<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File Number 0-22282.
USCI, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3702647
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
6115-A Jimmy Carter Blvd., Norcross, Georgia 30071
(Address of principal executive offices) (Zip Code)
(770) 840-8888
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the Issuer's classes of
Common Stock, as of the latest practicable date:
As of November 11, 1998, 11,004,089 shares of $.0001 par value Common Stock
were outstanding.
<PAGE> 2
In addition to historical information, this Quarterly Report contains
forward-looking statements made in good faith by the Company pursuant to the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995, including, but not limited to, those statements regarding the Company's
intention to continue to seek additional distribution channels, the proposed
expansion of the Company's reseller operations, and the expected financial
position, business and financing plans of the Company. Although the Company
believes that the expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to be
correct. Readers are cautioned not to place undue reliance on these
forward-looking statements as they are based on the Company's current
expectations and are subject to a number of risks, uncertainties and
assumptions relating to the Company's business and results of operations,
competitive factors, shifts in market demand and other risks and uncertainties,
including, in addition to those outlined in Exhibit 99.1 to this Quarterly
Report and elsewhere in this Quarterly Report, uncertainties with respect to
changes or developments in social, business, economic, industry, market, legal
and regulatory circumstances and conditions and actions taken or omitted to be
taken by third parties, including the Company's customers, suppliers,
competitors and stockholders and legislative, regulatory, judicial and other
governmental authorities. The Company undertakes no obligation to revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof.
<PAGE> 3
USCI, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
<S> <C> <C>
Part I FINANCIAL INFORMATION PAGE NO.
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as
of September 30, 1998 and December 31, 1997
Condensed Consolidated Statements of
Operations and Accumulated Deficit for
the Three months ended September 30, 1998
and September 30, 1997
Condensed Consolidated Statements of
Operations and Accumulated Deficit for
the Nine months ended
September 30, 1998 and September 30, 1997
Condensed Consolidated Statements of Cash
Flows for the Nine months ended
September 30, 1998 and September 30, 1997
Notes to Condensed Consolidated
Financial Statements
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations
for the Nine month and Three month periods
ended September 30, 1998 and September 30, 1997
Item 3 Quantitative and Qualitative Disclosures
about Market Risk - None
PART II OTHER INFORMATION
Item 1 Legal Proceedings - None
Item 2 Changes in Securities
Item 3 Default Upon Senior Securities - None
Item 4 Submission of Matters to a Vote of
Security Holders - None
Item 5 Other Information
Item 6 Exhibits and Reports on Form 8-K
</TABLE>
2
<PAGE> 4
USCI, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1998
(unaudited) December 31, 1997*
------------------ ------------------
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents, including restricted
cash of $677,101 in 1998 and $731,500 in 1997 $ 700,604 $ 1,105,530
Accounts receivable--trade, net of allowances of
$3,600,000 in 1998 and $1,250,000 in 1997 15,141,073 4,895,952
Accounts receivable--other, net of allowances of
$100,000 in 1998 and $137,000 in 1997 181,746 1,102,084
Inventory 7,587 25,458
Prepaid expenses 437,852 134,510
------------ ------------
Total current assets 16,468,862 7,263,534
------------ ------------
PROPERTY AND EQUIPMENT, net 2,038,447 3,422,476
OTHER ASSETS 1,798,910 2,908,037
------------ ------------
Total Assets $ 20,306,219 $ 13,594,047
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Notes payable $ 0 $ 3,305,000
Bank Debt 8,486,199 0
Accounts payable 10,779,375 3,939,212
Accrued expenses 5,743,046 4,315,161
Commissions payable 4,645,348 6,651,597
Promotional deposits 1,296,055 1,696,055
------------ ------------
Total current liabilities 30,950,023 19,907,025
------------ ------------
STOCKHOLDERS' DEFICIT:
Preferred stock, $.01 par value;
5,000 shares authorized, 1,937 shares issued at
September 30, 1998 19 0
Common stock, $.0001 par value; 100,000,000 shares
authorized; 11,402,630 shares issued at September 30,
1998 and 10,267,309 shares issued at December 31, 1997 1,137 1,027
Additional paid-in capital 55,360,876 33,714,623
Warrants 7,769,000 3,122,000
Accumulated deficit (73,746,790) (43,122,578)
Treasury stock, at cost, 5,500 shares in 1998 and 1997 (28,050) (28,050)
------------ ------------
Total Stockholders' Deficit (10,643,804) (6,312,978)
------------ ------------
Total Liabilities and Stockholders' Deficit $ 20,306,219 $ 13,594,047
============ ============
</TABLE>
* Condensed from audited financial statements.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 5
USCI, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
Three Months Ended September 30,
1998 (Unaudited) 1997
============ =============
<S> <C> <C>
REVENUES
Subscriber Sales $ 11,514,922 $ 1,202,811
Activation Commissions 2,290 405,883
Other Operating Revenues 0 21,794
------------ ------------
Total Revenues 11,517,212 1,630,488
------------ ------------
COST OF SALES
Cost of subscriber sales 6,464,521 673,489
Cost of activation commissions 800 141,926
------------ ------------
Total cost of sales 6,465,301 815,415
------------ ------------
GROSS MARGIN 5,051,891 815,073
------------ ------------
OPERATING EXPENSES
Selling, general and administrative 7,317,464 4,572,856
Subscriber acquisition and promotional costs 4,533,544 1,584,441
------------ ------------
Total Operating Expenses 11,851,008 6,157,297
------------ ------------
OPERATING LOSS (6,799,117) (5,342,224)
Interest expense (income), Net 1,992,012 (30,714)
------------ ------------
LOSS BEFORE INCOME TAXES (8,791,129) (5,311,510)
Income Taxes 0 0
------------ ------------
NET LOSS (8,791,129) (5,311,510)
Deficit at Beginning of Period (64,757,113) (21,419,817)
Preferred Dividend Declared (198,548) 0
------------ ------------
Deficit at End of Period $(73,746,790) $(26,731,327)
============ ============
Basic and Diluted Net Loss per Share $ (0.79) $ (0.52)
============ ============
Weighted Average Common Shares Outstanding 11,322,687 10,265,481
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 6
USCI, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 (Unaudited) 1997
=========== ============
<S> <C> <C>
REVENUES
Subscriber Sales $ 33,263,289 $ 1,845,051
Activation Commissions 13,040 2,854,292
Other Operating Revenues 0 232,994
------------ ------------
Total Revenues 33,276,329 4,932,337
------------ ------------
COST OF SALES
Cost of subscriber sales 19,163,868 964,944
Cost of activation commissions 9,400 1,277,684
------------ ------------
Total cost of sales 19,173,268 2,242,628
------------ ------------
GROSS MARGIN 14,103,061 2,689,709
------------ ------------
OPERATING EXPENSES
Selling, general and administrative 19,482,410 12,815,282
Subscriber acquisition and promotional costs 17,589,398 2,633,076
------------ ------------
Total Operating Expenses 37,071,808 15,448,358
------------ ------------
OPERATING LOSS (22,968,747) (12,758,649)
Interest expense (income), Net 7,330,250 (363,298)
------------ ------------
LOSS BEFORE INCOME TAXES (30,298,997) (12,395,351)
Income Taxes 0 0
------------ ------------
NET LOSS (30,298,997) (12,395,351)
Deficit at Beginning of Period (43,122,578) (14,335,976)
Preferred Dividend Declared (325,215) 0
------------ -------------
Deficit at End of Period $(73,746,790) $(26,731,327)
============ ============
Basic and Diluted Net Loss per Share $ (2.83) $ (1.21)
============ ============
Weighted Average Common Shares Outstanding 10,814,176 10,246,300
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE> 7
USCI, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months Ended September 30,
1998 (Unaudited) 1997
=========== =============
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(30,298,997) $(12,395,351)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 2,016,985 1,486,013
Amortization of discount on notes payable 5,342,000 0
Amortization of deferred financing costs 980,250 0
Provision for losses on accounts receivable 3,115,650 554,139
Changes in operating assets and liabilities:
Accounts receivable - trade (16,397,771) (1,291,596)
Accounts receivable - other 957,338 1,152,178
Inventory 17,871 0
Prepaids and other assets 169,549 (68,814)
Commissions payable 993,751 212,186
Accounts payable and accrued expenses 8,268,049 (591,766)
Deposits payable 0 (6,358)
Promotional deposits (400,000) (214,947)
----------- ------------
Total adjustments 5,063,672 1,231,035
----------- ------------
Net cash used in operating activities (25,235,325) (11,164,316)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (544,505) (658,730)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 6,000,000 0
Repayments of notes payable (4,500,000) 0
Proceeds from Term Loan 6,669,600 0
Repayments of Term Loan (608,919) 0
Borrowings on Revolving Line of Credit 8,816,954 0
Repayments on Revolving Line of Credit (6,391,436) 0
Costs associated with Term Loan & Line of Credit (432,465) 0
Issuance of common stock 2,625,319 0
Costs associated with issuance of common stock (192,421) 0
Issuance of preferred stock 15,000,000 0
Costs associated with issuance of
preferred stock (1,616,372) 0
Issuance of stock upon exercise of warrants 3,751 0
Issuance of stock upon exercise of options 893 39,207
------------ ------------
Net cash provided by financing activities 25,374,904 39,207
------------ ------------
NET INCREASE (DECREASE) IN CASH (404,926) (11,783,841)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD 1,105,530 15,581,244
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 700,604 $ 3,797,405
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
<PAGE> 8
USCI, INC.
Notes to Condensed Consolidated Financial Statements
September 30, 1998
(Unaudited)
Note 1: BASIS OF PRESENTATION
The unaudited financial information furnished herein in the opinion of
management reflects all adjustments which are necessary to fairly state the
Company's financial position, the results of its operations and its cash flows.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Form 10-K for the year ended
December 31, 1997. Footnote disclosure which would substantially duplicate the
disclosure contained in those documents has been omitted. Operating results for
the nine month and three month periods ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
Note 2: LOSS PER SHARE
Basic earnings per share are based on the weighted average number of shares
outstanding. Diluted earnings per share are based on the weighted average
number of shares outstanding and the dilutive effect of outstanding stock
options and warrants (using the treasury stock method). For all periods
presented, outstanding options and warrants have been excluded from diluted
weighted average shares outstanding, as their impact was antidilutive.
Net loss for the nine month and three month periods ended September 30, 1998 is
adjusted by dividend requirements of $325,215 and $198,548 respectively related
to the Company's Convertible Preferred Stock.
Note 3: CONVERTIBLE PREFERRED STOCK AND BRIDGE LOAN CONVERSIONS
On March 24, 1998, the Company entered into an agreement for the private
placement of up to $15 million in Series A, B, and C Convertible Preferred
Stock (the "Convertible Preferred Stock"). The Convertible Preferred Stock
provides for dividends at a rate of 6% per annum, payable quarterly in cash or
registered common stock. All outstanding principal and accrued dividends may be
converted into the Company's common stock at the lower of 120% of the average
closing price for five days immediately preceding the conversion notice or 85%
of the average of the three lowest closing prices of the common stock for the
25 trading days preceding the conversion notice, and automatically converts
three years from issuance. The Convertible Preferred Stock is mandatorily
redeemable by the Company upon the occurrence of certain events. The Company
has filed a registration statement which was declared effective on June 2, 1988
covering the shares of common stock issuable upon conversion of the Convertible
Preferred Stock and exercise of certain outstanding options and warrants.
On March 24, 1998, the initial $5 million was provided to the Company which
issued 500 shares of Series A Convertible Preferred Stock and five-year
warrants to the preferred stockholder to purchase up to 149,522 shares of
the Company's Common Stock at an exercise price of $6.89 per share. The Company
paid a finder's fee of $500,000 and issued five-year warrants to the finder to
purchase 62,500 shares of common stock at an exercise price of $6.89 per share.
On May 7, 1998, the second tranche of $5 million was provided to the Company
which issued 500 shares of Series B Convertible Preferred Stock and five-year
warrants to purchase up to 203,749 shares of the Company's Common Stock at an
exercise price of $5.85 per share. The Company paid a finder's fee of $500,000
and issued five-year warrants to the finder to purchase 62,500 shares of Common
Stock at an exercise price of $5.85 per share.
7
<PAGE> 9
On July 31, 1998, the third tranche of $5 million was provided to the Company
which issued 500 shares of Series C Convertible Preferred Stock and five-year
warrants to purchase up to 332,246 shares of the Company's Common Stock at an
exercise price of $5.31 per share. The Company paid a finder's fee of $500,000
and issued five-year warrants to the finder to purchase 62,500 shares of Common
Stock at an exercise price of $5.85 per share.
On June 23, 1998, the Company issued 343,356 shares of Common Stock upon the
conversion of $1,150,000 principal amount and accrued interest on 10%
Convertible Notes issued by the Company in February 1998. On July 16, 1998, the
remaining $350,000 principal amount and accrued interest was converted
into 119,281 shares of Common Stock of the Company for a total converted amount
of $1,500,000 principal amount plus accrued interest.
On July 29, 1998, the Company issued an aggregate of 500 shares of 6% Series D
Convertible Preferred Stock in exchange for an aggregate of $4 million 8%
unsecured Convertible Restated Notes due July 31, 1998 and issued an aggregate
of 34,000 shares of Common Stock at a purchase price of $4.00 per share in
payment of the accrued interest on the Notes. The Series D Preferred Stock is
entitled to a dividend of 6% per annum, payable quarterly in arrears and is
convertible, together with accrued dividends, at a conversion price equal to
120% of the average closing bid price for five trading days immediately
preceding the closing date or 85% of the average of the three lowest closing
prices per share of Common Stock for the 25 trading days preceding the
conversion notice, with a floor of not less than $4.00 per share and a ceiling
of not more than $6.00 per share. The Series D Preferred Stock is redeemable at
the Company's option at the then applicable conversion price. Since the Company
did not complete a private offering of equity and debt securities by October
15, 1998, the shares of Series D Convertible Preferred Stock are convertible
into shares of Common Stock at a conversion price equal to the lesser of $5.00
per share or 80% of the average closing sales price of the Company's Common
Stock during the last five trading days prior to conversion. Reference is made
to the Company's Current Report on Form 8-K dated and filed on July 29, 1998
and the exhibits filed therewith for a complete description of all terms of the
Series D Convertible Preferred Stock and the Securities Purchase Agreement
pursuant to which it was issued.
For the three months ended September 30, 1998, an aggregate of 65 shares of
Series A Convertible Preferred Stock and accrued dividends were converted into
226,748 shares of Common Stock of the Company of which 213,480 shares were
purchased at $3.0104 per share and 13,268 shares were purchased at $1.5583 per
share.
For the three months ended September 30, 1998, an aggregate of 25 shares of
Series D Preferred Stock and accrued dividends were converted into 588,191
shares of the Company's Common Stock at $0.345 per share.
The Company is in default under both of the Convertible Preferred Stock
Agreements ("Agreements") above due to certain events such as failure to
register certain underlying securities, the delisting of the Company's common
stock from the NASDAQ National Market System along with other technical
noncompliance with the Agreements. The occurrence of these defaults and non
compliance gives the holders of the Preferred Stock the right to call for
redemption of part or all of the amounts of unconverted Preferred Stock. These
defaults have been waived by 89% of the holders through January 1, 1999. The
Company is negotiating to obtain a waiver for the remaining 11%.
Note 4: BANK FINANCING AND LETTERS OF CREDIT
On June 5, 1998, the Company entered into a four-year $20 million revolving
credit and term loan facility with Foothill Capital Corp. (the "Foothill Credit
Facility"). The Foothill Credit Facility provides for term loans which will
amortize equally over a 30-month period and revolving credit borrowings.
Availability is based on a number of factors, including eligible accounts
receivables and eligible cellular subscribers. Term loan borrowings bear
interest at the bank's base rate plus 2.5% and revolving credit borrowings bear
interest at the base rate plus 1.5%. The Foothill Credit Facility is secured by
substantially all of the Company's assets including its contracts with cellular
subscribers. The Company received proceeds of $6.1 million upon the closing of
the Foothill Credit Facility, of which $3 million was used to reduce secured
trade payables and the balance was used for other working capital and past due
obligations. As of September 30, 1998, the total outstanding under the Foothill
Credit Facility was approximately $8.5 million and as of November 12, 1998, the
Company was indebted under the Foothill Credit Facility for approximately $9.8
million.
8
<PAGE> 10
The Company is in default in the performance of its obligations under the terms
of the Credit Facility by failing to pay amounts due and payable thereby
creating an overadvance and by failing to comply with other material obligations
and financial covenants. On November 18, 1998, the Company entered into a
Forbearance Agreement with Foothill which acknowledges 1) the aforementioned
defaults, 2) provides for forbearance by Foothill from exercising it's rights
and remedies under the Credit Facility on account of such default until December
4, 1998, and 3) permits the Company an allowable overadvance of up to $750,000
through December 4, 1988 continues to advance funds to the Company. Due to the
defaults mentioned above all amounts due to Foothill are classified as current.
Subsequent to September 30, 1998, approximately $2.7 million of Standby Letters
of Credit issued on behalf of Ameritel Communications, Inc., a wholly-owned
subsidiary of the Company, have been drawn down out of a total of $3.1 million
in Letters of Credit issued by an investment bank in 1997. Payment to the
beneficiaries of these Letters of credit constitute payment of existing
obligations of the Company and do not create liabilities that would not
otherwise be recorded in the Company's financial statements. The issuer of the
Letters of Credit has made a demand upon Ameritel to repay the amounts paid
under the Letters of Credit which have not been repaid.
Note 5: CONTRACT TERMINATION
On October 13, 1998 the Company's contract with RadioShack, a division of Tandy
Corporation was terminated. RadioShack has demanded payments of claimed amounts
due and advised the Company that because of purported defaults in agreements
between the Company and RadioShack, the Cellular Service Agreement with
RadioShack was terminated. As a result, the Company is no longer activating new
subscribers referred by RadioShack. In an effort to collect part of amounts
claimed as due RadioShack has drawn down $2.5 million against a Standby Letter
of Credit provided for by the Company under the terms of the original Cellular
Service Agreement dated October 1, 1997 (see Note 4). Customers referred by
RadioShack accounted for approximately 83% of the Company's revenues during the
nine months ended September 30, 1998.
Note 6: RECLASSIFICATION
Certain prior year amounts have been reclassified to conform with the current
year's presentation.
Note 7: COMPREHENSIVE INCOME
The Company currently has no other comprehensive income items as defined by
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income."
9
<PAGE> 11
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF USCI, INC.
The following discussion should be read in conjunction with the Financial
Statements and Notes set forth elsewhere in this Report.
OVERVIEW
The Company was organized as U.S. Communications, Inc. in 1991 and commenced
operations in mid-1993 as a cellular activation processing agent. Between 1993
and 1996 the Company expanded its operations as a sales, marketing and
activation processing agent for facilities-based cellular and paging carriers.
By late 1996, the Company had entered into agency agreements with cellular
carriers which enabled the Company to offer cellular activation service in
virtually all of the Metropolitan Statistical Areas ("MSAs") and a majority of
the Rural Service Areas ("RSAs") in the United States.
In the fourth quarter of 1996, the Company began a planned transition to
becoming a national reseller of wireless communications services. During 1997,
the Company entered into reseller agreements with a number of facilities-based
cellular and paging carriers to replace, on a market by market basis, its
carrier agency agreements.
Historically, the Company's revenues have consisted of commissions earned as an
activation agent for cellular and paging carriers and, since the last quarter
of 1996, revenues from the resale of cellular and paging services. For the
three months ended September 30, 1998, reseller revenues were $11.5 million.
The Company bills its resale customers for monthly access to the underlying
carrier's cellular or paging network, cellular usage based on the number, time
and duration of calls, the geographic location of both the originating and
terminating phone numbers, extra service features, the applicable rate plan in
effect and the time of the call.
The wholesale cost of subscriber service includes monthly access, usage (home
and roaming) and special features charges paid by the Company to the cellular
and paging carriers.
Subscriber acquisition and promotional costs includes commission payments made
by the Company to its channels of distribution (or to equipment suppliers on
their behalf) for each activation by their customers of a cellular telephone,
certain advertising costs incurred by the Company or its distribution channels
and reduced access and/or free airtime for a limited period to its cellular
subscribers. These costs are recoverable from the long-term revenue stream
created by the continuation of subscribers services. The Company's ability to
capture such revenue streams may be adversely affected by service cancellations
("churn") and by losses caused by fraudulent use of service by third persons
which, by law, are not recoverable from subscribers (access fraud). Under
existing agreements with the carriers providing the Company with cellular
service, the wholesale cost of access fraud is generally recoverable and
although not generally recoverable, subscriber fraud (a customer fraudulently
uses another person's identification to become a subscriber of the Company) is
also recoverable under certain circumstances. The Company is attempting to
mitigate churn through competitive pricing, and retention programs and has taken
steps to mitigate losses due to fraud through improved controls and the hiring
of additional personnel to monitor fraud and install fraud prevention
procedures.
Selling expense includes the costs of providing sales and other support
services for customers including salaries and commissions to salesforce
personnel and the Company's independent sales representatives. General and
administrative expense include the costs of the billing and information
systems, other administrative expenses, personnel required to support the
Company's operations as well as all amortization expenses.
10
<PAGE> 12
The Company experienced significant growth in its resale operations in the
latter half of 1997 and the first half of 1998 and has experienced and continues
to experience significant operating and net losses and negative cash flow from
operations. The Company expects that operating and net losses and negative cash
flow from operations will continue until such point that the revenue from
subscribers exceeds the direct costs to carriers and the overhead that the
Company is rapidly reducing. At such time the Company may experience operating
and net profits and positive cash flow. There is no assurance that the Company
will be able to achieve revenue from subscribers that will exceed direct costs
to carriers and the reduced overhead it is attempting to achieve. See "Liquidity
and Capital Resources."
As a result of the Company's inability to obtain sufficient financing to fund
the rapid growth it experienced during the past 12 months, the Company was
unable to pay its principal vendors and customers the amounts owed by the
Company on a timely basis including the amounts due under the terms of a
Forbearance Agreement dated May 13, 1998, as amended, entered into with its
principal customer, RadioShack, a division of Tandy corporation, and to finance
the cost of doing future business with such customer, which accounted for
approximately 83% of the Company's revenues during the nine months ended
September 30, 1998. On October 13, 1998, RadioShack demanded payments of
claimed amounts due and advised the Company that because of purported defaults
in agreements between the Company and RadioShack, the agreement to supply
cellular radio service to the customers of RadioShack was terminated.
In order to reduce the operating costs and the acquisition costs of obtaining
new subscribers, the Company has reduced its staff from 270 in September 1998 to
105 employees currently and has substantially curtailed the enrollment of new
cellular subscribers. The Company is also actively seeking to negotiate terms
with its existing vendors and suppliers to extend the terms of payments for the
amounts due to such companies.
In order to substantially reduce the acquisition costs associated with
traditional sale of cellular service through the Company's channels of
distribution, the Company has elected to change its strategy and concentrate on
the sale of prepaid cellular service through existing channels of distribution
and on the Internet. To implement this new prepaid strategy, the Company has
entered into an agreement with a major manufacturer of cellular telephones and
is currently negotiating with channels of distribution to introduce the
Company's new prepaid cellular program. Successful implementation of this
strategy will depend, in part, upon the Company's ability to obtain the
financing necessary to implement the program and conclude agreements with the
channels of distribution for the introduction of the program. There is no
assurance and no representation is made that the Company will be successful in
either obtaining the necessary capital or concluding the necessary business
arrangements with the channels of distribution to sell the prepaid program.
11
<PAGE> 13
RESULTS OF OPERATIONS
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1997
Revenues
Total revenues for the nine months ended September 30, 1998 ("1998 Nine
Months"), consisting primarily of subscriber sales, were $33,276,329 as
compared to $4,932,337 for the nine months ended September 30, 1997 ("1997 Nine
Months"). Total revenues for the three months ended September 30, 1998 ("1998
Quarter"), consisting primarily of subscriber sales, were $11,517,212 as
compared to $1,630,488 for the three months ended September 30, 1997 ("1997
Quarter").
The increased revenues for the 1998 Nine Months and 1998 Quarter are
attributable to increased sales of the Company's Ameritel brand cellular and
paging services. Cellular and paging subscriber revenues amounted to
$33,263,289 for the 1998 Nine Months compared to $1,845,051 for the 1997 Nine
Months and $11,514,911 for the 1998 Quarter compared to $1,202,822 for the 1997
Quarter.
Agency activation commissions, which the Company receives from other wireless
carriers for which it performs activation processing services, decreased
significantly from the 1997 Nine Months to the 1998 Nine Months due to the
Company's transition from agent to reseller. Agency commissions in the 1998
Nine Months were $13,040 as compared to $2,854,292 in the 1997 Nine Months.
Agency commissions for the 1998 Quarter were $2,290 as compared to $405,883 in
the 1997 Quarter.
Cost of Sales
Costs of subscriber services, which consist of direct charges from cellular and
paging carriers for access, airtime (including local, long distance and
roaming) and services resold to the Company's subscribers, amounted to
$19,163,868 and $6,464,521 for the 1998 Nine Months and 1998 Quarter,
respectively, and $964,944 and $673,489 for the 1997 Nine Months and 1997
Quarter, respectively. The gross margin for subscriber sales were $14,099,421
or 42% and $5,050,401 or 44% for the 1998 Nine Months and 1998 Quarter,
respectively, and $880,107 or 48% and $529,322 or 44% for the 1997 Nine Months
and 1997 Quarter, respectively. The increase in gross margin dollars from the
1997 to 1998 periods is due to the substantial increase in the number of
markets in which the Company operated as a reseller rather than as an agent.
Operating Expenses
Subscriber acquisition and promotional costs represent expenses incurred by the
Company in its efforts to acquire new subscribers for its cellular and paging
services. These costs consist primarily of commissions paid to retailers,
equipment suppliers and outside sales representatives, below cost discounts,
such as reduced monthly access charges and/or free airtime granted to
subscribers when utilizing the Company's cellular or paging services, rebates
issued to subscribers and certain advertising costs. Subscriber acquisition and
promotional costs amounted to $17,589,398 and $4,533,544 for the 1998 Nine
Months and 1998 Quarter, respectively and $2,633,076 and $1,584,441 for the
1997 Nine Months and 1997 Quarter, respectively.
Since the Company has substantially curtailed its acquisition of new
subscribers under existing programs, it believes that the subscriber
acquisition and promotional costs will be substantially reduced in future
quarters.
12
<PAGE> 14
Selling, general and administrative expenses for the 1998 Nine Months
aggregated $19,482,410 as compared to $12,815,282 for the 1997 Nine Months and
$7,317,464 for the 1998 Quarter as compared to $4,572,856 for the 1997 Quarter,
reflecting the Company's growth. Salaries and related employee benefits
increased by 56% to approximately $7.8 million for the 1998 Nine Months from
approximately $5.0 million for the 1997 Nine Months and by 35% to approximately
$2.3 million for the 1998 Quarter from approximately $1.7 million for the 1997
Quarter, reflecting the Company's hiring of executive, managerial, customer
service and information systems personnel to support its growth.
Telecommunications expenses were unchanged at $1.4 million for the 1998 Nine
Months and Nine Months and decreased by 21% to $377,000 for the 1998 Quarter
from $474,000 for the 1997 Quarter. Billing and credit review services
increased to $1.8 million for the 1998 Nine Months from $129,000 for the 1997
Nine Months and increased to $695,000 for the 1998 Quarter from $95,000 for the
1997 Quarter. Bad debt expense increased to $3.1 million for the 1998 Nine
Months from $742,000 for the 1997 Nine Months and to $2.1 million for the 1998
Quarter from $318,000 for the 1997 Quarter. The increase in both billing and
credit review and provision for bad debt is due, in substantial part, to
increased activity and growth of the reseller business. As a percentage of
revenues, selling, general and administrative expenses exclusive of
depreciation and amortization and bad debt were 38% for the 1998 Quarter
compared to 54% in the first quarter of 1998 and 39% in the second quarter of
1998.
Interest Expense
Interest expense (net of income) aggregated approximately $7.3 million and $2.0
million in the 1998 Nine Months and 1998 Quarter, respectively, and interest
income (net of expense) aggregated approximately $400,000 and $31,000 for the
1997 Nine Months and 1997 Quarter, respectively. The increase in interest
expense during 1998 is related to approximately $6.3 million for the 1998 Nine
Months and $1.4 million for the 1998 Quarter of non-cash interest expense
attributable to the fair value of warrants issued in connection with three
private financings and to the Company's use of cash and cash equivalents and
the effect of borrowings to fund increased operating expenses and capital
expenditures discussed above. See "Liquidity and Capital Resources."
Net Loss
The Company incurred net losses of $30,298,997 and $12,395,351 for the 1998
Nine Months and 1997 Nine Months, respectively and incurred net losses of
$8,791,129 and $5,311,510 for the 1998 Quarter and 1997 Quarter, respectively.
Liquidity and Capital Resources
At September 30, 1998, the Company's working capital deficiency was $14,481,161
compared to a working capital deficiency of $12,643,491 at December 31, 1997.
Cash and cash equivalents totaled $700,604 (of which $677,101 was restricted) at
September 30, 1998 compared to $1,105,530 (of which $731,500 was restricted) at
December 31. 1997. The Company's stockholders' deficit was $10,643,804 at
September 30, 1998, compared to a stockholders' deficit of $6,312,978 at
December 31, 1997.
For the nine months ended September 30, 1998, the Company continued to
experience monthly negative cash flow from operations due to its growing
subscriber base which created a working capital deficiency due to the initial
acquisition costs and the other working capital needs associated with the high
rate of subscriber growth.
13
<PAGE> 15
In order to fund its operations, the Company obtained additional financing
aggregating $3.1 million in October, 1997 through letter of credit financing
from an investment banking firm, an additional $23.5 million was raised in 1998
as follows: short term loans totaling $6.0 million from private individuals (of
which $500,000 was repaid in the first quarter of 1998, $1.5 million plus
accrued interest which was converted into a total of 462,637 shares of Common
Stock and $4.0 million was exchanged for 500 shares of 6% Series D Convertible
Preferred Stock) and entered into the Credit Facility (described below) in June
1998. In addition, the Company raised approximately $2.4 million from the
private sale of Common Stock and $15.0 million from the private sale of
Convertible Preferred Stock through July 31, 1998. The $3.1 million letter of
credit financing is collateralized by Common Stock of the Company pledged by
officers, directors and a stockholder of the Company. Subsequent to September
30, 1998, Letters of Credit aggregating $2.7 million (out of $3.1 million above)
have been drawn down and the issuer of the letter of credit has demanded payment
from the Company. Payment to the beneficiaries of these Letters of Credit
constitute payment of existing obligations and do not create liabilities that
would not otherwise be recorded in the Company's financial statements. The
Company has not made payment of any of the sums demanded by the issuer of the
letter of credit.
In connection with these financings, the Company also issued warrants to
purchase an aggregate of 5,462,284 shares of Common Stock as of July 31, 1998
at exercise prices ranging from $5.00 to $7.1875 per share. Reference is made
to Note 3 of the Notes to Condensed Consolidated Financial Statements included
as part of this Quarterly Report.
The Company is in default under both of the Convertible Preferred Stock
Agreements ("Agreements") above due to certain events such as failure to
register certain underlying securities, the delisting of the Company's common
stock from the NASDAQ National Market System along with other technical
noncompliance with the Agreements. The occurrence of these defaults and non
compliance gives the holders of the Preferred Stock the right to call for
redemption of part or all of the amounts of unconverted Preferred Stock. These
defaults have been waived by 89% of the holders through January 1, 1999. The
Company is negotiating to obtain a waiver for the remaining 11%.
In June 1998 the Company entered into an agreement providing for $20.0 million
revolving credit and term loan facility with Foothill Capital Corp.
Availability under this facility is dependent upon meeting certain formulas.
Reference is made to Note 4 of the Notes to Condensed Consolidated Financial
Statements included as part of this Quarterly Report.
As of November 12, 1998, the Company was indebted under the Foothill Credit
Facility for approximately $9.8 million. The Company is in default in the
performance of its obligations under the terms of the Credit Facility by failing
to pay amounts due and payable thereby creating an overadvance and by failing to
comply with other material performance obligations and financial covenants. On
November 18, 1998, the Company entered into a Forbearance Agreement with
Foothill which acknowledges 1) the aforementioned defaults, 2) provides for
forbearance by Foothill from exercising it's rights and remedies under the
Credit Facility on account of such defaults until December 4, 1998, and 3)
permits the Company an allowable overadvance of up to $750,000 through December
4, 1998 and continues to advance funds to the Company. There is no assurance
that the Forbearance Agreement will be extended beyond December 4, 1998.
Due to recurring losses from operations, a net capital deficiency and the
Company's inability to date to obtain sufficient financing commitments to
support current and anticipated levels of operations, the Company's independent
public accountants' audit opinion for the year ended December 31, 1997 stated
that these matters raise substantial doubt about the Company's ability to
continue as a going concern.
The Company currently requires substantial amounts of capital to meet past due
obligations and to fund current operations and is presently seeking to raise
funds privately and restructure outstanding obligations. There is no assurance,
however, and no representation is made that the Company will be successful in
raising funds privately. If the Company is not successful in obtaining adequate
financing and is unable to restructure or repay its indebtedness, it will be
required to cease all of its operations. In addition, if it experiences
unanticipated costs or pricing or other competitive pressures, if the Company is
unable to avail itself of additional amounts under the Foothill Credit Facility,
if Foothill Capital Corp. exercises its remedies under the Foothill Credit
Facility or if the Company's plans or assumptions change or otherwise prove to
be inaccurate, the Company will be required to curtail its planned changes in
marketing strategy reduce or cease all of its operations.
INFLATION
To date, inflation has not had any significant impact on the Company's
business.
14
<PAGE> 16
PART II
Item 2 - CHANGES IN SECURITIES
Previously reported under Item 5 of the Company's Current Report on Form 8-K
dated and filed on July 29, 1998.
Item 5 - OTHER INFORMATION
The shares of the Company's Common Stock have been delisted from the Nasdaq
National Market effective as of the close of business on November 13, 1998
since the Company no longer meets the listing criteria. Trading of the
Company's Common Stock will be available on the Bulletin Board effective
November 16, 1998.
15
<PAGE> 17
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
NUMBER DESCRIPTION OF EXHIBIT
3.1 Certificate of Incorporation, as amended, including Certificates of
Designation for 6% Series A, B, C and D Convertible Preferred Stock
(8)
3.2 By-Laws of Registrant (1).
10.1 Warrant issued by the Registrant to Alan R. Dresher.(2) 10.2
Promissory Note issued by the Registrant to Alan R. Dresher. (2)
10.3 Warrant issued by the Registrant to Decameron Partners.(2)
10.4 Promissory Note issued by the Registrant to Decameron Partners.(2)
10.5 Warrant issued by the Registrant to Alan Baron. (2)
10.6 Warrant dated February 2, 1998 issued by the Registrant to Decameron
Partners, Inc.(3)
10.7 Warrant dated February 2, 1998 issued by the Registrant to
Alan R. Dresher.(3)
10.8 Warrant dated February 2, 1998 issued by the Registrant to
Alan Baron.(3)
10.9 Private Placement Purchase Agreement dated February 24, 1998 among
the Registrant, George Karfunkel, Michael Karfunkel, Huberfeld Bodner
Family Foundation, Inc., Laura Huberfeld/ Naomi Bodner Partnership
and Ace Foundation, Inc.(3)
10.10 Convertible Restated Note dated February 24, 1998 issued by the
Registrant in favor of George Karfunkel.(3)
10.11 Convertible Restated Note dated February 24, 1998 issued by the
Registrant in favor of Michael Karfunkel.(3)
10.12 Convertible Restated Note dated February 24, 1998 issued by the
Registrant in favor of Laura Huberfeld/Naomi Bodner Partnership.(3)
10.13 Convertible Restated Note dated February 24, 1998 issued by the
Registrant in favor of Huberfeld Bodner Family Foundation, Inc.(3)
10.14 Warrant dated February 24, 1998 issued by the Registrant to
George Karfunkel.(3)
10.15 Warrant dated February 24, 1998 issued by the Registrant to
Michael Karfunkel.(3)
10.16 Warrant dated February 24, 1998 issued by the Registrant to
Laura Huberfeld/Naomi Bodner Partnership.(3)
10.17 Warrant dated February 24, 1998 issued by the Registrant to Huberfeld
Bodner Family Foundation, Inc.(3)
10.18 Convertible Note dated February 24, 1998 issued by the
Registrant in favor of George Karfunkel.(3)
10.19 Convertible Note dated February 24, 1998 issued by the
Registrant in favor of Ace Foundation.(3)
10.20 Warrant dated March 5, 1998 issued by the Registrant to Alan
R. Dresher.(3)
10.21 Warrant dated March 5, 1998 issued by the Registrant to
Bulldog Capital Management.(3)
10.22 Warrant dated March 5, 1998 issued by the Registrant to Alan
Baron. (3)
10.23 Convertible Preferred Stock Purchase Agreement between the
Registrant and JNC Opportunity Fund Ltd. dated March 24, 1998(4).
10.24 Registration Rights Agreement dated March 24, 1998 between
the Registrant and JNC Opportunity Fund, Ltd. (4)
16
<PAGE> 18
10.25 Escrow Agreement dated March 24, 1998 among the Registrant,
JNC Opportunity Fund, Ltd. and Robinson Silverman Pearce Aronsohn &
Berman LLP (4)
10.26 Warrant dated March 24, 1998 granted by the Registrant to JNC
Opportunity Fund Ltd. (4)
10.27 Warrant dated March 24, 1998 granted by the Registrant to Wharton
Capital Partners, Ltd. (4)
10.28 Escrow Agreement dated May 7, 1998 among the Registrant,
JNC Opportunity Fund, Ltd. and Robinson Silverman Pearce Aronsohn &
Berman LLP (5)
10.29 Warrant dated May 7, 1998 granted by the Registrant to
JNC Opportunity Fund Ltd. (5)
10.30 Warrant dated May 7, 1998 granted by the Registrant to Wharton
Capital Partners, Ltd. (5)
10.29 Warrant dated July 31, 1998 granted by the Registrant to JNC
Opportunity Fund Ltd. (8)
10.30 Warrant dated July 31, 1998 granted by the Registrant to Wharton
Capital Partners, Ltd. (8)
10.31 Loan and Security Agreement by and between Ameritel Communications,
Inc. and Foothill Capital Corporation dated as of June 5, 1998 (6)
10.32 Convertible Preferred Stock Purchase Agreement dated as of
July 29, 1998 among the Registrant, George Karfunkel, Michael
Karfunkel, Laura Huberfeld/Naomi Bodner Partnership and Huberfeld
Bodner Family Foundation, Inc. (7)
27 Financial Data Schedule (9) (for SEC use only)
99.1 Risk Factors (9)
- ----------------------------
(1) Incorporated by reference to an Exhibit filed as part of Trinity's
Registration Statement on Form S-1 (File No. 33-64489).
(2) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 8-K dated and filed on January 13, 1998.
(3) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 8-K dated and filed on March 12, 1998.
(4) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 10-K for the year ended December 31, 1997.
(5) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 10-Q for the quarter ended March 31, 1998.
(6) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 8-K dated and filed on July 7, 1998.
(7) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 8-K dated and filed on July 29, 1998.
(8) Incorporated by reference to an Exhibit filed as part of the Registrant's
Form 10-Q for the quarter ended June 30, 1998.
(9) Filed herewith.
(b) REPORTS ON FORM 8-K
On July 7, 1998, the Company filed a Current Report on Form 8-K disclosing that
Ameritel Communications, Inc., a wholly-owned subsidiary of the Company, had
entered into a four-year Loan and Security Agreement with Foothill Capital
Corp. for a $20.0 million revolving line of credit and term loan facility.
On July 29, 1998, the Company filed a Current Report on Form 8-K disclosing
that it issued an aggregate of 500 shares of 6% Series D Convertible Preferred
Stock in exchange for an aggregate of $4 million 8% unsecured Convertible
Restated Notes due July 31, 1998.
17
<PAGE> 19
FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf by the
undersigned thereunto duly authorized.
USCI, INC.
/s/ ROBERT J. KOSTRINSKY
---------------------------
Robert J. Kostrinsky,
Executive Vice President;
Chief Financial Officer
Date: November 19, 1998
18
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 700,604
<SECURITIES> 0
<RECEIVABLES> 19,022,819
<ALLOWANCES> 3,700,000
<INVENTORY> 7,587
<CURRENT-ASSETS> 16,468,862
<PP&E> 8,001,891
<DEPRECIATION> 5,963,444
<TOTAL-ASSETS> 20,306,219
<CURRENT-LIABILITIES> 27,557,183
<BONDS> 0
0
19
<COMMON> 1,141
<OTHER-SE> (10,644,964)
<TOTAL-LIABILITY-AND-EQUITY> 20,306,219
<SALES> 0
<TOTAL-REVENUES> 33,276,329
<CGS> 0
<TOTAL-COSTS> 19,173,268
<OTHER-EXPENSES> 37,071,808
<LOSS-PROVISION> 22,968,747
<INTEREST-EXPENSE> 7,330,250
<INCOME-PRETAX> (30,298,997)
<INCOME-TAX> 0
<INCOME-CONTINUING> (30,298,997)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (30,298,997)
<EPS-PRIMARY> (2.83)
<EPS-DILUTED> (2.83)
</TABLE>
<PAGE> 1
Exhibit 99.1
RISK FACTORS
HISTORY OF LOSSES; UNCERTAIN FUTURE PROFITABILITY; LIMITED OPERATING HISTORY AS
A RESELLER
The Company, which has never operated at a profit, has experienced increasing
losses and negative operating cash flow since its inception in 1991. The Company
expects that operating and net losses and negative cash flow from operations
will continue until such point that the revenue from subscribers exceeds the
direct costs to carriers and the overhead that the Company is rapidly reducing.
At such time the Company may experience operating and net profits and positive
cash flow. There is no assurance that the Company will be able to achieve
revenue from subscribers that will exceed direct costs to carriers and the
reduced overhead it is attempting to achieve. As of September 30, 1998, the
Company had an accumulated deficit of approximately $73,750,000. The Company has
also experienced a persistent working capital deficiency. There can be no
assurance that the Company will successfully develop as a profitable reseller of
wireless services, that the Company's existing retail mass merchandiser
distribution channels will expand their use of the Company's services or that
the Company will obtain additional channels of distribution.
To date, the Company has had limited capital with which to fund the up-front
costs of acquiring new subscribers and has, therefore, been forced to control
its subscriber growth both by limiting marketing activities in its distribution
points and growth in the number of distribution points. The Company has
substantially reduced the acquisitions of new subscribers and all marketing
activity during the period in which the Company is attempting to raise
additional capital and restructure its debt.
NEED FOR ADDITIONAL FINANCING
The wireless resale industry is highly capital intensive, particularly for
expanding resellers such as the Company, as substantial costs are incurred in
connection with the acquisition of new subscribers. The Company currently
requires substantial amounts of capital to meet past due obligations and to fund
current operations and is presently seeking to raise funds privately and
restructure outstanding obligations. There is no assurance, however, and no
representation is made that the Company will be successful in raising funds
privately. If the Company is not successful in obtaining adequate financing and
is unable to restructure or repay its indebtedness, it will be required to cease
all of its operations. In addition, if it experiences unanticipated costs or
pricing or other competitive pressures, if the Company is unable to avail itself
of additional amounts under the Foothill Credit Facility, if Foothill Capital
Corp. exercises its remedies under the Foothill Credit Facility or if the
Company's plans or assumptions change or otherwise prove to be inaccurate, the
Company will be required to curtail its planned changes in marketing strategy
reduce or cease all of its operations.
19
<PAGE> 2
If the Company decides to raise additional funds through the incurrence of
debt, the Company may become subject to additional or more restrictive financial
covenants. If additional funds are raised by issuing equity securities, the
Company's stockholders may experience dilution. Further, such equity securities
may have rights, preferences or privileges senior to those of the Common Stock.
CONTINUANCE AS A GOING CONCERN
The Company's significant growth in subscribers has created a working capital
deficiency due to the initial acquisition costs associated with the high rate
of subscriber growth. The Company currently requires substantial amounts of
capital to fund both current operations and to expand its subscriber base. Due
to recurring losses from operations, a net capital deficiency and Company's
inability to date to obtain sufficient financing commitments to support current
and anticipated levels of operations, the Company's independent public
accountants audit opinion states that these matters raise substantial doubt
about the Company's ability to continue as a going concern.
DEVELOPMENT OF WIRELESS RESELLER OPERATIONS
A crucial component of the Company's strategy is its ongoing development as a
national wireless reseller. Since November 1996, the Company has been operating
as a reseller of the services of a number of cellular carriers and two national
paging carriers, and is continuing to negotiate agreements with other carriers.
The success of the Company's expansion plan is subject to certain risks. These
risks include the Company's ability to negotiate additional reseller agreements
on commercially reasonable terms, the increasingly competitive nature of the
wireless telecommunications industry, including the effect of the development
and introduction of new technologies, the ability to attract additional
management personnel, and the overall effects of the trend toward deregulation
of the telecommunications industry. These regulatory changes include the
possible elimination of the obligation of facilities-based wireless carriers to
make their services available for resale.
20
<PAGE> 3
DEPENDENCE ON MAJOR CHANNELS OF DISTRIBUTION
Of the Company's approximately 75,000 cellular subscribers at September 30,
1998, approximately 78% were enrolled at RadioShack stores in the New York
metropolitan area, Puerto Rico, the U.S. Virgin Islands and a portion of
Missouri, the Company's principal channel of distribution. Cellular subscribers
enrolled at RadioShack stores accounted for 78% of the Company's revenues in
the second quarter of 1998, as compared to 78% and 62% during the first quarter
of 1998 and the fourth quarter of 1997, respectively. The Company's
distribution contract with RadioShack has been terminated. The Company's growth
has been materially and adversely affected. The termination of, and potential
default under, the agreement with RadioShack constitutes an event of default
under the Foothill Credit Facility.
A significant component of the Company's growth strategy is the expansion of its
relationships with existing mass market channels and the addition of new mass
market channels to sell the Company's wireless services. There is no assurance
that the Company will be able to obtain new channels of distribution or raise
the productivity of existing channels of distribution to replace the
enrollments obtained through the RadioShack stores. Accordingly, the Company's
successful growth will be dependent in large part on the efforts of third
parties, whose efforts will depend on their own financial, competitive,
marketing and strategic considerations. Such considerations include the relative
advantages of alternate products being offered by competitors. There can be no
assurance that these mass market channels will devote sufficient time, attention
and energy to the marketing of the Company's wireless services.
DEPENDENCE ON WIRELESS CARRIERS
The Company is dependent upon facilities-based cellular telephone and paging
service providers for the supply of services to be resold to the Company's
subscribers as well as for information as to usage needed by the Company to bill
customers. Because of a lack of capital, the Company has not paid carriers
within the time period required under carrier agreements. The Company would be
adversely affected if the carriers failed to renew existing agreements with the
Company, failed to provide adequate service or billing information or if they
experienced financial, technical or regulatory difficulties, or if future demand
for service exceeds current service capabilities. Further, an increase in the
wholesale rates charged by the carriers would force the Company to either
increase the rates it charges subscribers, which could adversely affect its
ability to attract new, and retain existing, subscribers, or accept lower
operating margins, which would adversely affect its results of operations. In
view of the fact that the Company has been unable to pay amounts due to carriers
on a timely basis, there is no assurance that it can maintain existing
relationships with such carriers.
21
<PAGE> 4
POTENTIAL ADVERSE EFFECT OF COMPETITION
The wireless communications industry is highly competitive and rapidly
changing. Competition for wireless services subscribers is based principally
upon the services and enhancements offered, the technical quality of the
system, customer service, system coverage, capacity and price. The Company
competes with both facilities-based and non-facilities-based cellular, PCS and
paging service providers, as well as enhanced specialized mobile radio ("ESMR")
companies and landline telephone service providers. Many of these service
providers, including joint ventures involving some of the nation's largest
regional and long distance carriers, have substantially greater access to
capital than the Company, substantially greater marketing, technological, sales
and distribution resources than those of the Company and significantly greater
experience than the Company in providing wireless services. Some of the
Company's competitors are expected to bundle their wireless services with other
offerings, such as landline telephone and cable services, or to operate,
through joint ventures and affiliation arrangements, wireless communications
systems that encompass most of the continental United States.
Competition in the wireless communications industry is expected to continue to
intensify. Due to the rapid introduction of 800 mhz digital technology PCS,
ESMR, satellite-based communications and the growth in the number of
facilities-based wireless carriers, many areas of the country which previously
were covered by two licensed cellular carriers are now, or will soon be, served
by several wireless providers. The trend toward consolidation within the
telecommunications industry, accelerated by deregulation at the federal level,
can also be expected to exert increased competitive pressures on companies that
remain independent. There can be no assurance that new technologies that will
compete with the Company's wireless services will not evolve or that the
Company will be able to successfully operate in the increasingly competitive
wireless telecommunications market.
DEPENDENCE ON EFFECTIVE INFORMATION AND BILLING SYSTEMS; YEAR 2000 TECHNOLOGY
RISKS
The Company's operations are substantially dependent upon its activation
network, information and billing systems. The Company uses these systems to
enroll subscribers, monitor costs, bill and receive payments from customers,
manage credit exposure and achieve operating efficiencies. The Company will
have to upgrade and expand these systems as the Company expands its operations.
The Company has limited experience in developing, managing and expanding these
systems, and there can be no assurance that the Company will be successful in
expanding and upgrading these systems. If the Company were to fail in expanding
and upgrading these systems as necessary, or if the Company's systems were to
fail for any period of time, the Company's ability to conduct its operations
and achieve operating efficiencies would be severely hampered, which would
materially adversely affect the Company's business, financial condition and
results of operations.
22
<PAGE> 5
The Company currently relies on a third party, Celltech, to perform billing
services. There can be no assurance that Celltech will continue to perform such
services competently or on a timely basis, and any failure of Celltech to do so
would have a material adverse effect on the Company's business, relationships
with mass market channels, financial condition and results of operations.
Although the Company does not believe that any significant financial
expenditure or investment is expected to be required to make its computer
systems currently in use year 2000 compliant, the Company is unable to predict
whether the facilities-based cellular telephone and paging service providers,
which provide the Company with the usage information needed to generate
customer bills, or Celltech, have made sufficient modifications to their
computer systems to address the potential problems of year 2000 software
shortcomings. The failure of these third parties to effectively upgrade their
software and systems for transition to year 2000 would have a material adverse
effect on the Company's business, financial condition and results of
operations.
ADVERSE EFFECT OF SUBSCRIBER DISCONNECTIONS
The Company's results of operations are significantly affected by subscriber
disconnections. In order to realize net growth in units in service, disconnected
users must be replaced, and additional users must be added. However, the sales
and marketing costs associated with attracting new subscribers are substantial
relative to the costs of providing service to existing customers, and expenses
associated with each new unit placement exceed the average gross profit received
by the Company during the initial contract term. Because the Company's business
is characterized by relatively high fixed costs of acquisition, disconnections
directly and adversely affect operating income. The Company's subscriber churn
rates are expected, in the short term to equal or exceed industry averages,
which are projected by industry sources to range from 1.9% to 2.5% per month
through 2002. Due to the fact that customer service resources have been reduced
by the Company and many customers who enrolled under one year contracts will
expire in the fourth quarter of 1997 a substantial number of such customers may
not choose to continue service with the Company which would reduce ongoing
revenue and could have a material adverse effect to the Company. An increase in
its rate of disconnections would adversely affect the Company's results of
operations. To date the Company has not entered into contracts greater than one
year in duration with most of its cellular and paging subscribers. There can be
no assurance that substantial numbers of its subscribers will continue to
purchase wireless services from the Company. In the event that a significant
percentage of its subscribers choose to purchase cellular telephone or paging
service from another carrier or otherwise cease to purchase service from the
Company, there can be no assurance that the Company will be able to replace its
subscribers with new cellular and paging subscribers. Since a substantial number
of subscriber contracts are expiring during the fourth quarter, disconnections
may increase and exceed industry averages during this period.
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<PAGE> 6
EXPOSURE TO FRAUDULENT USE OF WIRELESS SERVICES
The cellular industry has been subject to telecommunications fraud and, in
particular, "cloning" (or access fraud) of legitimate phone numbers leading to
the illegal use of such numbers and subscriber fraud. Under its existing
agreements with cellular carriers, the Company is generally not liable for the
wholesale cost of access fraud, which results from the unauthorized duplication
of a cellular telephone number. However, these agreements generally provide that
the Company is liable for subscriber fraud, which occurs when a customer
fraudulently uses another person's identification to become a subscriber of the
Company and obtain wireless services. Since the Company is a reseller of
cellular service, it does not have access to cellular usage on a "real time"
basis. As a result, the discovery of the fraud mentioned above will occur in
periods subsequent to that in which the actual fraud occurred. There can be no
assurance that the Company will not in the future become subject to increased
liability for access fraud or that the Company's liability for fraud will not
have a material adverse effect on the Company's business.
DEPENDENCE ON KEY PERSONNEL
The Company's future success will depend upon the continued service of several
key personnel, particularly Bruce A. Hahn, the Company's Chairman and Chief
Executive Officer, as well as its ability to attract and retain highly
qualified managerial and operational personnel. Competition for such personnel
is intense, and there can be no assurance that the Company will retain its
existing key managerial, technical or other personnel or that it will attract
and retain such employees in the future. The loss of key personnel or the
inability to hire or retain qualified personnel in the future could have a
material adverse effect upon the Company's results of operations. Mr. Hahn's
employment agreement expired in December 1997 and the Company is currently
negotiating a new agreement with him. The Company does not maintain key man
life insurance on any of its personnel.
RAPID TECHNOLOGICAL CHANGE
The market for the Company's telecommunications services is characterized by
rapid technological change and evolving industry standards. The introduction of
services embodying new technology and the emergence of new industry standards
can rapidly erode the competitive position of existing telecommunications
services. The Company's success will be substantially dependent upon its
ability to anticipate changes in technology and industry standards and
successfully introduce new and enhanced services on a timely basis. If the
Company is unable for technological or other reasons to introduce new services
in a timely manner, it could have a material adverse effect on the Company's
business.
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<PAGE> 7
GOVERNMENT REGULATION
The resale of interstate and intrastate cellular mobile telephone service is
subject to federal regulation as a commercial mobile radio service ("CMRS")
and, as such, to certain aspects of common carrier regulation. Although the
Federal Communications Commission ("FCC") has the authority to do so, it has to
date elected not to regulate rates and the entry of wireless services
providers, and states are precluded, as a matter of federal law, from
regulating the rates or entry of CMRS resellers. However, the Company remains
subject to the general obligations of all common carriers, including the
requirement to charge just and reasonable rates and to service all customers in
a non-discriminatory manner. Because Congress has preempted all state rate and
entry regulation CMRS providers, the Company is not required to obtain state
certification or file state tariffs in connection with its provision of
wireless services. States, however, retain authority to regulate other terms
and conditions of wireless services. This has been interpreted to include the
ability of a state public utility commission to act on a complaint regarding an
underlying carrier's alleged discrimination against a cellular reseller. The
Company also remains subject to state regulations generally affecting
corporations that do business within a state, including a state's consumer
protection laws.
Common carriers are currently required to make their services available for
resale. However, the FCC has determined to terminate the resale obligations of
cellular, PCS and ESMR providers on November 24, 2002. The FCC order
terminating such resale obligations is currently being reconsidered by the FCC.
The Company cannot predict the outcome of the FCC's reconsideration; however,
if the FCC upholds its decision to terminate the resale obligation of carriers,
the Company's business, results of operations and financial condition could be
adversely affected.
Effective January 1, 1998, a new universal service support system went into
effect to ensure the provision of service to rural, insular and high-cost
areas, to low-income individuals and to eligible schools, libraries and rural
healthcare providers. Under this system, the Company is required to contribute
a percentage of its revenues to these universal service programs. Although
these charges apply equally to all carriers, to the extent that the charges
increase the rates charged by the Company, they could adversely affect the
Company's business.
The Company expects that there will continue to be numerous changes in federal
and state regulation of the telecommunications industry. The Company is unable
to predict the future course of such legislation and regulation, and further
changes in the regulatory framework could have a material adverse effect on the
Company's business, results of operations and financial condition.
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<PAGE> 8
INTELLECTUAL PROPERTY RISKS
The Company relies on copyrights, trade secret protection and non-disclosure
agreements to establish and protect its rights relating to its proprietary
software platform and other technology. The Company does not hold any patents.
Despite the Company's efforts to safeguard and maintain its proprietary rights,
there can be no assurance that it will be successful in doing so, or that its
competitors will not independently develop and/or patent computer software and
hardware that is functionally substantially equivalent or superior to the
Company's Activation Services Network ("ASN") system, which could have a
material adverse effect on the Company's business. The Company has also been
advised that its use of the service mark and trade name "Ameritel" and the
service mark "Family Link" both of which are registered Trademarks owned by the
Company may infringe on trademarks and service marks of others in certain
states. Additionally, the Company is aware that several other companies are
using the name "Ameritel" or similar names, and that it is unlikely that the
Company can obtain exclusive or even broad service mark protection for the
"Ameritel" name. There also can be no assurance that other companies using the
"Ameritel" name or a similar name will not challenge the Company's right to use
the "Ameritel" name and will not seek to enjoin the Company from using such
name. Accordingly, the Company is in the process of exploring whether to seek a
new name under which to market its services; however, a change in name may cause
confusion in the marketplace and may adversely affect the Company's business
strategy of developing a brand name and identity, which in turn may adversely
affect the Company's growth, particularly in the short-term.
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<PAGE> 9
ABSENCE OF DIVIDENDS
The Company has not paid and does not anticipate paying any cash dividends on
its Common Stock in the foreseeable future. The Company intends to retain its
earnings, if any, for use in the Company's growth and ongoing operations. In
addition, the terms of the Foothill Credit Facility restrict the ability of the
Company to pay dividends on the Common Stock.
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<PAGE> 10
CONVERTIBLE PREFERRED STOCK DILUTION
The Company has approximately $19 million of Convertible Preferred Stock
outstanding, which is convertible into shares of Common Stock at a conversion
price equal to the lesser of (i) 85% of the average of the three lowest closing
prices per share of Common Stock for the 25 trading days immediately preceding
the conversion notice and (ii) $6.89 per share in respect of $5.0 million of
Convertible Preferred Stock, $5.85 per share in respect of an additional $5.0
million of Convertible Preferred Stock $5.31 per share in respect of an
additional $5.0 million of Convertible Preferred Stock and $5.51 per share with
respect to an additional $4.0 million of Convertible Preferred Stock. Further,
the conversion price of each series of Convertible Preferred Stock is subject
to reduction if the Company does not comply with certain covenants within
specified time periods. Accordingly, a decline in the price of the Common Stock
below the fixed conversion price will result in the issuance of additional
shares of Common Stock and the number of such additional shares may be
material. In addition, holders of securities having conversion features similar
to those of the Convertible Preferred Stock tend to sell their shares
immediately upon conversion, which generally results in a decline in the price
of the Common Stock and an increase in the number of shares issued upon the
next conversion. Accordingly, any conversion of the Convertible Preferred Stock
is likely to increase substantially the number of shares of Common Stock
outstanding, adversely affect the price of the Common Stock and result in
dilution to existing stockholders. In addition, under generally accepted
accounting principles a portion of the proceeds from the sale of the
Convertible Preferred Stock was allocated to this beneficial conversion
feature, and this discount is amortized; to the extent conversion occurs prior
to the full amortization of the discount, the Company will be required to
recognize the remainder of the discount in the period of conversion, which will
reduce earnings in that period.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of Common Stock by existing stockholders under Rule 144
promulgated under the Securities Act, or through the exercise of registration
rights or the issuance of shares upon the exercise of options or warrants could
materially adversely affect the market price of shares of Common Stock and
could materially impair the Company's ability to raise capital through an
offering of Common Stock. No predictions can be made as to the effect, if any,
market sales of such shares or the availability of such shares for future sales
will have on the market price of shares of Common Stock prevailing from time to
time.
POSSIBLE VOLATILITY OF STOCK PRICE
In recent years, the stock market in general, and the market for shares of
small capitalization companies (such as the Company) in particular, have
experienced extreme price fluctuations which have been unrelated to changes in
the operating performance of the affected companies. Over the past 12 months,
the Company also has experienced significant volatility in its stock price, and
there can be no assurance that such fluctuations will not adversely affect the
market price of the Company's Common Stock in the future.
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