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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10/A
GENERAL FORM FOR REGISTRATION OF SECURITIES
PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
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AMERIVISION COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1378798
(State or other jurisdiction (IRS employer identification
of incorporation or organization) number)
5900 Mosteller Drive, Suite 1800 73112
Oklahoma City, Oklahoma (Zip Code)
(Address of principal
Executive offices)
Registrant's telephone number, including area code: (405) 600-3800
Securities to be registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON
TO BE SO REGISTERED WHICH EACH CLASS IT BE REGISTERED
------------------- ---------------------------------
None
Securities to be registered pursuant to Section 12(g) of the Act:
Title of Class
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Common Voting Stock, $0.10 par value
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TABLE OF CONTENTS
<TABLE>
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ITEM 1. Business....................................................................................... 3
ITEM 2. Financial Information.......................................................................... 15
ITEM 3. Properties..................................................................................... 28
ITEM 4. Security Ownership of Certain Beneficial Owners and Management................................. 28
ITEM 5. Directors and Executive Officers............................................................... 29
ITEM 6. Executive Compensation......................................................................... 31
ITEM 7. Certain Relationships and Related Transactions................................................. 35
ITEM 8. Legal Proceedings.............................................................................. 40
ITEM 9. Market Price of and Dividends on Common Equity and Related Stockholder Matters................. 42
ITEM 10. Recent Sales of Unregistered Securities........................................................ 42
ITEM 11. Description of Company's Securities to be Registered........................................... 42
ITEM 12. Indemnification of Directors and Officers...................................................... 44
ITEM 13. Financial Statements and Supplementary Data.................................................... 44
ITEM 14. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 44
ITEM 15. Financial Statements and Exhibits.............................................................. 44
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ITEM 1. BUSINESS
GENERAL
Amerivision Communications, Inc. (the "Company" or "Amerivision") is a
provider of domestic long distance and other telecommunications services
primarily to residential users. The Company employs a specialized marketing
program known as affinity-based marketing. Under this program, the Company
obtains membership lists from non-profit organizations that support strong
family values, such as Concerned Women For America, Christian Broadcasting
Network, Trinity Broadcasting Network and Christian Coalition, and markets its
services under the LIFELINE(R) service mark to those organizations' members. The
non-profit organizations receive a percentage, currently approximately 10%, of
certain collected revenues generated from their members. In some cases the
organizations will directly contact their members to sell the Company's
services. In return the organizations may receive a flat fee for each new
customer obtained by that organization, in addition to the percentage of
revenues. The Company has experienced substantial success marketing to this
family values affinity largely because its customers, in addition to receiving
essential telecommunications services, are able to indirectly contribute to
causes they strongly support.
Amerivision believes it is one of the largest affinity-based marketing
resellers of telecommunications services to non-profit organizations in the
United States. The Company is affiliated with thousands of non-profit
organizations and as of March 31, 2000 had over 550,000 subscribers for its
telecommunication services in all 50 states. The Company has historically
experienced rapid growth with revenues increasing from $2.9 million in 1993 to
$114.7 million in 1999. The Company does not, however, except its growth to
continue at this rate in the future and has in fact experienced a decline in
growth recently.
MCI WorldCom, Inc. ("MCI WorldCom") primarily carries the Company's long
distance traffic. Although Amerivision has not in the past operated its own long
distance network, effective February 1, 1999 the Company began operating the
switching assets and personnel of Hebron Communications Corporation ("Hebron"),
which includes telecommunications switches in Oklahoma City and Chicago. The
Company purchased the switches in April 2000 under terms of an asset purchase
agreement with Hebron. This purchase allows the Company to originate and
terminate a portion of its long distance calls. See Item 7 below for a
discussion of Hebron and the terms of the transaction with Hebron. In addition
to residential long distance service, the Company also offers its customers
other telecommunications services such as Internet access, paging, calling
cards, prepaid phone cards and toll-free service.
The Company was incorporated in 1991 as an Oklahoma corporation and
maintains its principal executive offices at 5900 Mosteller Drive, Suite 1800,
Oklahoma City, Oklahoma 73112 and its telephone number is (405) 600-3800.
MAJOR DEVELOPMENTS
Several important developments have occurred with respect to the Company and
its business which include:
RESOLUTION OF SECURITIES AND EXCHANGE COMMISSION'S INVESTIGATION. In July
1996, at the request of the Company, the Securities and Exchange Commission (the
"Commission") instituted an investigation into whether the Company and its then
directors and principal officers had violated any federal securities laws. In
July 1998 the Commission issued a cease-and-desist order to the Company, Hebron
and Tracy C. Freeny, at that time President of the Company, and Carl Thompson,
at that time Senior Vice President of the Company with respect to the subject
matter of investigations which concluded the investigation. See Item 8 - "Legal
Proceedings - Investigation by the Securities and Exchange Commission."
ADDITION OF NEW DIRECTORS. In October 1998, three new members of the board
of directors of the Company were elected, bringing a wide range of skills and
experiences to the Company. The new directors are Stephen D. Halliday, a lawyer
and accountant with 20 years of professional experience; Jay A. Sekulow, a
lawyer who is in charge of a nationally-known public interest law firm; and John
B. Damoose, a former executive with a Fortune 500 corporation. See Item 5 -
Directors and Officers.
ADDITION OF NEW OFFICERS AND KEY EMPLOYEES. In October 1998, Stephen D.
Halliday was elected President and Chief Executive Officer of the Company. Prior
to that, Mr. Halliday had been performing various consulting services for the
Company while serving as a partner at Wiley, Rein & Fielding, a leading
telecommunications law firm. In December 1998, five members of
PricewaterhouseCoopers LLP telecommunications consulting practice with,
collectively, over 75 years of experience in the telecommunications industry
joined the Company, including Kerry A. Smith, a Vice President of the Company,
and such persons are very active in the Company's business and operations. In
April 1999, David E. Grose joined the Company as Vice President and Chief
Financial Officer and brings with him over 10 years experience as chief
financial officer of publicly-traded concerns. See Item 5 - Directors and
Officers.
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TERMINATION OF RELATIONSHIP WITH VISIONQUEST MARKETING SERVICES, INC.
Effective January 1, 1999, the Company and VisionQuest Marketing Services, Inc.
("VisionQuest") mutually terminated their business relationship. Until such time
VisionQuest had performed substantially all of the Company's telemarketing
service requirements, but the Company determined it needed to establish a core
telemarketing business, which it has been able to operate on a more
cost-effective basis than through its prior relationship with VisionQuest. See
Item 7 - Certain Relationships and Related Transactions - Transactions with
VisionQuest.
NEW CREDIT FACILITY WITH COAST BUSINESS CREDIT, INC. In February 1999, the
Company entered into a credit facility with Coast Business Credit, Inc. ("Coast
Loan") providing the Company with up to $12.6 million in financing and in May
2000 the Company increased the availability under the credit facility to an
aggregate of $35.0 million. The proceeds of the Coast Loan have been used by the
Company to repay more expensive indebtedness and to pay for necessary capital
improvements and restructuring. In connection with the Coast Loan, Hebron, three
directors of the Company, including Tracy C. Freeny, Chairman of the Board of
the Company, one significant shareholder of the Company and one former
shareholder of the Company all agreed to subordinate all amounts owed to them by
the Company to the Coast Loan.
NEW SUPPLY AGREEMENT WITH MCI WORLDCOM. In April 1999, the Company entered
into a multi-year supply agreement with MCI WorldCom for long distance services.
The Company lowered its costs as a result of the new agreement and resolved
certain billing disputes between the two parties. See Item 1 - Business -
Suppliers.
TRANSACTIONS WITH HEBRON. Effective February 1999, the Company began
operating certain telecommunications switches of Hebron and acquired such
switches in April 2000. The Company also acquired all of Hebron's assets related
to an Internet product it had been jointly developing with the Company. The
closing of the transaction allows the Company to have both switched and
switchless long distance under its full control and to operate both the switches
and the Internet assets on a more effective and cost efficient basis than
through its prior relationship with Hebron. See Item 7 - Certain Relationships
and Related Transactions - Transactions with Hebron.
BUSINESS STRATEGY
The Company's overall strategy is to profitably grow its telecommunications
and other services by further developing the family values affinity. Elements of
the Company's strategy include:
o Building the Company's Brand. Although the Company is a significant
affinity-based marketing company, the Company believes that it is
still relatively unknown in the marketplace. The Company has retained
one of the nation's leading non-profit marketing consulting firms, to
assist the Company in improving its image and brand awareness.
o Expanding its Marketing Efforts and Portfolio of Telecommunications-
Related Services. In 1999 substantially all of the Company's revenues
were derived from the provision of long distance telephone service.
The Company believes that it can grow its revenues by increasing the
marketing of its existing services to the membership of organizations
currently endorsing LifeLine services and offering additional
telecommunications services, such as voicemail, conference calls and
Internet access, and bundling such services with the long distance
telephone service it already provides.
o Providing Cost Competitive Services. The Company continually works to
position its services in a manner, which is cost-competitive with
similar services provided by other telecommunications services
providers. To achieve competitive margins on its telecommunications
services the Company intends to continually review and refine its
operations to achieve operating and cost effectiveness.
o Building a Filtered Family Friendly Internet Access Service. In July
1999, the Company launched a filtered family friendly Internet access
service nationwide and is marketing this service to both its existing
customers and new customers.
o Building a Business-Oriented Product Offering. Historically, the vast
majority of the Company's customers have been residential. The Company
believes that it can expand its customer profile to include small and
medium size businesses. The Company is planning to increase its
marketing efforts to small and medium size businesses by approaching
organizations currently endorsing LifeLine.
o Marketing Non-Telecommunications Products and Services. In light of
the Company's success in marketing telecommunications services to the
family values affinity group, the Company believes that there is a
substantial opportunity
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to market non-telecommunication services to its customer base. For
example, the Company provides a credit card product and is evaluating
additional product opportunities.
INDUSTRY OVERVIEW
LONG DISTANCE
Long distance companies can be categorized in different ways. One
distinction is between facilities-based companies and non-facilities-based
companies, or resellers. Facilities-based companies own transmission facilities,
such as fiber optic cable or digital microwave equipment. Profitability for
facilities-based carriers is dependent not only upon their ability to generate
revenues but also upon their ability to manage complex networking and
transmission costs Non-facilities-based companies, such as the Company, contract
with facilities-based carriers to provide transmission of their customers' long
distance traffic. Pricing in such contracts is typically either on a fixed rate
lease basis or a call volume basis. Profitability for non-facilities based
carriers is based primarily on their ability to generate and retain sufficient
revenue volume to negotiate attractive pricing with one or more facilities-based
carriers.
A second distinction among long distance companies is that of switch-based
versus switchless carriers. Switched carriers have one or more switches,
computers that direct telecommunications traffic in accordance with programmed
instructions. All of the facilities-based carriers are switched carriers, as are
many non-facilities-based companies. Switchless carriers depend on one or more
facilities-based carriers to provide both transmission capacity and switch
facilities. In addition, switchless resellers enjoy the benefit of offering
their service on a nationwide basis, assuming that their underlying carrier has
a nationwide network. As a result of the acquisition of certain assets of
Hebron, the Company operates and owns switches in two markets, Oklahoma City and
Chicago, but will continue to contract with facilities-based carriers to provide
most of its switching services.
Competition in the long distance industry is based primarily upon pricing,
customer service, network quality and value-added services. The success of a
non-facilities-based carrier such as the Company depends almost entirely upon
the amount of traffic that it can commit to the underlying carrier; the larger
the commitment, the lower the cost of service. Subject to contract restrictions
and customer brand loyalty, resellers like the Company may competitively bid
their traffic among other national long distance carriers to gain improvement in
the cost of service. The non-facilities-based carrier devotes its resources
entirely to marketing, operations and customer service, deferring many of the
costs of network maintenance and management to the underlying carrier.
The relationship between resellers and the major underlying carriers is
predicated primarily upon the pricing strategies of the first-tier companies,
which has resulted historically in higher rates for individuals and small
business customers. Individuals and small business customers do not generate
enough volume to receive reduced rates. The higher rates result from the higher
cost of credit, collection, billing and customer service per revenue dollar
associated with small billing level long distance customers. By committing to
large volumes of traffic, the reseller is guaranteeing traffic to the underlying
carrier. The underlying carrier is also relieved of the administrative burden of
qualifying and servicing large numbers of relatively small accounts. The
successful reseller efficiently markets the long distance product, processes
orders, verifies credit and provides customer service to these large numbers of
small accounts.
INTERNET ACCESS SERVICES
Internet access and related value-added services ("Internet services")
represent one of the fastest growing segments of the telecommunications
marketplace. Declining prices in the personal computer market, continuing
improvements in Internet connectivity, advancements in Internet navigation
technology, and the proliferation of services, applications, information and
other content on the Internet have attracted a rapidly growing number of users.
PRODUCTS AND SERVICES
In 1999, the Company's revenues were substantially all from long distance
sales, however, as discussed below, other products are entering the sales cycle.
TELECOMMUNICATIONS SERVICES.
Long Distance. The Company provides long distance service to over 550,000
subscribers, as of March 31, 2000 most of whom are residential. In addition, the
Company offers calling cards, prepaid phone cards, and toll-free service. For
these services, the Company
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offers pricing on a competitive basis (including discounted rates for higher
volume) with the larger long distance companies. The Company also intends to
offer additional services such as audio conferencing, voice mail and caller ID.
Wireless. The Company resells the paging services of Paging Networks, Inc.,
the largest provider of paging service in the U.S. Local, regional and national
paging service is offered on an alpha and numeric basis. The Company is also
exploring offering wireless telephone service by reselling the services of a
national wireless provider.
Internet Access. In July 1999, the Company began offering Internet access
services nationwide. The Company's Internet access service, marketed as
"ifriendly.com," has been designed for the Company's affinity group customer
base so that its subscribers will not, subject to certain limitations inherent
to the filtering technology, be able to access "offensive" materials on the
Internet.
NON-TELECOMMUNICATIONS SERVICES.
In light of the Company's success in marketing telecommunications services
to the family values affinity group, the Company believes that there is a
substantial opportunity to market non-telecommunication services to its customer
base. The Company has entered into an agreement to issue a branded credit card
through First National Bank of Omaha ("FNBO") based in Omaha, Nebraska. The
Company believes that the pricing and terms to be offered to its participating
organizations will be competitive with major credit card providers.
MARKETING AND SALES
The Company primarily markets its telecommunications services utilizing the
family values affinity. To obtain new customers, the Company uses sales
executives, telemarketing and various promotional efforts including direct mail,
radio, television, convention advertising and the Internet.
Some of the sales executives expend the majority of their efforts obtaining
new non-profit organizations who will endorse LifeLine services and maintaining
existing relationships. The other sales executives principally seek to expand
the number of members of existing non-profit organizations who endorse LifeLine
services as well as sell additional services to and seek to improve the
retention rate of existing subscribers. Prior to 1999, sales executives were
compensated based on a percentage of sales revenue collected. Although some
commission agreements remain in place, effective January 1, 1999, subject to
certain transition arrangements, sales executives are generally compensated with
a base salary and the opportunity to earn bonuses based on their individual
performance.
Once membership lists of non-profit organizations have been obtained, the
Company generally contacts members and solicits their telecommunications
services through direct mail or telemarketing. The Company works with the
organizations in its direct mail efforts, often placing advertising in
newsletters or inserting brochures about the Company in the organizations'
mailings. The Company will also use its telemarketing resources to contact
members of participating organizations. The Company's telemarketing efforts are
also scripted towards affinities of members of a particular organization. The
Company operates a call center in Tahlequah, Oklahoma and, as of March 31, 2000,
the call center had an aggregate of 350 full and part time employees who operate
over 250 call stations. The Company advertises its services through television
and radio programs, which target viewers and listeners who support the family
values affinity, including Christian radio and television networks. The Company
participates in conferences and conventions sponsored by organizations endorsing
LifeLine services. Prior to those events, the Company will either advertise in
materials being sent or send materials to persons attending the event in order
to increase awareness of the telecommunications services the Company offers. At
the actual events, the Company will set up booths or make presentations
regarding its telecommunications services and have personnel on site to explain
the services and assist in enrolling customers.
The Company has also recently begun capitalizing upon the marketing
opportunities created through the Internet. On some websites of participating
organizations, the Company's services are promoted or a link to the Company's
website is provided. The Company is investigating other ways to expand the
marketing to current and potential customers through the Internet.
The Company believes that due to its affinity program it has an average
retention rate of customers better than industry average. Nonetheless, through
improved customer service, competitive rate plans and additional services the
Company is striving to further improve its retention rate. The Company believes
that significant growth may be obtained through the above efforts as well as
expanded marketing initiatives.
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SUPPLIERS
In April 1999, the Company executed a new contract with MCI WorldCom for
provision of the Company's long distance traffic. The contract has certain
monthly minimum volume commitments and the Company must direct all of its
switchless long distance traffic to MCI WorldCom. The Company also received a
credit and was released of any prior liability to MCI WorldCom in connection
with the settlement of various billing disputes between the Company and MCI
WorldCom. This contract resulted in a pricing reduction from the prior MCI
WorldCom billing rates charged to the Company and additional reductions have
been subsequently negotiated.
COMPETITION
OVERVIEW. The telecommunications services industry is highly competitive,
rapidly evolving and subject to constant technological change. While the Company
believes it is one of the largest affinity-based marketing reseller of
telecommunications services to organizations advocating family values in the
United States, there are numerous companies offering the services the Company
offers, and the Company expects competition to increase in the future. The
Company believes that existing competitors are likely to continue to expand
their service offerings and/or lower their prices to appeal to existing or
potential customers of the Company. Many of the Company's existing competitors
have financial, personnel and other resources, including brand name recognition,
substantially greater than that of the Company. Moreover, the Company expects
that new competitors are likely to enter the communications market, and some of
these new competitors may market communications services similar to the
Company's services. Some of these new competitors may have financial, personnel
and other resources, including brand name recognition, substantially greater
than those of the Company. In particular, the regional Bell operating companies
("RBOCs") will be strong competitors once they are allowed to provide long
distance services in their in-region markets. In addition, AT&T has recently
purchased the cable company TeleCommunications, Inc. and has received regulatory
approval to purchase another cable company, MediaOne Group Inc. AT&T intends to
use these cable facilities and those of other cable companies with which it has
signed agreements to offer local telephony, long distance, Internet, and other
services to customers in competition with incumbent local exchange carriers and
other competitive local exchange carriers ("CLECs").
In addition, the regulatory environment in which the Company operates is
undergoing significant change. As this regulatory environment evolves, changes
may occur which could create greater or unique competitive advantages for all or
some of the Company's current or potential competitors, or could make it easier
for additional parties to provide services similar to those offered by the
Company.
LONG DISTANCE. The Company provides long distance services by reselling the
facilities of other carriers in the United States. The long distance industry is
intensely competitive and significantly influenced by the marketing and pricing
decisions of the larger industry participants such as AT&T, Sprint and MCI
WorldCom. Moreover, the industry has undergone and will continue to undergo
significant consolidation that has created and will continue to create numerous
other entities with substantial resources to compete for long distance business,
such as Excel Communications, Inc., Frontier and Qwest. In addition, as a result
of the Telecommunications Act of 1996 ("Telecommunications Act"), RBOCs will
soon be able to enter the long distance market. These larger competitors have
significantly greater name recognition and financial, technical, network and
marketing resources. They may also offer a broader portfolio of services and
have longer standing relationships with customers targeted by the Company.
Moreover, there can be no assurance that certain of the Company's competitors
will not be better situated to negotiate contracts with suppliers of
telecommunications services which are more favorable than contracts negotiated
by the Company. Many of the Company's competitors enjoy economies of scale that
can result in a lower cost structure for transmission and related termination
costs, and which could cause significant pricing pressures on the Company.
The Company competes in the long distance market primarily on the basis of
price, customer service and the ability to provide a variety of communications
products and services. Customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. Prices for long distance calls have declined in recent years and
are likely to continue to decrease. Competition in all of the relevant markets
is expected to increase which could adversely affect net revenue per minute and
gross margins as a percentage of net revenue. There can be no assurance that the
Company will be able to compete effectively in the long distance market.
INTERNET TELEPHONY. Internet Telephony is the transmission of voice long
distance services over Internet protocols rather than traditional long distance
networks ("IP Telephony"). Certain ISPs have recently announced plans to use IP
Telephony to introduce long distance services at rates 30% to 50% below standard
long distance rates. IP Telephony could increase pressure on the Company and
other communications companies to reduce prices and margins from long distance
services. There can be no assurance that the Company will not experience
substantial decreases in call volume, pricing and/or margins due to IP
Telephony. There can also
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be no assurance that the Company will be able to offer its telecommunications
services to end users at a price which is competitive with the IP Telephony
services offered by these new companies.
INTERNET SERVICE PROVIDER. In July 1999, the Company began providing
Internet access on a nationwide basis and is substantially increasing its
investment in this line of business. The Internet services market is highly
competitive, as there are no substantial barriers to entry, and the Company
expects that competition will continue to intensify. The Company's competitors
in this market include ISPs, other telecommunications companies, online service
providers and Internet software providers. Many of these competitors have
greater financial, technological and marketing resources than those available to
the Company. Internet services are currently deemed enhanced services by the FCC
and therefore are not subject to federal and state common carrier regulations,
including long distance interstate and intra-state access fees. There can be no
assurance that Internet services will not be subject to additional regulation in
the future.
TECHNOLOGICAL ADVANCES. In the future, the Company may be subject to intense
competition due to the development of new technologies resulting in an increased
supply of transmission capacity. The telecommunications industry is experiencing
a period of rapid and significant technological evolution marked by the
introduction of new product and service offerings and increasing satellite
transmission capacity for services similar to those to be provided by the
Company. The introduction of new products or emergence of new technologies may
cause capacity to greatly exceed the demand, reducing the pricing of certain
services to be provided by the Company. There can be no assurance that the
Company's services will satisfy future customer needs, that the Company's
technologies will not become obsolete in light of future technological
developments, or that the Company will not have to make significant additional
capital investments to upgrade or replace its system and equipment. The effect
on the Company's operations of technological changes cannot be predicted and if
the Company is unable to keep pace with advances, it could have a material
adverse effect on the Company.
REGULATION
The terms and conditions under which the Company provides telecommunications
products and services are subject to government regulation. Federal laws and
Federal Communications Commission ("FCC") regulations apply to interstate
telecommunications, while particular state regulatory authorities have
jurisdiction over telecommunications that originate and terminate within the
same state.
DOMESTIC FEDERAL REGULATION. The Company is classified by the FCC as a
non-dominant carrier, and therefore is subject to significantly reduced federal
regulation. After the reclassification of AT&T as a non-dominant carrier in its
provision of domestic services, among domestic carriers only the LECs are
classified as dominant carriers for the provision of interstate access services.
As a consequence, the FCC regulates many of the rates, charges, and services of
the LECs to a greater degree than the Company's. A separate affiliate of an RBOC
complying with certain statutory separation requirements and, once authorized,
offering in-region interstate inter-exchange services is regulated as a
non-dominant carrier. Similarly, a separate affiliate of an independent LEC
offering in-region interstate inter-exchange services is treated as
non-dominant, but the separation requirements it must comply with are less
strict than those applicable to the RBOCs. This non-dominant treatment may make
it easier for the RBOCs to compete directly with the Company for long distance
subscribers. Because AT&T is no longer classified as a dominant carrier, certain
pricing restrictions that formerly applied to AT&T have been eliminated, which
may make it easier for AT&T to compete with the Company for low volume long
distance subscribers.
The FCC generally does not exercise direct oversight over cost justification
and the level of charges for services of non-dominant carriers, such as the
Company, although it has the statutory power to do so. Non-dominant carriers are
required by statute to offer interstate services under rates, terms, and
conditions that are just, reasonable, and not unduly discriminatory. The FCC has
the jurisdiction to act upon complaints filed by third parties or brought on the
FCC's own motion against any common carrier, including non-dominant carriers,
for failure to comply with its statutory obligations. Additionally, the
Telecommunications Act grants explicit authority to the FCC to "forbear" from
regulating any telecommunications services provider in response to a petition
and if the agency determines that the public interest will be served for such
inaction.
The FCC imposes only minimal reporting requirements on non-dominant
carriers, although the Company is subject to certain reporting, accounting, and
record keeping obligations. A number of these requirements are imposed, at least
in part, on all carriers, and others are imposed on carriers such as the Company
whose annual operating revenue exceed $100 million.
Resale carriers, like all other interstate carriers, are also subject to a
variety of miscellaneous regulations that, for instance, govern the
documentation and verifications necessary to change a subscriber's long distance
carrier, limit the use of "800" numbers for pay-per-call services, require
disclosure of certain information if operator assisted services are provided,
and govern interlocking directors
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and management. Other types of FCC regulation may impose costs on the Company,
such as regulatory fees, universal service contribution obligations, North
American Numbering Plan Administration fees, Telecommunications Relay Services
obligations, number portability obligations, Communications Assistance for Law
Enforcement Act obligations, the Universal Service Fund surcharge and the
Primary Interexchange Carrier Charge.
The Telecommunications Act authorizes the RBOCs to provide inter-Local
Access and Transport Area ("LATA") services within their regions only, upon
specific FCC approval. To obtain such approval, an RBOC must demonstrate on a
state-by-state basis that is has satisfied a checklist of interconnection and
other requirements. The Telecommunications Act also provides for certain
safeguards against anticompetitive conduct by the RBOCs in the provision of
inter-LATA service including a requirement for a separate subsidiary and certain
joint marketing limitations.
The Telecommunications Act prohibits carriers from changing a subscriber's
carrier of telephone exchange or toll services except in conformance with the
FCC's verification rules. In addition to other penalties imposed by the
Telecommunications Act and the FCC's rules, a carrier that violates the FCC's
verification rules and collects charges from the subscriber is liable to the
carrier previously authorized by the subscriber for the amount collected. The
FCC has adopted rules implementing these provisions. The FCC's order was
appealed and some of its rules have been stayed, pending final review by the
Court of Appeals.
STATE REGULATION. The Company is subject to varying levels of regulation in
virtually all states. The vast majority of the states require the Company to
apply for certification, which entails proof of technical, managerial and
financial ability to provide intrastate telecommunications services, or at least
to register or to be found exempt from regulation, before commencing intrastate
service. A majority of states also require the Company to file and maintain
detailed tariffs listing their rates for intrastate service. Many states also
impose various reporting requirements and/or require prior approval or notice
for various actions including (i) transfers of control of certified carriers;
(ii) corporate reorganizations; (iii) acquisitions of telecommunications
operations; (iv) assignments of carrier assets, including subscriber bases and
(v) carrier securities offerings. Certificates of authority can generally be
conditioned, modified, canceled, terminated, or revoked by state regulatory
authorities for failure to comply with state law and/or the rules, regulations,
and policies of the state regulatory authorities. Fines and other penalties,
including the return of all monies received for intrastate traffic from
residents of a state, may be imposed for such violations. In addition, several
states have verification rules different from the FCC's regarding changing a
subscriber's authorized carrier.
Currently, the Company can provide originating interstate and intrastate
service to customers in all 50 contiguous states and the District of Columbia.
Of the states in which the Company provides originating service, some state
Public Utilities Commissions ("PUCs") actively assert regulatory oversight over
the services offered by the Company.
Additionally, the rules for each state vary in regard to the authorization
of long distance versus local service. As a result of the Telecommunications
Act, local competition is now allowed in all states. Generally speaking, as the
rules have been modified, the states have either ordered that all certified long
distance carriers now have the authority to provide local services, or
directives have been given for companies to apply for local authority or revise
existing tariffs to comply with state regulations. In those states, which issued
directives for companies to apply for local authority or revise tariffs, the
Company has complied with such orders.
The Company will also be subject to various registration requirements in
connection with the marketing and administration of its credit card business.
The Company continuously monitors regulatory developments in all states in
which it does business in order to ensure regulatory compliance. The Company
believes that it is in compliance in all material respects with the requirements
of federal and state regulatory authorities and maintains contact regularly with
the various regulatory authorities in each jurisdiction.
PROPRIETARY RIGHTS
The Company has obtained a federally registered service mark for the name
LIFELINE for long distance telecommunications services. With the exception of
the LIFELINE(R) service mark, the Company does not own or use in its operations
any other material intellectual property.
INFORMATION SYSTEMS
In August 1998, the Company completed a comprehensive independent review of
its information systems ("Information Systems"). Based on the results of such
review, the Company decided that its current Information Systems, which are
based on FoxPro
9
<PAGE> 10
software, were not sufficient, determining that the current Information Systems
need to be modified and supplemented and new Information Systems need to be
implemented in order for the Company to operate more effectively. To most
efficiently accommodate customer growth and new product offerings, the Company
is pursuing a Windows NT environment with underlying client/server architecture.
This platform will also include a data warehouse with front-end tools to address
financial, operational, and sales and marketing research and reporting. The
costs of the Information Systems improvements are anticipated to be
approximately $3.5 million to $4.0 million. The Company currently anticipates
funding the Information Systems improvements from the Coast Loan, but, if
proceeds from this loan are not available, it may not have sufficient other
capital resources to implement the improvements. There can be no assurances that
the Company will have the capital resources available which are necessary to
implement the improvements or that, if implemented, the improvements will
function effectively. The failure to implement the improvements or if the
improvements are ineffective Information Systems could have a material adverse
effect on the Company.
EMPLOYEES
As of March 31, 2000, the Company had approximately 350 full time employees
and 100 part time and temporary employees. None of the Company's employees is
party to any collective bargaining agreement and the Company has never
experienced a work stoppage. The Company considers its relations with its
employees to be good.
FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS.
There are many factors that affect the Company's business and the results of
its operations, some of which are beyond the control of the Company. The
following is a description of some of the important factors that may cause the
actual results of the Company's operations in future periods to differ
materially from those currently expected or desired.
HISTORY OF LOSSES; POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. Since the
formation of the Company in 1991, the Company incurred losses in each year
through December 31, 1998. Despite realizing net income in 1999, there can be no
assurances that the Company will attain consistent profitability. Also, the
Company is experiencing significant expenditures related to its recent
introduction of Internet access service, its Information Systems improvements
and its reorganization efforts and anticipates these expenditures will continue,
possibly for an extended period of time. See Note J--Financial Condition and
Results Of Operations.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside of the Company's control, including general economic
conditions, specific economic conditions in the telecommunications industry, the
relationships with non-profit organizations, the effects of governmental
regulation and regulatory changes, user demand, capital expenditures and other
costs relating to the expansion of operations, the introduction of new services
by the Company or its competitors, the mix of services sold, pricing changes and
new service introductions by the Company and its competitors and prices charged
by suppliers. For example, revenues decreased 7.6% in 1999 compared to 1998 and
revenues decreased 9.2% for the three months ended March 31, 2000 as compared to
the three months ended March 31, 1999. The Company believes that this decrease
was primarily attributable to its reduced telemarketing efforts, which the
Company has begun to increase, but there can be no assurance that such decline
will not continue in the future. As a strategic response to a changing
competitive environment, the Company may elect from time to time to make certain
pricing, service or marketing decisions that could have a material adverse
effect on the Company.
SUBSTANTIAL INDEBTEDNESS; NEED FOR ADDITIONAL CAPITAL. As of March 31, 2000,
the Company had outstanding indebtedness (excluding current liabilities of $41.9
million) of $11.4 million, total assets of $30.6 million and a working capital
deficit of $24.4 million. Since formation, the Company has experienced
significant cash shortages and has had to raise equity through the sale of
securities and borrow money from various affiliates to fund its operations and
continue as a going concern.
The Company intends:
o to modify its current Information Systems and implement additional
Information Systems to improve the flow of information related to the
operations;
o to incur other capital expenditures and reorganization expenses; and
o to continue to pursue its Internet access service.
The aggregate cost of implementation of these activities are not known at
this time, but may exceed $6.0 million. The Company will need to raise
additional capital from public or private equity or debt sources in order to
finance these costs and its working capital
10
<PAGE> 11
needs, debt service obligations and contemplated capital expenditures. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the Company's then current shareholders would be
reduced. There can be no assurance that the Company will be able to raise such
capital on satisfactory terms or at all. In the event that the Company is unable
to obtain such additional capital or is unable to obtain such additional capital
on acceptable terms, the Company may be required to reduce the scope of its
operations.
LIABILITIES FOR BREACH OF SECURITIES LAWS. Substantially all of the
Company's sales of Common Stock and certain notes, other than sales to officers
and directors of the Company, failed to comply with certain provisions of the
federal and states' securities laws, including compliance with registration
requirements and, possibly, compliance with anti-fraud provisions. The Company
and two of its officers, after voluntarily presenting these facts to the
Securities and Exchange Commission (the "Commission") in July 1996, consented in
July 1998 to the entry of a cease and desist order from the Commission
concerning violations of the federal securities laws. See Item 8 below for a
more detailed description of these proceedings.
The federal securities laws provide legal causes of action against the
Company by persons buying the securities from the Company including action to
rescind the sales. With respect to the offerings described above, the statutes
of limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. All of these sales were made by the
Company more than three years ago.
While certain suits under the federal acts may be barred, similar laws in
many of the states provide similar rights. The Company sold stock to persons in
over forty states, and those states typically provide that a purchaser of
securities in a transaction that fails to comply with the state's securities
laws can rescind the purchase, receiving from the issuing company the purchase
price paid plus an interest factor, frequently 10% per annum from the date of
sales of such securities, less any amounts paid to such security holder. The
statutes of limitations for these rights typically do not begin running until a
purchaser discovers the violation of the law, and therefore in most instances,
and depending on individual circumstances, the statute of limitations do not
appear to limit those rights for most purchasers of securities from the Company.
Also, depending on the law of the state and individual circumstances, monetary
damages and other remedies may be granted for breach of state securities laws.
Accordingly, the Company has a significant, material contingent liability under
state securities laws for those sales of approximately $10.0 million at March
31, 2000.
Additionally, the Company may be liable for rescission or other remedies
under states securities laws to the purchasers of the Hebron common stock
because of the relationships of the two companies, creating an additional
significant, material contingent liability to the Company of approximately $3.2
million at March 31, 2000. While the Company may have liability for rescission
of the sales of the Hebron securities, the holders of Hebron securities will not
have any damages under the rescission rights if Hebron successfully completes
its currently proposed liquidation. See Item 7 below for a description of the
Hebron transaction including its proposed liquidation. If the liquidation is
completed as currently proposed, and the Company pays the notes in full, the
Company anticipates that the Hebron shareholders would receive assets in the
liquidation with a value greater than the value of their rescission rights.
If purchasers of securities of either the Company or Hebron are successful
in asserting any of the above-described claims, it could result in, among other
adverse things, the Company being required to make payments which it may not
have the ability to make without obtaining additional sources of capital and
possibly affect the Company's ability to operate as a going concern.
DEPENDENCE ON RELATIONSHIPS WITH NON-PROFIT ORGANIZATIONS. Substantially all
of the Company's revenues are derived from the members of the non-profit
organizations with which it has relationships. The non-profit organizations
receive a percentage, currently approximately 10%, of certain collected revenues
generated from their members. The Company does not have long term written
agreements with many of these non-profit organizations. Accordingly, a
non-profit organization may have no legal obligation to maintain its
relationship with the Company and there is nothing to ensure that compensation
to the non-profit organizations will remain at current levels. There can be no
assurances that the Company will be able to maintain its relationships with the
non-profit organizations or establish relationships with new non-profit
organizations. If one or more significant non-profit organizations chooses to
sever its relationship with the Company or the rate of compensation to the
non-profit organizations is changed, it could result in, among other adverse
things, the loss of a significant source of revenue or the incurrence of an
unexpected expense, thus lowering profitability and impairing cash flow.
COMPETITION. The telecommunications industry is highly competitive and is
significantly influenced by the marketing and pricing decisions of the larger
industry participants, such as AT&T, MCI WorldCom and Sprint. Many of the
Company's competitors are significantly larger and have substantially greater
financial, technical and marketing resources than the Company. The industry has
relatively insignificant barriers to entry, numerous entities competing for the
same customers and high churn rates (customer
11
<PAGE> 12
turnover), as customers frequently change long distance providers in response to
the offering of lower rates or promotional incentives by competitors. The
Company competes to a large extent on the basis of price and also on the basis
of customer service and its ability to provide a variety of telecommunications
services. The Company expects competition on the basis of price and service
offerings to increase.
In addition to these competitive factors, recent and pending deregulation
may encourage new entrants. For example, as a result of federal legislation
enacted in 1996, after fulfilling certain statutory requirements, RBOCs will be
allowed to enter the long distance market, AT&T, MCI WorldCom and other long
distance carriers are allowed to enter the local telephone services market, and
any entity (including cable television companies and utilities) is allowed to
enter both the local service and long distance telecommunications markets. In
addition, the FCC has reclassified AT&T as a "non-dominant" carrier, which
substantially reduces the regulatory constraints on AT&T.
DEPENDENCE ON MCI WORLDCOM. The Company does not own telecommunications
transmission lines. Accordingly, substantially all telephone calls made by the
Company's customers are transmitted over MCI WorldCom's network under an
agreement with MCI WorldCom which is also a competitor of the Company. The
Company's ability to maintain and expand its business is currently dependent
upon whether the Company continues to maintain a favorable relationship with MCI
WorldCom and whether MCI WorldCom remains a viable supplier to the Company. The
deterioration or termination of the Company's relationship with MCI WorldCom or
MCI WorldCom's failure to remain a viable supplier to the Company could result
in, among other adverse things, the Company being temporarily unable to provide
the majority of its services or unable to provide its services at the current
cost.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant
degree upon the continued contributions of its management team, particularly
Stephen D. Halliday, its President and Chief Executive Officer, and Tracy
Freeny, its Chairman of the Board, and marketing, technical and sales personnel.
The Company's employees may voluntarily terminate their employment with the
Company at any time. Competition for qualified employees and personnel in the
telecommunications industry is intense and, from time to time, there are a
limited number of persons with knowledge of and experience in particular sectors
of the telecommunications industry. The Company's success also will depend on
its ability to attract and retain qualified management, marketing and sales
personnel. The process of locating such personnel with the combination of skills
and attributes required to carry out the Company's strategies is often lengthy.
There can be no assurance that the Company will be successful in attracting and
retaining such personnel. The loss of the services of key personnel, or the
inability to attract additional qualified personnel, could result in, among
other adverse things, a decrease in the Company's financial and operating
performance.
LACK OF RECORDS AND AMBIGUITIES. The Company over the first several years of
its existence did not maintain complete records as to certain of its corporate
activities. The Company, working with its auditors and legal counsel, has
reconstructed certain records including minutes of meetings of its board of
directors relating to the issuance of Common Stock and notes and approval of
other acts and transactions of the Company. These minutes are based on certain
records of the Company and upon affidavits of persons who served as directors
during such earlier periods. To the extent, if any, that such reconstructed
records fail to reflect shares of Common Stock issued and outstanding, dilution
would occur to known existing shareholders. To the extent, if any, notes or
other indebtedness are outstanding but not reflected in current records, the
Company's net worth would be reduced.
Certain records and documents that were maintained by the Company contain
ambiguities, which require interpretations of their meanings and contain
provisions inconsistent with actions of the Company. See for example Note F to
Notes to Consolidated Financial Statements concerning the secured nature of
certain notes of the Company. Where records and documents of the Company are
ambiguous, parties to such documents may interpret those records and documents
in a manner contrary to the Company's interpretations, which could affect the
obligations and rights of the Company in an adverse manner.
POTENTIAL ADVERSE EFFECTS OF REGULATION. The Telecommunications Act provides
specific guidelines under which the RBOCs can provide long distance services,
which will permit the RBOCs to compete with the Company in the provision of
domestic and international long distance services. The legislation also opens
all local service markets to competition from any entity (including, for
example, long distance carriers, such as AT&T, cable television companies and
utilities). Because the legislation opens the Company's markets to additional
competition, particularly from the RBOCs, the Company's ability to compete may
be adversely affected. Moreover, as a result of and to implement the
legislation, certain federal and other governmental regulations will be adopted,
amended or modified, and any such adoption, amendment or modification could
result in, among other adverse things, more competition or increased operating
expense for the Company.
12
<PAGE> 13
The FCC and relevant PUCs have the authority to regulate interstate and
intrastate rates, respectively, ownership of transmission facilities, and the
terms and conditions under which the Company's services are provided. Federal
and state regulations and regulatory trends have had, and in the future are
likely to have, both positive and negative effects on the Company and its
ability to compete. In general, neither the FCC nor the relevant state PUCs
currently regulate the Company's long distance rates or profit levels, but
either or both may do so in the future. A move by the FCC toward lessened
regulation has given AT&T, the largest long distance carrier in the U.S.,
increased pricing flexibility that has permitted it to compete more effectively
with smaller long distance carriers, such as the Company. In addition, the
commitments made by the U.S. government in the recently completed World Trade
Organization negotiations will make it easier for certain foreign-affiliated
carriers to provide service in competition with the Company. There can be no
assurance that changes in current or future Federal or state regulations or
future judicial changes would not have a material adverse effect on the Company.
In order to provide their services, long distance carriers, including the
Company, must generally purchase "access" from LECs to originate calls from and
terminate calls in the local exchange telephone networks. Access charges
presently represent a significant portion of the Company's network costs in all
areas in which it operates. The FCC regulates interstate access charges while
intrastate access charges are regulated by the relevant state PUCs. The FCC is
currently considering how to reform its access charge rules. The access charge
structure ultimately adopted by the FCC could have a material adverse effect on
the Company, particularly if it imposes relatively greater costs on smaller
carriers (such as the Company) compared to larger carriers (such as AT&T and MCI
WorldCom).
The Company currently competes with the RBOCs and other LECs such as GTE in
the provision of "short haul" toll calls completed within a LATA. Subject to a
number of conditions, the Telecommunications Act eliminated many of the
restrictions which prohibited the RBOCs and GTE from providing long-haul, or
local toll service, and thus the Company will face additional competition. To
complete long-haul and short-haul toll calls, the Company must purchase "access"
from the LECs. The Company must generally price its toll services at levels
equal to or below the retail rates established by the LECs for their own
short-haul or long-haul toll services. To the extent that the LECs are able to
reduce the margin between the access costs to the Company and the retail toll
prices charged by LECs, either by increasing access costs or lowering retail
toll rates, or both, the Company will encounter adverse pricing and cost
pressures in competing against LECs in both the short-haul and long-haul toll
markets.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS. The Company has determined that
its current Information Systems are not sufficient. It has determined that the
current Information Systems will need to be modified and supplemented and new
Information Systems will need to be implemented in order for the Company to
operate more effectively. The costs of the Information Systems improvements is
anticipated to be approximately $3.5 to $4.0 million. If the proceeds of the
Coast Loan are not available to fund this cost, the Company may not have
sufficient capital resources to implement the improvements. There can be no
assurances that the Company will have or, if necessary, be able to obtain the
capital resources necessary to implement the improvements or that, if
implemented; the improvements will function effectively. The failure to
implement the improvements or the ineffectiveness of the improvements could
result in, among other adverse things, the Company being unable to obtain and
manage important data and information related to its business and operations.
MINIMUM VOLUME COMMITMENTS AND SHORTFALLS. The Company has entered into a
supply contract with MCI WorldCom for the long distance telecommunication
services provided to its customers. To obtain favorable forward pricing from MCI
WorldCom, the Company has committed to purchase certain minimum volumes of a
variety of long distance services during the term of the contract. There can be
no assurance that the Company will not incur shortfalls in the future or that it
will be able to successfully renegotiate, or otherwise obtain relief from, its
minimum volume commitments in the future. If future shortfalls occur, the
Company may be required to make substantial payments without associated revenue
from customers or MCI WorldCom may terminate service and commence formal action
against the Company. Such payments are not presently contemplated in the
Company's capital budgets and would be difficult to pay and could result in
money being used to make this payment which would have otherwise been used in
other important areas of the Company.
Because of the Company's commitments to purchase fixed volumes of use from
MCI WorldCom at predetermined rates, the Company could be adversely affected if
MCI WorldCom were to lower the rates it makes available to the Company's target
market without a corresponding reduction in the Company's rates. Similarly, the
Company could be adversely affected if MCI WorldCom fails to adjust its overall
pricing, including prices to the Company, in response to price reductions of
other major carriers. MCI WorldCom has agreed to review rates charged to the
Company but the language of the agreement states that MCI WorldCom is not
legally obligated to lower the rates charged to the Company.
CUSTOMER ATTRITION. Customer attrition is a problem inherent in the long
distance industry. The Company believes it experiences customer attrition at
levels less than industry average, nevertheless; the Company's revenue is
adversely affected by
13
<PAGE> 14
customer attrition. The customer attrition experienced by the Company is
attributable to a variety of factors, including the Company's termination of
customers for non-payment and the marketing and sales initiatives of the
Company's competitors such as, among other things, national advertising
campaigns, telemarketing programs and the use of cash or other incentives. There
can be no assurances that this attrition will not increase from current levels.
RAPID TECHNOLOGICAL CHANGE. The telecommunications industry is characterized
by rapidly evolving technology. The Company believes that its success will
increasingly depend on its ability to offer, on a timely basis, new services
based on evolving technologies and industry standards. There can be no assurance
that the Company will have the ability or resources to develop the new services,
that new technologies required for such services will be available to the
Company on favorable terms or that such services and technologies will enjoy
market acceptance. Further, there can be no assurance that the Company's
competitors will not develop products or services that are technologically
superior to those used by the Company or that achieve greater market acceptance.
The development of any such superior technology by the Company's competitors, or
the inability of the Company to successfully respond to such a development,
could render the Company's existing products or services obsolete.
DEPENDENCE UPON INTEGRITY OF CALL DATA RECORDS. The Company depends on the
timeliness and accuracy of call data records provided to it by MCI WorldCom
which supplies the Company with telecommunications services, and there can be no
assurance that accurate information will consistently be provided on a timely
basis. Failure of the Company to receive prompt and accurate call data records
will impair the Company's ability to bill its customers on a timely basis. Such
billing delays could impair the Company's ability to collect amounts owed by its
customers. Due to the multitude of billing rates and discounts which suppliers
must apply to the calls completed by the Company's customers, and due to routine
logistical issues such as the addition or termination of customers, the Company
regularly has disagreements with MCI WorldCom concerning the amounts invoiced
for its customers' traffic. The Company pays MCI WorldCom according to its own
calculation of the amounts owed as recorded on the computer tapes provided by
MCI WorldCom. The Company's computations of amounts owed are frequently less
than the amount shown on the MCI WorldCom's invoices. Accordingly, MCI WorldCom
may consider the Company to be in arrears in its payments until the amount in
dispute is resolved. Although these disputes have generally been resolved on
terms favorable to the Company, there can be no assurance that this will
continue to be the case. Future disputes, which are not resolved favorably to
the Company, could have a material adverse effect on the Company's financial and
operating performance.
LACK OF RETURNS ON INVESTMENT. From July 31, 1994 until December 31, 1997,
the Company declared quarterly distributions to its shareholders on the shares
of Common Stock and accrued distribution amounts payable to Messrs. Freeny and
Thompson for distributions declared from July 1995 through December 1997. The
Company does not anticipate paying any other cash dividends or distributions in
the foreseeable future and anticipates that future earnings will be retained to
repay outstanding indebtedness and to finance operations. As a result, the only
way that a shareholder can get any return on its investment in Common Stock is
by disposing such Common Stock for which as discussed below, there is currently
no established public trading market. Furthermore, the terms of the Coast Loan
limit the payment of any returns of capital or other dividends or distributions
to its shareholders.
NO PUBLIC MARKET; ILLIQUIDITY. There is no established public trading market
for the shares of Common Stock and the Company currently does not intend to seek
inclusion of the shares of Common Stock in any established public trading
market. As a result, a holder of shares of Common Stock will not easily or at
all be able to dispose of his shares of Common Stock and must bear the economic
risk of their investment for an indefinite period of time. Further restricting
liquidity of the Common Stock is a right of first refusal provided for in the
bylaws of the Company in favor of the Company and certain stockholders with
respect to any sales of Common Stock by its shareholders. There can be no
assurances that an established public trading market will ever exist for the
shares of Common Stock or that a shareholder will be able to dispose of his
shares of Common Stock through any other methods.
FORWARD-LOOKING STATEMENTS. Certain statements contained in this Form 10 are
not based on historical facts, but are forward-looking statements that are based
upon numerous assumptions as of the date of this Form 10 that could prove to be
inaccurate. When used in this Form 10, the words "anticipate", "believe",
"estimate", "expect", "will", "could", "may" and similar expressions, as they
relate to management or the Company, are intended to identify forward-looking
statements. Such statements reflect the current views of management with respect
to future events and are subject to certain risks, uncertainties and
assumptions, including those described in "The Company -- Risk Factors" herein.
Should one or more of these risks or uncertainties materialize, or should the
underlying assumptions prove incorrect, actual results may vary materially from
those described herein.
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<PAGE> 15
ITEM 2. FINANCIAL INFORMATION
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA
The historical financial data presented in the following table for and at
the end of the three-month periods ended March 31, 1999 and 2000 are derived
from the unaudited consolidated financial statements of the Company. In the
opinion of management of the Company, such unaudited consolidated condensed
financial statements include all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of the financial data for such
periods. The results for the three months ended March 31, 2000 are not
necessarily indicative of the results to be achieved for the full year.
The historical financial data for the years ended December 31, 1995, 1996,
1997, 1998 and 1999 are derived from the audited consolidated financial
statements of the Company. This information is not necessarily indicative of the
company's future performance. The data presented below should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto included elsewhere herein and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net Sales ........................................ $ 59,313 $ 100,858 $ 113,351 $ 124,232 $ 114,661
---------- ---------- ---------- ---------- ----------
Operating expenses:
Cost of telecommunication services ............. 35,088 48,748 44,711 48,787 53,050
---------- ---------- ---------- ---------- ----------
Cost of telecommunication services
Provided by related parties ................ -- 4,685 13,529 14,736 1,469
---------- ---------- ---------- ---------- ----------
Selling, general and administrative ............ 21,059 36,194 44,530 49,368 48,028
---------- ---------- ---------- ---------- ----------
Selling, general and administrative
To related parties ......................... 11,222 9,977 5,893 6,805 --
---------- ---------- ---------- ---------- ----------
Depreciation and amortization .................. 375 593 683 2,102 2,899
---------- ---------- ---------- ---------- ----------
Total operating expenses ................... 67,744 100,197 109,346 121,798 105,446
---------- ---------- ---------- ---------- ----------
Operating income (loss) .......................... (8,431) 661 4,005 2,434 9,215
---------- ---------- ---------- ---------- ----------
Other income and (expense):
Interest expense and other financing charges ... (441) (1,536) (3,245) (4,993) (4,873)
---------- ---------- ---------- ---------- ----------
Interest expense and other financing charges
Incurred to related parties ................ (42) (297) (924) (974) (698)
---------- ---------- ---------- ---------- ----------
Loss on loans and other receivables ............ -- (200) -- (552) 182
---------- ---------- ---------- ---------- ----------
Impairment loss on asset held for disposal ..... -- -- -- (215) (103)
---------- ---------- ---------- ---------- ----------
Equity in income (losses) of affiliates ........ 135 28 (99) 41 --
---------- ---------- ---------- ---------- ----------
Other income ................................... 111 86 14 59 95
---------- ---------- ---------- ---------- ----------
Income (loss) before income tax (benefit) ...... (8,668) (1,258) (249) (4,200) 3,818
---------- ---------- ---------- ---------- ----------
Income tax expense (benefit) ................... (3,371) (396) 92 (643) 1,905
---------- ---------- ---------- ---------- ----------
Net income (loss) .............................. $ (5,297) $ (862) $ (341) $ (3,557) $ 1,913
---------- ---------- ---------- ---------- ----------
Earnings (loss) per share:
Basic .......................................... $ (9.75) $ (3.79) $ (1.01) $ (4.22) $ 2.50
---------- ---------- ---------- ---------- ----------
Diluted ........................................ $ (9.75) $ (3.79) $ (1.01) $ (4.33) $ 2.14
---------- ---------- ---------- ---------- ----------
CASH FLOWS:
Operating activities ........................... $ (5,014) $ 1,489 $ (1,624) $ 7,118 $ (1,664)
---------- ---------- ---------- ---------- ----------
Investing activities ........................... (618) (294) (922) (148) (2,806)
---------- ---------- ---------- ---------- ----------
Financing activities ........................... 2,815 (967) 2,008 (6,350) 4,826
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA:
Total assets ................................... $ 18,654 $ 20,961 $ 24,554 $ 25,517 $ 31,109
---------- ---------- ---------- ---------- ----------
Working capital (deficit) ...................... (6,592) (18,321) (20,811) (23,590) (22,217)
---------- ---------- ---------- ---------- ----------
Total long-term debt ........................... 14,217 5,494 9,062 10,244 13,959
---------- ---------- ---------- ---------- ----------
Total stockholder's deficit(1) ................. (13,360) (16,827) (22,612) (25,971) (23,229)
---------- ---------- ---------- ---------- ----------
OTHER FINANCIAL DATA:
EBITDA(2) ...................................... $ (8,056) $ 1,254 $ 4,688 $ 4,536 $ 12,114
---------- ---------- ---------- ---------- ----------
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 2000
---------- ----------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net Sales ........................................ $ 29,040 $ 26,362
---------- ----------
Operating expenses:
Cost of telecommunication services ............. 13,479 11,952
---------- ----------
Cost of telecommunication services
Provided by related parties ................ 1,469 --
---------- ----------
Selling, general and administrative ............ 11,549 11,850
---------- ----------
Selling, general and administrative
To related parties ......................... -- --
---------- ----------
Depreciation and amortization .................. 937 1,050
---------- ----------
Total operating expenses ................... 27,434 24,852
---------- ----------
Operating income (loss) .......................... 1,606 1,510
---------- ----------
Other income and (expense):
Interest expense and other financing charges ... (1,225) (1,154)
---------- ----------
Interest expense and other financing charges
Incurred to related parties ................ (175) (153)
---------- ----------
Loss on loans and other receivables ............ -- --
---------- ----------
Impairment loss on asset held for disposal ..... -- --
---------- ----------
Equity in income (losses) of affiliates ........ -- --
---------- ----------
Other income ................................... 211 38
---------- ----------
Income (loss) before income tax (benefit) ...... 417 241
---------- ----------
Income tax expense (benefit) ................... 401 120
---------- ----------
Net income (loss) .............................. $ 16 $ 121
---------- ----------
Earnings (loss) per share:
Basic .......................................... $ .02 $ .10
---------- ----------
Diluted ........................................ $ .02 $ .08
---------- ----------
CASH FLOWS:
Operating activities ........................... $ (1,534) $ 969
---------- ----------
Investing activities ........................... 386 (1,167)
---------- ----------
Financing activities ........................... 556 564
---------- ----------
BALANCE SHEET DATA:
Total assets ................................... $ 30,614 $ 30,614
---------- ----------
Working capital (deficit) ...................... (26,293) (24,387)
---------- ----------
Total long-term debt ........................... 11,758 11,379
---------- ----------
Total stockholder's deficit(1) ................. (25,954) (22,741)
---------- ----------
OTHER FINANCIAL DATA:
EBITDA(2) ...................................... $ 2,543 $ 2,560
---------- ----------
</TABLE>
15
<PAGE> 16
----------
(1) Dividends were declared through December 31, 1997. See "Dividend
Policy."
(2) EBITDA (earnings before interest, taxes, depreciation and
amortization) consists of net sales less cost of telecommunication
services and selling, general and administrative expenses. EBITDA is
provided because it is a measure commonly used by investors to analyze
and compare companies on the basis of operating performance. EBITDA is
presented to enhance an understanding of the Company's operating
results and is not intended to represent cash flows or results of
operations in accordance with generally accepted accounting principles
("GAAP") for the periods indicated. EBITDA is not a measurement under
GAAP and is not necessarily comparable with similarly titled measures
for other companies.
AMERIVISION COMMUNICATIONS, INC. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company provides domestic long distance and other telecommunications
services, primarily to residential users. Since its formation in 1991, the
Company's annual long distance telephone volume has grown from approximately
$1.0 million in net sales in 1991 to over $114.7 million in net sales in 1999.
Substantially all of this growth is attributable to the increase in the
Company's subscriber base. The Company's subscriber base has increased from
approximately 30,000 subscribers at the beginning of 1994 to approximately
550,000 subscribers at March 31, 2000. The Company does not, however, expect its
revenues or subscriber base to continue to grow at this rate in the future and
has in fact experienced a decline in the subscriber base recently. See "-Results
of Operation- Three Months Ended March 31, 2000 Compared to Three Months Ended
March 31, 1999." The net sales for the three months ended March 31, 1999 totaled
$29.0 million compared to $26.4 million for the three months ended March 31,
2000.
From its inception through December 31, 1998, the Company had incurred
cumulative net operating losses totaling approximately $12.1 million. During the
year ended December 31, 1999, the Company generated net income of $1.9 million,
which was achieved from reductions in operating expenses. The Company's
accumulated stockholders' deficiency increased from approximately $22.6 million
at December 31, 1997 to approximately $26.0 million at December 31, 1998. The
net income of $1.9 million during 1999 contributed to the decrease in
accumulated stockholders' deficiency to approximately $23.2 million at December
31, 1999. The net income generated during the three months ended March 31, 2000
also contributed to the decrease in accumulated stockholders' deficiency to
approximately $22.7 million at March 31, 2000. In addition to the net operating
losses, the accumulated deficit has been attributed to the Company's declaration
of quarterly distributions to its stockholders during 1994 through 1997 totaling
approximately $19.0 million. Furthermore, the Company's current liabilities
exceeded its current assets by approximately $20.8 million, $23.6 million, $22.2
million, and $24.4 million at December 31, 1997, 1998, 1999 and at March 31,
2000, respectively. These factors among others may indicate that the Company may
be unable to continue as a going concern for a reasonable period of time. See
"Note J to the Consolidated Financial Statements."
The growth in the Company's long distance revenues and customer base is
attributable to the Company's marketing efforts. The Company entered into
agreements or made strategic alliances with various non-profit organizations.
From the first quarter of 1993 through the middle of 1996, the Company relied
almost exclusively on the telemarketing efforts of VisionQuest, a related entity
in which the Company owned an equity interest, to solicit and acquire new long
distance customers. The non-profit organizations would provide the Company and
VisionQuest with its membership rosters, and VisionQuest would direct its
telemarketing services to those individuals. The Company has decreased the use
of telemarketing for its marketing efforts and began, in the middle of 1996, to
increase its own marketing related efforts through direct mail, television and
radio advertising, including sponsorship of various radio and television
programs for the organizations whose members subscribe to the Company's long
distance services. These marketing efforts as well as telemarketing are
currently being utilized by the Company to solicit and acquire new long distance
customers.
Sales commissions are paid to both employees and independent contractors.
Salespersons earn commissions based upon a percentage of the commissionable,
billable traffic generated by the non-profit organizations for which the
salesperson has been assigned. The total sales commission for each non-profit
organization is approximately 5.0%. This payment is generally split among
several people, including the outside salesperson that is the primary contact
with the non-profit organization and the inside salesperson that is responsible
for working with the outside salesperson in servicing the accounts. Although the
Company has approximately 150 salespersons and employees who receive
commissions, approximately 55.0%, 59.0%, 66% and 65% of total commissions were
earned by the top 10 salespersons in 1997, 1998, 1999 and for the three months
ended March 31, 2000, respectively.
The Company bills its customers under several different methods. Some
customers receive their long distance bills directly from the Company. The
Company also has billing and collection agreements with several of the RBOCs.
Customers who are billed through the RBOCs receive their long distance phone
bill with their local phone bill from the RBOC. The Company also utilizes two
16
<PAGE> 17
third party billing and collection services for customer billings through other
LECs or RBOCs with whom the Company does not have a separate billing and
collection agreement.
Although the Company does not own or operate its own long distance network,
effective February 1, 1999 the Company began operating the switching assets and
related personnel of Hebron, which includes telecommunications switches in
Oklahoma City and Chicago. The Company purchased the switches in April 2000
under terms of an asset purchase agreement with Hebron. This allows the Company
to originate and terminate certain long distance calls. MCI WorldCom carries the
majority of the Company's long distance traffic. The Company pays its carriers
based on the type of calls, time of certain calls, duration of calls, the
terminating phone numbers, and the terms of the Company's contract in effect at
the time of the calls. In addition to residential long distance service, the
Company also offers its customers other telecommunication services such as
paging, Internet access services, calling cards, prepaid phone cards and
toll-free service.
The Company rebates a percentage, approximately 10.0%, of the customer's
gross billings to a non-profit organization selected by the customer but
approved by the Company. Gross billings include all revenues, except
international long distance calls.
Beginning in the fourth quarter of 1996, the Company began offering a
"Non-Profit Organization Bonus Sign-Up" program in certain instances. During the
years ended December 31, 1997, 1998, 1999 and for the three months ended March
31, 2000 total bonus sign up expense was $311,000, $283,000, $42,000 and $2,130,
respectively.
Selling, general and administrative expenses include billing fees charged by
LECs and other third party billing and collection companies, bad debts,
commissions to salespersons, advertising and telemarketing expenses, customer
service and support, and other general overhead expenses.
Interest expense includes the cost of financing the Company's accounts
receivables and loans from individuals.
The Company has recognized a net deferred tax for the tax effects of
temporary differences and net operating loss carryforwards, to the extent that
the Company has determined that it is more likely than not that it will realize
those tax benefits.
PICC Fees.
In 1996, the Federal Communications Commission adopted regulations
implementing the Telecommunications Act enacted that year. To support universal
service, carriers are required to contribute certain percentages of their annual
gross receipts to fund the High Cost Fund, the Schools and Libraries Fund, and
the Low Income Fund. The FCC has allowed carriers to offset these charges by
passing them through to their customers. In addition, the FCC adopted a Primary
Interexchange Carrier Charge ("PICC") to allow LECs to recover through
non-usage-sensitive charges certain costs associated with long distance carriers
having access to LEC networks. The FCC has also allowed the long distance
carriers to offset these amounts by passing these charges on to their customers.
In May 2000, the FCC adopted an order which consolidates PICC charges with
certain other subscriber charges and initially decreases the charges effective
July 1, 2000 and then annually increases such charges. The Company is in the
process of analyzing the impact of these changes which are not expected to be
material.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 COMPARED TO THREE MONTHS ENDED MARCH 31, 1999
The following table sets forth for the three-month periods indicated the
percentage of net sales represented by certain items in the Company's statements
of operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 2000
---------- ----------
<S> <C> <C>
Net sales ................................................ 100.0% 100.0%
---------- ----------
Operating expenses:
Cost of telecommunication services .................. 51.5% 45.3%
---------- ----------
Selling, general and administrative expenses ........ 39.8% 45.0%
---------- ----------
Depreciation and amortization expense ............... 3.2% 4.0%
---------- ----------
Total operating expenses ....................... 94.5% 94.3%
---------- ----------
Income from operations ................................... 5.5% 5.7%
---------- ----------
Interest expense ......................................... (4.8)% (4.9)%
---------- ----------
Other income ............................................. 0.7% 0.1%
---------- ----------
Income (loss) before income tax (benefit) ................ 1.4 .9%
---------- ----------
Income tax expense (benefit) ............................. 1.3% .5%
---------- ----------
Net income (loss) ........................................ .1% .4%
---------- ----------
</TABLE>
17
<PAGE> 18
Net Sales: Net sales decreased 9.2% to $26.4 million for the three months
ended March 31, 2000 from $29.0 million for the three months ended March 31,
1999. This decrease was the result of a decrease in total minutes of traffic and
a reduction in minutes under certain rate plans, which are billed at a higher
per minute rate. Total billable minutes were approximately 138 million minutes
for the three months ended March 31, 2000 compared to 156 million minutes for
the three months ended March 31, 1999, a decrease of 11.5%.
The Company believes it is more cost effective to bill its residential
customers who have smaller than average phone bills through the LECs as opposed
to billing them directly. As a result, a greater percentage of customers who are
billed directly by the Company are the commercial customers or residential
customers who generate larger than average monthly phone bills. Approximately
72.0% of net sales were billed through the LECs or other billing and collection
services for the three months ended March 31, 2000, compared to 76.0% for the
three months ended March 31, 1999. Customers receiving their bills directly from
the Company were approximately 28.0% for the three months ended March 31, 2000
compared to 24.0% for the same period in 1999.
Cost Of Telecommunication Services: The Company's cost of sales are variable
costs based on amounts paid by the Company to its providers for its customers'
long distance usage, as well as the amounts paid to providers for customer
service and support. For the three months ended March 31, 2000, the Company's
overall cost per minute decreased as compared to the three months ended March
31, 1999. This decrease resulted from rate reductions received by the Company
from its switchless carrier and due to the fact that the Company gained
operating efficiencies as it began operating the switches during February 1999,
which were previously operated by Hebron. During the three months ended March
31, 2000 and 1999, the amounts and relative percentage of net sales to each of
its providers was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------------
1999 2000
--------------------------- ---------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
MCI WorldCom ............ $ 9,462 32.6% $ 6,175 23.4%
---------- ---------- ---------- ----------
Hebron .................. 1,469 5.1% -- --%
---------- ---------- ---------- ----------
Switched Operations ..... 2,248 7.7% 2,863 10.9%
---------- ---------- ---------- ----------
PICC/USF Fees ........... 1,769 6.1% 2,914 11.0%
---------- ---------- ---------- ----------
Totals ............... $ 14,948 51.5% $ 11,952 45.3%
---------- ---------- ---------- ----------
</TABLE>
MCI WorldCom: The Company's overall percentage usage of MCI WorldCom
decreased as a result of the Company beginning to operate, effective February 1,
1999 the switches previously operated by Hebron. The Company purchased the
switches on April 1, 2000 under terms of an asset purchase agreement with
Hebron. For the three months ended March 31, 2000, total minutes of usage from
MCI WorldCom were approximately 113 million minutes compared to approximately
117 million minutes for the same period in 1999, a decrease of 3.5% resulting
from the switch purchase.
Hebron: The decrease in cost of sales to Hebron is attributable to the
decreased minutes of usage to approximately 12 million minutes for the three
months ended March 31, 1999 resulting from the Company assuming operation of the
switches.
Switched Operations: Effective February 1, 1999 the Company began operating
the switching assets and related personnel of Hebron, which includes
telecommunications switches in Oklahoma City and Chicago. The total minutes of
usage for switched operations for the three months ended March 31, 2000 were 36
million minutes.
PICC/USF Fees: These expenses increased for the three months ended March 31,
2000 compared to the same period in 1999 because the rates were increased during
July 1999.
Selling, General and Administrative Expenses: The significant components of
selling, general and administrative expenses include the following:
18
<PAGE> 19
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------------
1999 2000
--------------------------- ---------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Billing fees and charges ............... $ 2,605 9.0% $ 2,327 8.8%
---------- ---------- ---------- ----------
Advertising expense .................... 955 3.3% 737 2.8%
---------- ---------- ---------- ----------
Other general and administrative ....... 5,548 19.1% 6,568 24.9%
---------- ---------- ---------- ----------
Telemarketing expense .................. 179 .6% 297 1.1%
---------- ---------- ---------- ----------
Rebates to non-profit organizations .... 2,262 7.8% 1,921 7.3%
---------- ---------- ---------- ----------
Totals .............................. $ 11,549 39.8% $ 11,850 44.9%
---------- ---------- ---------- ----------
</TABLE>
Billing Fees and Charges: Billing fees and charges include the contractual
billing fees and bad debts charged by LEC's and other third party billing
companies. During 1998, in an effort to improve the timing of cash flows, the
Company utilized the third party billing and collection services of Billing
Information Concepts ("BIC") and Hold Billing Services ("Hold") for a percentage
of its billings. However, the Company increased its direct billings during 1999.
Total billings processed through BIC and Hold were approximately 20.0% of net
sales for the three months ended March 31, 2000 compared to 32.0% of net sales
for the three months ended March 31, 1999. Applicable billing charges from BIC
and Hold were approximately 2.7% and 3.6% of net sales for the three months
ended March 31, 2000 and 1999, respectively.
Advertising Expense: Advertising expenses decreased 22.8% to $737,000 for
the three months ended March 31, 2000 compared to $955,000 for the three months
ended March 31, 1999 due to the Company curtailing its advertising expenses. The
Company utilizes direct mail, radio, television and other forms of advertising
to acquire new customers.
Other General and Administrative Expense: Other general and administrative
expenses increased by approximately 18.4% for the three months ended March 31,
2000 as compared to the same period in 1999 due to additional wages related to
an increase in personnel on the Company's management team, with some offset in
reductions in commissions to salespersons.
Rebates to Non-Profit Organizations: During the three months ended March 31,
2000, rebates to non-profit organizations decreased by approximately 15.1% to
$1.9 million compared to $2.3 million for the same period in 1999. The majority
of the decrease is due to a 4% bad debt factor utilized to reduce the
commissionable revenues and a decrease in additional discretionary commission
amounts, set by management to maintain a more constant rebate amount to the
non-profit organizations. As of March 31, 2000, the Company was affiliated with
approximately 36,000 organizations for its rebate program, compared to
approximately the same number of organizations as of March 31, 1999. For the
three months ended March 31, 2000 and 1999, approximately 37.9% and 39.2%,
respectively, of total rebates were paid to the top ten organizations.
Depreciation and Amortization: Depreciation and amortization expense
increased 10.8% to $1.0 million for the three months ended March 31, 2000
compared to $937,000 for the same period in 1999. This increase is attributable
to an increase in the value of the Company's property and equipment primarily
due to recording the purchase of switch and Internet equipment associated with
the Hebron transaction and the additions for the new call center.
Interest Expense and Other Finance Charges: Interest expense decreased 6.6%
to $1.3 million for the three months ended March 31, 2000 compared to $1.4
million for the same period in 1999. This decrease is attributable to an
increase in borrowings related to the Company's credit facility partially offset
by a decrease in the average applicable interest rates for the three months
ended March 31, 2000 as compared to same earlier period.
Other Income (Expense): For the three months ended March 31, 2000, interest
income and rental income decreased to $38,000 compared to $211,000 for the same
period in 1999. However, the recoveries of certain non-recurring items totaling
$210,000 were recorded as income in 1999, which related to an accounts
receivable loss and an impairment loss previously written off.
Income Tax Expense (Benefit): For the three months ended March 31, 2000 the
Company recorded a deferred income tax expense of approximately $120,000 and
$401,000 for the three months ended March 31, 2000 and 1999, respectively. The
income tax benefits recognized in the financial statements consist primarily of
the deferred tax effects of the temporary differences between the financial and
tax bases of assets and liabilities, and net operating loss carryforwards. The
Company believes that it will realize the tax benefits of net operating loss
carryforwards within the period allowed under Federal tax laws (15 years).
Net Income (Loss): During the three months ended March 31, 2000 and 1999,
the Company reported net income of $121,000 and $16,000, respectively.
19
<PAGE> 20
STATEMENTS OF OPERATIONS DATA FOR THE YEARS ENDED
DECEMBER 31, 1997, 1998 AND 1999:
The following table sets forth for the years indicated the percentage of net
sales represented by certain items in the Company's statements of operations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Net sales .......................................... 100.0% 100.0% 100.0%
---------- ---------- ----------
Operating expenses:
Cost of telecommunication services ............ 51.4% 51.1% 47.5%
---------- ---------- ----------
Selling, general and administrative expenses .. 44.5% 45.2% 41.9%
---------- ---------- ----------
Depreciation and amortization expense ......... 0.6% 1.7% 2.5%
---------- ---------- ----------
Total operating expenses ................. 96.5% 98.0% 91.9%
---------- ---------- ----------
Income from operations ............................. 3.5% 2.0% 8.1%
---------- ---------- ----------
Interest expense ................................... (3.7)% (4.8)% (4.9)%
---------- ---------- ----------
Other income (expense) ............................. --% (0.6)% 0.1%
---------- ---------- ----------
Loss before income tax (benefit) ................... (0.2)% (3.4)% 3.3%
---------- ---------- ----------
Income tax expense (benefit) ....................... 0.1% (0.5)% 1.6%
---------- ---------- ----------
Net loss ........................................... (0.3)% (2.9)% 1.7%
---------- ---------- ----------
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net Sales: Net sales decreased 7.6% to $114.7 million in 1999 compared to
$124.2 million in 1998. This decrease was the result of a decrease in billable
minutes and the customer base. Total billable minutes were approximately 611
million minutes in 1999 compared to 635 million minutes in 1998, a decrease of
3.8%. PICC and USF fees billed to customers totaled $11.2 million in 1999,
compared to $10.1 million in 1998. The increase was the result of a full year
implementation in 1999 and an increase in the rates in July 1999.
The Company believes it is more cost effective to bill its residential
customers who have smaller than average phone bills through the LECs as opposed
to billing them directly. As a result, a greater percentage of customers who are
billed directly by the Company are the commercial customers or residential
customers who generate larger than average monthly phone bills. Approximately
76.0% of net sales were billed through the LECs or other billing and collection
services in 1999, compared to 77.0% in 1998. Customers receiving their bills
directly from the Company were approximately 24.0% in 1999 compared to 23.0% in
1998.
Cost Of Telecommunication Services: The Company's cost of sales are variable
costs based on amounts paid by the Company to its providers for its customers'
long distance usage. For the year ended December 31, 1999, the Company's overall
cost per minute as compared to 1998 decreased by 13.2%. During the years ended
December 31, 1999 and 1998, the amounts and relative percentage of net sales to
each of its providers was as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1998 1999
-------------------------- --------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
MCI WorldCom ............ $ 41,650 33.5% $ 31,178 27.2%
---------- ---------- ---------- ----------
Hebron .................. 14,736 11.9% 1,469 1.2%
---------- ---------- ---------- ----------
PICC/USF Fees ........... 7,137 5.7% 10,070 8.8%
---------- ---------- ---------- ----------
Switched Operations ..... -- -- 11,802 10.3%
---------- ----------
Totals ............... $ 63,523 51.1% $ 54,519 47.5%
---------- ---------- ---------- ----------
</TABLE>
MCI WorldCom: The Company's overall percentage usage of MCI WorldCom during
1999 as compared to 1998 declined as a result of the Company's total billable
minutes and total customer base. During 1999 total minutes of usage from MCI
WorldCom were approximately 439 million minutes and during 1998, total minutes
of usage from MCI WorldCom were approximately 475 million minutes.
20
<PAGE> 21
Hebron: The decrease in cost of sales to Hebron is attributable to the
decreased minutes of usage, from approximately 12 million minutes in 1999
compared to 208 million minutes in 1998. The decrease results from the Company
assuming operation of the switches in February 1999.
PICC/USF Fees: These expenses increased for the year ended December 31, 1999
compared to the same period in 1998 because the collection of these fees was
implemented in 1998, and many carriers and LEC's did not bill in the first month
or so of 1998. In addition, the rates were increased in July 1999. See "General
- PICC Fees."
Switched Operations: These expenses reflect the cost of the Company
operating the switches from February 1, 1999 as opposed to previously purchasing
the minutes from Hebron.
Selling, General and Administrative Expenses: The significant components of
selling, general and administrative expenses include the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1998 1999
-------------------------- --------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Billing fees and charges ............... $ 12,580 10.1% $ 9,410 8.2%
Advertising expense .................... 5,107 4.1% 3,688 3.3%
Other general and administrative ....... 20,923 16.8% 25,142 21.9%
Related party telemarketing expense .... 6,805 5.5% -- --
Telemarketing expense .................. -- -- 951 .8%
Rebates to non-profit organizations..... 10,758 8.7% 8,837 7.7%
---------- ---------- ---------- ----------
Totals .............................. $ 56,173 45.2% $ 48,028 41.9%
---------- ---------- ---------- ----------
</TABLE>
Billing Fees and Charges: Billing fees and charges include the contractual
billing fees and bad debts charged by LECs and other third party billing
companies. During 1999, the Company decreased its utilization of third party
billing and collection services of Zero Plus Dialing ("ZPDI") and Hold for a
percentage of its billings as compared to 1998. Total billings processed through
ZPDI and Hold decreased to approximately 25.7% of net sales in 1999 compared to
35.0% of net sales in 1998. Applicable billing charges from ZPDI and Hold were
approximately 2.7% and 4.6% of net sales in 1999 and 1998, respectively.
Advertising Expense: Advertising expense decreased in 1999 to $3.7 million,
compared to $5.1 million in 1998, a decrease of 27.8% due to the Company
curtailing its advertising expenses.
Other General and Administrative Expense: Other general and administrative
expenses increased by approximately 14.0% during 1999 compared to 1998 due to
increased fees for professional and other services and due to additional wages
related to an increase in personnel on the Company's management team, with some
offset in reductions in commissions to salespersons.
Telemarketing Expense to Related Party: The Company incurred no related
party telemarketing expense during 1999 compared to $6.8 million during 1998.
This decrease was due from moving telemarketing from utilization of VisionQuest
to being conducted by the Company and due to reduced telemarketing activity.
During 1998, reimbursement of 100% of corporate overhead expenses incurred by
VisionQuest were approximately $4.7 million, representing 3.8% of net sales.
Telemarketing Expense: The Company incurred telemarketing costs of $951,000
in 1999 as it began conducting telemarketing operations internally at the end of
1999 in conjunction with the opening of a new call center located in Tahlequah,
Oklahoma. The new call center allows the Company to better manage the costs of
telemarketing and control the productivity of the telemarketing personnel.
Rebates to Non-Profit Organizations: During 1999, rebates to non-profit
organizations decreased by approximately 17.9%, to $8.8 million in 1999 compared
to $10.8 million in 1998. The majority of the decrease is due to a 4% bad debt
factor utilized to reduce the commissionable revenues and a decrease in
additional discretionary commission amounts, set by management to maintain a
more constant rebate amount to the non-profit organizations. At the end of 1999,
the Company was affiliated with approximately 35,000 organizations for its
rebate program, compared to a similar number of organizations at the end of
1998. For 1999 and 1998, approximately 40.0% and 42.0%, respectively, of total
rebates were paid to the top ten organizations.
Depreciation and Amortization: Depreciation and amortization expense
increased 65.5% to $3.5 million in 1999 compared to $2.1 million in 1998. This
increase is attributable to an increase in the value of the Company's property
and equipment primarily due to
21
<PAGE> 22
recording the purchase of switch and Internet equipment associated with the
Hebron transaction and the amortization of not to compete covenants contained in
certain separation agreements.
Interest Expense and Other Finance Charges: Interest expense and other
finance charges decreased to $5.6 million in 1999 compared to $6.0 million in
1998. This decrease is attributable to an increase in borrowings related to the
Company's credit facility partially offset by a decrease in the average
applicable interest rates for the year ended December 31, 1999 as compared to
same earlier period.
Other Income (Expense): Interest income and rental income increased to
$95,000 during 1999 compared to $59,000 in 1998, principally as a result of the
Company having more cash to invest in 1999, and partially offset by a decrease
in interest on notes receivable from VisionQuest in 1998. The Company's equity
in income and in the net loss incurred by VisionQuest in 1998 was approximately
$41,000. In 1998, the Company relocated substantially all of its corporate
offices from a building that it owned to an adjacent building owned by Hebron.
The Company decided to sell this building, and obtained an appraisal in 1998.
As a result of the appraisal, the Company determined that the carrying amount
of the building was impaired, and accordingly, recognized a pre-tax loss of
$215,000 in its 1998 financial statements. Upon the sale of the building in
February 1999, the Company recorded a recovery of this loss of $22,000. During
1997 and 1998, the Company provided billing and collection services for an
unrelated third party. The Company discontinued providing these services in
October 1998. At that time, the Company had made outstanding advances to this
third party totaling approximately $552,000. The Company determined that it was
not likely that it would collect these advances, and wrote the entire
receivable off as of December 31, 1998. In March 1999, the Company did recover
approximately $182,000 of this receivable, but does not anticipate and is not
pursuing collections of the remaining $370,000.
Income Tax Expense (Benefit): In 1999 the Company recorded a deferred income
tax expense of approximately $1.9 million, and in 1998, the Company recorded a
deferred income tax benefit of approximately $643,000. The income tax benefits
recognized in the financial statements consist primarily of the deferred tax
effects of the temporary differences between the financial and tax bases of
assets and liabilities, and net operating loss carryforwards. The Company
believes that it will realize the tax benefits of net operating loss
carryforwards within the period allowed under Federal tax laws (15 years).
Net Income (Loss): During the year ended December 31, 1999 the Company
incurred net income of $1.9 million and in 1998, the Company incurred a net loss
of $3.6 million.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net Sales: Net sales increased 9.6% to $124.2 million in 1998 compared to
$113.4 million in 1997. This increase was the result of PICC and USF revenues in
the amount of $10.1 million, which began in 1998 and an increase in billable
minutes and the customer base. Total billable minutes were approximately 635
million minutes in 1998 compared to 616 million minutes in 1997, an increase of
3.1%.
The Company believes it is more cost effective to bill its residential
customers who have smaller than average phone bills through the LECs as opposed
to billing them directly. As a result, a greater percentage of customers who are
billed directly by the Company are the commercial customers or residential
customers who generate larger than average monthly phone bills. In 1997, the
Company began billing a larger percentage of its customers through the LECs and
other billing and collection services. Approximately 77.0% of net sales were
billed through the LECs or other billing and collection services in 1998,
compared to 73.0% in 1997. Customers receiving their bills directly from the
Company were approximately 23.0% in 1998 compared to 27.0% in 1997.
Cost Of Telecommunication Services: The Company's cost of sales are variable
costs based on amounts paid by the Company to its providers for its customers'
long distance usage. For the year ended December 31, 1998, the Company's overall
cost per minute as compared to 1997 decreased by 8%. During the years ended
December 31, 1998 and 1997, the amounts and relative percentage of net sales to
each of its providers was as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1997 1998
-------------------------- --------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
MCI WorldCom ............ $ 44,711 39.5% $ 41,650 33.5%
---------- ---------- ---------- ----------
Hebron .................. 13,529 11.9% 14,736 11.9%
---------- ---------- ---------- ----------
PICC/USF Fees ........... -- -- 7,137 5.7%
---------- ---------- ---------- ----------
Totals ............... $ 58,240 51.4% $ 63,523 51.1%
---------- ---------- ---------- ----------
</TABLE>
MCI WorldCom: The Company's overall percentage usage of MCI WorldCom
declined as a result of the Company directing a larger percentage of its traffic
to Hebron in 1998. Total minutes of usage from MCI WorldCom were approximately
475 million minutes in 1998 compared to 481 million minutes in 1997. In June
1997, the Company received approximately a $0.01 per minute rate reduction on
its regular, interstate traffic from MCI WorldCom.
Hebron: In March 1997, Hebron began providing the Company with
telecommunications services through its Chicago switch as well as its Oklahoma
City switch. The cost of sales to Hebron remained constant while minutes of
usage increased to 208 million minutes in 1998 compared to 175 million minutes
in 1997, an increase of 18.9%. The cost per minute decreased and was primarily
attributable to a $1.1 million rate reduction provided by Hebron during 1998 to
match rates charged by MCI WorldCom.
22
<PAGE> 23
PICC/USF Fees: This program for collection of fees was implemented in 1998.
See "- General - PICC Fees."
Selling, General and Administrative Expenses: The significant components of
selling, general and administrative expenses include the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1997 1998
-------------------------- --------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Billing fees and charges ............... $ 10,347 9.1% $ 12,580 10.1%
---------- ---------- ---------- ----------
Advertising expense .................... 4,115 3.6% 5,107 4.1%
---------- ---------- ---------- ----------
Other general and administrative ....... 18,536 16.4% 20,923 16.8%
---------- ---------- ---------- ----------
Related party telemarketing expense .... 5,894 5.2% 6,805 5.5%
---------- ---------- ---------- ----------
Rebates to non-profit organizations .... 11,531 10.2% 10,758 8.7%
---------- ---------- ---------- ----------
Totals .............................. $ 50,423 44.5% $ 56,173 45.2%
---------- ---------- ---------- ----------
</TABLE>
Billing Fees and Charges: Billing fees and charges include the contractual
billing fees and bad debts charged by LECs and other third party billing
companies. During 1998, the Company decreased its utilization of third party
billing and collection services of Zero Plus Dialing ("ZPDI") and Hold for a
percentage of its billings as compared to 1997. Total billings processed through
ZPDI and Hold decreased to approximately 35.0% of net sales in 1998 compared to
40.0% of net sales in 1997. Applicable billing charges from ZPDI and Hold were
approximately 4.6% and 7.0% of net sales in 1998 and 1997, respectively.
Advertising Expense: Advertising expense increased significantly in 1998 to
$5.1 million, compared to $4.1 million in 1997, an increase of 24.0% due to
increased marketing efforts, including direct mail, radio, television and other
forms of advertising.
Other General and Administrative Expense: Other general and administrative
expenses increased by approximately 13.0% during 1998 compared to 1997 due to
increased fees for professional and other services, with some offset in
reductions in commissions to salespersons.
Telemarketing Expense to Related Party: The Company's telemarketing expense
increased during 1998, as the Company paid VisionQuest its direct cost spent for
telemarketing projects, plus reimbursement of 100% of corporate overhead
incurred by VisionQuest. In 1997, telemarketing expenses included reimbursement
of a portion of the overhead costs incurred by VisionQuest in connection with
its telemarketing activities for the Company. During 1997, total telemarketing
expense was reduced by $670,000, as VisionQuest agreed to reimburse that amount
to the Company, in the form of a note. During 1998 and 1997, corporate overhead
expenses incurred by VisionQuest were approximately $4.7 million and $900,000,
respectively, representing 3.8% and 0.8% of net sales, respectively
Rebates to Non-Profit Organizations: During 1998, rebates to non-profit
organizations decreased by approximately 7.0%, to $10.8 million in 1998 compared
to $11.5 million in 1997. The majority of the decrease is due to an increase in
the bad debt factor utilized to reduce the commissionable revenues and a
decrease in additional discretionary commission amounts, set by management to
maintain a more constant rebate amount to the non-profit organizations. At the
end of 1998, the Company was affiliated with approximately 35,000 organizations
for its rebate program, compared to approximately 31,000 organizations at the
end of 1997. For 1998 and 1997, approximately 42.0% and 44.0%, respectively, of
total rebates were paid to the top ten organizations.
Depreciation and Amortization: Depreciation and amortization expense
increased 208% to $2.1 million in 1998 compared to $683,000 in 1997. This
increase is attributable to the amortization of a not to compete covenant
contained in Carl Thompson's separation agreement.
Interest Expense and Other Finance Charges: Interest expense and other
finance charges increased to $6.0 million in 1998 compared to $4.2 million in
1997. The primary reasons for the increase were the Company's increased use of
debt financing and an increase in the Company's use of working capital line of
credit agreements to finance its accounts receivable during 1997.
Other Income (Expense): Interest income and rental income increased to
$59,000 during 1998 compared to $14,000 in 1997, principally as a result of the
Company having more cash to invest and an increase in interest income on certain
notes offset by less space available for rental purposes in a building formerly
owned by the Company. The Company's equity in income and in the net loss
incurred by VisionQuest in 1998 and 1997 was approximately $41,000 and $99,000,
respectively.
23
<PAGE> 24
Income Tax Expense (Benefit): In 1998 the Company recorded a deferred income
tax benefit of approximately $643,000, and in 1997, the Company recorded a
deferred income tax expense of approximately $92,000. The income tax benefits
recognized in the financial statements consist primarily of the deferred tax
effects of the temporary differences between the financial and tax bases of
assets and liabilities, and net operating loss carryforwards. The Company
believes that it will realize the tax benefits of net operating loss
carryforwards within the period allowed under Federal tax laws (15 years).
Net Income (Loss): During the years ended December 31, 1998 and 1997, the
Company incurred a net loss of $3.6 million and $341,000, respectively.
FINANCIAL CONDITION AND LIQUIDITY
Net cash provided by operations for 1996 was $1,489,000, compared to net
cash used in operations of $1,624,000 in 1997, net cash provided by operations
of $7,118,000 in 1998, and net cash used in operations of $1,664,000 in 1999.
The variations in cash flow from operations are primarily attributable to the
timing of collections on accounts receivable and the timing of payment of
accounts payable. In the opinion of management of the Company, the increase in
cash provided by operations from 1997 to 1998 is not the beginning of a trend
for the following reasons: (a) net cash used in operations of $(1,624,000) in
1997 was primarily due to the increase in accounts receivable as the Company
billed a smaller percentage of it's customers directly and switched more
customers to being billed by the LEC's; (b) net cash provided by operating
activities of $7,118,000 in 1998 was primarily due to the Company extending
terms on accounts payable with vendors and (c) net cash used by operations of
$(1,664,000) in 1999 primarily due to the Company's payment of accounts payable
with vendors.
From its existence through 1995, the Company's primary source of financing
was the sale of equity securities. Approximately $12.0 million in equity
securities were sold to investors during this period. Beginning in December 1995
and continuing through August 1996, the Company also raised approximately $4.9
million through the issuance of short-term promissory notes. Substantially all
of the Company's sales of Common Stock and certain notes, other than sales to
officers and directors of the Company, failed to comply with certain provisions
of the federal and states' securities laws, including compliance with
registration requirements and, possibly, compliance with anti-fraud provisions.
While certain actions under the federal acts may be barred, similar laws in many
of the states provide similar rights. The Company sold stock to persons in over
forty states and those states typically provide that a purchaser of securities
in a transaction that fails to comply with the state's securities laws can
rescind the purchase, receiving from the issuing company the purchase price paid
plus an interest factor, frequently 10% per annum from the date of sales of such
securities, less any amounts paid to such security holder. Accordingly, the
Company has a significant, material contingent liability under state securities
laws for those sales of approximately $10.0 million at March 31, 2000. The
Company has also financed its working capital needs through various accounts
receivable credit facilities with Trinity Financial Resources ("Trinity"),
Hebron, and other billing and collection companies. In September 1997, the
Company entered into a $5,000,000 accounts receivable purchase agreement with
RFC Capital Corporation ("RFC"). Other sources of financing have included
various short and long-term borrowings, primarily from individuals and related
parties, and by extending payables to vendors and tax authorities beyond payment
terms.
The Company's primary uses of cash have historically been for telemarketing
efforts to increase the Company's customer base, and to pay distributions to its
stockholders. From the beginning of 1994 through December 31, 1998, total
amounts expended for telemarketing activities were approximately $32.6 million.
Substantially all of these expenses were to VisionQuest. In addition, from 1994
through the end of 1997, the Company declared $19.0 million in distributions to
its stockholders. As of March 31, 2000, all distributions had been paid, except
for amounts payable to Tracy Freeny totaling $3.2 million. The Company and
Freeny have agreed to defer payment of such amounts owed to Freeny until such
time as the Company's financial condition further improves and it has funds
available, legally and in good business practice, to pay any such accrued
distributions. In consideration for this deferral and Freeny's subordination of
the accrued distributions to the Coast Loan, the Company will pay him, in
addition to his salary, $300,000 per year, subject to limitations under the
Coast Loan Agreement, until the payment of the accrued distributions is resumed
and, if resumed, all amounts paid to Freeny pursuant to the agreement shall be
credited against his accrued distributions.
The Company's financing costs have historically exceeded market rates. Most
of the note payable obligations have borne interest at 18% or higher. Interest
costs and late fees on vendor payables and tax obligations also generally have
an effective rate of 18% or higher. The effective interest rates on the
Company's accounts receivable credit facilities have ranged from 12% to 58%.
Financing costs have been increased by fees charged by Hebron, and finance
companies such as Trinity, Hold and RFC in connection with the line of credit
financing and accounts receivable factoring arrangements. Other LEC billings
were financed through the Company's line of credit agreements with Hebron and
Trinity in 1998 and 1997 and beginning in the fourth quarter of 1997, through
the Company's credit arrangement with RFC. The arrangements with Hebron and
Trinity provided for a 2.0% billing fee, respectively as well as a 2 cents per
call record charge by Hebron, in addition to the interest charged under the
agreements. During 1998 and 1997, total billing
24
<PAGE> 25
fees charged by Hebron, Trinity and RFC were approximately 1.3% and 1.0% of net
sales, respectively. Such fees were negligible in 1996.
This combination of high financing costs, distribution payments, and the
short-term nature of most of the Company's indebtedness have contributed to the
Company's lack of profitability and negative working capital, which totaled
$24.4 million at March 31, 2000.
During 1998, the Company was approved for a $30 million credit facility
("Credit Facility") with Coast Business Credit ("Coast"). In February 1999, the
Company closed on the first phase of the Credit Facility.
The first phase of the Credit Facility was accounts receivable based, and
provided initial funding of approximately $12.6 million. The proceeds from this
Credit Facility were used to replace the existing accounts receivable credit
facilities and purchase agreement, and to enable the Company to become
substantially current on its existing past due vendor payables and tax
obligations. In connection with closing the first phase of the Credit Facility
the Company also obtained $2.5 million in subordinated debt financing from
Patrick Enterprises ("Patrick Note"), an investor. These funds were initially
restricted to maintain reserves as specified in the Credit Facility with Coast.
During the three months ended March 31, 2000, the Company paid off $500,000 of
the Patrick Note, extended the maturity date for one year and reduced the
interest rate by approximately three percent.
In April 1999, the Company met the terms and conditions for converting the
Credit Facility from an accounts receivable based facility to a full credit
facility. Accordingly, Coast approved the conversion to the full credit
facility. Under the terms of the Credit Facility, funding availability is based
upon recurring monthly accounts receivable collections or earnings multiples.
The Company's initial availability in April 1999 was approximately $29.0 million
under the Credit Facility, but was increased to the full $30 million later in
the year.
Of the $30.0 million in availability, approximately $22.8 million was
outstanding as of March 31, 2000 under the Credit Facility. The remaining
balance of $7.2 million is available to the Company for working capital, capital
improvements and debt reduction. In addition, the $2.0 million subordinated
Patrick Note as amended during the first quarter of 2000 is also available for
working capital, capital improvements and debt reduction. The Company either
paid off or negotiated with certain of its non-subordinated creditors to replace
their existing indebtedness with some other form of debt instrument,
subordinated to the Credit Facility. This increased, on a dollar for dollar
basis, the Company's availability under the Credit Facility, as these
non-subordinated creditors totaling $6.8 million were reserved under the Credit
Facility. At March 31, 2000 the remaining balance owed of approximately $177,000
represents lenders who agreed to restructure their debt as subordinated to Coast
Facility.
In October 1999, the Company, subject to the condition set forth below,
increased its availability under the Credit Facility to $35.0 million. This
increase is due to an increase in the Company's borrowing multiple for accounts
receivable collections. This increase in availability to the Company was subject
to Coast being able to syndicate the Credit Facility within 90 days following
the Company's request to increase the availability from $30.0 million to $35.0
million. The Company believes that the availability under the Credit Facility,
the additional $2.0 million of subordinated indebtedness under the Patrick Note
and cash flow from operations, will be sufficient to fund operations of the
Company for the remainder of the year ending December 31, 2000.
The Credit Facility is secured by a blanket lien on all of the Company's
assets, including accounts receivable and the Company's customer base. The terms
of the Credit Facility are for three years from initial funding, with an
interest rate of prime plus 3.5%. Although the Credit Facility has a three-year
term, it will be classified as a current liability in the Company's financial
statements because the agreement contains certain subjective acceleration
clauses and requires that all cash receipts be deposited to a lockbox, the
proceeds of which are used daily to repay the debt.
The Company expects that its future capital requirements will be
significant. Approximately $3.5 to $4.0 million will be required to upgrade the
Company's management information systems. Additionally, the Company estimates
$3.0 to $3.5 million will be required for various aspects of reorganization. The
Company has increased its telemarketing activities and has upgraded its outbound
telemarketing and inbound customer service facilities, and the total cost for
these activities is approximately $1.0 million. Furthermore, Internet
expenditures have approximated $2.5 million to date and are estimated to be
approximately $1.0 million during the year ended December 31, 2000.
The Company estimates cash flow from operations and, to the extent
required, borrowings under the Credit Facility would be sufficient to fund its
remaining obligations and to meet its other anticipated capital requirements for
2000. As of March 31, 2000, the Company had $22.8 million of borrowings
outstanding under the Credit Facility, and approximately $7.2 million of
available borrowing capacity under the Credit Facility. An additional $5.0
million in availability under the Credit Facility became available
25
<PAGE> 26
during the second quarter of 2000. In the event the Company's estimates of
capital requirements are too low, and the Company does not have sufficient
availability under the Credit Facility or is unable to obtain alternate sources
of financing, the Company may be required to curtail its capital improvement and
telemarketing expansion plans. See "Note J--Financial Condition and Results Of
Operations."
During 1999, the Company paid off debt of approximately $6.7 million to
certain of its non-subordinated creditors. This increased on a dollar for dollar
basis the Company's availability under the Credit Facility, as these payments to
certain non-subordinated creditors were part of the amount totaling $6.8 million
reserved under the Credit Facility.
Operating Activities
Significant uses of cash in operating activities for the three months ended
March 31, 2000 include decreases in accounts payable of $1.5 million. Accounts
receivable increased by $1.5 million and prepaid expenses decreased by $628,000.
The Company also generated cash from operations by recording net income of
$121,000; $120,000 from recording a deferred income tax expense; $1.0 million in
certain non-cash expenses, principally depreciation and amortization and
$325,000 from recording the issuance of stock warrants, options and awards.
Significant uses of cash in operating activities for the year ended December
31, 1999 include decreases in accounts payable of $9.4 million. Accounts
receivable increased by $533,000 and prepaid expenses increased by $709,000. The
Company also generated cash from operations by recording net income of $1.9
million; $1.9 million from recording a deferred income tax expense; $3.0 million
in certain non-cash expenses, principally depreciation and amortization and
$727,000 from recording the issuance of stock warrants, options and awards.
Significant sources of cash in operating activities in 1998 include
decreases in accounts receivable of $2.7 million. Net non-cash expenses of $2.8
million, principally depreciation, amortization, impairment loss on fixed assets
and losses on other receivables significantly offset the net loss of $3.6
million incurred by the Company in 1998. The Company also generated cash from
operations of approximately $5.8 million by extending or delaying payments to
vendors.
Significant uses of cash in operating activities in 1997 included increases
in accounts receivable of $6.1 million. Net non-cash expenses of $874,000,
principally depreciation and amortization, offset the net loss of $341,000
incurred by the Company in 1997. The Company also generated cash from operations
of approximately $1.6 million by extending or delaying payments to vendors, and
$2.4 million in connection with the sale of certain of its accounts receivable.
Investing Activities
The Company's investing activities for the three months ended March 31, 2000
consisted primarily of property and equipment purchases of $1.2 million.
The Company's investing activities for the year ended December 31, 1999
consisted primarily of property and equipment purchases of $3.3 million offset
by proceeds of $522,000 from the sale of an asset held for disposal.
The Company's investing activities in 1998 consisted primarily of property
and equipment purchases of $353,000. Investments totaling $55,000, which had
been pledged as collateral for a loan in 1996, were released in 1998. Sources of
cash included repayments of advances made to related parties totaling $150,000.
The Company's investing activities in 1997 consisted primarily of property
and equipment purchases of $337,000 and a loan made to a related company in the
amount of $670,000. Investments totaling $85,000, which had been pledged as
collateral for a loan in 1996, were released in 1997.
Financing Activities
During the three months ended March 31, 2000, financing activities provided
$556,000 in cash. The most significant source of cash was an increase of $1.9
million in borrowings under the Company's Credit Facility. Other financing
activities included repayments to related parties totaling $319,000; other
repayments totaling $765,000 and loan closing fees of $322,000, for net use of
cash totaling $1.4 million.
26
<PAGE> 27
During the year ended December 31, 1999, financing activities provided $4.8
million in cash. The most significant source of cash was an increase of $12.9
million in borrowings under the Company's Credit Facility. Other financing
activities included borrowings from related parties totaling $262,000 and
repayments to related parties totaling $1.3 million, for net use of cash
totaling $1.0 million, and other borrowings totaling $2.6 million and repayments
totaling $9.2 million, for net use of cash totaling $6.6 million.
During the year ended December 31, 1998, financing activities used $6.4
million in cash. The most significant use of cash was a decrease of $2.9 million
in borrowings under the Company's various line of credit agreements.
Additionally, distributions paid to stockholders and redemption of Common Stock
also comprised the use of cash in financing activities, totaling $1.5 million in
1998. Other financing activities included borrowings from related parties
totaling $1.6 million and repayments to related parties totaling $3.1 million,
for net use of cash totaling $1.5 million, and other borrowings totaling
$400,000 and repayments totaling $748,000, for a net use of cash totaling
$348,000.
During the year ended December 31, 1997, financing activities provided $2.0
million in cash to the Company. The most significant source of cash was an
increase of $6.8 million in borrowings under the Company's various line of
credit agreements. Distributions paid to stockholders and redemptions of Common
Stock comprised the largest use of cash in financing activities, totaling $5.0
million in 1997. Other financing activities included borrowings from related
parties totaling $3.7 million and repayments to related parties totaling $4.4
million, for a net use of cash of $700,000, and other borrowings totaling $1.4
million and repayments totaling $500,000, for net proceeds of cash totaling
$900,000.
RECENT EVENTS
In July 1999, the Company launched a filtered family friendly Internet
access service nationwide and intends to market this service to both its
existing customers and new customers.
YEAR 2000 COMPUTER ISSUES
The year 2000 issue related to whether the Company's computer systems would
properly recognize date sensitive information due to the change in year 2000, or
"00". Systems that fail to properly recognize such information could generate
erroneous data or cause a system to fail.
To date, the Company has not experienced any significant problems as a
result of the commencement of the year 2000. There remains a possibility that
residual consequences stemming from the change to the year 2000 could occur and,
if these consequences become widespread, they could have a material adverse
effect on the Company's business, financial condition, cash flows and results of
operations. However, the Company considers this possibility remote and does not
anticipate any significant problems due to the year 2000 issue.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 129, "Disclosure of
Information about Capital Structure," which establishes standards for disclosing
information about an entity's capital structure and is effective for financial
statements for periods ending after December 15, 1997. In June 1997, the FASB
issued SFAS No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in the financial statements for fiscal years beginning after December 15, 1997.
The FASB also issued, in June 1997, SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
public companies disclose information about operating segments, products and
services, geographic areas and major customers. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. The Company
has determined that the impact on its financial statements of adopting SFAS Nos.
129, 130 and 131 is not material. In June 1998, the FASB issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for fiscal quarters ending after June 15, 1999. The effective date of
SFAS No. 133 was delayed to fiscal quarters ending after June 15, 2000, by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133", issued in June 1999.
The Company does not expect the adoption of SFAS No. 133 to have a material
impact on its financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is not exposed to market risk from changes in marketable
securities, as the Company has no such instruments.
27
<PAGE> 28
The Company is exposed to future earnings or cash flow fluctuations from
changes in interest rates on borrowings under the Credit Facility since amounts
borrowed under the Credit Facility accrue interest at a fluctuating rate equal
to the prime lending rate ("Prime") plus 3.5%. The outstanding balance of the
Company's borrowings under the Credit Facility at March 31, 2000 was $22.8
million. Market risk is estimated as the potential increase in interest rate
for borrowings under the Company's Credit Facility resulting from an increase
in Prime. Based on borrowings under the Credit Facility at March 31, 2000, a
hypothetical increase of 1.00% in Prime increases the Company's cost of
borrowings by approximately $228,000 annually. To date, the Company has not
entered into any derivative financial instruments to manage interest rate risk
and is currently not evaluating the future use of any such financial
instruments.
The Company's operations are all originated within the United States and
therefore conducts all business transactions in U.S. dollars.
ITEM 3. PROPERTIES
The Company's executive offices and substantially all of its operations are
located in over 45,000 square feet of leased office space in a 195,000 square
foot, 20-story office building owned by Hebron. The Company also operates a call
center in Tahlequah, Oklahoma and maintains offices in the States of Virginia
and Texas. The Company believes that these facilities are adequate for the
Company's intended activities for the foreseeable future.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information concerning the beneficial
ownership of Common Stock, $0.10 par value of the Company ("Common Stock"), as
of May 31, 2000, by (a) each person known by the Company to own beneficially
more than 5% of the outstanding Common Stock, (b) each director of the Company,
(c) each Named Executive Officer (as defined in Item 6 below) and (d) all
executive officers and directors as a group. The Company believes that each of
such stockholders has the sole voting and dispositive power over the shares held
by such stockholder except as otherwise indicated.
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS AND DIRECTORS:
SHARES OWNED
--------------------------
NAME NUMBER PERCENTAGE
---- ---------- ----------
<S> <C> <C>
Tracy C. Freeny (1) ......................... 155,183 18.8
Stephen D. Halliday (2) ..................... 9,490 1.1
Kerry A. Smith .............................. -- --
David E. Grose .............................. -- --
John B. Damoose (3) ......................... 2,675 --
Jay A. Sekulow (4) .......................... 42,453 5.1
All Executive Officers and Directors as
A Group (8 Persons) (1)(2)(3)(4) ........ 209,801 25.4
OTHER 5% STOCKHOLDERS:
Sharon Freeny (5) ........................... 155,183 18.8
Harvey Price (6) ............................ 50,000 6.0
Donald Price (7) ............................ 50,000 6.0
</TABLE>
----------
(1) Includes 152,983 shares held jointly by Mr. Freeny and his wife and 2,200
shares held by Mr. Freeny's minor son. Mr. Freeny disclaims beneficial
ownership of the shares owned by his minor son. Mr. Freeny's address is
6220 N.E. 113th Street, Edmond, Oklahoma 73034.
(2) Includes 6,824 shares subject to options held by Mr. Halliday and 2,666
shares which Mr. Halliday and/or CASE has the option to purchase from Mr.
Thompson. Additionally, the Company is obligated to grant to Mr. Halliday
on July 1, 2000, shares which represent 0.5% of the fully diluted
outstanding Common Stock on such date, in connection with his service on
the Board of Directors of the Company, which shares are not included here
in this total and are subject to forfeiture pursuant to the terms of the
Halliday Employment Agreement (as defined herein).
(3) Includes 2,275 shares subject to options held by Mr. Damoose and 400 shares
subject to warrants to be issued to Mr. Damoose. Additionally, the Company
is obligated to grant to Mr. Damoose on July 1, 2000, shares which
represent 0.5% of the fully diluted outstanding Common Stock on such date,
in connection with his service on the Board of Directors of the Company,
which shares are not included here in this total and are subject to
forfeiture pursuant to the terms of the Stock Agreement (as defined
28
<PAGE> 29
herein). Mr. Damoose also has the option to acquire shares upon the
conversion of the Damoose Note (as defined herein), however, the number of
shares issuable upon conversion cannot be determined because the conversion
price is not currently ascertainable. The Damoose Note is convertible at
any time into shares of Common Stock, at the option of Damoose, at per
share price equal to the lower of (x) the fair market value of the Common
Stock on January 1, 1998, as determined by an appraisal, or (y) the lowest
publicly traded price of the Common Stock three months following the
establishment of a public trading market for the Common Stock.
(4) Includes 6,824 shares subject to options held by Mr. Sekulow; 2,666 shares
which C.A.S.E., Inc. ("CASE") and/or Mr. Halliday has the option to
purchase from Mr. Thompson; 3,400 shares subject to warrants to be issued
to CASE, an entity of which Mr. Sekulow is President and a director and
29,563 shares held by CASE. Additionally, the Company is obligated to grant
to Mr. Sekulow on July 1, 2000, shares which represent 0.5% of the fully
diluted outstanding Common Stock on such date, in connection with his
service on the Board of Directors of the Company, which shares are not
included here in this total and are subject to forfeiture pursuant to the
terms of the Stock Agreement (as defined herein). CASE also has the right
to acquire shares upon the conversion of the CASE Note (as defined herein),
however, the number of shares issuable upon conversion cannot be determined
because the conversion price is not currently ascertainable. The CASE Note
is convertible at any time into shares of Common Stock, at the option of
CASE, at per share price equal to the lower of (i) the fair market value of
the Common Stock on January 1, 1998, as determined by an appraisal, or (ii)
the lowest publicly traded price of the Common Stock three months following
the establishment of a public trading market for the Common Stock.
(5) Includes 152,983 shares held jointly by Ms. Freeny and her husband and
2,200 shares held by Ms. Freeny's minor son. Ms. Freeny disclaims
beneficial ownership of the shares owned by her minor son. Ms. Freeny's
address is 6620 N.E. 113th Street, Edmond, Oklahoma 73034.
(6) Harvey Price's address is Route 1, Box 49D, Wetomka, Oklahoma 74883.
(7) Donald Price's address is Route 2, Box 46, Holdenville, Oklahoma 74848.
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information concerning the executive
officers and directors of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Tracy C. Freeny .............. 55 Chairman of The Board
Stephen D. Halliday .......... 51 President, Chief Executive Officer and Director
David E. Grose ............... 47 Vice President and Chief Financial Officer
Kerry A. Smith ............... 38 Vice President
John B. Damoose .............. 53 Director
Jay A. Sekulow ............... 44 Director
</TABLE>
Tracy C. Freeny is a founder of the Company and has served as Chairman of
the Board since the formation of the Company in May 1991 and served as President
from such time until October 1998. As Chairman of the Board, Mr. Freeny not only
performs traditional Chairman of the Board duties but also assists the Company's
relationship with the non-profit organizations and its shareholders. From 1970
until 1990 Mr. Freeny operated a life insurance agency affiliated with Phoenix
Mutual Life Insurance Company and is a lifetime member of the life insurance
industry Million Dollar Roundtable. In 1990, Mr. Freeny went to work for
AmeriTel Communications, Inc. ("AmeriTel") a reseller of long distance telephone
services and in 1991 acquired the assets of AmeriTel to begin the Company. Mr.
Freeny graduated from Oklahoma State University with a bachelor of arts degree
in finance. In July 1998, Mr. Freeny agreed to a cease and desist order issued
by the Securities and Exchange Commission regarding the violation of various
federal securities laws. For more information regarding this order, see Item 8
below.
Stephen D. Halliday has been the President, Chief Executive Officer and a
director of the Company since October 1998. From 1980 until 1997, Mr. Halliday
was a partner with Coopers & Lybrand LLP (which is now PricewaterhouseCoopers
LLP) and from 1997 until October 1998 he was a partner in the law firm of Wiley,
Rein & Fielding ("WRF") in Washington, D.C. He continues to serve as of counsel
with WRF for matters, which do not involve the Company. Mr. Halliday graduated
from Duke University with
29
<PAGE> 30
bachelor of arts degree in accounting, William & Mary University with a law
degree and Georgetown University with a masters of law degree in taxation.
David E. Grose has been a Vice President and the Chief Financial Officer of
the Company since April 1999. From July 1997 through April 1999, Mr. Grose
served as Vice President and Chief Financial Officer of Bayard Drilling
Technologies, Inc., formerly a publicly traded oil and gas company. Prior to
that Mr. Grose was affiliated with Alexander Energy Group from its inception in
March 1980, serving from 1987 through 1996 as a director and Vice President,
Treasurer and Chief Financial Officer. In August 1996, National Energy Group
acquired Alexander Energy Corporation and he served as Vice President of Finance
and Treasurer through February 1997. Mr. Grose graduated from Oklahoma State
University with a bachelor of arts degree in political science and University of
Central Oklahoma with a masters degree in business administration.
Kerry A. Smith has been a Vice President of the Company since December 1998.
Most recently he served as the Telecom/Infocom Practice Director for
PricewaterhouseCoopers LLP in Dallas, Texas, and has extensive product-marketing
experience with MCI WorldCom. Mr. Smith has more than 15 years experience in the
telecommunications industry holding key senior staff and management positions.
His resume includes key positions managing global alliance partners in Canada,
Latin America, Mexico, and Great Britain developing strategic business plans and
launching new products and services. Mr. Smith graduated from Capitol College
with a bachelor of science in telecommunication engineering technology.
John B. Damoose has been a director of the Company since October 1998.
Since, May 1997 Mr. Damoose has been President of two non-profit organizations,
Religious Heritage of America Foundation and Freedom of Ministries of America.
Prior to that, from May 1996 until May 1997, he served as President of the
Christian Broadcasting Network and from November 1993 until May 1996 he served
as Senior Vice President - Marketing and Communications for International Family
Entertainment. Mr. Damoose also held various management positions with Chrysler
Corporation from November 1982 through November 1993, most recently serving as
Vice President of Worldwide Marketing. Mr. Damoose graduated from the University
of Michigan with a bachelor of science degrees in economics/political science
and Columbia University with a masters degree in business administration.
Jay A. Sekulow has been a director of the Company since October 1998. Mr.
Sekulow is an attorney and has been Chief Counsel of the American Center for Law
and Justice, a non-profit public interest law firm ("ACLJ") since 1992. He has
also been, since 1995, Chief Executive Officer of Regency Productions, Inc.
("Regency"), a radio production company which produces a thirty-minute daily
radio program on legal issues hosted by Mr. Sekulow and, since 1987, President
and a Director of CASE, a non-profit public interest law firm. Mr. Sekulow
graduated cum laude from Mercer University with both a bachelor of arts degree
in history and law degree.
BOARD OF DIRECTORS MATTERS
All directors hold offices until the next annual meeting of the shareholders
and until their successors have been duly elected and qualified. Each officer
serves at the discretion of the Board of Directors, subject to the terms of
certain employment agreements described below.
The Board of Directors has established an Audit Committee and a
Compensation/Nominating Committee. The Audit Committee is composed of Messrs.
Sekulow and Damoose, with Mr. Damoose serving as Chairman. The Audit Committee
is responsible for (a) reviewing the scope of, and the fees for, the annual
audit of the Company, (b) reviewing with the independent auditors the Company's
accounting practices and policies, (c) reviewing with the independent auditors
their final report, (d) reviewing with internal and independent auditors overall
accounting and financial controls and (e) being available to the independent
auditors for consultation purposes.
The Compensation/Nominating Committee is composed of Messrs. Sekulow and
Damoose, with Mr. Sekulow serving as Chairman. The Compensation/Nominating
Committee is responsible for reviewing the Company's policies with respect to
the compensation of its officers at the Vice President level or higher,
including the basis of the compensation of its chief executive officer and its
relationship to corporate objectives and identifying and nominating future
nominees as members of the Board of Directors.
The Board of Directors has also adopted a policy statement on conflict of
interest transactions, which requires that all proposed conflict of interest
transactions be approved by a majority of directors who will receive no benefit
from the transaction.
30
<PAGE> 31
ITEM 6. EXECUTIVE COMPENSATION
The following table summarizes the compensation paid the Company's chief
executive officer and vice president of the Company for services rendered in
1998 and 1999 (collectively, the "Named Executive Officers"). See Item 7 below
for a description of transactions involving Mr. Halliday and the directors of
the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG TERM COMPENSATION
---------------------------- -----------------------------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS/SARS(#) COMPENSATION($)
--------------------------- ---- --------- -------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Stephen D. Halliday, President and
Chief Executive Officer ................ 1999 $450,000 $50,000 27,296 --
1998 $128,462 -- -- $127,500(1)
Kerry A. Smith, Vice President ......... 1999 $215,000 $50,000 -- --
1998 $ 17,917 -- -- --
</TABLE>
(1) These amounts represent payments made to Mr. Halliday prior to his becoming
the Company's President and Chief Executive Officer.
The following table sets forth the information regarding the options granted to
the Chief Executive Officer of the Company in 1999:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF STOCK PRICE
INDIVIDUAL GRANTS APPRECIATION FOR OPTION TERM
---------------------------------------------------- ------------------------------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS/SARS EXERCISE
UNDERLYING GRANTED TO OR BASE
OPTIONS/SARS EMPLOYEE IN PRICE EXPIRATION
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE 0% 5% 10%
<S> <C> <C> <C> <C> <C> <C> <C>
Stephen D. Halliday............. 6,824 25% $28.86 July 1, 2004 $86,255 $164,497 $259,149
6,824 25% $28.86 July 1, 2005 $86,255 $182,569 $304,758
6,824 25% $28.86 July 1, 2006 $86,255 $201,545 $354,928
6,824 25% $28.86 July 1, 2007 $86,255 $221,469 $410,115
</TABLE>
HALLIDAY EMPLOYMENT AGREEMENT
Effective as of May 24, 1999 (the "Commencement Date"), the Company entered
into an amended and restated employment agreement (the "Halliday Employment
Agreement") with Stephen D. Halliday, President, Chief Executive Officer and a
director of the Company. The initial term of the Halliday Employment Agreement
is for five years, with automatic one-year extensions. Pursuant to the Halliday
Employment Agreement, Mr. Halliday initial received an annual salary of $450,000
which was increased to $600,000 on October 1, 1999, subject to annual review by
the board of directors of the Company, which shall increase his salary at the
annual consumer price index rate of increase and may further increase but not
decrease such salary at the board of directors discretion. Also, on October 1,
1999, Mr. Halliday received a one-time bonus of $100,000. Mr. Halliday is also
entitled to receive various medical, dental and group insurance, pension and
other retirement benefits, disability and other benefit plans and vacation as
the Company makes available to its senior executive officers. Mr. Halliday may
be terminated in the event of his disability, for cause (as defined in the
Halliday Employment Agreement) or without cause and Mr. Halliday may terminate
his employment for good reason (as defined in the Halliday Employment Agreement,
which includes any termination of Mr. Halliday's employment by the Company other
than for cause and any change of control of the Company). If Mr. Halliday is
terminated for cause or without cause (subject to the right of Mr. Halliday to
terminate his employment for good reason) because of his death, he or his
estate, as the case may be, will receive his salary and other benefits accrued
as of the date of termination or death. If Mr. Halliday's employment is
terminated as a result of his disability, Mr. Halliday will receive his salary
and other benefits accrued as of the date of disability and 60% of his base
salary for the period of disability but not exceeding the remaining term of the
Halliday Employment Agreement. If Mr. Halliday terminates his
31
<PAGE> 32
employment for good reason, he is entitled to continue to receive his base
salary for the remaining term of the Halliday Employment Agreement and, in
addition, all his Common Stock and options to purchase Common Stock will
continue to vest and he will receive upon each vesting date a cash bonus which
will equal all taxes payable by Mr. Halliday as a result of the vesting of the
Common Stock and the payment of this bonus. If the Company intends to terminate
Mr. Halliday's employment without cause, it must give him notice and he is
entitled to terminate his employment for good reason.
Pursuant to the Halliday Employment Agreement, as of July 1, 2000, the
Company will issue Mr. Halliday shares of Common Stock equal to 0.5% of the
fully diluted outstanding Common Stock on such date, subject to certain vesting
requirements. This issued stock vests as follows: 50% of the shares will vest on
July 1, 2000 and 25% of the shares will vest on each July 1 thereafter. If Mr.
Halliday fails to serve as an officer of the Company all unvested shares will be
forfeited unless Mr. Halliday terminated his employment for good reason.
Additionally, Mr. Halliday is to receive a cash bonus after any portion of these
shares vests that will equal all taxes payable by him as a result of the vesting
and the payment of this bonus.
The Halliday Employment Agreement also granted Mr. Halliday two options to
purchase shares of Common Stock. The first option effective as of the
Commencement Date granted Mr. Halliday options to purchase 27,296 shares (3% of
fully diluted outstanding Common Stock as of such date) at $28.86 per share (the
fair value of the Common Stock as of February 1, 1998, as was determined by a
third party appraiser) (the "Exercise Price"). These options are subject to the
following vesting schedule: 25% of the options vested on July 1, 1999 and 25% of
the options vest on each July 1 thereafter. The second option, which will be
effective three years after the Commencement Date, will entitle Mr. Halliday to
purchase 2% of the fully diluted outstanding Common Stock as of such date at the
Exercise Price plus 25%. The second option vests as follows: 50% of the options
vest four years after the Commencement Date and 50% of the options vest five
years after the Commencement Date. If Mr. Halliday fails to serve as an officer
of the Company, unless he terminated his employment for good reason, the vesting
will immediately cease; however, Mr. Halliday can exercise all vested options
after such time until the termination of the options. All of these options will
vest upon any sale of the Company. Once an option to purchase shares has vested
it will remain exercisable for five years from such vesting date.
Tracy Freeny also individually agreed that for as long as Mr. Halliday is
employed by the Company to vote all of his shares of Common Stock for Mr.
Halliday and for a period of five years from the Commencement Date for each of
the other current directors of the Company for election to the board of
directors of the Company. Also, pursuant to an employment agreement, which was
replaced by the Halliday Employment Agreement, Carl Thompson agreed to vote for
Messrs. Halliday, Damoose and Sekulow's election to the board of directors of
the Company. In June 1999, Mr. Thompson executed an agreement pursuant to which
he agreed to honor his agreements contained in such prior employment agreement.
SMITH EMPLOYMENT AGREEMENT
Effective as of December 31, 1998 (the "Effective Date"), the Company
entered into an employment agreement (the "Smith Employment Agreement") with
Kerry A. Smith, a Vice President of the Company. The initial term of the Smith
Employment Agreement is for two years, with automatic one-year extensions
subject to 90 days notification prior to the extension if the Company elects to
not renew his agreement. Pursuant to the Smith Employment Agreement, Mr. Smith
receives an annual base salary of $215,000 and a bonus of $50,000. Both Mr.
Smith's annual base salary and guaranteed bonus are subject to review after the
initial term of the Smith Employment Agreement and may, at the Company's
discretion, be adjusted from time-to-time according to Mr. Smith's
responsibilities, capabilities, performance and other criteria deemed
appropriate by the Company. Mr. Smith is entitled to receive various medical,
dental and group insurance, pension and other retirement benefits, disability
and other benefit plans and vacation as the Company makes available to its
senior executive officers. The Company may also terminate this Agreement at any
time during the initial term and for any reason whatsoever upon ninety (90)
days' notice to Mr. Smith. If the Company notifies Mr. Smith of its election to
terminate Mr. Smith before the first anniversary of the Effective Date, Mr.
Smith shall be entitled to receive severance pay equal to six (6) months pay
(and payable in a lump sum or over the course of such period, at the option of
the Company) and health insurance for such period. If the Company notifies Mr.
Smith of its election to terminate Mr. Smith between the first anniversary of
the Effective Date and the second anniversary of the Effective Date, Mr. Smith
shall be entitled to receive severance pay equal to four (4) months pay and
health insurance for such period. Severance pay shall be payable in a lump sum
or over the course of the period covered, at the option of the Company. In
addition to the amounts set forth in the previous two sentences, upon
termination Mr. Smith is entitled to receive a share of the bonus pro rated from
the beginning of the fiscal year in which the termination occurs to the date of
the termination notice. Severance pay after the initial term shall be subject to
negotiation between Mr. Smith and the Company.
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<PAGE> 33
FREENY EMPLOYMENT AGREEMENT
Effective as of the Commencement Date, the Company entered into an
employment agreement (the "Freeny Employment Agreement") with Tracy C. Freeny;
Chairman of the Board of the Company, as consideration for the additional
services Mr. Freeny performs for the Company. The initial term of the Freeny
Employment Agreement is for five years, with automatic one-year extensions.
Pursuant to the Freeny Employment Agreement, Mr. Freeny receives an annual
salary of $300,000, subject to annual review by the board of directors of the
Company, which shall increase his salary at the annual consumer price index rate
of increase and may further increase but not decrease such salary at the board
of directors discretion. Mr. Freeny is also entitled to receive various medical,
dental and group insurance, pension and other retirement benefits, disability
and other benefit plans and vacation as the Company makes available to its
senior executive officers. Mr. Freeny may be terminated in the event of his
disability, for cause (as defined in the Freeny Employment Agreement) or without
cause and Mr. Freeny may terminate his employment for good reason (as defined in
the Freeny Employment Agreement, which includes any termination of Mr. Freeny's
employment by the Company other than for cause and any change of control of the
Company). If Mr. Freeny is terminated for cause or without cause (subject to the
right of Mr. Freeny to terminate his employment for good reason) because of his
death, he or his estate, as the case may be, will receive his salary and other
benefits accrued as of the date of termination or death. If Mr. Freeny's
employment is terminated as a result of his disability, Mr. Freeny will receive
his salary and other benefits accrued as of the date of disability and 60% of
his base salary for the period of disability but not exceeding the remaining
term of the Freeny Employment Agreement. If Mr. Freeny terminates his employment
for good reason, he is entitled to continue to receive his base salary for the
remaining term of the Freeny Employment Agreement and, in addition, one year
following the date of his termination. If the Company intends to terminate Mr.
Freeny's employment without cause, it must give him notice and he is entitled to
terminate his employment for good reason. Pursuant to a separate written
agreement, Mr. Freeny has agreed to defer certain accrued distributions owed to
him by the Company. See Item 7 - Certain Relationships and Related Transactions
- Transactions with Messrs. Freeny and Thompson.
TELLING AGREEMENTS
Effective as of the Commencement Date, the Company entered into an
employment agreement (the "Telling Employment Agreement") with John E. Telling,
a former director of the Company and former executive of the Internet department
of the Company. The initial term of the Telling Employment Agreement was for
five years, with automatic one-year extensions. Pursuant to the Telling
Employment Agreement, Mr. Telling was to receive an annual salary of $250,000,
subject to annual review by the board of directors of the Company. Mr. Telling
was also entitled to receive various medical, dental and group insurance,
pension and other retirement benefits, disability and other benefit plans and
vacation as the Company made available to its senior executive officers.
Pursuant to the Telling Employment Agreement, as of the Commencement Date,
the Company issued Mr. Telling 9,099 shares of Common Stock (1.0% of the fully
diluted outstanding Common Stock on such date) (the "Restricted Shares"),
subject to certain vesting requirements. The Telling Employment Agreement also
granted Mr. Telling options to purchase 27,296 shares (3% of fully diluted
outstanding Common Stock as of such date) ("Options") at the Exercise Price,
which were to vest over time. These Options were granted subject to the
following vesting schedule: 25% of the shares vested on July 1, 1999 and 25% of
the shares vest on each July 1 thereafter.
Effective as of December 31, 1999, Mr. Telling resigned as a director and
employee of the Company and in connection with such resignation the Company and
Mr. Telling entered into a letter agreement (the "Resignation Agreement"). The
Resignation Agreement provides that Mr. Telling will receive monthly payments
totaling $500,000 in 2000 and $250,000 per year from January 1, 2001 until May
1, 2004. Also, the Resignation Agreement provides (a) that the Restricted Shares
immediately vested and the Company paid Mr. Telling a cash bonus equal to all
taxes payable by him as a result of the vesting and the payment of the bonus and
(b) the Options remain in effect and will become exercisable on the terms
provided in the Telling Employment Agreement. The Resignation Agreement also
provided for a mutual release between Mr. Telling and the Company and Mr.
Telling agreed to certain non-competition covenants.
STOCK AGREEMENTS
Each of Jay A. Sekulow and John B. Damoose, directors of the Company, have
entered into amended and restated stock agreements with the Company (the "Stock
Agreements"). The Stock Agreements are also effective as of the Commencement
Date and provide that the party thereto (the "Party") shall receive certain
compensation for his agreement to serve and continued service as a director of
the Company. On July 1, 2000, the Company shall be obligated to issue each Party
shares of Common Stock equal to 0.5% of fully diluted outstanding Common Stock
on such date, subject to vesting. This issued stock vests as follows: 50% of the
shares will vest on July 1, 2000 and 25% of the shares vest on each July 1
thereafter. If a Party fails for any reason to serve as a director, all unvested
shares will be forfeited. Additionally, each Party is to receive a cash bonus
after any portion of these shares vests that will equal all taxes payable by the
Party as a result of the vesting and the payment of this bonus.
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<PAGE> 34
The Stock Agreements also grant each Party options to purchase a certain
number of shares of Common Stock at the Exercise Price. Messrs. Sekulow and
Damoose received options to purchase 27,296 shares (3.0% of fully diluted
outstanding Common Stock as of such date) and 9,099 shares (1.0% of fully
diluted outstanding Common Stock on such date), respectively. These options are
subject to the following vesting schedule: 25% of the options vested on July 1,
1999 and 25% of the options vest on each July 1 thereafter. If a Party ceases to
serve as a director, the vesting will immediately cease; however, the Party can
exercise all vested options after such time until the termination of the
options. All of the options will vest upon any sale of the Company. Once an
option to purchase shares has vested it will remain exercisable for five years
from such vesting date.
Tracy Freeny also individually agreed for a period of five years from the
execution of such agreement to vote all of his shares of Common Stock for the
Party for election to the board of directors of the Company. Also pursuant to a
stock agreement with Mr. Sekulow which was replaced by the Stock Agreement, Carl
Thompson agreed to vote for Messrs. Halliday, Damoose and Sekulow's election to
the board of directors of the Company. In June 1999, Mr. Thompson executed an
agreement pursuant to which he agreed to honor his agreements contained in such
prior agreement.
SEPARATION AGREEMENT WITH CARL THOMPSON
In April 1998, Mr. Thompson resigned as Senior Vice President and director
of the Company. In connection with such resignation, the Company and Mr.
Thompson entered into an agreement pursuant to which Mr. Thompson will receive
(a) $40,000 a month until all accrued and unpaid distributions ($995,952 as of
the date of the agreement) have been paid, all of which amounts have been paid
as of March 31, 2000 and (b) $20,000 a month for the remainder of his life so
long as Mr. Thompson does not take any action significantly detrimental to the
Company. The agreement also contains certain non-competition provisions, which
Mr. Thompson was required to comply with until April 1999.
STOCK INCENTIVE PLAN
The Board of Directors has approved a 1999 Stock Incentive Plan (the
"Plan") relating to up to 40,000 shares of Common Stock of the Company
("Shares"). The Plan permits the granting of stock options to employees,
directors and consultants, and includes additional features (such as restricted
shares and stock appreciation rights), described in more detail below, that
enhance the flexibility of the Company in hiring, retaining and motivating key
individuals. The Plan provides that it shall be administered by the compensation
committee of the Board of Directors of the Company (the "Committee"). The Plan
may be amended without shareholder approval, except as specified in the Plan.
Pursuant to the Plan, the Company may from time to time grant to employees,
directors and consultants of the Company and its affiliates, Shares, options to
purchase Shares ("Options"), and stock appreciation rights. Shares issued under
the Plan shall be restricted shares which are subject to cancellation upon such
terms and conditions as may be determined by the Company.
Options under the Plan may be either incentive stock options which receive
special tax treatment or non-qualified options which do not receive such special
tax treatment. Incentive stock options will expire not more than ten years from
the date of grant. In addition, it is expected that non-qualified options will
generally expire not more than ten years from the date of grant.
The purchase price per Share to be specified in each Option granted under
the Plan may not be less than the fair market value of a share of Common Stock
of the Company on the date the Option is granted. The Plan permits the
adjustment of outstanding Options to accommodate for mergers, acquisitions and
other events, and to specify a lower purchase price, through amendment of
outstanding options or through cancellation of outstanding options and the grant
of replacement options.
The Plan permits the Company to provide that payment of the purchase price
upon exercise of options may be made in cash, shares owned by the optionee, any
other lawful form of consideration or a combination thereof, in each case
acceptable to the Committee. Any shares received by the Company in payment of
the purchase price will be valued at their fair market value on the date of
exercise.
Stock appreciation rights may be granted in tandem with options or may be
free-standing. The terms of stock appreciation rights may be amended from time
to time by the Committee. Payment to participants upon the exercise of stock
appreciation rights will generally be made in cash or in shares (such shares to
be valued at their fair market value on the date of exercise of the stock
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<PAGE> 35
appreciation rights). Tandem stock appreciation rights may be granted at the
time a grant is made under the Plan or added to outstanding grants, provided
that in the case of stock appreciation rights granted in tandem with incentive
stock options, such grant may only be made at the time of the grant of the
incentive stock option.
The Committee has approved grants of Options to purchase up to 25,500 Shares
effective July 1, 2000, of which Options to purchase 3,000 Shares and 1,500
Shares will be issued to Mr. Smith and Mr. Grose, respectively. No options will
be exercisable prior to shareholder approval of the Plan.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH MESSRS. FREENY AND THOMPSON
During 1995, 1996, 1997 and 1998, the Company repaid certain amounts owed by
the Company to Messrs. Freeny and Thompson and Mrs. Thompson. The following
table sets forth the terms of such loans and the repayment status of those loans
(each of these Loans bore interest at 8% per annum):
<TABLE>
<CAPTION>
DATE PAYEE ORIGINAL PRINCIPAL AMOUNT MATURITY DATE PAYMENT STATUS
---- ----- ------------------------- ------------- --------------
<S> <C> <C> <C> <C>
June 1, 1995 Carl Thompson $ 100,000 May 31, 1997 paid in full at maturity
August 31, 1995 Willeta Thompson 658,813 August 31, 1997 paid in full in March 1998
September 30, 1995 Tracy Freeny 318,134 September 30, 1997 paid in full at maturity
October 31, 1995 Tracy Freeny 962,120 October 31, 1997 paid in full at maturity
November 30, 1995 Tracy Freeny 29,765 November 30, 1997 paid in full at maturity
December 31, 1995 Tracy Freeny 9,399 December 31, 1997 paid in full at maturity
March 31, 1996 Tracy Freeny 343,501 March 31, 1998 paid in full at maturity
October 23, 1996 (1) Tracy Freeny 345,000 demand note paid in full in May 1997
</TABLE>
----------
(1) This loan was not in connection with the sale of stock by the payee.
In 1995 and 1996, Tracy Freeny, at that time President of the Company; Carl
Thompson, at that time Senior Vice President of the Company; and Willeta
Thompson, Mr. Thompson's wife sold 21,204 shares of Company stock that they
owned to 100 individuals at an aggregate price of approximately $2,480,000. The
selling price ranged from $40 per share to $150 per share averaging $117 per
share. The former officers and the spouse then loaned the proceeds of the sale
of the stock to the Company. The loans carried an interest rate of 8% per annum,
and matured two years from the date of issuance. The Company repaid these loans
in 1997 and 1998, and all such notes have been repaid in full as of December 31,
1999.
Concurrently with these sales of stock the Company also entered into stock
redemption agreements with the purchasers thereof (see Note H for a description
of the redemption agreements). Through December 31, 1999, the Company has
redeemed 5,278 shares and paid a total of $1,060,000 in connection with these
redemptions. The amounts paid consisted of $790,000 for the amounts paid by the
stockholders and $270,000 for the specified rate of return, as described in the
agreements.
In December 1997 Mr. Thompson borrowed $400,000 from a shareholder of the
Company and subsequently loaned all of the proceeds therefrom to the Company.
Mr. Thompson then directed the Company to make all payments in respect of his
loan, to the Company, to the shareholder in satisfaction of his loan to Mr.
Thompson. This loan bore interest at an imputed rate of 51% based on repayment
of the loan in 10 monthly payments of $50,000. This loan has been paid in full.
Additionally, during 1996, 1997 and 1998, Messrs. Freeny and Thompson and
Tom Anderson, Mr. Thompson's son-in-law, periodically made short-term,
non-interest bearing loans to the Company for working capital that remained
outstanding from one day to up to three months. The following table sets forth
the amounts advanced and repaid during such periods:
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<TABLE>
<CAPTION>
1996 1997 1998
PARTY LOANS REPAYMENTS LOANS REPAYMENTS LOANS REPAYMENTS
----- ----- ---------- ----- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C>
Tracy Freeny $ 845,000 $ 500,000 $ 601,000 $ 946,000 $497,824 $ 400,000
Carl Thompson 155,000 155,000 120,000 120,000 -- --
Tom Anderson 120,000 120,000 -- -- -- --
</TABLE>
Each of Messrs. Freeny and Thompson is a founder of the Company and acquired
his original shares of Common Stock upon formation of the Company without
payment of cash consideration. These shares represent a majority of the shares
of Common Stock owned by each of them. During 1995, 1996 and 1997, the Company
paid distributions to all shareholders except Messrs. Freeny and Thompson. As to
them, the Company accrued distributions of $849,118, $1,659,443 and $1,260,343,
respectively, to Mr. Freeny and accrued distributions of $301,827, $582,459 and
$433,010, respectively, to Mr. Thompson on their shares of Common Stock. These
distributions were accrued on the same per share basis as paid to all other
shareholders of the Company. As of December 31, 1999, the Company's financial
statements reflect outstanding non-interest bearing accrued distributions
payable to Messrs. Freeny and Thompson of $3,200,000 and $337,500, respectively.
The Company began paying Mr. Thompson monthly installments of $40,000 towards
these accrued but unpaid distributions in connection with his separation
agreement with the Company. Pursuant to a letter agreement entered into in July
1999, the Company deferred payment to Mr. Freeny of his accrued distributions
and Mr. Freeny agreed to such deferment until such time as the Company's
financial condition improved and it has funds available, legally and in good
business practice, to pay any such accrued distributions. In consideration for
this deferral, Mr. Freeny's subordination of the accrued distributions to the
Coast Loan and certain other acts performed by Mr. Freeny while President of the
Company which were outside of the customary responsibilities of an officer such
as personally guaranteeing debt, the Company will pay him, in addition to his
salary, $300,000 per year until the payment of the accrued distributions is
resumed and, if resumed, all amounts paid to Mr. Freeny pursuant to this
agreement shall be credited against his accrued distributions. The Company
agreed to seek a determination of the propriety of paying the accrued
distributions no later than December 31, 2001. In January 1995, the Company
redeemed 2,140 shares of Common Stock for $214,164 from Mr. Freeny and 250
shares of Common Stock for $25,000 from Mr. Thompson.
From 1996 to 1998, Messrs. Freeny and Thompson received sales commissions
from the Company, which were based on the amount of revenue the Company derived
from certain customers. The total amount of commissions was 5% of the revenue
generated from all customers of the Company for which no other sales agent or
representative of the Company was receiving a commission. The total commissions
from such sales were split evenly among Messrs. Freeny, Thompson and a third
employee. In 1996, 1997 and 1998, commissions paid to Messrs. Freeny and
Thompson were $228,176 and $228,176; $238,195 and $231,314; and $246,111 and
$85,004, respectively.
TRANSACTIONS WITH VISIONQUEST
The Company, Messrs. Freeny and Thompson and Shawn Rohrer, Mr. Freeny's
son-in-law, to outsource substantially all of the Company's telemarketing
service requirements formed VisionQuest in March 1993. Messrs. Freeny and
Thompson served as directors and officers of VisionQuest and Mr. Rohrer is the
President and a director of VisionQuest. Effective January 1, 1999, pursuant to
various written agreements, the Company and VisionQuest terminated their
business relationship. The Company purchased from VisionQuest the rights to use
all of VisionQuest's assets related to its call center located in Tahlequah,
Oklahoma through December 1999 ("Tahlequah Assets") for the following
consideration (i) 1,099,850 shares of common stock of VisionQuest, which
represented approximately 48% of the outstanding stock of VisionQuest (397,100
of these shares were owned by the Company and 702,750 of these shares were owned
by Tracy Freeny which he conveyed to the Company for no consideration
immediately prior to the consummation of this transaction) and (ii) cancellation
of all remaining amounts owed by VisionQuest to the Company pursuant to a
promissory note dated December 31, 1997 in the original principal amount of
$670,000 ($520,000 was owed as of the effective date of the transaction). Also,
in connection with and as consideration for the transaction, each of the Company
and VisionQuest executed mutual releases related to all prior dealings between
the parties including all contracts or obligations between the two parties.
The Company believes that the terms of its above-described transaction with
VisionQuest were fair and in the best interests of the Company for the following
reasons: (i) the value of the stock of VisionQuest was low because VisionQuest
would no longer have the Company's telemarketing business, which represented a
substantial portion of VisionQuest's business, (ii) the $520,000 obligation
which was forgiven was a rate reduction given by VisionQuest to the Company in
anticipation of a proposed business combination between the two entities and
those plans were discontinued, and (iii) the Company determined it needed to
establish a core telemarketing business and could use the Tahlequah Assets to
begin establishing its own telemarketing center, which the Company believed it
could operate on a more cost-effective basis than through its prior relationship
with VisionQuest. With the opening of the Company's new call center in
Tahlequah, telemarketing operations on a more cost-effective basis have been
achieved.
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<PAGE> 37
The Company compensated VisionQuest for its service through variety of
arrangements including commissions, hourly fees and overhead and expense
reimbursements. In 1995, 1996, 1997 and 1998, the Company's total payments to
VisionQuest were $11,103,000, $8,987,000, $5,274,000 and $6,209,000,
respectively, which resulted in the Company paying VisionQuest an effective
hourly rate of $36, $31, $33 and $50, respectively, in those years. The Company
believes that VisionQuest charged the Company a higher rate for its services
than it charged independent third parties and higher than the Company could have
obtained in an arms-length transaction with an unaffiliated third party that
provides the same telemarketing services.
Mr. Freeny received compensation from VisionQuest in 1995, 1996 and 1997
totaling approximately $303,600, $414,000 and $6,500, respectively; Mr. Thompson
received compensation from VisionQuest in 1995, 1996 and 1997 totaling
approximately $292,000, $378,000 and $5,800, respectively; and Mr. Rohrer
received compensation from VisionQuest in 1995, 1996 and 1997 totaling
approximately $367,000, $503,000, and $590,000, respectively. In January 1997
all compensation paid to Messrs. Freeny and Thompson from VisionQuest was
permanently discontinued.
Periodically during 1997 and 1998, VisionQuest made short-term working
capital loans to the Company. These loans ranged from $50,000 to $100,000, did
not bear interest and were repaid within three to five business days. All of
these loans have been paid in full.
In connection with its telemarketing services, VisionQuest utilized the
Company's telecommunication services and paid the Company's out-of-pocket
expenses for such services. In 1995, 1996, 1997 and 1998, VisionQuest paid the
Company approximately $930,000, $1,030,000, $788,000 and $1,001,000 for
telecommunication services.
TRANSACTIONS WITH HEBRON
Hebron was formed in December 1995 to provide certain telecommunications
services to the Company. Hebron's primary assets consisted of various equipment
and leases for equipment utilized in telecommunications switching network
services ("Switching Assets"), a 20-story, 195,000 square foot office tower in
Oklahoma City, Oklahoma, where the Company's principal executive offices and
substantially all of its operations are located, and certain assets
jointly-developed with the Company and used in connection with the Company's
Internet operations ("Internet Assets"). John Telling, a former director and
executive of the Company, has been the President and Chief Executive Officer and
a director of Hebron since its formation in December 1995 and is also a major
shareholder of Hebron. In 1997, 1998 and 1999, Hebron paid Mr. Telling $112,308,
$187,308 and $125,000, respectively, as salary and cash bonuses for his services
to Hebron and in 1998 Mr. Telling received a bonus of Hebron stock valued at
$225,000. Each of Messrs. Freeny and Thompson served as directors and officers
of Hebron from its formation until November 1996 and were shareholders of Hebron
and John Damoose, a director of the Company, is a director of Hebron. Messrs.
Telling, Freeny and Thompson received stock in Hebron for serving as directors
of Hebron. As of December 31, 1999, Mr. Telling and his wife, collectively, and
Messrs. Freeny and Thompson owned 8.80%, 5.87%, and 5.87%, respectively, of the
outstanding stock of Hebron. Mr. Damoose does not own any stock in Hebron and
receives no compensation for serving as a director of Hebron. In December 1998,
Messrs. Freeny and Thompson each returned the 2,500 shares of Hebron stock they
received for serving as directors of Hebron.
Effective February 1, 1999, the Company began operating the Switching Assets
and the Internet Assets and, in April 2000 acquired all of such assets (the
"Hebron Acquisition"). At the closing of the Hebron Acquisition, the Company
paid to Hebron the following: (i) as consideration for the Switching Assets,
$567,073 in the form of a promissory note (the "Switch Note") and (ii) as
consideration for the Internet Assets, $584,295 in the form of a promissory note
("Internet Note"). Also, the Company issued to Hebron a promissory note
("Payables Note") in the amount of $2,274,416 as consideration for amounts owed
by the Company directly to Hebron for switching services prior to February 1,
1999. Also in connection with the Hebron Acquisition, the Company assumed the
following liabilities of Hebron: (a) all liabilities under contracts it is
assuming related to the Switching Assets and Internet Assets, (b) the costs of
Hebron in excess of its revenues in winding up its business from February 1,
1999 until May 1, 2001 with such costs not to exceed $1,156,000, with any such
payments to be credited against the outstanding principal balance of the Switch
Note and Internet Note, and (c) all outstanding accounts payable of Hebron to
unaffiliated third parties which result from the use by the Company of the
Switching Assets which total $2,338,580. One of the contracts to be assumed by
the Company is a long term contract between Hebron and IXC Communications, Inc.
("IXC") pursuant to which Hebron contracts for services guaranteeing IXC a
minimum of $550,000 monthly revenue from such contract. All of the Company's
obligations pursuant to the Switch Note, Internet Note and Payables Note are
guaranteed by Mr. Freeny, with such guaranty being secured by a pledge of 50,000
shares of Common Stock owned by Mr. Freeny. At the closing of the Hebron
Acquisition, each of Messrs. Freeny and Thompson and another individual
delivered 20,000 shares of Hebron Stock owned by each of them to Hebron and in
return Hebron transferred to each 2,000 shares of Common Stock owned by Hebron.
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<PAGE> 38
The Switch Note and the Internet Note have identical terms which are as
follows: interest accrues at 12.50% per annum for the first nine months after
issuance and 16.25% per annum thereafter, accrued interest is paid monthly in
arrears, principal is payable in six equal installments with the first payable
due 13 months from issuance and continuing each month thereafter until paid in
full 18 months from such issuance and all obligations under these notes will be
subordinated to the Coast Loan. The Payables Note was issued effective as of
February 1, 1999 and its terms are identical to the Switch Note and the Internet
Note except that the outstanding principal amount of the Payables Note is due
and payable in one installment on August 31, 2000.
The Company believes that the terms of its above-described transaction with
Hebron were fair and in the best interests of the Company because (i) the
purchase of the Switching Assets allows the Company to have both switchless and
certain switched long distance under its full control, (ii) the Company paid
Hebron's net book value for the Switching Assets, (iii) the Company reimbursed
Hebron for Hebron's out-of-pocket costs for the Internet Assets, (iv) the
Company believes it can operate both the Switching Assets and Internet Assets on
a more effective and cost efficient basis than through its prior relationship
with Hebron and (v) the Company was able to convert a significant account
payable into a long term subordinated obligation.
In 1995, the Company purchased equipment, which was then sold to Hebron in
March 1996 for the Company's cost basis in such equipment. Also in 1995, the
Company entered into a lease agreement with a third party to lease the required
switching network equipment. In March 1996, the Company sublet this equipment to
Hebron on identical terms as the Company's lease terms and ultimately assigned
the lease to Hebron in July 1996, but the Company remained a guarantor of the
lease obligation. Finally, the Company assigned a telecommunications services
agreement to Hebron. During 1996, 1997, 1998 and the first month of 1999, the
Company incurred telecommunications services expense payable to Hebron of
approximately $4,685,000, $13,529,000, $14,736,000 and $1,469,000, respectively.
In 1997, the Company believes that it could have obtained the services provided
by Hebron on more favorable terms in an arm's length transaction with an
unaffiliated third party. The higher rates paid to Hebron were the result of the
Company's primary carrier lowering its rates in 1997, but Hebron failed to match
such rate reductions. However, in 1998 the Company and Hebron adjusted the rates
being charged so that the Company was paying Hebron generally what the Company
would pay for similar services in an arm's length transaction with an
unaffiliated third party.
In December 1995, the Company advanced Hebron $170,000 to make the cash
payment to purchase the office building owned by Hebron. This advance was
interest free and repaid in March 1996. Beginning in 1996, the Company leased
office space from Hebron. Since January 1998, the Company's principal executive
offices and office space for substantially all of its operations were being
leased from Hebron. During 1997, 1998, 1999 and for the three months ended March
31, 2000, the Company incurred rent expense payable to Hebron of approximately
$110,000, $380,000, $530,000 and $147,000, respectively. The Company believes
that the terms of the lease with Hebron were at least as favorable to the
Company as could have been obtained in an arm's length transaction with an
unaffiliated third party.
In December 1996, Hebron began providing advance funding to the Company on
billings transmitted by the Company to certain LECs. Certain shareholders of
Hebron, including Judith Telling, Mr. Telling's wife, and Art Richardson and
David Dalton, each directors of Hebron, loaned Hebron money at 18% per annum so
that Hebron could make the loans to the Company. The Company assigned specific
LEC tapes to an independent escrow agent designated by Hebron, who would forward
the tapes to the applicable LEC and, upon confirmation of receipt of the tape,
advance up to 75% of the net tape amount to the Company. When the escrow agent
received payment from the LEC it would remit payment to the Company of any
remaining amounts owed to the Company after deducting interest of 18% per annum
on the advance amount and factoring fees charged by Hebron of 2% of the tape
amount plus $0.02 per call record. In 1996, 1997 and 1998, the Company incurred
expenses in connection with these advances of approximately $57,000, $908,000
and $879,000, respectively. At December 31, 1998 all amounts had been repaid.
Based on the amount of interest and factoring fees charged on these loans to the
Company by Hebron pursuant to this program, the effective costs of funds on such
loans was approximately 58% per annum. The Company believes that it could have
obtained unaffiliated third party financing on more favorable terms.
Additionally, Hebron periodically has made loans to the Company for working
capital purposes in amounts less than $1,275,000, which bore interest at 10%.
In 1996 and 1997, Hebron paid Mr. Telling and his wife aggregate dividends
of $31,500 and $70,500, respectively, with respect to the stock they owned in
Hebron. Hebron also paid dividends of $23,625 and $52,875 to each of Mr. Freeny
and Mr. Thompson in 1996 and 1997.
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<PAGE> 39
TRANSACTIONS WITH DIRECTORS
Jay A. Sekulow, a director of the Company, is Chief Executive Officer, a
director and 50% shareholder of Regency, and, through Regency, hosts a daily
nationally syndicated radio talk show. The Company currently pays Regency
$159,000 per month to fund a portion of the cost that Regency incurs in creating
this show and Mr. Sekulow advertises the long distance services of the Company
during the show at no additional charge. In 1997, 1998, 1999 and for the three
months ended March 31, 2000, these payments were $1,803,000, $1,918,000,
$1,908,000 and $477,000, respectively. Regency also receives 10% of certain
collected revenues from the customers subscribed as a result of the advertising
during the show. The Company estimates that it has received over 105,000
customer subscriptions as a result of advertising during Mr. Sekulow's show.
Mr. Sekulow is also Chief Counsel of ACLJ and President and a director of
CASE, each of which provides its membership list to the Company in return for
receiving 10% of certain collected revenues from members of such organizations
who become customers of the Company, which, like the arrangement with Regency,
is the same arrangement that all other non-profit organizations have with the
Company. For 1997, 1998, 1999 and for the three months ended March 31, 2000,
Regency, ACLJ and CASE collectively received aggregate payments from the Company
as a result of these arrangements (but not including amounts funded by the
Company in respect of the radio show) of approximately $775,000, $1,060,000,
$1,107,000 and $265,836, respectively. Additionally, these non-profit
organizations receive an agent commission ranging between 2 and 3% of certain
collected revenues, which for 1997, 1998, 1999 and for the three months ended
March 31, 2000, were approximately $168,000, $497,000, $102,000 and $124,250,
respectively.
Effective January 1, 1999, the Company entered into Royalty Agreements with
each of Regency and CASE, pursuant to which the Company agreed to pay (a)
Regency $110,500 in 1999 and $102,000 in each of 2000 and 2001 and (b) CASE
$386,500 in 1999 and $395,000 in each of 2000 and 2001, in each case as
settlement for all past royalties claims by Regency and CASE and certain
non-competition agreements of Regency and CASE.
From August 1997 through November 1997, CASE loaned the Company an aggregate
of $1,000,000 ("CASE Loan"). The terms and conditions of the CASE Loan have been
subsequently amended. The CASE Loan accrued interest at 10% and a portion of the
principal had been repaid. In April 1999, the outstanding principal balance and
all accrued interest thereon of the CASE Loan was converted into a new note
payable to CASE in the original principal amount of $850,000, of which $588,183
was the remaining principal balance and accrued interest of the CASE Loan and
$261,817 was a new loan from CASE to the Company (the "CASE Note"). The CASE
Note bears interest at 10% per annum which is payable monthly and the entire
outstanding principal balance is payable in full in April 2004 which can be
extended at CASE's option for an additional five years on the same terms and
conditions. The CASE Note is subordinated to the Coast Loan and is convertible
at any time into shares of Common Stock, at the option of CASE, at a per share
price equal to the lower of (i) the fair market value of the Common Stock on
January 1, 1998, as determined by an appraisal, or (ii) the lowest publicly
traded price of the Common Stock three months following the establishment of a
public trading market for the Common Stock. Prior to the fourth anniversary of
the Note, the Company has the right to prepay the CASE Note at a 10% premium to
its then appraised value (including conversion value) ("Prepayment Right"). The
Company also had the option, which it did not exercise, to borrow an additional
$150,000 from CASE on or prior to June 20, 1999. In connection with the issuance
of the CASE Note, the Company is required to issue CASE warrants to purchase
3,400 shares of Common Stock for $0.01 per share. The Company believes that the
terms and conditions of the CASE Loan and CASE Note were at least as favorable
as the Company could have obtained in an arm's length transaction with an
unaffiliated third party.
In June 1998, John Damoose, a director of the Company, loaned the Company
$150,000. The loan accrued interest at 18% and $50,000 of the principal was
repaid in May 1999. In May 1999, the outstanding principal balance and all
accrued interest thereon of the Damoose Loan was converted into a new note
payable to Mr. Damoose in the original principal amount of $100,000 ("Damoose
Note"). The terms of the Damoose Note and the terms of the CASE Note are
identical other than the amounts. The Damoose Note matures in April 2001 and can
be extended, at Mr. Damoose's option, for an additional three years on the same
terms and conditions. In connection with the issuance of the Damoose Note, the
Company is required to issue Mr. Damoose warrants to purchase 400 shares of
Common Stock for $0.01 per share. The Company believes that the terms and
conditions of the Damoose Loan and Damoose Note were at least as favorable as
the Company could have obtained in an arm's length transaction with an
unaffiliated third party.
From 1997 until October 1998, Mr. Halliday, the President, Chief Executive
Officer and a director of the Company, was a partner in the law firm of WRF and
Mr. Halliday continues to serve as Of Counsel with WRF for matters which do not
involve the Company. In 1997, 1998, 1999 and for the three months ended March
31, 2000, the Company paid WRF $69,000, $741,000, $767,000 and $150,000,
respectively, for legal fees and expenses. WRF billed the Company its standard
billing rates for work performed for the Company. WRF will continue to perform
work for the Company in the future, which will continue to be billed to the
Company at WRF's standard rates.
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<PAGE> 40
In addition, Messrs. Halliday, Damoose and Sekulow received and are entitled
to receive certain other payments from the Company more particularly described
in Item 6 above.
OTHER MISCELLANEOUS TRANSACTIONS
In 1997, the Company entered into 25-year sales representative agreements
with certain of its key sales representatives, including, Tom Anderson, Mr.
Thompson's son-in-law; Diana Riske, Mr. Telling's daughter; and Jeff Cato, Mr.
Freeny's son-in-law. The agreements provide that the sales representatives will
receive a commission of 3% of the net domestic billings of customers who
subscribe to the Company's telecommunication services either directly or
indirectly through any subscriber, business or organization procured as a result
of the sales representatives contact with such subscriber, business or
organization. In addition, the sales representatives will receive a commission
of 1% of the net domestic billings of customers subscribed through any sales
representative of the Company recruited by the sales representative. The sales
representatives will receive substantially all of the payments under these
agreements if they die or are terminated, with or without cause, during the term
of the agreement. One sales representative who also has a 25-year sales
representative agreement, David Dalton, has received over $700,000 per year for
each of 1997,1998 and 1999 under his agreement. For 1997, 1998, 1999 and the
three months ended March 31, 2000, Mr. Anderson, Ms. Riske and Mr. Cato received
salary and commissions of approximately $232,000, $206,000, $150,000 and
$25,500; $51,000, $55,000, $93,000 and $17,000; and $94,000, $134,000, $133,000
and $31,000, respectively. In April 1998, Mr. Anderson resigned as an employee
of the Company and, pursuant to the terms of a separation agreement with Mr.
Anderson, the Company will pay him 100% of all amounts under his agreement until
the Company completes an initial public offering when he will receive 75% of
such amounts. In July 1999, Mr. Cato voluntarily agreed to terminate his
contract.
ITEM 8. LEGAL PROCEEDINGS
INVESTIGATION BY THE SECURITIES AND EXCHANGE COMMISSION
In 1995, the Company determined that it may not have registered its
securities with the Commission when it was obligated to do so under the federal
securities laws and that, consequently, it may have engaged in the sale or
delivery of unregistered securities in violation of the federal securities laws.
In July 1996, the Company voluntarily reported this information to the
Commission, which then instituted an investigation into whether the (a) Company;
(b) Tracy L. Freeny, the Company's Chairman of the Board and, at that time, the
Company's President; and (c) Carl D. Thompson, at that time, the Company's
Senior Vice President had violated any of the federal securities laws. In 1997,
the Commission requested documents relating to Hebron's sale and delivery of
securities. The Company, Freeny, Thompson, and Hebron cooperated with the
Commission during this investigation. Mr. Freeny and Mr. Thompson voluntarily
gave sworn statements to the Commission in 1997. Hebron also voluntarily
provided documents to the Commission when requested to do so.
On September 24, 1997, the Commission's staff attorney who was conducting
the investigation informed the Company that she intended to recommend to the
Commission that it institute cease-and-desist proceedings against the Company
based upon the staff's belief that the Company violated Sections 5(a) and 5(c)
of the Securities Act of 1933, as amended ("Securities Act"), and Section 12(g)
of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and Rule
12g-1 promulgated under the Exchange Act ("Rule 12g-1"). Also on September 24,
1997, the Commission's staff attorney informed Messrs. Freeny and Thompson, and
Hebron that she intended to recommend that the Commission institute
cease-and-desist proceedings against them. On July 15, 1998, the Company and
Messrs. Freeny and Thompson each executed an offer of settlement (the "Offers")
that were contingent upon the Commission accepting the staff attorney's
recommendation. In the Offers, the Company and Messrs. Freeny and Thompson
consented to the entry of a cease-and-desist order which provided that they
would cease and desist from committing or causing any violations or future
violations of Sections 5(a) and 5(c) of the Securities Act and Section 12(g) of
the Exchange Act and Rule 12g-1. Additionally, in the Offers, Hebron consented
to the entry of a cease-and-desist order which provided that it would cease and
desist from committing or causing any violations or future violations of
Sections 5(a) and 5(c) of the Securities Act.
On July 23, 1998, the Commission approved the Commission's staff attorney's
recommendation and accepted the Offers. On July 30, 1998, the Commission issued
a cease-and-desist order which stated that (a) the Company, Messrs. Freeny and
Thompson, and Hebron had violated Sections 5(a) and 5(c) of the Securities Act;
(b) the Company had violated Section 12(g) of the Exchange Act and Rule 12g-1;
and (c) Messrs. Freeny and Thompson had caused the violation of Section 12(g) of
the Exchange Act and Rule 12g-1. The Commission ordered the Company, Messrs.
Freeny and Thompson, and Hebron to cease and desist from committing or causing
any violations and any future violations of Sections 5(a) and 5(c) of the
Securities Act and the Company and Messrs. Freeny and Thompson to cease and
desist from committing or causing any violations or future violations of Section
12(g) of the Exchange Act
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<PAGE> 41
and Rule 12g-1. The Commission did not order any monetary penalties, fines,
sanctions, or disgorgement against the Company, Messrs. Freeny or Thompson,
Hebron or anyone else associated with the Company or any of the other parties.
INVESTIGATIONS BY STATE SECURITIES COMMISSIONS
In December 1994, the Washington Department of Financial Institutions -
Securities Division ("WDS") notified the Company that it was aware that the
Company may have offered unregistered securities to residents of the State of
Washington and instructed the Company to cease and desist such offers and to
provide information with respect to any sales of such securities. In April 1997,
the WDS told the Company that it was trying to close its file on the Company and
attempted to serve a subpoena on the Company that sought various documents
relating to the Company's shareholders in Washington state. The Company
voluntarily produced documents in response to the improperly served subpoena in
May 1997. The WDS has not corresponded with the Company since May 1997.
In February 1996, the Oklahoma Department of Securities ("ODS") made an
inquiry to the Company with regard to the basis upon which the Company and
Hebron had offered and sold securities and effected issuances of short-term
notes under an advance payment loan program, without registration under the
Oklahoma Securities Act. The Company responded to such inquiry in February 1996
advising the ODS that neither the Company nor its Oklahoma counsel believed that
the short-term notes issued under the advance payment loan program constituted
securities, and claiming that the Common Stock was exempt from registration
under Section 401(b)(9)(B) of the Oklahoma Securities Act. Hebron responded to
the ODS inquiry under separate cover in February 1996. In its response, Hebron
stated that it had not engaged in an advance payment loan program, that it had
authorized a private offering and sale under Section 4(6) of the Securities,
Rule 505 of Regulation D promulgated under the Securities Act and, as
applicable, state Uniform Limited Offering Exemptions. Neither the Company nor
Hebron have had any further contact with the ODS since their responses.
LIABILITIES FOR BREACH OF SECURITIES LAW
Substantially all of the Company's sales of Common Stock and certain notes,
other than sales to officers and directors of the Company, failed to comply with
certain provisions of the federal and states' securities laws, including
compliance with Sections 5 (a) and (c) of the Securities Act, compliance with
registration requirements of certain states' securities laws and, possibly,
compliance with Section 10 (b) of the Exchange Act and Rule 10 b-5 promulgated
under the Exchange Act and any similar anti-fraud provisions under state
securities laws. The Company and two of its officers, after voluntarily
presenting these facts to the Commission in August 1996, consented in July 1998
to the entry of a cease and desist order from the Commission concerning
violations of the federal securities laws.
The federal securities laws provide legal causes of action against the
Company by persons buying the securities from the Company including action to
rescind the sales. With respect to the offerings described above, the statutes
of limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. The Company made all of these sales more
than three years ago.
While certain suits under the federal acts may be barred, similar laws in
many of the states provide similar rights. The Company sold stock to persons in
over forty states, and those states typically provide that a purchaser of
securities in a transaction that fails to comply with the state's securities
laws can rescind the purchase, receiving from the issuing company the purchase
price paid plus an interest factor, frequently 10% per annum from the date of
sales of such securities, less any amounts paid to such security holder. The
statutes of limitations for these rights typically do not begin running until a
purchaser discovers the violation of the law, and therefore in most instances,
and depending on individual circumstances, the statute of limitations do not
appear to limit those rights for most purchasers of securities from the Company.
Also, depending on the law of the state and individual circumstances, monetary
damages and other remedies may be granted for breach of state securities laws.
Accordingly, the Company has a significant, material contingent liability under
state securities laws for those sales of approximately $10.0 million at March
31, 2000.
Additionally, the Company may be liable for rescission or other remedies
under states securities laws to the purchasers of the Hebron common stock
because of the relationships of the two companies, creating an additional
significant, material contingent liability to the Company of approximately $3.2
million at March 31, 2000. While the Company may have liability for rescission
of the sales of the Hebron securities, the holders of Hebron securities will not
have any damages under the rescission rights if Hebron successfully completes
its currently proposed liquidation. See Item 7 below for a description of the
Hebron transaction including its proposed liquidation. If the liquidation is
completed as currently proposed, and the Company pays the notes it owes Hebron
in full, the Company anticipates that the Hebron shareholders would receive
assets in the liquidation with a value greater than the value of their
rescission rights.
41
<PAGE> 42
If purchasers of securities of either the Company or Hebron are successful
in asserting any of the above-described claims, it could have a material adverse
effect on the Company.
OTHER LEGAL PROCEEDINGS
The Company is not party to any other material pending legal proceedings.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is no established public trading market for the shares of Common Stock
and the Company currently does not intend to seek inclusion of the shares of
Common Stock in any established public trading market. At March 31, 2000, there
were 825,278 outstanding shares of Common Stock owned by approximately 1,200
holders of record. All of the outstanding shares of Common Stock can be sold
pursuant to Rule 144 of the Securities Act without limitations except for
251,280 shares of Common Stock held by affiliates of the Company. All but 22,747
shares of the shares held by affiliates may be sold subject to the limitations
provided for in Rule 144. As of March 31, 2000, the Company had issued (i)
options to purchase an aggregate of 90,987 shares of Common Stock to certain of
its officers and directors, (ii) warrants to purchase an aggregate of 3,800
shares of Common Stock to certain creditors of the Company and (iii) convertible
notes in the aggregate principal amount of $385,800 ("Convertible Notes"). The
Convertible Notes generally have no specified maturity date and are convertible
into Common Stock at the option of the Company. The Convertible Notes contain
varying terms with respect to conversion price. Some of the Convertible Notes
contain specific conversion prices while others do not set forth a conversion
price. With respect to the Convertible Notes, which do not contain specific
conversion prices, the Company has assumed between $135 and $150 per share
conversion prices. Based on the foregoing assumptions, the Company estimates
that the outstanding Convertible Notes are convertible into 2,765 shares of
Common Stock. Additionally, if the Company employs Mr. Halliday on May 24, 2002,
the Company is required to issue him options to purchase shares of Common Stock
equal to 2% of the fully diluted outstanding Common Stock on such date. The
Company has not granted any registration rights to any holder of its Common
Stock or any person who has the right to acquire Common Stock.
During 1996 and 1997, the Company declared distributions on its shares of
Common Stock of $8,137,721 and $6,193,684, respectively, all of which were paid
when declared or have been subsequently paid except for $3,200,000 which was
accrued and is payable as of March 31, 2000 to Mr. Freeny. The Company has not
declared any distributions or other cash dividends on its shares of Common Stock
since December 31, 1997. The Company does not anticipate paying any other cash
dividends in the foreseeable future and anticipates that future earnings will be
retained to finance operations. Furthermore, the terms of the Coast Loan limit
the payment of any distributions or other dividends to its shareholders.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
In May 1999, the Company issued 9,099 shares of Common Stock to Mr. Telling,
a former director of the Company, pursuant to the Resignation Agreement The
shares were issued as consideration for past services by Mr. Telling to the
Company and the Company did not receive any cash proceeds in connection with
such issuances. Exemption from registration for all of the sales was claimed
under Section 4(2) of the Securities Act regarding transactions not involving
any public offering. No commissions were paid by any person in connection with
these sales.
ITEM 11. DESCRIPTION OF COMPANY'S SECURITIES TO BE REGISTERED
GENERAL
The Company has authorized capital stock consisting of 1,000,000 shares of
Common Stock, $0.10 par value. As of March 31, 2000, there were 825,278
outstanding shares of Common Stock owned by approximately 1,200 holders of
record. All holders of Common Stock have full voting rights and are entitled to
one vote for each share held of record on all matters submitted to a vote of the
shareholders. Votes are not cumulated in the election of directors. Shareholders
have no preemptive or subscription rights. Holders of Common Stock are entitled
to dividends when, as and if declared by the Board of Directors from funds
legally available therefor and are entitled, upon liquidation to share ratably
in all assets remaining after payment of liabilities. The Company is the
transfer agent and registrar for the Common Stock, but reserves the right to
retain a third party to perform such services.
42
<PAGE> 43
REDEMPTION RIGHTS
While the Company's Certificate of Incorporation authorizes the Company only
to issue a single class of Common Stock, the Company has from time to time
entered into various contracts with certain of its shareholders pursuant to
which the Company agreed, upon request of one or more of such shareholders, to
redeem the shares of Common Stock owned by such shareholder. The Company has for
financial accounting purposes segregated its Common Stock into two distinct
groups, redeemable and non-redeemable. Of the 825,278 shares of Common Stock
outstanding at March 31, 2000, 15,537 shares are characterized as redeemable and
are held of record by approximately 150 shareholders and 809,741 shares are
characterized as non-redeemable and are held of record of by approximately 1,050
shareholders.
The Company has entered into four variations of redemption agreements, which
it classifies as Type A, Type B, Type C and Type D. Generally, each redemption
agreement provides that the shares of Common Stock shall be repurchased for an
amount that gives the shareholder a specified rate of return based on the length
of time the shareholder owned such shares. Type A agreements were issued
primarily between October 1992 and December 1992 and Type B agreements were
issued primarily between January 1993 and May 1995. Both the Type A and Type B
agreements provide that shareholders owning their shares of Common Stock between
6 months and one year receive a 12% annual return; between one year and 18
months receive a 15% annual return; and between 18 months and two years receive
an 18% annual return. All of the Type A and Type B agreements are no longer
exercisable pursuant to their terms.
Type C agreements were issued primarily between July 1992 and September 1992
and have terms identical to the Type A and Type B agreements except that these
agreements remain exercisable without limitation and the Company agreed to
redeem the shares of Common Stock owned for more than two years for the highest
price shares of Common Stock have been sold to an investor. Type D Agreements
have no expiration and were issued from May 1995 until the Company discontinued
issuing redemption agreements altogether in February 1996. Type D agreements
provide that shareholders owning their shares of Common Stock less than one year
receive a 10% annual return; between one year and 18 months receive a 15% annual
return; between 18 months and three years receive an 18% annual return; and over
three years an amount based on the estimated market price for the shares of
Common Stock, as determined by management. At March 31, 2000, of the 15,537
shares of Common Stock that were classified as redeemable, 0 shares, 0 shares,
1,577 shares and 13,960 shares were subject to Type A, Type B, Type C and Type D
agreements, respectively. Irrespective of the existence of these redemption
obligations, availability of funds, restrictions in financing agreements and
corporate law considerations may affect or restrict the ability of the Company
to make redemption.
ANTI-TAKEOVER STATUTES
Section 1090.3 of the Oklahoma General Corporation Act ("OGCA") contains
provisions prohibiting a broad range of business combinations, such as a merger
or consolidation, between an Oklahoma corporation with a class of voting stock
that is listed on a national securities exchange, authorized for quotation on an
inter-dealer quotation system or held of record by 1,000 or more shareholders,
and an "interested shareholder" (which is defined as any owner of 15% or more of
the corporation's stock) for three years after the date on which such
shareholder became an interested shareholder, unless, among other things, the
stock acquisition which caused the person to become an interested shareholder
was approved in advance by the corporation's board of directors. Because the
Company has more than 1,000 shareholders, it is subject to this Section 1090.3.
Sections 1145 through 1155 of the OGCA also contain provisions regulating a
"control share acquisition" which effectively deny voting rights to shares of an
Oklahoma corporation acquired in control share acquisitions unless a resolution
granting such voting rights is approved at a meeting of shareholders by
affirmative majority of all voting power, excluding all interested shares. A
control share acquisition is one in which a purchasing shareholder acquires more
than one-fifth, one-third, or a majority, under various circumstances, of the
voting power of the stock of an "issuing public corporation." An "issuing public
corporation" is an Oklahoma corporation that has (i) any class of securities
registered pursuant to Section 12 or subject to Section 15(d) of the Exchange
Act; (ii) 1,000 or more shareholders; and (iii) either (a) more than 10% of its
shareholders are Oklahoma residents; (b) more than 10% of its shares owned by
Oklahoma residents; or (c) at least 10,000 shareholders are Oklahoma residents.
Upon filing of this Form 10, the Company will meet the statutory definition of
an "issuing public corporation" and will be subject to the control share
acquisition provisions of the OGCA.
RIGHT OF FIRST REFUSAL
The Bylaws of the Company provide that any shareholder desiring to transfer
its shares of Common Stock ("Selling Shareholder") must first comply with a
right of first refusal in favor of Tracy Freeny, Aubrey Price, Carl Thompson and
any other shareholder owning 11,000 or more shares of Common Stock (a "Major
Shareholder") and, if the Major Shareholders decline such right, the Company. A
Selling Shareholder must give written notice to the Company of its intention to
sell and the Company will forward notice of the same to each Major Shareholder.
A Major Shareholder has 15 days from mailing of notice by the Company to express
its
43
<PAGE> 44
intention to purchase the shares being sold. If none or less then all of the
shares are purchased by the Major Shareholders and the Company, the Selling
Shareholder shall thereafter be entitled to sell all shares not purchased.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 1031 of the OGCA empowers a corporation to indemnify any person who
was or is a party to or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative (other than an action by or in the right of the
corporation), by reason of the fact that he is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorney's fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action, suit or
proceeding if he acted in good faith and in a manner he reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect
to any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful. With respect to actions or suits by or in the right of the
corporation, such indemnification is limited to expenses (including attorneys'
fees) actually and reasonably incurred by such person in connection with the
defense or settlement of such action or suit. Further, no indemnification shall
be made in respect of any claim, issue or matter as to which such person shall
have been adjudged to be liable to the corporation unless and only to the extent
that the court in which such action or suit was brought shall determine upon
application that, despite the adjudication of liability but in view of all the
circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses which the court shall deem proper. Additionally, a
corporation is required to indemnify its directors and officers against expenses
to the extent that such directors or officers have been successful on the merits
or otherwise in defense of any action, suit or proceeding referred to above or
in defense of any claim, issue or matter therein.
An indemnification can be made by the corporation only upon a determination
made in the manner prescribed by the statute that indemnification is proper in
the circumstances because the party seeking indemnification has met the
applicable standard of conduct as set forth in the OGCA. The indemnification
provided by the OGCA shall not be deemed exclusive of any other rights to which
those seeking indemnification may be entitled under any bylaw, agreement, vote
of stockholders or disinterested directors, or otherwise. A corporation also has
the power to purchase and maintain insurance on behalf of any person covering
any liability incurred by such person in his capacity as a director, officer,
employee or agent of the corporation, or arising out of his status as such,
whether or not the corporation would have the power to indemnify him against
such liability. The indemnification provided by the OGCA shall, unless otherwise
provided when authorized or ratified, continue as to a person who has ceased to
be a director, officer, employee or agent and shall inure to the benefit of the
heirs, executors and administrators of such a person.
The Company's Bylaws provide that the Company shall indemnify its officers,
directors, employees and agents to the extent permitted by the OGCA.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are set forth following the
signature page hereof beginning on page F-1.
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements
The Financial Statements listed below are filed as part of this Registration
Statement on Form 10 following the signature page hereof beginning on page F-1.
Index to Consolidated Financial Statement
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1998
and 1999 and March 31, 2000
Consolidated Statements of Operations for the Years
Ended December 31, 1997, 1998 and 1999
and the three months ended March 31,
1999 and 2000
Consolidated Statements of Stockholders'
Deficiency for the Years Ended December
31, 1997, 1998 and 1999 and the three
months ended March 31, 1999 and 2000
Consolidated Statements of Cash Flows for
the Years Ended December 31, 1997, 1998
and 1999 and the three months ended
March 31, 1999 and 2000
44
<PAGE> 45
Notes to Consolidated Financial Statements
(b) Exhibits
<TABLE>
<S> <C>
3.1 - Certificate of Incorporation of the Company
3.2 - Bylaws of the Company
3.3 - Secretary certificate regarding amended and restated bylaws
4.1 - Form of certificate representing shares of the Company's common stock
4.2 - Form of Type A Redemption Agreement
4.3 - Form of Type B Redemption Agreement
4.4 - Form of Type C Redemption Agreement
4.5 - Form of Type D Redemption Agreement
4.6 - Form of Convertible Note
4.7 - Promissory Note dated April 20, 1999, payable by the Company to
C.A.S.E., Inc.
4.8 - Promissory Note dated April 20, 1999, payable by the Company to John
Damoose
10.1 - Agreement, dated as of April 13, 1998, between the Company and Carl
Thompson
10.2 - First Amendment to April 13, 1998 Agreement between Amerivision
Communications, Inc. and Carl Thompson, dated as of December 31,
1998, among the Company, Carl Thompson and Willeta Thompson
10.3* - Amended and Restated Employment Agreement, dated as of May 24, 1999
between the Company and Stephen D. Halliday
10.4* - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the Company, Jay A. Sekulow and Tracy Freeny
10.5* - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the Company, John Damoose and Tracy Freeny
10.6 - Employment Agreement, dated as of May 24, 1999, between the
Company and John E. Telling
10.7 - Employment Agreement dated as of May 24, 1999 between the
Company and Tracy Freeny
10.8 - Reaffirmation of Commitments made in Employment Agreement of
Stephen D. Halliday dated as of June 30, 1999
10.9 - Reaffirmation of Commitments made in Stock Agreement of Jay A.
Sekulow dated as of June 30, 1999
10.10 - Agreement effective January 1, 1999, between the Company and
VisionQuest
10.11 - Telemarketing Services Agreement, effective as of January 1, 1999
Between the Company and VisionQuest
10.12 - Clarification to Agreement, effective as of June 9, 1999, by and
Between the Company and VisionQuest
10.13 - Asset Purchase Agreement, dated as of April 30, 1999, among Hebron,
the Company, Tracy Freeny, Carl Thompson and S. T. Patrick.
10.14 - Lease/License Agreement, dated as of April 30, 1999 between Hebron
and the Company.
10.15 - Form of Promissory Note payable by the Company to Hebron (form to
be used with respect to Switch Note and Internet Note)
10.16 - Promissory Note dated February 1, 1999, in the original principal
amount of $2,274,416 payable by the Company to Hebron
10.17 - Capital Stock Escrow and Disposition Agreement dated April 30,
1999 among Tracy C. Freeny, Hebron and Bush Ross Gardner Warren
& Rudy, P.A.
10.18 - Loan and Security Agreement dated as of February 4, 1999 between
10.18.1 - Amendment Number One to Loan and Security Agreement dated as of
October 12, 1999 between the Company and Coast Business Credit
10.18.2* - Amendment Number Two to Loan and Security Agreement dated as of May
10, 2000 between the Company and Coast Business Credit
10.19** - Telecommunications Services Agreement dated April 20, 1999
by and between the Company and WorldCom Network Services, Inc.
10.20** - Program Enrollment Terms dated April 20, 1999 between the Company
and WorldCom Network Services, Inc.
10.21 - Security Agreement dated April 20, 1999 by and between the Company
and WorldCom Network Services, Inc.
10.22 - Letter Agreement dated July 14, 1999 between the Company and Tracy
C. Freeny
10.23 - Employment Agreement dated December 31, 1998, between the Company
and Kerry Smith
10.24* - Letter Agreement dated as of December 31, 1999 between the Company
and John Telling
10.25* - Royalty Agreement dated as of January 1, 1999 between the Company
and Regency Productions, Inc.
10.26* - Royalty Agreement effective as of January 1, 1999 between the
Company and Christian Advocates Serving Evangelism, Inc.
10.27* Stock Incentive Plan
21.1 - List of subsidiaries of the Company
23.1* - Consent of Cole & Reed, P.C.
27.1* - Financial Data Schedule
27.2* - Financial Data Schedule
</TABLE>
* Filed herewith.
** Information from this agreement has been omitted because the Company has
requested confidential treatment. The information has been filed
separately with the Securities and Exchange Commission.
45
<PAGE> 46
SIGNATURE
Pursuant to the requirements of the Section 12 of Securities Exchange Act of
1934, the Registrant has duly caused this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
AMERIVISION, INC.
Date: July 10, 2000 By: /s/ Stephen D. Halliday
--------------------------
Stephen D. Halliday
President and Chief Executive Officer
<PAGE> 47
Audited Consolidated Financial Statements
AMERIVISION COMMUNICATIONS, INC.
As of December 31, 1998 and 1999, and for the Years Ended December 31, 1997,
1998 and 1999
<TABLE>
<S> <C>
Independent Auditors' Report................................................ F-2
Consolidated Balance Sheets................................................. F-3
Consolidated Statements of Operations....................................... F-5
Consolidated Statements of Stockholders' Deficiency......................... F-6
Consolidated Statements of Cash Flows....................................... F-7
Notes to Consolidated Financial Statements.................................. F-9
</TABLE>
F-1
<PAGE> 48
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
AmeriVision Communications, Inc.
Oklahoma City, Oklahoma
We have audited the accompanying consolidated balance sheets of AmeriVision
Communications, Inc. as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' deficiency, and cash flows
for each of the three years in the period ended December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AmeriVision
Communications, Inc. at December 31, 1998 and 1999, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.
Oklahoma City, Oklahoma
March 31, 2000, except for Note N, for which
the effective date is May 26, 2000
F-2
<PAGE> 49
CONSOLIDATED BALANCE SHEETS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
---------- ---------- ----------
(Unaudited)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 635 $ 991 $ 1,357
Accounts receivable, net of allowance for uncollectible
accounts of $393 and $500 at December 31, 1998 and 1999,
and $756 at March 31, 2000 16,058 16,743 15,257
Receivables from related parties 152 -- --
Investment in and note receivable from affiliate 578 -- --
Prepaid expenses and other current assets 231 428 975
---------- ---------- ----------
TOTAL CURRENT ASSETS 17,654 18,162 17,589
OTHER ASSETS
Property and equipment, net 1,118 5,420 5,118
Deposits -- 355 1,174
Net deferred income tax benefits 5,520 3,615 3,495
Covenants not to compete 546 3,200 2,800
Asset held for disposal 500 -- --
Other assets 179 357 438
---------- ---------- ----------
7,863 12,947 13,025
---------- ---------- ----------
TOTAL ASSETS $ 25,517 $ 31,109 $ 30,614
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 50
CONSOLIDATED BALANCE SHEETS (dollars in thousands)--Continued
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
---------- ---------- ----------
(Unaudited)
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Revolving line of credit $ -- $ 20,880 $ 22,826
Accounts payable and accrued expenses 21,487 13,984 12,472
Accounts payable to related parties 3,232 -- --
Borrowings under accounts receivable based credit facilities 7,964 -- --
Accrued interest payable 292 5 12
Short-term notes payable to individuals 5,268 553 399
Loans and notes payable to related parties, current portion 686 2,657 2,417
Current portion of other notes payable and capital lease obligations 2,315 2,300 3,713
---------- ---------- ----------
TOTAL CURRENT LIABILITIES 41,244 40,379 41,839
LONG-TERM DEBT TO RELATED PARTIES, net of current portion 4,218 5,425 5,253
ACCRUED DISTRIBUTIONS TO RELATED PARTY 3,225 3,201 3,201
LONG-TERM DEBT, net of current portion 1,046 3,694 1,465
REDEEMABLE COMMON STOCK, carried at redemption value 1,755 1,639 1,597
Shares outstanding at December 31, 1998: 15,737
Shares outstanding at December 31, 1999: 15,537
STOCKHOLDERS' DEFICIENCY
Common Stock--par value $0.10 per share, 80 81 81
authorized 1,000,000 shares
total issued and outstanding:
December 31, 1998: 816,379
December 31, 1999: 825,278
net of redeemable shares:
December 31, 1998: 800,642
December 31, 1999: 809,741
Additional paid-in capital 9,928 11,600 11,600
Unearned compensation -- (946) (621)
Retained earnings (deficit) (35,979) (33,964) (33,801)
---------- ---------- ----------
TOTAL STOCKHOLDERS' DEFICIENCY (25,971) (23,229) (22,741)
---------- ---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $ 25,517 $ 31,109 $ 30,614
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 51
CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except share and
per share amounts)
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
Three Months Ended
Years Ended December 31 March 31
1997 1998 1999 1999 2000
--------- --------- --------- --------- ---------
(Unaudited)
<S> <C> <C> <C> <C> <C>
NET SALES $ 113,351 $ 124,232 $ 114,661 $ 29,040 $ 26,362
OPERATING EXPENSES
Cost of telecommunication services 44,711 48,787 53,050 13,479 11,952
Cost of telecommunication services provided by related parties 13,529 14,736 1,469 1,469 --
Selling, general and administrative expenses 44,530 49,368 48,028 11,549 11,850
Selling, general and administrative expenses to related parties 5,893 6,805 -- -- --
Depreciation and amortization 683 2,102 2,899 937 1,050
--------- --------- --------- --------- ---------
TOTAL OPERATING EXPENSES 109,346 121,798 105,446 27,434 24,852
--------- --------- --------- --------- ---------
INCOME FROM OPERATIONS 4,005 2,434 9,215 1,606 1,510
OTHER INCOME (EXPENSE)
Interest expense and other finance charges (3,245) (4,993) (4,873) (1,225) (1,154)
Interest expense and other finance charges to related parties (924) (974) (698) (175) (153)
(Loss) recovery on loans and other receivables -- (552) 182 180 --
Net gain (loss) on long-lived assets -- (215) (103) 22 --
Equity in income (losses) of affiliates (99) 41 -- -- --
Other income 14 59 95 9 38
--------- --------- --------- --------- ---------
(4,254) (6,634) (5,397) (1,189) (1,269)
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE (BENEFIT) (249) (4,200) 3,818 417 241
INCOME TAX EXPENSE (BENEFIT) 92 (643) 1,905 401 120
--------- --------- --------- --------- ---------
NET INCOME (LOSS) $ (341) $ (3,557) $ 1,913 $ 16 $ 121
========= ========= ========= ========= =========
BASIC EARNINGS (LOSS) PER SHARE $ (1.01) $ (4.22) $ 2.50 $ 0.02 $ 0.10
========= ========= ========= ========= =========
DILUTED EARNINGS (LOSS) PER SHARE $ (1.01) $ (4.33) $ 2.14 $ 0.02 $ 0.08
========= ========= ========= ========= =========
Weighted average number of shares outstanding
Basic earnings (loss) per share 799,398 800,634 806,329 800,642 809,741
========= ========= ========= ========= =========
Diluted earnings (loss) per share 799,398 821,593 895,872 816,379 928,768
========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 52
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
Nonredeemable Common Stock
-------------------------- Additional
Number of Paid-in
Shares Amount Capital
--------- -------- ----------
<S> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 789,926 $ 79 $ 9,228
Acquisition and cancellation of nonredeemable common stock (100) -- (5)
Expiration of redemption obligations applicable to redeemable common stock 10,617 1 686
Accretion of redemption value of redeemable common stock -- -- --
Distributions to nonredeemable stockholders ($7.54 per share) -- -- --
Net loss -- -- --
-------- -------- --------
BALANCE AT DECEMBER 31, 1997 800,443 80 9,909
Expiration of redemption obligations applicable to redeemable common stock 199 -- 19
Decrease in redemption value of redeemable common stock -- -- --
Net loss -- -- --
-------- -------- --------
BALANCE AT DECEMBER 31, 1998 800,642 80 9,928
Decrease in redemption value of redeemable common stock -- -- --
Shares reserved for detachable stock warrants issued with convertible notes -- -- 158
Shares issued for restricted stock awards to Company officer 9,099 1 377
Shares reserved for issuance of stock options to Company officers and directors -- -- 1,137
Vesting of restricted stock awards and stock options -- -- --
Net income -- -- --
-------- -------- --------
BALANCE AT DECEMBER 31, 1999 809,741 $ 81 $ 11,600
Change in redemption value of redeemable common stock (unaudited) -- -- --
Vesting of restricted stock awards and stock options (unaudited) -- -- --
Net income (unaudited) -- -- --
-------- -------- --------
BALANCE AT MARCH 31, 2000 (unaudited) 809,741 $ 81 $ 11,600
======== ======== ========
<CAPTION>
Retained
Unearned Earnings
Compensation (Deficit) Total
------------ -------- --------
<S> <C> <C> <C>
BALANCE AT JANUARY 1, 1997 $ -- $(26,134) $(16,827)
Acquisition and cancellation of nonredeemable common stock -- (10) (15)
Expiration of redemption obligations applicable to redeemable common stock -- -- 687
Accretion of redemption value of redeemable common stock -- (470) (470)
Distributions to nonredeemable stockholders ($7.54 per share) -- (5,646) (5,646)
Net loss -- (341) (341)
-------- -------- --------
BALANCE AT DECEMBER 31, 1997 -- (32,601) (22,612)
Expiration of redemption obligations applicable to redeemable common stock -- -- 19
Decrease in redemption value of redeemable common stock -- 179 179
Net loss -- (3,557) (3,557)
-------- -------- --------
BALANCE AT DECEMBER 31, 1998 -- (35,979) (25,971)
Decrease in redemption value of redeemable common stock -- 102 102
Shares reserved for detachable stock warrants issued with convertible notes -- -- 158
Shares issued for restricted stock awards to Company officer (378) -- --
Shares reserved for issuance of stock options to Company officers and directors (1,137) -- --
Vesting of restricted stock awards and stock options 569 -- 569
Net income -- 1,913 1,913
-------- -------- --------
BALANCE AT DECEMBER 31, 1999 $ (946) $(33,964) $(23,229)
Change in redemption value of redeemable common stock (unaudited) -- 42 42
Vesting of restricted stock awards and stock options (unaudited) 325 -- 325
Net income (unaudited) -- 121 121
-------- -------- --------
BALANCE AT MARCH 31, 2000 (unaudited) $ (621) $(33,801) $(22,741)
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 53
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
Years Ended December 31
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (341) $ (3,557) $ 1,913
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation of property and equipment 611 464 1,890
Amortization of intangible assets 72 1,638 1,009
Equity in undistributed net (income) losses of affiliates 99 (41) --
Losses on other receivables -- 552 --
Impairment loss (recovery) on asset held for disposal -- 215 (22)
Loss on disposal of fixed assets -- -- 125
Deferred income tax expense (benefit) 92 (643) 1,905
Issuance of detachable stock warrants -- -- 158
Amortization of unearned compensation related to stock options and awards -- -- 569
Changes in assets and liabilities:
Decrease (increase) in operating assets:
Accounts receivable (5,575) 2,187 (685)
Sale of accounts receivable 2,435 -- --
Receivables from related parties (503) 351 152
Other receivables (85) 194 --
Prepaid expenses and other assets 20 (62) 709
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses 518 5,367 (7,503)
Accounts payable to related parties 1,221 410 (1,597)
Interest payable (188) 43 (287)
-------- -------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (1,624) 7,118 (1,664)
INVESTING ACTIVITIES
Purchases of property and equipment (337) (353) (2,983)
Deposits paid on fixed assets -- -- (355)
Proceeds from sale of asset held for disposal -- -- 522
Release of investments pledged 85 55 10
Advances and loans to related parties (670) -- --
Repayments from related parties -- 150 --
-------- -------- --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (922) (148) (2,806)
FINANCING ACTIVITIES
Proceeds of loans from related parties 3,699 1,554 262
Repayments of loans and other obligations to related parties (4,324) (3,051) (1,297)
Net increase (decrease) in borrowings under line of credit arrangements 6,790 (2,850) 12,916
Loan closing fees paid -- (169) (345)
Proceeds from notes payable and long-term debt 590 250 2,553
Repayment of notes and leases payable (224) (304) (4,510)
Proceeds from short-term notes payable to individuals 773 150 --
Repayment of short-term notes payable to individuals (322) (444) (4,715)
Accrued distributions paid to related party -- (242) (24)
Distributions paid to other stockholders (4,906) (1,090) --
Redemptions of common stock (68) (154) (14)
-------- -------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,008 (6,350) 4,826
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (538) 620 356
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 553 15 635
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15 $ 635 $ 991
======== ======== ========
<CAPTION>
Three Months Ended
March 31
1999 2000
-------- --------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 16 $ 121
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation of property and equipment 391 650
Amortization of intangible assets 546 400
Equity in undistributed net (income) losses of affiliates -- --
Losses on other receivables -- --
Impairment loss (recovery) on asset held for disposal (22) --
Loss on disposal of fixed assets -- --
Deferred income tax expense (benefit) 401 120
Issuance of detachable stock warrants -- --
Amortization of unearned compensation related to stock options and awards -- 325
Changes in assets and liabilities:
Decrease (increase) in operating assets:
Accounts receivable (1,363) 1,486
Sale of accounts receivable -- --
Receivables from related parties -- --
Other receivables -- --
Prepaid expenses and other assets (95) (628)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses 251 (1,512)
Accounts payable to related parties (1,597) --
Interest payable (62) 7
-------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (1,534) 969
INVESTING ACTIVITIES
Purchases of property and equipment (136) (348)
Deposits paid on fixed assets -- (819)
Proceeds from sale of asset held for disposal 522 --
Release of investments pledged -- --
Advances and loans to related parties -- --
Repayments from related parties -- --
-------- --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 386 (1,167)
FINANCING ACTIVITIES
Proceeds of loans from related parties -- --
Repayments of loans and other obligations to related parties (319) (412)
Net increase (decrease) in borrowings under line of credit arrangements 1,962 1,946
Loan closing fees paid (322) --
Proceeds from notes payable and long-term debt -- 44
Repayment of notes and leases payable (765) (993)
Proceeds from short-term notes payable to individuals -- --
Repayment of short-term notes payable to individuals -- (21)
Accrued distributions paid to related party -- --
Distributions paid to other stockholders -- --
Redemptions of common stock -- --
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 556 564
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (592) 366
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 635 991
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 43 $ 1,357
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 54
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)--Continued
AMERIVISION COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
Years Ended December 31
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest and other finance charges paid $ 4,357 $ 5,924 $ 5,521
======== ======== ========
Income taxes paid $ -- $ -- $ 60
======== ======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Reserve of shares for issuance of stock options to Company officers $ -- $ -- $ 1,137
======== ======== ========
Acquisition of assets and increase in liability to related company $ -- $ 192 $ --
======== ======== ========
Assets acquired by incurring capital lease obligations $ 375 $ 70 $ 351
======== ======== ========
Assets acquired by incurring capital lease obligations and notes payable
to related parties $ -- $ -- $ 2,983
======== ======== ========
Conversion of redeemable common stock to subordinated note payable $ -- $ 928 $ --
======== ======== ========
Issuance of shares for restricted stock awards to Company officer $ -- $ -- $ 378
======== ======== ========
Exchange of investment in common stock and note receivable for lease
of telemarketing facility $ -- $ -- $ 578
======== ======== ========
Conversion of trade payables to related party to notes payable
to related party $ -- $ 1,224 $ 1,635
======== ======== ========
Termination settlement obligations to former officer and employees $ -- $ 2,184 $ 3,834
======== ======== ========
Loan from individual, restricted for reserves in the Company's credit facility $ -- $ -- $ --
======== ======== ========
Conversion of short-term notes payable to individuals to subordinated
promissory notes $ -- $ -- $ --
======== ======== ========
<CAPTION>
Three Months Ended
March 31
1999 2000
-------- --------
(Unaudited)
<S> <C> <C>
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest and other finance charges paid $ 1,439 $ 1,256
======== ========
Income taxes paid $ -- $ --
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Reserve of shares for issuance of stock options to Company officers $ -- $ --
======== ========
Acquisition of assets and increase in liability to related company $ -- $ --
======== ========
Assets acquired by incurring capital lease obligations $ 211 $ --
======== ========
Assets acquired by incurring capital lease obligations and notes payable
to related parties $ 2,926 $ --
======== ========
Conversion of redeemable common stock to subordinated note payable $ -- $ --
======== ========
Issuance of shares for restricted stock awards to Company officer $ -- $ --
======== ========
Exchange of investment in common stock and note receivable for lease
of telemarketing facility $ 578 $ --
======== ========
Conversion of trade payables to related party to notes payable
to related party $ 1,635 $ --
======== ========
Termination settlement obligations to former officer and employees $ -- $ --
======== ========
Loan from individual, restricted for reserves in the Company's credit facility $ 2,500 $ --
======== ========
Conversion of short-term notes payable to individuals to subordinated
promissory notes $ -- $ 177
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
(Information with respect to March 31, 2000 and for the three months ended March
31, 1999 and 2000 is unaudited)
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Description of Business: AmeriVision Communications, Inc. (the
"Company") was incorporated in Oklahoma on March 15, 1991. The Company provides
long distance telecommunications services to subscribers throughout the United
States, and completes subscriber calls to all directly dialable locations
worldwide.
The Company is a predominantly switchless long distance reseller, and obtains
the majority of its switching and long haul transmission of its service from
WorldCom, Inc. ("WorldCom"). Beginning in 1996, Hebron Communications
Corporation ("Hebron"), a related party, also began providing the Company with a
portion of its switching and transmission services. Hebron leases switching
facilities in Oklahoma City and Chicago. Both WorldCom and Hebron bill the
Company, at contractual per-minute rates, which vary depending on the time,
distance, and type of call, for the combined usage of the Company's nationwide
base of customers. Effective February 1, 1999, the Company assumed operations of
the switches.
In 1998, the Company began developing an internet service product, and in July
1999, began marketing the service under the brand name "ifriendly.com".
Principles of Consolidation: The Company owns 100% of the common stock of
AmeriTel Communications, Inc. and AmeriVision Network, Inc. Neither of these
companies has any operations nor any assets or liabilities.
Unaudited Interim Information: The information presented as of March 31, 2000,
and for the three months ended March 31, 1999 and 2000, has not been audited and
certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. In the opinion of management, the unaudited interim financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the Company's financial position as of
March 31, 2000, and the results of its operations, stockholders' deficiency and
cash flows for the three months ended March 31, 1999 and 2000. The results of
operations for the interim periods are not necessarily indicative of the results
to be expected for the full fiscal year.
Accounting Estimates: The preparation of 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 consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
Cash Equivalents: The Company defines cash equivalents as highly liquid,
short-term investments with an original maturity of three months or less.
Investments pledged as collateral for loans are not considered cash equivalents.
F-9
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Accounts Receivable: The Company bills its customers either directly, through
billing agreements with Local Exchange Carriers ("LEC"), or through two
unrelated billing and collection companies, collectively referred to as the
Billing Agents, which bill the customer through LECs with which the Company does
not have a LEC billing agreement. At December 31, 1998 and 1999, approximately
69% and 75%, respectively, of the Company's total accounts receivable were from
LECs or Billing Agents. In addition, approximately 8% of total accounts
receivable at both December 31, 1998 and 1999, respectively, were attributable
to revenues earned in December of the respective year but not billed to the
customers until the normal billing dates in January of the following year.
Property and Equipment: Property and equipment is stated at cost, net of
accumulated depreciation. Depreciation is provided using straight-line and
accelerated methods over the estimated useful lives of the assets. Maintenance
and repairs are charged to expense as incurred.
Asset Held for Disposal: The Company's asset held for disposal at December 31,
1998, is carried at the lower of book value or fair value, less estimated costs
to sell.
Advertising Costs: Advertising and telemarketing costs are expensed as incurred,
and totaled approximately $9,942, $11,912 and $4,640 during the years ended
December 31, 1997, 1998 and 1999, respectively.
Investment in and Note Receivable from Affiliate: At December 31, 1998, the
investment in and note receivable from affiliate included the underlying book
value of the Company's 13.25% ownership in VisionQuest Marketing Services, Inc.
("VisionQuest"), and the balance due related to a note receivable from
VisionQuest. As discussed in Note B, the Company and VisionQuest terminated
their business relationship effective January 1, 1999.
Interest Expense and Other Finance Charges: Interest expense and other finance
charges included interest incurred on short-term and long-term borrowings,
interest and related fees on the Company's line of credit facilities, and
interest, penalties and late charges on amounts payable to vendors and taxing
authorities.
Revenue Recognition: The Company recognizes telecommunications revenues when the
Company's customers make long distance telephone calls from their business or
residential telephones or by using the Company's telephone calling cards. Income
from prepaid telephone calling cards is recognized as the telephone service is
utilized.
Deferred Loan Closing Costs: Costs incurred in connection with the Company's
revolving credit facility with a financial institution have been capitalized and
are being amortized over the term of the credit facility.
Commissions: Certain independent Company representatives, as well as certain
officers and employees, receive commissions by soliciting non-profit
organizations to promote and market the Company's services to the non-profit
organization's members. The commission percentages are approximately 5% of net
commissionable revenues. Commissions expense is included in selling, general and
administrative expenses.
F-10
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Royalty Payments to Non-profit Organizations: The Company pays royalties of
approximately 10% of a customer's commissionable long distance revenues to a
non-profit organization. This royalty payment is included in selling, general
and administrative expenses.
Concentrations of Credit Risk: Financial instruments that potentially subject
the Company to concentrations of credit risk include accounts receivable from
customers and accounts payable to its carrier. The Company's customer base is
distributed throughout the United States, and the Company does not require any
collateral from its customers. Although significant portions of the Company's
revenues are billed through the Billing Agents and LECs, the ultimate
collectibility of these accounts is dependent upon the status of the individual
customer. There are no significant concentrations of revenues or accounts
receivable among individual customers.
The Company enlists the support of non-profit organizations to promote the
Company's services in return for the Company's royalty payment. The loss of the
support of one or more significant non-profit organizations could have a
material, adverse impact on the Company's results of operations. Approximately
44%, 42%, and 40% of the Company's net sales during the years ended December 31,
1997, 1998 and 1999, respectively, were earned from customers that have
designated the ten (10) most significant non-profit organizations as recipients
of the Company's royalty payment.
The Company purchases the majority of its long distance switching and network
services from WorldCom.
The Company maintains deposits at financial institutions that at times exceed
federally insured limits. Management does not believe there is any significant
risk of loss associated with this concentration of credit.
Redeemable Common Stock: Redeemable common stock is carried at its redemption
value. Redemption value includes the proceeds received upon issuance of the
common stock, and is increased by accretions resulting from the Company's
agreement to redeem the stock at cost plus annual rates of return, as specified
in the redemption agreements (see Note H). The carrying value is reduced by
quarterly returns of capital payments made to the holders of redeemable common
stock, and by the redemption price paid to each selling stockholder. As the
redemption options expire, as more fully discussed in Note H, the principal
amounts invested by the individual stockholders are reclassified as
nonredeemable common stock.
Nonredeemable Common Stock: Nonredeemable common stock consists of stock issued
to certain officers upon formation of the Company, and to other stockholders
with whom the Company had not executed a redemption agreement. Nonredeemable
common stock also includes the principal amounts invested by stockholders whose
redemption options have expired.
F-11
<PAGE> 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Income Taxes: Income tax expense is based on pretax financial accounting income.
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. This method also requires the
recognition of future tax benefits such as net operating loss carryforwards, to
the extent that realization of such benefits is more likely than not.
Earnings (Loss) Per Share: The Company presents basic and diluted earnings
(loss) per share. Basic earnings (loss) per share is computed by dividing
earnings (losses) available to nonredeemable common stockholders by the weighted
average number of nonredeemable shares outstanding during the year. Diluted
earnings (loss) per share reflect per share amounts that would have resulted if
dilutive potential nonredeemable common stock had been converted to
nonredeemable common stock. Potential nonredeemable common stock includes
redeemable common stock, stock warrants, stock options and convertible notes
payable. For 1997, conversions of potential nonredeemable common stock were not
included in the computation of earnings (loss) per share, however, since they
would have resulted in an antidilutive effect.
Covenants Not to Compete: Covenants not to compete are discounted to their
present value based upon the terms of the agreement, and are being amortized
over the effective period of the covenant, generally 2 to 4 years.
Fair Values of Financial Instruments: The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
Cash and cash equivalents--The carrying amount of cash and cash
equivalents approximates its fair value, because of the short
maturities of such instruments.
Short and long-term debt--Based upon the Company's current incremental
borrowing rates and the general short-term nature of most debt, the
carrying amount of short and long-term debt approximates its fair
value.
Redeemable Common Stock--The Company believes that the fair value of
its redeemable common stock is not significantly different from its
carrying amount. The redeemable common stock is not traded in the open
market.
F-12
<PAGE> 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Stock-Based Compensation: The Company accounts for stock-based compensation
plans in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees", and its various interpretations.
Under APB 25, the Company recognizes compensation expense equal to the
difference between the fair value of the common stock at the date of the grant
and the exercise price of the option. Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation",
prescribes the recognition of compensation expense based on the fair value of
options on the grant date, but allows companies to apply APB 25 if certain pro
forma disclosures are made assuming hypothetical fair value method application.
See Note K for pro forma disclosures required by SFAS No. 123 plus additional
information on the Company's stock-based compensation plans.
Reclassifications: Certain amounts in the prior year financial statements have
been reclassified to conform to the presentation used in the current year. The
most significant reclassification was to reclassify the Company's presentation
of an accounts receivable line of credit facility, as described in Note D to the
financial statements.
NOTE B--RELATED PARTY TRANSACTIONS
During each of the three years ended December 31, 1997, 1998 and 1999, the
Company participated in transactions with its officers and directors,
VisionQuest, and Hebron.
Officers and Directors
From 1994 through 1997, the Company declared quarterly distributions to its
stockholders. Two of the Company's original founders, both of whom are
stockholders, were paid their pro rata distributions through June 30, 1995.
Distributions declared by the Company from July 1995 through December 1997
attributable to the two founders were not paid at the time of declaration, but
were accrued as a liability by the Company.
One of the original founders is currently the Chairman of the Board of
Directors. At December 31, 1998 and 1999, accrued distributions to this founder
totaled approximately $3,225 and $3,201, respectively. In July 1999, the Company
and this founder agreed to defer payments of this accrued payable until such
time as the Company's financial condition improves, and the Company has the
ability, both legally and in good business practices, to pay the accrued
distributions. In consideration for this founder's subordination of the accrued
distributions to the Company's credit facility, and in consideration for this
founder agreeing to pledge 100,000 shares of Company common stock owned by the
founder as security for two notes payable owed by the Company, the Company
agreed to pay this founder $25 per month, subject to the limitations described
in the Company's credit facility. During 1999, the Company paid this founder
$150 pursuant to this agreement, and has recorded these payments as a charge to
operations in 1999. If the Company's Board of Directors decides to resume
payments of the accrued distributions at some future date, all amounts paid to
this founder pursuant to the July 1999 agreement shall be applied to reduce the
accrued distributions that are recorded in the Company's balance sheet.
F-13
<PAGE> 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Officers and Directors, Continued
In April 1998, one of the Company's other founders resigned. This individual was
an officer and director of the Company at the time of his resignation. In
connection with his resignation, the Company and this founder agreed to the
following:
o The Company agreed to pay the accrued distributions, totaling $1,209
at December 31, 1997, in the amount of $40 per month. At December 31,
1999, the remaining payable was $98.
o The Company agreed to pay the former officer $20 per month for the
rest of his life, in exchange for the former officer's agreement to
(1) not compete with the Company for one year from the date of the
agreement, (2) agree to take no actions significantly detrimental to
the Company (other than competition), and (3) waive any claims against
the Company as of the date of the agreement.
The Company recorded a liability of $2,184 as of the date of the agreement,
based upon the present value of the obligation over the expected life of the
former officer at the date of the agreement. The Company also recorded a
covenant not to compete of $2,184 at the date of the agreement, and amortized
this covenant over the one-year term. The covenant not to compete was fully
amortized as of March 31, 1999.
In 1995 and 1996, the Company's two founders and a related family member sold
21,204 shares of Company stock that they owned to 100 individuals at an
aggregate selling price of approximately $2,480. The selling price ranged from
$40 per share to $150 per share averaging $117 per share. The founders and the
related family member then loaned the proceeds of the sale of the stock to the
Company. The loans carried an interest rate of 8% per annum, and matured two
years from the date of issuance. The Company repaid these notes payable to the
founders and related family member in 1997 and 1998, and all such notes have
been repaid in full as of December 31, 1999.
Concurrently with the sale of stock by the Company's two founders and related
family member to the unrelated third parties, the Company also entered into
stock redemption agreements with the third parties (see Note H for a description
of the redemption agreements). Through December 31, 1999, the Company has
redeemed 5,278 shares and paid a total of $1,060 in connection with these
redemptions. The amounts paid consisted of $790 for the amounts paid by the
stockholders and $270 for the specified rate of return, as described in the
agreements.
A member of the Company's Board of Directors is affiliated with or controls
several organizations that participate in transactions with the Company. In
connection with the Company's 10% royalty program, the Company incurred
approximately $775, $1,060, and $1,107 of royalty expenses in 1997, 1998 and
1999, respectively, to organizations affiliated with or controlled by this
director. The Company also incurred advertising expenses of $1,803, $1918, and
$1,908 in 1997, 1998 and 1999, respectively, to organizations affiliated with or
controlled by this director.
These organizations also earned sales commissions in addition to the 10% royalty
payments. During the years ended December 31, 1997, 1998 and 1999, sales
commissions earned by these organizations totaled approximately $168, $497 and
$102, respectively. In 1999, the Company terminated the existing sales
agreements with these organizations and entered into new agreements. The new
agreements provide for the Company to pay the organizations an aggregate of
$1,491 over three (3) years, in exchange for the organizations' release of all
prior claims and obligations, and an agreement to not compete with the Company
over the term of the agreements.
In December 1999, a Company officer and director, who is also the President of
Hebron, resigned from the Company. In connection with his termination agreement,
the Company agreed to pay the former director $1,359 over four (4) years, in
exchange for the director agreeing not to compete with the Company over that
term. The Company accrued the present value of this obligation and is amortizing
the noncompete agreement over the term of the agreement. The liability to the
former director is included in the financial statement caption Notes Payable and
Long-Term Debt to Related Parties, and is further described in Note F below.
F-14
<PAGE> 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Officers and Directors, Continued
During the years ended December 31, 1997, 1998 and 1999, the Company expended
approximately $69, $741 and $767, respectively, to a law firm which the
Company's current President and CEO is a former partner, and is currently a
consultant.
As discussed in Note K, in 1999, the Company also entered into stock option and
award agreements with certain officers and directors.
VisionQuest
VisionQuest is related to the Company through common ownership, management, and
family relationships. Through June 30, 1998, the Company, and its two principal
founders collectively owned approximately 60% of the outstanding common stock of
VisionQuest. Effective July 1, 1998, VisionQuest acquired all of the VisionQuest
common stock owned by the founder that resigned in April 1998, thus reducing the
Company's effective ownership percentage in VisionQuest to 48% of the
outstanding common stock. In addition, the Company's two founders served on the
Board of Directors of VisionQuest, and the son-in-law of one of the founders is
the president of VisionQuest and also a member of the VisionQuest Board of
Directors. As discussed below, the Company and VisionQuest terminated their
business relationship effective January 1, 1999.
The Company utilized VisionQuest as its provider of telemarketing services from
1993 through December 31, 1998. Total amounts paid to VisionQuest for
telemarketing services during the years ended December 31, 1997 and 1998, were
approximately $5,242 and $6,209, respectively.
Telemarketing expenses incurred in 1998 included the direct costs of
telemarketing services provided by VisionQuest to the Company during 1998, plus
reimbursement of all of VisionQuest's operating expenses and corporate overhead.
From January 1997 through October 1997, telemarketing expenses included an
hourly billing rate for telemarketing services. In addition, from January 1997
through October 1997, the Company helped to fund VisionQuest's operating
expenses in the amount of approximately $25 per week, for a total of
approximately $1,330. In November and December 1997, the Company's telemarketing
expenses incurred to VisionQuest equaled the direct costs of telemarketing
services incurred by VisionQuest, plus reimbursement of all of VisionQuest's
operating expenses and corporate overhead.
In November 1997, the Company and VisionQuest agreed that the portion of the
operating expenses that related to VisionQuest's other clients should be repaid
to the Company. In April 1998, and effective December 31, 1997, VisionQuest
signed a note payable to the Company, totaling $670, to repay these expenses. In
June 1998, VisionQuest repaid $150 of this note to the Company. The balance of
$520 was canceled effective January 1, 1999, as part of the agreement to
terminate all business relationships between the two companies, as discussed
below.
F-15
<PAGE> 62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
VisionQuest, Continued
As a result of the Company's payment of VisionQuest's corporate payroll and
operating expenses in 1997 and 1998, the Company paid VisionQuest a higher rate
for its telemarketing services than VisionQuest charged independent third
parties. The Company also paid VisionQuest a higher rate for telemarketing
services than the Company could have obtained in an arms-length transaction with
an unaffiliated third party that provides the same telemarketing services.
The Company paid the higher rates to VisionQuest because VisionQuest gave
priority to the Company's requests, and because VisionQuest agreed to do
business with the Company with no long-term or minimum purchase agreement. The
Company was also conducting merger negotiations with VisionQuest at the time,
and was willing to pay a higher rate in order to retain key VisionQuest
executives.
The Company believes that the amounts it paid to VisionQuest for telemarketing
services were higher than what it could have obtained in an arms-length
transaction from an unaffiliated third party by approximately $1,000 and $3,000
in 1997 and 1998, respectively.
Effective January 1, 1999, the Company and VisionQuest mutually terminated their
business relationship. The Company acquired from VisionQuest the rights to use
all of the assets located in VisionQuest's Tahlequah, Oklahoma telemarketing
center, from January 1, 1999, through September 30, 1999, in exchange for all of
the Company's ownership interests in VisionQuest, all of the Company President's
ownership interests in VisionQuest (which were transferred to the Company for no
consideration immediately prior to the transfer), and cancellation of the note
receivable between the Company and VisionQuest. The agreement also provided for
a release of all claims and obligations between the two companies. Upon transfer
of the stock and cancellation of the note receivable, the Company reclassified
its investment in and note receivable from VisionQuest, totaling $578, to a
prepaid operating lease, and amortized the amount to expense over the term of
the agreement.
Hebron
Hebron was incorporated in November 1995 to provide switching network services
to the Company. Hebron has a relationship with the Company through partially
integrated management and certain shared ownership. The Company's two principal
founders served on Hebron's Board of Directors from its inception in November
1995 until their resignation in November 1996. In addition, the President of
Hebron served on the Company's Board of Directors from October 1998 through
December 1999 and another Company director is also on Hebron's Board of
Directors.
F-16
<PAGE> 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Hebron, Continued
Cost of sales in 1997, 1998 and 1999 includes approximately $13,529, $14,736 and
$1,469, respectively, of telecommunications services provided by Hebron. In
1997, Hebron charged the Company a higher rate for the switched one-plus
interstate and intrastate services it provided to the Company than the Company
could have obtained from its primary carrier. The higher rates were the result
of the Company's primary carrier lowering its rates in 1997, but Hebron did not
match such rate reductions. The Company believes that the amounts it paid to
Hebron for telecommunication services in 1997 were approximately $1,300 higher
than what it could have obtained from its primary carrier. Effective January
1998, Hebron agreed to lower its rates so that they matched those of the
Company's primary carrier.
Hebron also charged the Company interest of 18% per annum on the accounts
payable for telecommunication services that are over 55 days from the invoice
date. This interest rate is comparable to the rate charged by the Company's
primary carrier. During 1997, 1998 and 1999, the Company incurred interest
expense of approximately $35, $129 and $22, respectively, related to past due
accounts payable invoices.
The Company's principal operating and administrative offices are located in an
office building owned by Hebron. Total rent expense incurred to Hebron was
approximately $110, $380 and $583 in 1997, 1998 and 1999, respectively.
From December 1996 through October 1998, Hebron provided the Company with an
account receivable line of credit facility (the "Hebron Loan Program"). The
Hebron Loan Program provided for the Company to pay 18% interest on the amounts
advanced under the credit facility, plus fees of 2% of billings processed and 2
cents per call record. As a result of the stated interest rate and the fees, the
effective interest rate of this financing arrangement was approximately 58% in
1996, 1997 and 1998. This effective interest rate was higher than what the
Company could have obtained in an arrangement with independent third parties.
The Company incurred total interest and other related financing costs of
approximately $805 and $885 in 1997 and 1998, respectively, under the Hebron
Loan Program.
At December 31, 1998, all advances under the Hebron Loan Program credit facility
had been repaid. Receivables from related parties of $152 at December 31, 1998,
consists of amounts that had been withheld as a reserve for interest and escrow
fees under the Hebron Loan Program but which were reimbursed to the Company in
January 1999.
In 1997 and through July 1998, the Company transmitted a portion of its accounts
receivables through one of its Billing Agents through an account maintained at
the Billing Agent under Hebron's name. Hebron charged the Company a fee equal to
2% of the net revenues transmitted under this arrangement. The total fees
incurred by the Company in 1997 and 1998 were approximately $135 and $101,
respectively.
F-17
<PAGE> 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Hebron, Continued
In 1997 and 1998, Hebron periodically made loans to the Company for working
capital purposes. The loans generally carried an interest rate of 10%. Total
interest expense incurred on loans made by Hebron to the Company was
approximately $46 and $6, respectively, during the years ended December 31, 1997
and 1998.
At December 31, 1998, the Company owed Hebron $3,892 for telecommunications and
other services incurred through that date. In addition, the Company agreed to
reimburse Hebron for costs and expenses totaling approximately $563 incurred by
Hebron in connection with the development of an internet service product. At
December 31, 1998, $1,224 of this liability has been reclassified as a long-term
obligation, as a result of the transactions described below.
In April 1999, and effective February 1, 1999, the Company and Hebron entered
into an asset purchase agreement (the "Hebron APA"). Under the terms of the
Hebron APA, the Company agreed to:
(1) pay Hebron for all expenses that Hebron incurred prior to January 31,
1999, related to the switch network, and convert the balance owed to
Hebron for telecommunications services previously provided, totaling
approximately $2,300, to a note payable,
(2) reimburse Hebron for its costs and expenses incurred on the Company's
behalf in connection with the development of an internet service
product, totaling approximately $584, and acquire the rights to the
assets and assume all of the related lease obligations incurred by
Hebron in connection with the internet service product, totaling
approximately $1,200, and
(3) purchase all of the switch assets at their net book value, assume all
of the related switch lease obligations totaling approximately $1,300,
and issue a note payable to Hebron for the net amount of $567.
In connection with the Hebron APA, the Company issued a promissory note payable
to Hebron totaling approximately $2,300 for item (1) discussed above. This note
payable has been subordinated to the Company's credit facility described below.
Effective April 1, 2000, the Hebron APA was closed, and the Company issued notes
payable for the internet and switch assets, which were also subordinated to the
Company's credit facility.
F-18
<PAGE> 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Hebron, Continued
Pursuant to a lease license agreement between the Company and Hebron, the
Company assumed operations of the switch and internet assets effective February
1, 1999. Under the terms of the lease license agreement, the Company and Hebron
agreed that Hebron would transfer to the Company custody and control of the
switch and internet assets, and the Company shall hold and operate such assets
as if the Company owned the assets. The terms of the lease license agreement
also provided that the Company will assume all of the rights and obligations
associated with owning and operating the switch and internet assets. The lease
license agreement also provides that the Company will pay Hebron a monthly fee
equal to the amount of interest that is payable on the switch and internet
assets. Accordingly, the Company has recorded the assets and the related lease
and note payable obligations in its financial statements effective February 1,
1999, and the statement of operations from February 1999 forward reflect the
costs of operating those switches and internet assets.
NOTE C--PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Office equipment, furniture and fixtures $ 2,477 $ 3,620 $ 3,784
Switch equipment -- 1,938 1,938
Internet equipment 98 1,169 1,277
Other fixed assets 149 787 863
-------- -------- --------
2,724 7,514 7,862
Less accumulated depreciation 1,606 2,094 2,744
-------- -------- --------
$ 1,118 $ 5,420 $ 5,118
======== ======== ========
</TABLE>
As discussed in Note B above, the Company recorded the Oklahoma City and Chicago
switches and the internet assets effective February 1, 1999. The total cost of
these assets acquired by assuming the related lease obligations and issuing
notes payable to Hebron for the net book value was approximately $2,926. The
total cost of all assets held under capital lease obligations was $493 and
$3,776 at December 31, 1998 and 1999, respectively and $3,776 at March 31, 2000.
Accumulated depreciation of leased equipment was approximately $160 and $1,468
at December 31, 1998 and 1999, respectively, and $1,834 at March 31, 2000.
Depreciation expense on property and equipment, including depreciation on assets
held under capital leases, was approximately $611, $464, and $1,890 during the
years ended December 31, 1997, 1998, and 1999, respectively, and $391 and $650
for the three months ended March 31, 1999 and 2000, respectively.
Deposits totaling $355 at December 31, 1999, and $1,174 at March 31, 2000,
represent amounts paid for fixed assets that had not been placed into service.
F-19
<PAGE> 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE C--PROPERTY AND EQUIPMENT--Continued
In 1998, the Company determined that the carrying amount of the office building
it owned but was no longer utilizing was impaired. The Company reduced the
carrying amount from $715 to $500, which was the estimated fair value of the
building based upon an appraisal, less the estimated costs to sell the building.
The Company recognized a loss of $215 in 1998. In February 1999, the Company
sold the building for $522, and realized a recovery of $22.
NOTE D--LINE OF CREDIT ARRANGEMENTS
The Company has a $30,000 line of credit facility (the "Credit Facility") with a
financial institution. Borrowing availability is based upon collections
multiples and earnings ratios, subject to the maximum line of credit. At
December 31, 1999, the Company could borrow up to the full amount of the $30,000
available under the Credit Facility. The outstanding balance at December 31,
1999, was $20,880.
The Credit Facility matures on January 30, 2003, and carries an interest rate of
prime plus 3.5%. The interest rate at December 31, 1999, was 11.5%. The Credit
Facility is secured by substantially all of the Company's assets, including
accounts receivable and the Company's customer base.
The Credit Facility is classified as a current liability in the Company's
financial statements, because under the terms of the agreement, the Company is
required to maintain a lockbox, and apply collections from customers to the
outstanding amounts under the Credit Facility, and because the terms of the
agreement provide the lender with the discretionary ability to declare the note
due and payable.
The Company incurred $169 and $345 in loan closing fees in 1998 and 1999,
respectively, in connection with the Credit Facility. These fees are included in
other assets and are being amortized over the term of the Credit Facility.
In connection with closing the Credit Facility, several of the Company's
creditors agreed to subordinate the Company's obligations to them in favor of
the financial institution providing the Credit Facility. These creditors include
Patrick Enterprises, Hebron, two members of the Company's Board of Directors, a
Company founder, and a former stockholder who redeemed his stock in exchange for
a note payable from the Company. Repayment of these obligations is limited as
specified in the loan and security agreement between the Company and the
financial institution. The total outstanding debt owed to subordinated creditors
as of December 31, 1999, was approximately $5,259. In addition, one of the
Company's founders agreed to subordinate accrued distributions, totaling $3,201
at December 31, 1999, in favor of the Credit Facility.
F-20
<PAGE> 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE D--LINE OF CREDIT ARRANGEMENTS--Continued
The Credit Facility contains various financial and other covenants with which
the Company must comply, including a minimum net worth requirement, as defined
in the agreement, of negative ($12,000), restrictions on asset acquisitions,
restrictions on the payment of dividends, and restrictions on principal and
interest payments to subordinated creditors. At December 31, 1999, the Company
was not in compliance with the restrictions on principal payments to certain
subordinated creditors. However, the Company received a letter from the lender
waiving the deficiencies. At March 31, 2000, the Company was in compliance with
the covenants contained in the agreement.
In 1997 and 1998, the Company had various line of credit arrangements with
Hebron, as described in Note B, and with various unrelated third parties. The
aggregate outstanding balance on the lines of credit was $7,964 at December 31,
1998. The effective interest rates ranged from 12.5% with one lender to 58% with
Hebron during both 1997 and 1998. The average effective interest rates for all
of the various agreements were approximately 28% and 18% in 1997 and 1998,
respectively. As discussed in Note B, the line of credit arrangement with Hebron
was discontinued in October 1998, and all outstanding advances had been paid in
full as of December 31, 1998. The Company repaid the other credit facilities in
full upon closing of the Credit Facility in February 1999.
One of the Company's prior credit facilities was structured as an accounts
receivable purchase agreement, and instead of recognizing a liability, the
Company reduced its accounts receivable for the proceeds of sales of the
receivables to the third party. The Company subsequently determined that these
transactions did not qualify as a transfer of financial assets in accordance
with SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities", which became effective January 1, 1998.
Accordingly, the 1998 financial statements have been reclassified to account for
the transactions as a secured borrowing. The effect of this reclassification was
to increase both current assets and current liabilities by $4,258 at December
31, 1998. There was no effect on stockholders' deficiency or the results of
operations. The reclassification also reduced cash flows from operating
activities and increased cash flows from financing activities from amounts
previously reported by $1,823.
NOTE E--SHORT-TERM NOTES PAYABLE TO INDIVIDUALS
Short-term notes payable to individuals consist of the following:
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Convertible notes payable $ 2,477 $ 3,620 $ 399
Advance payment loan program notes 4,077 154 --
Direct bill program notes 770 -- --
-------- -------- --------
$ 5,268 $ 553 $ 399
======== ======== ========
</TABLE>
F-21
<PAGE> 68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE E--SHORT-TERM NOTES PAYABLE TO INDIVIDUALS--Continued
Convertible Notes Payable: In 1995, the Company issued promissory notes payable
to approximately seventy-five (75) individuals, substantially all of which are
convertible to common stock. These notes generally have no specified maturity
date and are convertible to common stock at the option of the Company. Interest
accrues at 10% and is payable quarterly. All of these notes are classified as
current liabilities. The individual notes contain varying terms with regard to
the conversion agreements. Some of the notes do not specify any conversion terms
other than they are convertible at the option of the Company. Other notes
specify that the conversion will be based on a specific price per share.
Notes Payable - Advance Payment Loan Program: In November 1995, the Company
initiated an Advance Payment Loan Program (APLP), under which individuals have
lent the Company money to finance working capital needs. Although the loan
agreements indicated that the loans were to be secured by accounts receivable
from the LECs, no security agreements were perfected and all of the Company's
LEC accounts receivables are pledged under the Company's Credit Facility, as
discussed in Note D. Therefore, these loans are effectively unsecured. Interest
on the APLP notes is 18% per annum, payable quarterly. In June 1999, the Company
repaid in full the outstanding balances of substantially all lenders with a
balance of $10 or less. In October 1999, the Company offered the remaining
lenders to either (a) have their balances paid in full or (b) options to convert
their notes to subordinated debt under various terms. Such conversions would be
subject to the lenders qualifying as accredited investors. Substantially all of
the investors chose to either have their notes repaid or did not respond to the
Company's offer, and the Company repaid these amounts in December 1999.
Effective February 15, 2000, notes totaling $177 were converted from APLP notes
to subordinated promissory notes.
Notes Payable - Direct Bill Program: In the fourth quarter of 1997, the Company
obtained a series of loans from third parties, for the purpose of financing
working capital operations. The loan agreements indicate that the security for
the loans are the Company's accounts receivable arising from its customers which
are billed directly by the Company, although no security agreements were
perfected. These loans bore interest at rates of 20% to 25% per annum, payable
quarterly. All of these notes were repaid in full in June 1999.
F-22
<PAGE> 69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT
Related Parties
Notes payable and long-term debt to related parties consists of the following:
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Loan payable to a Company founder,
made May 1998, unsecured, no
specified interest rate or
maturity date, balance paid in
full in 1999 $ 98 $ -- $ --
Accrued distributions payable to a
Company founder, unsecured, no
stated interest rate, monthly
payments of $40 until paid in
full, subordinated to the Credit
Facility in February 1999 575 98 --
Accrued termination obligation
payable to a Company founder,
effective April 1998, payment
terms of $20 per month with an
imputed interest rate of 11.25%
over his estimated life at the
date of the agreement, unsecured 2,169 2,161 2,159
Accrued payable to former Company
director and current President of
Hebron, effective December 1999,
payment terms of $42 per month
beginning in January 2000, and
$21 per month beginning January
2001 through May 2004, imputed
interest rate of 11.75%,
unsecured -- 1,120 985
Accrued payable to Christian
Advocates Serving Evangelism
(C.A.S.E.), an organization
affiliated with a Company
director, effective January 1999,
payment terms of $33 per month
beginning in January 2000 through
December 2001, imputed interest
rate of 11.75%, unsecured -- 708 652
</TABLE>
F-23
<PAGE> 70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Related Parties, Continued
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Accrued payable to Regency
Productions, a company affiliated
with a Company director,
effective January 1999, payment
terms of $9 per month beginning
in January 2000 through December
2001, imputed interest rate of
11.75%, unsecured $ -- $ 183 $ 162
Note payable to C.A.S.E., dated
July 1997, unsecured,
subordinated to the Credit
Facility, restructured in April
1999, as described below 688 850 850
Note payable to Company director,
dated June 2, 1998, unsecured,
subordinated to Credit Facility,
restructured in April 1999, as
described below 150 100 100
Note payable to Hebron, dated
February 1, 1999, with an
original principal amount of
$2,274, interest rate of 12.5%
through November 1999, increased
to 16.25% effective December
1999, subordinated to Credit
Facility, monthly interest only
payments plus specified
prepayments of principal not to
exceed $1,234 through March 2000,
balance due August 1, 2000,
secured by 50,000 shares of
Company common stock owned by a
Company founder -- 1,711 1,611
Payable to Hebron, converted to
note payable effective February
1, 1999, as described above 1,224 -- --
</TABLE>
F-24
<PAGE> 71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Related Parties, Continued
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Note payable to Hebron for switch
assets, effective upon closing of
transaction, initial interest
rate of 12.5%, interest only
payments for 12 months, matures
18 months from effective date -- 567 567
Note payable to Hebron for internet
assets and reimbursement of
related expenses, effective upon
closing of transaction, initial
interest rate of 12.5%, interest
only payments for 12 months,
matures 18 months from effective
date -- 584 584
-------- -------- --------
4,904 8,082 7,670
Amounts due within one year 686 2,657 2,417
-------- -------- --------
$ 4,218 $ 5,425 $ 5,253
======== ======== ========
</TABLE>
In April 1999, the note payable with C.A.S.E. was restructured. The new note
provided for additional advances of approximately $260, bringing the total
outstanding balance to $850, and monthly interest only payments at 10% for five
years, with the unpaid principal due at maturity in April 2004. The lender has
the option to convert the note to common stock at a per share price equal to the
lower of (1) the fair market value of the common stock on January 1, 1998, as
determined by an appraisal, or (2) the lowest publicly traded price of the
common stock three months following the establishment of a public trading market
for the common stock. The terms of the agreement also provide for the Company to
issue the organization warrants to purchase 3,400 shares of Company common stock
at a strike price of $0.01 per share. In connection with the warrants, the
Company valued the warrants using a minimum value of $41.50 dollars per share.
The value was based upon an appraised value of the Company's common stock as of
June 30, 1999. Accordingly, the Company recorded paid-in-capital and a
corresponding charge to interest and other financing charges of $141 for the
stock warrants. As a result of the stated interest rate in the note and the
costs associated with the warrants, the effective interest rate of this
agreement is 15.7%.
F-25
<PAGE> 72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Related Parties, Continued
The note payable to the Company director was also restructured in April 1999.
The balance was paid down to $100, and the new payment terms provide for monthly
interest only payments at 10%, with the unpaid principal due in April 2001. The
note may be extended for an additional three years at the option of the Company.
This note also contains conversion options similar to the ones described above.
The terms of the agreement also provide for the Company to issue the director
warrants to purchase 400 shares of Company common stock at a strike price of
$0.01 per share. In connection with the warrants, the Company valued the
warrants using a minimum value of $41.50 dollars per share, based upon the same
appraisal described above. Accordingly, the Company recorded paid-in-capital and
a corresponding charge to interest and other financing charges of $17 for the
stock warrants. As a result of the stated interest rate in the note and the
costs associated with the warrants, the effective interest rate of this
agreement is 15.9%.
Other Notes Payable, Long-Term Debt and Capital Lease Obligations
Notes payable, long-term debt and capital lease obligations to others consists
of the following:
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Notes payable to unaffiliated
companies and third parties,
dated at various dates in 1996
through 1998, described in the
agreements as being secured by
the Company's customer base or
direct bill accounts receivable,
but not perfected, agreements
totaling $1,205 contained the
personal guaranties of the
Company founders, interest of 18%
payable monthly (one note had a
stated interest rate of 25%
payable quarterly), all notes
were repaid in full during 1999 $ 1,655 $ -- $ --
Loans payable to two individuals,
originating in December 1997 and
May 1998, maturing in December
2005 and May 2006, monthly
payments of $8 in the aggregate,
including interest with an
effective rate of approximately 58% 183 182 182
</TABLE>
F-26
<PAGE> 73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Other Notes Payable, Long-Term Debt and Capital Lease Obligations, Continued
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Note payable to seller of building,
secured by first mortgage on
office building, monthly payments
of $10 including interest at 10%,
matures April 1, 2001 (repaid
upon sale of building in February
1999) $ 245 $ -- $ --
Note payable to individual,
interest at 18% payable monthly,
principal due upon maturity in
January 2000, subordinated to the
Credit Facility, secured by
50,000 shares of Company common
stock owned by a Company founder,
restructured in January 2000 with
the Company making a $500
principal reduction, and the
balance of the note allocated
among two individuals with a new
maturity date of January 2001,
effective interest rates reduced
to 15%, no change in security -- 2,500 2,000
Note payable to individual for
redemption of 5,000 shares of
Type D redeemable common stock,
imputed interest rate of 14%,
payable in monthly installments
with the balance paid in full in
August 1999, subordinated to the
Credit Facility 928 -- --
Subordinated promissory notes to
individuals, unsecured, interest
rates ranging from 9% to 11%,
maturity dates ranging from
February 15, 2001 to February 15,
2005 -- -- 177
</TABLE>
F-27
<PAGE> 74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Other Notes Payable, Long-Term Debt and Capital Lease Obligations, Continued
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Accrued liabilities to former
salesmen, effective at various
dates from June 1999 through
September 1999, aggregate monthly
payments of $46 per month with
imputed interest rate of 10.5%,
maturing at various dates from
April 2002 through September
2002, unsecured $ -- $ 1,213 $ 1,106
Capital lease obligation for
telephone system, effective
February 1997 with subsequent
amendments, effective interest
rate of 21.5%, payable in monthly
installments of $16 through
August 2002 315 352 319
Capital lease obligation for
internet equipment, assumed from
Hebron, monthly payments of $39
through June 2001, effective
interest rate of 12% -- 666 557
Capital lease obligation for switch
equipment, assumed from Hebron,
monthly payments of $26 through
December 2000, effective interest
rate of 13.25% -- 368 272
Capital lease obligation for switch
equipment, assumed from Hebron,
monthly payments of $20 through
March 2002, effective interest
rate of 12% -- 473 424
Other notes payable and capital
leases 35 240 141
-------- -------- --------
3,361 5,994 5,178
Amounts due within one year 2,315 2,300 3,713
-------- -------- --------
$ 1,046 $ 3,694 $ 1,465
======== ======== ========
</TABLE>
F-28
<PAGE> 75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Future maturities of notes payable and long-term debt as of March 31, 2000, are
as follows:
<TABLE>
<CAPTION>
Related
Parties Others Total
---------- ---------- ----------
<S> <C> <C> <C>
2001 $ 2,417 $ 3,713 $ 6,130
2002 1,805 1,006 2,811
2003 221 270 491
2004 247 43 290
2005 879 82 961
Thereafter 2,101 64 2,165
---------- ---------- ----------
$ 7,670 $ 5,178 $ 12,848
========== ========== ==========
</TABLE>
NOTE G--INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
Current
<S> <C> <C> <C>
Federal and state $ -- $ -- $ --
Deferred
Federal and state 92 (643) 1,905
-------- -------- --------
$ 92 $ (643) $ 1,905
======== ======== ========
</TABLE>
At December 31, 1999, the Company has net operating loss carryforwards totaling
approximately $5,100 that may be used to offset future taxable income. These net
operating loss carryforwards expire in the years 2009 through 2014.
Income tax expense (benefit) for the years ended December 31, 1997, 1998 and
1999, differs from the expected rate of 34% for the following reasons:
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Federal income tax (benefit) at statutory rate (34.0) (34.0) 34.0
Expenses and losses not providing a tax benefit 81.9 8.9 0.1
Change in valuation allowance -- 15.5 10.1
State income tax (benefit), net (5.5) (5.7) 5.7
-------- -------- --------
42.4 (15.3) 49.9
======== ======== ========
</TABLE>
F-29
<PAGE> 76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE G--INCOME TAXES--Continued
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31 March 31
1998 1999 2000
-------- -------- --------
<S> <C> <C> <C>
Tax effect of future tax deductible items
Allowance for uncollectible receivables $ 158 $ 200 $ 302
Deferred telemarketing costs 2,516 858 692
Accrued termination obligation 650 865 865
Deferred stock compensation -- 170 200
Depreciable assets 75 153 192
Loss carryforwards 2,165 2,274 2,188
Other reserves and settlements 606 130 121
-------- -------- --------
Total deferred tax assets 6,170 4,650 4,560
Less valuation allowance (650) (1,035) (1,065)
-------- -------- --------
Net deferred tax asset $ 5,520 $ 3,615 $ 3,495
======== ======== ========
</TABLE>
The Company believes that the improvements in its operating results, as
discussed in Note J, provides sufficient positive evidence to indicate that it
is more likely than not that it will realize the net deferred tax benefit of
$3,615 recorded in the financial statements. The Company's actual operating
results in 1999 and projections for future taxable income provide for full
utilization of the deferred tax asset, net of the valuation allowance, over the
periods in which the temporary differences are anticipated to reverse.
At December 31, 1998 and 1999, the Company has provided a valuation allowance of
$650 and $1,035, respectively, for the tax effects of the accrued termination
obligation to the former Senior Vice President and for the compensation cost
recorded in the financial statements for stock options issued to certain Company
officers and non-employee directors, because the Company cannot assess that it
is more likely than not that it will realize these benefits. The change in the
total valuation allowance for the year ended December 31, 1999, is due to the
excess of expenses recorded in the financial statements for the accrued
termination obligation and the deferred stock compensation over the amounts that
were currently deductible for income tax purposes.
F-30
<PAGE> 77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE H--REDEEMABLE AND NONREDEEMABLE COMMON STOCK
From time to time, the Company entered into various agreements with certain of
its shareholders pursuant to which the Company agreed, upon request of one or
more of such shareholders, to redeem the shares of Common Stock owned by such
shareholder. While the Company's Certificate of Incorporation authorizes the
Company to issue a single class of Common Stock, the Company has, for financial
accounting purposes, segregated its Common Stock into two distinct groups,
redeemable and nonredeemable. Of the 825,278 shares of Common Stock outstanding
at December 31, 1999, 15,537 shares are characterized as redeemable common stock
and 809,741 shares are characterized as nonredeemable common stock.
The Company has entered into four variations of the redemption agreements, which
it classifies as Type A, Type B, Type C and Type D. Generally, each redemption
agreement provides that the shares of Common Stock shall be repurchased for an
amount that gives the shareholder a specified rate of return based on the length
of time the shareholder owned such shares. Type A agreements were issued
primarily between October 1992 and December 1992 and Type B agreements were
issued primarily between January 1993 and May 1995. Type A redemption agreements
provide that shareholders owning their shares of Common Stock between 6 months
and one year receive a 12% annual return; between one year and 18 months receive
a 15% annual return; and between 18 months and two years receive an 18% annual
return. Type B redemption agreements provide that shareholders owning their
shares of common stock between one year and 18 months receive a 15% annual
return, and between 18 months and two years receive an 18% annual return. Each
of the Type A and Type B agreements expires two years after issuance. All of the
Type A and Type B agreements have now expired pursuant to their terms.
Type C agreements were issued primarily between July 1992 and September 1992 and
have terms identical to the Type A agreements except that Type C agreements have
no expiration. The Company has agreed at its option to redeem the shares of
Common Stock owned for more than two years for the last highest price that the
shares of Common Stock have been sold to an investor. Type D Agreements have no
expiration and were issued from May 1995 until the Company discontinued issuing
redemption agreements altogether in February 1996. Type D agreements provide
that shareholders owning their shares of Common Stock less than one year receive
a 10% annual return; between one year and 18 months receive a 15% annual return;
between 18 months and three years receive an 18% annual return; and over three
years an amount based on a formula specified in the agreement.
During the years ended December 31, 1998 and 1999, substantially all of the
outstanding Type D redeemable common stock had been outstanding for over three
years. Accordingly, the redemption price was based upon the formula specified in
the Type D redemption agreements for stock held over three years. Application of
the formula to the carrying amount of Type D redeemable common stock resulted in
a net reduction of the redemption price of approximately $179 and $102,
respectively, during the years ended December 31, 1998 and 1999.
F-31
<PAGE> 78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE H--REDEEMABLE AND NONREDEEMABLE COMMON STOCK--Continued
At December 31, 1998 and 1999, the carrying amount of redeemable common stock is
as follows:
<TABLE>
<CAPTION>
1998 1999
-------- --------
<S> <C> <C>
Principal amount invested by stockholders $ 1,506 $ 1,492
Accumulated accretion of agreed upon redemption
price, net of periodic distributions paid to
the stockholders 249 147
-------- --------
$ 1,755 $ 1,639
======== ========
</TABLE>
The carrying amounts of redeemable common stock applicable to the various types
of redemption agreements were as follows at December 31, 1998 and 1999:
<TABLE>
<CAPTION>
1998 1999
-------- --------
<S> <C> <C>
Type C redemption agreements $ 391 $ 391
Type D redemption agreements 1,364 1,248
-------- --------
$ 1,755 $ 1,639
======== ========
</TABLE>
A summary of activity of redeemable common stock during each of the years ended
December 31, 1997, 1998 and 1999, and the three months ended March 31, 2000, is
as follows:
<TABLE>
<CAPTION>
Three Months
Ended
Year Ended December 31 March 31
1997 1998 1999 2000
-------- -------- -------- ------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 3,853 $ 3,035 $ 1,755 $ 1,639
Redemptions of redeemable common stock (53) (1,082) (14) --
Expiration and cancellation of redemption options (687) (19) -- --
Change in redemption value of redeemable
common stock 470 (179) (102) (42)
Distributions to redeemable stockholders (548) -- -- --
-------- -------- -------- --------
Balance at end of period $ 3,035 $ 1,755 $ 1,639 $ 1,597
======== ======== ======== ========
</TABLE>
F-32
<PAGE> 79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES
Violations of Federal and State Securities Laws
In 1995, the Company determined that it may not have registered its securities
with the Securities and Exchange Commission (the "Commission") when it was
obligated to do so under Federal securities laws and that, consequently, it may
have engaged in the sale or delivery of unregistered securities in violation of
the Federal securities laws. In July 1996, the Company voluntarily reported this
information to the Commission, which then instituted an investigation into
whether the Company and its two principal founders had violated any of the
Federal securities laws. The Company and its two founders cooperated with the
Commission during this investigation.
In September 1997, the Commission's staff attorney who was conducting the
investigation informed the Company that the staff intended to recommend to the
Commission that it institute cease-and-desist proceedings against the Company,
based upon the staff's belief that the Company had violated Sections 5(a) and
5(c) of the Securities Act of 1933, as amended ("Securities Act"), and Section
12(g) of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and
Rule 12g-1 promulgated under the Exchange Act. Also in September 1997, the
Commission's staff attorney informed the two founders and Hebron that the staff
intended to recommend that the Commission institute cease-and-desist proceedings
against them.
On July 15, 1998, the Company, the two founders and Hebron executed an offer of
settlement in which they consented to the entry of a cease-and-desist order
contingent upon the Commission accepting the Commission's staff's
recommendation. The offers provided that the Company and the two founders would
cease and desist from committing or causing any violations or future violations
of Sections 5(a) and 5(c) of the Securities Act and Section 12(g) of the
Exchange Act and Rule 12g-1. Additionally, in the offers, Hebron consented to
the entry of a cease-and-desist order which provided that it would
cease-and-desist from committing or causing any violations or future violations
of Sections 5(a) and 5(c) of the Securities Act.
On July 23, 1998, the Commission approved the Commission's staff attorney's
recommendation and accepted the offers of settlement. On July 30, 1998, the
Commission issued a cease-and-desist order which stated that (a) the Company,
the two founders and Hebron had violated Sections 5(a) and 5(c) of the
Securities Act; (b) the Company had violated Section 12(g) of the Exchange Act
and Rule 12g-1; and (c) the two founders had caused the violation of Section
12(g) of the Exchange Act and Rule 12g-1. The Commission ordered the Company,
the two founders, and Hebron to cease and desist from committing or causing any
violations and any future violations of Sections 5(a) and 5(c) of the Securities
Act and Section 12(g) of the Exchange Act and Rule 12g-1. The Commission did not
order any monetary penalties, fines, sanctions, or disgorgement against the
Company, the two founders, Hebron or anyone else associated with the Company or
any of the other parties.
F-33
<PAGE> 80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Violations of Federal and State Securities Laws, Continued
The Federal securities laws provide legal causes of action against the Company
by persons buying the securities from the Company, including action to rescind
the sales. With respect to the sales described above, the statutes of
limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. The Company made substantially all of the
stock sales more than three years ago. However, with respect to such sales,
other causes of actions may exist under federal law, including causes of action
for which the statute of limitations may not have expired.
Each of the states in which the Company has effected sales of common stock has
its own securities laws, which likely have equal applicability to the Company's
activities discussed above. The Company sold stock to persons in over forty
states, and those states typically provide that a purchaser of securities in a
transaction that fails to comply with the state's securities laws can rescind
the purchase, receiving from the issuing company the purchase price paid plus an
interest factor, frequently 10% per annum from the date of sales of such
securities, less any amounts paid to such security holder. The statutes of
limitations for these rights typically do not begin running until a purchaser
discovers the violation of the law, and therefore in most instances, and
depending on individual circumstances, the statute of limitations do not appear
to limit those rights for most purchasers of securities from the Company. Also,
depending on the law of the state and individual circumstances, monetary damages
and other remedies may be granted for breach of state securities laws. As a
result, the Company may have a significant contingent liability in excess of
$10,000 under state securities laws. The Company cannot predict how many of the
stockholders will attempt to exercise their right of rescission, and no
liability has been accrued at December 31, 1999.
In addition, the Company may be liable for rescission under state securities
laws to the purchasers of the Hebron common stock because of the relationships
of the two companies. The amount of this contingent liability at December 31,
1999, is approximately $3,200. The Company cannot predict how many of the Hebron
stockholders will exercise their right of rescission, and no liability has been
accrued at December 31, 1999.
Other Securities Matters
In December 1994, the Washington Department of Financial Institutions -
Securities Division ("WDS") notified the Company that it was aware that the
Company may have offered unregistered securities to residents of the State of
Washington and instructed the Company to cease and desist such offers and to
provide information with respect to any sales of such securities. In April 1997,
the WDS told the Company that it was trying to close its file on the Company and
served a subpoena on the Company that sought various documents relating to the
Company's shareholders in Washington State. The Company voluntarily produced
documents in response to the subpoena in May 1997. The WDS has not corresponded
with the Company since May 1997.
F-34
<PAGE> 81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Other Securities Matters
In February 1996, the Oklahoma Department of Securities ("ODS") made an inquiry
to the Company with regard to the basis upon which the Company had offered and
sold securities and effected issuances of short-term notes under the APLP
without registration under the Oklahoma Securities Act. The Company responded to
such inquiry in February 1996 advising the ODS that neither the Company nor its
Oklahoma counsel believed that the short-term notes issued under the APLP
constituted securities, and claiming that the common stock was exempt from
registration under Section 401(b)(9)(B) of the Oklahoma Securities Act. The
Company has not received a response from ODS and consequently has not had any
further contact with the ODS since its response.
Commitments with Providers and Others
In April 1999, the Company entered into a telecommunications contract with
WorldCom, its primary provider of switchless telecommunications services. The
term of the contract is for three years, with early termination provided for
based on meeting specified purchase commitments during the term of the contract.
In connection with the contract, WorldCom agreed to subordinate its interests in
the Company's customer base, as well as its accounts payable and other rights
and obligations, to the financial institution providing the Company's Credit
Facility. WorldCom has a second security lien on all of the assets in which the
financial institution has a first security lien. The agreement provided for
reduced rates and credits for disputed payables. The Company recognized these
credits as a reduction of expenses during the year ended December 31, 1999. The
Company is required to maintain minimum purchase commitments under the terms of
its contract with WorldCom. During the year ended December 31, 1999, the Company
met the minimum purchase commitments, and expects to be able to continue to meet
these requirements.
In connection with the Asset Purchase Agreement with Hebron, as described in
Note B, the Company also assumed responsibility for the telecommunications
contract between Hebron and IXC Communications, Inc., the underlying carrier
that transports the Company's call records through the Oklahoma City and Chicago
switches. This contract is effective through September 2003, and also requires
the Company to maintain minimum monthly purchase commitments. The Company met
the minimum purchase commitments during 1999, and expects to be able to continue
to meet these requirements.
At December 31, 1999, the Company has commitments to purchase equipment and
system software totaling approximately $4,000.
F-35
<PAGE> 82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Deferred Compensation Contracts
In 1997, and as amended in 1998, the Company entered into non-qualified deferred
compensation agreements with certain salespersons. The deferred compensation
plan, which is not funded, allowed these salespersons to defer portions of their
current compensation. The Company agreed to pay the salespersons an amount equal
to their deferred compensation plus an effective rate of return, ranging from
45% to 55%. In 1999, the Company repaid in full all but one of these
obligations. The liability for the deferred compensation contracts is included
in accounts payable and accrued expenses, and totaled approximately $385 and $43
at December 31, 1998 and 1999, respectively.
Long-Term Agreements with Salespersons
In 1997, the Company entered into long-term agreements with certain
salespersons. The agreements were effective for twenty-five (25) years, and
provide for a 3% commission of the net domestic phone billings, as defined in
the agreement, to be paid to the salespersons, plus additional commissions
through recruitment efforts, death and termination benefits, and other benefits
as described in the agreements. The termination benefits defined in the original
agreement provide for the salespersons to receive 75% of the commissions earned
under the contract for current subscribers assigned to the salesperson at the
termination date, plus 50% of the commissions earned for all additional
subscribers who enroll under the salespersons' existing non-profit
organizations, for a period of 25 years. In exchange for the extended contract
terms and death and termination benefits, the Company received non-competition
agreements, as defined in the agreements, with each of the salespersons. In
1999, the Company renegotiated or terminated the agreements with these
salespersons, by (1) replacing the original agreements with full-time or
part-time employment contracts, or independent contractor agreements ranging
from three to five years; (2) entering into negotiated settlement agreements
with the salespersons, or (3) continuing to pay the salespersons under the
termination provisions of the original contract.
Non-Cancelable Operating Leases
The Company leases office space, copiers and other equipment under agreements
that are accounted for as operating leases. These lease agreements expire in
varying years through 2004. Total lease expense was approximately $229, $472,
and $692 in 1997, 1998 and 1999, respectively. Future commitments under
non-cancelable operating leases are as follows:
<TABLE>
<S> <C>
Year Ended December 31
2000 $ 614
2001 420
2002 431
2003 111
2004 105
-------------
$ 1,681
=============
</TABLE>
F-36
<PAGE> 83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Other Matters
From time to time, the Company may be party to litigation, claims and
assessments arising in the normal course of business. In the opinion of
management, the outcomes of such proceedings will not be material to the
Company's financial position, results of operations or cash flows.
NOTE J--FINANCIAL CONDITION AND RESULTS OF OPERATIONS
From its inception through December 31, 1998, the Company had incurred
cumulative net operating losses totaling approximately $12,000. In 1999, the
Company implemented a series of cost reduction measures that enabled the Company
to realize net income of $1,913. Despite the profitability, however, the
Company's total net sales declined by 7.7% from 1998 to 1999, and the net sales
from long distance revenues, exclusive of the pass-through charges that began in
1998, declined from $113,000 and $114,000 in 1997 and 1998, respectively, to
$102,000 in 1999. In addition, the accumulated stockholders' deficiency was
($23,229) at December 31, 1999. These factors, among others, indicate that the
Company will be unable to continue as a going concern for a reasonable period of
time.
Beginning in 1998 and continuing into 1999 and 2000, the Company has taken
several steps which management believes will enable the Company to continue to
realize profitability, as well as improve the Company's overall financial
position and liquidity. These steps include:
o Despite recurring net losses, the Company previously had a policy of
declaring distributions to its stockholders. From 1994 through 1997,
the Company declared cumulative distributions to nonredeemable
stockholders totaling approximately $15,700. Through December 31,
1999, approximately $12,400 had been paid, and $3,300 was payable at
December 31, 1999. The amounts payable at December 31, 1999, were to
the Chairman and the former Senior Vice President. When declared, the
distributions were recorded as a charge to retained earnings
(deficit). In addition, accretions of the redemption value of the
redeemable common stock, as described in Note H, were also recorded as
a charge to retained earnings (deficit). Through December 31, 1999,
the cumulative charge to retained earnings (deficit) as a result of
accretions to the redeemable common stock was approximately $3,400.
The Company reduced this liability through payments of the
distributions to redeemable stockholders as well. Cumulative payments
of distributions to redeemable stockholders totaled approximately
$3,300. The deficit in retained earnings is larger by approximately
$19,100 as a result of the distributions to nonredeemable stockholders
and accretions of the redemption value of redeemable stock to the
redeemable stockholders.
The Company discontinued the policy of declaring distributions to its
stockholders at the end of 1997. Future dividends or distributions to
owners are restricted under the Company's revolving line of credit
agreement, as described in Note D to the financial statements. The
Company believes that retaining earnings will enable the Company to
sustain profitability.
F-37
<PAGE> 84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE J--FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Continued
o As discussed in Note D, the Company has obtained funding from a
financial institution for a $30,000 line of credit. The proceeds of
this line of credit have enabled the Company to become and remain
current on its operating liabilities, and to repay existing loans and
notes that carried higher interest rates. The proceeds have also
provided the Company with the necessary capital to upgrade its core
computer systems. The Company has been notified by the financial
institution that it has been approved for an increase in the line of
credit to $35,000.
o In April 1999, the Company entered into a new telecommunications
contract with WorldCom, as discussed in Note I to the financial
statements. The new agreement provides the Company with reduced rates
on its switchless long distance services. The Company has passed some
of the savings from reduced rates to its customers, in order to
compete with industry-wide rate reductions, and has retained the
benefit of some of the savings. The agreement provides for further
periodic reviews of the rates, and in December 1999, the Company
received an additional rate reduction from WorldCom.
o Effective February 1, 1999, the Company acquired the rights and
responsibilities of the switched services operations that were
previously provided by Hebron, as discussed in Note B to the financial
statements. The Company realized significant savings in 1999 from
operation of the switches as compared to purchasing the switched
services from Hebron, and the Company expects these savings to
continue in the future.
o Beginning in January 1999, the Company began operating its
telemarketing department internally, rather than outsourcing those
services to VisionQuest. Internally operating the telemarketing
department resulted in significant cost savings in 1999, and the
Company expects these savings to continue in the future. In the fourth
quarter of 1999, the Company began acquiring new telemarketing
equipment, and opened a new telemarketing facility in Tahlequah,
Oklahoma in January 2000. In an effort to increase its revenues and
customer base, the Company plans to increase its telemarketing efforts
in 2000.
Management believes that the above factors will enable the Company to continue
to realize profitable operations and reduce its deficits, improve its liquidity
ratios, and continue to meet its obligations on an ongoing basis.
F-38
<PAGE> 85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION
In May 1999, the Company's Board of Directors adopted non-qualified,
non-variable, compensatory stock option plans for certain officers and directors
of the Company. The Company is accounting for these plans under the provisions
of APB 25, which provides for compensation cost to be recognized based upon the
difference ("intrinsic value") between the fair value of the common stock at the
date of the grant and the exercise price of the option. The Board of Directors
also approved restricted stock bonuses to the same officers and directors.
Stock Option Plans
Effective May 24, 1999, the Company's Board of Directors granted two officers
and two non-employee directors options to purchase Company stock. Three of the
options granted entitle the individuals to purchase 3% of the fully diluted
outstanding common stock as of the grant date, and one of the options granted
entitles the individual to purchase 1% of the fully diluted common stock as of
the grant date. The exercise price for each option is based on the fair value,
as determined by an independent appraisal, of the Company's common stock as of
February 1, 1998. The fair value as of the grant date, as determined by an
independent appraiser, was $41.50 per share; the exercise price for each option
is $29 per share, resulting in an intrinsic value of $12.50 per share.
The options are exercisable at 25% on July 1, 1999, and 25% each July 1
thereafter until fully vested. Each exercise right shall continue in force for a
period of five years following its commencement, irrespective of the
individual's subsequent employment status with the Company. The Company recorded
unearned compensation and paid-in-capital of $1,137 for the shares granted under
the option plans. The Company has recognized compensation cost for the initial
25% that vested on July 1, 1999, and has also accrued an additional 12.5% for
the stock options that will vest on July 1, 2000. The total pre-tax compensation
expense recognized in 1999 was $427.
Following is a recap of the outstanding stock options at December 31, 1999:
<TABLE>
<S> <C>
Granted on May 24, 1999 90,987
Outstanding at December 31, 1999 90,987
Options exercisable at:
July 1, 1999 22,747
July 1, 2000 22,747
July 1, 2001 22,747
July 1, 2002 22,746
</TABLE>
F-39
<PAGE> 86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION--Continued
Pursuant to SFAS No. 123, the Company is required to disclose the pro forma net
earnings and earnings per share effects of the stock options, as if the stock
options had been accounted for under the provisions of SFAS No. 123. SFAS No.
123 prescribes that the compensation cost be recorded equal to the fair value of
the options as of the grant date, and that compensation costs be recognized
ratably over the vesting period of the options. Had compensation costs been
determined in accordance with SFAS No. 123, the Company's net income and net
income per share amounts for the year ended December 31, 1999 would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<S> <C>
Net income
As reported $ 1,913
Pro forma 1,680
Basic earnings per share
As reported $ 2.50
Pro forma 2.21
Diluted earnings per share
As reported $ 2.14
Pro forma 1.88
</TABLE>
Because the Company's stock is not publicly traded, the fair value of the
Company stock options was estimated on the date of the grant using the minimum
valuation method, as prescribed by SFAS No. 123. Under the minimum value method,
expected stock price volatility is set at a level that approximates 0%. The fair
value of the stock options as of the grant date was $20.40 per share, using the
following assumptions:
<TABLE>
<S> <C>
Expected stock price volatility 0.0001%
Risk-free rate 6.36%
Expected dividend yield 0.0%
Expected life 5 years
</TABLE>
F-40
<PAGE> 87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION--Continued
Stock Bonuses
Under the provisions of the stock bonus agreements, effective May 24, 1999, the
Company granted one officer (the President of Hebron) 1% (9,099 shares) of the
fully diluted outstanding common stock, after consideration of the stock options
described above. This stock bonus had an original vesting schedule of 25% on
July 1, 1999, and 25% each year thereafter, until fully vested. As described in
Note B, the officer resigned in December 1999, and the vesting provisions were
amended in January 2000, to provide for vesting of the stock bonus effective in
January 2000. The stock bonus agreement also provides for the Company to pay the
officer a cash bonus equal to the amount of income taxes for which the officer
will be liable as a result of the vesting of the stock bonus, and an additional
cash bonus equal to the amount of income taxes for which the officer will be
liable as a result of the first cash bonus. The Company recorded the stock bonus
as unearned compensation based upon the initial grant of the stock of 9,099
shares and a fair value of $41.50 per share, as determined by an independent
appraisal. The Company recognized an expense and reduction of the unearned
compensation based upon the initial 25% vesting as of July 1, 1999, plus an
accrual of an additional 12.5% for the amounts expected to vest on July 1, 2000.
The Company also recognized an expense for the cash bonuses that it will be
required to pay as a result of the initial 25% vesting, plus an accrual for the
12.5% earned through December 31, 1999, of the stock bonus. The total pre-tax
expense recognized in 1999 under the stock bonus arrangement for this officer
was $142 for the stock bonus and $80 for the related accrued cash bonuses. The
Company recognized the remaining expense in the first quarter of 2000.
F-41
<PAGE> 88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE L--EARNINGS (LOSS) PER SHARE (per share amounts not in thousands)
The computation of basic and diluted earnings (loss) per share is as follows:
<TABLE>
<CAPTION>
Three Months Ended
Years Ended December 31 March 31
1997 1998 1999 1999 2000
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Basic Earnings (Loss) Per Share
Net income (loss) $ (341) $ (3,557) $ 1,913 $ 16 $ 121
Decrease (increase) in redemption value of
redeemable common stock (470) 179 102 -- (42)
-------- -------- -------- -------- --------
Net income (loss) available to nonredeemable
common stockholders $ (811) $ (3,378) $ 2,015 $ 16 $ 79
======== ======== ======== ======== ========
Average shares of nonredeemable common stock outstanding 799 801 806 801 810
======== ======== ======== ======== ========
Basic Earnings (Loss) Per Share $ (1.01) $ (4.22) $ 2.50 $ 0.02 $ 0.10
======== ======== ======== ======== ========
Diluted Earnings (Loss) Per Share
Net income (loss) available to nonredeemable
common stockholders $ (811) $ (3,378) $ 2,015 $ 16 $ 79
Decrease (increase) in redemption value of
redeemable common stock -- (179) (102) -- --
-------- -------- -------- -------- --------
Net income (loss) available to nonredeemable common
stockholders and assumed conversions $ (811) $ (3,557) $ 1,913 $ 16 $ 79
======== ======== ======== ======== ========
Average shares of nonredeemable common stock outstanding 799 801 806 801 810
Employee stock options -- -- 72 -- 115
Stock warrants -- -- 2 -- 4
Conversion of redeemable common stock -- 21 16 16 --
-------- -------- -------- -------- --------
Average shares of common stock outstanding
and assumed conversions 799 822 896 817 929
======== ======== ======== ======== ========
Diluted Earnings (Loss) Per Share $ (1.01) $ (4.33) $ 2.14 $ 0.02 $ 0.08
======== ======== ======== ======== ========
</TABLE>
The average shares listed below (in thousands) were not included in the
computation of diluted earnings (loss) per share because to do so would have
been antidilutive for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended
Years Ended December 31 March 31
1997 1998 1999 1999 2000
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Conversion of convertible notes 3 3 3 3 3
Conversion of redeemable common stock 23 -- -- -- 15
</TABLE>
F-42
<PAGE> 89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE M--QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
------------ ------------ ------------ ------------
(in thousands except per share data)
<S> <C> <C> <C> <C>
Net sales $ 30,842 $ 31,810 $ 31,494 $ 30,086
Net loss (520) (999) (699) (1,339)
Basic earnings (loss)
per share (0.79) (1.28) (0.58) (1.56)
Diluted earnings (loss)
per share (0.79) (1.28) (0.85) (1.63)
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
------------ ------------ ------------ ------------
(in thousands except per share data)
<S> <C> <C> <C> <C>
Net sales $ 29,040 $ 28,141 $ 29,371 $ 28,109
Net income (loss) 17 2,785 649 (1,538)
Basic earnings (loss)
per share 0.02 3.47 0.84 (1.83)
Diluted earnings (loss)
per share 0.02 3.18 0.69 (1.83)
</TABLE>
In November 1999, the Company obtained an independent appraisal of its common
stock as of June 30, 1999. As a result of the appraisal, the Company recorded
pre-tax expenses of approximately $569 in the fourth quarter of 1999 in
connection with the stock-based compensation agreements, as described in Note L,
and $158 of expenses related to the stock warrants, as described in Note F. In
addition, the Board of Directors approved bonuses and other compensation
agreements, resulting in pre-tax expenses of approximately $725 in the fourth
quarter. For the fourth quarter of 1999, diluted earnings (loss) per share is
the same as basic earnings (loss) per share, because potentially dilutive
securities were antidilutive.
In the second quarter of 1999, the Company received significant credits in
connection with its new telecommunications service agreement with WorldCom. The
Company also recovered $182 of the loss on the advances made to an unrelated
long-distance reseller, as described below.
In the fourth quarter of 1998, the Company recorded pre-tax losses of $215 in
connection with the impairment of its former corporate headquarters and $552 for
a loss on a receivable from an unrelated long-distance reseller.
For the first and second quarters of 1998, diluted earnings (loss) per share is
the same as basic earnings (loss) per share, because potentially dilutive
securities were antidilutive.
F-43
<PAGE> 90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE N--SUBSEQUENT EVENTS
In May 2000, the Company and lender entered into an amendment to the Credit
Facility, which increased the maximum availability under the line of credit to
$35,000, subject to the collections and earnings multiples contained in the
original agreement, and as amended.
In May 1999, and as amended in May 2000, the Board of Directors approved stock
bonuses to the Chief Executive Officer and to two non-employee directors of the
Company. The initial grant date was May 24, 1999, but was subsequently amended
to provide for an initial grant date of July 1, 2000. Each officer / director
will receive 0.5% (4,549 shares each) of the fully diluted outstanding common
stock, after consideration of the stock options described above. These stock
bonuses will have an initial vesting of 50% on July 1, 2000, and 25% on July
1, 2001 and July 1, 2002. The agreements also provide for the payment of cash
bonuses for the income tax effects to the individual officer / directors, in a
manner similar to that as described above.
F-44
<PAGE> 91
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
3.1 - Certificate of Incorporation of the Company
3.2 - Bylaws of the Company
3.3 - Secretary certificate regarding amended and restated bylaws
4.1 - Form of certificate representing shares of the Company's common stock
4.2 - Form of Type A Redemption Agreement
4.3 - Form of Type B Redemption Agreement
4.4 - Form of Type C Redemption Agreement
4.5 - Form of Type D Redemption Agreement
4.6 - Form of Convertible Note
4.7 - Promissory Note dated April 20, 1999, payable by the Company to
C.A.S.E., Inc.
4.8 - Promissory Note dated April 20, 1999, payable by the Company to John
Damoose
10.1 - Agreement, dated as of April 13, 1998, between the Company and Carl
Thompson
10.2 - First Amendment to April 13, 1998 Agreement between Amerivision
Communications, Inc. and Carl Thompson, dated as of December 31,
1998, among the Company, Carl Thompson and Willeta Thompson
10.3 * - Amended and Restated Employment Agreement, dated as of May 24, 1999
between
the Company and Stephen D. Halliday
10.4 * - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the
Company, Jay A. Sekulow and Tracy Freeny
10.5 * - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the
Company, John Damoose and Tracy Freeny
10.6 - Employment Agreement, dated as of May 24, 1999, between the
Company and John E. Telling
10.7 - Employment Agreement dated as of May 24, 1999 between the
Company and Tracy Freeny
10.8 - Reaffirmation of Commitments made in Employment Agreement of
Stephen D. Halliday dated as of June 30, 1999
10.9 - Reaffirmation of Commitments made in Stock Agreement of Jay A.
Sekulow dated as of June 30, 1999
10.10 - Agreement effective January 1, 1999, between the Company and
VisionQuest
10.11 - Telemarketing Services Agreement, effective as of January 1, 1999
Between the Company and VisionQuest
10.12 - Clarification to Agreement, effective as of June 9, 1999, by and
Between the Company and VisionQuest
10.13 - Asset Purchase Agreement, dated as of April 30, 1999, among Hebron,
the Company, Tracy Freeny, Carl Thompson and S. T. Patrick.
10.14 - Lease/License Agreement, dated as of April 30, 1999 between Hebron
and the Company.
10.15 - Form of Promissory Note payable by the Company to Hebron (form to
be used with respect to Switch Note and Internet Note)
10.16 - Promissory Note dated February 1, 1999, in the original principal
amount of $2,274,416 payable by the Company to Hebron
10.17 - Capital Stock Escrow and Disposition Agreement dated April 30,
1999 among Tracy C. Freeny, Hebron and Bush Ross Gardner Warren
& Rudy, P.A.
10.18 - Loan and Security Agreement dated as of February 4, 1999 between
10.18.1 - Amendment Number One to Loan and Security Agreement dated as of
October 12, 1999 between the Company and Coast Business Credit
10.18.2* - Amendment Number Two to Loan and Security Agreement dated as of May
10, 2000 between the Company and Coast Business Credit
10.19 ** - Telecommunications Services Agreement dated April 20, 1999
by and between the Company and WorldCom Network Services, Inc.
10.20 ** - Program Enrollment Terms dated April 20, 1999 between the Company
and WorldCom Network Services, Inc.
10.21 - Security Agreement dated April 20, 1999 by and between the Company
and WorldCom Network Services, Inc.
10.22 - Letter Agreement dated July 14, 1999 between the Company and Tracy
C. Freeny
10.23 - Employment Agreement dated December 31, 1998, between the
Company and Kerry Smith
10.24 * - Letter Agreement dated as of December 31, 1999 between the Company
and John Telling
10.25 * - Royalty Agreement dated as of January 1, 1999 between the Company
and Regency Productions, Inc.
10.26 * - Royalty Agreement effective as of January 1, 1999 between the
Company and Christian Advocates Serving Evangelism, Inc.
10.27 * Stock Incentive Plan
21.1 - List of subsidiaries of the Company
23.1* - Consent of Cole & Reed, P.C.
27.1* - Financial Data Schedule
27.2* - Financial Data Schedule
</TABLE>
* Filed herewith.
** Information from this agreement has been omitted because the Company has
requested confidential treatment. The information has been filed
separately with the Securities and Exchange Commission.
