<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, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission File Number: 0-22944
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)
2 Greenwood Square, 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)
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 November 15, 1999
------------ -----------------
$.001 20,551,944
<PAGE>
US WATS, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page(s)
PART I -------
======
<S> <C>
FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 1999 (unaudited) and December 31, 1998 3 - 4
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 1999 and 1998 (unaudited) 5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1999 and 1998 (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
Item 1. Legal Proceedings
Item 2. Changes in Securities and use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE PAGE 17
</TABLE>
<PAGE>
PART I
======
FINANCIAL INFORMATION
Item 1.
- -------
Financial Statements
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
Assets 1999 (unaudited) 1998
- ------ ================ ============
<S> <C> <C>
Current Assets
Cash and cash equivalents $2,493,356 $1,665,485
Accounts receivable, net of allowance for
doubtful accounts of $1,499,947 for 1999,
and $934,624 for 1998 6,317,663 6,165,896
Prepaid expenses and other 162,922 166,977
----------- -----------
Total Current Assets 8,973,941 7,998,358
----------- -----------
Property and Equipment
Telecommunications equipment 4,106,842 5,031,047
Equipment 1,805,851 1,690,490
Software 655,422 652,422
Office furniture and fixtures 161,282 157,006
Leasehold improvements 668,820 46,671
----------- -----------
7,398,217 7,577,636
Less accumulated depreciation and amortization 4,239,949 4,708,113
----------- -----------
Total Property and Equipment, net 3,158,268 2,869,523
----------- -----------
Other assets, net 343,895 153,583
----------- -----------
$12,476,104 $11,021,464
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
-3-
<PAGE>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 (unaudited) 1998
---------------- ------------
<S> <C> <C>
Liabilities and Shareholders' Equity
------------------------------------
Current Liabilities
Note payable $ 1,553,783 $ 1,121,341
Capital lease obligations, current portion 194,080 226,968
Accounts payable 5,242,216 4,372,548
Accrued commissions 863,055 891,318
Accrued expenses and other 1,141,000 790,699
State and Federal taxes payable 1,070,053 961,731
Deferred revenue -- 2,887
----------- -----------
Total Current Liabilities 10,064,187 8,367,492
Long-Term Liabilities
Capital lease obligations, net of current portion 13,585 149,792
----------- -----------
Commitments and Contingencies
Redeemable preferred stock, $.01 par, authorized
150,000 shares; 0 shares issued and
outstanding in 1999 and 30,000 in 1998
Redemption value: $11.00 per share -- 330,000
----------- -----------
Common Shareholders' Equity
Common stock, $.001 par, authorized
30,000,000 shares; issued:
20,770,944 shares in 1999
20,077,144 shares in 1998 20,771 20,077
Additional paid-in capital 11,921,348 9,514,075
Accumulated deficit (9,543,568) (7,358,853)
----------- -----------
2,398,551 2,175,299
Common stock held in treasury
(219,000 shares in 1999 and 1,119,000 in 1998), at cost (219) (1,119)
----------- -----------
Total Equity 2,398,332 2,174,180
----------- -----------
$12,476,104 $11,021,464
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated 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,
-------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $10,827,823 $11,228,935 $30,250,139 $ 34,944,836
Cost of sales 7,679,851 7,912,957 21,272,411 25,066,972
----------- ----------- ----------- ------------
Gross profit 3,147,972 3,315,978 8,977,728 9,877,864
Selling, general and administrative expenses 3,872,808 3,957,255 11,117,349 10,816,001
----------- ----------- ----------- ------------
(Loss) from operations (724,836) (641,277) (2,139,621) (938,137)
Other income (expense)
Interest income 34,791 68,693 103,371 126,861
Interest expense (45,503) (52,479) (134,965) (176,612)
----------- ----------- ----------- ------------
(Loss) before income taxes (735,548) (625,063) (2,171,215) (987,888)
Income tax expense 0 0 0 0
----------- ----------- ----------- ------------
Net loss (735,548) (625,063) (2,171,215) (987,888)
Preferred dividends 0 6,750 13,500 20,250
----------- ----------- ----------- ------------
Net loss available to common shareholders $ (735,548) $ (631,813) $(2,184,715) $(1,008,138)
=========== =========== =========== ============
Net loss per share available
to common shareholders (.04) $ (.03) $ (.11) $ (.05)
=========== =========== =========== ============
Weighted average number of shares outstanding 20,390,496 19,701,677 19,819,088 18,978,022
=========== =========== =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
-5-
<PAGE>
US WATS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999 1998
--------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss before preferred dividends $ (2,171,215) $ (987,888)
Adjustments to reconcile net (loss)
to net cash provided by (used-in) operating activities
Issuance of stock options 20,807
Depreciation and amortization 826,884 964,502
Provision for bad debts 1,152,275 583,343
Changes in assets and liabilities which provided
(used) cash:
Accounts receivable (1,304,042) (486,002)
Prepaid expenses and other 4,055 (32,401)
Other assets 57,656 (39,794)
Deferred revenue (2,887) (25,071)
Accounts payable and accrued expenses 1,191,701 (1,264,198)
State and Federal Taxes payable 108,322 (217,836)
---------------- ----------------
Net cash used in operating activities (116,444) (1,505,345)
---------------- ----------------
INVESTING ACTIVITIES
Purchase of property and equipment (1,101,099) (109,093)
---------------- ----------------
Net cash used in investing activities (1,101,099) (109,093)
FINANCING ACTIVITIES
Proceeds from private placement 1,530,000
Proceeds from stock option exercises 265,567 2,663,109
Increase in notes payable net 432,442 29,781
Repayment of capital lease obligations (169,095) (208,197)
Preferred stock dividends (13,500) (20,250)
Buyback of common stock -- (1,042,800)
Short swing profit proceeds -- 2,480,979
---------------- ----------------
Net cash provided by financing activities 2,045,414 3,902,622
---------------- ----------------
Net increase in cash 827,871 2,288,184
Beginning cash and cash equivalents 1,665,485 1,588,267
---------------- ----------------
Ending cash and cash equivalents $ 2,493,356 $ 3,876,451
================ ================
</TABLE>
Supplemental disclosure of non cash investing and financing activities:
On July 1, 1999 the preferred shareholder converted 30,000 shares of preferred
stock into 300,000 shares of common stock. Also, on August 31, 1999 the Company
acquired certain assets of JMR Marketing Corporation in exchange for 150,000
shares of the Company's common stock with a fair market value of $262,500 based
on the closing price of the Company's stock as of the date of the acquisition.
The accompanying notes are an integral part of these consolidated 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 and California (on-net areas). Approximately 85% 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. Substantially all of the Company's revenues are earned from
its customers located on the East Coast.
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
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 and nine months ended
September 30, 1999 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, 1998.
-7-
<PAGE>
2. Summary of Significant Accounting Policies
- ----------------------------------------------
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its four wholly-owned subsidiaries, USW Corporation, USW Enterprises, Inc.,
Carriers Group Inc., and US Wats of Virginia Inc. after elimination of all
inter-company accounts, transactions and profits.
Business Segments
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This statement establishes standards for
the reporting of information about operating segments on an annual basis and is
effective for fiscal years beginning after December 15, 1997. The Company's
operations have been aggregated into a single reportable segment, as permitted
under SFAS No. 131, since management has chosen not to organize the Company
around products and services, geographic areas, regulatory environments,
economic characteristics, or types of customers.
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 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.
-8-
<PAGE>
Marketing
All costs related to marketing and advertising the Company's products and
services are expensed in the period incurred.
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, 1999 and 1998, 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: 1999 1998
--------------------------------
<S> <C> <C>
Stock Options 486,705 812,488
Stock Warrants 0 227,446
Cumulative, Convertible, Redeemable Preferred Stock 198,901 300,000
-------- ---------
685,606 1,339,934
======== =========
</TABLE>
-9-
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30,
1999 1998
Potential Common Shares resulting from: -----------------------------------
<S> <C> <C>
Stock Options 423,125 689,641
Stock Warrants 0 0
Cumulative, Convertible, Redeemable Preferred Stock 0 300,000
423,125 989,641
======== =========
</TABLE>
On July 1, 1999 the preferred shareholder converted 30,000 shares of preferred
stock into 300,000 shares of common stock.
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.
Acquisition
On August 31, 1999 the Company acquired certain assets of JMR Marketing
Corporation in exchange for 150,000 shares of the Company's common stock with a
fair market value of $262,500. The acquisition of JMR Marketing Corporation was
accounted for by the purchase method, and accordingly, the cost of the
acquisition was allocated to the assets acquired. The excess fair value of net
assets acquired of $256,920 was recorded as goodwill to be amortized on a
straight line basis over three years.
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 such
estimated cash flows are 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 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. The Company adopted this standard in January, 1999, which had no
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.
-10-
<PAGE>
3. Note Payable
- ----------------
In May the Company negotiated the terms of the Loan and Security Agreement with
Century Business Credit Corporation for the renewal of three successive one year
periods beginning on May 11, 1999. Interest for the new term is calculated at
prime plus 2 3/4%. The renewal period includes a revolving $2,000,000 credit
facility 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
1999, 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 duty of good dealing, fraudulent and negligent asserted
faith and fair 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. On June 9,
1999, the court issued its decision and judgment was entered in favor of Mr.
Scully and against the Company and two former officers for the sum of
$626,442.20. The Court denied Mr. Scully's claim for attorneys' fees and
liquidated damages. An additional amount of $376,000 was accrued during the
quarter ended June 30, 1999 to increase the reserve to the full judgment amount
and was recorded in SG&A expenses. The Company has appealed the decision and
maintains that the Court made a number of errors of law and that the Court
applied the wrong measure of damages. Mr. Scully has appealed the judgment as
well.
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. SALES INFORMATION
- ----------------------
Net sales information by the Company's product groups for the nine months ended
September 30 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
Amount % Amount %
------ ------
<S> <C> <C> <C> <C>
Domestic 1+ $14,471,647 48 $15,655,964 45
International 6,517,605 22 8,934,981 25
Inbound 5,308,969 17 5,192,361 15
Wireless 838,586 3 1,347,218 4
Domestic Carrier Termination 3,113,332 10 3,814,312 11
----------- --- ----------- ---
Total $30,250,139 100% $34,944,836 100%
=========== === =========== ===
</TABLE>
-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, 1999 decreased
approximately $401,000 (4%) from the level recorded for the quarter ended
September 30, 1998, however increased by approximately $591,000 (6%) over the
quarter ended June 30, 1999. The increase in revenue was due to substantial
increases in the Company's wholesale sales channels, mostly carrier sales.
Three months ended September 30, 1999 as compared with Three months ended
- -------------------------------------------------------------------------
September 30, 1998
- ------------------
The Company's total revenue for the quarter ended September 30, 1999 decreased
by approximately $401,000 over the third quarter ended September 30, 1998, or
4%. This decrease was primarily due to a decrease in the Company's revenue
derived from retail sales through the agent and reseller channels of
approximately $255,000 (64%). This was primarily due to decreased selling rates
as a result of strong competition in the marketplace. Competitive pressures
resulted in a decline in the Company's average retail rate per minute from $.124
for the three months ended September 30, 1998 to $.099 for the three months
ended September 30, 1999. In addition, approximately $124,000 (31%) of the
revenue decrease was due to a decline in international callback revenue. This
revenue decrease was attributed to the Company's decision to gradually exit the
International Callback business. This decision was based primarily on the
telecommunication deregulation in European and Asian countries. As pricing for
long distance services decreases in these areas, the international callback
business as a whole is diminishing. Finally, approximately $22,000 (5%) of the
revenue decrease is due a decline from the carrier channel (sales to other
carrier customers).
For the quarter ended September 30, 1999, gross profit as a percentage of
revenue remained relatively unchanged at approximately 29.1% as compared to
29.5% for the quarter ended September 30, 1998. The Company's gross profit for
the quarter ended September 30, 1999, decreased approximately $168,000 over the
third quarter ended September 30, 1998, primarily due to the decrease in revenue
as noted above.
-12-
<PAGE>
The minimal effect on the gross profit percentage despite a decrease in gross
profit is due to the Company's continued benefit from the negotiated cost
decreases from significant off-net vendors. As an example, the Company lowered
the cost of certain underlying facilities by $45,000 per month, which was
realized in the quarter ended September 30, 1999. The Company is continually
striving to improve its network efficiency in order to reduce its network cost
per minute as the market conditions require retail rates per minute to be
reduced.
Selling, General, and Administrative ("SG&A") expenses for the quarter ended
September 30, 1999 decreased approximately $84,000 (2%) over the amount for the
quarter ended September 30, 1998. Of this decrease, approximately $103,000 was
attributed to lower commission expense as a result of lower revenues. In
addition, approximately $296,000 is due to lower salaries. In the quarter ended
September 30, 1998, salary expense of approximately $300,000 represented
severance paid to the Company's former President upon his retirement. Also,
depreciation expense decreased approximately $285,000 primarily due to
accelerated depreciation in 1998 on certain equipment, which was since replaced.
The remainder of the decrease in SG&A expenses is attributed to a variety of
miscellaneous expenses. These decreases were offset by an increase in bad debt
expense of approximately $814,000, primarily due to a writeoff of a large
carrier account. As a result of potential bankruptcy from a large carrier
customer, the Company increased allowance for doubtful accounts for the
potential uncollectable account. SG&A expense as a percentage of
revenue increased from 35.2% during the quarter ended September 30, 1998 to
35.8% for the quarter ended September 30, 1999.
For the quarter ended September 30, 1999, interest expense incurred by the
Company decreased by approximately $7,000 from the quarter ended September 30,
1998. This decrease was due to a decrease in long-term debt during the quarter
ended September 30, 1999.
The Company recorded a net loss before preferred dividends for the quarter ended
September 30, 1999 of approximately $736,000 as compared to a net loss $625,000
for the quarter ended September 30, 1998, an increase of approximately $111,000.
As a result of gross profit as a percentage of revenues remaining relatively the
same, the net loss reported for the quarter ended September 30, 1999 is
primarily due to the bad debt expense associated with a large carrier account.
Nine Months ended September 30, 1999 as compared with Nine Months ended
- -----------------------------------------------------------------------
September 30, 1998
- ------------------
The Company's overall revenue for the nine months ended September 30, 1999
decreased approximately $4,695,000 over the nine months ended September 30,
1998, or 13%. This decrease was primarily due to a decrease in revenue from the
agent and reseller sales channels of approximately $2,062,000 (44%). This was
primarily attributed to decreasing selling rates as a result of strong
competition in the marketplace. Competitive pressures resulted in a decline in
the Company's average retail rate per minute of $.024 from the nine months ended
September 30, 1998 to the nine months ended September 30, 1999. Also,
approximately $1,674,000 (36%) of the decrease was due to a decline in revenue
from the carrier sales channel. In addition, approximately $959,000 (20%) of the
decrease was due to a decline in international callback revenue for reasons
noted above.
The Company's gross profit for the nine months ended September 30, 1999
decreased approximately $900,000 (9%) over the nine months ended September 30,
1998, due the decrease in revenues as noted above. However, the Company's gross
profit margin increased from 28.3% for the nine months ended September 30, 1998
to 29.7% for the nine months ended September 30, 1999. Management has been able
to negotiate lower costs from significant off-net vendors and anticipates this
trend to continue going forward.
-13-
<PAGE>
SG&A expenses for the nine months ended September 30, 1999 were approximately
$301,000 higher than the amount incurred for the nine months ended September 30,
1998. Of this increase, $105,000 was attributed to higher commission expense.
Also, bad debt expense increased by approximately $569,000, which was primarily
due to a writeoff of a large carrier account as previously discussed. These
increases were offset by a decrease in salary expense of approximately $244,000,
and a decrease in depreciation expense of approximately $138,000 with the
remainder attributable to a variety of miscellaneous expenses. SG&A expenses for
the nine months ended September 30, 1999 were 36.8% of revenue, compared to
31.0% of revenue for the nine months ended September 30, 1998. This increase was
primarily attributed to the increase in bad debt expense as well as the decrease
in revenues.
For the nine months ended September 30, 1999, interest expense incurred by the
Company decreased by approximately $42,000 from the nine months ended September
30, 1998. This decrease was due to a decrease in long-term debt and more
favorable interest rates during 1999.
The Company recorded a net loss for the nine months ended September 30, 1999 of
approximately $2,171,000, compared to a net loss of approximately $988,000 for
the nine months ended September 30, 1998, an increase of approximately
$1,183,000. This increase was primarily due to the increase in bad debt expense
as well as an increase in the legal accrual necessary for a lawsuit judgment
(see footnote 4) of approximately $376,000, which was recorded in the second
quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, cash and cash equivalents were approximately $2,493,000.
Cash flow used in operations in the first nine months of 1999 was approximately
$116,000. Net cash used in investing activities was approximately $1,101,000,
which was used for the purchase of property and equipment.
Working capital at September 30, 1999, was approximately $(1,090,000) as
compared to $(369,000) at approximately December 31, 1998. The decrease in
working capital was primarily due to the year to date net loss.
The Company's working capital ratio (current assets divided by current
liabilities) decreased from 0.96:1.00 at December 31, 1998 to 0.89:1.00 at
September 30, 1999. The Company's cash balance increased approximately $828,000
from its balance at December 31, 1998. This was attributed to a private
placement of common stock in the amount of $1,530,000 and an increase in note
payable of approximately $432,000, offset by an increase in property and
equipment of approximately $1,101,000, mainly due to the leasehold improvements
and installation of the new switch in Philadelphia.
The Company has a revolving $2,000,000 credit facility with Century Business
Credit Corporation, which was renewed for three successive one year periods
beginning on May 11, 1999. Interest on the revolving credit facility is
currently calculated at the prime lending rate plus 2 3/4%, on a minimum loan
balance of $750,000. The loan is collateralized by accounts receivable and fixed
and intangible assets of the Company. As of September 30, 1999, the Company's
outstanding balance on its credit facility was approximately $1,554,000, leaving
approximately $446,000 available for future borrowing under the credit facility.
Management will focus on obtaining additional financing or possibly raising
additional equity through private placement, in order to support future growth.
The Company's plans for growth include 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
-14-
<PAGE>
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.
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 had 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 Company purchased a new DSC DEX600 switch, which is
Year 2000 compliant, to replace the existing switch in Philadelphia. The switch
was installed and began supporting operations in the third quarter of 1999. The
total cost of replacing the switch was approximately $2.0 million.
The Company has identified all vendors that the Company interacts with
electronically or otherwise relies on in order to conduct business. The Company
has contacted a majority of the vendors in order to obtain the appropriate
assurances that those third parties are or will be Year 2000 compliant. The
Company is monitoring those returns and continues to 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 is developing and, if necessary, will implement contingency plans to
minimize the effects of any significant Year 2000 noncompliance. On the
telecommunications network side, these contingency plans would include, but not
be limited to, immediately directing terminating traffic away from a long
distance carrier who was not Year 2000 compliant. Traffic would then be
transferred to different carriers with potentially higher rates to desired
locations for an undetermined period of time. This could have a material adverse
effect on the Company's results and operations and liquidity.
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 contingency plans, if they are required to be
implemented, cannot be assessed at this time but are 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 effect on the Company's results of operations and liquidity.
Item 3
- ------
Quantitative and Qualitative Disclosure About Market Risk
Not applicable.
-15-
<PAGE>
PART II
=======
Other Information
Item 1. Legal Proceedings
See Note 4 to the Consolidated Financial Statements contained
herein.
Item 2. Changes in Securities
On August 31, 1999, the Company purchased certain assets of
JMR Marketing Corporation including a customer base, property
and equipment and sales contracts associated with certain
Affinity Groups for 150,000 shares of common stock. The shares
of common stock were issued to James M. Rossi (the sole
shareholder of JMR Marketing Corporation) in reliance on the
exemption from the registration requirements of the Securities
Act of 1933 contained in Section 4(2) of such Act.
On July 1, 1999 a preferred shareholder converted 30,000
shares of preferred stock into 300,000 shares of common stock.
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 16, 1999, the Company filed Form 8-K regarding
the election of James M. Rossi to the Board of Directors,
the approval of an amendment to the By-Laws, whereby the
Company may indemnify a director without court approval in
cases where applicable state law may otherwise have required
court approval, and the amendment and extension of the Loan
and Security Agreement with Century Business Credit
Corporation.
-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: November 15, 1999
-17-
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