<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
_______________________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission File Number: 0-22944
US WATS, INC.
-------------
(Exact name of Registrant as specified in its charter)
New York 22-3055962
- - ------------------------------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3331 Street Road, Suite 275
Bensalem, Pennsylvania 19020
- - ---------------------- -----
(Address of principal executive offices) (Zip Code)
(215) 633-9400
--------------
(Registrant's telephone number, including area code)
111 Presidential Boulevard
Bala Cynwyd, Pennsylvania 19004
---------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports); and, (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
___ ___
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Outstanding at
Common Stock November 16, 1998
------------ -----------------
$.001 18,956,394
<PAGE>
US WATS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page (s)
--------
<S> <C>
PART I
======
FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997(unaudited) 3 - 4
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 1998 and 1997 (unaudited) 5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7 - 11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12 - 15
Item 3. Quantitative and Qualitative Disclosure about Market Risk 16
PART II
=======
OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and use of Proceeds 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE PAGE 18
</TABLE>
<PAGE>
PART I
======
Financial Information
ITEM 1.
- - ------
FINANCIAL STATEMENTS
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
1998 1997
---- ----
Assets
------
<TABLE>
<CAPTION>
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 3,876,451 $1,588,267
Accounts receivable, net of allowance for
doubtful accounts of $1,015,333 for 1998,
and $1,498,749 for 1997 6,801,741 6,899,082
Prepaid expenses and other 141,084 108,683
----------- -----------
Total Current Assets 10,819,276 8,596,032
----------- -----------
Property and Equipment
Telecommunications equipment 4,958,982 3,881,857
Equipment 1,658,925 1,579,435
Software 652,422 647,797
Office furniture and fixtures 156,660 155,553
Leasehold improvements 44,872 36,432
----------- -----------
7,471,861 6,301,074
Less accumulated depreciation and
amortization 4,237,815 3,286,435
----------- -----------
Total Property and Equipment, net 3,234,046 3,014,639
----------- -----------
Other assets, principally deposits net of
accumulated amortization of $127,507
for 1998, and $114,387 for 1997 229,478 202,804
----------- -----------
$14,282,800 $11,813,475
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-3-
<PAGE>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---- ----
Liabilities and Shareholders' Equity(DEFICIENCY)
------------------------------------------------
<S> <C> <C>
Current Liabilities
Note payable $ 720,607 $ 690,826
Capital lease obligations, current portion 240,991 273,095
Accounts payable 7,055,566 6,975,779
Accrued commissions 869,031 943,556
Accrued expenses and other 850,213 1,007,980
State and Federal taxes payable 1,075,581 1,293,417
Deferred revenue 50,423 75,494
----------- -----------
Total Current Liabilities 10,862,412 11,260,147
----------- -----------
Long-Term Liabilities
Capital lease obligations, net of current portion 204,167 380,260
----------- -----------
Commitments and Contingencies
Redeemable preferred stock, $.01 par, authorized
150,000 shares; 30,000 shares issued
and outstanding in 1998 and 1997
Redemption value: $11.00 per share 330,000 330,000
----------- ----------
Common Shareholders' Equity (Deficiency)
Common stock issuable -- 166
Common stock, $.001 par, authorized
30,000,000 shares;
issued 20,075,394 shares in 1998,
and 17,654,100 shares in 1997 20,076 17,654
Additional paid-in capital 9,378,883 5,328,982
Accumulated Deficit (6,511,619) (5,503,484)
----------- ----------
2,887,340 (156,682)
Common stock held in treasury
(1,119,000 shares), at par value (1,119) (250)
----------- -----------
Total Equity(Deficiency) 2,886,221 (156,932)
----------- -----------
$14,282,800 $ 11,813,475
=========== ===========
</TABLE>
The accompanying notes are an intergral part of these financial statements.
-4-
<PAGE>
US WATS, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $11,228,935 $13,911,630 $34,944,836 $43,302,987
Cost of sales 7,912,957 10,505,021 25,066,972 31,720,290
----------- ----------- ----------- -----------
Gross profit 3,315,978 3,406,609 9,877,864 11,582,697
Selling, general and administrative expenses 3,957,255 4,337,847 10,816,001 12,628,637
----------- ----------- ----------- -----------
Income (loss) from operations (641,277) (931,238) (938,137) (1,045,940)
Other income (expense)
Interest income 68,693 14,642 126,861 52,313
Interest expense 52,479 91,966 176,612 251,105
----------- ----------- ----------- -----------
Total other income (expense) 16,214 (77,324) (49,751) (198,792)
Income (loss) before income taxes (625,063) (1,008,562) (987,888) (1,244,732)
Income taxes 0 0 0 0
----------- ----------- ----------- -----------
Net income (loss) before preferred dividends (625,063) (1,008,562) (987,888) (1,244,732)
Preferred dividends earned 6,750 6,750 20,250 20,250
----------- ----------- ----------- -----------
Net income (loss) available to common shareholders $ (631,813) $(1,015,312) $(1,008,138) $(1,264,982)
=========== =========== =========== ===========
Earnings per common shares available
to common shareholders $(.03) $(.06) $(.05) $(.08)
=========== =========== =========== ===========
Weighted average number of shares 19,701,677 15,935,187 18,978,022 15,927,170
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-5-
<PAGE>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1998 1997
--------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) before preferred dividends $ (987,888) $(1,244,732)
Adjustments to reconcile net loss
to net cash provided by (used-in) operating
activities
Depreciation and amortization 964,502 756,386
Provision for bad debts 583,343 555,015
Changes in assets and liabilities which
provided
(used) cash:
Accounts receivable (486,002) (3,952,965)
Prepaid expenses and other (32,401) (22,382)
Other assets (39,794) 89,700
Deferred revenue (25,071) 3,266
Accounts payable and accrued expenses (1,264,198) 2,291,016
State and Federal Taxes payable (217,836) 282,168
----------- -----------
Net cash used in operating activities (1,505,345) (1,242,528)
----------- -----------
INVESTING ACTIVITIES
Purchase of property and equipment (109,093) (379,852)
Net cash used in investing activities (109,093) (379,852)
----------- -----------
FINANCING ACTIVITIES
Proceeds from stock option exercises 2,663,109 90,875
Increase (decrease) in notes payable net 29,781 854,343
Repayment of capital lease obligations (208,197) 13,225
Preferred stock dividend (20,250) (20,250)
Buyback of common stock (1,042,800) --
Payment of lease acquisition costs -- (40,743)
Short swing profit proceeds 2,480,979 --
----------- -----------
Net cash provided by financing activities 3,902,622 897,450
----------- -----------
Net increase (decrease) in cash and cash equivalents 2,288,184 (724,930)
Beginning cash and cash equivalents 1,588,267 1,455,186
----------- -----------
Ending cash and cash equivalents $3,876,451 $730,256
=========== ===========
Supplemental disclosure of non cash investing
and financing activities:
The Company acquired property and equipment
and the amount is included in Accounts payable
at September 30, 1998 $1,061,693 --
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
-6-
<PAGE>
US WATS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BACKGROUND
- - --------------
US WATS, Inc. ("the Company") is a switch-based interexchange carrier providing
long distance telephone communications services primarily to small and medium-
size business customers. The Company also provides inbound-800 long distance
services, as well as other telecommunications services such as travel cards
(calling cards), cellular, paging, internet service, dedicated access, data
services, pre-paid calling cards (debit cards), International Callback and
carrier termination services. The Company uses its own switches and facilities
to originate, transport and terminate calls for customers located in the Mid-
Atlantic region as well as all of California with the exception for select
Independent Telephone Company territories. Approximately 90% of the calls billed
by the Company each month are processed through the Company's own switches. For
calls originating or terminating outside the Company's own network (off-net
area), the Company utilizes the services provided by other long distance
companies.
The Company's revenues are derived primarily from the transport of outgoing and
incoming calls which are billed by the Company to end-users at specified rates.
Transport costs of these calls are billed to the Company from other carriers at
contractual rates. These carriers supply the Company with call detail
information which enables the Company to bill its customers depending upon the
Company's individual rates. The combination of the efficiency of the Company's
network and facilities, and the purchase of long distance services in bulk from
other carriers allow the Company to offer competitive rates to small and medium-
sized businesses.
The Company differentiates itself from a price-only sales approach by offering
various value-added services for its customers, provided by its customized
proprietary software. The Company's outbound long distance services, inbound
800 services, cellular services, as well as paging and internet services are
provided on one combined bill which includes various management reports. The
Company believes its consultative approach to meeting its customers' needs
distinguishes it from its larger competitors. All of the Company's customer
support functions, such as customer service, credit and collections, and
administrative services are centrally located at the Company's offices at 3331
Street Road, Suite 275, Bensalem, Pennsylvania 19020. The Company's telephone
number at that location is (215) 633-9400.
The accompanying unaudited interim consolidated financial statements and related
notes have been prepared pursuant to the rules and regulations of the Securities
and Exchange Commission and in the opinion of management, include all
adjustments necessary for a fair presentation of such financial statements.
Such adjustments consist only of normal recurring items. Certain information
and note disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. Where appropriate, certain amounts in
the prior period financial statements have been reclassified to conform to the
current period presentation. The results of operations for the three months and
nine months ended September 30, 1998 are not necessarily indicative of results
to be expected for the full year.
The accompanying unaudited interim consolidated financial statements and related
notes should be read in conjunction with the financial statements and related
notes included in the Company's Form 10-K for the year ended December 31, 1997.
-7-
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- - ----------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its three wholly-owned subsidiaries, USW Corporation, USW Enterprises, Inc., and
Carriers Group Inc., after elimination of all inter-company accounts,
transactions and profits. The Company's investment in an internet service
provider is accounted for under the cost method.
REVENUE RECOGNITION
The Company recognizes revenue based upon the customer's usage of services. The
Company primarily bills its customers for service on a monthly basis, however,
in some instances, it bills certain customers on a more frequent basis.
CASH AND CASH EQUIVALENTS
The Company considers cash in its bank and repurchase agreements with a maturity
of three months or less when purchased as cash and cash equivalents.
At certain times during the year, the Company has balances in its operating
accounts that in the aggregate exceed the $100,000 Federal Deposit Insurance
Corporation insurance limit.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is calculated for
financial reporting purposes using the straight line method over the estimated
useful lives of the assets:
Telecommunications equipment 7 years
Furniture fixtures and other 5 years
The Company intends to replace its Dex 400 switch in Philadelphia by no later
than the end of the first quarter of 1999 as a result of the switch's capacity
limitations and lack of Year 2000 compliance. Therefore, the Company has changed
the estimated remaining life of all the related fixed assets associated with
this switch and as a result has accelerated its depreciation by approximately
$166,000 this quarter and will do the same in each of the next two quarters.
This will result in reducing the book value of such items to zero dollars by the
end of the first quarter of 1999.
DEFERRED FINANCING COSTS
Loan origination costs are amortized by the straight-line method over the term
of the related loan, and are included in other assets.
ACCOUNTS PAYABLE
Accounts payable includes the cost of access charges due local telephone
companies and long distance transport purchased from long distance carriers.
MARKETING
All costs related to marketing and advertising the Company's products and
services are expensed in the period incurred.
-8-
<PAGE>
USE OF ESTIMATES
The preparation of the Consolidated Financial Statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
INCOME (LOSS) PER COMMON SHARE APPLICABLE TO COMMON SHAREHOLDERS
Income (loss) per common share applicable to common shareholders is computed by
dividing net income (loss), after deduction of preferred stock dividends, by the
weighted average number of common shares outstanding during the period.
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share," which was adopted by the Company effective for the year ended December
31, 1997, as required by the statement. For the nine and three months ended
September 30, 1998 and 1997, the Company's potential common stock equivalents
have either an antidilutive or no effect on income (loss) per share applicable
to common shareholders and, therefore, diluted income (loss) per common share
applicable to common shareholders has not been presented.
The following table summarizes those securities that could potentially dilute
income (loss) per common share applicable to common shareholders in the future
that were not included in determining the fully diluted income (loss) per common
share applicable to common shareholders as there is either no effect or the
effect is antidilutive.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
Potential Common Shares resulting from: 1998 1997
--------------------- ----------------------
<S> <C> <C>
Stock Options 812,488 598.016
Stock Warrants 227,446 251,723
Cumulative, Convertible, Redeemable Preferred Stock 300,000 300,000
--------- ---------
1,339,934 1,149,739
========= =========
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
Three Months Ended September 30,
Potential Common Shares resulting from: 1998 1997
--------------------- ----------------------
Stock Options 689,641 1,160,421
Stock Warrants 0 394,431
Cumulative, Convertible, Redeemable Preferred Stock 300,000 300,000
------- ---------
989,641 1,854,852
======= =========
</TABLE>
-9-
<PAGE>
Fair Value of Financial Instruments
The fair value of the Company's financial instruments such as accounts
receivable, accounts payable, and note payable approximate their carrying
amounts.
CARRYING VALUE OF LONG-TERM ASSETS
The Company evaluates the carrying value of long-term assets, including
property, plant and equipment, and other intangibles, based upon current and
anticipated undiscounted cash flows, and recognizes an impairment when it is
probable that such estimated cash flows will be less than the carrying value of
the asset. Measurement of the amount of impairment, if any, is based upon the
difference between carrying value and fair value.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income." This statement, establishes standards for reporting and disclosure for
comprehensive income. The Company adopted this statement during the first
quarter of fiscal year 1998. Adoption of this statement had no impact on the
Company's consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." This statement, which establishes
standards for the reporting of information about operating segments and requires
the reporting of selected information about operating segments in interim
financial statements. SFAS No. 131 is not required to be applied to interim
financial statements in the initial year of application. Reclassification of
segment information for earlier periods presented for comparative purposes is
required under SFAS No. 131. As this statement only requires additional
disclosures in the Company's consolidated financial statements, its adoption
will not have any impact on the Company's consolidated financial position,
results of operations or cash flows. The Company will adopt SFAS No. 131 in its
December 31, 1998 annual financial statements.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This statement improves disclosure
about pensions and other postretirement benefits. The Company adopted this
statement during the quarter ended March 31, 1998. Adoption of this statement
had no impact on the Company's consolidated financial statements.
In March 1998, the AICPA issued Statement of Position ("SOP") 98-1, Accounting
For the Costs of Computer Software Developed For or Obtained for Internal-Use.
The SOP is effective for the Company in 1999. The SOP will require the
capitalization of certain costs incurred after the date of adoption in
connection with developing or obtaining software for internal use. The Company
has not yet assessed what the impact of the SOP will be on the Company's future
earnings or financial position.
In March 1998, the AICPA issued Statement of Position ("SOP") 98-1, Accounting
For the Costs of Computer Software Developed For or Obtained for Internal-Use.
The SOP is effective for the Company in 1999. The SOP will require the
capitalization of certain costs incurred after the date of adoption in
connection with developing or obtaining software for internal use. The Company
has not yet assessed what the impact of the SOP will be on the Company's future
earnings or financial position.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and hedging activities.
-10-
<PAGE>
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. This statement is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. Adoption of SFAS No. 133 is not anticipated
to have a material impact on the Company's financial statements.
RECLASSIFICATION OF ACCOUNTS
Certain reclassifications have been made to conform prior years' balances to the
current year presentation.
3. NOTE PAYABLE
- - ----------------
On May 11, 1995, the Company entered into a Loan and Security Agreement with
Century Business Credit Corporation for a revolving credit facility of
$2,000,000. The loan was established for an initial period of two years, and was
automatically renewed for two successive years on March 11, 1997. Interest on
the loan is currently calculated at prime plus 3 3/4% with a minimum loan value
of $750,000 subject for additional interest charges for amounts below that
level. The loan is collateralized by accounts receivable and fixed and
intangible assets of the Company. In the event the Company fails to meet the
subjective financial performance criteria during 1998, the lender has the right
to call the loan in full.
4. LITIGATION
- - ---------------
On June 13, 1997, Mark Scully, the former President and Chief Operating Officer
of the Company, filed a complaint against the Company, and certain past and
current officers of the Company in the United States District Court for the
Eastern District of Pennsylvania. Mr. Scully asserts various claims in
connection with his termination of employment with the Company on December 30,
1997. In particular, he alleges, among other things, breach of contract in
connection with the termination of certain stock options, breach of the alleged
contract for employment, breach of an asserted duty of good faith and fair
dealing, fraudulent and negligent misrepresentation, and civil conspiracy. Mr.
Scully alleges damages of at least $1.6 million, plus attorneys' fees, costs and
other disbursements and the cost of COBRA payments and interest; $1 million of
the alleged damages claimed are punitive. The Company contests the allegations
of the complaint and intends to vigorously defend against the action. As of the
date of this report the Company has filed an answer. A court date of December
14, 1998 has been set.
The Company is party, in the ordinary course of business, to other litigation
involving services rendered, contract claims and other miscellaneous causes of
action arising from its business. The Company has established reserves relating
to its legal claims and believes that potential liabilities in excess of those
recorded will not have a material adverse effect on the Company's consolidated
financial statements, however, there can be no assurances to that effect.
5. SEVERANCE AGREEMENT
- - ----------------------
Effective August 21, 1998, the Company and Stephen Parker entered into a
severance agreement whereby Mr. Parker resigned as an employee and officer of
the Company. Mr. Parker had been the President and Chief Executive Officer of
the Company. The severance agreement superseded Mr. Parker's employment
agreement with the Company dated December 23, 1993 and provided that the Company
pay Mr. Parker a single lump sum severance of $300,000.
-11-
<PAGE>
ITEM 2.
- - ------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain information contained herein may include "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. All statements, other than statements of historical facts included in
this report are forward-looking statements. Such statements are subject to
certain risks and uncertainties, including, but not limited to, changes in
general economic conditions, increasing levels of competition in the
telecommunications industry, changes in telecommunications technologies, changes
in FCC regulations, the Company's reliance on transmission facilities based
carriers, risks involved in conducting international operations, the inability
to generate sufficient revenues to meet debt service obligations and operating
expenses, unanticipated costs associated with the Company's recent and future
acquisitions and the failure of the Company to manage its growth effectively.
Should one or more of these risks or uncertainties materialize, actual results
may vary materially from those estimated, anticipated or projected. Although the
Company believes that the expectations reflected by such forward-looking
statements are reasonable based on information currently available to the
Company, no assurance can be given that such expectations will prove to have
been correct. Cautionary statements identifying important facts that could cause
actual results to differ materially from the Company's expectations are set
forth in this report. All forward-looking statements included herein are
expressly qualified in their entirety by these cautionary statements.
RESULTS OF OPERATIONS
The Company's revenues for the quarter ended September 30, 1998 decreased
approximately $616,000 (5.2%) versus the prior quarter, and declined by
approximately $2,683,000 (19.3%) versus the quarter ended September 30, 1997.
The overall decrease in revenue was due to declining retail rates as a result of
competitive market pressures, the Company's gradual exit of the International
Callback business, and a decrease in carrier revenue.
THREE MONTHS ENDED SEPTEMBER 30, 1998 AS COMPARED WITH THREE MONTHS ENDED
- - -------------------------------------------------------------------------
SEPTEMBER 30, 1997
- - ------------------
The Company's total revenue for the third quarter ended 1998 decreased
approximately $2,683,000 versus the third quarter ended September 30, 1997, or
19.3%. This decrease was due to a decrease in revenue in several areas. First,
revenues through the carrier sales channel decreased by approximately $851,000.
In the quarter ended September 30, 1997, revenue through the carrier channel
consisted of a large amount of high credit risk international traffic.
Currently, the Company limits the amount of this traffic in order to reduce bad
debt exposure. Revenues also decreased due to a decline in the International
Callback revenue channel by approximately $578,000 resulting from management's
decision to gradually exit the International Callback business. This decision
was based mainly on the telecommunication deregulation in European and Asian
countries. As pricing for long distance services has decreased in these areas,
the International Callback business as a whole has diminished. Finally, the
Company's retail revenue for the quarter ended September 30, 1998 decreased
approximately $1,254,000 from the quarter ended September 30, 1997. The
Company's average retail rate per minute decreased $.017 from the quarter ended
September 30, 1997 to the quarter ended September 30, 1998, and as a result
retail revenue decreased approximately $1,020,000 for the same period. This was
mainly due to stronger competition in the market place. The Company is
continually striving to improve its network efficiency in order to reduce its
network cost per minute more rapidly than the market conditions require retail
rates per minute to be reduced.
The Company's gross profit for the third quarter ended September 30, 1998
decreased approximately $91,000 over the third quarter ended September 30, 1997,
or 2.7%. The Company's gross profit margin increased to 29.5% for the quarter
ended September 30, 1998 from 24.5% for the quarter ended September 30, 1997.
The increase in gross profit margin was primarily due to the substantial
decrease in carrier revenue, which decreased from approximately $4,004,000 in
the third quarter of 1997 to approximately $3,153,000 in the third quarter of
1998. Carrier revenue generates a much lower margin than the retail products,
but is a necessary component of utilizing network facilities. In addition, in
the third quarter of 1998, the Company continued to benefit from negotiated cost
reductions from significant off-net vendors which has benefited gross profit
margins.
-12-
<PAGE>
Also, internal
controls have been implemented to monitor both carrier and retail traffic in
order to ensure that it is routed to the least cost provider.
Selling, General, and Administrative ("SG&A") expenses for the third quarter
ended September 30, 1998 decreased approximately $381,000, or 8.8% versus the
amount for the third quarter ended September 30, 1997. Of this decrease,
$337,000 was attributed to lower commission expense, $189,000 to lower bad debt
expense, $299,000 to lower salary expense, and the remainder attributed to a
variety of miscellaneous expenses of approximately $124,000. The decrease in
commission expense is primarily a result of lower revenues. The decrease in bad
debt expense is a result of lower revenues as well as the implementation of
effective controls for monitoring high credit risk traffic. The decrease in
salary expense is a result of a decrease in headcount. These decreases in
SG&A expenses were offset by an increase in salary expense of approximately
$300,000 representing severence paid to the former President upon his
retirement, an increase in miscellaneous expense of approximately $102,000
associated with moving the corporate office, and an increase in depreciation
expense of approximately $166,000(see footnote 2 under Property and Equipment).
The switch is to be replaced at the end of the first quarter of 1999. SG&A
expense increased as a percentage of revenue from 31.2% during the third quarter
ended September 30, 1997 to 35.2% for the third quarter ended September 30,
1998, mainly due to expenses related to the severence, office move and
accelerated depreciation as noted above. Excluding these one time expenses, SG&A
expenses as a percentage of revenue was 30.1% for the quarter ended September
30, 1998.
For the quarter ended September 30, 1998, interest expense incurred by the
Company decreased by approximately $39,000 compared to the third quarter ended
September 30, 1997. This was due to the Company's ability to maintain the loan
balance on its line of credit near the minimum required level as a result of the
Company's improved cash position.
The Company recorded a net loss before preferred dividends for the quarter ended
September 30, 1998 of approximately $625,000 versus a net loss of approximately
$1,009,000 for the quarter ended September 30, 1997, a decrease of approximately
$384,000. The decrease in net loss reported in 1998 is substantially due to
improved overhead efficiencies and increased gross profit from retail core
revenue channels. Included in the net loss before preferred dividends for the
quarter ended September 30, 1998 were three notable one time items. Those items
consisted of approximately $320,000 in expenses related to the former
President's severance, approximately $102,000 in miscellaneous expense for the
corporate office move and approximately $166,000 in depreciation expense as
noted above.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AS COMPARED WITH NINE MONTHS ENDED
- - -----------------------------------------------------------------------
SEPTEMBER 30, 1997
- - ------------------
The Company's total revenue for the nine months ended September 30, 1998
decreased approximately $8,358,000 versus the nine months ended September 30,
1997, or 19.3%. This decrease was primarily due to a decrease in revenue through
the carrier sales channel of approximately $2,719,000. Throughout the nine
months ended September 30, 1997, revenue through the carrier channel consisted
of a large amount of high credit risk international traffic. As noted above, the
Company now limits the amount of this traffic in order to reduce exposure. The
total revenue decrease was also due to a decrease of approximately $2,181,000
through the International Callback revenue channel. As noted above, the
International Callback business as a whole is on the decline.
In addition, the Company's retail revenue for the nine months ended September
30, 1998 decreased approximately $3,458,000 versus the quarter ended September
30, 1997. The Company's average retail rate per minute decreased $.017 versus
the nine months ended September 30, 1997 to the nine months ended September 30,
1998, and as a result retail revenue decreased approximately $3,060,000 for the
same period. This was mainly due to declining retail rates in the long distance
market.
-13-
<PAGE>
Throughout the first quarter of 1998, the Company was engaged in merger
activities with ACC Corp., which was terminated in March. During that time
frame, the Company was involved in integration plans associated with the merger.
This had a significant impact on the Company's business as sales and operating
initiatives were delayed during this period. Given that the long distance
industry is a recurring billing business, the lack of sales growth in the first
quarter of 1998 had a critical impact on the Company's ability to increase
revenues throughout the remainder of the nine month period.
The Company's gross profit for the nine months ended September 30, 1998
decreased approximately $1,705,000 versus the nine months ended September 30,
1997, or 14.7%. However, the Company's gross profit margin increased from 26.7%
for the nine months ended September 30, 1997 to 28.3% for the nine months ended
September 30, 1998. The increase in gross profit margin was primarily attributed
to the substantial decrease in carrier revenue, which decreased from
approximately $11,826,000 for the nine months ended September 30, 1997 to
approximately $9,107,000 for the nine months ended September 30, 1998. Carrier
revenue generates a much lower margin than retail revenue, but is a necessary
component of utilizing network facilities. Improved network controls for least
cost routing and cost reductions from other carrier vendors also contributed to
increased gross profit margins.
Selling, General, and Administrative ("SG&A") expenses for the nine months ended
September 30, 1998 were approximately $1,813,000 lower than the amount incurred
for the nine months ended September 30, 1997. The decline in SG&A expenses
was due to a decrease in commission expense by approximately $1,311,000 which
resulted from the decrease in revenues. Also, SG&A expenses was reduced as a
result of a decrease in salary expense by approximately $413,000 which was
attributed to a reduction in headcount by approximately 23% from September 30,
1997 to September 30, 1998. The remainder of the decrease in SG&A expenses were
due to a decline in other miscellaneous expenses by approximately $89,000. SG&A
expenses for the nine months ended September 30, 1998 were 31.0% of revenue,
whereas SG&A expenses for the nine months ended September 30, 1997 were 29.2% of
revenue. This increase in 1998 was due to an increase in salary expense of
approximately $300,000 associated with severance paid to the former President,
an increase in miscellaneous expenses of approximately $102,000 associated with
moving the corporate office and an increase of depreciation expense of
approximately $166,000(See footnote 2 under Property and Equipment).
For the nine months ended September 30, 1998, interest expense incurred by the
Company decreased by approximately $75,000 compared to the nine months ended
September 30, 1997. This was primarily due to the Company's ability to maintain
the loan balance on its line of credit at the minimum required level as a result
of the Company's improved cash position.
The Company recorded a net loss before preferred dividends for the nine months
ended September 30, 1998 of approximately $988,000 compared to a net loss of
approximately $1,245,000 for the nine months ended September 30, 1997, a
decrease in net loss of approximately $257,000. The decrease in net loss in
1998 resulted from improved gross profit margins and improved overhead
efficiencies.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital ratio declined during the quarter ended September
30, 1998 to 1.00: 1.00 compared to 1.22: 1.00 for the quarter ended June 30,
1998. However, the Company's working capital ratio during the quarter ended
September 30, 1998 increased from .76: 1.00 at December 31, 1997. The Company's
cash balance increased approximately $2,288,000 from its balance at December 31,
1997. However, the Company's cash balance decreased approximately $1,457,000
from its balance at June 30, 1998. This decrease in cash resulted from the
Company's buyback of 869,000 restricted shares from the former President for a
total of $1,042,800.
Gross accounts receivable decreased approximately $581,000 or 6.9%
-14-
<PAGE>
from December 31, 1997 to September 30, 1998, compared to a 14.7% decrease in
gross revenue for the quarter ended September 30, 1998 compared to the quarter
ended December 31, 1997. Bad debt expense for the nine months ended September
30, 1998 was 1.7% of revenue.
The Company has been able to finance its growth to date with limited equity
capital, which has been sufficient for current needs. The Company's plans for
continued growth includes both internal growth and potential acquisition of
other long distance companies. In order to achieve the Company's plans for
growth in the long distance business as well as its entry into the local
exchange arena, the Company may require additional equity and is currently
seeking sources of funding. The Company cannot give assurance as to the
potential success of these efforts. However, the Company's improvement in cash
and working capital position should provide the Company with better funding
alternatives than it has had in the past.
YEAR 2000
Many computers and computer applications define dates by the last two digits of
the year, and as such may not be able to accurately calculate, store, use or
identify a date after December 31, 1999. This could result in major system
errors that could adversely affect the Company's operation. This Year 2000 issue
might also adversely affect the systems of the Company's customers, vendors or
resellers.
The Company has initiated a project to identify and address the Year 2000 issue
and is addressing the most critical needs first. The Company has completed an
inventory of its computer systems, network elements, software applications and
other office systems. The preliminary results indicated that the Company would
be required to replace its long distance switch located in Philadelphia. The
Company has recently purchased a new DSC DEX600 switch, which is Year 2000
compliant, to replace its existing switch in Philadelphia. The Company
anticipates that the new switch will be installed by the end of the first
quarter of 1999. Although the original Philadelphia switch required replacement
as a result of Year 2000 compliance issues, the Company also needed to replace
the switch due to its inability to support any significant growth. The total
estimated cost of replacing the switch will be approximately $1.9 million.
The Company has identified all vendors that the Company interacts with
electronically or otherwise relies on in order to conduct business. The Company
is contacting those vendors in order to obtain the appropriate assurances that
those third parties are or will be Year 2000 compliant. As of this writing, the
Company has requested Year 2000 compliance status from 154 vendor/suppliers and
has received 47 responses that have indicated that they are indeed Year 2000
compliant or would be compliant by December 31, 1999. The Company continues to
monitor these returns and will make assessments as to their relative impact on
the Company's systems. If compliance is not achieved in a timely manner by the
Company or any significant related third party, the Year 2000 issue could have a
material adverse effect on the Company's operations.
The Company plans to develop and, if necessary, implement contingency plans to
minimize the effects of any significant Year 2000 noncompliance. For instance,
on the telecommunications network side, these contingency plans would include,
but would not be limited to, directing terminating traffic away from a long
distance carrier who did not give the Company adequate assurances of their being
Year 2000 compliant. Traffic would then be transferred to a carrier of which
the Company had received adequate assurances.
On the data network side, information would be compiled and transferred manually
to firms that were unable to accept data electronically because of
noncompliance. The Company currently has these manual alternative procedures in
place. The cost of all such plans cannot be assessed at this time but are not
expected to have a material adverse financial impact on the Company. However,
these and any other plans may not be adequate and any additional significant
expenditures could have a material adverse affect on the Company.
-15-
<PAGE>
Item 3.
- - -------
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
-16-
<PAGE>
PART II
=======
OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of pending legal proceedings, see Note 4 to the
Consolidated Financial Statements contained in this filing, which
Note 4 is incorporated by reference into this Item 1.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. 27, Financial Data Schedule
(b) Reports on Form 8-K
On September 1, 1998, the Company filed Form 8-K (Item 5)
regarding the severance agreement for Stephen Parker, former
President and Director of the Company, as well as the buyback
of 869,000 of Mr. Parker's restricted shares of common stock
into Treasury.
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
US WATS, Inc.
(Registrant)
By: /s/ Michael McAnulty
----------------------
MICHAEL McANULTY
Chief Financial Officer
Dated: November 16, 1998
-18-
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