<PAGE>
THE 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 June 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)
111 Presidential Boulevard
Bala Cynwyd, Pennsylvania 19004
- ------------------------- -----
(Address of principal executive offices) (Zip Code)
(610) 660-0100
--------------
(Registrant's telephone number, including area code)
Not Applicable
--------------
(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 August 14, 1998
------------ ---------------
$.001 20,009,394
<PAGE>
US WATS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
Page (s)
--------
PART I
======
FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets-
June 30, 1998 (unaudited) and December 31, 1997 3 - 4
Consolidated Statements of Operations-
Three and Six Months Ended June 30, 1998 and 1997 (unaudited) 5
Consolidated Statements of Cash Flows-
Six Months Ended June 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 15
PART II
=======
OTHER INFORMATION 16
SIGNATURE PAGE 17
<PAGE>
PART I
======
Financial Information
ITEM 1.
- ------
Financial Statements
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1998 (unaudited) 1997
---------------- ----
<S> <C> <C>
Assets
------
Current Assets
Cash and cash equivalents $ 5,333,812 1,588,267
Accounts receivable, net of allowance
for doubtful accounts of $1,000,457
for 1998, and $1,498,749 for 1997 6,874,589 6,899,082
Prepaid expenses and other 192,461 108,683
---------- ----------
Total Current Assets 12,400,862 8,596,032
---------- ----------
Property and Equipment
Telecommunications equipment 3,885,300 3,881,857
Equipment 1,623,442 1,579,435
Software 652,422 647,797
Office furniture and fixtures 155,553 155,553
Leasehold improvements 38,932 36,432
---------- ----------
6,355,649 6,301,074
Less accumulated depreciation
and amortization 3,791,898 3,286,435
---------- ----------
Total Property and Equipment, net 2,563,751 3,014,639
---------- ----------
Other assets, principally deposits 228,851 202,804
---------- ----------
$15,193,464 $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
<TABLE>
<CAPTION>
June 30, December 31,
1998 (unaudited) 1997
---------------- ----
<S> <C> <C>
Liabilities and Shareholders' Equity (Deficiency)
-------------------------------------------------
Current Liabilities
Note payable $ 1,023,267 $ 690,826
Capital lease obligations, current portion 259,141 273,095
Accounts payable 6,130,811 6,975,779
Accrued commissions 825,848 943,556
Accrued expenses and other 861,337 1,007,980
State and Federal taxes payable 1,015,620 1,293,417
Deferred revenue 21,999 75,494
---------- ----------
Total Current Liabilities 10,138,023 11,260,147
---------- ----------
Long-Term Liabilities
Capital lease obligations,
net of current portion 255,233 380,260
---------- ----------
Commitments and Contingencies
Redeemable preferred stock, $.01 par,
authorized 150,000 shares,
issued and outstanding:
in 1998, and 30,000 shares 1997
Redemption value: $11.00 per share 330,000 330,000
---------- ----------
Common Shareholders Equity (Deficiency)
Common stock, $.001 par, authorized
Common stock issuable -- 166
30,000,000 shares; issued:
20,009,394 shares in 1998
17,654,100 shares in 1997 20,010 17,654
Additional paid-in capital 10,330,255 5,328,982
Accumulated deficit (5,879,807) (5,503,484)
---------- ----------
4,470,458 (156,682)
Common stock held in treasury
(250,000 shares), at cost (250) (250)
---------- ----------
Total Equity (Deficiency) 4,470,208 (156,932)
---------- ----------
$15,193,464 $11,813,475
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-4-
<PAGE>
US WATS, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $11,844,652 $15,884,285 $23,715,902 $29,391,357
Cost of sales 8,538,178 11,592,457 17,154,015 21,215,269
----------- ----------- ----------- -----------
Gross profit 3,306,474 4,291,828 6,561,886 8,176,088
Selling, general and administrative expenses 3,247,700 4,333,829 6,865,746 8,290,790
----------- ----------- ----------- -----------
Income (loss) from operations 58,774 (42,001) (296,859) (114,702)
Other income (expense)
Interest income 41,237 18,586 58,168 37,671
Interest expense (64,542) (84,215) (124,133) (159,139)
----------- ----------- ----------- -----------
Total other income (expense) (23,305) (65,629) (65,965) (121,468)
Income (loss) before income taxes 35,469 (107,630) (362,824) (236,170)
Income taxes 0 0 0 0
----------- ----------- ----------- -----------
Net income (loss) before preferred dividends 35,469 (107,630) (362,824) (236,170)
Preferred dividends earned 6,750 6,750 13,500 13,500
----------- ----------- ----------- -----------
Net income (loss) available to common
shareholders $ 28,719 $ (114,380) $ (376,324) $ (249,670)
=========== =========== =========== ===========
Earnings per common shares available
to common shareholders $ -- $ (.01) $ (.02) $ (.02)
=========== =========== =========== ===========
Weighted average number of shares 19,479,945 15,927,100 18,610,198 15,924,890
=========== =========== =========== ===========
</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>
Six Months Ended
June 30,
1998 1997
--------- ----------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss before preferred dividends $ (362,824) $ (236,170)
Adjustments to reconcile net income (loss)
to net cash used-in operating activities
Depreciation and amortization 514,211 506,419
Provision for bad debts 472,394 254,998
Changes in assets and liabilities which provided
(used) cash:
Accounts receivable (447,901) (4,093,564)
Prepaid expenses and other (83,778) (11,711)
Other assets (34,794) (5,373)
Deferred revenue (53,495) 1,618
Accounts payable and accrued expenses (1,159,318) 1,707,288
State and Federal Taxes payable (277,797) 151,397
--------- ----------
Net cash used in operating activities (1,433,302) (1,725,098)
--------- ----------
INVESTING ACTIVITIES
Purchase of property and equipment (54,574) (212,033)
--------- ----------
Net cash provided by (used in) investing activities (54,574) (212,033)
--------- ----------
FINANCING ACTIVITIES
Proceeds from stock option exercises 2,572,482 25,000
Increase (decrease) in notes payable net 332,441 1,077,920
Repayment of capital lease obligations (138,981) 74,220
Preferred stock dividend (13,500) (13,500)
Payment of lease acquisition costs -- (40,743)
Short swing profit proceeds 2,480,979 --
--------- ----------
Net cash provided by financing activities 5,233,421 1,122,897
--------- ----------
Net increase (decrease) in cash and cash equivalents 3,745,545 (814,234)
Beginning cash and cash equivalents 1,588,267 1,455,186
--------- ----------
Ending cash and cash equivalents $5,333,812 $ 640,952
========= ==========
</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 111
Presidential Boulevard, Suite 114, Bala Cynwyd, Pennsylvania 19004. The
Company's telephone number at that location is (610) 660-0100.
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
ended June 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
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 six and three months ended June
30, 1998 and 1997, the Company's potential common stock equivalents either have
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>
Six Months Ended June 30,
1998 1997
--------- ---------
<S> <C> <C>
Potential Common Shares resulting from:
Stock Options 725,868 312,722
Stock Warrants 269,827 179,488
Cumulative, Convertible, Redeemable Preferred
Stock 300,000 300,000
--------- ---------
1,295,695 792,210
========= =========
Three Months Ended June 30,
Potential Common Shares resulting from: 1998 1997
--------- ---------
<S> <C> <C>
Stock Options 607,283 209,758
Stock Warrants 0 124,958
Cumulative, Convertible, Redeemable Preferred Stock 300,000 300,000
--------- ---------
907,283 634,716
========= =========
</TABLE>
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.
-9-
<PAGE>
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 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. 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.
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.
Reclassification of Accounts
Certain reclassifications have been made to conform prior years' balances to the
current year presentation.
-10-
<PAGE>
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. 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, Kevin O'Hare, Aaron Brown
and Stephen Parker 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, 1996. 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.
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. CAPITAL CONTRIBUTION
- -------------------------
In April 1998, it was determined that a 10% beneficial owner of the Company was
in violation of the Securities Exchange Act of 1934 Section 16(b). As a result,
the shareholder was required to remit approximately $2,481,000 to the Company.
This amount less $50,000 for associated legal costs has been considered a
contribution to capital, and as such has been recorded as an addition to paid in
capital.
-11-
<PAGE>
ITEM 2.
- ------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
The Company's revenues remained relatively flat over the prior quarter
decreasing by approximately $26,000 (0.2%) from the level recorded for the
quarter ended March 31, 1998, although revenues decreased by approximately
$4,039,000 (25.4%) over the quarter ended June 30, 1997.
THREE MONTHS ENDED JUNE 30, 1998 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1997
- -------------------------------------------------------------------------------
The Company's total revenue for the quarter ended June 30, 1998 decreased
$4,040,000 over the second quarter ended June 30, 1997, or 25.4%.
Approximately $1,975,000 (48.9%) of the decrease was due to a decline in revenue
from the carrier channel. In the quarter ended June 30, 1997, revenue through
the carrier channel consisted of a large amount of high risk international
traffic. Currently, the Company limits the amount of high risk international
traffic in order to reduce exposure.
In addition, approximately $858,000 (21.2%) of the revenue decrease was due to a
decline in international callback revenue. This revenue decrease was attributed
to the Company's decision to discontinue service to two international callback
wholesalers as a result of their operational problems. Also, as a result of
telecommunication deregulation in European and Asian countries, pricing for long
distance services has decreased in these areas. Therefore, the international
callback business as a whole is diminishing. Finally, approximately $1,206,000
(29.9%) of the revenue decrease from the quarter ended June 30, 1997 was due to
a decline in the Company's revenue derived from retail sales through the agent
and reseller channels. Throughout the first quarter of 1998, the Company was
involved with integration plans associated with the proposed merger agreement
with ACC Corp. This had a significant impact on the Company's business, which
carried over to the second quarter, as sales and operating initiatives were
delayed during this period. Since the termination of the merger agreement took
place in March, the Company has issued aggressive pricing to the agents. The
Company has also reinstituted an aggressive agent recruitment program by hiring
three new agent managers to be located in on-net markets. Management believes
these strategies will allow the Company to build the revenue base.
For the quarter ended June 30, 1998, gross profit as a percentage of revenue was
approximately 28% versus 27% for the quarter ended June 30, 1997. The increase
in gross profit margin is attributed to two main factors. First, the Company
experienced a decrease in carrier revenue as a percentage of overall revenue,
decreasing from approximately 31% for the quarter ended June 30, 1997 to
approximately 24% for the quarter ended June 30, 1998. Carrier revenue has
lower gross margins than other revenue streams. Therefore, as a result of this
percentage decrease in carrier revenue to total revenue, the Company's overall
gross margin increased. Also, the Company recently negotiated lower rates from
significant off-net vendors which has benefited gross profit margins.
Management believes this trend will continue going forward. Overall, the
Company's gross profit decreased approximately $985,000, mainly due to the
decrease in revenue as noted above.
-12-
<PAGE>
Selling, General, and Administrative ("SG&A") expenses for the second quarter
ended June 30, 1998 decreased approximately $1,086,000, or 25.1% over the amount
for the second quarter ended June 30, 1997. Of this decrease, $616,000 was
attributed to lower commission expense, $186,000 to lower salary expense,
$50,000 to lower bad debt expense, with the remainder attributable to a variety
of miscellaneous expenses. The decrease in commissions paid to resellers and
agents is a result of the decrease in revenue through these channels. The
decrease in salary expense was a result of a decrease in headcount, including
the termination of high salaried management personnel occurring in the third and
fourth quarters of 1997. The decrease in bad debt expense is a result of lower
revenues as well as the implementation of effective controls for monitoring high
risk traffic. SG&A expense as a percentage of revenue remained relatively
unchanged from 27.3% during the second quarter ended June 30, 1997 to 27.4% for
the second quarter ended June 30, 1998.
For the second quarter ended June 30, 1998, interest expense incurred by the
Company decreased over the second quarter ended June 30, 1997 by approximately
$20,000. This was primarily due to Management's ability to maintain the loan
balance on the line of credit near the minimum required level throughout the
current period as a result of the Company's improved cash position.
The Company recorded a net income before preferred dividends for the quarter
ended June 30, 1998 of approximately $35,000 versus a net loss of approximately
$108,000 for the quarter ended June 30, 1997, an increase of approximately
$143,000. The net income reported in 1998 stems from the achievement of higher
gross margins as a result of a higher percentage of total revenue through the
Company's Agent, Direct Sales, and Reseller sales channels.
During the second quarter of 1998, the Company's recorded net income before
preferred dividends of approximately $35,000 compared favorably with its net
loss of approximately $398,000 for the first quarter ended March 31, 1998, an
increase of approximately $443,000. The increase in operating results from the
first quarter 1998 to the second quarter 1998 is substantially due to improved
overhead efficiencies and increased gross profit from retail core revenue
channels.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997
- ---------------------------------------------------------------------------
The Company's total revenue for the six months ended June 30, 1998 decreased
approximately $5,675,000 over the six months ended June 30, 1997, or 19.3%.
This decrease was primarily due to a decrease in revenue through the carrier
sales channel of approximately $1,869,000 (32.9%). In the six months ended June
30, 1997, revenue through the carrier channel consisted of a large amount of
high-risk international traffic. Currently, the Company limits the amount of
high risk international carrier traffic in order to keep exposure at a minimum.
In addition, approximately $1,604,000 (28.3%) of the revenue decrease was due to
a decrease in international callback revenue. This revenue decrease was due to
the Company's decision to discontinue service to two international callback
wholesalers as a result of their operational problems. Also, as a result of
deregulation in the telecommunications industry in European and Asian countries,
pricing for long distance services has decreased from country to country in
these areas. Therefore, as mentioned above, the international callback product
as a whole is diminishing. Finally, approximately $2,202,000 (38.8%) of the
revenue decrease from the six months ended June 30, 1997 was due to a decline in
revenue derived from retail sales through the agent and reseller channels.
Throughout the timeframe that the Company was engaged in a merger agreement with
ACC Corp., the Company was focusing on 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. Subsequent to the
termination of the merger agreement in March 1998, the Company issued aggressive
pricing to the agents in the second quarter. The Company has also reinstituted
an aggressive
-13-
<PAGE>
agent recruitment program by hiring three new agent managers to be located in
on-net markets. Management believes that these strategies will allow the Company
to grow the revenue base beyond previous levels in the term.
The Company's gross profit for the six months ended June 30, 1998 decreased
approximately $1,614,000 over the six months ended June 30, 1997 or 19.7%.
However, the Company's gross profit margin remained relatively unchanged from
27.8% for the six months ended June 30, 1997 to 27.7% for the six months ended
June 30, 1998. The decrease in gross profit is due to the decrease in revenue
as noted above.
SG&A expenses for the six months ended June 30, 1998 were approximately
$1,425,000 less than the amount incurred for the six months ended June 30, 1997.
Of this decrease, $974,000 was attributed to lower commission expense and
$424,000 was due to lower salary expense. The decrease in commissions paid to
agents and resellers is a result of the decrease in revenue through these
channels. The decrease in salary expense was a result of a decrease in
headcount including the termination of high salaried management personnel
occurring in the third and fourth quarters of 1997. SG&A expense for the six
months ended June 30, 1998 was 28.9% of revenue, compared to SG&A expense for
the six months ended June 30, 1997 of 28.2%.
For the six months ended June 30, 1998, interest expense incurred by the Company
decreased to $124,000 compared to $159,000 during the six months ended June 30,
1997. This was primarily due to the ability to maintain the loan balance on the
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 six months
ended June 30, 1998 of approximately $363,000 versus a net loss of approximately
$236,000 for the six months ended June 30, 1997, an increase of approximately
$127,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital ratio improved during the second quarter ended
June 30, 1998 to 1.22:1.00 from 0.75:1.00 for the first quarter ended March 31,
1998 and from 0.76:1.00 at December 31, 1997. The Company's cash balance
increased approximately $3,746,000 from its balance at December 31, 1997.
Accounts receivable net of allowance for doubtful accounts decreased
approximately .4% from December 31, 1997 to June 30, 1998 versus a 10.0%
decrease in gross revenue for the quarter ended June 30, 1998 compared to the
quarter ended December 31, 1997. Bad debt expense for the six months ended June
30, 1998 was approximately (2%) of revenue.
The Company's cash and equity positions were significantly improved in the
quarter ended June 30, 1998. The Company's Chairman and Chief Executive Officer
each exercised 300,000 stock options and 569,000 warrants for a total of
$2,034,124. In addition, short-swing profits of $2,480,979 were remitted to the
Company as a result of a violation of Section 16(b) of the Securities Exchange
Act of 1934 by a beneficial owner.
In June 1998, as a result of the equity increases mentioned above, the Company
satisfied the NASDAQ requirement of maintaining $2.0 million in equity.
-14-
<PAGE>
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 substantial internal growth and the 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 then it has had in the past.
YEAR 2000
- ---------
The Company is in the preliminary stages of a project to determine the impact of
the Year 2000 issue on the Company's computer systems. The Company is currently
assembling a list of, and analyzing, its internally developed software,
purchased software, hardware, and external data feeds, including switches used
by carriers who terminate the Company's off-net traffic, that utilize embedded
date codes which may experience operational problems when the Year 2000 is
reached. The Company currently plans to complete its analysis by the end of
1998 and will continue to make required modifications to the identified problem
areas through the early part of 1999.
Preliminary results indicated that the Company would be required to replace its
switch located in Philadelphia. The Company has taken delivery of a new DSC
DEX600 switch to replace the existing switch in Philadelphia, which is
anticipated to be installed in the fourth quarter of 1998. The estimated cost of
the new switch is approximately $1.7 million. The total remaining cost of making
the Company "Year 2000 Compliant" cannot be accurately determined at this time.
In addition, the Company currently cannot assess the effect of incomplete or
untimely resolution of Year 2000 issues on its operations.
ITEM 3
- ------
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
-15-
<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.
Item 2. Changes in Securities
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: Financial Data Schedule, Exhibit No. 27.
(b) Reports on Form 8-K: None.
-16-
<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: August 14, 1998
-17-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS SET FORTH IN THIS FORM 10-Q FOR THE SIX MONTHS ENDED JUNE
30, 1998 AND IS QUALIFIED IN ITS ENTIRELY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 5,333,812
<SECURITIES> 0
<RECEIVABLES> 7,875,046
<ALLOWANCES> 1,000,457
<INVENTORY> 0
<CURRENT-ASSETS> 12,400,862
<PP&E> 6,355,649
<DEPRECIATION> 3,791,898
<TOTAL-ASSETS> 15,193,464
<CURRENT-LIABILITIES> 10,138,023
<BONDS> 255,233
330,000
0
<COMMON> 20,010
<OTHER-SE> 4,450,448
<TOTAL-LIABILITY-AND-EQUITY> 15,193,464
<SALES> 0
<TOTAL-REVENUES> 23,715,902
<CGS> 0
<TOTAL-COSTS> 17,154,015
<OTHER-EXPENSES> 6,865,746
<LOSS-PROVISION> 472,394
<INTEREST-EXPENSE> 124,133
<INCOME-PRETAX> (362,824)
<INCOME-TAX> 0
<INCOME-CONTINUING> (362,824)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (362,824)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
