AvTel has had significant losses in each of its last four fiscal
quarters. AvTel expects that it will continue to lose money for the
foreseeable future. AvTel has not generated enough revenue to offset the
substantial amounts that it has spent to grow its business, and it plans to
continue to incur significant expenses.
AVTEL WILL NEED TO RAISE ADDITIONAL CAPITAL
In the past, AvTel's cash flow from operations, together with its
secured borrowings, has been sufficient to meet its working capital and
capital expenditure requirements. AvTel does not expect to generate
sufficient cash flow to fully implement its business strategy without raising
additional capital. As of March 31, 1999, AvTel was in violation of one
provision of its loan and security agreement with Coast Business Credit that
stipulates that AvTel must maintain a net worth equal to or greater than two
million dollars. AvTel's net worth as of March 31, 1999 was $321,517. Coast
Business Credit has waived its right of acceleration of the obligation as it
relates to AvTel not meeting the net worth covenant through July 31, 1999,
but retains its right of acceleration if AvTel is in violation of the net
worth covenant at any time after July 31, 1999. Accordingly, AvTel will need
to raise additional capital to meet the net worth covenant beginning August
1999 as required by Coast Business Credit.
Although AvTel recently entered into an equity line agreement with
Cambois Finance, through which it may sell or "put" AvTel common stock to
Cambois Finance, the right to put common stock is subject to the satisfaction
of several conditions. If AvTel is unable to put common stock to Cambois
Finance pursuant to the equity line agreement and if it is unable to obtain
other financing in a timely manner and on acceptable terms, AvTel 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
AvTel to continue to operate through the first quarter of 2000. This plan
would include reducing AvTel's workforce, eliminating advertising
expenditures, reducing professional services, reducing or eliminating other
discretionary expenditures, and possibly the sale of assets. If AvTel
implements this plan, its business could be adversely affected, which may
adversely affect its operating results and financial condition.
AVTEL'S STOCK PRICE IS VOLATILE
AvTel common stock has been traded on The Nasdaq SmallCap Market since
May 28, 1998. Trading in its stock was halted by Nasdaq after the close of
trading on November 12, 1998, through the close of trading on November 13,
1998, as a result of an unusual upsurge in its stock price and trading
volume. See "Business--Legal Proceedings." The trading volume of the common
stock has been variable, but generally low. As a result, relatively small
trades may significantly affect the market price of the common stock. The
market price of the shares of
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common stock has been highly volatile and may be significantly affected by
factors such as actual or anticipated fluctuations in AvTel's operating
results, AvTel's announcement of potential acquisitions, changes in
regulations, activities of the largest domestic providers, industry
consolidation and mergers, conditions and trends in the telecommunications
market, adoption of new accounting standards affecting the telecommunications
industry, changes in recommendations and estimates by securities analysts,
general market conditions and other factors. In addition, the stock market
has from time to time experienced significant price and volume fluctuations
that have particularly affected the market prices for the shares of emerging
growth companies like AvTel. Many of these factors are beyond AvTel's
control.
AVTEL IS A DEFENDANT IN A SECURITIES CLASS ACTION LITIGATION; AVTEL MAY BE
ADVERSELY AFFECTED BY AN ADVERSE OUTCOME OF THIS LITIGATION OR BY THE COSTS
OF DEFENDING THIS LITIGATION
As noted above, on November 12, 1998, AvTel experienced an unusual
upsurge in its stock price and trading volume. This unusual event has
triggered the initiation of class action litigation under the federal
securities laws. See "Business--Legal Proceedings." AvTel believes that
these claims are without merit and intends to defend vigorously this
litigation. However, it is not possible at this time for AvTel to predict
with certainty the outcome of this litigation. AvTel's operating results and
financial condition could be adversely affected by an adverse outcome of this
litigation. Even if AvTel prevails in the litigation, the expenses of the
defense could have a material adverse effect on AvTel's operating results and
financial condition.
AVTEL MAY NOT BE ABLE TO COMPETE SUCCESSFULLY
The telecommunications industry is intensely competitive and subject to
rapid change. AvTel's competitors include facilities-based and
non-facilities-based providers, many of which have substantially more
resources than AvTel. Providers compete on the basis of price, customer
service, transmission quality, breadth of service offerings and value-added
services. AvTel believes that competition will continue to increase,
resulting in lower prices. Lower prices could adversely affect AvTel's gross
margins if AvTel is not able to reduce its costs commensurate with price
reductions.
AVTEL MUST KEEP PACE WITH TECHNOLOGICAL CHANGE TO REMAIN COMPETITIVE
The telecommunications industry is in a period of rapid technological
evolution, marked by the introduction of competitive product and service
offerings, such as the use of the Internet for international voice and data
communications. AvTel's future success depends, in part, on its ability to
use leading technologies effectively, to develop its technological expertise,
to enhance its existing services and to develop new services that meet
changing customer needs on a timely and cost-effective basis. AvTel is
unable to predict which technological development will challenge its
competitive position or the amount of expenditures that will be required to
respond to a rapidly changing technological environment. AvTel's failure to
respond in a timely and effective manner to new and evolving technologies
could have a negative impact on its operating results and financial condition.
AVTEL IS DEPENDENT ON TELECOMMUNICATIONS CARRIERS AND OTHER SUPPLIERS
AvTel relies on traditional telecommunications carriers to transmit its
traffic over local and long distance networks. These networks may experience
disruptions that are not easily remedied. In addition, AvTel depends on
certain suppliers of hardware and software. If AvTel's suppliers fail to
provide it with network services, equipment or software in the quantities, at
the quality levels or at the times AvTel requires, it will be difficult for
AvTel to provide its services.
REGULATORY AND LEGAL UNCERTAINTIES COULD HARM AVTEL'S BUSINESS
AvTel's business is subject to various federal and state laws,
regulations, agency actions and court decisions, some of which impose prior
certification, notification, registration and/or tariff requirements on
AvTel. Certificates of authority can generally be conditioned, modified or
revoked by state regulatory authorities for failure to comply with
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state laws and regulations. Fines and other penalties may be imposed. The
loss of a certificate of authority or the imposition of fines or other
penalties could have a material effect on AvTel's business, operating results
and financial condition. In addition, future changes in any of these sources
of regulation could have a material adverse effect on AvTel's business,
operating results and financial condition.
AVTEL'S EXECUTIVE OFFICERS, DIRECTORS AND EXISTING STOCKHOLDERS WILL HAVE THE
ABILITY TO EXERCISE SIGNIFICANT CONTROL OVER IT
AvTel's executive officers, directors and members of their families
beneficially own, in the aggregate, approximately 70% of its common stock
prior to this offering. Although this percentage will decrease each time
AvTel sells common stock to Cambois Finance under the equity line agreement,
these stockholders will be able to exercise control over all matters
requiring approval by AvTel's shareholders, including the election of
directors and the approval of significant corporate transactions. In
addition, effective May 18, 1999, the family members of Jeffrey Jensen, an
AvTel director, entered into a voting trust agreement. Although Mr. Jensen
is not a party to the voting trust agreement, and votes his shares
independent of the voting trust, the voting trust relates to approximately
43% of the AvTel common stock outstanding prior to this offering. This
concentration of ownership may also have the effect of delaying or preventing
a change of control of AvTel, which could negatively affect AvTel's stock
price. Please see "Security Ownership of Beneficial Owners and Management."
FUTURE SALES OF AVTEL COMMON STOCK MAY NEGATIVELY AFFECT ITS STOCK PRICE
Following the offering, AvTel will have a large number of shares of
common stock outstanding and available for resale. In addition, 6,457,123
shares of common stock that are held by executive officers and directors of
AvTel, members of their families and certain charitable foundations are,
pursuant to a registration rights and lockup agreement, currently unable to
be sold by these holders. As of December 1, 1999, these restrictions will no
longer apply, making these shares immediately available for resale, subject,
in some cases, to volume limitations imposed by Rule 144 of the Securities
Act of 1933. AvTel is required to register these shares for resale pursuant
to the registration rights and lockup agreement. The market price of AvTel
common stock could decline as a result of sales of a large number of shares
of AvTel common stock in the market, or the perception that such sales could
occur. These sales might also make it more difficult for AvTel to sell
equity securities in the future at a time that AvTel deems appropriate.
AVTEL IS DEPENDENT ON ITS KEY MANAGEMENT PERSONNEL FOR ITS FUTURE SUCCESS
AvTel's success depends to a significant degree upon the efforts of
senior management personnel, in particular, Anthony E. Papa, AvTel's Chairman
and Chief Executive Officer, and James P. Pisani, AvTel's President and Chief
Operating Officer. The departure of any of AvTel's officers or key employees
could materially adversely affect its ability to implement its business plan.
AVTEL MAY NOT BE ABLE TO HIRE AND RETAIN QUALIFIED EMPLOYEES
AvTel believes that its future success will depend in large part upon
its continuing ability to attract and retain highly skilled personnel.
Competition for qualified, high-level telecommunications personnel is intense
and there can be no assurance that AvTel will be successful in attracting and
retaining qualified personnel. AvTel's loss of the services of one or more of
its key individuals, or its failure to attract and retain other key
personnel, could materially adversely affect AvTel's business, operating
results and financial condition.
AVTEL MAY NOT BE ABLE TO SUCCESSFULLY MAKE ACQUISITIONS OF OTHER COMPANIES
An important component of AvTel's past growth has been to develop its
business through acquisitions. This growth strategy is dependent on the
continued availability of suitable acquisition candidates and subjects AvTel
to a number of risks. Acquisitions may place significant demands on AvTel's
financial and management resources, as the process for integrating acquired
operations presents a significant challenge to AvTel's management and may
lead to
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unanticipated costs or a diversion of management's attention from AvTel's
day-to-day operations. There can be no assurance that AvTel will be able to
successfully integrate into its operations any acquisitions it makes in the
future.
AVTEL COULD LOSE REVENUES AND INCUR SIGNIFICANT COSTS IF ITS SYSTEMS OR
MATERIAL THIRD PARTY SYSTEMS ARE NOT YEAR 2000 COMPLIANT
A significant percentage of the software that runs most of the computers
in the United States relies on two-digit date codes to perform computations
and decision-making functions. Beginning on January 1, 2000, these computer
programs may fail from an inability to interpret date codes properly,
misinterpreting "00" as the year 1900 rather than 2000. In association with
Electronic Data Systems Corporation, AvTel's principal software vendor for
such Year 2000 deficient systems, AvTel is upgrading its billing, credit and
call tracking systems to become Year 2000 compliant, at a cost of up to
approximately $750,000. At the same time, a number of the computers of
AvTel's vendors that interface with AvTel's systems may run on programs that
have Year 2000 problems, which may disrupt AvTel's billing, credit and
tracking systems. Failure of any of the computer programs integral to AvTel's
vendors could adversely affect AvTel's business, operating results and
financial condition. In addition, AvTel is dependent upon the ability of its
service providers to achieve Year 2000 compliance. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance."
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THE EQUITY LINE AGREEMENT
On April 23, 1999, AvTel entered into an equity line agreement with
Cambois Finance, pursuant to which, subject to the satisfaction of certain
conditions, AvTel may issue or sell, from time to time, up to an aggregate of
$13,500,000, after deducting discounts, of its common stock.
Beginning on the date the registration statement, of which this
prospectus is a part, is declared effective by the Securities and Exchange
Commission, and continuing for a period of 36 months thereafter, AvTel may
from time to time, in its sole discretion, sell or "put" shares of its common
stock to Cambois Finance at a price equal to 89% of the then current market
price of the common stock. The current market price of AvTel common stock,
for purposes of calculating the purchase price, is the single lowest closing
bid price, as reported by Bloomberg L.P., of its common stock on the Nasdaq
SmallCap Market for the five days beginning two days before and ending two
days after AvTel notifies Cambois Finance of its intention to put the common
stock to them.
The following conditions must be satisfied before AvTel can put shares
of common stock to Cambois Finance, and before Cambois Finance becomes
obligated to purchase the common stock:
- The registration statement, of which this prospectus is a part, must
have been declared effective by the Securities and Exchange Commission
and must remain effective and available for making resales of the put
shares of AvTel common stock;
- AvTel's representations and warranties to Cambois Finance contained in
the equity line agreement must be accurate as of the date of each put;
- No statute, rule, regulation, executive order, decree, ruling or
injunction may be in effect which prohibits or directly and adversely
affects any of the transactions contemplated by the equity line
agreement;
- At the time of a put, there must not have been any material adverse
change in AvTel's business, operations, properties, prospects or
financial condition since the date of filing of AvTel's most recent
report with the Securities and Exchange Commission pursuant to the
Securities Exchange Act of 1934;
- AvTel common stock must not have been delisted from the Nasdaq
SmallCap Market nor suspended from trading by the Securities and
Exchange Commission or the Nasdaq SmallCap Market;
- AvTel common stock must have a minimum bid price of $2.26 per share at
the time of the put;
- At least 15 trading days must have elapsed since the date of the last
put notice; and
- The dollar value of the average daily trading volume of AvTel common
stock during the 30 days prior to the put date shall be at least
$20,000.
Cambois Finance, or other underwriters of the securities, have the right
to review this registration statement and AvTel's records and properties to
obtain information about it and the accuracy of this registration statement
and prospectus. Cambois Finance has the opportunity to comment on the
registration statement and prospectus, but is not entitled to reject a put by
AvTel based on their review. Cambois Finance may be entitled to
indemnification by AvTel for any lawsuits based on language in this
prospectus with which they do not agree.
There can be no assurance that AvTel will satisfy all conditions
required under the equity line agreement, or will be able to sell any shares
to Cambois Finance under the agreement. Cambois Finance has agreed that it
will not engage in short sales of AvTel common stock except that it may
engage in short sales or other hedging investments that it deems appropriate
with respect to the shares that it purchases in connection with a particular
put, so long as the
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number of shares sold short or used for hedging does not exceed the number of
shares being sold to Cambois Finance under the put, and the short sales are
otherwise in compliance with Regulation M under the Securities Act.
In conjunction with the equity line agreement, AvTel issued to Trinity
Capital Advisors, AvTel's financial advisor for the transaction, 3,000 shares
of common stock, and AvTel is required to pay the financial advisor four
percent of the proceeds actually received under the equity line agreement as
compensation for arranging the transactions set forth in the equity line
agreement.
Under the equity line agreement, AvTel agreed to register the common
stock for resale by Cambois Finance to permit the resale from time to time in
the market or in privately-negotiated transactions. AvTel will prepare and
file such amendments and supplements to the registration statement as may be
necessary in accordance with the Securities Act of 1933 and the rules and
regulations promulgated thereunder, in order to keep it effective as long as
registrable securities are outstanding. AvTel has agreed to bear certain
expenses, other than broker discounts and commissions, if any, in connection
with the registration statement.
PRICE RANGE OF AVTEL COMMON STOCK
AvTel common stock is currently listed on the Nasdaq SmallCap Market
under the symbol "AVCO." For each quarter since the beginning of 1997, the
high and low bid quotations for our common stock, as reported by Nasdaq, were
as follows:
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1997 HIGH LOW
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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
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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
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First Quarter . . . . . . . . . . . . . . . . . . . . . 12.50 4.00
Second Quarter (through June 3, 1999) . . . . . . . . . 8.75 4.44
</TABLE>
The foregoing bid quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commissions and may not necessarily represent actual
transactions.
As of May 11, 1999, there were 397 record holders of AvTel common stock.
The last reported sales price of AvTel common stock on June 3, 1999 was
$4.875.
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DIVIDEND POLICY
AvTel has never declared or paid any dividends on its common stock.
Further, AvTel 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 board of directors intends to review AvTel's dividend
policy from time to time. Under its secured credit facility with Coast
Business Credit, AvTel is prohibited from paying cash dividends unless
approved by Coast Business Credit. In addition, AvTel 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 AvTel receives this approval, the
holders of the outstanding series A and series B preferred stock are entitled
to be paid any unpaid dividends 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.
USE OF PROCEEDS
The proceeds from the sale of common stock will be received directly by
Cambois Finance. No proceeds will be received by AvTel from the sale of the
common stock offered by this prospectus. However, AvTel will receive the put
price pursuant to the equity line agreement if and to the extent the common
stock is sold by AvTel to Cambois Finance pursuant to the equity line
agreement. The put price equals 89% of the then current average market price
of AvTel common stock, as determined under the equity line agreement. See
"The Equity Line Agreement." All proceeds from the sale of common stock
under the equity line agreement will be used for working capital and other
general corporate purposes.
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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 AvTel. 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 AvTel's
consolidated financial statements, which statements have been audited by KPMG
LLP, independent certified public accountants. AvTel'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
prospectus. The information for the three months ended March 31, 1999 and
1998 was not derived from audited financial statements, but in the opinion of
AvTel'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 three
months ended March 31, 1999 is not necessarily indicative of the results that
can be expected for the year ending December 31, 1999.
On December 1, 1997, AvTel and Matrix Telecom, Inc. completed a share
exchange, whereby all of the outstanding stock of Matrix Telecom was
exchanged for shares of AvTel common stock. For accounting purposes, the
share exchange was treated as a reverse acquisition of AvTel by Matrix
Telecom. Accordingly, AvTel's results of operations reflect the operations
of Matrix Telecom prior to December 1, 1997 and reflect the combined
operations of AvTel and Matrix Telecom 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 THREE MONTHS
ENDED MARCH 31, YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
---------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues........................ $9,322,414 $12,444,839 $44,013,498 $51,389,080 $71,558,295 $64,289,718 $59,551,307
Operating income (loss)......... (2,982,190) (1,704,470) (7,423,753) (10,757,960) 4,091,034 2,422,393 604,109
Net income (loss)............... (3,066,131) (1,672,490) (7,127,318) (10,191,720) 2,566,734 (2,440,493) 643,200
Net loss per common
share-basic and diluted (1)..... (0.29) (0.18) (0.74) (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 MARCH 31, AS OF DECEMBER 31,
---------------------------------------------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
------------ ---------- ------------ ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Working capital (deficit)....... ($4,604,708) $4,341,015 ($3,022,959) $5,570,657 $6,066,620 $206,071 ($140,741)
Total assets.................... 13,023,590 17,731,204 14,634,354 18,724,850 20,338,404 17,580,694 14,957,279
Long term borrowings............ 2,188,458 -- 1,112,890 -- -- -- --
Stockholders' equity............ 321,517 6,401,111 3,185,253 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 AvTel as a result of the reverse acquisition in 1997.
-10-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF AVTEL'S FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH AVTEL'S FINANCIAL
STATEMENTS, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE IN THIS
PROSPECTUS. ALL STATEMENTS, TREND ANALYSIS AND OTHER INFORMATION CONTAINED IN
THIS PROSPECTUS RELATIVE TO MARKETS FOR AVTEL'S SERVICES AND TRENDS IN
AVTEL'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, AvTel and Matrix Telecom completed a share
exchange, whereby all of the outstanding common stock of Matrix Telecom was
exchanged for shares of AvTel common stock. For accounting purposes, the
share exchange was treated as a reverse acquisition of AvTel by Matrix
Telecom. AvTel was the legal acquirer and accordingly, the share exchange
was effected by the issuance of AvTel common stock in exchange for all of the
common stock then outstanding of Matrix Telecom. In addition, holders of
Matrix outstanding stock options received non-qualified stock options of
AvTel. The following discussion of results of operations reflects the
operations of Matrix Telecom prior to December 1, 1997 and reflects the
combined operations of AvTel and Matrix Telecom subsequent to December 1,
1997. Accordingly, references to AvTel refer to operations of Matrix Telecom
prior to the share exchange and the combined operations of Matrix Telecom and
AvTel subsequent to the share exchange.
The reverse acquisition of AvTel by Matrix Telecom was accounted for
using the purchase method of accounting. In order to value the consideration
given in the share exchange, the market price of AvTel common stock for a
period immediately preceding the announcement of the share exchange was used.
As of the date of acquisition, AvTel determined the fair value of the net
tangible and intangible assets and liabilities acquired. The underlying fair
value of AvTel's net assets was substantially less than the indicated market
value of AvTel's common and preferred stock. Accordingly, AvTel 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 Telecom acquired New Best Connections,
Inc., an affiliate of Matrix Telecom 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 Telecom 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. AvTel is in the process of merging Best Connections into
AvTel.
ACQUISITION AND DISPOSITION OF DNS COMMUNICATIONS, INC.
In October 1995, Matrix Telecom 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 and as of
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<PAGE>
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 Telecom 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 Telecom and a former shareholder of DNS Communications for
approximately $5.2 million. Matrix Telecom 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 Telecom has recorded its interest in
DNS Communications operations using the equity method of accounting.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1998
REVENUES
Revenues for the three months ended March 31, 1999 were $9.3 million, a
decline of 25.1% or $3.1 million from $12.4 million for the three months
ended March 31, 1998. Revenue of AvTel's Business Markets Group increased
$1.4 million, which is in part attributable to the acquisition of Remote
Lojix/PCSI, Inc. during the fourth quarter of 1998. Revenue of AvTel's
Channel Markets Group decreased $4.5 million. The Channel Markets Group's
revenue from traditional voice products declined $4.7 million, while Internet
revenue increased $167,000 or 21.0%. 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 AvTel during the period continued to
be voice distribution channels. Pricing pressures within the industry
continued to reduce retail pricing of long distance products. These factors,
similar in nature to those affecting all resellers of long distance, have
continued to affect a decline in the Channel Markets Group's revenues for the
three months ended March 31, 1999 compared to the three months ended March
31, 1998. Decreases in the Channel Markets Group's revenues were additionally
affected by a continued attrition of a maturing customer base primarily in
the areas of telemarketed and direct mail customers, which was determined not
to be cost effective. Revenue from these bases decreased $1.9 million to $1.5
million for the three months ended March 31, 1999 from $3.4 million for the
three months ended March 31, 1998. Consistent with plan, AvTel determined to
turn the sales force focus away from these channels and towards affinity and
agent groups.
Excluding consumer voice traffic, AvTel's revenues generated by the data
needs of its customers increased $1.7 million to $3.8 million for the three
months ended March 31, 1999 from $2.1 million for the three months ended
March 31, 1998. Accordingly, AvTel's dependence on revenue from voice
distribution channels decreased 23 percentage points to 60% of AvTel's total
revenue for the three months ended March 31, 1999 from 83% for the three
months ended March 31, 1998.
As of April 30, 1999, the Business Markets Group had over 30 accounts in
the process of activation and installation. AvTel expects these new accounts
to start producing revenue within 60 to 120 days. In addition, as of April
30, 1999, the Channel Markets Group had added seven new Internet service
providers and four affinity groups with the ability to reach up to 180,000
members, with marketing agents nationwide.
Data networking needs of the corporate customer and the Internet have
continued to drive and change the telecom industry. The future focus of AvTel
continues to move toward incorporating voice and data networking solutions
into the construction of corporate intranets and wide area networks which
will decrease its dependence on traditional long distance services of the
residential consumer.
-12-
<PAGE>
GROSS MARGIN
Gross margin as a percentage of revenues increased by 3.6 percentage
points to 29.0% for the three months ended March 31, 1999 from 25.4% for the
three months ended March 31, 1998. Gross margin decreased $455,000 to $2.7
million for the three months ended March 31, 1999 from $3.2 million for the
three months ended March 31, 1998.
The Business Markets Group's gross margin as a percent of revenue
increased 12.5 percentage points to 23.4% for the three months ended March
31, 1999 from 10.9% for the three months ended March 31, 1998. Two primary
factors affected this increase. First, AvTel negotiated significantly lower
rates with 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 International, Inc., 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 4.2 percentage points to 31.3% for the three months ended March 31,
1999 from 27.1% for the three months ended March 31, 1998. The increasing
Internet service gross margin, coupled with the stable and slightly
increasing traditional voice gross margin, have resulted in an overall higher
gross margin. Internet service gross margin within the Channel Markets Group
increased $187,000 or 33.4% to $745,000 for the three months ended March 31,
1999 from $559,000 for the three months ended March 31, 1998. Provision for
bad debt decreased $274,000, which was fully attributable to the decline in
voice revenues.
SELLING, GENERAL, AND ADMINISTRATIVE COSTS
Selling, general, and administrative costs increased $707,000 to $5.3
million for the three months ended March 31, 1999 from $4.6 million for the
three months ended March 31, 1998. As a percentage of revenues, selling,
general, and administrative costs increased by 19.9 percentage points to
56.7% for the three months ended March 31, 1999 from 36.8% for the three
months ended March 31, 1998.
The Business Markets Group's selling, general, and administrative costs
increased $1.4 million to $2.0 million for the three months ended March 31,
1999 from $608,000 for the three months ended March 31, 1998. The primary
reason for the increase was attributable to the acquisition of Remote Lojix
and Digital Media in the fourth quarter of 1998. The remaining increase in
cost was associated with expanded sales force and related expenses including
general office expense, rent, utilities and travel expenditures.
The Channel Markets Group's selling, general, and administrative costs
decreased $665,000 to $3.3 million for the three months ended March 31, 1999
from $4.0 million for the three months ended March 31, 1998. As a percent of
revenue, selling, general, and administrative costs increased 14.6 percentage
points to 50.4% for the three months ended March 31, 1999 from 35.8% for the
three months ended March 31, 1998. The principal reason for the decrease in
costs was attributable to the decline in billing and collection, and
commission expenses associated with the decline in revenue. Stock
compensation expense for the three months ended March 31, 1999 was $81,000
compared to $234,000 for the three months ended March 31, 1998, a decrease of
$153,000. Certain option and restricted stock plans were accelerated and
completely expensed during 1998. Additionally, commission expense declined
$174,000 for the quarter ended March 31, 1999 due to the amortization of
advanced commissions being fully realized during 1998.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $116,000 to $395,000 for the
three months ended March 31, 1999 from $279,000 for the three months March
31, 1998. The increase primarily resulted from the acquisition and
consolidation of assets related to the purchase of Remote Lojix and Digital
Media during the fourth quarter of 1998, and the amortization of certain
intangible costs related to a long term borrowing agreement entered into on
October 1998.
-13-
<PAGE>
INTEREST EXPENSE AND OTHER INCOME, NET
Interest expense increased $87,000 to $99,000 for the three months ended
March 31, 1999 from $12,000 for the three months ended March 31, 1998. The
Company recognized $56,000 of interest expense from long term borrowings and
$34,000 from accrued interest on liabilities acquired with the Remote Lojix
purchase. Other income decreased $29,000 to $15,000 for the three months
ended March 31, 1999 from $44,000 for the three months ended March 31, 1998
primarily due to a decrease in the amount of cash available for investment.
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 AvTel's Channel Markets Group. AvTel's focus is to be a
provider of broadband network services integrating voice, data and Internet
solutions to mid-size corporations, small-office home-office professionals
and select residential market segments. Historically, the Channel Markets
Group has focused on selling retail 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
AvTel'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, AvTel 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 a continued attrition and
price reductions of a maturing customer. The effects of reduced revenue from
discontinued sales channels is expected to be offset by increasing revenues
from AvTel's repositioning of the Channel Markets Group and the addition of
new marketing organizations. The effects of competitive lower pricing as
well as the decline of the customer base is expected to lessen dramatically
as pricing pressure decreases within the industry and reaches its floor, and
AvTel increases its focus on third party distributors, affinity groups and
niche markets. Management additionally anticipates that the revenue decrease
will stabilize as the continued integration of and revenue from the Business
Markets Group targeting corporate data networking, voice and Internet service
needs continues to expand and grow beyond the long distance portion.
Decreases in revenues following the share exchange of AvTel and Matrix
Telecom effective December 1, 1997 were anticipated by AvTel 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 AvTel's dependence on low
margin, high churn segments and to focus its resources in the business
markets with higher average billing and retention rates, niche ethnic
consumer markets, small office-home office distributors and agents, and
Internet service providers. For the year ended December 31, 1998, revenues
generated from discontinued sales channels decreased 43.4% or $8.2 million to
$10.7 million from $18.9 million for the year ended December 31, 1997. Long
distance revenue generated from agents increased 3.5% or $665,000 to $19.5
million for the year ended December 31, 1998 from $18.9 million for the year
ended December 31, 1997.
Data networking needs of the corporate customer and the Internet have
continued to drive and change the telecom industry. AvTel'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 AvTel's dependence on traditional
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<PAGE>
long distance services of the residential consumer. AvTel'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, AvTel 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 AvTel'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 AvTel's now discontinued
casual calling business. The majority of AvTel's revenues are billed by the
local exchange carriers and AvTel'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 AvTel's bad
debt expense as a percentage of revenues increased. The majority of new
products being sold by AvTel have been designed as direct billed or
electronic Internet billed products, and the bad debt percentages experienced
by AvTel's internal collection staff are significantly lower than those of
the local exchange carriers. For the fourth quarter of 1998, AvTel
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 AvTel
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 AvTel'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 AvTel, effective November 1, 1998. As of December 31, 1998, AvTel
had three primary business locations, eight additional sales locations
throughout the United States and 47 sales and marketing related employees
compared to two primary business locations, two remote sales locations and 21
sales and marketing related employees as of December 31, 1997.
The decrease in revenue as explained above resulted in a decrease in
selling expenses of $1.6 million for the year ended December 31, 1998. Stock
compensation expense for the year ended December 31, 1998 was $477,000
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<PAGE>
compared to $749,000 for the year ended December 31, 1997. The change was due
primarily to two circumstances. First, during 1998, AvTel 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
AvTel. Accordingly, stock compensation was expensed under the requirements
of SFAS No. 123.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $427,000 to $1,107,000 for the
year ended December 31, 1998 from $680,000 for the year ended December 31,
1997. The increase primarily resulted from amortization of the acquired
customer base associated with the share exchange of AvTel and Matrix Telecom
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, AvTel
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 AvTel
and Matrix Telecom. 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
AvTel recognized a tax benefit of $202,000 for the year ended December
31, 1998 compared to $276,000 for the year ended December 31, 1997. The tax
benefit in 1998 resulted from the loss from operations. As of December 31,
1998, AvTel has net operating loss carryforwards for federal tax purposes of
approximately $9.1 million which are available on a limited basis to offset
future federal taxable income, if any, through 2018.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
REVENUE
Revenue for the year ended December 31, 1997, decreased 28.1% or $20.2
million to $51.4 million from $71.6 million for the year ended December 31,
1996. The decrease in revenue resulted primarily from decreases in sales
from three significant sales channels, all of which were affiliated with
AvTel through substantially common ownership prior to the share exchange of
AvTel and Matrix Telecom 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 resulting from the sale of the DNS Communications customer
bases in June of 1996.
AvTel 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.
-16-
<PAGE>
Attrition rates associated with long distance products are a normal industry
occurrence; however, methods of calculation differ within the industry.
AvTel sought to reduce its risk from reliance on a small group of
distributors, and refocused to obtain multiple revenue sources external to
AvTel. New distributors significantly contributed to the mix in 1997. 1997
sales from sources other than AvTel'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, AvTel was forced to
continue decreasing its retail rates in 1997 to meet the competitive rate
reductions; however, the underlying carrier costs to AvTel 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 AvTel's revenues were billed
and collected from the local exchange carriers, with which AvTel has
agreements. Collection policies and aggressiveness in collection procedures
differ among the local exchange carriers. AvTel 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
AvTel's selling, general, and administrative costs decreased $2.7
million in 1997 from 1996. As a percentage of revenue, such costs increased
5.1 percentage points to 31.4% for the year ended December 31, 1997 compared
to 26.3% for the year ended December 31, 1996. This increase resulted
primarily from the decrease in revenues causing the expense as a percentage
of revenue to increase. Certain changes are more fully described below.
Certain selling, general, and administrative costs related to the
addition of AvTel operations to Matrix Telecom subsequent to the effective
date of the share exchange, December 1, 1997, amounted to approximately
$286,000, accounting for .56% of the increase as a percentage of revenues in
1997 over 1996. Selling costs related to direct mailing to the casual or
dial-around customer (which were absorbed by the sales distributor in 1996)
were approximately $605,000 in 1997, accounting for 1.18% of the increase as
a percentage of revenues in 1997 over 1996. Salary expenses increased
approximately $651,000 between the years, or 3.76% as a percentage of
revenues in 1997 over 1996, resulting primarily from integration of AvTel
employees subsequent to the share exchange and the addition of certain sales
and marketing personnel in 1997.
Billing and collection fees and distributor commissions decreased
approximately $3.9 million, or 1.82% as a percentage of revenues. Most of
the new products sold in 1997 were direct billed. As the percentage of
direct billed customers increased, billing and collection fees have
decreased. Similarly, as sales of certain products having a higher commission
structure have declined, commission expense has also declined.
Certain regulatory and professional services increased approximately
$266,000, or 1.22% as a percentage of revenues in 1997 over 1996. Carrier
fees specific to telecommunication providers upon reaching certain thresholds
of customers were met in the last half of the year in 1996; therefore,
increased fees in 1997 resulted from being charged the lower volume based
fees for a full year. Professional fees increased in 1997 over 1996 for two
primary reasons. First, due to increased market demands for information
systems programmers, AvTel was forced to secure external contractors.
Second, certain telemarketing and verification costs associated with the
sales process increased in 1997
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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. AvTel
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
AvTel 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
AvTel'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, AvTel reported net losses of $7,127,318 and $10,191,720,
respectively. In addition, as of December 31, 1998, AvTel had a working
capital deficit of $3,022,959, and for the year ended December 31, 1998, net
cash used in operations totaled $5,978,797. During the quarters that ended
March 31, 1999 and March 31, 1998, AvTel reported net losses of $3,066,131
and $1,672,490, respectively. In addition, as of March 31, 1999, AvTel had a
working capital deficit of $4,604,708, and for the quarter ended March 31,
1999, net cash used in operations totaled $1,307,598.
As a result, as of March 31, 1999, unless AvTel effects substantial
changes in its operating methods, AvTel does not have sufficient resources to
meet its anticipated operating requirements during 1999 without obtaining
additional financing. Although AvTel recently entered into an equity line
agreement, through which it may sell or "put" AvTel common stock to Cambois
Finance, the right to put common stock is subject to the satisfaction of
several conditions. If AvTel is unable to put common stock to Cambois Finance
pursuant to the equity line agreement or if it is unable to obtain other
financing in a timely manner and on acceptable terms, management is
developing and intends to implement a plan that would allow AvTel to continue
to operate through the first quarter of 2000. This plan would include
significantly reducing AvTel's workforce, eliminating advertising
expenditures, reducing professional services, reducing or eliminating other
discretionary expenditures and possibly the sale of assets. The equity line
agreement provides for Cambois Finance to purchase up to $13,500,000 of AvTel
common stock, subject to AvTel 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 "Equity
Line Agreement."
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On October 2, 1998, AvTel 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, AvTel 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% (9.75% at March 31, 1999). As of December
31, 1998, borrowing outstanding under the credit facility amounted to
$1,113,000 with approximately $1,634,000 available for future borrowings. As
of March 31, 1999, borrowings outstanding under the credit facility amounted
to $2,188,000 with approximately $424,000 available for future borrowings.
Borrowings under the credit facility are secured by substantially all of the
assets of AvTel. The credit facility expires on October 31, 2000. Net cash
provided by financing activities was $1.2 million and $18,000 for the three
months ended March 31, 1999 and 1998, respectively.
As of March 31, 1999, AvTel was in violation of one provision of the
loan and security agreement with Coast Business Credit that stipulates that
AvTel must maintain a net worth equal to or greater than two million dollars.
AvTel's net worth as of March 31, 1999 was $321,517. Coast Business Credit
has waived its right of acceleration of the obligation as it relates to AvTel
not meeting the net worth covenant through July 31, 1999, but retains its
right of acceleration if AvTel is in violation of the net worth covenant in
any month after July 31, 1999. AvTel believes that the equity line agreement
that it entered as of April 23, 1999, together with the proceeds from the
issuance of 1,500 shares of its newly-designated series B convertible
preferred stock for $1,500,000, less $60,000 in costs, will enable it to meet
the net worth covenant beginning August 1999 as required by Coast Business
Credit.
The primary sources of operating cash flow for AvTel are (1) revenues
derived from the sale of information technology and telecommunications
services to individuals and business, (2) its secured credit 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 $1.3 million for
the three months ended March 31, 1999, compared to $1.2 million for the three
months ended March 31, 1998.
An important component of AvTel's past growth has been to develop its
business through acquisitions, including the share exchange and the
acquisitions of Remote Lojix and Digital Media. AvTel intends to continue
this strategy. In appropriate circumstances, AvTel may use its capital stock
for acquisitions in addition to debt and equity financing.
On April 13, 1999, AvTel 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 AvTel's
option. The annual dividend will increase to $60 per share if AvTel 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. The conversion price will not be less than $3.00 for 180 days
after the date of issuance of the series B convertible preferred 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, AvTel could
issue up to 750,000 shares of common stock upon conversion if all of the
series B convertible preferred stock were converted at the lowest possible
conversion price, assuming such revenue and EBITDA requirements continue to
be met. Unless AvTel has obtained the approval of its voting stockholders in
accordance with the rules of The Nasdaq Stock Market, AvTel will not issue
shares of common stock upon conversion
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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 AvTel 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. AvTel will pay converting
series B investors in cash for any excess over such amount.
Although the conversion feature of the series B convertible preferred
stock will not effect AvTel's net loss, it will increase AvTel's basic and
fully-diluted loss per share attributable to its common stock in the second
quarter of 1999. The loss used in the per share calculation will be
increased by the difference between the conversion price and the trading
price of the common stock on the date the series B convertible preferred
stock first becomes convertible multiplied by the number of shares issuable
upon conversion at that date.
AvTel 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.
AvTel and the series B investors entered into a Registration Rights
Agreement that requires AvTel 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 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. AvTel
will be subject to significant monetary penalties if it fails to obtain or
maintain the effectiveness of such registration statement. AvTel filed the
registration statement on May 20, 1999 and it went effective on June 2, 1999.
AvTel paid Trinity Capital Advisors, Inc. $60,000 as compensation for
providing financial advisory services relating to the series B stock.
As of December 31, 1998, AvTel had a working capital deficit of $3.0
million. AvTel's accounts receivable decreased to $4.8 million at December
31, 1998 from $7.0 million at December 31, 1997. The decrease was primarily
due to a corresponding decrease in sales described elsewhere in this
discussion. Current liabilities increased to $10.2 million as of December 31,
1998 from $9.8 million as of December 31, 1997. The increase in current
liabilities is due to the additional liabilities acquired with the purchase
of Remote Lojix, offset by the decrease in accrued liabilities due to a
corresponding decrease in sales. Sales and excise taxes included in current
liabilities increased to $1.4 million for the year ended December 31, 1998
from $736,000 for the year ended December 31, 1997, as a result of the tax
liabilities assumed with the purchase of Remote Lojix. Due to affiliates
decreased to $324,000 for the year ended December 31, 1998 from $2.7 million
for the year ended December 31, 1997. In 1998, Pacific Gateway Exchange was
no longer affiliated with AvTel. As of December 31, 1997, $2.3 million was
included in due to affiliates associated with Pacific Gateway Exchange.
Net cash used in investing activities was $201,000 for the three months
ended March 31, 1999, and net cash provided by investing activities was
$322,000 for the three months ended March 31, 1998. AvTel loaned $2.0 million
to an affiliated company during 1997. Of such amount, $201,000 was repaid
during 1997, $410,000 was repaid during the first quarter of 1998 and the
remainder was repaid in subsequent quarters of 1998.
The Company 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 March 31, 1999. A hypothetical increase of 97 basis
points in interest rate (ten percent of the Company's overall borrowing rate)
would not result in a material fluctuation in future earnings or cash flow.
The Company 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
The Year 2000 issue concerns the inability of computer systems and
certain other equipment to properly recognize and process data that uses two
digits rather than four to designate particular years. AvTel has initiated a
Year 2000 project plan to assess whether its systems that process date
sensitive information will perform satisfactorily leading up to and beyond
January 1, 2000. The goal of the plan is to correct, prior to January 1,
2000, any Year 2000-related problem with critical systems, the failure of
which could have a material adverse effect on AvTel's operations. The plan
includes steps to (1) identify each critical system element that requires
date code remediation, (2) establish a plan to remediate such systems, (3)
implement all required remediations and (4) selectively test the remediated
systems.
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Thus far, the identification phase has identified Year 2000 issues in
the following critical systems owned and leased by AvTel: rating and billing
systems used by AvTel to process and prepare billing data for its customer
base. In addition, AvTel receives critical services from providers of
utilities and other services to facilities that house employees and
equipment. AvTel is also critically reliant upon the systems of other
telecommunications providers on which AvTel depends to deliver services and
invoices to its customers. The identification and planning phases of the
plan are materially complete as they relate to systems owned and leased by
AvTel. As they relate to third party vendors and other telecommunications
carriers, the identification and planning phases are on-going and are
expected to be materially complete during second quarter 1999.
Based on work completed under the plan to date, AvTel currently intends
to take the following additional steps under its plan with respect to owned
and leased systems, third-party vendors and other telecommunications carriers:
- AvTel generally plans to remediate owned and leased rating, billing
and collection systems through the revision or replacement of current
system components. Necessary changes to systems owned and leased by
AvTel are in process and are expected to be completed by third quarter
1999. The selective testing and verification of such changes are
expected to be completed in the third quarter of 1999. Due to the
large number of system components requiring remediation, AvTel does
not intend to test every remediated system but will rely upon the
results of testing of the critical components of such systems to
determine the effectiveness of remediation efforts. Components not
tested are not considered critical to AvTel's business.
- With respect to critical services provided by utilities and other
third parties, AvTel is in the process of contacting all such
suppliers. Thus far, a majority of those suppliers who have responded
have indicated that their systems and service delivery mechanisms are
Year 2000 compliant or can be made so through currently available
modifications. AvTel plans to continue monitoring all third-party
remediation efforts and to develop contingency plans for the delivery
of such services as necessary.
- The Year 2000 compliance status of other telecommunications providers
with which AvTel's systems interact is not yet known. AvTel is making
inquiries of these providers to determine their compliance status and
expects to obtain the results of compliance tests during second
quarter 1999, although there can be no assurance that providers will
supply this information.
While AvTel currently believes that it will be able to remediate and
selectively test owned and leased systems in time to minimize any detrimental
effect on its operations, there can be no assurance that such steps will be
successful. Failure by AvTel to timely and effectively remediate its
systems, or the failure of critical vendors and suppliers and other
telecommunications carriers to remediate affected systems, could have a
material adverse impact on AvTel's business, financial condition, results of
operations and prospects. Because the impact of Year 2000 issues on AvTel is
materially dependent on the mitigation efforts of parties outside AvTel's
control, AvTel cannot assess with certainty the magnitude of any such
potential adverse impact. However, based upon risk assessment work conducted
thus far, AvTel believes that the worst case scenario of the failure by
AvTel, its suppliers or other telecommunications carriers with which AvTel
interacts to resolve Year 2000 issues would be an inability by AvTel to
timely and accurately process service requests and to timely and accurately
bill its customers. In addition to lost earnings, these failures could also
result in loss of customers due to service interruptions and billing errors,
substantial claims by customers and increased expenses associated with
stabilizing operations and executing mitigation plans.
Contingency planning to maintain and restore service in the event of
natural disasters, power failures and systems-related problems is a routine
part of AvTel's operations. AvTel believes that such contingency plans will
assist AvTel in responding to the failure by outside service providers to
successfully address Year 2000 issues. In addition, AvTel 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
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2000-specific contingency plans are expected to be materially completed
during the second quarter of 1999, but their review and development will
continue throughout 1999.
Although the total costs to implement the plan cannot be precisely
estimated, AvTel incurred minimal costs during 1998 (none of which was
related to hardware costs) and anticipates spending an aggregate of
approximately $750,000 during 1999 (which includes $250,000 of hardware
costs). These costs will be expensed as incurred, unless new systems or
equipment are purchased that should be capitalized in accordance with
generally accepted accounting principles. Some of the costs represent ongoing
investment in systems upgrades, the timing of which is being accelerated in
order to facilitate Year 2000 compliance. In some instances, these upgrades
will position AvTel to provide more and better-quality services to its
customers than they currently receive. AvTel expects to fund these costs with
a combination of financing provided by the hardware vendor, cash provided by
operations, and other debt or equity financing. Cost estimates and
statements of AvTel's plans discussed above are forward-looking statements
that are derived using numerous assumptions of future events, many of which
are outside AvTel's control, including the availability and future cost of
trained personnel and various other resources, third party modification
plans, the absence of systems requiring remediation that have not yet been
discovered, and other factors.
INFLATION
AvTel does not believe that the relatively moderate rates of inflation
over the past three years have had a significant effect on its net sales or
its profitability.
RECENTLY-ISSUED ACCOUNTING PRONOUNCEMENTS
On January 1, 1998, AvTel adopted SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for reporting and presentation of
comprehensive income and its components in a full set of financial
statements. Comprehensive income consists of net income and net unrealized
gains (losses) on securities and is presented in the consolidated statements
of stockholders' equity and comprehensive income. The statement requires
only additional disclosures in the consolidated financial statements; it does
not affect AvTel's financial position or results of operations. Comprehensive
income (loss) for the years ended December 31, 1998, 1997 and 1996 and for
the three-months ended March 31, 1999 and 1998 is equal to net income (loss)
reported for such periods.
In 1998, AvTel adopted the provisions of SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for the way that public business enterprises report information
about operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. This statement supersedes SFAS No. 14, Financial
Reporting for Segments of a Business Enterprise, but retains the requirement
to report information about major customers. See Note 11 of the Notes To
Consolidated Financial Statements for segment disclosures.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
133 establishes accounting and reporting standards for derivative instruments
and hedging activities. This statement is effective for all fiscal quarters
of all fiscal years beginning after June 15, 1999. Management does not
anticipate that this statement will have a material impact on AvTel's
consolidated financial statements.
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BUSINESS
BACKGROUND
GENERAL
AvTel Communications, Inc. is a provider of broadband network services
integrating voice, data and Internet solutions. AvTel 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. AvTel targets mid-size corporations and
resellers and distributors of communications services.
HISTORY
AvTel was incorporated on October 31, 1981, but did not commence its
current business until February, 1995. Prior to October 23, 1996, AvTel
conducted operations under the name "Hi, Tiger International, Inc.". The
name change was effected in connection with AvTel's acquisition of AvTel
Holdings, Inc., a California corporation on that date. As a result of the
acquisition of AvTel Holdings, AvTel 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 AvTel 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 AvTel with and into AvTel Holdings, as a result
of which AvTel acquired 100% of the issued and outstanding capital stock of
AvTel Holdings in exchange for 1,063,127 shares of AvTel common stock,
representing approximately 61% of the issued and outstanding AvTel common
stock after giving effect to the merger, and 250,000 shares of newly
authorized shares of AvTel'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, AvTel acquired Silicon Beach Communications, Inc., an
Internet service provider and provider of software development services. In
February, 1997, AvTel acquired all of the issued and outstanding capital
stock of WestNet Communications, Inc., a Ventura, California Internet service
provider. Following completion of this acquisition, AvTel 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, AvTel acquired Matrix Telecom, a privately-held
Texas corporation by means of a share for share exchange. Matrix Telecom is
a provider of long distance telephone services. See "Background--Acquisition
of Matrix Telecom" below.
On September 25, 1998, AvTel acquired all of the issued and outstanding
capital stock of Digital Media, a privately-held corporation based in Santa
Barbara, California, which develops software for educational, entertainment
and other applications.
In November, 1998, AvTel acquired all of the issued and outstanding
capital stock of Remote Lojix, 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.
ACQUISITION OF MATRIX TELECOM
AvTel and Matrix Telecom 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 Telecom
would transfer to AvTel all of their Matrix Telecom stock and, in exchange,
AvTel would issue to the Matrix Telecom stockholders shares of AvTel common
stock. The share exchange was completed pursuant to the terms of
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the stock exchange agreement on December 1, 1997. For accounting purposes,
the acquisition was treated as a reverse acquisition with Matrix Telecom as
the acquirer.
In connection with the completion of the share exchange, the Matrix
Telecom stockholders and AvTel 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 Telecom common stock agreed, for a two-year period
commencing on the closing of the share exchange, not to offer, pledge, sell,
or otherwise dispose of any shares of the Company issued to them pursuant to
the terms of the stock exchange agreement. As of April 30, 1999, this
"lockup" provision relates to a total of 6,457,123 shares of AvTel stock held
by the following shareholders: Ronald L. Jensen (329,321 shares), Gladys
Jensen (731,847 shares), James J. Jensen (800,000 shares), Jami J. Jensen
(851,738 shares), Janet Jensen Krieger (961,939 shares), Jeffrey J. Jensen
(851,738 shares), Julie J. Jensen (851,738 shares), The RJ & GJ Foundation
(329,692 shares), The Janet Foundation (24,124 shares), The OUI Foundation
(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 AvTel 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, AvTel 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
AvTel 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 AvTel.
BUSINESS OF AVTEL
AvTel is a provider of broadband network services integrating voice,
data and Internet solutions. AvTel sells and markets a broad range of
telecommunications and advanced network services through independent value
added resellers and internal direct sales professionals. AvTel targets
mid-size corporations and resellers and distributors of communications
services through two primary business units: the Business Markets Group and
the Channel Markets Group.
BUSINESS MARKETS GROUP
The Business Markets Group targets mid-size corporate customers for
their broadband data, voice and Internet networking needs. Following this
sales strategy, AvTel's objective is to become the underlying
telecommunications carrier for the transport of data, voice and Internet
traffic. Through a value-added sales process, AvTel designs, provisions and
manages its customers' networks. AvTel will provide a host of additional
value added services assisting its customers to create enhanced intranet and
extranet applications. AvTel believes its strategy to focus on the corporate
customer for enterprise-wide network services offers significant opportunity.
The Business Markets Group 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. AvTel's Business Markets Group strategy is driven by
corporate end users' needs for network connectivity as a result of new
software applications and technology advancements developed in the
information technology arena. This has become a critical element in the
ability of businesses, professional and other organizations to improve
productivity and lower costs. This can be accomplished through the use of a
variety of telecommunications services, including branch office, remote
office and telecommuter networking ("intranets") as well as providing network
access to customers, vendors, suppliers ("extranets") and the Internet.
While management expects these factors to continue to increase market demand
for
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these services, there are no assurances regarding the size of such demand or
that AvTel 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
and wide area 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.
AvTel 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. AvTel'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. AvTel believes that communications
requirements such as bandwidth availability and network design are replacing
computer requirements such as processor speed, memory or operating systems as
the delimiting factors for business applications. Video conferencing, remote
patient diagnostics with medical imaging and telecommuting are all business
applications in which the success of the deployment is defined by the
available bandwidth. The ultimate realization of this trend is the Web and
applications developed with Internet-specific tools. Web-based applications
are computer platform and operating system independent but depend entirely
upon connectivity and bandwidth for successful deployment and execution.
As a result, connectivity is becoming one of the most important factors
in enhancing business productivity and customer service. Large corporations
have historically created private wide area networks through leased dedicated
data lines. However, dedicated point-to-point facilities have several
deficiencies: leased lines are very expensive; remote offices and
telecommuters are omitted; and leased lines are not suited for unscheduled
and asynchronous communications. Accordingly, small and medium size companies
that have sought the benefits of internetworking have been required to use
modems and dial-up telephone lines which are generally too slow to handle
today's applications.
Growing demands for high speed capabilities have given way to the
emergence of new carrier-based data communication services to overcome the
deficiencies of both dedicated leased and dial-up lines. 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.
-25-
<PAGE>
STRATEGY. The implementation of AvTel's Business Markets Group strategy
involves the marketing of products and services integrated into
enterprise-wide network solutions for business customers. These
enterprise-wide solutions include network design, system integration and
service, wide area network connectivity, voice connectivity, Internet access
and World-Wide Web ("Web") development. The Business Market Group's sales
and marketing activities result in monthly, recurring revenues from
networking customers under multi-year term agreements. The group's primary
sales strategy includes in-house direct sales professionals and an agent
program through which the Business Markets Group distributes its services
through value added resellers of information technology products. The
Business Markets Group leverages the existing customer relationships of these
value added resellers gaining more immediate access to a wider group of
prospective customers and greater credibility in the sales process.
Additionally, this value added reseller channel becomes the service
organization for AvTel's business customers requiring on-site repair and
maintenance visits.
CHANNEL MARKETS GROUP
The Channel Markets Group 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. AvTel's Channel Partners generally require business-to-business
account management, have a large and somewhat captive audience of
members/customers and distribute information and services. Historically,
telecommunications companies have leveraged third party organizations to sell
long distance telephone service to their member/customers sharing a
percentage of the revenues generated by the group. Substantially all of the
revenues for the Channel Markets Group is generated by outside sales agents.
AvTel has recognized that the Internet explosion has created an
"business Imperative" among these organizations that is generating new sales
opportunities for AvTel. AvTel assists these organizations in designing and
launching their Web presence and seeks to sell Internet access and additional
telecom services to the organization's member/customer base. In turn, the
Channel Partner participates in the revenue generated by their members' use
of AvTel's services. AvTel believes that it is one of a few companies
offering Channel Partners a turnkey-solution with private labeling and total
technical, billing and customer service support.
The Channel Markets Group provides Internet access, long distance
telephone and other services to customers in 49 states. AvTel is fully
certified or registered in all states where required and operates under
Section 214 authority from the Federal Communications Commission. AvTel,
through a wholly owned subsidiary has a national-deployed Carrier
Identification Code. The Carrier Identification Code provides AvTel greater
network flexibility and permits AvTel 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."
AvTel maintains its own convergent billing platform, rating system and
monitoring center.
AvTel and various subsidiary companies market Channel Markets Group's
services under a variety of brands, which include AvTel-TM-, Matrix
Telecom-TM-, MatrixInet-TM-, Silicon Beach-TM-, WestNet Communications-TM-
Remote Lojix-TM-, Addictive Media-TM- and Digital Meteor-TM-. Channel
Partners, at their expense, use a variety of marketing strategies which
include direct mail, outbound telemarketing and direct sales. In November,
1998, AvTel introduced its nationwide Internet access program for dial-up
connectivity. This program is provided by AvTel 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
and management reports available in paper format or on line through AvTel's
eBill and NetAgent platforms. AvTel believes that its agreements with
Channel Partners provides highly-leveraged access to large, loyal groups of
-26-
<PAGE>
individuals. AvTel also believes that accessing these individuals through its
Channel Partners enables lower marketing expenditures, lower customer churn
and a greater customer motivation to purchase additional services.
OPERATIONS AND SUPPORT
CUSTOMER SERVICE CENTER. AvTel's inbound customer service center is
designed to provide AvTel's customers with a high-level of service and
support. Customer service representatives are available 24 hours a day, 7
days a week in order to answer inquiries generated by AvTel's marketing
campaigns, as well as to support existing customers. Customer service
representatives are trained to answer a broad range of inquiries from
prospective customers relating to service, pricing, and optional features. In
addition to competitive rates and a wide variety of products, AvTel is able
to offer business customers a highly specialized direct bill summary package
that includes call summaries by account code, department, employee, project,
client, area code, country code, and time-of-day. Customer call management
reports are available in a variety of media formats including electronic
support via the Internet.
AvTel's call center and technical support center are equipped with
state-of-the-art computer and telecommunications technology. Incoming calls
are managed with the help of an automatic call distributor and an automated
attendant. This system allows for management of call queue time, the
formation of distinct work groups for different projects, and on-line
monitoring of customer service calls for quality assurance purposes.
Bilingual customer service representatives are available during day and
evening shifts.
BILLING AND INFORMATION SYSTEMS. AvTel has dedicated substantial
resources to its management information systems. AvTel's information systems
enable AvTel to
- monitor and respond to the evolving needs of its customers by
developing new and customized services;
- provide sophisticated billing information that can be tailored to meet
the requirements of its customer base;
- provide high quality customer service;
- detect and minimize fraud;
- verify payables to suppliers; and
- integrate additions to its customer base.
In addition, AvTel has complete facilities for rating, formatting and
distributing direct bills to its larger commercial subscribers. Small
business customers and individuals may receive either a direct or a local
exchange carrier bill, depending upon the services provided to the customer.
AvTel provides secure remote electronic access to certain activation,
provision and billing information to its customers through the Internet.
AvTel has invested in call rating, billing, and customer service
infrastructure. In addition, AvTel holds billing and collection agreements
with local exchange carriers, including all of the regional bell operating
companies, and independent local exchange companies. These billing
agreements permit AvTel to include its billing on the customer's local
telephone bill. AvTel's billing information systems and services also allows
it to provide direct bills to customers in a paper format and electronically
through the Internet.
STRATEGIC ALLIANCES AND CARRIER AGREEMENTS. AvTel has executed
strategic agreements with Sprint for its underlying voice carrier services,
Qwest and IXC for data carrier services and GST, GTE and PSINet for Internet
access services. As noted above, AvTel holds billing and collection
agreements with all of the regional bell operating companies and independent
local exchange companies. AvTel developed with Prosoft I-Net Solutions a
specialized
-27-
<PAGE>
training program designed to educate value-added resellers of AvTel's
services on the integration of data, voice and video products.
ACE CERTIFIED ENGINEER TRAINING PROGRAM. On March 16, 1998 AvTel
announced the availability of its ACE Certified Engineering training program.
The ACE program has been designed specifically for value added resellers in
the telecommunications industry. The ACE program provides a complete
curriculum over a broad range of courses. The program includes four tracks:
- a general overview of the telecommunications industry and
technologies;
- voice equipment and network design;
- data communications and network design; and
- the integration of voice, video and data, traffic design and network
engineering.
Each track is a technical course focusing on how to use, engineer and
integrate proven and leading-edge voice, video and data networking
technologies. The complete program includes on-line and classroom training
and course work requiring 128 hours of in-depth course work and labs.
REGULATION
The services which AvTel 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 AvTel'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 AvTel's services or AvTel's profit levels, but either or
both may do so in the future. However, AvTel is required by federal and
state law and regulations to file tariffs listing the rates, terms and
conditions of services provided. AvTel 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 AvTel.
COMPETITION
The telecommunications industry is highly competitive and affected by
rapid regulatory and technological change. AvTel 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. AvTel's future success will depend in part upon its
ability to compete with AT&T, MCI Worldcom, Sprint and other carriers
(including the regional bell operating companies when approved to enter the
long distance market) and other long distance providers, and America Online
and other national and local Internet service providers, many of which have
considerably greater financial and other resources than AvTel.
-28-
<PAGE>
INTELLECTUAL PROPERTY
AvTel has registered several trademarks for use in its marketing
materials. The Matrix Telecom name and logo, used by AvTel to market Internet
access, long distance service, and calling card services is a registered
trademark. AvTel also uses several unregistered trademarks as part of its
Business Markets Group and Channel Markets Group businesses, including
AvTel-TM-, MatrixInet-TM-, Silicon Beach-TM-, Addictive Media-TM- and Digital
Meteor-TM-, which it may seek to register. While AvTel believes these
trademarks are important to its business, AvTel May 5, 1999 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 April 30, 1999, AvTel, including its subsidiaries, had 252
full-time employees. None of the employees of AvTel are represented by a
union. AvTel supplements its work force from time to time with contractors,
administrative personnel through employment agencies, and part time
employees. AvTel believes that it has good relations with its employees.
FACILITIES
AvTel does not own any real property. The table below sets forth
certain information with respect to the material properties leased by AvTel,
including the AvTel's executive offices in Santa Barbara, California. All of
such properties consist of office space. AvTel and its subsidiaries also
operate points-of-presence for the purpose of creating local access points to
its network backbone.
<TABLE>
<CAPTION>
EXPIRATION CURRENT MONTHLY
LOCATION SQUARE FEET DATE(2) RENT(1)
------------------------ --------------- ----------- ---------------
<S> <C> <C> <C>
501 Bath Street 6,798 March 2003 $11,863
Santa Barbara, CA
8721 Airport Freeway 24,500 June 2000 $23,050
Fort Worth, TX
104 West Anapamu 3,441 November 2001 $4,800
Suites C&D
Santa Barbara, CA
70 West 36th St., Suite 605 2,500 December 2002 $4,800
New York, NY
38 East 32nd St., 8th Floor 4,400 February 2004 $4,416
New York, NY
1600 Parkwood Circle 2,190 December 2001 $3,750
Suite 603
Atlanta, GA
2333 Mill Creek Drive 1,446 February 2001 $3,370
Suite 120
Laguna Hills, CA
</TABLE>
- ---------------
-29-
<PAGE>
(1) All amounts shown are on a "triple net" basis.
(2) Subject to certain renewal options held by AvTel.
In addition, AvTel 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
AvTel 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 AvTel 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 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 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. Defendants
filed a motion to dismiss the complaint on April 14, 1999. The motion to
dismiss is in the process of being briefed and argued. The plaintiffs have
yet to state the amount of damages they seek.
AvTel 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 Telecom 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 Telecom, 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 claims against Mr. Jensen, Mr. Sanders is
apparently seeking 171,548 shares of AvTel's common stock, or its monetary
equivalent, from AvTel.
While AvTel and Matrix Telecom are still reviewing the matter, both
intend to defend this complaint vigorously.
AvTel is not aware of any proceedings against it contemplated by any
governmental authority.
-30-
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The directors and executive officers of AvTel are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH AVTEL
<S> <C> <C>
Anthony E. Papa............. 36 Chairman of the Board and Chief
Executive Officer
James P. Pisani............. 34 President, Chief Operating
Officer, Secretary and Director
Michael J. Ussery........... 40 Chief Financial Officer
M. Scott Hall............... 40 Senior Vice President of Channel
Markets Group
Frank A. Leone.............. 52 President of Business Markets
Group
Joe Renteria, Jr............ 52 Vice President, Information
Systems
John E. Allen............... 62 Director
Jeffrey J. Jensen........... 40 Director
Anthony D. Martin........... 49 Director
</TABLE>
ANTHONY E. PAPA, age 36, has been the Chairman of the Board and Chief
Executive Officer of AvTel since October 1996. Mr. Papa was also President
of AvTel from October 1996 until February 1998. Prior to October 1996, Mr.
Papa had served as President of ICS Communications, Inc., Richardson, Texas,
a national provider of cable television, wireless paging, local and
long-distance telephone services from December 1992. Before joining ICS
Communications, Mr. Papa served as general manager for Spectradyne, Inc., the
largest provider of pay-per-view entertainment and interactive services to
the hospitality industry. Mr. Papa is a director of International School of
Information Management, Inc., an accredited university and an electronic
publisher and provider of electronic services, and a director of ABC-Clio,
Inc., an international publisher of historical reference materials for
institutions of higher education. Mr. Papa received a B.S. in Management
from Iona College, in New Rochelle, New York.
JAMES P. PISANI, age 34, has been the President of AvTel since February
1998, and has served as Chief Operating Officer and Secretary of AvTel since
October 1996. Mr. Pisani has also served as Chief Accounting Officer of
AvTel since October 1998. From October 1996 to May 1999, Mr. Pisani was the
Chief Financial Offer of AvTel. From October 1996 to February 1998, Mr.
Pisani was the Executive Vice President of AvTel. Prior to October 1996, he
served as Vice President of Sales and National Accounts for ICS
Communications. While at ICS, Mr. Pisani was responsible for that firm's
business-to-business and consumer sales activities. Prior to joining ICS
Communications, from June 1989 to June 1994, Mr. Pisani served as Vice
President of a national mortgage banking firm serving, primarily,
institutional accounts. Mr. Pisani graduated from Princeton University in
1986, with a degree in Economics.
MICHAEL J. USSERY, age 40, has been Chief Financial Officer of AvTel
since May 3, 1999. From July 1998 until May 1999, he served as a lecturer
and consultant to several accounting firms and corporations on issues of
Securities and Exchange Commission compliance and accounting interpretations.
Mr. Ussery served as Controller of Triton Energy in Dallas, Texas from
October 1993 to July 1998. Prior to that, Mr. Ussery was a senior audit
manager for PricewaterhouseCoopers LLP. Mr. Ussery graduated from Stephen F.
Austin State University in 1981, with a B.B.A. in Accounting and Finance.
-31-
<PAGE>
M. SCOTT HALL, age 40, was appointed Senior Vice President of AvTel's
Channel Markets Group in October 1998. From November 1994 to September 1998,
Mr. Hall was Vice President of One Call Communications, Inc., a long-distance
and Internet service provider. Prior to that time, Mr. Hall was Manager,
Business Development for Transnational Communications. Mr. Hall graduated
from the University of Hawaii in 1982, with a B.A. in Sociology.
FRANK A. LEONE, age 52, was appointed President of AvTel's Business
Markets Group in November 1998. From November 1996 to July 1998, Mr. Leone
was Executive Vice President of Sales for First Image Management Company, a
division of First Data Corporation. From November 1994 to November 1996, Mr.
Leone was President of FAL Consultants, in which capacity he provided
strategy and marketing consulting to corporations. Prior to that time, Mr.
Leone held an executive management position with Recycled Paper Greetings,
the fourth largest greeting card manufacturer in the United States, and
executive management positions with Baxter Healthcare Corporation and Xerox
Corporation. Mr. Leone graduated from Gannon University, Erie, Pennsylvania,
with a B.S. in Business Administration.
JOE RENTERIA, JR., age 52, was appointed Vice President, Information
Systems of AvTel in February 1999. Prior to that time, he had been employed
for more than five years by Matrix Telecom. During his tenure with Matrix
Telecom, Mr. Renteria has served as Manager of Data Processing, Director of
Information Services and was promoted to Vice President of Information
Services in May of 1997. Prior to joining Matrix Telecom, Mr. Renteria held
various information technology management positions, primarily in the
manufacturing sector.
JOHN E. ALLEN, age 62, has been a director of AvTel since December 1997.
He is Vice Chairman of the Boards of Amli Residential Properties Trust and
Amli Commercial Properties Trust, and President of Amli Realty Co., a
commercial real estate firm, which he co-founded in 1980. Prior to
co-founding Amli Realty Co., he was a partner at the Chicago law firm of
Mayer, Brown & Platt, with which he had been associated since 1964. Mr.
Allen is also a member of the Board of Directors of Excell Global Services,
an owner and operator of telephone call centers. Mr. Allen received a B.S.
in Business from Indiana University and a J.D. from Indiana University School
of Law.
JEFFREY J. JENSEN, age 40, has been a director of AvTel since January
1998. He has been the President of Specialized Association Services, Ltd.,
which provides marketing and administrative services to trade associations,
for more than five years. Between 1996 and July 1998, Specialized Association
Services was known as CORE Marketing, Inc. and provided direct mail and
telemarketing facilities in addition to its other activities. Mr. Jensen has
also been the Vice President of United Group Service Centers, Inc., an
employee leasing company, for more than five years. In addition, from 1992
to 1995, Mr. Jensen was a founding partner of Association Dental Plan, which
provided discounted dental services to 40,000 members. Mr. Jensen holds
equity interests in several Internet and technology companies. Mr. Jensen
received B.A. degrees in Economics and Philosophy from Cornell College, in
Mount Vernon, Iowa and holds an M.S. in Information Systems from the
University of Texas at Arlington.
ANTHONY D. MARTIN, age 49, has been a director of AvTel since April
1999. Mr. Martin is Managing Director of CrossHill Financial Group Inc., a
position he has held since March 1998. From January 1997 through July 1997,
he served as President and CEO of Nexus Communications, Inc., a start-up
company providing information services. From January 1994 to December 1996,
he served as Vice President, Business Development of MCI Metro, MCI
Telecommunications, Inc.'s local service initiative. Prior to that, he held
several senior management positions at MCI, including Vice President, Access
Services Project Management; Vice President, Systems Engineering and Support
Operations; Vice President, Carrier Marketing and Alliances; Vice President,
Finance Administration; and Vice President, Technical Planning. He received
a B.S. from the United States Naval Academy and an M.B.A. from the University
of Detroit.
There are no family relationships between any directors or executive
officers of AvTel. The directors are elected annually to serve a one-year
term and until his or her respective successor is elected and qualified.
-32-
<PAGE>
DIRECTOR COMPENSATION
During 1998, directors did not receive compensation for their membership
on the board of directors, although AvTel did reimburse their reasonable
expenses in connection with attendance at board and committee meetings.
AvTel has established a policy to pay non-employee directors a fee of $1,000,
in addition to reimbursement of expenses, for each board or committee meeting
they attend in excess of four meetings a year. Directors (including
non-employee directors) are also eligible to receive grants of stock options
and restricted stock under AvTel's 1997 Stock Incentive Plan and 1998 Stock
Incentive Plan.
During 1998, Director John E. Allen received a grant of 60,000 shares of
restricted stock under AvTel's 1997 Stock Incentive Plan. These shares are
subject to restrictions on transfer. These restrictions will lapse as to
30,000 of such shares on February 24, 2001, and as to the remaining 30,000
shares on February 24, 2002. The lapse of these restrictions will be
accelerated upon Mr. Allen's retirement from the board of directors and upon
certain other events set forth in the 1997 Stock Incentive Plan.
In April 1999, Directors John E. Allen, Jeffrey J. Jensen and Anthony D.
Martin received grants of 25,000 options each under AvTel's 1998 Stock Incentive
Plan. One-half of such options will become exercisable in April 2000, and the
remainder will become exercisable in April 2001. Unless exercised, the options
will expire in April 2004. The exercise price for Mr. Allen's and Mr. Jensen's
options is $4.88 per share. The exercise price for Mr. Martin's options is
$4.6875 per share.
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<PAGE>
EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to AvTel's Chief
Executive Officer, each other executive officer of AvTel whose total annual
salary and bonus exceeded $100,000 for the fiscal year ended December 31,
1998, and two individuals that ceased to be executive officers during such
fiscal year (the "Named Officers"). Titles shown are those held by the
Named Officers at December 31, 1998, or at the date they ceased to be
executive officers.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
---------------------------------------------------- ----------------------
NAME AND
PRINCIPAL FISCAL OTHER ANNUAL SECURITIES UNDERLYING
POSITION YEAR SALARY BONUS COMPENSATION ($) OPTIONS (#)
- ------------------------- -------- --------- ----------- ---------------- -----------------------
<S> <C> <C> <C> <C> <C>
Anthony E. Papa (1) 1998 $198,000 $50,000 -- --
Chairman and Chief 1997 158,459 -- -- 31,250
Executive Officer 1996 46,875 -- -- --
James P. Pisani (1) 1998 180,000 50,000 -- --
President, Chief 1997 152,500 -- -- 31,250
Operating Officer, 1996 46,875 -- -- --
Chief Financial
Officer and Secretary
D. Stephen DeWindt (2) 1998 150,000 40,000 2,908(3) 6,250
President - Business 1997 127,083 15,556 -- 56,250
Network Services
Division
Frank Dziuba (4) 1998 100,000 -- -- 15,000
Senior Vice-President 1997 85,833 39,300 -- 31,250
Software Development 1996 7,500 -- -- 12,474
</TABLE>
- --------------------
(1) Employed as of July 31, 1996.
(2) Employed as of January 27, 1997. Mr. DeWindt ceased to be employed with
AvTel as of October 30, 1998.
(3) Reflects sales commissions.
(4) Employed as of November 20, 1996. Mr. Dziuba ceased to be an executive
officer of AvTel as of December 14, 1998. He continues as Senior Vice
President of AvTel's Addictive Media Group.
Frank A. Leone was appointed President of AvTel's Business Markets Group
in November 1998. Administration. His annual base salary is $165,000. Mr.
Leone also received options to purchase 150,000 shares of common stock,
including 50,000 with an exercise price per share of $2.75 and 100,000 with
an exercise price per
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<PAGE>
share of $4.00. None of these options are vested or will vest within 60
days. These options vest over four years and expire in 2008.
M. Scott Hall was appointed Senior Vice President of AvTel's Channel
Markets Group in October 1998. His annual base salary is $130,000. Mr. Hall
also received options to purchase 150,000 shares of common stock, including
50,000 with an exercise price per share of $2.75 and 100,000 with an exercise
price per share of $4.00. None of these options are vested or will vest
within 60 days. These options vest over four years and expire in 2008.
The following table summarizes all option grants to the Named Officers
during the year ended December 31, 1998. No stock appreciation rights were
awarded during 1998.
OPTION GRANTS IN LAST FISCAL YEAR
---------------------------------
(Individual Grants)
<TABLE>
<CAPTION>
% OF TOTAL POTENTIAL REALIZABLE VALUE AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION TERM (1)
UNDERLYING EMPLOYEES IN EXERCISE ---------------------------------------
NAME OPTIONS GRANTED FISCAL YEAR PRICE EXPIRATION DATE 5% 10%
- ---------------- --------------- ------------- --------- --------------- ------------------ ------------------
<S> <C> <C> <C> <C> <C> <C>
Anthony E. Papa 0 0% -- -- -- --
James P. Pisani 0 0% -- -- -- --
D. Stephen 6,250(2) .73% $7.813 January 27, $30,710 $77,824
DeWindt 2008
Frank Dziuba 15,000(3) 1.75% 4.00 December 14, 37,734 95,625
2008
</TABLE>
- --------------------
(1) The potential realizable portion of the foregoing table illustrates value
that might be realized upon exercise of options immediately prior to the
expiration of their term, assuming (for illustrative purposes only) the
specified compounded rates of appreciation of the price of the Common Stock
over the term of the respective option. The 5% and 10% assumed annual
rates of compounded stock price appreciation are mandated by the rules of
the Securities and Exchange Commission and do not represent AvTel's
estimate or projection of its future common stock prices. These amounts
represent certain assumed rates of appreciation in the value of the common
stock from the fair market value on the date of grant. These numbers do
not take into account provisions providing for the termination of the
option following termination of employment, nontransferability or
difference in vesting terms.
(2) Options vested six months after the grant date. Options terminated
unexercised 90 days after the termination of Mr. DeWindt's employment with
AvTel.
(3) Options vest in annual increments of 25% over the four years after the
grant date.
-35-
<PAGE>
The following table provides information with respect to stock options
exercised by the Named Officers during the year ended December 31, 1998 and
the unexercised stock options held as of December 31, 1998 by the Named
Officers.
OPTION EXERCISES DURING YEAR ENDED DECEMBER 31, 1998
AND OPTION VALUES AT DECEMBER 31, 1998
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT DECEMBER 31, 1998 DECEMBER 31, 1998 (2)
SHARES ---------------------------- -----------------------------
ACQUIRED ON
NAME EXERCISE VALUE REALIZED (1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------- ----------- ------------------ ----------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Anthony E. Papa -- -- 7,813 23,437 $3,516 $10,547
James P. Pisani -- -- 7,813 23,437 $3,516 $10,547
D. Stephen DeWindt 26,562 $93,450 -- -- -- --
Frank Dziuba -- -- 20,287 38,437 $5,860 $17,578
</TABLE>
- --------------------
(1) Calculated on the basis of the fair market value of AvTel common stock on
the date of exercise, minus the exercise price of the options.
(2) Calculated on the basis of the fair market value of AvTel common stock on
December 31, 1998, minus the exercise price of the options. The closing
price of the Common Stock on The Nasdaq SmallCap Market on December 31,
1998 was $3.75 per share.
EMPLOYMENT AGREEMENTS
Until December 1, 1997, AvTel had employment agreements in place with
each of Messrs. Papa and Pisani. Under these employment agreements,
generally, each executive was to be employed for a term commencing in August
1996 and expiring July 31, 1999, subject to certain extension rights. In
connection with the acquisition of Matrix Telecom by AvTel, Messrs. Papa and
Pisani agreed that, upon the closing of the acquisition, their respective
employment agreements would be terminated. Accordingly, both employment
agreements terminated on December 1, 1997, and Messrs. Papa and Pisani now
serve on an "at-will" basis.
In connection with its acquisition of Silicon Beach Communications on
November 21, 1996, AvTel entered into an employment agreement with Mr. Dziuba
pursuant to which he is employed for a three-year term ending November 21,
1999 at an initial base annual salary of $80,000, subject to increase, if
any, as may be determined by the board of directors. This agreement also
provides, among other things, for stock option grants and an "earn-out" bonus
paid to Mr. Dziuba upon satisfaction of certain operational performance
objectives. The amounts, if any, due under the special performance bonus,
are subject to certain set-off rights of AvTel in the event of a breach of
certain representations, warranties and agreements relating to its
acquisition of Silicon Beach Communications. The agreement does not call for
any payments as a result of any change in control of AvTel.
-36-
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1998, the compensation committee consisted of Mr. Allen, Mr.
Jensen and, until his resignation from the board of directors on December 17,
1998, Gregory T. Mutz. Mr. Martin was appointed to the compensation
committee on April 9, 1999, to fill the vacancy caused by Mr. Mutz's
resignation. None of such compensation committee members was or has been an
officer or employee of AvTel or any of its subsidiaries. Certain entities
with which Mr. Jensen was affiliated received payments from AvTel during
1998. See "Certain Relationships and Related Transactions."
No executive officer of AvTel served at any time during the year ended
December 31, 1998 as a member of the board of directors or compensation
committee of any entity that has one or more executive officers serving as a
member of AvTel's board or compensation committee.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
DEALINGS WITH UICI ORGANIZATIONS IN CONNECTION WITH MARKETING SERVICES.
Jeffrey J. Jensen, an AvTel director, his father, Ronald L. Jensen, and his
adult siblings, own approximately 35% of UICI, a publicly-traded insurance
and financial services company. Until December 31, 1998, John E. Allen, an
AvTel director, was also a director of UICI. Among their other activities,
UICI's marketing organizations sell AvTel's long distance and Internet
products to their customers. Matrix Telecom paid sales commissions and
related payments to UICI, together with certain other affiliated entities, of
$140,187 in 1998. AvTel believes that it receives the foregoing services on
terms no less favorable to AvTel than could be obtained from unrelated third
parties.
LONG DISTANCE SERVICES. Matrix Telecom also provides long distance
telephone service to certain affiliates of Mr. Jensen, his father and his
adult siblings, including UICI. AvTel received $2.4 million in 1998 from
UICI and its affiliates for such services. AvTel believes that it provides
the foregoing services on terms no less favorable to AvTel than could be
obtained from unrelated third parties.
EMPLOYEE LEASING. Until December 31, 1998, Matrix Telecom leased a
substantial portion of its employees from United Group Service Center.
Jeffrey J. Jensen was the Vice President of United Group Service Center, an
entity affiliated with Jeffrey J. Jensen, his immediate family and UICI.
Matrix Telecom paid United Group Service Center $5,581,428 for such
employees' services in 1998. Matrix Telecom terminated this employee leasing
arrangement effective December 31, 1998. AvTel believes that it received the
foregoing services on terms no less favorable to AvTel than could be obtained
from unrelated third parties
LOAN TO AFFILIATE. During 1997, Matrix Telecom made an interest-free
loan to CORE Marketing, Inc. in the total amount of $2,000,000 as an advance
against commissions to be incurred by Matrix Telecom for marketing services
supplied by CORE Marketing. Jeffrey J. Jensen was the President of CORE
Marketing, and he and his adult siblings owned a controlling interest in CORE
Marketing. The loan was repaid in full during 1998.
POLICY ON RELATED PARTY TRANSACTIONS. In connection with its listing on
The Nasdaq SmallCap Market, AvTel has undertaken to conduct an appropriate
review of all related party transactions on an ongoing basis and to use the
audit committee of the board of directors to review potential conflict of
interest situations where appropriate.
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<PAGE>
SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of April 30, 1999,
with respect to the beneficial ownership of AvTel common stock by each person
known by AvTel to be the beneficial owner of more than 5% of its outstanding
common stock, by each director, by each of AvTel'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. The number of shares set forth below includes
those shares of common stock issuable pursuant to options which are
exercisable or shares which are convertible within 60 days of April 30, 1999.
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 AvTel common stock subject to options held by that person that are
exercisable within sixty (60) days following April 30, 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 Company's name. The percentages
of beneficial ownership shares in this table are based upon 10,542,997 shares
of the common stock outstanding.
Effective as of May 18, 1999, certain shareholders of AvTel entered into
a voting trust agreement with Thomas 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 4,578,321 shares of AvTel 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. The voting trust agreement has an
initial terms 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)....................... 961,939 9.1%
9003 Airport Freeway
Fort Worth, TX 76180
Jeffrey J. Jensen (1) .................... 851,738 8.1%
2121 Precinct Line Road
Hurst, TX 76054
James J. Jensen (1)....................... 800,000 8.1%
6304 Alexandria Circle
Atlanta, GA 30326
-38-
<PAGE>
<CAPTION>
AMOUNT BENEFICIALLY
NAME AND ADDRESS OWNED PERCENT OF CLASS
- ------------------------------------------ ------------------- ----------------------
<S> <C> <C>
Jami J. Jensen (1)........................ 851,738 8.1%
1933 Swede Gulch
Golden, CO 80120
Julie J. Jensen (1)....................... 851,738 8.1%
Box 540, Kenwood Station
5257 River Road
Bethesda, MD 20816
Anthony E. Papa (2) ...................... 778,588 7.4%
James P. Pisani (2) ...................... 772,188 7.3%
Gladys J. Jensen (1)...................... 731,847 7.0%
c/o United Group Association,
Inc.
4001 McEwen Drive, Suite 200
Dallas, TX 75244
John E. Allen (3)......................... 185,000 1.8%
Anthony D. Martin......................... -- *
D. Stephen DeWindt........................ -- *
Frank Dziuba.............................. 44,599 *
All directors and executive officers 2,641,122 25.1%
as a group (8 persons) (4)................
- ----------------------------------
</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.
(2) 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 April 30, 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 AvTel Communications, Inc., 501 Bath Street,
Santa Barbara, CA 93101.
-39-
<PAGE>
(3) Includes 60,000 shares of restricted stock awarded to Mr. Allen under
AvTel's 1997 Stock Incentive Plan. See "Management--Director Compensation"
above. 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.
(4) Includes 31,250 shares of common stock that may be acquired under options
that were exercisable within 60 days of April 30, 1999. Only includes
shares for the current directors and executive officers of AvTel. It does
not include the shares beneficially owned by Frank Dziuba.
-40-
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following summarizes the material provisions of AvTel's certificate
of incorporation and bylaws. Such summaries do not purport to be complete and
are subject to, and are qualified in their entirety by reference to, all of
the provisions of the certificate of incorporation and the bylaws, including
the definitions therein of certain terms, copies of which are filed as
exhibits to the registration statement of which this prospectus is a part.
AUTHORIZED STOCK; ISSUED AND OUTSTANDING SHARES
As of the date of this prospectus, AvTel's authorized capital stock
consists of 20,000,000 shares of common stock, par value $0.01 per share, and
1,000,000 shares of preferred stock, $0.01 per share, of which 250,000
shares have been designated series A convertible preferred stock and 1,500
shares have been designated series B convertible preferred stock. The
description below is a summary of all material provisions of AvTel common
stock, preferred stock and convertible preferred stock.
As of April 30, 1999, 10,542,997 shares of common stock were issued and
outstanding, excluding treasury shares, and 20,000 shares of common stock
were reserved for issuance upon the exercise of outstanding warrants and
approximately 2,426,287 shares were reserved for issuance pursuant to stock
option plans and employee stock purchase plans. As of April 30, 1999,
147,700 shares of series A convertible preferred stock were issued and
outstanding, and 1,500 shares of series B convertible preferred stock were
issued and outstanding.
As of April 30, 1999, 20,000 warrants to purchase common stock were
issued and outstanding. The warrants entitle the warrant holders 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.
COMMON STOCK
The holders of common stock are entitled to one vote per share on all
matters voted on by the stockholders, including elections of directors.
Except as otherwise required by law or as provided in any resolutions adopted
by the board of directors with respect to the preferred stock of AvTel, the
holders of shares of common stock will exclusively possess all voting power.
Subject to the preferential rights, if any, of holders of any then
outstanding preferred stock, the holders of common stock are entitled to
receive dividends when, as and if declared by the board of directors of AvTel
out of funds legally available therefor. The terms of the common stock do
not grant to the holders thereof any preemptive, subscription, redemption,
conversion or sinking fund rights. Subject to the preferential rights of
holders of any then outstanding preferred stock, the holders of common stock
are entitled to share ratably in the assets of AvTel legally available for
distribution to stockholders in the event of the liquidation, dissolution or
winding up of AvTel.
PREFERRED STOCK
Pursuant to the certificate of incorporation, AvTel has the authority to
issue up to 1,000,000 shares of preferred stock, $0.01 par value per share,
in one or more series as determined by the board of directors of the AvTel.
AvTel's board of directors may, without further action by the stockholders of
AvTel, issue one or more series of preferred stock and fix the rights and
preferences of such shares, including the dividend rights, dividend rates,
conversion rights, exchange rights, voting rights, terms of redemption,
redemption price or prices, liquidation preferences and the number of shares
constituting any series or the designation of such series. The rights of the
holders of common stock will be subject to, and may be adversely affected by,
the rights of holders of preferred stock issued by AvTel in the future. In
addition, the issuance of preferred stock could have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, control of AvTel.
-41-
<PAGE>
THE SERIES A CONVERTIBLE PREFERRED STOCK
The series A convertible preferred stock has a liquidation preference of
$4.00 per share. The series A convertible preferred stock bears a cumulative
dividend, payable semi-annually, equal to 8% of the liquidation preference,
or $.32. AvTel cannot pay a cash dividend on its common stock while any
series A convertible preferred stock is outstanding without the approval of
at least 50% of the outstanding shares of the series A convertible preferred
stock. The series A convertible preferred stock is redeemable in whole or in
part at any time after the second anniversary of its issue date, so long as
AvTel redeems at least 25% of the series A convertible preferred stock. The
redemption price is the cash amount equal to the liquidation preference per
share of the series A convertible preferred stock. The series A convertible
preferred stock is convertible, upon the happening of certain events, into
shares of AvTel common stock. The series A convertible preferred stock is
convertible, at the option of the holder, into such number of fully paid and
nonassessable shares of AvTel common stock as determined by dividing $4.00 by
the conversion price applicable to such share. The conversion price is
initially set at $4.00 per share, subject to adjustments for stock splits,
combinations, dividends, distributions, reclassification, reorganizations,
mergers, consolidations or sales of assets. If AvTel sells its common stock,
pursuant to a registered public offering, at a public offering price equal to
or exceeding $10.00 per share and the proceeds to AvTel are not less than $15
million, then each share of the series A preferred stock shall automatically
convert into common stock of AvTel, at a conversion price equal to the lower
of (1) $4.00 per share and (2) a price determined by multiplying .80 times
the price per share of the common stock issued in the public offering.
THE SERIES B CONVERTIBLE PREFERRED STOCK
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 AvTel's
option. The series B convertible preferred stock has a dividend preference
over the common stock. The annual dividend will increase to $60 per share if
AvTel 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 holders at any time. The number of
shares of common stock to be received by a holder 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.
The conversion price will not be less than $3.00 for 180 days after the date
of issuance of the series B convertible preferred 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, AvTel could issue up to 750,000
shares of common stock upon conversion if all of the series B convertible
preferred stock were converted at the lowest possible conversion price,
assuming such revenue and EBITDA requirements continue to be met. Unless
AvTel has obtained the approval of its voting stockholders in accordance with
the rules of The Nasdaq Stock Market, AvTel 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 AvTel 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. AvTel will pay
converting holders in cash for any excess over such amount.
TRANSFER AGENT AND REGISTRAR
U.S. Stock Transfer Corp. is the transfer agent and registrar for the
common stock.
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<PAGE>
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
AvTel is subject to the provisions of Section 203 of the Delaware
General Corporation Law ("Section 203"). Under Section 203, certain
"business combinations" between a Delaware corporation whose stock generally
is publicly traded or held of record by more than 2,000 stockholders and an
"interested stockholder" are prohibited for a three-year period following the
date that such a stockholder became an interested stockholder, unless (i) the
corporation has elected in its original certificate of incorporation not to
be governed by Section 203; (ii) the business combination was approved by the
board of directors of the corporation before the other party to the business
combination became an interested stockholder, (iii) upon consummation of the
transaction that made it an interested stockholder, the interested
stockholder owned at least 85% of the voting stock of the corporation
outstanding at the commencement of the transaction (excluding voting stock
owned by directors who are also officers or held in employee benefit plans in
which the employees do not have a confidential right to tender or vote stock
held by the plan); or (iv) the business combination was approved by the board
of directors of the corporation and ratified by two-thirds of the voting
stock which the interested stockholder did not own. The three-year
prohibition also does not apply to certain business combinations proposed by
an interested stockholder following the announcement or notification of
certain extraordinary transactions involving the corporation and a person who
had not been an interested stockholder during the previous three years or who
became an interested stockholder with the approval of the majority of the
corporation's directors.
The term "business combination" is defined generally to include mergers
or consolidations between a Delaware corporation and an interested
stockholder, transactions with an interested stockholder involving the assets
or stock of the corporation or its majority-owned subsidiaries and
transactions which increase an interested stockholder's percentage ownership
of stock. The term "interested stockholder" is defined generally as a
stockholder who, together with affiliates and associates, owns (or, within
three years prior, did own) 15% or more of a Delaware corporation's voting
stock. Section 203 could prohibit or delay a merger, takeover or other
change in control of AvTel and therefore could discourage attempts to acquire
AvTel.
SELLING STOCKHOLDER
Cambois Finance, Inc. is a British Virgin Islands Corporation engaged in
the business of investing in publicly-traded equity securities. Cambois
Finance's offices are located at Auelestrasse 74, Vaduz, Liechtenstein. Cambois
Finance's investment decisions are made by its Board of Directors, Mr. Hans
Gassner, Dr. Kurt Alig and Dr. Alex Wiederkehr. Cambois Finance does not own
any shares of AvTel common stock or other AvTel securities as of the date of
this prospectus, and other than its obligations to purchase shares under the
equity line agreement, Cambois Finance has no other commitments or arrangements
to purchase or sell any other securities of AvTel. There are no business
relationships between Cambois Finance and AvTel other than the equity line
agreement.
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<PAGE>
PLAN OF DISTRIBUTION
AvTel has been advised by Cambois Finance that it may sell the common
stock from time to time in transactions on the Nasdaq SmallCap Market, in
negotiated transactions, or otherwise, or by a combination of these methods,
at fixed prices which may be changed, at market prices at the time of sale,
at prices related to market prices or at negotiated prices. Cambois Finance
may effect these transactions by selling the common stock to or through
broker-dealers, who may receive compensation in the form of discounts,
concessions or commissions from Cambois Finance or the purchasers of the
common stock for whom the broker-dealer may act as an agent or to whom they
may sell the common stock as a principal, or both. The compensation to a
particular broker-dealer may be in excess of customary commissions. Cambois
Finance is an "underwriter" within the meaning of the Securities Act in
connection with the sale of the common stock offered hereby. Broker-dealers
who act in connection with the sale of the common stock may also be deemed to
be underwriters. Profits on any resale of the common stock as a principal by
such broker-dealers and any commissions received by such broker-dealers may
be deemed to be underwriting discounts and commissions under the Securities
Act. Any broker-dealer participating in such transactions as agent may
receive commissions from Cambois Finance (and, if they act as agent for the
purchaser of such common stock, from such purchaser). Broker-dealers may
agree with Cambois Finance to sell a specified number of common stock at a
stipulated price per share, and, to the extent such a broker-dealer is unable
to do so acting as agent for Cambois Finance, to purchase as principal any
unsold common stock at the price required to fulfill the broker-dealer
commitment to Cambois Finance. Broker-dealers who acquire common stock as
principal may thereafter resell such common stock from time to time in
transactions (which may involve crosses and block transactions and which may
involve sales to and through other broker-dealers, including transactions of
the nature described above) in the over-the-counter market, in negotiated
transactions or otherwise at market prices prevailing at the time of sale or
at negotiated prices, and in connection with such resales may pay to or
receive from the purchasers of such common stock commissions computed as
described above.
To the extent required under the Securities Act, a supplemental
prospectus will be filed, disclosing (a) the name of any such broker-dealers;
(b) the number of shares of common stock involved; (c) the price at which
such common stock is to be sold; (d) the commissions paid or discounts or
concessions allowed to such broker-dealers, where applicable; (e) that such
broker-dealers did not conduct any investigation to verify the information
set out or incorporated by reference in this prospectus, as supplemented; and
(f) other facts material to the transaction.
Under applicable rules and regulations under the Exchange Act, any
person engaged in a distribution of the common stock may not simultaneously
engage in market making activities with respect to such securities for a
period beginning when such person becomes a distribution participant and
ending upon such person's completion of participation in a distribution,
including stabilization activities in the common stock to effect covering
transactions, to impose penalty bids or to effect passive market making bids.
In addition and without limiting the foregoing, in connection with
transactions in the common stock, AvTel and Cambois Finance will be subject
to applicable provisions of the Exchange Act and the rules and regulations
thereunder, including, without limitation, Rule 10b-5 and, insofar as AvTel
and Cambois Finance are distribution participants, Regulation M and Rules
100, 101, 102, 103, 104 and 105 thereof. All of the foregoing may affect the
marketability of the common stock.
Cambois Finance has agreed that it will not engage in short sales of
AvTel common stock except that it may engage in short sales or other hedging
investments that it deems appropriate with respect to the shares that it
purchases in connection with a particular put, so long as the number of
shares sold short or used for hedging does not exceed the number of shares
being sold to Cambois Finance under the put, and the short sales are
otherwise in compliance with Regulation M under the Securities Act.
Cambois Finance will pay all commissions and certain other expenses
associated with the sale of the common stock. The common stock offered
hereby is being registered pursuant to contractual obligations of AvTel, and
AvTel has agreed to pay the costs of registering the shares hereunder,
including legal fees, commissions and certain other expenses for resale of
the common stock. AvTel has also agreed to indemnify Cambois Finance with
respect to the
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<PAGE>
common stock offered by this prospectus against certain liabilities,
including, without limitation, certain liabilities under the Securities Act,
or, if such indemnity is unavailable, to contribute toward amounts required
to be paid in respect of such liabilities.
AvTel has also agreed to reimburse Cambois Finance for certain costs and
expenses incurred in connection with this offering. These may include the
fees, expenses and disbursements of counsel for Cambois Finance incurred in
the preparation of the equity line agreement and associated documentation and
the registration statement of which this prospectus forms a part. AvTel's
reimbursement obligation is limited to $5,000, plus $750 per closing of each
put.
The price at which the common stock will be issued by AvTel to Cambois
Finance shall be 89% of the market price on the date AvTel issues shares, as
defined in the equity line agreement. Assuming an offering price of $4.94
(based on the average of the high and low bid prices of the common stock as
reported by the Nasdaq SmallCap Market on June 3, 1999), underwriting
compensation for Cambois Finance based on the discounted purchase price is
$1,143,280.45.
WHERE YOU CAN FIND MORE INFORMATION
AvTel files annual, quarterly and special reports, proxy statements and
other information with the Securities and Exchange Commission. AvTel has
filed with the Securities and Exchange Commission a registration statement on
Form S-1 under the Securities Act with respect to the shares of common stock
offered by this prospectus. This prospectus does not contain all of the
information set forth in the registration statement and the exhibits and
schedules thereto. For further information with respect to AvTel and the
common stock offered by this prospectus, reference is made to the
registration statement and the exhibits and schedules filed therewith.
Statements contained in this prospectus as to the contents of any contract or
any other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document
filed as an exhibit to the registration statement, each such statement being
qualified in all respects by such reference. A copy of the registration
statement may be inspected without charge at the Securities and Exchange
Commission's public reference facilities in the Washington, D.C., New York,
New York or Chicago, Illinois. You may also read and copy any document AvTel
files with the Securities and Exchange Commission at prescribed rates by
writing to the Public Reference Section of the Securities and Exchange
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further
information on the operation of the public reference facilities. The
Securities and Exchange Commission maintains a Web site (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants, such as AvTel, that file electronically with the
Securities and Exchange Commission.
LEGAL MATTERS
The validity of the shares of common stock being offered hereby and
certain other legal matters will be passed upon for AvTel by Mayer, Brown &
Platt, Chicago, Illinois.
EXPERTS
The consolidated financial statements and related financial statement
schedule of AvTel Communications, Inc. and subsidiaries at December 31, 1998,
and 1997, and for each of the years in the three-year period ended December
31, 1998, have been included herein and in the registration statement in
reliance upon the report of KPMG LLP, independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm
as experts in accounting and auditing.
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<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Balance Sheets, March 31, 1999 (Unaudited) and December 31, 1998. . . . . . . . . . F-2
Consolidated Statements of Operations,
Three Month Periods ended March 31, 1999 and 1998 (Unaudited) . . . . . . . . . . . . . . F-3
Consolidated Statements of Cash Flows,
Three Month Periods ended March 31, 1999 and 1998 (Unaudited) . . . . . . . . . . . . . . F-4
Notes to Consolidated Financial Statements (Unaudited) . . . . . . . . . . . . . . . . . . . . . F-5
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-11
Consolidated Balance Sheets, December 31, 1998 and 1997. . . . . . . . . . . . . . . . . . . . .F-12
Consolidated Statements of Operations, Years ended December 31, 1998, 1997 and 1996. . . . . . .F-13
Consolidated Statements of Stockholders' Equity,Years ended December 31, 1998, 1997 and 1996 . .F-14
Consolidated Statements of Cash Flows,Years ended December 31, 1998, 1997 and 1996 . . . . . . .F-15
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . .F-16
</TABLE>
F-1
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
1999 DECEMBER 31,
(UNAUDITED) 1998
------------- ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents..................................................... $ 588,759 $ 911,179
Accounts receivable, net...................................................... 4,335,567 4,804,532
Due from affiliates........................................................... 168,797 501,858
Other current assets.......................................................... 643,721 921,435
----------- -------------
Total current assets...................................................... 5,736,844 7,139,004
Property and equipment, net...................................................... 1,673,604 1,684,707
Goodwill, net.................................................................... 4,359,945 4,463,747
Other assets, net................................................................ 1,253,197 1,346,896
----------- ------------
Total assets.............................................................. $13,023,590 $14,634,354
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and other accrued expenses................................... $2,857,041 $2,643,761
Accrued network services costs................................................ 4,294,598 4,217,206
Sales and excise tax payable.................................................. 1,475,506 1,433,483
Unearned revenue.............................................................. 867,948 954,101
Due to affiliates............................................................. 193,368 324,020
Other current liabilities..................................................... 653,091 589,392
----------- ------------
Total current liabilities.................................................. 10,341,552 10,161,963
Long-term borrowings............................................................. 2,188,458 1,112,890
Common stock subject to put option............................................... 168,867 168,867
Other liabilities................................................................ 3,196 5,381
----------- ------------
Total liabilities.......................................................... 12,702,073 11,449,101
----------- ------------
Stockholders' Equity:
Preferred stock, authorized 750,000 shares, $0.01 par value................... --
Series A convertible preferred stock, 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
Common stock, authorized 20,000,000 shares, $0.01 par value, issued
10,565,335 and 10,409,473 shares at March 31, 1999 and December 31,
1998 respectively, including 112,578 shares subject to put options...... 104,527 102,969
Additional paid in capital.................................................... 19,854,984 19,630,404
Accumulated deficit........................................................... (19,639,360) 16,549,597)
Treasury stock, $0.01 par value, 11,075 at March 31, 1999 and none at
December 31, 1998.......................................................... (111) --
----------- ------------
Total stockholders' equity.................................................... 321,517 3,185,253
Commitments and contingencies................................................... -- --
----------- ------------
Total liabilities and stockholders' equity................................. $13,023,590 $14,634,354
----------- ------------
----------- ------------
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
F-2
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
---------------
1999 1998
---- ----
<S> <C> <C>
Revenues..................................... $9,322,414 $12,444,839
Cost of revenues............................. 6,620,713 9,287,995
----------- -----------
Gross margin........................... 2,701,701 3,156,844
Operating expenses:
Selling, general and administrative....... 5,289,312 4,582,446
Depreciation and amortization............. 394,579 278,868
----------- -----------
Total operating expenses............. 5,683,891 4,861,314
----------- -----------
Operating loss............................... (2,982,190) (1,704,470)
Interest expense............................. (99,144) (11,975)
Other income, net............................ 15,203 43,955
----------- -----------
Loss before income taxes..................... (3,066,131) (1,672,490)
Income taxes................................. -- --
----------- -----------
Net loss..................................... $(3,066,131) $(1,672,490)
----------- -----------
----------- -----------
Net loss per share - basic and diluted....... $ (0.29) $ (0.18)
----------- -----------
----------- -----------
Weighted average number of common shares -
basic and diluted......... 10,482,416 9,477,489
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
F-3
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
------------------------
1999 1998
---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss................................................................ $(3,066,131) $(1,672,490)
Adjustments to reconcile net loss to net to net cash used in
operating activities:
Depreciation and amortization....................................... 394,579 278,868
Loss on disposition of assets....................................... 14,562 --
Amortization of advanced commissions................................ -- 173,919
Provision for bad debts............................................. 475,422 749,725
Stock compensation earned........................................... 81,356 234,098
Changes in certain operating assets and liabilities:
Accounts receivable.............................................. (6,457) (1,210,854)
Due from affiliates.............................................. 333,061 223,966
Other current assets............................................. 277,714 (321,100)
Accounts payable and accrued liabilities......................... 318,948 214,681
Due to affiliate................................................. (130,652) 176,617
------------- -----------
Net cash used in operating activities......................... (1,307,598) (1,152,570)
Cash Flows from Investing Activities:
Additions of property and equipment..................................... (201,587) (88,431)
Payments received on loans to affiliates................................ -- 410,192
Proceeds from sale of property and equipment............................ 1,050 --
------------ ------------
Net cash provided by (used in) investing activities........... (200,537) 321,761
Cash Flows from Financing Activities:
Principal payments on capital leases.................................... (10,892) (12,142)
Issuance of common stock for exercise of options........................ 222,071 30,455
Preferred stock dividend payments....................................... (23,632) --
Borrowing on line of credit............................................. 9,716,886 --
Amounts paid on line of credit.......................................... (8,641,318) --
Purchase of common stock for treasury................................... (77,400) --
----------- -----------
Net cash provided by financing activities..................... 1,185,715 18,313
----------- -----------
Net decrease in cash and cash equivalents..................... (322,420) (812,496)
Cash and cash equivalents at beginning of quarter............................. 911,179 4,807,441
----------- -----------
Cash and cash equivalents at end of quarter................................... $ 588,759 $3,994,945
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
F-4
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
(1) BASIS OF PRESENTATION
The unaudited consolidated financial statements of AvTel
Communications, Inc. and Subsidiaries (the "Company") for the three month
periods ended March 31, 1999 and 1998 have been prepared in accordance with
generally accepted accounting principles for interim financial reporting.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements and should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Form 10-K
for the year ended December 31, 1998. All significant intercompany balances
and transactions have been eliminated in consolidation. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of the interim financial
information have been included. The results of operations for any interim
period are not necessarily indicative of the results of operations for the
entire year.
(2) EARNINGS PER COMMON SHARE
The Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, Earnings per Share ("SFAS 128") in the fourth
quarter of 1997, which required companies to present basic earnings per
share and diluted earnings per share.
<TABLE>
<CAPTION>
MARCH 31,
------------------------------
1999 1998
-------------- -------------
<S> <C> <C>
Numerator:
Net loss $(3,066,131) $(1,672,490)
Less preferred dividends 11,816 11,816
----------- -----------
Loss applicable to common shareholders $(3,077,947) $(1,684,306)
----------- -----------
----------- -----------
Denominator:
Weighted average number of common shares
used in basic and diluted loss per common
share 10,482,416 9,477,489
----------- -----------
----------- -----------
Basic and diluted loss per common share $ (0.29) $ ( 0.18)
----------- -----------
----------- -----------
</TABLE>
F-5
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
(3) STOCKHOLDERS' EQUITY
During February 1999, the Company purchased 11,075 shares of its
common stock at prices ranging from $5.875 to $7.41 in the open market
pursuant to the Company's 1999 GO Plan. The 1999 GO Plan was established to
provide the Company's employees with cash bonuses for up to four years to
promote longevity of employment.
(4) LIQUIDITY
As shown in the consolidated financial statements for the three months
ended March 31, 1999, the Company reported a net loss of $3,066,131. In
addition, as of March 31, 1999, the Company had a working capital deficit of
$4,604,708, and for the three months ended March 31, 1999, net cash used in
operations totaled $1,307,598. As a result, the Company must obtain
additional financing or make significant changes to operations.
As of March 31, 1999, the Company was in violation of one provision of
the Loan and Security Agreement with Coast Business Credit that stipulates
that the Company must maintain a net worth equal to or greater than two
million dollars. Coast Business Credit has waived its right of acceleration
of the obligation as it relates to the Company not meeting the net worth
covenant through July 31, 1999, but retains its right of acceleration if the
Company is in violation of the net worth covenant in any month after July
31, 1999. The Company believes that the Private Equity Line entered into by
the Company as of April 23, 1999, together with the proceeds from the
issuance of 1,500 shares of its newly-designated Series B Convertible
Preferred Stock for $1,500,000 (Note 6), will enable the Company to meet the
net worth covenant beginning August 1999 as required by Coast Business
Credit.
The Private Equity Line provides for investors to purchase up to
$13,500,000 of the Company's common stock, subject to the Company filing and
maintaining an effective registration statement, trading price and volume
minimums, and limits on the amount and frequency on sales of common stock
under the line (Note 6).
If the Company is unable to draw upon the Private Equity Line or other
existing sources of capital or obtain new sources of capital in a timely
manner, management has developed and intends to implement a plan that would
allow the Company to continue to operate through the first quarter of 2000.
This plan would include significantly reducing the Company's workforce,
eliminating advertising expenditures, reducing professional services,
reducing or eliminating other discretionary expenditures and possibly the
sale of assets.
(5) SEGMENT REPORTING
The Company's two primary business segments are Business Markets Group
("BMG") and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data,
voice and Internet networking needs. Through a value-added sales process, the
Company designs, provisions and manages its customers' networks. The Company
provides a host of additional value-added services assisting its customers to
create enhanced intranet and extranet applications. Additionally, BMG markets
to its customer base a variety of traditional communications
F-6
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
products and services such as Internet access, long distance telephone
service, executive calling cards and audio/video conferencing.
CMG targets and markets to distribution companies, agents, resellers
and affinity groups ("Channel Partners") that maintain access to large groups
of individuals and small businesses through affinity relationships and niche
marketing strategies. Channel Partners include non-profit organizations and
for-profit distribution groups. CMG provides Internet access, long distance
telephone and other services to customers in 49 states.
The Company measures the progress of BMG and CMG based on revenues,
gross margin and earnings before interest, taxes, depreciation and
amortization ("EBITDA"). EBITDA is not a measure of financial performance
under generally accepted accounting principles and should not be considered
as an alternative to net income or cash flows from operations, as a measure
of performance. The results for the three months ended March 31, 1999 and
1998 are as follows:
THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
BMG CMG TOTAL
---------------- ----------------- ------------------
<S> <C> <C>
Revenues $ 2,761,953 $ 6,560,461 $ 9,322,414
Gross margin 646,874 2,054,827 2,701,701
Selling, general and administrative 1,979,956 3,309,356 5,289,312
Other income, net 16,600 (1,397) 15,203
EBITDA (1,316,482) (1,255,926) (2,572,408)
Total assets 8,106,121 4,917,469 13,023,590
Gross margin $2,701,701
Selling, general and administrative 5,289,312
Depreciation and amortization (99,144)
Other income, net 15,203
------------
Net loss $ (3,066,131)
------------
------------
</TABLE>
F-7
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
THREE MONTHS ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
BMG CMG TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
Revenues $ 1,349,846 $11,094,993 $12,444,839
Gross margin 146,885 3,009,959 3,156,844
Selling, general and administrative 607,719 3,974,727 4,582,446
Other income, net 3,325 40,630 43,955
EBITDA (457,509) (924,138) (1,381,647)
Total assets 2,495,046 14,961,216 17,456,262
Gross margin $3,156,844
Selling, general and administrative 4,582,446
Depreciation and amortization 278,868
Interest expense (11,975)
Other income, net 43,955
-----------
Net loss $(1,672,490)
-----------
-----------
</TABLE>
(6) SUBSEQUENT EVENTS
On April 13, 1999, the Company sold 1,500 shares of its newly-designated
Series B Convertible Preferred Stock (the "Series B Stock") to AMRO
International, S.A., an entity organized under the laws of Panama, Austinvest
Anstalt Balzers, an entity organized under the laws of Liechtenstein, and
Esquire Trade & Finance Inc., an entity organized under the laws of the British
Virgin Islands (the "Series B Investors") for $1,500,000. The Series B Stock has
a liquidation preference of $1,000 per share. The Series B Stock will be
entitled to an annual dividend of $30 per share, payable in cash or Common
Stock, at the Company's option. The annual dividend will increase to $60 per
share if the Company ever ceases to be listed on The NASDAQ Stock Market or any
national securities exchange. The Series B Stock is convertible into Common
Stock at the option of the Series B Investors at any time. The number of shares
of Common Stock to be received by a Series B Investor upon conversion will equal
the liquidation preference of the amount converted, divided by the conversion
price. The conversion price will be the lesser of (1) $6.875, or (2) 89% of the
lowest closing bid price for the Common Stock on The NASDAQ SmallCap Market
during the five trading day period prior to the date of conversion. The
conversion price will not be less than $3.00 for 180 days after the date of
issuance of the Series B Stock. Thereafter the conversion price will not be less
than $2.00 as long as certain revenue and EBITDA requirements are met. As a
result, the Company could issue up to 750,000 shares of Common Stock upon
conversion if all of the Series B Stock were converted at the lowest possible
conversion price (assuming such revenue and EBITDA requirements continue to be
met). Unless the Company shall have obtained the approval of its voting
stockholders in accordance with the rules of The NASDAQ Stock Market, the
Company will not issue shares of Common Stock upon conversion of any shares of
Series B Stock if such issuance of Common Stock, when added to the number of
shares of Common Stock previously issued by 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.
F-8
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
The Company also issued the Series B Investors warrants to purchase up
to 20,000 shares of Common Stock at a price of $8.60 per share. The warrants may
be exercised beginning September 30, 1999, and terminate on March 31, 2002.
The Company and the Series B Investors entered into a Registration
Rights Agreement that requires the Company to file, and obtain and maintain the
effectiveness of, a Registration Statement with the Securities and Exchange
Commission (the "Commission") in order to register the public resale of all
shares of the Common Stock acquired by the Series B Investors (a) upon
conversion of the Series B Stock, (b) in payment of dividends on the Series B
Stock, and (c) upon exercise of the warrants. The Company will be subject to
significant monetary penalties if it fails to obtain or maintain the
effectiveness of such Registration Statement.
The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation
for financial advisory services in connection with the placement of the Series B
Stock.
On April 23, 1999, the Company entered into a Private Equity Line with
Cambois Finance, Inc., a British Virgin Islands corporation (the "Investor").
Pursuant to the Private Equity Line, the Investor, subject to the Company filing
and maintaining an effective registration statement, trading price and volume
minimums, and limits on the amount and frequency on sales of common stock under
the line, agreed to purchase up to $13,500,000 of the Company's Common Stock
(the "Common Stock") over three years, as, when and if shares are put to the
Investor by the Company. The actual number of shares that may be issued by the
Company under the Private Equity Line is limited to 2,103,939 shares, unless and
until the Company obtains approval of the Private Equity Line from its
stockholders pursuant to the applicable corporate governance rules of The NASDAQ
Stock Market.
The Company's ability to require the Investor to purchase Common Stock
is subject to a number of significant conditions, including the continued
effectiveness of the Registration Statement described below. There can be no
assurance that the Investor will be able to purchase Common Stock when and as
required by the Company under the Private Equity Line.
The Company may put shares to the Investor in amounts ranging from
$75,000 up to $2,000,000 (varying with the Common Stock's trading price and
volume) every 15 trading days. The purchase price for the shares put to the
Investor will be 89% of the lowest closing bid price for the Common Stock on The
NASDAQ SmallCap Market during the five trading day period consisting of the two
trading days preceding the delivery of the put notice to the Investor by the
Company, the day of such delivery, and the two trading days after such delivery.
The Company may not put shares to the Investor unless the lowest closing bid
price during such five trading day period is in excess of $2.25 per share. The
closing bid price for the Common Stock on April 30, 1999, was $5.625 per share.
In connection with the Private Equity Line, the Company and the Investor
entered into a Registration Rights Agreement that requires the Company to file,
and obtain and maintain the effectiveness of, a Registration Statement on Form
S-1 with the Commission in order to register the sale and public resale of
shares of the Common Stock acquired by the Investor under the Private Equity
Line (the "Registration Statement"). The Investor will be named as an
underwriter in such Registration Statement. The Investor will also be subject to
certain restrictions on short selling of the Common Stock and certain "blackout"
periods on its ability to resell Common Stock under the Registration Statement.
If the Registration Statement has not been declared effective by October 30,
1999, the Investor's obligation
F-9
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1999 AND 1998
to purchase Common Stock under the Private Equity Line shall terminate, and
the Company will be required to pay the Investor $25,000 in liquidated
damages.
The Company has issued 3,000 shares of Common Stock to Trinity Capital
Advisors, Inc. and is required to pay four percent of all proceeds actually
received by the Company under the Private Equity Line to Trinity Capital
Advisors, Inc. as compensation for financial advisory services in connection
with the transactions set forth in the Private Equity Line.
On April 1, 1999 the Company granted nonstatutory stock options to two
board members to purchase 50,000 shares of the Company's common stock at an
exercise price of $4.88 per share (fair market value at date of grant) vesting
at a rate of 50% per year over two years. The Company also granted incentive
stock options to three executive officers to purchase 300,000 shares of the
Company's common stock at an exercise price of $4.88 per share (fair market
value at date of grant) vesting at a rate of 25% per year over four years. These
options were granted pursuant to the Company's 1998 Stock Incentive Plan.
On April 6, 1999 a former employee of the Company relinquished 36,262
shares of the Company's common stock to settle an employee receivable. The
shares where subsequently canceled and retired.
On April 9, 1999 the Company granted nonstatutory stock options to a new
board member to purchase 25,000 shares of the Company's common stock at an
exercise price of $4.6875 per share (fair market value at date of grant). The
options were granted pursuant to the Company's 1998 Stock Incentive Plan and
vest at the rate of 50% per year over two years.
On May 3, 1999 the Company granted incentive stock options to an
executive officers to purchase 50,000 shares of the Company's common stock at an
exercise price of $5.625 per share (fair market value at date of grant) vesting
at a rate of 25% per year over four years. These options were granted pursuant
to the Company's 1998 Stock Incentive Plan.
F-10
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
AvTel Communications, Inc.:
We have audited the accompanying consolidated balance sheets of AvTel
Communications, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1998.
In connection with our audits of the consolidated financial statements, we also
have audited the accompanying financial statement schedule. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of AvTel
Communications, Inc. and subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
KPMG LLP
Dallas, Texas
April 14, 1999
F-11
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------------- -------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents...................................................... $ 911,179 $ 4,807,441
Accounts receivable, net....................................................... 4,804,532 6,961,953
Due from affiliates............................................................ 501,858 2,127,771
Federal and state income tax receivable........................................ --- 598,970
Other current assets........................................................... 921,435 861,950
-------------- -------------
Total current assets......................................................... 7,139,004 15,358,085
Property and equipment, net............................................................. 1,684,707 1,791,682
Goodwill, net........................................................................... 4,463,747 ---
Other assets, net....................................................................... 1,346,896 1,575,083
-------------- -------------
Total assets................................................................. $14,634,354 $18,724,850
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued expenses.................................... $2,643,761 $1,546,762
Accrued network service costs.................................................. 4,217,206 4,319,198
Sales and excise taxes payable................................................. 1,433,483 736,012
Unearned revenue............................................................... 954,101 ---
Due to affiliates.............................................................. 324,020 2,719,417
Other current liabilities...................................................... 589,392 466,039
-------------- --------------
Total current liabilities.................................................... 10,161,963 9,787,428
Deferred income taxes................................................................... --- 498,712
Long term borrowings.................................................................... 1,112,890 ---
Other liabilities....................................................................... 5,381 50,782
Common stock subject to put option (note 4)............................................. 168,867 578,880
-------------- --------------
Total liabilities............................................................ 11,449,101 10,915,802
-------------- -------------
Stockholders' equity:
Preferred stock, authorized 750,000 shares, $0.01 par value.................... --- ---
Series A convertible preferred stock, authorized 250,000 shares,
$0.01 par value, cumulative 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............................................................ (16,549,597) (9,422,279)
Treasury stock, none at December 31, 1998 and 1,999,997 common
shares at December 31, 1997.................................................... --- (20,000)
-------------- -------------
Total stockholders' equity................................................... 3,185,253 7,809,048
-------------- -------------
Commitments and contingencies
Total liabilities and stockholders' equity..................................... $14,634,354 $ 18,724,850
-------------- -------------
-------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-12
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
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)................................... (201,579) (276,352) (1,686,876)
------------ ----------- -----------
Net income (loss)..................................... $(7,127,318) $(10,191,720) $2,566,734
------------ ----------- -----------
------------ ----------- -----------
Net loss per common share--basic and diluted (note 6).......... $ (0.74) $ (1.23)
------------ -----------
------------ -----------
Weighted average number of common shares....................... 9,633,474 8,267,296
------------ -----------
------------ -----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-13
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------- ------------------------- PAID IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- --------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1995.................. -- $ -- 6,872,883 $5,336,815 $ --
Purchase of common stock.............. -- -- -- -- --
Issuance of common stock.............. -- -- 1,463,771 2,195,211 --
Net income............................ -- -- -- -- --
--------- --------- ------------ ------------ -------------
Balances at December 31, 1996.................. -- $ -- 8,336,654 $7,532,026 --
Acquisition of Best (note 2).......... -- -- 934,987 3,361,208 --
Share for share exchange between
AvTel and Matrix (note 2):
Reverse acquisition of AvTel...... 207,700 2,077 1,839,563 18,396 9,129,040
Reflect new capitalization of
Company........................ -- -- (171,548) (10,802,234) (7,064,710)
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.............................. -- -- -- -- --
--------- --------- ------------ ------------ -------------
Balances at December 31, 1997.................. 207,700 $2,077 11,051,136 $110,511 $17,138,739
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
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) --
Net loss.............................. -- -- -- -- --
--------- --------- ------------ ------------ -------------
Balances at December 31, 1998.................. 147,700 $1,477 10,296,895 $102,969 $19,630,404
--------- --------- ------------ ------------ -------------
--------- --------- ------------ ------------ -------------
<CAPTION>
RETAINED
EARNINGS TREASURY STOCK
(ACCUMULATED ------------------------------------
DEFICIT) SHARES AMOUNT TOTAL
------------ -------------- ---------- -------------
<S> <C> <C> <C> <C>
Balances at December 31, 1995.................. $(1,797,293) -- $ -- $3,539,522
Purchase of common stock.............. -- (171,548) (439,584) (439,584)
Issuance of common stock.............. -- -- -- 2,195,211
Net income............................ 2,566,734 -- -- 2,566,734
--------- --------------- ---------------- ---------
Balances at December 31, 1996.................. $ 769,441 (171,548) $(439,584) $7,861,883
Acquisition of Best (note 2).......... -- (1,999,997) (3,317,940) 43,268
Share for share exchange between
AvTel and Matrix (note 2):
Reverse acquisition of AvTel...... -- -- -- 9,149,513
Reflect new capitalization of
Company........................ -- 171,548 3,737,524 --
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) -- -- (10,191,720)
----------- --------------- --------------- -----------
Balances at December 31, 1997.................. $(9,422,279) (1,999,997) $ (20,000) $7,809,048
Conversion of preferred stock (note 4) -- -- -- --
Issuance of common stock for
exercise of options and
restricted common stock............ -- -- -- 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)........ -- (207,604) (2,016) 372,761
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 --
Net loss.............................. (7,127,318) -- -- (7,127,318)
----------- --------------- --------------- -----------
Balances at December 31, 1998.................. $(16,549,597) -- $ -- $ 3,185,253
----------- --------------- --------------- -----------
----------- --------------- --------------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
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)............................................. $(7,127,318) $(10,191,720) $2,566,734
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization............................. 1,107,321 679,856 993,940
Amortization of advanced commissions...................... 220,928 1,355,492 618,791
Acquisition related write off............................. -- 9,098,545 --
Gain on disposition of assets............................. (83,139) -- --
Provision for bad debts................................... 2,727,803 1,829,770 1,461,471
Deferred income taxes..................................... (498,712) (80,377) (321,678)
Stock compensation earned................................. 477,148 748,884 --
Equity in income of DNS................................... -- -- (122,327)
Changes in certain operating assets and liabilities:
Accounts receivable..................................... 374,477 1,969,332 (1,971,970)
Due from affiliates..................................... (106,071) (915,357) 345,336
Federal and state income tax receivable................. 583,906 (598,970)
Other current assets.................................... (224,820) 1,787,672 (393,781)
Accounts payable and accrued liabilities................ (1,034,923) (2,876,789) (1,397,160)
Due to affiliates....................................... (2,395,397) (1,138,568) (742,663)
------------ ------------- ----------
Net cash provided by (used in) operating activities... (5,978,797) 1,667,770 1,036,693
------------ ------------- ----------
Cash flows from investing activities:
Cash received (paid) in acquisitions (note 2) ................ (474,082) 477,643
Loans to affiliate............................................ -- (2,000,000) --
Payments received on loans to affiliates...................... 1,798,889 201,111 --
Purchase of property and equipment............................ (473,089) (212,421) (701,718)
Repayments from DNS, net...................................... -- -- 1,577,432
Proceeds from sale of property and equipment.................. 94,370 2,749 (14,482)
Net cash provided by (used in) investing activities... 946,088 (1,530,918) 861,232
------------ ------------- ----------
Cash flows from financing activities:
Principal payments on capital leases.......................... (59,055) (4,306) --
Issuance of common stock for exercise of options.............. 517,612 52,500 --
Borrowings on line of credit.................................. 9,753,467 -- --
Amounts paid on line of credit................................ (8,640,577) -- --
Purchase of officer notes receivable.......................... (435,000) -- --
Purchase of common stock for treasury......................... -- -- (439,583)
Net cash provided by (used in) financing activities... 1,136,447 48,194 (439,583)
------------ -------------
Net increase (decrease) in cash and cash equivalents................... (3,896,262) 185,046 1,458,342
Cash and cash equivalents at beginning of year......................... 4,807,441 4,622,395 3,164,053
------------ ------------- ----------
Cash and cash equivalents at end of year............................... $ 911,179 $ 4,807,441 $4,622,395
------------ ----------
------------ ----------
Cash paid (received) during the year for:
Interest...................................................... $ 86,12 $ 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 AvTel 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-15
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BUSINESS AND BACKGROUND
On December 1, 1997, AvTel Communications, Inc. ("AvTel") and Matrix
Telecom, Inc. ("Matrix") completed a share for share exchange pursuant to a
stock exchange agreement dated April 29, 1997 as subsequently amended ("Share
Exchange"). For accounting purposes, the Share Exchange was treated as a
reverse acquisition of AvTel by Matrix. AvTel was the legal acquirer and
accordingly, the Share Exchange was effected by the issuance by AvTel of
9,582,493 shares of common stock in exchange for all of the common stock then
outstanding of Matrix. In addition, holders of outstanding Matrix stock options
received 22,338 non-qualified stock options of AvTel. The purchase method of
accounting was used, with Matrix being treated as the acquirer for accounting
purposes. The results of operations reported in the accompanying consolidated
financial statements reflect the operations of Matrix prior to December 1, 1997
and the combined operations of AvTel and Matrix subsequent to December 1, 1997.
References to the "Company" refer to operations of Matrix prior to the Share
Exchange and the combined operations of Matrix and AvTel subsequent to the Share
Exchange. As a result of the Share Exchange, Matrix became a wholly owned
subsidiary of AvTel. (See note 2).
The Share Exchange provided that each Matrix shareholder would receive
2.4819 AvTel common shares for each common share of Matrix then issued including
treasury shares held by Matrix. For periods prior to the December 1, 1997 Share
Exchange, all share amounts have been restated to reflect the Share Exchange as
a 2.4819 for one stock split. In addition, on March 10, 1997 Matrix declared an
18 for one stock split. All share amounts have also been restated to reflect
this stock split.
AvTel was formed to be a provider of broadband network services
integrating voice, data and Internet solutions for individuals and corporate
customers. The Company sells and markets a broad range of telecommunications
and advanced network services through independent value added resellers, third
party marketing organizations and internal direct sales professionals. The
Company targets mid-size corporations, small-office home-office professionals
and select residential market segments through two primary business units, its
Business Markets Group ("BMG") and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data, voice
and Internet networking needs. Following this sales strategy, the Company's
objective is to become the underlying telecommunications carrier for the
transport of data, voice and Internet traffic. Through a value-added sales
process, the Company designs, provisions and manages its customers' networks.
The Company will provide a host of additional value-added services assisting its
customers to create enhanced intranet and extranet applications. Additionally,
BMG markets to its customer base a variety of traditional communications
products and services such as long distance telephone service, executive calling
cards and video/audio conferencing.
CMG targets and markets to distribution companies, agents, resellers and
affinity groups that maintain access to large groups of individuals and small
businesses through affinity relationships and niche marketing strategies. CMG
provides Internet access, long distance telephone and other services to
customers in 49 states. The Company is fully certified or registered in all
states where required and operates under Section 214 authority from the Federal
Communications Commission ("FCC"). The Company, through a wholly owned
subsidiary, has a national-deployed
F-16
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Carrier Identification Code ("CIC"). The Company maintains its own
convergent billing platform, rating system and monitoring center.
(b) LIQUIDITY
The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
consolidated financial statements during the years ended December 31, 1998 and
1997, the Company reported net losses of $7,127,318 and $10,191,720,
respectively. In addition, as of December 31, 1998, the Company had a working
capital deficit of $3,022,959, and for the year ended December 31, 1998, net
cash used in operations totaled $5,978,797.
As a result, as of December 31, 1998, unless the Company effects
substantial changes in its operating methods, the Company does not have
sufficient resources to meet its anticipated operating requirements during 1999
without obtaining additional financing. The Company is actively pursuing an
equity line 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-17
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(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
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.
F-18
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(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.
(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.
F-19
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
(p) COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes net income and other comprehensive income, which is generally composed
of changes in the fair value of available-for-sale marketable securities,
foreign currency translation adjustments and adjustments to recognize additional
minimum pension liabilities. The statement requires additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations. Comprehensive income (loss) for the
years ended December 31, 1998, 1997 and 1996 is equal to net income (loss)
reported for such periods.
(q) SEGMENT REPORTING
In 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS No. 131"). SFAS No. 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
(See Note 11).
(r) RECLASSIFICATIONS
Certain reclassifications have been made to prior period amounts in
order to conform to current year presentation.
(2) ACQUISITIONS
MATRIX TELECOM, INC. -- On December 1, 1997, AvTel and Matrix completed
the Share Exchange. For accounting purposes the Share Exchange was treated as a
reverse acquisition of AvTel by Matrix. AvTel was the legal acquirer and,
accordingly, the Share Exchange was effected by the issuance of AvTel common
stock in exchange for all of the common stock then outstanding of Matrix. In
addition, holders of outstanding Matrix stock options received non-qualified
stock options of the Company. Immediately after the Share Exchange the former
shareholders of Matrix held approximately 84% of the then outstanding common
stock of the Company.
The consummation of the Share Exchange was subject to the satisfaction
of several conditions by AvTel. These included the reincorporation of AvTel
(then a Utah corporation; "AvTel Utah") in Delaware by way of a merger (the
"Reincorporation Merger") with and into AvTel Communications, Inc., a Delaware
corporation, a wholly-owned subsidiary formed for the sole purpose of this
merger. As part of the merger, AvTel (the surviving Delaware corporation)
issued to its stockholders one share of new Delaware Common Stock for each four
shares of AvTel-Utah's Common Stock outstanding immediately prior to the
Reincorporation Merger. AvTel's Series A Convertible Preferred Stock and its
outstanding options were similarly adjusted. Accordingly, the Reincorporation
Merger essentially effected a one for four reverse stock split of AvTel's
shares.
F-20
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(2) ACQUISITIONS (CONTINUED)
The reverse acquisition of AvTel by Matrix was accounted for using the
purchase method of accounting. In order to value the consideration given in the
Share Exchange the market price of AvTel common stock for a period immediately
preceding the announcement of the Share Exchange was used. As of the date of
acquisition, the Company determined the fair value of the net tangible and
intangible assets acquired and liabilities assumed. Concurrently, the Company
determined that the carrying amount of recorded goodwill was not recoverable.
Accordingly, the Company recorded a charge to income of $9,098,545 immediately
subsequent to the reverse acquisition.
In connection with the completion of the Share Exchange, the Company
entered into a Registration Rights and Lockup Agreement dated December 1, 1997
(the "Registration Rights and Lockup Agreement"). The Registration Rights and
Lockup Agreement requires that the Company use its best efforts to file a shelf
registration statement providing for the sale by certain stockholders of all
securities issued to them in connection with the Exchange Agreement, subject to
a two-year holding restriction imposed on such stockholders. Under the
Registration Rights and Lockup Agreement, the Company is obliged to use its
reasonable efforts to keep the shelf registration statement effective on a
continuous basis for a period described in the Registration Rights and Lockup
Agreement. Such stockholders may also require the Company to undertake up to
two additional demand registrations of their securities if the shelf
registration is not in place. As of April 14, 1999, this registration
obligation related to 6,457,123 shares held by 14 stockholders.
BEST CONNECTIONS, INC. ("BEST") -- Effective July 1, 1997, shareholders
of Best, an affiliate of Matrix through substantially common ownership,
contributed their ownership of Best to Matrix in exchange for 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,
F-21
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(2) ACQUISITIONS (CONTINUED)
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................................... (9,124,180) (12,378,014)
Proforma net loss per share................ $ (0.89) $ (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.
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>
F-22
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(2) ACQUISITIONS (CONTINUED)
<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-23
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
(4) STOCKHOLDERS' EQUITY
The Series A convertible preferred shareholders are entitled to receive
cumulative annual dividends at a rate of 8% and are entitled to a preference in
liquidation in the amount of $4 per share plus unpaid dividends. There were
$137,000 cumulative Series A convertible preferred stock dividends in arrears at
December 31, 1998. The Series A preferred stock is convertible, on a
one-for-one basis, into shares of Company common stock. During 1998, a total of
60,000 shares of the Company's Series A convertible preferred stock was
converted to 60,000 shares of the Company's common stock.
In December 1998, the Company retired all of its outstanding treasury
stock.
In December 1996, the Company issued 1,463,771 shares of common stock
for future commissions due to affiliates as of October 31, 1996. A value of
$1.50 per share was used in determining the number of shares to issue in
settlement of the $2,195,211 obligation. Of this amount, $221,000, $1,355,000
and $619,000 was expensed as commission expense in 1998, 1997 and 1996,
respectively.
During 1996, the Company sold to certain employees 482,400 shares of
common stock at $1.50 per share. As of December 31, 1996, the Company had
recorded a $723,600 receivable for such shares, which was subsequently
collected. Proceeds used to repay the $723,600 receivable were loaned to the
employees by a major shareholder of the Company. As of December 31, 1998 and
1997, the shares subject to this agreement could be put to the Company at the
option of the employee at approximately $1.50 per share ($168,867 and $578,880),
respectively. Such amounts have been included in other liabilities. Under
certain circumstances (e.g. employee termination) the Company has a call at the
same amounts. The call and put rights vest over a period of five years. As of
December 31, 1998, these rights were forty percent vested. Activity in common
stock outstanding related to shares subject to put follows:
<TABLE>
<CAPTION>
SHARES AMOUNT
-------- -----------
<S> <C> <C>
Sale of common shares subject to put............................ 482,400 $ 7,23,600
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
F-24
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
acquired an additional 1,999,997 shares of its common stock as treasury stock.
As a part of the recapitalization done in connection with the AvTel reverse
acquisition, Matrix retired the 171,548 shares of its common stock discussed
above and the Company recorded the remaining treasury stock at par value.
(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.................................... $ -- $(234,899) $ 1,751,047
State and local............................ 7,531 (41,453) 257,507
---------- ---------- ------------
7,531 (276,352) 2,008,554
---------- ---------- ------------
Deferred tax expense (benefit):
Federal.................................... (209,110) -- (254,350)
State and local............................ -- (67,328)
---------- ---------- ------------
(209,110) -- (321,678)
---------- ---------- ------------
$(201,579) $(276,352) $(1,686,876)
---------- ---------- ------------
---------- ---------- ------------
</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............... 2,594,289 330,190 --
Other.......................................... (190,621) (113,561) 156,721
------------ ------------ ----------
$ (201,579) $ (276,352) $1,686,876
------------ ------------ ----------
------------ ------------ ----------
</TABLE>
F-25
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
(5) FEDERAL AND STATE INCOME TAXES (CONTINUED)
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 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 carryovers............ $ 3,494,634 $ 814,425
Compensation related items............... 480,137 299,554
Contingent liabilities and other ........ 268,340 204,978
----------- -----------
Gross deferred tax asset................. 4,243,111 1,318,957
Less valuation allowance................. (3,778,958) (1,184,669)
---------- -----------
Net deferred tax asset................... 464,153 134,288
Deferred tax liabilities:
Customer base intangible................. (464,153) (633,000)
----------- -----------
Net deferred tax liability............... $ -- $ (498,712)
----------- -----------
----------- -----------
</TABLE>
The valuation allowance for deferred tax assets increased $2,594,289
and $1,184,669 during 1998 and 1997, respectively.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and prior taxes paid in making this assessment. Based upon its
evaluation of these factors, management believes that it is more likely than not
that the Company will realize the benefits of these deductible differences, net
of the valuation allowance, at December 31, 1998. At December 31, 1998, the
Company has net operating loss carryforwards for federal tax purposes of
approximately $9,153,822 which are available on a limited basis to offset future
federal taxable income, if any, through 2018. When realized, such benefit will
first be utilized to reduce intangible assets recorded in the reverse
acquisition of AvTel by Matrix.
(6) RELATED PARTY TRANSACTIONS
The Company has had transactions in the normal course of business with
various companies which are affiliated with shareholders of the Company. Pacific
Gateway Exchange, Inc. ("PGE") provides the Company with significant domestic
and international transmission services. As of January 1, 1998, PGE was no
longer affiliated with the Company. During 1998, a director and several
significant holders of the Company's common stock divested themselves of a
substantial portion of their holdings of PGE common stock; they have advised the
Company that they no longer could be deemed to be in control of PGE. A
significant number of the Company's employees were
F-26
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
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-27
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997, AND 1996
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
Significant services and transactions incurred in the normal course of
operations with affiliated companies are summarized as follows:
<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
include the following:
Expenses paid on behalf of PGE (not considered
an affiliate in 1998) for access services,
for which the Company was reimbursed......... $ -- $ 3,534,154 $ 5,040,051
Expenses incurred for leasing employees from
United Group Service Center.................. 5,581,428 4,395,820 4,542,007
Sales commissions to affiliates:
Core Marketing, UICI, UGA, Best
Connections and AMLI......................... 140,187 990,533 5,335,233
Overhead expenses reimbursed to/from
UGA Divisions................................ 241,810 110,761 77,231
Core Marketing--casual mailings and
telemarketing................................ 21,425 603,742 --
---------- ----------- -----------
$5,984,850 $ 9,635,010 $14,994,522
---------- ----------- -----------
---------- ----------- -----------
Interest expense includes the following:
Interest paid to shareholder................... $ -- $ -- $ 173,380
---------- ----------- -----------
---------- ----------- -----------
</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
F-28
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(6) RELATED PARTY TRANSACTIONS (CONTINUED)
original notes, plus accrued interest, at the date of purchase by the Company
was $573,000. The Company purchased these notes for $435,000.
In connection with the purchase of the notes receivable above, the
Company repurchased 240,912 shares of its common stock subject to the Buyback
Agreement from terminated employees. The Company exercised its right to
repurchase 225,154 of such shares at a price range of $1.51 to $1.70 per
share, and the former employees used the $373,081 in proceeds to reduce the
amount of their notes. The Company repurchased an additional 15,758 shares in
satisfaction of the remaining balance of $116,085 on the former employees'
notes.
(7) STOCK COMPENSATION
AVTEL OPTIONS--Prior to the Share Exchange AvTel adopted a 1997
Incentive Stock Option Plan (the "AvTel 1997 Plan") for option grants to
officers and key employees. The AvTel 1997 Plan authorizes grants of options
to purchase up to 250,000 shares of authorized but unissued common stock and
125,000 shares of restricted common stock. Stock options are to be granted
with an exercise price greater than or equal to the stock's fair market value
at the date of grant. Options generally vest 25% after one year and 25% each
year thereafter until fully vested. Such options typically expire after ten
years. In addition, AvTel had other options which had been granted prior to
the adoption of the AvTel 1997 Plan. After the Share Exchange all outstanding
options became obligations of the Company.
On January 1, 1998, the Company granted options to purchase 75,000
shares of the Company's common stock at an exercise price of $1.50 per share.
On March 1, 1998 the Company granted options to purchase 100,000 shares of
the Company's common stock at an exercise price of $1.50 per share. These
options become exercisable based on qualified billings of long distance
customers generated by the optionees from the respective dates of grant
through December 31, 2000. As of December 31, 1998, 27,316 options are
exercisable.
On February 24, 1998, the Company's Board of Directors approved the
grant of a total of 120,000 shares of restricted common stock to two board
members pursuant to the Company's 1997 Stock Incentive Plan. The restricted
stock provisions will lapse over four years or fully lapse in the event of
death or permanent disability of the grantees. During 1998 one of the board
members resigned from the board and his 60,000 shares were vested
immediately. As of December 31, 1998, only those 60,000 shares of restricted
common stock are vested.
During 1998, the Company adopted the 1998 Stock Incentive Plan (the
"AvTel 1998 Plan"), which provides for the issuance of up to 1,500,000 shares
of AvTel common stock pursuant to stock options and issuances of restricted
stock, as well as for the grant of stock appreciation rights. Stock options
are to be granted with an exercise price greater than or equal to the stock's
fair market value at the date of grant. Options generally vest 25% after one
year and 25% each year thereafter until fully vested. Such options typically
expire after ten years. As of December 31, 1998, the Company granted 671,000
options under the AvTel 1998 Plan. Exercise prices range from $2.375 to $4.00
per share.
F-29
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(7) STOCK COMPENSATION (CONTINUED)
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.
The Company applies APB Opinion No. 25 in accounting for the AvTel
1997 Plan, 1998 Stock Incentive Plan and the Matrix options discussed above;
and, accordingly, no compensation cost has been recognized for its stock
options issued to employees in the financial statements. For stock options
granted to non-employees, the Company accounts for such options in accordance
with the requirements of SFAS No. 123. Had the Company determined
compensation cost based on the fair value at the grant date for stock options
issued to employees under SFAS No. 123, the Company's net loss in 1998 and
1997 would not have materially changed.
BEST CONNECTIONS, INC. OPTIONS--As discussed in Note 2, as a result
of the Matrix combination with Best, Matrix assumed the obligation to issue
stock options to Best's agents under Best's 1997 Option Plan. Effective as of
the date of combination, July 1, 1997, 1,292,000 options to purchase Matrix
common shares were granted to Best agents at $1.50 per share, which will
result in aggregate commission expense of approximately $764,000 over the
vesting period. The option price per share was $1.50. The agents' options
become exercisable no later than December 31, 1999 and may be exercised
earlier based on qualified billings of long distance customers generated by
the agents during six month measurement periods. After the Share Exchange
such options became obligations of the Company. As of December 31, 1998,
641,532 options have been earned and 172,120 exercised under the Plan and the
Company recorded expense totaling approximately $132,000 and $249,000 related
to such options based on qualified billings for 1998 and 1997, respectively.
Options generally expire two years from the date they become exercisable or
sixty days subsequent to termination of employment.
The per share weighted average fair value of stock options granted
on July 1, 1997 was $.59 on the date of the grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
expected volatility of 30%, risk-free interest rate of 6.0%, and an expected
life of 3.5 years.
BEST CONNECTIONS, INC. OPTIONS AND RESTRICTED STOCK AGREEMENTS--As
discussed in Note 2 as a result of the Matrix combination with Best, Matrix
assumed the obligation to issue stock options, consisting of Matrix common
shares owned by Best, to employees of affiliated companies. Effective July
15, 1997, the Company issued 247,500 options to purchase an equal number of
shares of its common stock, at $1.50 per share subject to the provisions of a
Restricted Stock Agreement. The Restricted Stock Agreement includes a call
provision by the Company that lapses 10 percent each six months beginning
December 15, 1997 through June 15, 2002 or fully lapses in the event of death
or permanent disability of the option holder. The call price is equal to the
initial purchase price of $1.50 plus the aggregate amount of net income or
less the aggregate amount of net losses per share for each fiscal quarter
beginning after December 15, 1997; provided that the call price could not be
less than $1.50 per share. During 1998 AvTel relinquished its right to call
the shares which caused the options to vest immediately and to expire if not
exercised before December 13, 1998. AvTel provided the holders the option of
a "cashless" exercise by purchasing up to one half the shares issuable at
$3.00 The Company recognized expense over the life of the options in
accordance with the provisions of SFAS No. 123 and recorded expense of
$500,000 in 1997 and a reduction of expense of $170,000
F-30
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(7) STOCK COMPENSATION (CONTINUED)
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.
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
AvTel options outstanding at time of Share Exchange... 255,109 4.52
Granted............................................... 1,539,500 1.50
Exercised............................................. (15,000) 3.50
---------
Outstanding at December 31, 1997............................... 1,801,947 1.78
Granted............................................... 1,024,500 3.31
Expired............................................... (46,750) 1.54
Forfeited............................................. (106,999) 1.91
Exercised............................................. (353,327) 1.81
--------- ----
Outstanding at December 31, 1998............................... 2,319,371 2.45
--------- ----
--------- ----
Exercisable at December 31, 1995 -- $ --
Exercisable at December 31, 1996 3,574 2.24
Exercisable at December 31, 1997 349,972 2.21
Exercisable at December 31, 1998 524,849 2.16
</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
-------------------------------------------------
WEIGHTED OPTIONS EXERCISABLE
RANGE OF AVERAGE WEIGHTED ---------------------------------------
EXERCISE NUMBER OF REMAINING AVERAGE NUMBER OF OPTIONS WEIGHTED AVERAGE
PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------- ---------- ---------------- -------------- ----------------- ----------------
<S> <C> <C> <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-31
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(8) EARNINGS PER COMMON SHARE
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, EARNINGS PER SHARE ("SFAS 128") in the fourth quarter of
1997, which required companies to present basic earnings per share and
diluted earnings per share.
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Numerator:
Net loss.............................................. $(7,127,318) $(10,191,720)
Less preferred dividends.............................. 47,264 5,540
------------- ------------
Loss applicable to common shareholders............. $(7,174,582) $(10,197,260)
------------- ------------
------------- ------------
Denominator:
Weighted average number of common shares used
in basic and diluted loss per common share......... 9,633,474 8,267,296
------------- ------------
------------- ------------
Basic and diluted loss per common share............... $ (0.74) $ (1.23)
------------- ------------
------------- ------------
</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-32
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
----------------------------
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 6,554,356 14,634,354
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------
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
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------
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>
F-33
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(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 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.
F-34
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
(13) SUBSEQUENT EVENTS (CONTINUED)
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.
F-35
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following is an itemized statement of the estimated amounts of all
expenses payable by the Registrant in connection with the registration of the
common stock offered hereby, other than underwriting discounts and commissions:
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee . . . . $ 2,814
Additional Listing Fee for Nasdaq SmallCap Market . . . . . 7,000
Blue Sky Fees and Expenses (including attorneys' fees). . . 1,000
Accounting Fees and Expenses. . . . . . . . . . . . . . . . 10,000
Attorneys' Fees and Expenses. . . . . . . . . . . . . . . . 50,000
Transfer Agent's and Registrar's Fees . . . . . . . . . . . 1,000
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . 8,186
-------
Total. . . . . . . . . . . . . . . . . . . . . . . . $80,000
-------
-------
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
(a) The Delaware General Corporation Law (Section 145) gives Delaware
corporations broad powers to indemnify their present and former directors and
officers and those of affiliated corporations against expenses incurred in the
defense of any lawsuit to which they are made parties by reason of being or
having been such directors or officers, subject to specified conditions and
exclusions, gives a director or officer who successfully defends an action the
right to be so indemnified, and authorizes the Registrant to buy directors' and
officers' liability insurance. Such indemnification is not exclusive of any
other rights to which those indemnified may be entitled under any bylaws,
agreement, vote of stockholders or otherwise.
(b) Article Eighth of the Certificate of Incorporation of the Registrant
permits, and Article Sixth of the Bylaws of the Registrant provides for,
indemnification of directors, officers, employees and agents to the fullest
extent permitted by law provided that AvTel is not required to advance expenses
incurred by directors and officers in connection with an action, suit or
proceeding (or part thereof) brought by AvTel which was authorized by a majority
of its board of directors and which alleges (i) willful misappropriation of
corporate assets by such director, officer, employee or agent, (ii) disclosure
of confidential information in violation of law or (iii) any other willful and
deliberate breach in bad faith of the duty of such director, officer, employee
or agent to AvTel or its stockholders.
(c) In accordance with Section 102(b)(7) of the Delaware General
Corporation Law, the Registrant's Certificate of Incorporation provides that
directors shall not be personally liable for monetary damages for breaches of
their fiduciary duty as directors except for (1) breaches of their duty of
loyalty to the Registrant or its stockholders, (2) acts or omissions not in good
faith or which involve intentional misconduct or knowing violations of law, (3)
under Section 174 of the Delaware General Corporation Law (unlawful payment of
dividends) or (4) transactions from which a director derives any improper
personal benefit.
II-1
<PAGE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
During the fiscal year ended September 30, 1997, AvTel issued shares of its
common stock, which were not registered under the Securities Act, in connection
with the acquisition of AvTel Holdings, the acquisition of Silicon Beach and the
acquisition of WestNet. AvTel also issued shares of series A convertible
preferred stock in connection with the acquisition of AvTel Holdings. (Such
shares are convertible into common stock on a one for one basis.) No
underwriters were used in these transactions and none of such shares were issued
publicly. In each case AvTel relied on the exemptions from registration
provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D
promulgated thereunder. In each case, the number of individuals receiving
shares of stock was very small, and such individuals were and are believed by
AvTel to possess the requisite level of financial sophistication and experience
in order to qualify for such exemptions. In each case, AvTel made available to
the recipients of such common stock all material information with respect to
AvTel and the respective transaction. The specific details of such issuances
were disclosed as part of relevant Form 8-K, Form 10-KSB or Form 10-QSB filings.
Certain summary information is set forth in the following table. All share
numbers have been adjusted to reflect the subsequent reverse stock split.
<TABLE>
<CAPTION>
Date Shares Issued Entity Acquired Purchasers
- ---- ------------- --------------- ----------
<S> <C> <C> <C>
October 23, 1996 1,063,127 (Common Stock) AvTel Holdings Anthony E. Papa,
James P. Pisani,
Barry A. Peters
October 23, 1996 250,000 (Preferred Stock) AvTel Holdings Tommy Lin, Patrick Lin
November 20, 1996 28,750 Silicon Beach Frank Dziuba
February 21, 1997 8,750 WestNet Theodore E. Padova,
Howard M. Tamaroff,
Hallas Color Photo Lab, Inc.
</TABLE>
On December 1, 1997, AvTel issued 9,582,493 shares of its common stock,
which were not registered under the Securities Act, in connection with the
acquisition of Matrix Telecom; 1,999,997 of such shares were held by a
subsidiary of AvTel as treasury stock after the transaction and were
subsequently canceled. No underwriters were used in this transaction and none
of such shares were issued publicly. AvTel relied on the exemptions from
registration provided by Section 4(2) of the Securities Act and Rule 506 of
Regulation D promulgated thereunder. The persons receiving shares were the 23
former Matrix Telecom shareholders. AvTel also issued options for 22,338 shares
of common stock to three former Matrix Telecom option holders with an exercise
price of $2.24 per share. These persons were and are believed by AvTel to
possess the requisite level of financial sophistication and experience in order
to qualify for such exemptions. AvTel made available to the recipients of such
common stock all material information with respect to AvTel and the share
exchange. Each such person signed an exchange statement containing appropriate
investment representations and covenants. The specific details of the issuances
were disclosed in AvTel's definitive Proxy Statement dated October 31, 1997, and
as part of relevant Form 8-K and Form 10-KSB filings.
In June 1997, New Best Connections, Inc., a subsidiary of Matrix Telecom,
awarded options to purchase shares of Matrix Telecom common stock to members of
its outside sales force in recognition of their past services to Best
Connections, Matrix Telecom and related companies (and in satisfaction of
certain obligations of Best Connections to shareholders of Matrix Telecom who
had contributed shares of Matrix Telecom stock to Best Connections). As a
result of the share exchange, the shares of Matrix Telecom common stock subject
to such options were converted into 1,292,000 shares of AvTel common stock. The
exercise price for such options is $1.50 per share. AvTel subsequently
registered such shares of its common stock prior to any of such options becoming
exercisable.
In July 1997, Best Connections issued options to purchase Matrix Telecom
common stock to 41 individuals in recognition of their past services to Best
Connections, Matrix Telecom and related companies (and in satisfaction
II-2
<PAGE>
of certain obligations of Best Connections to shareholders of Matrix Telecom
who had contributed shares of Matrix Telecom stock to Best Connections for this
purpose). As a result of the share exchange, the shares of Matrix Telecom
common stock subject to such options were converted into shares of AvTel common
stock. The exercise price for such options was $1.50 per share. During the
fiscal year ending December 31, 1998, (1) options were exercised for 107,250
shares, (2) options for 67,250 shares were canceled in connection with the
exercise of other options, and (3) options for 73,000 shares were forfeited or
expired unexercised. At December 31, 1998, none of such options remained
outstanding. No underwriters were used in connection with these option exercises
and none of the shares issued upon exercise was issued publicly. AvTel has
relied on the exemptions from registration provided by Section 4(2) of the
Securities Act and Rule 506 of Regulation D promulgated thereunder. The
optionees were and are believed by AvTel to possess the requisite level of
financial sophistication and experience in order to qualify for such exemptions.
AvTel made available to the recipients of such common stock all material
information with respect to AvTel.
On September 25, 1998, AvTel issued 30,000 shares of its common stock,
which were not registered under the Securities Act, in connection with the
acquisition of Digital Media, by means of a stock-for-stock exchange. No
underwriters were used in the transaction and none of such shares were issued
publicly. AvTel relied on the exemptions from registration provided by Sections
3(a) (11) and 4(2) of the Securities Act and Rule 505 of Regulation D
promulgated thereunder. The persons receiving shares were the three former
Digital Media shareholders. These persons were and are believed by AvTel to
possess the requisite level of financial sophistication and experience in order
to qualify for such exemptions. AvTel made available to the recipients of such
common stock all material information with respect to AvTel and the share
exchange. Each such person signed an exchange agreement containing appropriate
investment representations and covenants.
On November 19, 1998, AvTel issued 650,000 shares of its common stock,
which were not registered under the Securities Act, in connection with the
acquisition of Remote Lojix. No underwriters were used in this transaction and
none of such shares were issued publicly. AvTel relied on the exemptions from
registration provided by Section 4(2) of the Securities Act and Rule 506 of
Regulation D promulgated thereunder. The persons receiving shares were the 20
shareholders of Remote Lojix. These persons are believed by AvTel to possess
the requisite level of financial sophistication and experience in order to
qualify for such exemptions. AvTel made available to the recipients of such
common stock all material information with respect to AvTel. Each such person
signed a stock purchase agreement containing appropriate investment
representations and covenants.
On March 17, 1999, AvTel issued 14,845 shares of its common stock, which
were not registered under the Securities Act, to one of distributors upon the
exercise of an existing stock option. No underwriters were used in this
transaction and none of such shares were issued publicly. AvTel relied on the
exemptions from registration provided by Section 4(2) of the Securities Act and
Rule 506 of Regulation D promulgated thereunder. The distributor receiving
shares is believed by AvTel to possess the requisite level of financial
sophistication and experience in order to qualify for such exemptions. AvTel
made available to the distributor all material information with respect to
AvTel. The distributor signed a restricted stock agreement containing
appropriate investment representations and covenants.
On April 13, 1999, AvTel 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. AvTel relied on the exemptions from registration provided by Section
4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.
The persons receiving securities are believed by AvTel to possess the requisite
level of financial sophistication and experience in order to qualify for such
exemptions. AvTel made available to the investors all material information with
respect to AvTel. The investors signed a preferred stock and warrants purchase
agreement containing appropriate investment representations and covenants.
II-3
<PAGE>
On April 23, 1999, AvTel issued 3,000 shares of common stock to Trinity
Capital Advisors, Inc. in compensation for financial advisory services in
connection with the offering described in this registration statement. No
underwriters were used in this transaction and none of such shares were
issued publicly. AvTel relied on the exemptions from registration provided
by Section 4(2) of the Securities Act and Rule 506 of Regulation D
promulgated thereunder. Trinity is believed by AvTel to possess the requisite
level of financial sophistication and experience in order to qualify for such
exemptions. AvTel made available to Trinity all material information with
respect to AvTel. Trinity signed an agreement containing appropriate
investment representations and covenants.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits:
A list of the exhibits included as part of this Registration Statement
is set forth in the Exhibit Index which immediately precedes such exhibits
and is incorporated herein by reference.
(b) Financial Statement Schedules:
Other than Schedule II--Valuation and Qualifying Accounts for the years
ended December 31, 1998, 1997 and 1996 for AvTel Communications, Inc. and its
subsidiaries, which is included herein, all other schedules for which
provision is made in the applicable accounting regulations of the Securities
and Exchange Commission have been omitted because they are not required, are
inapplicable or the required information has already been provided elsewhere
in the registration statement.
ITEM 17. UNDERTAKINGS
The undersigned registrants hereby undertake:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most
recent post-effective amendment thereof) which, individually
or in the aggregate, represent a fundamental change in the
information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in
volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered)
and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b)
if, in the aggregate, the changes in volume and price
represent no more than a 20 percent change in the maximum
aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration
statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement;
II-4
<PAGE>
PROVIDED, HOWEVER, that paragraphs (a)(i) and (a)(ii) do not apply if the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed with the Commission by
the registrants pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 that are incorporated by reference in the registration
statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
The undersigned registrants hereby undertake that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrants pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective; and
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling
the registrants pursuant to the provisions set forth or described in Item 15
of this registration statement, or otherwise, the registrants have been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by a
registrant of expenses incurred or paid by a director, officer or controlling
person of such registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrants will, unless
in the opinion of their counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by them is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant has duly caused this Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Santa Barbara, California, on June 4, 1999.
By /s/ ANTHONY E. PAPA
-----------------------------
Anthony E. Papa
Chairman of the Board and
Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and
appoints Anthony E. Papa and James P. Pisani, the true and lawful
attorney-in-fact and agent of the undersigned, with full power of
substitution and resubstitution, for and in the name, place and stead of the
undersigned, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, and hereby grants to
such attorneys-in-fact and agents, and each of them, full power and authority
to do and perform each and every act and thing requisite and necessary to be
done, as fully to all intents and purposes as the undersigned might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities indicated on the 4th day of June 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ ANTHONY E. PAPA Chairman of the Board and Chief Executive Officer
- ----------------------------- (Principal Executive Officer)
Anthony E. Papa
/s/ JAMES P. PISANI President, Chief Operating Officer, Secretary and
- ---------------------------- Director
James P. Pisani
/s/ MICHAEL J. USSERY Chief Financial Officer (Principal Financial and
- ---------------------------- Accounting Officer)
Michael J. Ussery
/s/ JOHN E. ALLEN Director
- ----------------------------
John E. Allen
/s/ JEFFREY J. JENSEN Director
- ----------------------------
Jeffrey J. Jensen
/s/ ANTHONY D. MARTIN Director
- ----------------------------
Anthony D. Martin
</TABLE>
II-6
<PAGE>
AVTEL 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 2,594,000(c) -- 3,779,000
------------ --------- --------- ----------
------------ --------- --------- ----------
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.
II-7
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER Exhibit
- ------ -------
<S> <C>
2.1 Acquisition Agreement, dated as of August 30, 1996, by
and among Hi-Tiger International, Inc., a Utah
corporation, AvTel Communications, Inc., a Utah
corporation, and AvTel Holdings, Inc., a California
corporation. (Incorporated by reference to Exhibit A to
Registrant's Information Statement on Schedule 14C dated
October 2, 1996).
2.2 Amendment No. 1 to Acquisition Agreement, dated as of
October 22, 1996, among Hi-Tiger International, Inc.,
AvTel Communications, Inc., a Utah corporation, and AvTel
Holdings, Inc., (Incorporated by reference to Exhibit 2.2
to Registrant's Current Report on Form 8-K dated October
23, 1996).
2.3 Stock Exchange Agreement, dated as of April 29, 1997, by
and between the Registrant and Matrix Telecom, Inc.
(Incorporated by reference to Exhibit 2 to Registrant's
Current Report on Form 8-K dated April 30, 1997).
2.4 Amendment to Stock Exchange Agreement, dated as of August
25, 1997, by and between the Registrant and Matrix
Telecom, Inc. (Incorporated by reference to Exhibit 2 to
Registrant's Current Report on Form 8-K dated August 25,
1997).
2.5 Agreement and Plan of Merger, dated as of October 3,
1997, between AvTel Communications, Inc., a Delaware
corporation and AvTel Communications, Inc., a Utah
corporation. (Incorporated by reference to Exhibit 2.7 to
Registrant's Annual Report on Form 10-KSB for the year
ended September 30, 1997).
2.6 Stock Purchase Agreement, dated as of July 22, 1998,
among the Registrant and the shareholders of Remote
Lojix/PCSI, Inc. (Incorporated by reference to Exhibit
2.6 to Registrant's Annual Report on Form 10-K for the
year ended December 31, 1998).
2.7 First Amendment to Stock Purchase Agreement, dated as of
August 18, 1998, among the Registrant and the
shareholders of Remote Lojix/PCSI, Inc. (Incorporated by
reference to Exhibit 2.7 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1998).
2.8 Earnout Agreement, dated as of October 30, 1998, among
the Registrant and certain shareholders of Remote
Lojix/PCSI, Inc. (Incorporated by reference to Exhibit
2.8 to Registrant's Annual Report on Form 10-K for the
year ended December 31, 1998).
3.1 Certificate of Incorporation of the Registrant.
(Incorporated by reference to Exhibit 3.1 to Registrant's
Annual Report on Form 10-KSB for the year ended September
30, 1997).
3.2 Certificate of Designations, Preferences and Rights of
Series B Convertible Preferred Stock (Incorporated by
reference to Exhibit 3.2 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1998).
II-8
<PAGE>
3.3 By laws of the Registrant. (Incorporated by reference to
Exhibit 3.2 to Registrant's Annual Report on Form 10-KSB
for the year ended September 30, 1997).
4.1 Specimen Certificate of common stock of Registrant
(Incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement on Form S-8 dated May
22, 1998).
5.1 Opinion of Mayer, Brown & Platt
10.1 Rights Agreements dated October 23, 1996, between the
Registrant and holders of the Registrant's Series A
Convertible Preferred Stock. (Incorporated by reference
to Exhibit 4.2 to Registrant's Current Report on Form 8-K
dated October 23, 1996).
10.2 1997 Stock Incentive Plan. (Incorporated by reference to
Exhibit A to the Registrant's definitive Proxy Statement
on Schedule 14A dated January 8,1997).
10.3 1998 Stock Incentive Plan. (Incorporated by reference to
Exhibit A to Registrant's definitive Proxy Statement on
Schedule 14A dated April 28, 1998).
10.4 New Best Connections, Inc. Amended and Restated 1997
Option Plan. (Incorporated by reference to Exhibit 4.2 to
Registrant's Registration Statement on Form S-8 dated May
22, 1998).
10.5 First Amendment to New Best Connections, Inc. Amended and
Restated 1997 Option Plan (Incorporated by reference to
Exhibit 10.5 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998).
10.6 Registration Rights and Lockup Agreement dated December
1, 1997, between the Registrant and Matrix Telecom, Inc.,
on behalf of the stockholders of Matrix, (Incorporated by
reference to Exhibit 4 to Registrant's Current Report on
Form 8-K dated December 1, 1997).
10.7 Triple Net Real Property Lease (Multi-Tenant Building)
dated as of February 16, 1998, by and between Bath Street
Partners, a California limited partnership and the
Company. (Incorporated by reference to Exhibit 10.8 to
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1997).
10.8 Commercial Lease Agreement dated February 28, 1995,
Matrix Telecom, Inc. and Ameritas Life Insurance Corp.,
as amended by Lease Modification Agreement dated March 2,
1995. (Incorporated by reference to Exhibit 10.9 to
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1997).
10.9 Resale Solutions Switched Services Agreement dated March
12, 1998, between Matrix Telecom, Inc. and Sprint
Communications Company L.P. (Incorporated by reference to
Exhibit 10.10 to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997).
10.10 Amendment to Carrier Transport Switched Services
Agreement dated October 15, 1998, between Matrix Telecom
and Sprint Communications Company L.P. (Incorporated by
reference to Exhibit 10.1 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1998).
II-9
<PAGE>
10.11 Loan and Security Agreement dated October 2, 1998, among
Registrant, Matrix Telecom, Inc. and Coast Business
Credit. (Incorporated by reference to Exhibit 10.2 to
Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.12 License Agreement dated as of March 1, 1999, between
Matrix Telecom, Inc. and Electronic Data Systems
Corporation (Incorporated by reference to Exhibit 10.12
to Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998).
10.13 Convertible Preferred Stock and Warrants Purchase
Agreement dated as of April 5, 1999, among Registrant,
AMRO International, S.A., Austinvest Anstalt Balzers, and
Esquire Trade & Finance Inc. (Incorporated by reference
to Exhibit 10.13 to Registrant's Annual Report on Form
10-K for the year ended December 31, 1998).
10.14 Registration Rights Agreement dated as of April 5, 1999,
among Registrant, AMRO International, S.A., Austinvest
Anstalt Balzers, and Esquire Trade & Finance Inc.
(Incorporated by reference to Exhibit 10.14 to
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1998).
10.15 Stock Purchase Warrants granted by Registrant to AMRO
International, S.A., Austinvest Anstalt Balzers, and
Esquire Trade & Finance Inc. (Incorporated by reference
to Exhibit 10.15 to Registrant's Annual Report on Form
10-K for the year ended December 31, 1998).
10.16 Private Equity Line of Credit Agreement dated as of April
23, 1999, between the Registrant and Cambois Finance,
Inc. (Incorporated by reference to Exhibit 10.1 to
Registrant's Current Report on Form 8-K dated May 3,
1999).
10.17 Registration Rights Agreement dated as of April 23, 1999,
between the Registrant and Cambois Finance,
Inc.(Incorporated by reference to Exhibit 10.2 to
Registrant's Current Report on Form 8-K dated May 3,
1999).
23.1 Consent of KPMG LLP
23.2 Consent of Mayer, Brown & Platt is contained in their
Opinion filed as Exhibit 5.1 to this Registration
Statement.
24 Power of Attorney for certain officers and directors is
contained on the Signature Page of the Registration
Statement.
</TABLE>
II-10
<PAGE>
Exhibit 5.1
[Letterhead of Mayer, Brown & Platt]
June 3, 1999
AvTel Communications, Inc.
501 Bath Street
Santa Barbara, California 93101
Gentlemen:
We have acted as special securities counsel to AvTel Communications,
Inc., a Delaware corporation (the "Company"), in connection with the
registration under the Securities Act of 1933, as amended, of 2,103,939
shares of its Common Stock, $.01 par value (the "Shares"), that may be sold
by Cambois Finance, Inc. ("Cambois Finance"). In this connection, we have
examined such corporate and other records, instruments, certificates and
documents as we considered necessary to enable us to express this opinion.
Based upon the foregoing, we are of the opinion that the Shares are duly
authorized for issuance and, when issued to Cambois Finance in accordance
with the provisions of the Equity Line of Credit Agreement, dated as of April
23, 1999, between the Company and Cambois Finance, will be legally issued,
fully paid and non-assessable shares of the Company.
We consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to us under the caption "Legal
Matters."
Very truly yours,
MAYER, BROWN & PLATT
<PAGE>
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
AvTel Communications, Inc.:
We consent to the use of our report included herein and to the reference
to our firm under the heading "Experts" in the prospectus.
/s/ KPMG LLP
Dallas, Texas
June 3, 1999
