<PAGE>
NetLojix Communications Annual Report 1999
enterprise n. 1. a plan or design for a venture or undertaking. 2. readiness to
attempt or engage in what requires daring or energy: a bold, energetic, questing
spirit: independence of thought.
empower v. t. 1. to give faculties or abilities to: enable to.
2. to give official authority.
At NetLojix, We Empower Enterprises
Financial Highlights
<TABLE>
<CAPTION>
(amounts in thousands,
except where indicated and per share amounts) 1999 1998 1997
Operating Results
<S> <C> <C> <C>
Revenues $ 16,864 $ 9,888 $ 6,435
Gross Margin 7,481 4,219 1,573
Gross Margin % 44.4% 42.7% 24.4%
Loss from Continuing Operations (4,947) (3,271) (9,213)
Loss from Continuing Operations Per Share ($ 0.49) ($ 0.35) ($ 1.11)
Net Loss (2,198) (5,802) (10,192)
Net Loss Per Share ($ 0.23) ($ 0.61) ($ 1.23)
Balance Sheet Items
Total Assets $ 10,956 $ 10,725 $ 10,971
Long-Term Debt -- -- --
Stockholders' Equity 6,299 4,510 7,809
</TABLE>
Focus
Netlojix is an eBusiness enabler. We provide network infrastructure and
technical support to the mid-size business market. The three core components of
our business are: network connectivity; technical support; and applications
development and hosting. Collectively, these services comprise an enterprise
network solution. As a single-source provider of enterprise network solutions,
we offer these services on a stand-alone basis or bundled as part of a total
solution.
Execution
Our mPOP (multi-service points-of-presence) deployment, the co-location
facilities connected to those mPOPs, and our support team enable and support the
areas of greatest growth and excitement in the IT arena: Internet transport and
net-centric eBusiness applications.
Web-Centric Network Strategies
To Our Shareholders
1999 could certainly be characterized as a year of change, challenge and
excitement. Although we hit a few bumps in the road, we ended the year strongly,
with a wonderful outlook for the new millennium.
Of course, the most significant event of the year was our exit from the
residential long distance telephone market. This was a big decision for us. In
the end, we believe it was the right one for the Company and our shareholders.
The move allowed us to substantially increase our focus on our more profitable
and growing core business, which is providing eBusiness network services to
corporate customers. We are now well-positioned in one of the most exciting
areas of the internet services industry.
Today, our Company's total service portfolio embodies an Enterprise Network
Solution, which is the integration of technology, our people and a
communications platform to enhance our customers' ability to achieve their
objectives. Simply put, we design, build and manage corporate networks across
distances from desktop to desktop.
This core competency generated $16.9 million in revenue in 1999 with a
44.4% Gross Margin. That is a 70.6% increase in revenue and a 77.3% increase in
Gross Profit over 1998. Our sources of revenue are segmented into three primary
categories: Network Connectivity; Technical Support; and Applications
Development & Hosting. We initiated operations in IT Support and eBusiness
Solutions in November of 1998. In 1999, these two segments generated 31.2% and
12% of net revenue respectively and, 25.3% and 17.1% of Gross Profit.
As we are sure you have noted, the world of telecommunications and
computing has become very complex as new technologies and a burgeoning market of
new service providers are creating revolutionary applications along with
enhanced capabilities. These advancements are shaping the demand for greater
bandwidth and complex enterprise-wide network
<PAGE>
solutions. Our strategy in this quickly-changing, and therefore chaotic,
industry is clear: provide the technical support and network infrastructure to
the small to mid-size business market for business-to-business communications
and commerce. By serving as a technology partner for our customers, we bring
order to the chaos and assist them in mission critical technology decisions that
may significantly alter and enhance the future of their business. Only through
solid implementation and management of these 'Best-In-Class' network solutions
for their businesses, can we provide the value our customers expect.
Our network strategy has always provided us with the ability to integrate
the most appropriate network access and communications protocols for our
customers' needs. In November 1998, we launched DSLink service on the central
coast of California. DSLink is a local high-speed access service enabling
connectivity speeds up to 1.54 Mbs. More than 1,000 customers later, we believe
that DSLink is one of the most cost-effective high-capacity local access
services available today.
In December 1999, we announced the expansion of our network strategy and
the national expansion of DSLink. Our plans include new points-of-presence
(mPOPs) in Los Angeles, San Francisco, New York, Chicago and Dallas by year-end
2000. These markets were selected based upon our sales and engineering presence.
Our mPOPs enable any variation of data transport and will allow for voice over
IP and other services as demand dictates.
Each mPOP can support application hosting and co-location facilities,
thereby creating a complete eBusiness Center in each of our target markets. Our
first eBusiness Center in California plays host to 1,200 hosting customers and
20 dedicated co-location customers. Hosting services, both shared and dedicated,
provide our customers with a cost-effective solution for systems, bandwidth and
technical support, and an immediate presence in the 'eWorld'. We believe that
the vast majority of our customer base will require an increasing amount of
application hosting and co-location space well into the future. This is further
supported by the growth and prospects for the Application Service Provider (ASP)
industry. It should be noted that we are already providing ASP services in the
form of zTrieve and our eCommerce hosting base.
We recognize that providing reliable, cost-effective, state-of-the-art
network access for data, voice and Internet connectivity along with maximum
proximity application and database hosting is not the end game. The real-time
critical core component and the true value of a complete Enterprise Network
Solution is our people. Our value proposition to our customers is and will
continue to be the technical support and IT services that our skilled human
assets provide. This is why we instituted a variety of aggressive and high-level
training programs in 1999, all of which will continue in perpetuity. This is
also why every single NetLojix employee is a shareholder.
The Future
As we look to the exciting and expanding new world of web-centric network
technologies, we intimately understand the enormous demand for network
integration and management which will continue to grow beyond the next decade.
There are two constants that we believe to be absolute truths during these
revolutionary times: our existing customers will increase their annual spending
on network technologies and bandwidth; and we will add new customers that
require our services as their businesses become more web-centric.
It is absolutely clear that every business across the globe is
significantly increasing its networking expenditures as it deploys new
technologies for greater bandwidth to maximize productivity. NetLojix sales and
technical personnel will continue to partner with leading industry innovators to
maximize the value of our Enterprise Network Solutions and satisfy this
increasing demand for network services.
There are a few industry trends that we would like to share with you that
will drive our business for the next many years. They are:
- Increasing acceptance of the Internet as a transport medium for
mission critical data
- Business-to-business eCommerce activity growing significantly
- More companies are outsourcing systems and network infrastructure and
support
- An accelerated return to centralized computing through web-centric
application hosting across a distributed network architecture, giving
rise to the ASP industry
- Computing power and routing efficiencies will continue to grow
More and more companies are relying on the Internet for transport of
critical information and as a medium to conduct business. A new study by the
Boston Consulting Group predicts that as much as one-fourth of all U.S.
business-to-business purchasing will be done online by 2003. The report
estimates that between now and 2003, business-to-business e-commerce
transactions will grow by 33 percent each year and reach $2.8 trillion.
In this new world order, referred to by many as the age of the Internet
economy, we are categorized in the Internet Infrastructure sector. This sector
includes companies that create or enable IP network infrastructure. We view our
specific position as the company that enables the network infrastructure to
create eBusiness solutions to the desktop.
You can expect to continue to see NetLojix increase its national presence
in providing fully integrated, enterprise-wide solutions to business.
<PAGE>
Conclusion
We believe that we accomplished a great deal in 1999, yet remain more
excited by our expansion plans for 2000 and beyond. We got off to a good start
this year, and our goal is to make NetLojix a premier name in the industry. To
do this, our employees will strive to deliver exceptional service; our leaders
at all levels will provide clear direction, focus and energy to their respective
teams; and our entire organization will maintain an environment of technical
excellence.
We hope you find the information contained in this report interesting and
informative. We look forward to visiting with you at our annual meeting of
stockholders in Santa Barbara on May 25, 2000.
Very truly yours,
Anthony E. Papa James P. Pisani
Chairman President
Smart, adj. clever, ingenious. As a one-stop shop for high-bandwidth
applications, we believe that our expertise in the delivery of efficient,
high-performance, bundled solutions is a smart approach to a greatly underserved
middle market.
source n. 1. the place from which something comes or is obtained.
2. the point of origin.
network n. 1. an arrangement or pattern with intersecting lines.
2. a chain of interconnected people or operations.
solution n. the process of solving a problem, the answer found.
v. to solve: to find the answer to a problem or puzzle.
A Smart Ride Up The Technology Curve
Smart Sourcing, Smart Networking, Smart Solutions
NetLojix is an eBusiness enabler. We provide the most advanced and reliable
network infrastructure and technical support available to small to mid-size
businesses. Our solutions include broadband Internet, data, and voice
connectivity; application development and hosting services; and system
integration and maintenance. Collectively, our portfolio of services comprises
an Enterprise Network Solution.
NetLojix has the expertise to design a custom solution to enhance the
operations of businesses with multiple locations, requirements for the safe
transmission of crucial data across the globe, and a need for more
cost-effective intra- and extra-company communications.
We understand that the business environment is constantly evolving, along
with dramatic, technology-driven changes in the marketplace. Our solution starts
with the client's process, and ends with a trusting and valued relationship.
Reliable and secure networks and systems and superior technical support are a
staple in every business-to-business platform we provide for our clients.
An increasing number of companies are recognizing the power, cost savings
and reach of the Internet as a medium. Moreover, companies are recognizing the
need to outsource systems and network infrastructure and technical support.
Thinking in terms of eBusiness is central to a company's strategy. eBusiness is
more than electronic commerce; it is the smart use of electronic communications
and information technologies to accelerate the achievement of an enterprise's
goals.
Our suite of high-performance, cost-effective business communications and
integration services can empower businesses to compete more effectively by
making digital communications simple, fast and inexpensive. NetLojix offers a
vast set of data, voice and Internet service options, all from one source. Our
communications services include Wide Area Networks, Virtual Private Networks
(VPNs), Frame Relay, Private Line, Dedicated Internet Access, enhanced Toll-Free
Service, Broadcast Fax, IP Voice and traditional Voice, Audio and Video
Conferencing, and Business Calling Cards. We have dedicated Account Teams
located strategically across the country.
Our target market consists of companies that employ between 50 and 500
people. This is a very large, but underserved, segment of the business universe.
NetLojix professionals form long-term partnership-oriented relationships with
their customers, which results in high levels of customer retention. Our sales
force has a unique advantage over CLECs, DLECs, RBOCs, ISPs and IXCs, because we
provide a complete solution nationwide. Most of our customers maintain
operations in multiple xLEC service areas and require more than just bandwidth.
They require a total solution, which consists of the integration of technology,
people and a communications platform.
<PAGE>
In our continuous efforts to provide business customers with superior
network performance, we recently announced agreements with several data and
Internet transport providers in both the local loop and long haul arenas.
Through these alliances, NetLojix will utilize our partners' high bandwidth
Internet connectivity and DSL facilities for our mPOP expansion in Los Angeles,
New York and San Francisco, as well as other new markets we expect to open. By
selecting premier partners and combining them with our state-of-the-art network
build plans and technical team, we can orchestrate the routing of mission
critical data in a faster, more reliable, more managed fashion than conventional
Internet technology.
Through our mPOP network, our Data Centers are providing secure hosting and
co-location facilities for many premier corporate customers. These services
address a growing need in the market -- enabling companies that require a
presence in the "eWorld" but do not have, or want to provide, the capital or
technical resources to implement and support "e" platforms . By providing
customers with a complete package of systems, bandwidth and technical support,
we allow our customers to focus on their core competency and minimize their
total cost of ownership of technology. Whether it's hosting an application to be
used by the masses, or specific for a customer, we bring the most critical
components to the market -- network, systems and technical resource.
For example, one of our customers is a highly specialized Internet
financial portal, and we are providing secure co-location of its multi-server
platform with access to 45Mbps (DS3) of data throughput. NetLojix aggregates 56k
data streams carrying stock quote information from the leading ECN computerized
trading system based in New York City. NetLojix provides the client with a
state-of-the-art Internet Data Center infrastructure, complete with broadband
access and support. It is a solution that is highly reliable, cost-effective and
easily scalable as the client organization continues its rapid growth in
membership.
As the enterprise network solutions provider for a medical e-commerce
company, NetLojix created an intuitive user interface coupled with a powerful
commerce engine, so that the client could position itself as the leading online
source for home medical supply products 24 hours a day, 7 days a week. NetLojix
provides the network connectivity, hosting facilities, transaction processing
and eBusiness management services to support the company's online operations.
NetLojix provides the critical infrastructure to enable and support
organizations so that they can conduct business over the Internet. We meet their
need for hosting and co-location services. We are expanding the deployment of
mPOPs that primarily enable broadband Internet access, DSL and Frame Relay to
the Internet, so that we can provide local transport access to customers in each
of our target regions. Our DSL strategy and local loop focus will allow NetLojix
to leverage technology advances in the loop that will enable services
integration, management of networks to the desktop, and a lower cost of doing
business for our customers.
NetLojix. Our solutions are seamless and worry-free. We deliver world-class
network design and best-in-class support. We keep networks active so companies
can spend more time growing their businesses.
Network Connectivity Services
- System Design and Engineering
- Local and Wide Area Networking
- Broadband Services - Frame Relay, ATM, Private Line
- Virtual Private Network Solutions
- Global Remote Access and Management
- Network Management
- Switched and Dedicated Telephone Service
- IP Voice
- Audio and Video Conferencing
- High-Speed Internet Access
Technical Support Services
- Help Desk Management - Remote and On-Site
- Systems Integration
- Desktop and LAN Service and Maintenance
- On-Site System Installation and Relocation
Application Development & Hosting Services
- Web Development
- Commerce Applications
- Legacy Integration
- Interface Development
- Intranet Development and Management
- Hosting and Co-Location
<PAGE>
Competitive Landscape IT Service RBOCS /
NetLojix Company ISPs CLECs IXCs
Voice Network Design - -
Data Network Design - -
Intranet / Extranet Design - -
Voice System - -
LAN / WAN Service - -
Internet Access - - - - -
Frame Relay / ATM Access - - - -
Telephone Service - - - -
Multi-State Service - somemajors some -
Table of Contents
Selected Financial Data 10
Notes to Selected Financial Data 10
Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Independent Auditors' Report 16
Financial Statements 17
Consolidated Statements of Operations 17
Consolidated Balance Sheets 17
Consolidated Statements of Stockholders' Equity 18
Consolidated Statements of Cash Flows 19
Notes to Financial Statements 20
Market for Common Equity and Related Stockholder Matters 32
Selected Financial Data
For accounting purposes, the acquisition of Matrix Telecom on December 1,
1997 was treated as a reverse acquisition of NetLojix by Matrix Telecom.
Accordingly, our results of operations reflect the operations of Matrix Telecom
prior to December 1, 1997 and reflect the combined operations of NetLojix and
Matrix Telecom subsequent to December 1, 1997. In August, 1999, we decided to
exit the residential long distance business. Consequently, the residential
long-distance business has been reflected as a discontinued operation and all
prior period amounts have been restated.
The following selected operations data of NetLojix for the years ended
December 31, 1999, 1998, 1997, 1996 and 1995 and balance sheet data as of
December 31, 1999, 1998, 1997, 1996 and 1995 have been derived from our (or
Matrix Telecom's) audited financial statements. 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.
<TABLE>
<CAPTION>
Statement of Operations Data
Years Ended December 31 1999 1998 1997 1996 1995
<S> <C> <C> <C> <C> <C>
Revenues $ 16,864,283 $ 9,887,728 $ 6,435,246 $ 6,916,522 $ 3,532,758
Operating income (loss) (4,889,907) (3,467,346) (9,275,261) 397,650 (10,434)
Income (loss) from
continuing operations (4,947,398) (3,270,997) (9,212,521) 237,548 (1,850)
Income (loss)
from discontinued operations 2,749,663 (2,531,321) (979,199) 2,329,186 (2,438,643)
Net income (loss) (2,197,735) (5,802,318) (10,191,720) 2,566,7 (2,440,493)
Loss per common share from
continuing operations-basic
and diluted (0.49) (0.35) (1.11) N/A N/A
Income (loss) per common share
from discontinued operations 0.26 (0.26) (0.12) N/A N/A
Net loss per common share-
basic and diluted (0.23) (0.61) (1.23) N/A N/A
Cash dividends per common share -- -- -- -- --
N/A =Not applicable
Balance Sheet Data
As of December 31 1999 1998 1997 1996 1995
Working capital (deficit) $ 647,182 ($ 2,084,054) $ 5,570,657 $ 6,962,619 $ 206,071
Total assets 10,956,421 10,724,818 10,971,050 10,794,696 4,976,361
<PAGE>
Long term borrowings -- -- -- -- --
Stockholders' equity 6,299,193 4,510,253 7,809,048 7,861,883 3,539,522
</TABLE>
Notes to Selected Financial Data
1. Matrix Telecom was originally formed May 29, 1990 as a Texas general
partnership. The partners consisted of Matrix Communications, Limited ("MCL") a
Texas limited liability partnership and Onward and Upward, Inc. ("OUI").
Effective January 1, 1994, the partnership was dissolved. Prior to the
dissolution, cash distributions were made to OUI in satisfaction of its
partnership interest. Concurrent with the dissolution, all remaining tangible
and intangible assets and liabilities of Matrix then owned by MCL were
transferred to Matrix Telecom, Inc., a Texas corporation. Effective June 30,
1995, MCL was liquidated and its sole asset (Matrix Telecom capital stock) was
distributed to MCL's partners in proportion to their ownership interests.
2. Concurrent with the dissolution of MCL on June 30, 1995, Matrix Telecom's
then outstanding 1,000 shares of common stock were canceled and 100,000 shares
were distributed to the prior MCL partners in proportion to the ownership
interest in MCL. Effective March 10, 1997, an 18 for 1 stock split was declared
resulting in 3,484,260 shares being then outstanding. On December 1, 1997,
NetLojix effected a one for four reverse stock split as part of its
reincorporation in Delaware, and then acquired Matrix Telecom through the
issuance of 9,582,493 shares of Common Stock (including 1,999,997 shares held as
treasury stock after the share exchange which have subsequently been cancelled).
All share amounts have been restated to reflect the stock splits and share
exchanges.
3. In October 1995, Matrix Telecom issued 2,405,499 shares of its common stock
valued at $3,607,682 in exchange for all of the outstanding common stock of DNS
Communications, Inc., a Houston based long distance reseller. Subsequent to the
acquisition, the operations of DNS generated substantial losses. DNS's customer
churn rate and bad debts as well as projected cash flows were evaluated as of
December 31, 1995, and it was determined that the remaining investment in the
DNS acquired customer base totaling approximately $4,462,000 should be written
off.
4. Per share amounts are not reflected for 1996 and 1995 due to the
recapitalization of the Company as a result of the reverse acquisition in 1997.
5. All amounts have been restated to give effect to the discontinued operations
treatment of the residential long distance business.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion should be read in connection with the consolidated
financial statements and the accompanying footnotes included later in this
Annual Report. This discussion includes "forward-looking" statements which are
based on current expectations and judgements of management, which involve risks
and uncertainties. There are risks that what we expect may not happen in the
future. Because of these risks and uncertainties, what happens in the future may
be very different from what we contemplate in our forward-looking statements.
Background
Description of Our Revenue Segments
We classify our business into three segments: network connectivity,
technical support and application development and hosting. The segmentation of
our company is how we manage the day-to-day operations of our business and is
based on the types of services we provide. All of our services are targeted
toward small to mid-sized businesses.
Network Connectivity Services
The network connectivity segment includes services provided to our
customers that are connections for the transfer of data or voice traffic. We
provide numerous Internet service options, data and voice access and traditional
long distance services. Our Internet product offerings within the network
connectivity segment includes dial-up access, DSL, dedicated access and cable
access. Our telecommunications product offerings include dedicated or leased
lines, switched long distance, frame relay, ATM, calling cards, and "1-800"
services. This segment includes the Internet connectivity portion of our
Internet service provider business. Within this segment, our networking and
communications professionals will design, build and
<PAGE>
maintain a flexible, cost-effective package of data networking and voice
communication services to meet our customer's needs.
Technical Support Services
Technical support services encompasses a broad array of solutions including
system integration, desktop and network support, asset management and help desk
solutions aimed at keeping our customers' IT systems operational and their
networks running smoothly. The technical support team is certified by over 40
hardware and software manufacturers. Service options within this segment include
systems and network installations, flat-fee maintenance contracts, prepaid time
block retainers, help desk management contracts, warranty repairs and a small
amount of hardware sales.
Application Development and Hosting Services
The applications development and hosting services segment includes
producing, designing, and programming creative multimedia and commerce
applications that can be produced as a web application or a stand alone
application. Once a web site has been designed we can also provide site
maintenance services, host the web site on our own web servers or provide
co-location space within one of our data centers.
Financial Information Presentation
On December 1, 1997, we acquired Matrix Telecom through a share for share
exchange of common stock. (the "Share Exchange"). For accounting purposes, the
Share Exchange was treated as a reverse acquisition of NetLojix by Matrix
Telecom. Even though we were the legal acquirer, the historical financial
statements are required to be prepared as if Matrix Telecom acquired NetLojix.
Consequently, the following discussion of results of operations reflects the
operations of Matrix Telecom prior to December 1, 1997 and reflects the combined
operations of NetLojix and Matrix Telecom subsequent to December 1, 1997.
References to "the Company" or "our" financial statements and financial
information refer to operations of Matrix Telecom prior to the Share Exchange
and the combined operations of Matrix Telecom and NetLojix subsequent to the
Share Exchange.
The reverse acquisition of NetLojix 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 NetLojix's Common Stock for a
period immediately preceding the announcement of the Share Exchange was used. As
of the date of acquisition, we determined the fair value of the net tangible and
intangible assets and liabilities acquired. The underlying fair value of our net
assets was substantially less than the indicated market value of our common and
preferred stock. Accordingly, we recorded a charge to income of $9.1 million
immediately subsequent to the reverse acquisition.
In August, 1999 we decided to exit the residential long distance business
and focus exclusively on business customers. As of August, 1999 Matrix Telecom
was engaged in the residential long distance telephone business and represented
all of the Company's business in this segment. Consequently, effective with the
execution of a definitive agreement (the measurement date), the residential long
distance operations of Matrix Telecom have been reflected as a discontinued
operation in the consolidated financial statements. All prior year financial
information has been restated to conform to the discontinued operations
presentation.
Results of Operations
Year Ended December 31, 1999 compared with Year Ended December 31, 1998
Revenues
Revenues from continuing operations increased $7.0 million or 70.6% to
$16.9 for the year ended December 31, 1999 as compared to $9.9 million for 1998.
Approximately $5.4 million of the increase is attributable to acquisitions that
were completed late in 1998. In September 1998 we acquired DMI and in November
1998 we acquired Remote Lojix. The acquisitions contributed a full year of
operations in 1999 compared with a partial year in 1998. We did not complete any
acquisitions during 1999 as we concentrated our efforts on integrating our 1998
acquisitions. As a result, we anticipate revenue growth to come solely from
organic or internal expansion of our business segments and future acquisitions.
Network Connectivity Segment
During 1999 we derived 56.8% of our revenues from network connectivity
services versus 80.9% in 1998. Segment revenues increased $1.6 million to $9.6
million for the year ended December 31, 1999 from $8.0 million for the year
ended December 31, 1998. Within the network connectivity segment, data and voice
services accounted for $1.2 million of the increase with the balance of the
increase attributable to Internet services.
Data and voice services revenue increased 24.5% in 1999 over 1998 as the
Company significantly expanded its sales force during 1999. The increase was
attributable to an increase of $0.5 million in dedicated access and an increase
in billable
<PAGE>
revenue minutes to 75.6 million minutes from 50.6 million minutes, a 49.3%
increase. The increase in call traffic was partially offset by a decline in
billing rates per minute. Our average rate per minute during 1999 was 8.31 cents
compared to 9.98 cents per minute in 1998 or a 16.7% decline. The decrease in
per minute rates is attributable to continued competitive pricing pressures
within the telecommunications industry. We believe that the downward competitive
pressure on long distance rates will continue to adversely effect our revenues
and gross margins for our traditional long distance products.
Internet connectivity services revenues increased 11.6% to $3.3 million.
Demand for Internet connectivity in the central California area continues to be
strong with customer attrition rates running below industry averages at about
1.5% per month. The increase in revenues is attributable to dedicated Internet
access products which include frame relay, cable, ISDN and DSL. Our dedicated
Internet access customer base increased over 350% in 1999 as compared to 1998.
We believe that demand for broadband Internet access products will continue to
be strong. We have upgraded our product offerings through partnerships and
alliances with major vendors so that we can continue to increase our focus on
broadband products.
Technical Support Segment
Technical support services revenues were $5.3 million for the year ended
December 31, 1999 compared to $1.0 million in 1998. In November, 1998 we
acquired Remote Lojix which started our technical support services. Therefore
the 1998 results represent two months of operating activity as opposed to 12
months in 1999.
Application Development and Hosting Segment
Application development and hosting segment revenues increased to $2.0
million for the year ended December 31, 1999 from $0.9 million for the year
ended December 31, 1998. During 1998 we recorded a $119,000 management fee
relating to the acquisition of DMI. Excluding the one time management fee,
revenues for this segment grew by $1.2 million or over 150%. The increase is
primarily attributable to applications services that were acquired in the DMI
acquisition in September 1998.
Gross Margin
Gross margin on continuing operations as a percentage of revenues increased
to 44.4% for the year ended December 31, 1999 from 42.7% for the year ended
December 31, 1998. Total gross profit was $7.5 million for the year ended
December 31, 1999 compared with $4.2 million for 1998. The 77.3% increase is
primarily attributable to the 70.6% increase in total revenues, with the balance
attributable to increase in gross margin for several segments as described
below.
Network Connectivity Segment
The network connectivity segment recorded a gross margin of 45.0% during
1999 compared to a gross margin 38.2% for the year ended December 31, 1998. The
increase in gross margin was attributable to an increase in the gross margins on
our data and voice products.
Data and voice gross margins averaged 25.7% during 1999 compared with 13.2%
in 1998. During 1999, the Company received a credit from its major vendor of
$0.2 million relating to prior periods network service costs. Excluding the
effect of the one-time credit, the Company's gross margins for data and voice
services would have been 22.3%. Effective February 15, 1999, we negotiated
significantly lower rates with our major underlying carrier for dedicated
traffic. The improvement in gross margins was partially offset by the
re-negotiation of a major customer contract which resulted in lower retail
business rates. The lower rates were effective with August 1999 traffic and
extend through October 2000.
Gross margins for Internet services continue to be strong averaging 81.8%
during 1999 compared with 81.2% for 1998.
Technical Support Segment
Technical support services gross margins averaged 36.0% during the year
ended December 31, 1999 compared with 39.5% during 1998. During 1999 salaries
expense for technical service employees increased which adversely effected
margins. We expect margins will continue to be under pressure as the projected
demand for IT professionals is expected to outweigh the supply. We are
anticipating increasing retail prices in response to the increased demand for IT
professionals.
Application Development and Hosting Segment
Application development and hosting gross margins were 63.2% during 1999
compared with 86.5% for 1998. The decrease in gross margin is due to the
$119,000 management fee relating to the acquisition of DMI recorded in 1998 and
the increase in applications development projects within this segment. Gross
margins for applications development projects are negotiated on a project by
project basis and tend to fluctuate for each project depending on the total
dollar amount, deadline commitments and specialized expertise that may be
required for a particular project. Total gross profit increased to $1.3 million
from $.8 million in 1998.
<PAGE>
Selling, General, and Administrative Costs
Selling, general, and administrative costs from continuing operations
increased $4.2 million to $11.3 million for the year ended December 31, 1999
from $7.1 million for the year ended December 31, 1998. Approximately $2.3
million of the increase is attributable to the acquisitions of DMI and Remote
Lojix which were completed late in 1998. The acquisitions contributed a full
year of operations in 1999 compared with a partial year in 1998. As a percentage
of revenues, selling, general and administrative costs decreased to 67.3% for
year ended December 31, 1999 from 71.6% for 1998.
Approximately $0.6 million of the increase is due to increased legal and
professional fees, primarily due to the class action lawsuit. The remaining
increase in selling, general and administrative costs was associated with
expanded sales force and related expenses including salaries, general office
expense, rent, utilities and travel expenditures.
Depreciation and Amortization
Depreciation and amortization increased $0.4 million to $1.0 million for
the year ended December 31, 1999 from $0.6 million for the year ended December
31, 1998. The increase was primarily due to increased goodwill amortization
related to the purchase of Remote Lojix during the fourth quarter of 1998.
Discontinued operations
As noted earlier, in August, 1999 we decided to exit the residential long
distance business and focus exclusively on business customers. Consequently,
effective with the execution of a definitive agreement, the residential long
distance operations of Matrix Telecom have been reflected as a discontinued
operation in the Company's consolidated financial statements. All historical
years have been restated to conform to the discontinued operations presentation.
Loss from operations of our discontinued residential long distance business
was $3.0 million for the year ended December 31, 1999 compared with a loss of
$2.5 million 1998. The 1998 loss included a tax benefit of $1.4 million. The tax
benefit resulted from the loss from discontinued operations and the carry back
of a portion of such loss to prior years. In accordance with APB 30, since
September 1, 1999, all losses of Matrix Telecom were deferred and were
recognized as a reduction of the gain on the sale.
On November 30, 1999, we sold all of the stock of Matrix Telecom to Matrix
Acquisition Holdings Corp., a wholly-owned subsidiary of Platinum Equity
Holdings, LLC, and recorded a gain of $5.8 million. The purchase price for the
Matrix Telecom stock was valued at $6.1 million and consisted of four
components. First, we received a credit against future charges incurred for long
distance wholesale telephone traffic pursuant to our service contract with
Matrix Telecom. We calculated the amount of this credit to be $0.6 million.
Second, we eliminated $4.2 million in intercompany indebtedness owed to Matrix
Telecom by NetLojix. Third, we retained federal income tax refunds paid to or
due Matrix Telecom in the total amount of $1.2 million. Fourth, we may receive a
cash payment based upon Matrix Telecom's Internet service customer base. We
currently do not expect any payment as a result of this component. In addition,
we received an indemnity from Platinum against certain claims or liabilities
arising under NetLojix's secured credit facility with Coast Business Credit.
NetLojix also has been released by Coast Business Credit from any claims or
liabilities relating to borrowings secured by the assets of Matrix Telecom.
The amount of the final purchase price is subject to adjustment based on
finalization of a balance sheet for Matrix Telecom as of August 31, 1999 and
agreement by both parties. We completed the balance sheet and we have been
notified by Platinum that they materially disagree with the closing balance
sheet that we prepared. We are currently attempting to negotiate a settlement of
the balance sheet items in disagreement. If the we are unable to resolve the
matter, the balance sheet will be submitted to an independent firm of
accountants chosen by the parties for final resolution. Any material
adjustments, as determined by the independent accountants, will effect the
purchase price and the recorded gain. At this time, we believe that the ultimate
resolution of the items in dispute will not materially effect the recorded gain.
Results of Operations
Year Ended December 31, 1998 compared with Year Ended December 31, 1997
Revenues
Revenues from continuing operations increased $3.5 million or 53.7% to $9.9
million from $6.4 million for the year ended December 31, 1998 as compared to
the same period in 1997. The increase is attributable to the Share Exchange
between NetLojix and Matrix. NetLojix contributed approximately $0.3 million of
revenues for the period December 1, 1997 through December 31, 1997 (subsequent
to the Share Exchange) compared with approximately $5.3 million in 1998.
Network Connectivity Segment
<PAGE>
Segment revenues, increased $1.6 million to $8.0 million for the year ended
December 31, 1998 from $6.4 million for the year ended December 31, 1998. Within
the network connectivity segment, data and voice services decreased $1.1 million
or 17.7% and Internet services increased $2.7 million.
Data and voice billable minutes decreased to 50.6 million minutes or 7.5%
from 54.7 million minutes in 1997. The decrease in 1998 compared with 1997 is
attributable to the loss of a major customer in early 1997 and a decline in the
billing rates per minute. The loss of the major customer resulted in a decrease
of $0.7 million of revenues or approximately 6.5 million billable minutes. Our
average rate per minute during 1998 was 9.98 cents compared to 11.3 cents per
minute in 1997 or an 11.7% decline. The decrease in per minute rates is
attributable to continued competitive pricing pressures within the
telecommunications industry.
Internet connectivity revenues increased to $2.9 million in 1998 from $0.3
million in 1997. The increase is attributable to the Share Exchange as Internet
connectivity revenues for 1997 are for the period December 1, 1997 through
December 31, 1997 (subsequent to the Share Exchange) compared with twelve months
in 1998.
Technical Support Segment
Technical support services revenues were $1.0 million for the year ended
December 31, 1998 compared to zero in 1997. In November, 1998 we acquired Remote
Lojix which started our technical support services. Therefore the 1998 results
represents two months of operating activity compared with none in 1997.
Application Development and Hosting Segment
Application development and hosting segment revenues were $0.9 million for
the year ended December 31, 1998 compared to zero in 1997. The increase is
primarily attributable to applications services that were acquired in the DMI
acquisition in September 1998 and a $119,000 management fee relating to the
acquisition of DMI that was recorded in 1998.
Gross Margin
Gross margin from continuing operations increased $2.6 million to $4.2
million for the year ended December 31, 1998 from $1.6 million for the year
ended December 31, 1997. As a percentage of revenues, gross margin increased by
18.3 percentage points to 42.7% for the year ended December 31, 1998 from 24.4%
for the year ended December 31, 1997. The increase in gross margin was due to
the addition of Internet connectivity, technical support and applications
development and hosting segments in late 1997 and 1998 which typically
experience higher margins.
Network Connectivity Segment
The network connectivity segment recorded a gross margin of $3.1 million
during 1998 compared to a gross margin $1.5 million for the year ended December
31, 1997. The increase in gross margin was attributable to the addition of
Internet services on December 1, 1997.
Data and voice gross profit declined $0.6 million to $0.7 million in 1998
from $1.3 million in 1997. Gross margin as a percent of revenue averaged 13.2%
during 1998 compared with 21.3% in 1998. Due to increasing market demands, the
Company was forced to continue to decrease retail rates in 1998, however, the
underlying network costs did not change due to contractual commitments.
Internet services contributed $2.4 million to gross margin in 1998 compared
with $0.2 million in 1997. The increase is attributable to the Share Exchange as
Internet connectivity gross profit for 1997 includes the period December 1, 1997
through December 31, 1997 (subsequent to the Share Exchange) compared with 12
months in 1998.
Technical Support Segment
Technical support services contributed $0.4 million to gross margin for the
year ended December 31, 1998 compared with none in 1997. In November, 1998 we
acquired Remote Lojix which started our technical support services. Therefore
the 1998 results represents two months of operating activity compared with none
in 1997.
Application Development and Hosting Segment
Application development and hosting services contributed $0.8 million to
gross margin for the year ended December 31, 1998 compared to none in 1997. The
increase is primarily attributable to applications services that were acquired
in the DMI acquisition in September 1998 and a $119,000 management fee relating
to the acquisition of DMI that was recorded in 1998.
Selling, General, and Administrative Costs
Selling, general, and administrative costs from continuing operations
increased $5.4 million to $7.1 million for the year ended December 31, 1998 from
$1.7 million for the year ended December 31, 1997. The primary reasons for the
increase in selling, general, and administrative costs from continuing
operations were the Share Exchange and the acquisitions of
<PAGE>
Remote Lojix and DMI in 1998. Effective December 1, 1997, the selling general
and administrative costs of NetLojix were included in selling general and
administrative costs.
Salaries and wages increased $3.4 million, of which $2.2 is a attributable
to twelve months of NetLojix selling, general and administrative costs included
in the total in 1998 compared with one month in 1997. The acquisitions of DMI
and Remote Lojix added approximately $0.4 million and $0.5 million, respectively
of salaries and wages. The balance of the increase is attributable to the
addition of personnel and normal salary increases.
Stock compensation expense increased $0.4 million in 1998 compared with
1997. During 1998 an additional expense was recognized in connection with the
early vesting of a restricted stock grant to a departing director.
Professional services increased $0.5 million as a result of additional
expenses associated with public company reporting requirements.
Acquisition related write-off
The $9.1 million write-off relates to the Share Exchange as discussed above.
Depreciation and Amortization
Depreciation and amortization increased $0.5 million to $0.6 million for
the year ended December 31, 1998 from $0.1 million for the year ended December
31, 1997. The increase primarily resulted from amortization of the acquired
customer base associated with the share exchange of NetLojix and Matrix 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 DMI and Remote Lojix in the fourth
quarter of 1998, NetLojix recognized goodwill in the amount of $4.5 million.
Goodwill is amortized on a straight-line basis over fifteen years. Remote Lojix
comprised $4.4 million of the goodwill. Goodwill was determined by the purchase
price in excess of the fair value of the assets received.
Liquidity and Capital Resources
As of December 31, 1999 we had cash and cash equivalents of $1.1 million
and working capital (current assets minus current liabilities) of $0.6 million.
We had no debt outstanding as of December 31, 1999 and as of March 15, 2000 we
continue to have no outstanding debt. For the year ended December 31, 1999, we
incurred a loss from continuing operations of $4.9 million and we incurred
significant losses from continuing operations in each of the previous two years.
Our net loss totaled $2.2 million, $5.8 million and $10.2 million for the years
ended December 31, 1999, 1998 and 1997, respectively. Net cash used by
continuing operations totaled $4.7 million, $4.1 million and $2.9 million for
the years ended December 31, 1999, 1998 and 1997.
In November 1999 we completed the sale of Matrix Telecom. The purchase
price for the Matrix Telecom stock was valued at $6,052,529 which is subject to
adjustment based on finalization of a balance sheet for Matrix Telecom, Inc. as
of August 31, 1999 and agreement by both parties. We completed the balance
sheet, and we have been notified by Platinum that it materially disagrees with
the closing balance sheet that we prepared. We are currently attempting to
negotiate a settlement of the balance sheet items in disagreement. If we are
unable to resolve the matter, the balance sheet will be submitted to an
independent firm of accountants chosen by the parties for final resolution. Any
material adjustments, as determined by the independent accountants, will effect
the purchase price and the recorded gain. At this time, we believe that the
ultimate resolution of the items in dispute will not require any material
expenditure on our part.
We used $225,000 of the long distance credit received in the sale of Matrix
Telecom during the period commencing on September 1, 1999 and ending on November
30, 1999. After November 30, 1999, the amount of the long distance credit used
may not exceed $100,000 per month. We have used an additional $100,000 in
February, 2000 We intend to use this long distance credit, to the extent
available, to offset our costs for long distance service which we continue to
provide to our business customers. However, we are not obligated to continue to
purchase long distance services from Matrix Telecom.
In March, 2000, we restructured our secured credit facility with Coast
Business Credit. Under the restructured line of credit, we may borrow up to 75%
of eligible receivables (as defined) up to a total amount of $3.0 million. The
percentage may be increased to 80% of eligible receivables if we reach certain
operational targets. In addition, the line of credit may be used to provide a
facility for issuing letters of credit. Borrowings under the line of credit bear
interest, payable monthly, based upon the prime rate of Bank of America NT & SA
plus 2% (10.75% at March 15, 2000). Borrowings under the credit facility are
secured by substantially all of our assets. Currently no amount is outstanding
under the credit facility.
On April 23, 1999, we entered into the equity line agreement with Cambois
Finance. Under the terms of the equity line agreement, we may sell or put our
common stock to Cambois Finance, at our option at any time, subject to the
satisfaction of several conditions. The equity line agreement provides for
Cambois Finance to purchase up to $13,500,000 of our common stock, subject to
our filing and maintaining an effective registration statement, trading price
and volume minimums, and
<PAGE>
limits on the amount and frequency on sales of common stock under the line. As
of March 15, 2000, we had sold a total of 1,066,725 shares of common stock to
Cambois Finance for total proceeds of $2,000,000.
On April 13, 1999, we sold 1,500 shares of newly-designated Series B
Convertible Preferred Stock to three private investors for $1,500,000. The
Series B Convertible Preferred Stock was convertible into common stock at the
option of the Series B investors at any time. As of December 2, 1999, all shares
of the Series B Convertible Preferred Stock had been converted into a total of
804,328 shares of NetLojix Common Stock. As a result, no shares of the Series B
Convertible Preferred Stock are outstanding.
On March 3, 2000 we raised $1.5 million through a private placement of
375,000 shares of common stock at $4.00 per share.
Historically, our cash flow from operations, our secured borrowings, our
private placements of both common and preferred stock and our equity line
agreement with Cambois Finance, Inc. have been sufficient to meet working
capital and capital expenditure requirements. We believe that our cash flow from
operations, our equity line agreement and our secured line of credit with Coast
Business Credit are sufficient to meet our working capital requirements from our
current operations into the foreseeable future.
However, our ability to raise capital by putting common stock to Cambois
Finance under the equity line agreement is subject to the satisfaction of
several conditions, as discussed above. Additionally, an important component of
our past growth has been to develop our business through acquisitions. We intend
to continue this strategy. In appropriate circumstances, we may use our capital
stock for acquisitions in addition to debt and equity financing.
Inflation
We do not believe that the relatively moderate rates of inflation over the
past three years have had a significant effect on our net sales or our
profitability.
Recently-Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities. In July 1999, the Financial Accounting Standards Board
issued SFAS No. 137 which delayed the effective date of SFAS No. 133. SFAS No.
133 is now effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000. We do not anticipate that this statement will have a material
impact on our consolidated financial statements.
Quantitative and Qualitative Disclosures about Market Risk
We have not been exposed to material future earnings or cash flow
fluctuations from changes in interest rates on our long-term debt at December
31, 1999. A hypothetical increase of 100 basis points in interest rate (ten
percent of our overall borrowing rate) would not result in a material
fluctuation in future earnings or cash flow. We have not entered into any
derivative financial instruments to manage interest rate risk or for speculative
purposes and we are not currently evaluating the future use of such financial
instruments.
Independent Auditors' Report
The Board of Directors and Stockholders
NetLojix Communications, Inc.:
We have audited the accompanying balance sheets of NetLojix Communications,
Inc. (formerly AvTel Communications, Inc.) and subsidiaries as of December 31,
1999 and 1998, and the related statements of operations, stockholders' equity
and cash flows for each of the years in the three-year period ended December 31,
1999. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NetLojix
Communications, Inc. (formerly AvTel Communications, Inc.) and subsidiaries as
of December 31,
<PAGE>
1999 and 1998, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 1999, in conformity
with generally accepted accounting principles.
KPMG LLP
Dallas, Texas
February 18, 2000, except as to Note 13,
which is as of March 2, 2000
<TABLE>
<CAPTION>
Financial Statements
Consolidated Balance Sheets
1999 1998
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 1,134,625 222,059
Accounts receivable, net 2,471,941 1,295,459
Due from affiliates 715,457 773,667
Federal and state income tax receivable -- 1,325,000
Other current assets 982,387 340,078
Total current assets 5,304,410 3,956,263
Property and equipment, net 917,571 1,039,493
Goodwill, net 3,802,307 4,463,747
Other assets, net 932,133 1,265,315
Total assets $ 10,956,421 10,724,818
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable and other accrued expenses $ 2,317,587 2,004,498
Accrued network services costs 874,830 1,261,016
Sales and excise tax payable 118,503 473,072
Unearned revenue 990,699 954,101
Net liabilities of discontinued operations -- 843,500
Other current liabilities 355,609 504,130
Total current liabilities 4,657,228 6,040,317
Common stock subject to put option -- 168,867
Long-term obligations under capital leases -- 5,381
Total liabilities 4,657,228 6,214,565
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 $727,664
at December 31, 1999 and
1998 including dividends in arrears) 1,477 1,477
Common stock, authorized 20,000,000 shares, $0.01 par
value, issued 12,562,741 and 10,409,473 shares at
December 31, 1999 1998, respectively 125,627 102,969
Additional paid-in capital 23,650,546 19,630,404
Accumulated deficit (17,476,946) (15,224,597)
Treasury stock, $0.01 par value, 151,075 common share
at December 31, 1999 and none at December 31, 1998 (1,511) --
Total stockholders' equity 6,299,193 4,510,253
Commitments and contingencies (Notes 2, 9 and 12)
Total liabilities and stockholders' equity $ 10,956,421 10,724,818
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
Consolidated Statements of Operations
1999 1998 1997
<S> <C> <C> <C>
Revenues $ 16,864,283 9,887,729 6,435,246
Cost of Revenues 9,383,318 5,668,958 4,862,195
Gross Margin 7,480,965 4,218,771 1,573,051
Operating expenses
Selling, general and administrative 11,348,665 7,074,206 1,671,504
Acquisition related write off -- -- 9,098,545
Depreciation and amortization 1,022,207 611,911 78,263
Total operating expenses 12,370,872 7,686,117 10,848,312
Operating Loss (4,889,907) (3,467,346) (9,275,261)
Interest expense (80,550) (31,178) (3,220)
<PAGE>
Other income, net 23,059 92,337 37,219
Loss from continuing operations
before income taxes (4,947,398) (3,406,187) (9,241,262)
Income tax benefit -- 135,190 28,741
Loss from continuing operations (4,947,398) (3,270,997) (9,212,521)
Discontinued operations
Loss from operations of discontinued residential long distance business
(net of income tax benefit of $0, $1,391,389, and $247,611 in 1999,
1998 and 1997, respectively) (3,030,575) (2,531,321) (979,199)
Gain on disposition 5,780,238 -- --
Income (loss) from discontinued operations 2,749,663 (2,531,321) (979,199)
Net Loss $ (2,197,735) (5,802,318) (10,191,720)
Loss from continuing operations
per common share - basic and diluted $ (0.49) (0.35) (1.11)
Income (loss) from discontinued operations
per common share - basic and diluted 0.26 (0.26) (0.12)
Net loss per common share - basic and diluted $ (0.23) (0.61) (1.23)
Weighted average number of
common shares - basic and diluted 10,794,584 9,633,474 8,267,296
</TABLE>
<TABLE>
<CAPTION>
Consolidated Statements of Stockholders' Equity
Preferred Stock Common Stock
Shares Amount Shares Amount Capital
<S> <C> <C> <C> <C> <C>
Balances
December 31, 1996 -- -- 8,336,654 7,532,026 --
Acquisition of BestConnections -- -- 934,987 3,361,208 --
Share for share exchange between NetLojix and Matrix:
Reverse acquisition of NetLojix 207,700 2,077 1,839,563 18,396 9,129,040
Reflect new capitalization of company -- -- (171,548) (10,802,234) 7,064,710
Issuance of common stock for exercise of options -- -- 15,000 150 52,350
Expired put options -- -- 96,480 965 143,755
Stock compensation earned -- -- -- -- 748,884
Net loss -- -- -- -- --
Balances
December 31, 1997 207,700 2,077 11,051,136 110,511 17,138,739
Conversion of preferred stock (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 -- -- 680,000 6,800 1,526,950
Expired put options -- -- 48,187 482 36,770
Called put options 185,847 1,859 372,918
Purchase of officer note receivables -- -- -- -- (435,000)
Stock compensation earned -- -- -- -- 477,148
Retirement of treasury stock -- -- (2,201,601) (22,016) --
Net loss -- -- -- -- --
Balances
December 31, 1998 147,700 1,477 10,296,895 102,969 19,630,404
Issuance of common stock for exercise
of options and restricted common stock -- -- 315,477 3,155 481,990
Stock compensation earned -- -- -- -- 560,725
Issuance of common stock per equity line of credit -- -- 1,066,725 10,667 1,917,350
Purchase of treasury stock -- -- -- -- (77,289)
Shares acquired in legal settlement -- -- -- -- (429,827)
Cancelled put options -- -- 112,578 1,126 167,741
Retire treasury stock -- -- (36,262) (363) --
Issuance of preferred stock 1,500 15 3,000 30 1,407,480
Preferred stock dividends paid -- -- -- -- --
Conversion of preferred stock (1,500) (15) 804,328 8,043 (8,028)
Net loss -- -- -- -- --
Balances
December 31, 1999 147,700 1,477 12,562,741 125,627 23,650,546
</TABLE>
<TABLE>
<CAPTION>
Retained
Additional Earnings /
Paid-In (Accumulated Treasury Stock
Deficit) Shares Amount Total
<S> <C> <C> <C> <C>
Balances
December 31, 1996 769,441 (171,548) (439,584) 7,861,883
Acquisition of BestConnections -- (1,999,997) (3,317,940) 43,268
Share for share exchange between NetLojix and Matrix:
Reverse acquisition of NetLojix -- -- -- 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 -- -- -- 144,720
Stock compensation earned -- -- -- 748,884
Net loss (10,191,720) -- -- (10,191,720)
Balances
December 31, 1997 (9,422,279) (1,999,997) (20,000) 7,809,048
Conversion of preferred stock -- -- -- --
Issuance of common stock for exercise
of options and restricted common stock -- -- -- 517,612
Issuance of common stock for acquisitions -- -- -- 1,533,750
Expired put options -- -- -- 37,252
Called put options -- (201,604) (2,016) 372,761
Purchase of officer note receivables -- -- -- (435,000)
Stock compensation earned -- -- -- 477,148
Retirement of treasury stock -- 2,201,601 22,016 --
Net loss (5,802,318) -- -- (5,802,318)
Balances
December 31, 1998 (15,224,597) -- -- 4,510,253
Issuance of common stock for exercise
of options and restricted common stock -- -- -- 485,145
Stock compensation earned -- -- -- 560,725
Issuance of common stock per equity line of credit -- -- -- 1,928,017
Purchase of treasury stock -- (11,075) (111) (77,400)
Shares acquired in legal settlement -- (176,262) (1,763) (431,590)
Cancelled put options -- -- -- 168,867
Retire treasury stock -- 36,262 363 --
Issuance of preferred stock -- -- -- 1,407,525
Preferred stock dividends paid (54,614) -- -- (54,614)
Conversion of preferred stock -- -- -- --
Net loss (2,197,735) -- -- (2,197,735)
Balances
December 31, 1999 (17,476,946) (151,075) (1,511) 6,299,193
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
1999 1998 1997
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss from continuing operations $ (4,947,398) (3,270,997) (9,212,521)
Adjustments to reconcile net loss from continuing
operations to cash used by continuing
operating activities:
Depreciation and amortization 1,022,207 611,911 78,263
(Gain)loss on disposition of assets 9,555 (87,371) --
Acquisition related write off -- -- 9,098,545
Provision for bad debts 296,238 384,162 255,635
Deferred income tax -- (498,712) (80,377)
<PAGE>
Stock compensation earned 156,551 372,917 --
Changes in certain operating assets and liabilities:
Accounts receivable (1,472,720) (716,557) (320,365)
Due from affiliates 58,210 74,580 631,567
Federal and state income tax receivable 1,325,000 (741,094) (598,970)
Other current assets (642,309) 342,349 (541,276)
Accounts payable and accrued liabilities (499,217) (550,432) (966,234)
Due to affiliate -- (24,329) (1,259,215)
Cash used by continuing operating activities (4,693,883) (4,103,573) (2,914,948)
Cash provided (used) by discontinued
operating activities (2,983,421) (1,875,224) 4,582,718
Cash provided(used) by operating activities (7,677,304) (5,978,797) 1,667,770
Cash Flows From Investing Activities:
Additions to property and equipment (369,442) (323,128) (86,177)
Additions to property and equipment -
discontinued operations (409,947) (149,961) (126,244)
Loans to affiliate - discontinued operations -- -- (2,000,000)
Payments received on loans to affiliates -
discontinued operations -- 1,798,889 201,111
Cash received(paid)in acquisitions -- (474,082) 477,643
Proceeds from sale of property and equipment 1,050 94,370 --
Proceeds from sale of property and equipment -
discontinued operations 6,600 -- 2,749
Cash provided(used)by investing activities (771,739) 946,088 (1,530,918)
Cash Flows From Financing Activities:
Principal payments on capital leases (45,753) (59,055) (4,306)
Principal payments on capital leases -
discontinued operations (20,886) -- --
Issuance of common stock for exercise of options 485,145 517,612 52,500
Issuance of common stock on equity line of credit 1,928,017 -- --
Issuance of Series B preferred stock 1,407,525 -- --
Consolidated Statements of Cash Flows (Continued)
1999 1998 1997
Preferred stock dividend payments (54,614) -- --
Borrowings on line of credit 2,617,182 -- --
Amounts paid on line of credit (2,617,182) -- --
Borrowings on short-term note - discontinued operations 2,000,000 -- --
Borrowings on long-term note - discontinued operations 3,160,294 -- --
Borrowings on line of credit - discountinued operations 24,606,519 9,753,467 --
Amounts paid on line of credit - discontinued operations (24,716,358) (8,640,577) --
Purchase from third party of note receivable
for stock purchase -- (435,000) --
Purchase of common stock for treasury (77,400) -- --
Cash provided by financing activities 8,672,489 1,136,447 48,194
Net increase(decrease)in cash and cash equivalents 223,446 (3,896,262) 185,046
Cash and cash equivalents at beginning of period
for continuing and discontinued operations 911,179 4,807,441 4,622,395
Cash and cash equivalents at end of period for
continuing and discontinued operations(see Note 3) $ 1,134,625 911,179 4,807,441
Cash paid(received)during the period:
Interest - continuing operations $ 83,624 31,178 3,220
Interest - discontinued operations $ 309,271 54,943 8,374
Income taxes - continuing operations $ (112,201) (50,649) 89,741
Income taxes - discontinued operations $ (1,162,814) (436,358) 835,420
Noncash investing and financing activities:
Common stock issued for Best acquisition $ -- -- 3,361,208
Treasury stock acquired with Best acquisition $ -- -- (3,317,940)
Common and preferred stock issued in NetLojix
reverse acquisition $ -- -- 9,149,513
Common stock issued for DMI acquisition $ -- 1,462,500 --
Common stock issued for RLI acquisition $ -- 71,250 --
Common shares acquired in legal settlement $ (431,590) -- --
Net liabilities relinquished in Matrix sale $ 5,780,238 -- --
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
Notes to Financial Statements
1. Summary of Significant Accounting Policies
Business and Background
NetLojix is an eBusiness enabler, with offices principally located in
California, New York and Texas, providing advanced Internet, data and voice
connectivity, technical support and application hosting services, primarily to
mid-sized businesses. NetLojix currently sells and markets advanced network
services and technical support services through internal direct sales
professionals and independent VAR's.
NetLojix had previously been organized into two primary business units: the
Business Markets Group and the Channel Markets Group. On September 15, 1999,
NetLojix realigned its businesses and business segments in order to support
NetLojix's core mission of providing Enterprise Network Solutions to businesses.
As a result of this realignment, the Company's primary business segments are
network connectivity, technical support services and application development and
hosting.
Services provided by NetLojix include the transport of data, voice and
Internet traffic; systems integration, service and technical support; and
application development and hosting. Through a value-added sales process,
NetLojix designs, installs and manages its customers' networks. NetLojix will
provide a host of additional value added services assisting its customers to
create enhanced intranet and extranet applications. NetLojix cross-markets to
its customer base a variety of traditional telecommunications products and
services such as long distance telephone service, executive calling cards and
video/audio conferencing.
On December 1, 1997, NetLojix Communications, Inc. ("NetLojix") and Matrix
Telecom, Inc. ("Matrix Telecom") completed a stock for stock exchange pursuant
to a share exchange agreement ("Share Exchange"). For accounting purposes, the
Share Exchange was treated as a reverse acquisition of NetLojix by Matrix
Telecom. NetLojix was the legal acquirer and accordingly, the Share Exchange was
effected by the issuance of 9,582,493 shares of NetLojix common stock in
exchange for all of the common stock then outstanding of Matrix Telecom. In
addition, holders of outstanding Matrix Telecom stock options received 22,338
non-qualified stock options of NetLojix. The purchase method of accounting was
used, with Matrix Telecom being treated as the acquirer for accounting purposes.
The results of operations reported in the accompanying consolidated financial
statements reflect the operations of Matrix Telecom prior to December 1, 1997
and the combined operations of NetLojix and Matrix Telecom subsequent to
December 1, 1997. References to the "Company" refer to operations of Matrix
Telecom prior to the Share Exchange and the combined operations of Matrix
Telecom and NetLojix subsequent to the Share Exchange. As a result of the Share
Exchange, Matrix Telecom became a wholly-owned subsidiary of NetLojix. (See note
2).
The Share Exchange provided that Matrix Telecom shareholders would receive
2.4819 NetLojix common shares for each common share of Matrix Telecom then
issued including treasury shares held by Matrix Telecom. 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 Telecom declared an 18 for one stock split. All share
amounts have also been restated to reflect this stock split.
On November 30, 1999, the Company sold its wholly-owned subsidiary, Matrix
Telecom. Matrix Telecom represented all of the Company's residential long
distance business. As a result of the Company's decision to exit the residential
long distance business, the Company's consolidated financial statements as of
December 31, 1999 and 1998, and for the years ended December 31, 1999, 1998 and
1997 reflect the Company's residential long distance business as a discontinued
operation. (See note 3)
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
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 an
original maturity at date of purchase of less than ninety days to be cash
equivalents.
Accounts Receivable
Accounts receivable are net of allowances for doubtful accounts and other
provisions of $290,000 and $249,000 as of December 31, 1999 and 1998,
respectively. The Company establishes an allowance for doubtful accounts based
upon factors surrounding the credit risk of its customers, historical trends and
other information.
<PAGE>
Revenue Recognition
Revenues for long distance, frame relay, Internet, and applications
development and hosting services are recognized as service is provided. Amounts
paid in advance are recorded as unearned revenue and recognized as services are
provided. Within the technical support services segment, the Company sells its
services under hourly service contracts (whether prepaid or billed in arrears),
flat fee service call contracts or prepaid maintenance contracts. For prepaid
maintenance contracts, the Company recognizes revenues ratably over the service
period. For all other services, revenues are recognized when the services are
rendered.
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 of fixed assets using
the straight-line method over the estimated useful lives of the respective
assets.
Goodwill
Goodwill of $3,802,000 and $4,464,000 as of December 31, 1999 and 1998,
respectively, is net of accumulated amortization of $336,000 and $19,000 for the
same periods. Goodwill represents the excess of purchase price over fair value
of net assets acquired in the Digital Media, Inc. (DMI) and Remote Lojix (RLI)
acquisitions and is being 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 discounted 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.
Acquired Customer Base
Acquired customer base of $923,000 and $1,240,000 as of December 31, 1999
and 1998, respectively, is net of accumulated amortization of $660,000 and
$343,000 for the same periods. The acquired customer base is included in other
assets and is being amortized on a straight-line basis over five years. The
Company assesses the recoverability of this intangible asset by comparing the
recorded value to estimated undiscounted future cash flows from the use of the
asset. The amount of impairment, if any, is measured based on the difference
between the recorded net book value and the estimated fair value of the
intangible asset. The assessment of the recoverability of the acquired customer
base will be impacted if the estimated fair value declines below the recorded
book value.
Income Taxes
The Company utilizes the asset and liability method for accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
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.
Concentrations of Credit Risk
The Company's subscribers are primarily small to mid-size business owners
and are not concentrated in any specific geographic region of the United States.
The Company generally extends credit to its customers and accounts receivable
are generally not collateralized. As of December 31, 1999 four customers
comprise $1,300,000 or 52.6% of the accounts receivable balance as listed below.
<TABLE>
<S> <C>
Society Generale $ 623,880
Mattel Media 372,000
Infosys Technologies Limited 201,290
US Search.com 102,816
$ 1,299,986
</TABLE>
<PAGE>
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.
Loss Per Share
Basic and diluted loss per share has been computed using the weighted
average number of shares of common stock outstanding during the period. The
Company has excluded all outstanding convertible preferred stock and outstanding
options and warrants to purchase common stock from the calculation of diluted
net loss per share, as such securities are antidilutive for all periods
presented. Comprehensive income (loss) for the years ended December 31, 1999,
1998 and 1997 is equal to net income (loss) reported for such periods.
Segment Reporting
During 1999, the Company realigned its businesses into three business
segments: network connectivity, technical support services and application
development and hosting. In accordance with Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information", segment information is based on internal management reporting
segmentation. Consequently, the Company's segment reporting has been changed to
reflect the realignment and amounts presented for prior years have been
reclassified to conform with the current presentation. (See Note 11)
Reclassifications
Certain reclassifications have been made to prior period amounts in order
to conform to current year presentation including the reclassifications
necessary to reflect the residential long distance business of Matrix Telecom as
a discontinued operation.
2. Acquisitions and Dispositions
Matrix Telecom, Inc.
On December 1, 1997, NetLojix and Matrix Telecom completed the Share
Exchange. For accounting purposes the Share Exchange was treated as a reverse
acquisition of NetLojix by Matrix Telecom. NetLojix was the legal acquirer and,
accordingly, the Share Exchange was effected by the issuance of NetLojix common
stock in exchange for all of the common stock then outstanding of Matrix
Telecom. In addition, holders of outstanding Matrix Telecom stock options
received non-qualified stock options of the Company. Immediately after the Share
Exchange the former shareholders of Matrix Telecom held approximately 84% of the
then outstanding common stock of the Company.
The reverse acquisition of NetLojix 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 NetLojix's 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 expense 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 Share Exchange, 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 December 1, 1999, the two-year holding restriction imposed
on such shareholders by the Registrations Rights and Lockup Agreement expired.
On November 30, 1999, the Company sold all of the stock of Matrix Telecom
to Matrix Acquisition Holdings Corp., a wholly-owned subsidiary of Platinum
Equity Holdings, LLC. (Platinum) and recorded a gain of $5,780,000. The purchase
price for the Matrix Telecom stock was valued at $6,052,000 and consisted of
four components. First, the Company received a credit against future charges
incurred for long distance wholesale telephone traffic pursuant to a
telecommunications service contract with Matrix Telecom. The amount of the
credit was calculated to be approximately $614,000. Second, $4,190,000 in
intercompany indebtedness owed to Matrix Telecom by NetLojix was eliminated or
forgiven. Third, the
<PAGE>
federal income tax refunds paid to or due Matrix Telecom in the total amount of
$1,248,000 were assigned to NetLojix. Fourth, NetLojix is to receive a future
cash payment based upon Matrix Telecom's Internet service customer base. The
Company will recognize any amounts due based on Matrix Telecom's Internet
services as earned. The Company also received an indemnity from Platinum against
certain claims or liabilities arising under NetLojix's secured credit facility
with Coast Business Credit. NetLojix also has been released by Coast Business
Credit from any claims or liabilities relating to borrowings secured by the
assets of Matrix Telecom. The residential long distance operations of Matrix
Telecom have been reflected as a discontinued operation and all prior period
amounts have been restated. The Company has recorded a receivable due from
Platinum Equity in the amount of $674,000 relating to the sale of Matrix
Telecom, which is included in other current assets as of December 31, 1999.
The final amount of the purchase price is subject to adjustment based on
finalization of a balance sheet for Matrix Telecom as of August 31, 1999 and
agreement by both parties. The Company has been notified by Platinum that it
materially disagrees with the balance sheet of Matrix Telecom prepared by the
Company. The Company and Platinum are currently attempting to negotiate a
settlement of the balance sheet items in disagreement. If the Company is unable
to resolve the matter, the balance sheet will be submitted to an independent
firm of accountants chosen by the parties for final resolution. Any adjustments,
as determined by such independent accountants, will affect the purchase price
and the recorded gain. At this time, the Company does not believe that the
ultimate resolution of the items in dispute will materially affect the recorded
gain.
Best Connections, Inc. ("Best")
Effective July 1, 1997, shareholders of Best, an affiliate of the Company
through common ownership, contributed their ownership of Best to the Company in
exchange for 934,987 shares of the Company's common stock. Best's primary assets
were 1,999,997 shares of the Company's common stock and cash of $211,000.
Because the companies were under common control, the assets and liabilities of
Best were recorded at their historical cost, which approximated the fair value
of such assets as of July 1, 1997. As a result of the combination, the Company
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, which have been performed by the
recipients on behalf of the Company. Accordingly, the fair value of such options
has been charged to expense by the Company as the related services were
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 identifiable
assets received. The goodwill is being amortized on a straight-line basis over
fifteen years.
Remote Lojix/PCSI, Inc. ("RLI")
Effective November, 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 the date
of acquisition. The Company recorded goodwill of approximately $4,365,000, 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. During 1999 the Company settled all outstanding claims against the former
majority stockholder of RLI in exchange for relinquishment of 176,262 shares of
common stock of the Company. The relinquishment was recorded as a reduction of
goodwill in the amount of $432,000 during 1999.
Unaudited pro forma results of operations of the Company as if the share
exchange of Matrix Telecom and the acquisitions of Best, DMI and RLI had
occurred as of the beginning of the periods presented are as follows:
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997
<S> <C> <C>
Revenue $ 15,585,671 14,013,434
Operating loss (4,953,083) (11,912,522)
Loss from continuing operations (5,403,049) (12,063,724)
Pro forma loss from continuing operations per share $ (0.53) (1.00)
</TABLE>
<PAGE>
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
periods indicated, or which may occur in the future.
As of the date of acquisitions, the fair market value of the assets
acquired and liabilities assumed included the following:
<TABLE>
<CAPTION>
1998 DMI RLI Total
<S> <C> <C> <C>
Current assets other than cash $ 50,105 1,034,803 1,084,908
Property and equipment 44,313 132,169 176,482
Goodwill 117,169 4,375,191 4,492,360
Current liabilities (166,255) (3,579,663) (3,745,918)
Common stock issued (71,250) (1,462,500) (1,533,750)
Cash acquired (paid) $ 25,918 (500,000) (474,082)
1997 Matrix Telecom Best Total
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. Discontinued Operations
Selected financial information for the residential long distance business
discontinued operations is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Sales $ 18,993,330 34,125,769 44,953,834
Expenses (22,023,905) (38,048,479) (46,180,644)
Loss before income tax benefit (3,030,575) (3,922,710) (1,226,810)
Income tax benefit -- 1,391,389 247,611
Loss from operations of discontinued operations $ (3,030,575) (2,531,321) (979,199)
</TABLE>
<TABLE>
December 31,1998
<S> <C>
Cash $ 689,120
Accounts receivable 3,237,264
Other assets 1,308,152
Total assets $ 5,234,536
Liabilities $ 6,078,036
Accumulated deficit (843,500)
Total liabilities and deficit $ 5,234,536
</TABLE>
4. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
Estimated useful life 1999 1998
<S> <C> <C> <C>
Communications system 2-5 years $ 1,151,779 $979,659
Office furniture and equipment 1-7 years 423,082 396,688
Leasehold improvements Lease term 134,558 105,098
Total property and equipment 1,709,419 1,481,445
Accumulated depreciation and amortization (791,848) (441,952)
Property and equipment, net $ 917,571 $1,039,493
</TABLE>
The Company recognized total depreciation expense of $714,000, $737,000 and
$632,000 for 1999, 1998 and 1997, respectively. Depreciation expense for
continuing operations was $372,000, $254,000 and $65,000 for the same periods.
5. Stockholders' Equity
Common Stock Subject to Put Option
In 1996, approximately 482,000 shares of common stock were sold to officers
of the Company at $1.50 per share. Upon the termination of the recipient's
employment, such shares could be put or called at a price of $1.50 per share
plus the earnings per share or minus the losses per share of the Company from
the period July 1, 1996 to the end of the month prior to the date of
notification of termination of employment by the employee or the Company. As of
December 31, 1999 all put/call rights had been rescinded.
<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
<PAGE>
Balance, December 31, 1996 482,400 896,000
Decrease in share value subject to put recorded
as a reduction to expense -- (172,400)
Vested shares no longer subject to put (96,480) (144,720)
Balance, December 31, 1997 385,920 578,880
Vested shares no longer subject to put (48,187) (72,281)
Called shares subject to put (225,155) (337,732)
Balance, December 31, 1998 112,578 168,867
Vested shares no longer subject to put (37,527) (56,290)
Cancellation of put/call rights (75,051) (112,577)
Balance, December 31, 1999 -- $ --
</TABLE>
Issuance and Conversion of Preferred Stock
The Series A Convertible Preferred Stock ("Series A Stock") is convertible,
on a one-to-one basis, into shares of the Company's common stock. During 1998, a
total of 60,000 shares of the Series A Stock was converted to 60,000 shares of
the NetLojix common stock.
On April 13, 1999, the Company sold 1,500 shares of its newly-designated
Series B Convertible Preferred Stock (the "Series B Stock") to three private
investors for $1,500,000. The Series B Convertible Preferred Stock was
convertible into common stock at the option of the Series B investors at any
time. The conversion price was the lesser of $6.875 or 89% of the closing bid
price for the Company's common stock at the time of conversion. All of the
shares of the Series B Stock were converted into an aggregate of 804,328 shares
of NetLojix common stock during 1999.
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. During
1999, 9,328 of such warrants were cancelled.
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.
Equity Line Agreement
On April 23, 1999, the Company entered into an equity line of credit
agreement with Cambois Finance, Inc., through which the Company may sell or
"put" NetLojix common stock to Cambois Finance, Inc. subject to the satisfaction
of several conditions. The equity line agreement provides for Cambois Finance to
purchase up to $13,500,000 of NetLojix common stock, subject to 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. The Company filed the registration statement, which was declared
effective by the Securities and Exchange Commission on August 25, 1999. As of
December 31, 1999, the Company had put a total of 1,066,725 shares of its common
stock to Cambois Finance for $2,000,000 pursuant to the equity line agreement.
The equity line agreement provides that, without a vote of the Company's common
stockholders, the Company may not issue more than 2,103,939 shares of common
stock in the aggregate to Cambois Finance, Inc. under the equity line, which
number of shares is equal to 19.96% of the outstanding shares of the Company's
common stock on the date of the equity line agreement. As a result, as of
December 31, 1999, the Company could sell up to an additional 1,037,214 shares
to Cambois Finance, Inc. In order to issue shares in excess of that amount under
the equity line agreement, the Company would have to register additional shares
with the Securities and Exchange Commission, as well as obtain stockholder
approval.
The Company issued 3,000 shares of Common Stock to Trinity Capital
Advisors, Inc. as compensation for financial advisory services in connection
with the transactions as set forth in the Private Equity Line.
Common Stock Repurchases/Relinquishments
In December 1998, the Company retired all of its then outstanding treasury
stock, which consisted of 2,201,601 shares.
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. For four consecutive years starting in February
2000, the Company will sell 25% of the shares held under the 1999 GO Plan and
distribute the proceeds as cash bonuses to the employees who were employed at
both the date of the establishment of the 1999 GO Plan and at the date of
distribution.
During 1999, the former majority stockholder of RLI relinquished 176,262
shares of the Company's common stock to the Company in accordance with two
separate legal settlements related to disputes concerning the purchase of RLI.
These shares
<PAGE>
were originally issued in connection with the purchase of RLI. Of these shares,
140,000 shares are held as treasury stock while 36,262 shares were subsequently
canceled and retired. The value of the shares relinquished was recorded as an
adjustment to goodwill.
Preferred Stock Dividends
As a result of issuance of the Series B preferred stock, the Company was
required to account for the benefit of the conversion feature in a manner
similar to a preferred stock dividend equal to the difference between the market
price of the Company's common stock at the date the Company committed to issue
the Series B stock and the conversion price, times the number of common shares
issuable upon conversion. The effect of these preferred stock dividends on
earnings per share was recognized ratably over the period to the earliest
conversion date (90 days from date of issuance). During 1999, the Company
included preferred dividends related to the conversion feature on Series B stock
of $256,593 in the calculation of earnings per share.
On January 31, 1999 and July 31, 1999, the Company declared and paid in
cash semi-annual dividends of $23,632 each to the holders of the Company's
Series A convertible preferred stock.
On September 30, 1999, the Company declared and paid in cash quarterly
dividends of $7,350 to the holders of the Company's Series B preferred stock.
Stock Option Grants
NETLOJIX OPTIONS-Prior to the Share Exchange, NetLojix adopted a 1997
Incentive Stock Option Plan (the "NetLojix 1997 Plan") for option grants to
officers and key employees. The NetLojix 1997 Plan authorizes grants of options
to purchase up to 250,000 shares of authorized but unissued common stock and
125,000 shares of restricted common stock. Stock options are to be granted with
an exercise price greater than or equal to the stock's fair market value at the
date of grant. Options generally vest 25% after one year and 25% each year
thereafter until fully vested. Such options typically expire after ten years. As
of December 31, 1999, 57,585 options had been exercised and 120,938 options were
outstanding. In addition, NetLojix had other options which had been granted
prior to the adoption of the NetLojix 1997 Plan. After the Share Exchange all
outstanding options became obligations of the Company. As of December 31, 1999,
all options granted prior to the adoption of the NetLojix 1997 Plan had expired.
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 to long distance customers generated by
the optionees from the respective dates of grant through December 31, 2000. As
of December 31, 1999, and in connection with the sale of Matrix Telecom, all
grants under these agreements had been cancelled except for 26,657 options left
outstanding with an expiration date of December 31, 2002.
On February 24, 1998, the Company's Board of Directors approved a grant of
a total of 120,000 shares of restricted common stock to two board members
pursuant to the NetLojix 1997 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, 1999, only those
60,000 shares of restricted common stock are vested.
During 1998, the Company adopted the 1998 Stock Incentive Plan (the
"NetLojix 1998 Plan"), which provides for the issuance of up to 1,500,000 shares
of NetLojix common stock pursuant to stock options and issuances of restricted
stock, as well as for the grant of stock appreciation rights. Stock options are
to be granted with an exercise price greater than or equal to the stock's fair
market value at the date of grant. Options generally vest 25% after one year and
25% each year thereafter until fully vested. Such options typically expire after
ten years. As of December 31, 1999, the Company had granted options to purchase
1,040,500 shares and granted 20,000 shares of restricted stock under the
NetLojix 1998 Plan. Exercise prices range from $1.875 to $5.625 per share.
Options to purchase 998,000 shares were outstanding as of December 31, 1999.
During 1999 the Company granted nonstatutory stock options to three board
members to purchase a total of 75,000 shares of the Company's common stock at
exercise prices ranging from $4.625 to $4.88 (average exercise price of $4.82
per share), which was equivalent to the fair market value of the stock at the
respective dates of grant. The stock options vest at a rate of 50% per year over
two years and were granted pursuant to the NetLojix 1998 Plan.
During 1999, the Company granted incentive stock options to four officers
to purchase a total of 350,000 shares of the Company's common stock at exercise
prices ranging from $4.88 to $5.625 (average exercise price of $4.99 per share)
which was equivalent to the fair market value of the stock at the respective
dates of grant. The options vest at a rate of 25% per year over four years and
were granted pursuant to the NetLojix 1998 Plan.
The Company also granted incentive stock options to various non-executive
managers and employees to purchase a total
Market for Common Equity and Related Stockholder Matters
<PAGE>
Since May 28, 1998, our Common Stock has been traded on The Nasdaq SmallCap
Marketsm. The trading symbol is "NETX." Until September 15, 1999, the stock
traded under the trading symbol "AVCO." Prior to its listing on The Nasdaq
SmallCap Market, the Common Stock traded on the Electronic Bulletin Board. There
is no established public trading market for NetLojix's Preferred Stock. The
following table sets forth, for the indicated periods, high and low price
information for NetLojix's Common Stock. High and low bid information is
provided with respect to periods prior to May 28, 1998. High and low prices for
periods after May 28, 1998, reflect high and low sales prices. Such information
was provided by Nasdaq, various market makers and online quote reporting
services. The quotations provided reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
<TABLE>
<CAPTION>
Year ended December 31, 1998 High Low
<S> <C> <C>
First Quarter $8.63 $4.94
Second Quarter $15.88 $7.67
Third Quarter $8.00 $1.75
Fourth Quarter $31.00 $2.00
Year ended December 31, 1999
First Quarter $12.50 $4.00
Second Quarter $8.75 $3.75
Third Quarter $4.88 $1.63
Fourth Quarter $8.50 $1.63
</TABLE>
The number of shareholders of record of NetLojix Common Stock as of March
24, 2000, was 566. At that date there were two record holders of NetLojix's
Preferred Stock.
We have not paid any cash dividends on our Common Stock to date and we do
not anticipate paying dividends in the foreseeable future. We intend to utilize
all available funds for the development of our business. The terms of NetLojix's
Series A Convertible Preferred Stock prevent the payment of any dividend on the
Common Stock unless (1) all cumulative dividends on the Series A Convertible
Preferred Stock have been fully paid, and (2) the holders of at least 50% of the
outstanding shares of the Series A Convertible Preferred Stock have approved
such dividend. In addition, the terms of our secured credit agreement provide
that NetLojix cannot declare a dividend on any of its ownership interests
without the secured lender's approval.
Corporate Information
Corporate Officers and Directors
Anthony E. Papa
Chairman of the Board
Chief Executive Officer
James P. Pisani
President
Chief Operating Officer and Secretary
Director
Michael J. Ussery
Chief Financial Officer
Frank A. Leone
Executive Vice President of Field Sales and Service
Joseph Renteria, Jr.
Vice President, Information Systems
John E. Allen
Director
Vice Chairman, Amli Residential Properties Trust
Vice Chairman, Amli Commercial Properties Trust
<PAGE>
President, Amli Realty Co.
Executive Vice President, United CreditServ, Inc.
Jeffrey J. Jensen
Director
President, Specialized Association Services, Ltd.
President, United Group Service Centers, Inc.
Anthony D. Martin
Director
Managing Director, CrossHill Financial Group Inc.
Stock Trading
The Common Stock of NetLojix Communications, Inc. is traded on The Nasdaq
SmallCap Marketsm under the symbol: NETX.
Transfer Agent
U.S. Stock Transfer Corporation
1745 Gardena Avenue
Glendale, CA 91204
818.502.1404
General Counsel
Seed, Mackall & Cole LLP
1332 Anacapa Street
Santa Barbara, CA 93101
805.963.0669
Auditors
KPMG LLP
200 Crescent Court, Suite 300
Dallas, TX 75201
214.754.2000
Annual Meeting
The Annual Meeting of Shareholders will be held on Thursday, May 25, 2000
at 2:30 PM at the Hotel Santa Barbara, 533 State Street, Santa Barbara,
California.
Corporate Offices
NetLojix Communications, Inc.
501 Bath Street
Santa Barbara, CA 93101
tel. 805.884.6300
fax 805.884.6311
web site: www.netlojix.com
