AVTEL COMMUNICATIONS INC/DE, S-1/A, 1999-07-23

AVTEL COMMUNICATIONS INC/DE
S-1/A, 1999-07-23
TELEPHONE INTERCONNECT SYSTEMS

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As filed with the Securities and Exchange Commission on JULY 23, 1999
Registration No. 333-80023

- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------

AMENDMENT NO. 1
TO

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 (Prmiary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)

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
----------------------------
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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. / /

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 JULY 23, 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 July 22, 1999 was $4.0675 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................................................................10
Price Range of AvTel Common Stock........................................................12
Dividend Policy..........................................................................12
Use of Proceeds..........................................................................13
Selected Consolidated Financial Data.................................................... 14
Management's Discussion and Analysis of Financial Condition and Results of Operations... 16
Business................................................................................ 35
Management.............................................................................. 46
Executive Compensation.................................................................. 50
Certain Relationships and Related Transactions.......................................... 55
Security Ownership of Beneficial Owners and Management ................................. 56
Description of Capital Stock............................................................ 59
Selling Stockholder..................................................................... 62
Plan of Distribution.................................................................... 64
Where You Can Find More Information..................................................... 65
Legal Matters........................................................................... 66
Experts................................................................................. 66
Index to Financial Statements...........................................................F-1
</TABLE>

-------------------------------------

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.

<PAGE>

AVTEL

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 $1,646,517. 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.

3
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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 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.

4
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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 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.

5
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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.

THE ISSUANCE OF SHARES UNDER THE EQUITY LINE AGREEMENT AND THE CONVERSION OF
AVTEL'S SERIES B CONVERTIBLE PREFERRED STOCK MAY DILUTE AVtEL COMMON STOCK
HOLDERS AND ADVERSELY AFFECT AVTEL'S STOCK PRICE

The outstanding shares of AvTel's Series B convertible preferred stock
are convertible into common stock at a floating rate that will be below the
market price of the common stock. As a result, the lower the stock price goes,
the more common stock the holder receives. The same is true of the equity line
agreement. The following table illustrates the number of shares that AvTel would
be required to issue at various assumed prices pursuant to the equity line
agreement and upon conversion of the currently outstanding shares of Series B
preferred stock, subject to the limitations described in the text following the
table, and the percentage of outstanding stock that would be owned by existing

6
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stockholders as a result of the issuance of AvTel common stock at the indicated
price. The table is for illustrative purposes only, and you should not assume
that it represents AvTel's "best guess" of the range of future prices.

SHARES TOTAL OWNERSHIP OF
SHARES ISSUABLE ISSUABLE SHARES EXISTING
AVTEL UNDER THE UPON ISSUABLE STOCKHOLDERS AS
COMMON EQUITY LINE CONVERSION UNDER A RESULT OF
STOCK AGREEMENT OF EQUITY SHARE ISSUANCE
PRICE SERIES B LINE AND (1)
PREFERRED UPON
STOCK CONVERSION
OF SERIES B
PREFERRED
----- -------------- --------- ----------- ---------------

- ---------------

(1) Based on 10,725,850 shares outstanding on July 19, 1999.
(2) Low closing bid price for a share of AvTel common stock on
July 19, 1999.

Notwithstanding the conversion formulas, in order to comply with the
listing requirements of the Nasdaq SmallCap Market:

- The series B convertible preferred stock provides that without
the approval of AvTel's common stockholders, the amount of
AvTel common stock that may be issued upon conversion of the
series B convertible preferred stock may not exceed 19.9% of
the outstanding common stock on the date of sale of the series
B preferred stock, which amounts to 2,093,419 shares of common
stock and

- the equity line provides that without a vote of AvTel's common
stockholders, AvTel may not issue more than 2,103,939 shares
of common stock to Cambois

7
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Finance, which number of shares is equal to 20% of the
outstanding shares of Avtel common stock on the date of the
equity line agreement.

The above limitations are not cumulative, meaning that AvTel could issue up
to 39.9% of its outstanding common stock without obtaining a stockholder
vote. AvTel does not presently intend to seek shareholder approval to permit
it to issue more shares upon conversion of the series B convertible preferred
stock or to Cambois Finance in connection with the equity line. As a result,
if AvTel were to issue the maximum number of shares permitted, the ownership
of AvTel by existing shareholders would be diluted from 100% to 60.1% of
AvTel's outstanding common stock. If AvTel did obtain shareholder approval to
issue additional shares of common stock, the ownership of existing
shareholders could be diluted to virtually 0%.

To the extent that the holders of the series B convertible preferred
stock convert and then sell their common stock, the price of the common stock
may decrease due to the presence of additional shares in the market. This could
allow holders of the series B convertible preferred stock to convert their
preferred stock into greater amounts of common stock, subject to the 19.9% cap,
the sales of which could further depress AvTel's stock price.

The significant downward pressure on the price of the common
stock as the holders of the series B convertible preferred stock convert the
preferred stock into common stock or sales by Cambois Finance pursuant to
this prospectus could encourage short sales. This could exert further
downward pressure on the price of AvTel common stock.

AvTel is registering only 2,103,939 shares of its common stock
for possible issuance under the equity line agreement. In order to issue
shares in excess of that amount under the equity line agreement, AvTel would
have to register additional shares with the securities and exchange
commission, as well as obtaining stockholder approval.

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

8
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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 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."

9
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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;

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- 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 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. Trinity Capital Advisors, in its role as financial
advisor, conducted a financial analysis of AvTel and presented it with a
private placement structure. Trinity also provided AvTel with several
contacts with investors known to invest in the type of structure proposed.

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.

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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:

1997 HIGH LOW
- ---- ---- ---

<S> <C> <C>
First Quarter............................................... $ 3.50 $2.00
Second Quarter.............................................. 18.00 3.13
Third Quarter............................................... 19.00 9.75
Fourth Quarter.............................................. 19.00 7.00

1998
- ----
First Quarter............................................... 8.63 4.94
Second Quarter.............................................. 15.88 7.67
Third Quarter............................................... 8.00 1.75
Fourth Quarter.............................................. 31.00 2.00

1999
- ----
First Quarter............................................... 12.50 4.00
Second Quarter ............................................. 8.75 3.75
Third Quarter (through July 21, 1999)....................... 4.88 3.75
</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 July 8, 1999, there were 395 record holders of AvTel common
stock. The last reported sales price of AvTel common stock on July 22, 1999 was
$4.0625.

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

12
<PAGE>

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.

13
<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) (1,368,042) (5,802,318) (10,191,720) 2,566,734 (2,440,493) 643,200
Net loss per common
share-basic and diluted(1).. (0.29) (0.15) (0.61) (1.23) N/A N/A N/A
Cash dividends per
common share................ -- -- -- -- -- -- --
</TABLE>

- ------------------
N/A - Not applicable

BALANCE SHEET DATA:

14
<PAGE>

<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).. $(3,279,708) $ 4,645,463 (1,697,959) $ 5,570,657 $ 6,066,620 $ 206,071 $ (140,741)
Total assets............... 14,348,590 18,035,652 15,959,354 18,724,850 20,338,404 17,580,694 14,957,279

Long term borrowings....... 2,188,458 -- 1,112,890 -- -- -- --
Stockholders' equity....... 1,646,517 6,705,559 4,510,253 7,809,048 7,861,883 3,539,522 2,372,333
</TABLE>

- ------------------

(1) Per share amounts are not reflected for 1996, 1995 and 1994 due to the
recapitalization of AvTel as a result of the reverse acquisition in 1997.

15
<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

16
<PAGE>

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 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

17
<PAGE>

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.

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.

18
<PAGE>

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

19
<PAGE>

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.

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.

The income tax benefit for the three months ended March 31, 1999
decreased to $0 from $304,000 for the three months ended March 31, 1998. Any tax
benefit related to first quarter 1999 net operating losses will be applied to
future earnings. net operating losses for first quarter 1998 were used to reduce
prior years' taxable income.

YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997

REVENUES

Revenues for the year ended December 31, 1998 decreased 14.4% or $7.4
million to $44.0 million from $51.4 million for the year ended December 31,
1997. The decrease in revenues resulted primarily from the reorganization and
repositioning of 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.

20
<PAGE>

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 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.

21
<PAGE>

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

22
<PAGE>

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 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

23
<PAGE>

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 current and deferred tax benefit of $1,527,000
for the year ended December 31, 1998 compared to $276,000 for the year ended
December 31, 1997. The tax benefit in 1998 resulted from the loss from
operations and the current portion of the benefit is attributable to the
carryback of a portion of such loss to prior years. As of December 31, 1998,
AvTel has net operating loss carryforwards for federal tax purposes of
approximately $4.9 million which are available on a limited basis to offset
future federal taxable income, if any, through 2018.

YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996

REVENUE

Revenue for the year ended December 31, 1997, decreased 28.1% or $20.2
million to $51.4 million from $71.6 million for the year ended December 31,
1996. The decrease in revenue resulted primarily from 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. 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

24
<PAGE>

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.

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Billing and collection fees and distributor commissions decreased
approximately $3.9 million, or 1.82% as a percentage of revenues. Most of the
new products sold in 1997 were direct billed. As the percentage of direct billed
customers increased, billing and collection fees have decreased. Similarly, as
sales of certain products having a higher commission structure have declined,
commission expense has also declined.

Certain regulatory and professional services increased approximately
$266,000, or 1.22% as a percentage of revenues in 1997 over 1996. Carrier fees
specific to telecommunication providers upon reaching certain thresholds of
customers were met in the last half of the year in 1996; therefore, increased
fees in 1997 resulted from being charged the lower volume based fees for a full
year. Professional fees increased in 1997 over 1996 for two primary reasons.
First, due to increased market demands for information systems programmers,
AvTel was forced to secure external contractors. Second, certain telemarketing
and verification costs associated with the sales process increased in 1997
primarily resulting from the sales distributor absorbing these costs in 1996.
Other selling, general and administrative costs decreased approximately $213,000
in 1997. As a percentage of revenue, these costs increased .81% in 1997 over
1996 due to decreasing revenues.

ACQUISITION-RELATED WRITEOFF

The $9.1 million write off relates to the share exchange and is
discussed under "Background" above.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense decreased approximately $314,000
for the year ended December 31, 1997, compared to the year ended December 31,
1996, resulting primarily from older assets becoming fully depreciated.

INTEREST EXPENSE AND OTHER INCOME, NET

Interest expense decreased $219,000 to $12,000 for the year ended
December 31, 1997 from $231,000 for the year ended December 31, 1996. The
decrease resulted from reduced borrowings in 1997 compared to 1996. 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.

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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 $5,802,318 and $10,191,720, respectively. In addition, as
of December 31, 1998, AvTel had a working capital deficit of $1,697,959, and for
the year ended December 31, 1998, net cash used in operations totaled
$5,978,797. During the quarters that ended March 31, 1999 and March 31, 1998,
AvTel reported net losses of $3,066,131 and $1,368,042, respectively. In
addition, as of March 31, 1999, AvTel had a working capital deficit of
$3,279,708, and for the quarter ended March 31, 1999, net cash used in
operations totaled $1,307,598.

Based on the realization of the tax benefit of carrying back 1998 net
operating losses to reduce prior years' taxable income, AvTel expects to receive
a refund of approximately $1,325,000 of taxes paid in prior years, as reflected
on the balance sheets as of March 31, 1999 and December 31, 1998.

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. AvTel is currently negotiating with its major vendor for extended
payment terms with respect to invoices in the amount of approximately $4.4
million. 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 $1,646,517. 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.

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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.
The conversion price will be not less than $2.00 if AvTel reports on its form
10-Q or Form 10-K gross revenues for the applicable quarter equal to or greater
than:

- $10.0 million for the quarter ended June 30, 1999;

- $12.0 million for the quarter ended September 30, 1999; and

- $15.0 million for the quarter ended December 31, 1999;

and AvTel reports EBITDA for the month ending December 31, 1999 greater than or
equal to zero.

As of the date of this prospectus, holders have converted 520 shares of
series B preferred stock into 155,804 shares of AvTel common stock. As a result,
AvTel could issue up to 594,196 shares of common stock upon conversion if all of
the outstanding series B convertible preferred stock were converted at the
lowest possible conversion price, assuming such revenue and EBITDA requirements
continue to be met. However, 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 series B investors in cash for any
excess over such amount.

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Although the conversion feature of the series B convertible preferred
stock will not affect 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 $1.7
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. As of December 31, 1997, $2.3 million was included in due to affiliates
associated with Pacific Gateway Exchange. In 1998, Pacific Gateway Exchange
was no longer affiliated with AvTel.

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

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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.

MARKET RISK

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.

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.

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

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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 has contacted all such suppliers. 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.

- AvTel has made inquires about the Year 2000 compliance status
of other telecommunications providers with which AvTel's
systems interact. A majority of the telecommunications
providers who have responded have indicated that their systems
are Year 2000 compliant or can be made so through currently
available mechanisms.

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.

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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 2000-specific contingency plans
are expected to be materially completed during the third quarter of 1999, and
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.

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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. In July 1999, the Financial Accounting Standards Board
issued SFAS No. 137 which delayed the effective date of SFAS No. 133. SFAS No.
133 is now effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000. Management does not anticipate that this statement will have a
material impact on 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.

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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 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 June 30, 1999, this "lockup" provision relates
to a total of 6,457,123 shares of AvTel stock held by the following
shareholders: Thomas H. Patrick, as voting trustee for shares held by Ronald L.
Jensen, Gladys Jensen, James J. Jensen, Jami J. Jensen, Janet Jensen Kreiger and
Julie J. Jensen (4,526,583 shares), Jeffrey J. Jensen (851,738 shares), The RJ &
GJ Foundation (329,692 shares), The Janet Foundation (24,124 shares), The OUI
Foundation (75,862 shares), The Chasdrew Foundation (24,124 shares), John E.
Allen (125,000 shares), Anthony E. Papa (250,000 shares) and James P. Pisani
(250,000 shares)(together, the "Lockup Stockholders").

The registration rights and lockup agreement requires that 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

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<PAGE>

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 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

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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

38
<PAGE>

and DS-1) were leased from public carriers to provide voice, fax and data
communications links between larger offices and low speed leased lines (such
as DS-O) for branch office connectivity. For some applications, however, this
has proven expensive and inefficient because the entire bandwidth capacity is
dedicated 24 hours per day, whether or not it is used.

Packet-based services were developed to address the issue of allocation
and utilization. Today, "fast packet" networking technologies such as Frame
Relay and Asynchronous Transfer Mode have emerged as an integrated,
cost-effective, flexible wide area network solution. These networks allow for
"bandwidth on demand" between any two endpoints on a wide area network.

STRATEGY. The implementation of 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

39
<PAGE>

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 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

40
<PAGE>

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

41
<PAGE>

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 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

42
<PAGE>

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.

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 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 June 30, 1999, AvTel, including its subsidiaries, had 238
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.

43
<PAGE>

<TABLE>
<CAPTION>
CURRENT MONTHLY
LOCATION SQUARE FEET EXPIRATION 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
Suite 120 $3,370
Laguna Hills, CA
</TABLE>

- ---------------------

(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.

<PAGE>

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. A decision on the
motion to dismiss is currently pending. 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.

<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The directors and executive officers of AvTel are as follows:

NAME AGE POSITION WITH AVTEL
<S> <C> <C>
Anthony E. Papa....................... 36 Chairman of the Board and
Chief Executive Officer

James P. Pisani....................... 35 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......................... 63 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 35, 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

<PAGE>

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.

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 63, 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

<PAGE>

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.

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

<PAGE>

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.

<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.

<PAGE>

SUMMARY COMPENSATION TABLE

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 1998 150,000 40,000 2,908(3) 6,250
(2) 1997 127,083 15,556 -- 56,250
President -
Business
Network Services
Division
Frank Dziuba (4) 1998 100,000 -- -- 15,000
Senior 1997 85,833 39,300 -- 31,250
Vice-President 1996 7,500 -- -- 12,474
Software
Development
- ------------------
</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.

<PAGE>

(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 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)

% OF TOTAL POTENTIAL REALIZABLE VALUE AT
NUMBER OF OPTIONS ASSUMED ANNUAL RATES OF STOCK
SECURITIES GRANTED TO PRICE APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES TERM (1)
OPTIONS IN EXERCISE EXPIRATION --------------------------------
NAME GRANTED FISCAL YEAR PRICE DATE 5% 10%
- ----------------------- ------------ ------------- ---------- ------------ ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Anthony E. 0 0% -- -- -- --
Papa

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 $37,734 $95,625
14, 2008
</TABLE>

- ---------------------------

<PAGE>

(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.

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

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 VALUE
NAME EXERCISE 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 26,562 $93,450 -- -- -- --
DeWindt

Frank Dziuba -- -- 20,287 38,437 $5,860 $17,578
</TABLE>

- --------------------------

<PAGE>

(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.

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.

<PAGE>

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.

55
<PAGE>

SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information as of July 8,
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 July
8, 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 July 8, 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 10,570,046 shares
of the common stock outstanding.

Effective as of May 18, 1999, certain shareholders of AvTel entered
into a voting trust agreement with Thomas H. Patrick, an unrelated party, as
the voting trustee. Pursuant to the voting trust agreement, James J. Jensen,
Jami J. Jensen, Janet J. Jensen, Julie J. Jensen, Gladys J. Jensen and Ronald
L. Jensen conveyed legal title of a total of 4,526,583 shares of 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.

56
<PAGE>

AMOUNT BENEFICIALLY
NAME AND ADDRESS OWNED PERCENT OF CLASS
- --------------------------------------------- ------------------- ----------------

<S> <C> <C>
Janet J. Jensen (1)(2)....................... 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)(2)....................... 800,000 7.6%
6304 Alexandria Circle
Atlanta, GA 30326

Jami J. Jensen (1)(2)........................ 851,738 8.1%
1933 Swede Gulch
Golden, CO 80120

Julie J. Jensen (1)(2)....................... 851,738 8.1%
Box 540, Kenwood Station
5257 River Road
Bethesda, MD 20816

Anthony E. Papa (3).......................... 778,588 7.4%

James P. Pisani (3).......................... 772,188 7.3%

Gladys J. Jensen (1)(2)...................... 731,847 6.9%
c/o United Group Association, Inc.
4001 McEwen Drive, Suite 200
Dallas, TX 75244

John E. Allen (4)............................ 185,000 1.8%

Anthony D. Martin............................ -- *

D. Stephen DeWindt........................... -- *

Frank Dziuba................................. 44,599 *
</TABLE>

57
<PAGE>

AMOUNT BENEFICIALLY
NAME AND ADDRESS OWNED PERCENT OF CLASS
---------------- ------------------- ----------------

<S> <C> <C>
All directors and executive officers 2,641,122 24.9%

as a group (8 persons) (5)...................
</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) Shares are held by Thomas H. Patrick, as voting trustee under a
voting trust agreement dated May 18, 1999.

(3) As to each of Mr. Papa and Mr. Pisani, includes 15,625 shares of
common stock that may be acquired under options that were
exercisable within 60 days of 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.

(4) 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.

(5) 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.

58
<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, of which 520
shares have been converted into AvTel common stock. The description below is
a summary of all material provisions of AvTel common stock, preferred stock
and convertible preferred stock.

As of July 8, 1999, 10,570,046 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 July 8, 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 July 8, 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.

59
<PAGE>

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.

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.

60
<PAGE>

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. The conversion price will be
not less than $2.00 if AvTel reports on its Form 10-Q or Form 10-K gross
revenues for the applicable quarter equal to or greater than:

- $10.0 million for the quarter ended June 30, 1999;

- $12.0 million for the quarter ended September 30, 1999; and

- $15.0 million for the quarter ended December 31, 1999;

and AvTel reports EBITDA for the month ending December 31, 1999 greater than
or equal to zero.

As of the date of this prospectus, holders have converted 520 shares
of series B preferred stock into 155,804 shares of AvTel common stock. As a
result, AvTel could issue up to 594,196 shares of common stock upon
conversion if all of the outstanding 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.

61
<PAGE>

TRANSFER AGENT AND REGISTRAR

U.S. Stock Transfer Corp. is the transfer agent and registrar for
the common stock.

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

62
<PAGE>

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.

63
<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

64
<PAGE>

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
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

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<PAGE>

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.

66
<PAGE>

INDEX TO FINANCIAL STATEMENTS

PAGE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ----
<S> <C>
Condensed Consolidated Balance Sheets, March 31, 1999 (Unaudited) and December 31, 1998..........................F-2

Condensed Consolidated Statements of Operations,
Three Month Periods ended March 31, 1999 and 1998 (Unaudited)...........................................F-3

Condensed Consolidated Statements of Cash Flows,
Three Month Periods ended March 31, 1999 and 1998 (Unaudited)...........................................F-4

Notes to Condensed Consolidated Financial Statements (Unaudited).................................................F-5

CONSOLIDATED FINANCIAL STATEMENTS

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

Schedule II--Valuation of Qualifying Accounts....................................................................S-1
</TABLE>

F-1

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
MARCH 31, DECEMBER
1999 31,
(UNAUDITED) 1998
----------- ------------
ASSETS
<S> <C> <C>
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
Federal and state income tax receivable.................................. 1,325,000 1,325,000
Other current assets..................................................... 643,721 921,435
----------- ------------
Total current assets................................................. 7,061,844 8,464,004

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......................................................... $14,348,590 $ 15,959,354
=========== ============

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...................................................... (18,314,360) (15,224,597)

Treasury stock, $0.01 par value, 11,075 at March 31, 1999 and none at
December 31, 1998..................................................... (111) --
----------- ------------
Total stockholders' equity............................................... 1,646,517 4,510,253
Commitments and contingencies.............................................. -- --
----------- ------------
Total liabilities and stockholders' equity............................ $14,348,590 $ 15,959,354
=========== ============
</TABLE>

See accompanying notes to condensed consolidated financial
statements (unaudited).

F-2

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED 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 tax benefit............................................... -- 304,448
-------------- ---------------

Net loss......................................................... $ (3,066,131) $ (1,368,042)
============== ===============

Net loss per share - basic and diluted........................... $ (0.29) $ (0.15)
============== ===============

Weighted average number of common shares - basic and diluted.... 10,482,416 9,477,489
============== ===============
</TABLE>

See accompanying notes to condensed consolidated financial
statements (unaudited).

F-3

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED 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) $(1,368,042)
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
Federal and state income tax receivable............... -- (311,324)
Other current assets.................................. 277,714 (314,224)
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 condensed consolidated
financial statements (unaudited).

F-4
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)

MARCH 31, 1999 AND 1998

(1) BASIS OF PRESENTATION

The unaudited condensed 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 herein. All significant intercompany
balances and transactions have been eliminated in consolidation. In the opinion
of management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of the interim financial
information have been included. The results of operations for any interim period
are not necessarily indicative of the results of operations for the entire year.

The Company's condensed consolidated financial statements as of March
31, 1999 and December 31, 1998 have been restated to give effect to the
recognition of an income tax receivable of $1,325,000. The company's condensed
consolidated financial statements for the three months ended March 31, 1998 have
been restated to give effect to the recognition of an income tax receivable of
$304,448. As a result of this restatement, net loss for the three months ended
March 31, 1998 has been decreased by $304,448 ($0.03 per common share-basic and
diluted) from amounts previously reported.

(2) EARNINGS PER COMMON SHARE

The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, Earnings per Share ("SFAS 128") in the fourth quarter of
1997, which required companies to present basic earnings per share and diluted
earnings per share.

<TABLE>
<CAPTION>
MARCH 31,
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Numerator:
Net loss $(3,066,131) $(1,368,042)
Less preferred dividends 11,816 11,816
----------- -----------
Loss applicable to common shareholders $(3,077,947) $(1,379,858)
=========== ===========
Denominator:

F-5
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)

MARCH 31, 1999 AND 1998

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) $ (0.15)
=========== ===========
</TABLE>

(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 condensed 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 $3,279,708, 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

F-6
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)

MARCH 31, 1999 AND 1998

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 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:

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999

BMG CMG TOTAL
----------- ----------- -----------
<S> <C> <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 6,242,469 14,348,590

Gross margin $ 2,701,701
Selling, general and administrative 5,289,312
Depreciation and amortization 394,579

Interest expense 99,144
Other income, net 15,203
-----------
Net loss $(3,066,131)
===========
</TABLE>

F-7
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed 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 16,286,216 18,781,262

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
Income tax benefit 304,448
-----------
Net loss $(1,368,042)
===========
</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

F-8
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)

MARCH 31, 1999 AND 1998

Common Stock, when added to the number of shares of Common Stock previously
issued by the Company upon conversion of or as dividends on shares of the
Series B Stock, would exceed 19.9% of the number of shares of Common Stock
which were issued and outstanding on the original issuance date of the Series
B Stock. The Company will pay converting Series B Investors in cash for any
excess over such amount.

The Company also issued the Series B Investors warrants to purchase up
to 20,000 shares of Common Stock at a price of $8.60 per share. The warrants may
be exercised beginning September 30, 1999, and terminate on March 31, 2002.

The Company and the Series B Investors entered into a Registration
Rights Agreement that requires the Company to file, and obtain and maintain the
effectiveness of, a Registration Statement with the Securities and Exchange
Commission (the "Commission") in order to register the public resale of all
shares of the Common Stock acquired by the Series B Investors (a) upon
conversion of the Series B Stock, (b) in payment of dividends on the Series B
Stock, and (c) upon exercise of the warrants. The Company will be subject to
significant monetary penalties if it fails to obtain or maintain the
effectiveness of such Registration Statement.

The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation
for 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.

F-9
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)

MARCH 31, 1999 AND 1998

In connection with the Private Equity Line, the Company and the
Investor entered into a Registration Rights Agreement that requires the Company
to file, and obtain and maintain the effectiveness of, a Registration Statement
on Form S-1 with the Commission in order to register the sale and public resale
of shares of the Common Stock acquired by the Investor under the Private
Equity Line (the "Registration Statement"). The Investor will be named as an
underwriter in such Registration Statement. The Investor will also be subject
to certain restrictions on short selling of the Common Stock and certain
"blackout" periods on its ability to resell Common Stock under the
Registration Statement. If the Registration Statement has not been declared
effective by October 30, 1999, the Investor's obligation to purchase Common
Stock under the Private Equity Line shall terminate, and the Company will be
required to pay the Investor $25,000 in liquidated damages.

The 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, after restatement for the income
tax refund receivable discussed in Note 5. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

KPMG LLP

Dallas, Texas
April 14, 1999, except as to Note 5,
which is as of July 2, 1999

F-11
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1998 AND 1997

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......................... 1,325,000 598,970
Other current assets............................................ 921,435 861,950
---------------- ---------------
Total current assets.......................................... 8,464,004 15,358,085

Property and equipment, net........................................ 1,684,707 1,791,682
Goodwill, net...................................................... 4,463,747 ---
Other assets, net.................................................. 1,346,896 1,575,083
---------------- ---------------
Total assets.................................................. $ 15,959,354 $ 18,724,850
================ ===============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable and other accrued expenses..................... $2,643,761 $1,546,762
Accrued network service costs................................... 4,217,206 4,319,198
Sales and excise taxes payable.................................. 1,433,483 736,012
Unearned revenue................................................ 954,101 ---
Due to affiliates............................................... 324,020 2,719,417
Other current liabilities....................................... 589,392 466,039
---------------- ---------------
Total current liabilities..................................... 10,161,963 9,787,428
Deferred income taxes.............................................. ---- 498,712
Long term borrowings............................................... 1,112,890 ---
Other liabilities.................................................. 5,381 50,782
Common stock subject to put option (note 4)........................ 168,867 578,880
---------------- ---------------
Total liabilities............................................. 11,449,101 10,915,802
---------------- ---------------
Stockholders' equity:
Preferred stock, authorized 750,000 shares, $0.01 par value..... ---- ----
Series A convertible preferred stock, authorized 250,000 shares,
$0.01 par value, cumulative asset of 8% dividends, 147,700 and 207,700
shares issued and outstanding at December 31, 1998 and 1997 respectively.
(Liquidation preference of $704,032 December 31, 1998
including dividends in arrears............................... 1,477 2,077
Common stock, Authorized 20,000,000 shares, $0.01 par value;
issued 10,408,473 and 11,473,056 shares at December 31, 1998 and 1997
respectively, including 112,578 and 385,920 shares subject to
put options on December 31, 1998 and 1997 respectively....... 102,969 110,511
Additional paid in capital...................................... 19,630,404 17,138,739
Accumulated deficit............................................. (15,224,597) (9,422,279)
---------------- ---------------

Treasury stock, none at December 31, 1998 and 1,999,997 common
shares at December 31, 1997..................................... --- (20,000)
---------------- ---------------
Total stockholders' equity................................... 4,510,253 7,809,048
---------------- ---------------

Commitments and contingencies

Total liabilities and stockholders' equity...................... $ 15,959,354 $ 18,724,850
============== ==============
</TABLE>

See accompanying notes to consolidated financial statements.

F-12
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

1998 1997 1996
---------------- ---------------- ---------------
<S> <C> <C> <C>
Revenues (note 6)......................................... $ 44,013,498 $ 51,389,080 $ 71,558,295
Cost of revenues (note 6)................................. 31,849,354 36,227,507 47,674,396
---------------- ---------------- ---------------
Gross margin........................................... 12,164,144 15,161,573 23,883,899
---------------- ---------------- ---------------
Operating expenses:
Selling, general and administrative (note 6)........... 18,480,576 16,141,132 18,798,925
Acquisition related write off (note 2)................. -- 9,098,545 --
Depreciation and amortization.......................... 1,107,321 679,856 993,940
---------------- ---------------- ---------------
19,587,897 25,919,533 19,792,865
---------------- ---------------- ---------------
Operating income (loss)............................. (7,423,753) (10,757,960) 4,091,034
Interest expense (note 6)................................. (86,251) (11,692) (230,922)
Other income, net......................................... 181,107 301,580 393,498
---------------- ---------------- ---------------
Income (loss) before income tax expense............. (7,328,897) (10,468,072) 4,253,610
Income tax expense (benefit).............................. (1,526,579) (276,352) 1,686,876
---------------- ---------------- ---------------
Net income (loss)................................... $ (5,802,318) $ (10,191,720) $ 2,566,734
================ ================ ===============

Net loss per common share--basic and diluted (note 6)..... $ (0.61) $ (1.23)
================ ================

Weighted average number of common shares.................. 9,633,474 8,267,296
================ ================
</TABLE>

See accompanying notes to consolidated financial statements.

F-13
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

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
============ ========= =========== ============ ===========

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.................................... (5,802,318) -- -- (5,802,318)
----------- -------------- -------------- -----------

Balances at December 31, 1998.................. $(15,224,597) -- $ -- $ 4,510,253
============ ============== ============== ===========
</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

1998 1997 1996
--------------- -------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................ $ (5,802,318) $ (10,191,720) $ 2,566,734
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization........................... 1,107,321 679,856 993,940
Amortization of advanced commissions.................... 220,928 1,355,492 618,791
Acquisition related write off........................... -- 9,098,545 --
Gain on disposition of assets........................... (83,139) -- --
Provision for bad debts................................. 2,727,803 1,829,770 1,461,471
Deferred income taxes................................... (498,712) (80,377) (321,678)
Stock compensation earned............................... 477,148 748,884 --
Equity in income of DNS................................. -- -- (122,327)
Changes in certain operating assets and liabilities:
Accounts receivable................................... 374,477 1,969,332 (1,971,970)
Due from affiliates................................... (106,071) (915,357) 345,336
Federal and state income tax receivable............... (741,094) (598,970) --

Other current assets.................................. (224,820) 1,787,672 (393,781)
Accounts payable and accrued liabilities.............. (1,034,923) (2,876,789) (1,397,160)
Due to affiliates..................................... (2,395,397) (1,138,568) (742,663)
--------------- -------------- ---------------
Net cash provided by (used in) operating activities (5,978,797) 1,667,770 1,036,693
--------------- -------------- ---------------

Cash flows from investing activities:
Cash received (paid) in acquisitions (note 2) ............... (474,082) 477,643 --
Loans to affiliate........................................... -- (2,000,000) --
Payments received on loans to affiliates..................... 1,798,889 201,111 --
Purchase of property and equipment........................... (473,089) (212,421) (701,718)
Repayments from DNS, net..................................... -- -- 1,577,432
Proceeds from sale of property and equipment................. 94,370 2,749 (14,482)
Net cash provided by (used in) investing activities.......... 946,088 (1,530,918) 861,232
--------------- -------------- ---------------
Cash flows from financing activities:
Principal payments on capital leases......................... (59,055) (4,306) --
Issuance of common stock for exercise of options............. 517,612 52,500 --
Borrowings on line of credit................................. 9,753,467 -- --
Amounts paid on line of credit............................... (8,640,577) -- --
Purchase of officer notes receivable......................... (435,000) -- --
Purchase of common stock for treasury........................ -- -- (439,583)
--------------- -------------- ---------------
</TABLE>

F-15

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1998, 1997 AND 1996

<S> <C> <C> <C>
Net cash provided by (used in) financing
activities.......................................... 1,136,447 48,194 (439,583)

Net increase (decrease) in cash and cash equivalents............ (3,896,262) 185,046 1,458,342
Cash and cash equivalents at beginning of year.................. 4,807,441 4,622,395 3,164,053
--------------- -------------- ---------------
Cash and cash equivalents at end of year........................ $ 911,179 $ 4,807,441 $ 4,622,395

Cash paid (received) during the year for:
Interest..................................................... $ 86,121 $ 11,594 $ 212,404

Income taxes, net of refunds................................. $ (487,007) $ 925,161 $ 1,482,103
=============== ============== ===============
Noncash financing activities:
Common stock issued for advanced commissions................. $ -- $ -- $ 2,195,211
=============== ============== ===============
Common stock issued for receivable from major $ -- $ -- $ 723,600
shareholder................................................. =============== ============== ===============

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.

(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

F-16

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

operations of Matrix and AvTel subsequent to the Share Exchange. As a result
of the Share Exchange, Matrix became a wholly owned subsidiary of AvTel. (See
note 2).

The Share Exchange provided that each Matrix shareholder would receive
2.4819 AvTel common shares for each common share of Matrix then issued
including treasury shares held by Matrix. For periods prior to the December
1, 1997 Share Exchange, all share amounts have been restated to reflect the
Share Exchange as a 2.4819 for one stock split. In addition, on March 10,
1997 Matrix declared an 18 for one stock split. All share amounts have also
been restated to reflect this stock split.

AvTel was formed to be a provider of broadband network services integrating
voice, data and Internet solutions for individuals and corporate customers. The
Company sells and markets a broad range of telecommunications and advanced
network services through independent value added resellers, third party
marketing organizations and internal direct sales professionals. The Company
targets mid-size corporations, small-office home-office professionals and select
residential market segments through two primary business units, its Business
Markets Group ("BMG") and Channel Markets Group ("CMG").

BMG targets mid-size corporate customers for their broadband data, voice
and Internet networking needs. Following this sales strategy, the Company's
objective is to become the underlying telecommunications carrier for the
transport of data, voice and Internet traffic. Through a value-added sales
process, the Company designs, provisions and manages its customers' networks.
The Company will provide a host of additional value-added services assisting its
customers to create enhanced intranet and extranet applications. Additionally,
BMG markets to its customer base a variety of traditional communications
products and services such as long distance telephone service, executive calling
cards and video/audio conferencing.

CMG targets and markets to distribution companies, agents, resellers and
affinity groups that maintain access to large groups of individuals and small
businesses through affinity relationships and niche marketing strategies. CMG
provides Internet access, long distance telephone and other services to
customers in 49 states. The Company is fully certified or registered in all
states where required and operates under Section 214 authority from the Federal
Communications Commission ("FCC"). The Company, through a wholly owned
subsidiary, has a national-deployed Carrier Identification Code ("CIC"). The
Company maintains its own convergent billing platform, rating system and
monitoring center.

(b) LIQUIDITY

The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the
consolidated financial statements during the years ended December 31, 1998 and
1997, the Company reported net losses of $5,802,318 and $10,191,720,
respectively. In addition, as of December 31, 1998, the Company had a working
capital deficit of $1,697,959, and for the year ended December 31, 1998, net
cash used in operations totaled $5,978,797.

F-17

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

(d) CASH AND CASH EQUIVALENTS

For purposes of the statement of cash flows, the Company considers all
demand deposits, time deposits, and other highly liquid investments with a
remaining maturity at date of purchase of less than ninety days to be cash
equivalents.

(e) COMMISSIONS

Commissions to sales agents are paid and expensed based on a percentage of
billings as incurred.

Commissions paid in advance of $221,000 as of December 31, 1997, included
in other current assets, were expensed over a period of eighteen months based on
estimated billings of the customers for which the commissions were paid. The
above advances were fully expensed during 1998 and no additional advance
commission payments were made.

(f) REVENUE RECOGNITION

F-18

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

F-19

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.

(j) USE OF ESTIMATES

Management of the Company has made a number of estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period to prepare these consolidated financial statements in
conformity with generally accepted accounting principles. Actual results
could differ from those estimates.

(k) CONCENTRATIONS OF CREDIT RISK

The Company's subscribers are primarily small business owners and
residential subscribers and are not concentrated in any specific geographic
region of the United States. The Company has agreements with Local Exchange
Companies, which provide billing and collection services to the majority of the
Company's subscribers. A significant portion of the Company's accounts
receivable is due from these companies.

(l) ACCOUNTS RECEIVABLE

Accounts receivable are net of allowances for doubtful accounts and other
provisions of $935,000 and $982,000 as of December 31, 1998 and 1997,
respectively. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of subscribers, historical trends and
other information.

(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.

F-20

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(n) ACQUIRED CUSTOMER BASE

Acquired customer base of $1,240,000, which is net of accumulated
amortization of $343,000 at December 31, 1998, included in other assets, is
being amortized on a straight-line basis over five years. The Company
assesses the recoverability of this intangible asset by determining whether
the acquired customer base balance can be recovered through undiscounted
future operating cash flows of the acquired operations. The amount of
impairment, if any, is measured based on projected discounted cash flows. The
assessment of the recoverability of the acquired customer base will be
impacted if estimated future operating cash flows are not achieved.

(o) IMPAIRMENT OF LONG-LIVED ASSETS

In January, 1996, the Company adopted Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS No. 121"). SFAS No. 121 requires
that long-lived assets and certain intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the future net
cash flows expected to be generated by the asset. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the net asset exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or
fair value less costs to sell.

(p) COMPREHENSIVE INCOME

In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130
establishes standards for reporting and presentation of comprehensive income and
its components in a full set of financial statements. Comprehensive income
includes net income and other comprehensive income, which is generally composed
of changes in the fair value of available-for-sale marketable securities,
foreign currency translation adjustments and adjustments to recognize additional
minimum pension liabilities. The statement requires additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations.

F-21

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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

F-22

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(2) ACQUISITIONS (CONTINUED)

sole purpose of this merger. As part of the merger, AvTel (the surviving
Delaware corporation) issued to its stockholders one share of new Delaware
Common Stock for each four shares of AvTel-Utah's Common Stock outstanding
immediately prior to the Reincorporation Merger. AvTel's Series A Convertible
Preferred Stock and its outstanding options were similarly adjusted.
Accordingly, the Reincorporation Merger essentially effected a one for four
reverse stock split of AvTel's shares.

The reverse acquisition of AvTel by Matrix was accounted for using the
purchase method of accounting. In order to value the consideration given in
the Share Exchange the market price of AvTel 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

F-23

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(2) ACQUISITIONS (CONTINUED)

July 1, 1997. As a result of the combination, Matrix assumed the obligation
to grant up to 1,999,997 stock options to agents of Best and certain
employees of affiliated companies. Such option grants relate to services,
including sales promotion activities, to be performed by the recipients on
behalf of the Company. Accordingly, the fair value of such options is being
charged to expense by the Company as the related services are provided.

DIGITAL MEDIA, INC. ("DMI") -- Effective September 25, 1998, the Company
acquired all of the capital stock of DMI, a California based developer of
multimedia software. The Company exchanged 30,000 shares of its common stock
valued at $71,250 for all of the outstanding common stock of DMI. The
transaction was accounted for under the purchase method of accounting. The
assets and liabilities of DMI were recorded at their historical cost which
approximated their fair value at September 25, 1998. The Company recorded
goodwill of approximately $117,000, which represents the excess of the purchase
price over the fair value of the net assets received. The goodwill is being
amortized on a straight-line basis over fifteen years.

REMOTE LOJIX/PCSI, INC. ("RLI") -- Effective November 1, 1998, the Company
acquired all of the capital stock of RLI, a New York based provider of
information technology services to corporate customers. The Company exchanged
650,000 shares of its common stock valued at $1,462,500 and the outstanding
balance of a $500,000 loan from the Company for all of the outstanding common
stock of RLI. The transaction was accounted for under the purchase method of
accounting. The assets and liabilities of RLI were recorded at their historical
cost which approximated the fair value at November 1, 1998. The Company recorded
goodwill of approximately $4.4 million, which represents the excess of the
purchase price over the fair value of the assets received. The goodwill is being
amortized on a straight-line basis over fifteen years.

F-24
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(2) ACQUISITIONS (CONTINUED)

Unaudited pro forma results of operations of the Company as if the share
exchange of Matrix and the acquisitions of Best, DMI and RLI had occurred as of
the beginning of the periods presented is as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------
1998 1999
------------ ------------
<S> <C> <C>
Revenue...................................... $ 49,711,440 $ 58,967,268
Loss from operations......................... (8,909,490) (12,749,469)
Net loss..................................... (7,799,180) (12,378,014)
Proforma net loss per share.................. $ (0.76) $ (1.02)
</TABLE>

The pro forma financial information has been prepared for comparative
purposes only and does not purport to indicate the results of operations that
would have occurred had the acquisition been made at the beginning of the period
indicated, or which may occur in the future.

As of the date of acquisitions, the fair market value of the assets
acquired and liabilities assumed included the following:

<TABLE>
<CAPTION>
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-25

<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:

ESTIMATED DECEMBER 31
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-26
<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 $ 723,600
Increase in share value subject to put
charged to expense........................... -- 172,400
--------- ---------
Balance, December 31, 1996................ $ 482,400 $ 896,000
--------- ---------
--------- ---------

F-27
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

<S> <C> <C>
Decrease in share value subject to put recorded as a
reduction to expense.................................. -- (172,400)
Vested shares no longer subject to put.................. (96,480) (144,720)
---------- ----------
Balance, December 31, 1997............................ 385,920 578,880
Vested shares no longer subject to put.................. (48,187) (37,253)
Called shares subject to put............................ (225,155) (372,760)
---------- ----------
Balance, December 31, 1998............................ $ 112,578 $ 168,867
========== ===========
</TABLE>

During May 1996, the Company purchased 171,548 shares of its common stock
as treasury stock for $439,584. As further discussed in note 8 in connection
with the Best and Matrix combination effective July 1, 1997, Matrix acquired an
additional 1,999,997 shares of its common stock as treasury stock. As a part of
the recapitalization done in connection with the 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.......................... $(1,325,000) $(234,899) $ 1,751,047
State and local.................. 7,531 (41,453) 257,507
----------- ---------- -----------
(1,317,469) (276,352) 2,008,554
----------- ---------- -----------
Deferred tax expense (benefit):
Federal.......................... (209,110) -- (254,350)
State and local.................. -- -- (67,328)
----------- ---------- -----------
(209,110) -- (321,678)
----------- ---------- -----------
$(1,526,579) $ (276,352) $(1,686,876)
=========== ========== ===========
</TABLE>

F-28
<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)

Income tax expense differs from the amounts computed by applying the U.S.
federal income tax rate of 34 percent to pretax income as a result of the
following:

<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Computed "expected" tax expense
(benefit).............................. $(2,491,825) $(3,559,144) $1,404,637
State and local taxes, net of federal
income tax effect...................... (135,961) (27,359) 125,518
Other nondeductible items................ 22,539 3,093,522 --
Losses not providing tax benefit......... 1,269,289 330,190 --
Other.................................... (190,621) (113,561) 156,721
----------- ----------- ----------
$(1,526,579) $ (276,352) $1,686,876
=========== =========== ==========
</TABLE>

Deferred income taxes as of December 31, 1998 and 1997 reflect the impact
of temporary differences between financial statement carrying amounts and tax
bases of assets and liabilities. The tax effects of temporary differences that
give rise to significant portions of the net deferred tax assets at December 31,
1998 and 1997 are presented below:

<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1998 1997
---------- -----------
<S> <C> <C>
Deferred tax assets
Net operating loss and alternative
minimum tax credit carryovers....... $2,169,634 $ 814,425
Compensation related items............ 480,137 299,554
Contingent liabilities and other ..... 268,340 204,978
---------- -----------
Gross deferred tax asset.............. $2,918,111 $ 1,318,957
---------- -----------
---------- -----------

F-29
<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)

Less valuation allowance.............. (2,453,958) (1,184,669)
Net deferred tax asset................ 464,153 134,288
Deferred tax liabilities:
Customer base intangible.............. (464,153) (633,000)
---------- -----------
Net deferred tax liability.............. $ -- $ (498,712)
========== ===========
</TABLE>

The valuation allowance for deferred tax assets increased $1,269,289 and
$1,184,669 during 1998 and 1997, respectively.

In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and prior taxes paid in making this assessment. Based upon its evaluation of
these factors, management believes that it is more likely than not that the
Company will realize the benefits of these deductible differences, net of the
valuation allowance, at December 31, 1998. At December 31, 1998, the Company has
net operating loss carryforwards for federal tax purposes of approximately
$4,860,000 which are available on a limited basis to offset future federal
taxable income, if any, through 2018. When realized, such benefit will first be
utilized to reduce intangible assets recorded in the reverse acquisition of
AvTel by Matrix.

In accordance with the Internal Revenue Code of 1986, as amended, the
Company may carryback the 1998 net operating loss, subject to certain
limitations, up to two (2) years to reduce prior years' taxable income. Any
unused portion may be carried forward up to twenty (20) years. The Company
expects to utilize $4,294,000 of the net operating loss to offset prior years'
taxable income resulting in a refund of approximately $1,325,000 of taxes
previously paid.

The Company's 1998 consolidated financial statements have been restated to
give effect to the recognition of the income tax receivable discussed in the
preceding paragraph. as a result of this restatement, net loss for the year
ended December 31, 1998 has been

F-30
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

decreased by $1,325,000 ($0.13 per common share - basic and diluted) from
amounts previously reported.

(6) RELATED PARTY TRANSACTIONS

The Company has had transactions in the normal course of business with
various companies which are affiliated with shareholders of the Company. Pacific
Gateway Exchange, Inc. ("PGE") provides the Company with significant domestic
and international transmission services. As of January 1, 1998, PGE was no
longer affiliated with the Company. During 1998, a director and several
significant holders of the Company's common stock divested themselves of a
substantial portion of their holdings of PGE common stock; they have advised the
Company that they no longer could be deemed to be in control of PGE. A
significant number of the Company's employees were leased from United Group
Service Center, an affiliate, which provides such services to a number of
affiliated companies. This lease agreement was terminated on December 31, 1998,
at which time these individuals became employees of the Company. The Company
provides long distance and data network service to a number of affiliated
companies. Balances with affiliates related to operating activities are settled
monthly. In addition, the Company has made both interest bearing and
non-interest bearing advances to affiliated companies.

Due from affiliates consists of the following:

<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1998 1997
-------- ----------
<S> <C> <C>
Core Marketing--note receivable due September 1, 1998... $ -- $1,798,889
UICI Administrators (long distance services)............ 308,346 94,417
Interactive Media Works (IMW) (long distance services).. 6,214 25,263
Core Marketing (long distance services)................. 82,695 111,280
AMLI Management Co. (long distance services)............ 10,695 --
Other receivables from various affiliates............... 93,908 97,922
-------- ----------
$501,858 $2,127,771
======== ==========
</TABLE>

F-31
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(6) RELATED PARTY TRANSACTIONS (CONTINUED)

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-32
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

Significant services and transactions incurred in the normal course of
operations with affiliated companies are summarized as follows:

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
</TABLE>

F-33

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(6) RELATED PARTY TRANSACTIONS (CONTINUED)

1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Overhead expenses reimbursed to/from
UGA Divisions................................... 241,810 110,761 77,231
Core Marketing--casual mailings and
telemarketing................................... 21,425 603,742 --
------------ ------------ ------------
$ 5,984,850 $ 9,635,010 $ 14,994,522
============ ============ ============
Interest expense includes the following:
Interest paid to shareholder....................... $ -- $ -- $ 173,380
============ ============ ============
</TABLE>

During 1997, the Company loaned $2,000,000 to an affiliated company, Core
Marketing, LLC. Of such amount, $201,000 was repaid in 1997 and the remainder
was repaid in 1998.

In July 1998, the Company purchased notes receivable from one of the
Company's significant shareholders at a discount. The notes receivable evidenced
loans made by the significant shareholder in 1996 to Matrix employees to finance
their purchases of Matrix common stock (which was subsequently converted to
shares of the Company's common stock). Each of the employees who delivered a
note receivable also entered into a Buyback Agreement dated October 6, 1996 (the
"Buyback Agreement"), pursuant to which the Company has the option (but no
obligation) to repurchase a portion of such employee's stock upon the
termination of his or her employment. The original notes, plus accrued interest,
at the date of purchase by the Company was $573,000. The Company purchased these
notes for $435,000.

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

F-34

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(6) RELATED PARTY TRANSACTIONS (CONTINUED)

common stock and 125,000 shares of restricted common stock. Stock options are
to be granted with an exercise price greater than or equal to the stock's
fair market value at the date of grant. Options generally vest 25% after one
year and 25% each year thereafter until fully vested. Such options typically
expire after ten years. In addition, AvTel had other options which had been
granted prior to the adoption of the AvTel 1997 Plan. After the Share
Exchange all outstanding options became obligations of the Company.

On January 1, 1998, the Company granted options to purchase 75,000 shares
of the Company's common stock at an exercise price of $1.50 per share. On March
1, 1998 the Company granted options to purchase 100,000 shares of the Company's
common stock at an exercise price of $1.50 per share. These options become
exercisable based on qualified billings of long distance customers generated by
the optionees from the respective dates of grant through December 31, 2000. As
of December 31, 1998, 27,316 options are exercisable.

On February 24, 1998, the Company's Board of Directors approved the grant
of a total of 120,000 shares of restricted common stock to two board members
pursuant to the Company's 1997 Stock Incentive Plan. The restricted stock
provisions will lapse over four years or fully lapse in the event of death or
permanent disability of the grantees. During 1998 one of the board members
resigned from the board and his 60,000 shares were vested immediately. As of
December 31, 1998, only those 60,000 shares of restricted common stock are
vested.

During 1998, the Company adopted the 1998 Stock Incentive Plan (the "AvTel
1998 Plan"), which provides for the issuance of up to 1,500,000 shares of AvTel
common stock pursuant to stock options and issuances of restricted stock, as
well as for the grant of stock appreciation rights. Stock options are to be
granted with an exercise price greater than or equal to the stock's fair market
value at the date of grant. Options generally vest 25% after one year and 25%
each year thereafter until fully vested. Such options typically expire after ten
years. As of December 31, 1998, the Company granted 671,000 options under the
AvTel 1998 Plan. Exercise prices range from $2.375 to $4.00 per share.

MATRIX OPTIONS--Prior to the Share Exchange, the Board of Directors of
Matrix approved stock options for certain officers and employees. Stock option
transactions of Matrix are included in the table below. At the time of the Share
Exchange, Matrix had 22,338 options

F-35

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(7) STOCK COMPENSATION (CONTINUED)

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.

F-36

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(7) STOCK COMPENSATION (CONTINUED)

BEST CONNECTIONS, INC. OPTIONS AND RESTRICTED STOCK AGREEMENTS--As
discussed in Note 2 as a result of the Matrix combination with Best, Matrix
assumed the obligation to issue stock options, consisting of Matrix common
shares owned by Best, to employees of affiliated companies. Effective July
15, 1997, the Company issued 247,500 options to purchase an equal number of
shares of its common stock, at $1.50 per share subject to the provisions of a
Restricted Stock Agreement. The Restricted Stock Agreement includes a call
provision by the Company that lapses 10 percent each six months beginning
December 15, 1997 through June 15, 2002 or fully lapses in the event of death
or permanent disability of the option holder. The call price is equal to the
initial purchase price of $1.50 plus the aggregate amount of net income or
less the aggregate amount of net losses per share for each fiscal quarter
beginning after December 15, 1997; provided that the call price could not be
less than $1.50 per share. During 1998 AvTel relinquished its right to call
the shares which caused the options to vest immediately and to expire if not
exercised before December 13, 1998. AvTel provided the holders the option of
a "cashless" exercise by purchasing up to one half the shares issuable at
$3.00 The Company recognized expense over the life of the options in
accordance with the provisions of SFAS No. 123 and recorded expense of
$500,000 in 1997 and a reduction of expense of $170,000 in 1998. At December
31, 1998, 107,250 options had been exercised, 67,250 were used for the
cashless exercise, 45,500 expired, and 27,500 were canceled.

F-37

<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(7) STOCK COMPENSATION (CONTINUED)

Stock option activity is as follows:

WEIGHTED
OPTION AVERAGE
S 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.

F-38

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(7) STOCK COMPENSATION (CONTINUED)

OPTIONS OUTSTANDING
-------------------------------------------------
OPTIONS EXERCISABLE
WEIGHTED -----------------------------------
AVERAGE WEIGHTED NUMBER OF OPTIONS
RANGE OF NUMBER REMAINING AVERAGE AVERAGE
EXERCISE OF CONTRACTUAL EXERCISE EXERCISABLE WEIGHTED
PRICES OPTIONS LIFE PRICE PRICE EXERCISE
---------- --------- ------------------- ---------- ------------------ --------------
<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-39

<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.

1998 1997
--------------- -------------
<S> <C> <C>
Numerator:
Net loss............................................ $ (5,802,318) $ (10,191,720)
Less preferred dividends............................ 47,264 5,540
--------------- -------------
Loss applicable to common shareholders............. $ (5,849,582) $ (10,197,260)
=============== =============

Denominator:
Weighted average number of common shares used
in basic and diluted loss per common 9,633,474 8,267,296
share.............................................. =============== =============

Basic and diluted loss per common share............. $ (0.61) $ (1.23)
=============== =============
</TABLE>

Per share amounts are not reflected for 1996 due to the recapitalization of
the Company as a result of the reverse acquisition in 1997.

(9) LEASING ACTIVITIES AND OTHER COMMITMENTS

The Company leases office space and various equipment under operating
leases expiring in various years through 2004. In the normal course of business,
operating leases are generally renewed or replaced by other leases. Total rental
expenses were $546,000 in 1998, $245,000 in 1997, and $325,000 in 1996. Future
minimum lease payments under non-cancelable operating leases (with initial or
remaining lease terms in excess of one year) and future minimum capital lease
payments as of December 31, 1998 are: 1999--$731,000; 2000--$688,000;
2001--$426,000; 2002--$307,000; and 2003--$101,224.

Substantially all of the Company's switching and transmission facilities
have been provided by two suppliers under negotiated contractual agreements. The
Company purchases long distance services at certain per-minute rates, which vary
depending on the time and type of call.

F-40

<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

At December 31, 1998, there are outstanding contractual agreements committing
the Company to $18,570,000 minimum usage through February 15, 2000.

(10) REVOLVING LINE OF CREDIT

In 1998, the Company entered into a Loan and Security Agreement with a
bank, which provides for an asset-based revolving credit line with a floating
interest rate of prime plus 2% (9.75% at December 31, 1998), payable monthly.
The credit limit is the lesser of $7,500,000 or a percentage of the amount of
the Company's eligible receivables and other items. Borrowings are secured by
substantially all of the assets of the Company. The agreement also calls for
a minimum borrowing of $1,500,000 with a two-year term. At December 31, 1998,
there was $1,112,890 outstanding under the agreement, and an additional
$1,655,000 was eligible for borrowing under the revolving credit line.

The Loan and Security Agreement contains restrictions on net worth,
future acquisitions and other transactions.

(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

F-41
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(11) SEGMENT REPORTING (CONTINUED)

through affinity relationships and niche marketing strategies. Channel
Partners include non-profit organizations and for-profit distribution groups.
CMG provides Internet access, long distance telephone and other services to
customers in 49 states.

During 1998, the Company measured and monitored the progress of BMG and
CMG based on revenues from external customers and gross margin. The results
for the year ended December 31, 1998 are as follows:

YEAR ENDED DECEMBER 31, 1998

BMG CMG TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
Revenue from external customers.......... $6,338,114 $37,675,384 $44,013,498
Gross margin............................. 1,846,895 10,317,249 12,164,144
Total assets............................. 8,079,998 7,879,356 15,959,354

YEAR ENDED DECEMBER 31, 1997

BMG CMG TOTAL
---------- ----------- -----------
Revenue from external customers.......... $5,791,993 $45,597,087 $51,389,080
Gross margin............................. 1,715,205 13,446,368 15,161,573
Total assets............................. 2,241,825 16,483,025 18,724,850

F-42
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

YEAR ENDED DECEMBER 31, 1996

(11) SEGMENT REPORTING (CONTINUED)

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-43
<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.

F-44
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(13) SUBSEQUENT EVENTS (CONTINUED)

As a result, the Company could issue up to 750,000 shares of Common Stock
upon conversion if all of the Series B Stock were converted at the lowest
possible conversion price (assuming such revenue and EBITDA requirements
continue to be met). Unless the Company shall have obtained the approval of
its voting stockholders in accordance with the rules of The Nasdaq Stock
Market, the Company will not issue shares of Common Stock upon conversion of
any shares of Series B Stock if such issuance of Common Stock, when added to
the number of shares of Common Stock previously issued by the Company upon
conversion of or as dividends on shares of the Series B Stock, would exceed
19.9% of the number of shares of Common Stock which were issued and
outstanding on the original issuance date of the Series B Stock. The Company
will pay converting Series B Investors in cash for any excess over such
amount.

The Company also issued the Series B Investors warrants to purchase up
to 20,000 shares of Common Stock at a price of $8.60 per share. The warrants
may be exercised beginning September 30, 1999, and terminate on March 31,
2002.

The Company and the Series B Investors entered into a Registration
Rights Agreement that requires the Company to file, and obtain and maintain
the effectiveness of, a Registration Statement with the Securities and
Exchange Commission (the "Commission") in order to register the public resale
of all 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-45
<PAGE>

AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998, 1997 AND 1996

(14) QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
1998
-----------------------------------------------------------------------------------
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total
----------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Revenues 12,444,839 11,294,866 10,589,137 9,684,656 44,013,498
Gross Margins 3,156,844 2,938,848 3,336,290 2,732,162 12,164,144
Net Loss as previously reported (1,672,490) (2,112,947) (1,208,539) (2,133,342) (7,127,318)
Tax benefit from NOL
carryback (note 5) 304,448 413,004 156,006 451,542 1,325,000
Adjusted net loss (1,368,042) (1,699,943) (1,052,533) (1,681,800) (5,802,318)

Net loss per common
share--basic and diluted as
previously reported (0.18) (0.22) (0.13) (0.22) (0.74)
Net loss per common
share--basic and diluted
adjusted for tax benefit from
NOL carryback (0.15) (0.18) (0.11) (0.17) (0.61)
</TABLE>

During each of the quarters in 1998 the Company incurred a net
operating loss for federal income tax purposes. Approximately $4,294,000 of
the NOL may be carried back to reduce taxable income in prior years. The 1998
quarterly information has been adjusted to reflect the tax benefit of the
carryback of the tax NOL in each quarter.

F-46
<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
BEGINNING AT
OF END OF
DESCRIPTION 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.................. $1,185,00 1,269,000(c) -- 2,454,000
December 31, 1997.................. $ 0 1,185,000(c) -- 1,185,000
December 31, 1996.................. $ -- -- -- --
</TABLE>

- ----------------------

(a) Charged to cost of revenues.
(b) Amounts written off.
(c) Recognized as a component of deferred tax assets.

S-1
<PAGE>

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>
<CAPTION>
<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)

II-1
<PAGE>

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.

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.

II-2
<PAGE>

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 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.

II-3
<PAGE>

On March 17, 1999, AvTel issued 14,845 shares of its common stock,
which were not registered under the Securities Act, to one of its 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.

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. Trinity
Capital Advisors, in its role as financial advisor, conducted a financial
analysis of AvTel and presented it with a private placement structure. Trinity
also provided AvTel with several contacts with investors known to invest in the
type of structure proposed. No underwriters were used in this transaction and
none of such shares were issued publicly. 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

II-4
<PAGE>

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 theSecurities 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;

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.

II-5
<PAGE>

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-6
<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 July 23, 1999.

By /s/ ANTHONY E. PAPA
Anthony E. Papa
Chairman of the Board and
Chief Executive Officer

POWER OF ATTORNEY

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 23rd day of July 1999.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
*
- -------------------------------- Chairman of the Board and Chief
Anthony E. Papa Executive Officer (Principal Executive
Officer)

*
- -------------------------------- President, Chief Operating Officer,
James P. Pisani Secretary and Director

*
- -------------------------------- Chief Financial Officer (Principal
Michael J. Ussery Financial and Accounting Officer)

*
- -------------------------------- Director
John E. Allen

*
- -------------------------------- Director
Jeffrey J. Jensen

*
- -------------------------------- Director
Anthony D. Martin

* By: /s/ ANTHONY E. PAPA
- --------------------------------
Attorney-in-Fact
</TABLE>

II-7
<PAGE>

INDEX TO EXHIBITS

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, File No. 0-27580).
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, File No.
0-27580).
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, File No. 0-27580).
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, File
No. 0-27580).
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, File No. 0-27580).

II-8
<PAGE>

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, File
No. 0-27580).
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, File No.
0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File
No. 333-53435).
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, File No. 0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File
No. 333-53435).
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, File No. 0-27580).

II-9
<PAGE>

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, File No. 0-27580).
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, File No.
0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File No. 0-27580).
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, File No.
0-27580).

II-10
<PAGE>

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, File No.
0-27580).
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, File No. 0-27580).
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, File No.
0-27580).
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, File No. 0-27580).
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*
</TABLE>

- ------------
* Previously filed.

II-11

<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 headings "Selected Consolidated Financial Data" and
"Experts" in the prospectus.

/s/ KPMG LLP

Dallas, Texas
July 22, 1999