<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q/A
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AMENDMENT NO. 1 T0
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27580
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AVTEL COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT SPECIFIED IN ITS CHARTER)
---------
DELAWARE 87-0378021
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
501 BATH STREET
SANTA BARBARA, CALIFORNIA 93101
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(805) 884-6300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
As of May 4, 1999, there were 10,542,997 shares of the Registrant's Common
Stock, par value $0.01 per share, issued and outstanding, excluding treasury
stock.
1
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EXPLANATORY NOTE
AvTel Communications, Inc. hereby amends its Quarterly Report on
Form 10-Q for the quarter ended March 31, 1999. The consolidated financial
information contained in such report has been adjusted to reflect an income
tax receivable of $1,325,000, with a corresponding increase in stockholders'
equity. The adjustment was recorded in AvTel's Form 10-K/A for the year ended
December 31, 1998, which was filed with the Commission on July 2, 1999.
Additionally, the net loss for the three month period ended March 31, 1998
has been decreased by $304,448, from the previously-reported $1,672,490
($0.18 per common share--basic and diluted) to $1,368,042 ($0.15 per common
share--basic and diluted). The adjustment reflects the effect on the period
ended March 31, 1998 of the net operating loss carryback.
The restated consolidated financial information recognizes the tax
benefit of carrying back the net operating loss to reduce prior years'
taxable income.
<PAGE>
AVTEL COMMUNICATIONS, INC.
QUARTER ENDED MARCH 31, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31,
1999 (Unaudited) and December 31, 1998 3
Consolidated Statements of Operations for the
Three Month Periods Ended March 31,
1999 and 1998 (Unaudited) 4
Consolidated Statements of Cash Flows for the
Three Month Periods Ended March 31, 1999 and 1998
(Unaudited) 5
Notes to Consolidated Financial Statements
(Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
Signature Page 18
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
(Unaudited)
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 588,759 911,179
Accounts receivable, net 4,335,567 4,804,532
Due from affiliates 168,797 501,858
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
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STOCKHOLDERS' EQUITY
Preferred stock, authorized 750,000 shares, $0.01 par value -- --
Series A convertible preferred stock, aurthorized 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 -- --
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Total liabilities and stockholders' equity $ 14,348,590 15,959,354
------------ ------------
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</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
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AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------------
1999 1998
------------ ------------
<S> <C> <C>
REVENUES $ 9,322,414 12,444,839
COST OF REVENUES 6,620,713 9,287,995
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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
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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 Consolidated Financial Statements.
4
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-------------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,066,131) (1,368,042)
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 Consolidated Financial Statements.
5
<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 1999 and 1998
(1) BASIS OF PRESENTATION
The unaudited consolidated financial statements of AvTel
Communications, Inc. and Subsidiaries (the "Company") for the three month
periods ended March 31, 1999 and 1998 have been prepared in accordance with
generally accepted accounting principles for interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements
and should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's Form 10-K for the year
ended December 31, 1998. All significant intercompany balances and transactions
have been eliminated in consolidation. In the opinion of management, all
adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation of the interim financial information have been
included. The results of operations for any interim period are not necessarily
indicative of the results of operations for the entire year.
The Company's 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 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:
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 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.
6
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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 July 31, 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 and reducing or
eliminating other discretionary expenditures.
(5) SEGMENT REPORTING
The Company's two primary business segments are Business Markets Group
("BMG") and Channel Markets Group ("CMG").
BMG targets mid-size corporate customers for their broadband data,
voice and Internet networking needs. Through a value-added sales process, the
Company designs, provisions and manages its customers' networks. The Company
provides a host of additional value-added services assisting its customers to
create enhanced intranet and extranet applications. Additionally, BMG markets to
its customer base a variety of traditional communications 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:
7
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<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>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1998
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 Common Stock, when added to the number of
shares of Common Stock previously issued by
8
<PAGE>
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.
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
9
<PAGE>
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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS DOCUMENT THAT
ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE.
ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ARE BASED ON
INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES
NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. ACTUAL EVENTS AND
OUTCOMES COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF MANY FACTORS, INCLUDING THOSE DESCRIBED HEREIN AND
THOSE SET FORTH IN THE RISK FACTORS DESCRIBED IN ITEM 1 OF THE COMPANY'S ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998.
The following discussion and analysis should be read in connection with the
unaudited consolidated financial statements for the three month periods ended
March 31, 1999 and 1998 of the Registrant and related notes included elsewhere
in this report and the consolidated financial statements and related management
discussion and analysis included in the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
Overview
AvTel Communications, Inc. (the "Company") is a provider of broadband
network services integrating voice, data and Internet solutions. The Company
sells and markets a broad range of telecommunications and advanced network
10
<PAGE>
services through independent value added resellers, Affinity and agent
organizations, and internal direct sales professionals. The Company targets
mid-size corporations, small-office home-office professionals and select
residential market segments through two primary business units; the Business
Markets Group ("BMG") and the Channel Markets Group ("CMG").
On December 1, 1997, the Company acquired Matrix Telecom, Inc., a
privately-held Texas corporation ("Matrix") by means of a share for share
exchange. For accounting purposes, the acquisition was treated as a reverse
acquisition with Matrix as the acquirer. Matrix was a provider of long
distance telephone services and subsequently provides a bundled service
including Internet access.
On September 25, 1998, the Company acquired all of the issued and
outstanding capital stock of Digital Media International, Inc. ("DMI"), a
privately-held corporation based in Santa Barbara, California, which develops
software for educational, entertainment and other applications.
On November 19, 1998, the Company acquired all of the issued and
outstanding capital stock of Remote Lojix/PCSI, Inc. ("RLI"), a privately-held
corporation based in New York, which is a provider of system integration and
local area network ("LAN") services to corporate customers.
Results of Operations
Consolidated Statements of Operations as a Percent of Revenue
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
------ ------
<S> <C> <C>
Revenues 100.00% 100.00%
Cost of revenues 71.02% 74.63%
Gross margin 28.98% 25.37%
Operating expenses
Selling, general and administrative 56.74% 36.82%
Depreciation and amortization 4.23% 2.24%
------ ------
Total operating expenses 60.97% 39.06%
------ ------
Operating loss (31.99%) (13.69%)
Interest expense (1.06%) (0.10%)
Other income, net 0.16% 0.35%
Loss before income tax (32.89%) (13.44%)
Income tax benefit 0.00% 2.45%
------ ------
Net loss (32.89%) (10.99%)
------ ------
------ ------
</TABLE>
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. BMG revenue increased $1.4 million, which is in
part attributable to the acquisition of RLI during the fourth quarter of
1998. CMG revenue decreased $4.5 million. CMG revenue from traditional voice
products declined $4.7 million, while Internet revenue increased $167,000 or
21.0%. Historically, CMG has focused on selling retail long distance service
through telemarketing, direct mail, and distributors or agents. During the
fourth quarter of 1998, CMG implemented a new strategy to sell Internet
access and additional voice services exclusively through affinity groups,
agents and distributors with the main thrust focused on Internet access.
11
<PAGE>
The primary source of revenues of the Company 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 CMG revenues for the three months ended March
31, 1999 compared to the three months ended March 31, 1998. Decreases in CMG
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, the Company determined to turn the sales force focus away from these
channels and towards affinity and agent groups.
Excluding consumer voice traffic, the Company'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, the Company's dependence on revenue from voice
distribution channels decreased 23 percentage points to 60% of the Company'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, BMG had over 30 accounts in the process of
activation and installation. The Company expects these new accounts to start
producing revenue within 60 to 120 days. In addition, as of April 30, 1999, CMG
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 the
Company 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. 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.
BMG 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, significantly lower rates were negotiated with the Company's major
underlying carrier for dedicated traffic. These rates became effective February
15, 1999 and represent an approximate cost reduction of 20% on dedicated
traffic. Secondly, with the acquisitions of RLI and DMI, BMG is able to sell and
support higher margin products.
CMG gross margin as a percent of revenue increased 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 CMG
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.
12
<PAGE>
BMG 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 RLI and DMI 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.
CMG selling, general, and administrative costs decreased $665,000 to
$3.3 million for the three months ended March 31, 1999 from $4.0 million for the
three months ended March 31, 1998. As a percent of revenue, selling, general,
and administrative costs increased 14.6 percentage points to 50.4% for the three
months ended March 31, 1999 from 35.8% for the three months ended March 31,
1998. The principal reason for the decrease in costs was attributable to the
decline in billing and collection, and commission expenses associated with the
decline in revenue. Stock compensation expense for the three months ended March
31, 1999 was $81,000 compared to $234,000 for the three months ended March 31,
1998, a decrease of $153,000. Certain option and restricted stock plans were
accelerated and completely expensed during 1998. Additionally, commission
expense declined $174,000 for the quarter ended March 31, 1999 due to the
amortization of advanced commissions being fully realized during 1998.
Depreciation and Amortization
Depreciation and amortization increased $116,000 to $395,000 for the three
months ended March 31, 1999 from $279,000 for the three months March 31, 1998.
The increase primarily resulted from the acquisition and consolidation of assets
related to the purchase of RLI and DMI 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 RLI 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 the
decrease of interest income from cash investments.
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.
Liquidity and Capital Resources
As shown in the consolidated financial statements for the three months
ended March 31, 1999, the Company reported a net loss of $3,066,131. In
addition, as of March 31, 1999, the Company had a working capital deficit of
$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 their right of acceleration of the
obligation indefinitely as it relates to the Company not meeting the net worth
covenant through July 31, 1999, but retains their 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 will enable the Company to meet the net worth
covenant beginning August 1, 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
13
<PAGE>
the line (see Note 6 of Notes to Consolidated Financial Statements). In
addition, on April 13, 1999, the Company sold 1,500 shares of its newly
designated Series B Convertible Preferred Stock for $1,500,000 (see Note 6 of
Notes to Consolidated Financial Statements).
Based on the realization of the tax benefit of carrying back 1998
net operating losses to reduce prior years' taxable income, the Company
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.
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,
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 and reducing or
eliminating other discretionary expenditures.
The primary sources of operating cash flow for the Company are revenues
derived from the sale of information technology and telecommunications services
to individuals and business, and its secured credit facility. The primary uses
of cash are payments to underlying network vendors for provisioning
telecommunications facilities, to sales distributors for soliciting long
distance sales, and to the major LECs for directly billing to and collecting
from the end user. Net cash used in operating activities is $1.3 million for the
three months ended March 31, 1999, compared to $1.2 million for the three months
ended March 31, 1998.
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. The Company loaned $2.0 million to an
affiliated company during 1997. Of such amount, $201,000 was repaid during 1997,
$410,000 was repaid during the first quarter of 1998 and the remainder was
repaid in subsequent quarters of 1998.
Net cash provided by financing activities was $1.2 million and $18,000
for the three months ended March 31, 1999 and 1998, respectively. On October 2,
1998, the Company entered into a secured credit facility with Coast Business
Credit. This credit facility consists of a line of credit of up to $7.5 million.
Under the line of credit, the Company may borrow up to 75% of eligible
receivables (as defined). In addition, the line of credit may be utilized in
connection with certain acquisitions and equipment purchases as well as to
provide a facility for issuing letters of credit. Borrowings under the line of
credit bear interest, payable monthly, based upon the prime rate of Bank of
America NT & SA plus 2% (9.75% at March 31, 1999). As of March 31, 1999,
borrowing 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 the Company.
The credit facility expires on October 31, 2000.
The Company anticipates that future operations and growth strategies
(including possible acquisitions) of the Company will require funding from other
sources. The Company entered into the Coast agreement and the Private Equity
Line to help meet this need, as well as operating and capital expenditure needs,
for the next twelve months.
Year 2000
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. The Company has initiated
a Year 2000 Project Plan ("the 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 the Company'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.
14
<PAGE>
Thus far, the identification phase has identified Year 2000 issues in
the following critical Company-owned and leased systems: rating and billing
systems used by the Company to process and prepare billing data for its customer
base. In addition, the Company receives critical services from providers of
utilities and other services to facilities that house employees and equipment.
The Company is also critically reliant upon the systems of other
telecommunications providers on which the Company depends to deliver services
and invoices to its customers. The identification and planning phases of the
Plan are materially complete as they relate to Company-owned and leased systems.
As they relate to third party vendors and other telecommunications carriers, the
identification and planning phases are on-going and are expected to be
materially complete during second quarter 1999.
Based on work completed under the Plan to date, the Company currently
intends to take the following additional steps under its Plan with respect to
Company-owned and leased systems, third-party vendors and other
telecommunications carriers:
- - The Company generally plans to remediate Company-owned and leased
rating, billing and collection systems through the revision or
replacement of current system components. Necessary changes to
Company-owned and leased systems are in process and are expected to be
completed by third quarter 1999. The selective testing and verification
of such changes are expected to be completed in the third quarter of
1999. Due to the large number of system components requiring
remediation, the Company 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 the Company's business.
- - With respect to critical services provided by utilities and other third
parties, the Company is in the process of contacting all such
suppliers. Thus far, a majority of those suppliers who have responded
have indicated that their systems and service delivery mechanisms are
Year 2000 compliant or can be made so through currently available
modifications. The Company plans to continue monitoring all third-party
remediation efforts and to develop contingency plans for the delivery
of such services as necessary.
- - The Year 2000 compliance status of other telecommunications providers
with which the Company's systems interact is not yet known. The Company
is making inquiries of these providers to determine their compliance
status and expects to obtain the results of compliance tests during
second quarter 1999, although there can be no assurance that providers
will supply this information.
While the Company currently believes that it will be able to remediate
and selectively test Company-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 the Company 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 the Company's business, financial condition, results of
operations and prospects. Because the impact of Year 2000 issues on the Company
is materially dependent on the mitigation efforts of parties outside the
Company's control, the Company cannot assess with certainty the magnitude of any
such potential adverse impact. However, based upon risk assessment work
conducted thus far, the Company believes that the worst case scenario of the
failure by the Company, its suppliers or other telecommunications carriers with
which the Company interacts to resolve Year 2000 issues would be an inability by
the Company to timely and accurately process service requests and to timely and
accurately bill its customers. In addition to lost earnings, these failures
15
<PAGE>
could also result in loss of customers due to service interruptions and billing
errors, substantial claims by customers and increased expenses associated with
stabilizing operations and executing mitigation plans.
Contingency planning to maintain and restore service in the event of
natural disasters, power failures and systems-related problems is a routine part
of the Company's operations. The Company believes that such contingency plans
will assist the Company in responding to the failure by outside service
providers to successfully address Year 2000 issues. In addition, the Company 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 second quarter of 1999,
but their review and development will continue throughout 1999.
Although the total costs to implement the Plan cannot be precisely
estimated, the Company incurred minimal costs to date (none of which was related
to hardware costs) and anticipates spending an aggregate of up to $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, such upgrades will position the Company to provide more and
better-quality services to its customers than they currently receive. The
Company 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 the Company's plans discussed above
are forward-looking statements that are derived using numerous assumptions of
future events, many of which are outside the Company'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.
16
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule - Three Months Ended March 31, 1999
(b) Reports on Form 8-K
The registrant filed no reports on Form 8-K during the quarter ended
March 31, 1999.
17
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AVTEL COMMUNICATIONS, INC.,
a Delaware corporation
By: /S/ ANTHONY E. PAPA
------------------------------------
Anthony E. Papa
Chairman and Chief
Executive Officer
(Duly Authorized Officer)
July 2, 1999
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
- ------- -------------------
<S> <C>
27.1 Restated Financial Data Schedule - Three Months Ended March 31, 1999
27.2 Restated Financial Data Schedule - Three Months Ended March 31, 1998
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF
MARCH 31, 1999 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 589
<SECURITIES> 0
<RECEIVABLES> 4,336
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 7,062
<PP&E> 1,674
<DEPRECIATION> 0
<TOTAL-ASSETS> 14,349
<CURRENT-LIABILITIES> 10,342
<BONDS> 2,188
0
1
<COMMON> 105
<OTHER-SE> 216
<TOTAL-LIABILITY-AND-EQUITY> 14,349
<SALES> 0
<TOTAL-REVENUES> 9,322
<CGS> 0
<TOTAL-COSTS> 6,620
<OTHER-EXPENSES> 5,684
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 99
<INCOME-PRETAX> (3,066)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,066)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,066)
<EPS-BASIC> (0.29)
<EPS-DILUTED> (0.29)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS OF AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES AS OF
MARCH 31, 1998 AND THE RELATED CONSOLIDATED STATEMENTS OF OPERATIONS AND CASH
FLOWS FOR THE THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 3,995
<SECURITIES> 0
<RECEIVABLES> 7,423
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 14,859
<PP&E> 4,769
<DEPRECIATION> 3,070
<TOTAL-ASSETS> 18,036
<CURRENT-LIABILITIES> 10,214
<BONDS> 0
1
0
<COMMON> 111
<OTHER-SE> 6,593
<TOTAL-LIABILITY-AND-EQUITY> 18,036
<SALES> 12,445
<TOTAL-REVENUES> 12,445
<CGS> 9,288
<TOTAL-COSTS> 9,288
<OTHER-EXPENSES> 4,861
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12
<INCOME-PRETAX> (1,672)
<INCOME-TAX> (304)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,368)
<EPS-BASIC> (.15)
<EPS-DILUTED> (.15)
</TABLE>
