UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended December 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _________, 19__ to _________, 19___.
Commission File Number: 0-25482
EQUALNET HOLDING CORP.
(Exact Name of Registrant as Specified in its Charter)
TEXAS 76-0457803
(State of Other Jurisdiction of (I.R.S. Employer Identi-
Incorporation or Organization) fication Number)
1250 WOOD BRANCH PARK DRIVE
HOUSTON, TEXAS 77079
Address of Principal Executive Offices, Including Zip Code
(281) 529-4600
(Registrant's Telephone Number, Including Area Code)
N/A
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
There were 6,152,000 shares of the Registrant's $.01 par value common stock
outstanding as of February 12, 1997.
<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
EQUALNET HOLDING CORP.
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1996 1996
------------ ------------
(UNAUDITED)
ASSETS
Current assets
Cash and equivalents ........................... $ 381,849 $ 496,036
Accounts receivable, net of allowance for
doubtful accounts of
$3,284,886 at June 30, 1996 and $1,792,903
at December 31, 1996 ........................... 14,372,858 11,468,312
Receivable from officers ....................... 28,367 28,367
Due from agents, net of allowances of
$1,000,000 at June 30,
1996 and $0 at December 31, 1996 ............... 1,640,808 2,318,194
Prepaid expenses and other ..................... 582,052 422,576
Recoverable federal income taxes ............... 1,302,595 541,509
Deferred tax assets ............................ 696,868 696,868
------------ ------------
Total current assets ........................... 19,005,397 15,971,862
Property and equipment
Computer equipment ............................. 3,172,950 3,217,736
Office furniture and fixtures .................. 1,204,880 1,206,937
Leasehold improvements ......................... 1,174,510 1,174,777
------------ ------------
5,552,340 5,599,450
Accumulated depreciation and amortization ...... (1,864,068) (2,808,574)
------------ ------------
3,688,272 2,790,876
Customer acquisition costs, net of accumulated
amortization of
$5,379,338 at June 30, 1996 and $11,767,624 at
December 31, 1996 .............................. 9,019,774 2,707,943
Deferred tax assets ............................ 1,531,209 2,334,054
Other assets ................................... 1,351,180 1,112,528
Intangible assets .............................. -- 920,350
------------ ------------
Total assets ................................... $ 34,595,832 $ 25,837,613
============ ============
See accompanying notes.
2
<PAGE>
EQUALNET HOLDING CORP.
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1996 1996
------------ ------------
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable ............................... $ 2,057,092 $ 2,763,275
Accrued expenses ............................... 1,080,627 1,322,829
Accrued sales taxes ............................ 912,123 908,809
Brokerage commissions payable .................. 177,891 378,990
Payable to providers of long-distance
services ....................................... 7,194,856 9,876,484
Note payable ................................... -- 583,604
Current maturities of capital lease
obligations .................................... 90,000 90,000
Revolving line of credit ....................... 10,654,245 5,542,063
------------ ------------
Total current liabilities ...................... 22,166,834 21,466,054
Long term obligations under capital leases ..... 45,000 3,000
Shareholders' equity
Preferred stock (non-voting), $.01 par
value, Authorized shares - 1,000,000
at June 30, 1996 and December 31, 1996
December 31, 1996, Issued and outstanding
shares - 0 at June 30, 1996 and
December 31, 1996 .............................. -- --
Common stock, $.01 par value, Authorized
shares - 20,000,000 at June 30, 1996,
and December 31, 1996, Issued and
outstanding shares - 6,002,000 at June
30, 1996, and 6,152,000 at December 31, 1996 ... 60,237 61,738
Treasury stock at cost: 21,750 shares at
June 30, 1996 and December 31, 1996 ............ (104,881) (104,881)
Additional paid in capital ..................... 19,942,428 20,390,927
Warrants to purchase common stock .............. -- 199,000
Deferred compensation .......................... (335,836) (290,832)
Accumulated deficit ............................ (7,177,950) (15,887,393)
------------ ------------
Total shareholders' equity ..................... 12,383,998 4,368,559
------------ ------------
Total liabilities and shareholders' equity ..... $ 34,595,832 $ 25,837,613
============ ============
See accompanying notes.
3
<PAGE>
EQUALNET HOLDING CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales ...................................... $ 19,046,733 $ 12,090,069 $ 42,966,902 $ 25,404,968
Cost of sales .............................. 13,598,776 9,645,373 31,810,837 19,932,937
------------ ------------ ------------ ------------
5,447,957 2,444,696 11,156,065 5,472,031
Selling, general and administrative expenses 3,673,338 3,036,984 6,811,902 6,214,681
Depreciation and amortization .............. 1,179,694 1,847,675 2,243,313 3,697,823
Write down of deferred acquisition costs ... 3,700,000 4,400,000 3,700,000 4,400,000
------------ ------------ ------------ ------------
Operating loss ............................. (3,105,075) (6,839,963) (1,599,150) (8,840,473)
Other income (expense)
Interest income ............................ 10,737 30 55,477 62
Interest expense ........................... (135,922) (208,363) (243,501) (478,640)
Miscellaneous .............................. (40,860) (102,674) (44,947) (193,237)
------------ ------------ ------------ ------------
(166,045) (311,007) (232,971) (671,815)
Loss before federal income taxes ........... (3,271,120) (7,150,970) (1,832,121) (9,512,288)
Benefit for federal income taxes ........... (1,269,195) -- (710,864) (802,845)
------------ ------------ ------------ ------------
Net loss ................................... $ (2,001,925) $ (7,150,970) $ (1,121,257) $ (8,709,443)
============ ============ ============ ============
Net loss per share ......................... $ (0.33) $ (1.18) $ (0.19) $ (1.44)
============ ============ ============ ============
Weighted average number of shares .......... 6,023,750 6,083,552 6,023,750 6,042,761
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
EQUALNET HOLDING CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
DECEMBER 31,
1995 1996
------------ ------------
OPERATING ACTIVITIES
Net loss ....................................... $ (1,121,257) $ (8,709,443)
Adjustments to reconcile net loss to cash
provided by
operating activities
Depreciation and amortization .................. 2,243,313 3,697,823
Provision for bad debt ......................... 531,404 1,211,714
Equity in loss on investment ................... -- 150,704
Benefit for deferred income taxes .............. (1,321,279) (802,845)
Loss on sale of assets ......................... -- 341
Compensation expense recognized
for common stock issue ......................... 70,001 45,004
Write down of long term assets ................. 3,700,000 4,400,000
Change in operating assets and liabilities
Accounts receivable ............................ 272,925 1,692,832
Due from agents and commissions ................ (2,190,842) (979,698)
Prepaid expenses and other ..................... (594,734) 920,562
Other assets ................................... (335,799) (374,023)
Accounts payable and accrued liabilities ....... 1,180,803 4,140,052
------------ ------------
Net cash provided by operating activities ...... 2,434,535 5,393,023
INVESTING ACTIVITIES
Purchase of property and equipment ............. (3,466,537) (48,999)
Commission rate buydown ........................ (710,347) --
Purchase of customer accounts .................. (7,272,260) (76,455)
Proceeds from sale of equipment ................ -- 800
------------ ------------
Net cash used in investing activities .......... (11,449,144) (124,654)
FINANCING ACTIVITIES
Proceeds from revolving line of credit ......... 41,628,934 24,660,000
Repayments on revolving line of credit ......... (35,940,696) (29,772,182)
Repayments on capital lease obligations ........ (54,000) (42,000)
------------ ------------
Net cash provided by (used in) financing
activities ..................................... 5,634,238 (5,154,182)
------------ ------------
Net increase (decrease) in cash and equivalents (3,380,371) 114,187
Cash and equivalents, beginning of period ...... 3,526,543 381,849
------------ ------------
Cash and equivalents, end of period ............ $ 146,172 $ 496,036
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Noncash investing activities:
Common stock issued for acquisition ......... $ 450,000
Warrants issued for acquisition ............. 199,000
Liabilities assumed ......................... 271,350
------------
$ 920,350
============
See accompanying notes.
5
<PAGE>
EQUALNET HOLDING CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - MANAGEMENT'S REPRESENTATION
The consolidated financial statements included herein have been
prepared by the management of EqualNet Holding Corp. (the "Company")
without audit. Certain information and note disclosures normally
included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been omitted. In
the opinion of the management of the Company, all adjustments
considered necessary for fair presentation of the consolidated
financial statements have been included and were of a normal
recurring nature, and the accompanying consolidated financial
statements present fairly the financial position of the Company as
of December 31, 1996, and the results of operations for the three
and six months ended December 31, 1995 and 1996, and cash flows for
the six months ended December 31, 1995 and 1996.
It is suggested that these consolidated financial statements be read
in conjunction with the consolidated financial statements and notes
for the three years ended June 30, 1996, included in the Company's
Annual Report on Form 10-K for the year ended June 30, 1996, as
amended, which was filed with the Securities and Exchange
Commission. The interim results are not necessarily indicative of
the results for a full year.
NOTE 2 - INCOME TAXES
The Company has recorded an income tax benefit at the federal
statutory rate of 34% for the three months ended September 30, 1996,
and has recorded no benefit for the three months ended December 31,
1996. A valuation allowance has been provided to record deferred tax
assets to a level which, more likely than not, will be realized. The
net deferred tax assets reflect management's estimate of the amount
that will be realized from future profitability. There can be no
assurance however, that the Company will generate taxable earnings
or any specific level of continuing earnings in the future. The
Company has recorded no tax benefit for state and local taxes.
NOTE 3 - CARRIER COMMITMENTS
At December 31, 1996, the Company had an agreement with AT&T Corp.
("AT&T") which expires in November 1998. The agreement covers the
pricing of services and establishes minimum semi-annual revenue
commitments ("MSARCs") which must be met to receive the contractual
price and to avoid shortfall penalties. The Company's commitment to
AT&T is segregated into components differentiated
6
<PAGE>
by the type of traffic. At December 31, 1996 the Company was $11.4
million deficient in achieving the cumulative MSARC.
In the past, management has been able to renegotiate the multi-year
agreement approximately every six months, and the Company is
currently in negotiation with AT&T to amend the agreement to reduce
the rates being charged for long-distance and to modify the MSARCs.
Historically, the Company has been able to negotiate a settlement
with the carrier that has resulted in no penalty being incurred by
the Company, and, therefore, no amount has been accrued in the
financial statements for any failure to meet the MSARCs. No
assurances can be made that the Company will be able to reach
similar favorable settlements with the carrier should it continue to
fail to meet its commitment.
NOTE 4 - DEBT
At December 31, 1996, the Company has a $12.5 million revolving line
of credit with a bank which will expire December 1, 1997 with an
effective interest rate equal to the bank's prime rate plus three
percent. At December 31, 1996, the Company was in violation of
certain financial covenants of the credit agreement. Subsequent to
December 31, 1996, the Company executed an amendment to the credit
agreement which, subject to the receipt of proceeds from the
issuance of notes to a third party, waives any prior events of
default, including the violation of the covenants at December 31,
1996. See Note 8.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company's intrastate long-distance telecommunications operations
are subject to various state laws and regulations, including prior
certification, notification or registration requirements. The
Company must generally obtain and maintain certificates of public
convenience and necessity from regulatory authorities in most states
in which it offers service. The Company has responded to formal
consumer protection inquiries from nine states. The inquiries do not
state specific damage amounts, and the potential liability, if any,
is not determinable. The Company believes these inquiries will be
resolved satisfactorily, although settlement offers may be made or
accepted in instances in which it is determined to be cost
effective. During the year ended June 30, 1996, the Company recorded
an accrual of $250,000 for such estimated settlements. No assurances
can be made however, that the inquiries can be settled for amounts
within the amount currently accrued, that additional states will not
begin inquiries or that the current accruals will be sufficient to
provide for existing or future settlements. Failure to resolve
inquiries satisfactorily or reach a settlement with the regulatory
agencies could, in the extreme, result in the inability of the
Company to provide long-distance service in the jurisdiction
requiring regulatory certification. Any failure to maintain proper
certification could have a material adverse effect on the Company's
business.
7
<PAGE>
NOTE 6- ACQUISITION OF ASSETS
On November 12, 1996, the Company purchased certain assets of
Creative Communications International, Inc., a Texas-based debit
card company, for 150,000 shares of EqualNet Holding Corp. common
stock, $.01 par value per share ("Common Stock"), a warrant to
purchase 100,000 shares of Common Stock, and the assumption of
certain liabilities totaling approximately $271,000. The warrant
issued in this transaction was outstanding at December 31, 1996 and
allows the holder to purchase an aggregate of 100,000 shares of
Common Stock at a price of $7.50 per share. The warrant expires on
November 1, 2001.
NOTE 7- WRITE DOWN OF DEFERRED ACQUISITION COSTS
During the quarter ended December 31, 1996, the Company recorded a
charge to earnings for $4.4 million to reduce the carrying value of
purchased customer accounts to an estimate of future discounted cash
flows from the purchased accounts. Continued higher than expected
attrition associated with the purchased accounts resulted in a
decline in anticipated future cash flows, necessitating the write
down.
NOTE 8- SUBSEQUENT EVENTS
Effective February 3, 1997, the Company executed an agreement with
The Furst Group, Inc., a privately held reseller of long-distance
and other telecommunications services, pursuant to which The Furst
Group agreed to loan the Company $3 million at an annual interest
rate of 10%, maturing December 31, 1998. In addition, the Company
agreed to issue stock purchase warrants to The Furst Group,
exercisable for an aggregate of 1,500,000 shares of Common Stock at
a purchase price of $2.00 per share. In connection with this
agreement, the Company began utilizing, effective November 1, 1996,
The Furst Group's contract with Sprint Communications Company, L.P.
("Sprint"). The Company also amended its credit agreement with its
senior lender, subject to and effective upon receipt by EqualNet of
the proceeds of the notes from the Furst Group. The amendment allows
for less restrictive financial covenants, waives previous financial
covenant defaults and resets the maturity date of the revised credit
facility to July 1, 1997.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Sales for the three months ended December 31, 1996 decreased 36.5% to $12.1
million compared with sales of $19.0 million for the same period of the prior
year. Gross margin decreased to $2.4 million compared to $5.4 million for the
same period of the prior year. The Company recorded a $7.2 million loss before
taxes for the three months ended December 31, 1996, compared to a loss of $3.3
million for the same period in the prior year. The net loss for the three months
ended December 31, 1996 was $7.2 million and included no tax benefit. The net
loss for the corresponding period in the previous year was $2.0 million and
included a tax benefit of $1.3 million (an effective rate of 38.8%). The three
months ended December 31, 1996 included a $4.4 million charge to decrease the
net book value of acquired customers to an estimate of future discounted cash
flows associated with those customers. The three months ended December 31, 1995
included a similar $3.7 million charge.
The following table sets forth for the fiscal periods indicated the percentages
of total sales represented by certain items reflected in the Company's
consolidated statements of income:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
----- ----- ----- -----
Total sales ........................ 100.0% 100.0% 100.0% 100.0%
Cost of sales ...................... 71.4% 79.8% 74.0% 78.5%
----- ----- ----- -----
Gross margin ....................... 28.6% 20.2% 26.0% 21.5%
Selling, general and
administrative expense ............. 19.3% 25.1% 15.9% 24.5%
Depreciation and amortization ...... 6.2% 15.3% 5.2% 14.5%
Write down of deferred
acquisition costs .................. 19.4% 36.4% 8.6% 17.3%
----- ----- ----- -----
Operating loss ..................... (16.3%) (56.6%) (3.7%) (34.8%)
Other income (expense)
Interest income .................... 0.0% 0.0% 0.1% 0.0%
Interest expense ................... (0.7%) (1.7%) (0.6%) (1.9%)
Miscellaneous ...................... (0.2%) (0.8%) (0.1%) (0.8%)
----- ----- ----- -----
(0.9%) (2.5%) (0.6%) (2.7%)
Loss before federal income
taxes .............................. (17.2%) (59.1%) (4.3%) (37.5%)
Benefit for federal income
taxes .............................. (6.7%) 0.0% (1.7%) (3.2%)
----- ----- ----- -----
Net loss ........................... (10.5%) (59.1%) (2.6%) (34.3%)
===== ===== ===== =====
9
<PAGE>
SALES
The Company experienced a decrease in sales in the three months ended
December 31, 1996 of 36.5% to $12.1 million compared to $19.0 million for the
comparable period of the prior year. For the six months ended December 31,
1996 sales decreased 40.9% to $25.4 million compared to $43.0 million for the
same period in the previous year. The decrease for both periods was due
primarily to a decrease in the number of customer accounts and a
corresponding decrease in billable minutes. Total billable minutes for the
quarter ended December 31, 1996 decreased 33.9% to 44.5 million minutes from
67.3 million minutes for the same period of the prior year and for the six
months ended December 31, 1996 decreased 39.9% to 87.0 million minutes from
144.7 million minutes for the comparable period of fiscal 1996. The decline
in revenues and billable minutes was the result of an increased rate of
attrition for existing customers and a decline in order activity beginning in
January 1996. The Company began reducing order activity in early calendar
1996 to reduce the incidence of loss due to delayed provisioning times at
AT&T and because it discovered the NetBase Plus customer management system
was severely hampering the Company's ability to provision and service new
customers. The Company slowly began increasing order activity once it had
reverted to the original customer management system and provisioning times
had returned to acceptable levels; however, the Company began experiencing
liquidity problems during this time frame and has been unable to fund order
activity as significant as that achieved prior to January 1996.
COST OF SALES
The cost of sales for the three months ended December 31, 1996 decreased
29.1% to $9.6 million compared to $13.6 million for the comparable period of
the prior year. Cost of sales for the six months ended December 31, 1996
decreased 37.3% to $19.9 million compared to $31.8 million for the six months
ended December 31, 1995. The decreases were primarily attributable to a
decrease in sales. Cost of sales as a percentage of sales increased to 79.8%
and 78.5% for the three and six months ended December 31, 1996, respectively,
from 71.4% and 74.0% for the corresponding periods in the previous year. The
increases were primarily the result of increases in commission expense,
billing expense and bad debt expense as a percent of sales.
Commission expense as a percent of sales increased to 7.6% for the second
quarter of fiscal 1997, compared to 3.6% for the second quarter of fiscal
1996. Commission expense for the second quarter of fiscal 1997 includes a
$400,000 charge to expense advances to agents that are not expected to be
recovered through future commissions earned by those agents. Excluding the
charge for advances, commission expense as a percent of sales increased
moderately for the quarter to 4.3%, reflecting the Company's return to
acquiring new customers utilizing advances and residual commissions rather
than through purchased orders. Commission expense as a percent of revenues
for the six months ended December 31, 1996 was 5.4%, comparable to the first
six months of fiscal 1996 which was 5.6%.
10
<PAGE>
Billing expense as a percentage of sales increased to 6.9% for the three
months ended December 31, 1996 compared to 4.4% for the same period in the
previous year, and 6.2% for the six months ended December 31, 1996 compared
to 3.8% for the same period in fiscal 1996 as a result of the Company
beginning to bill a portion of its customers through Local Exchange Carriers
("LECs"). Billings through the LECs represented 21.8% and 16.5% of the
Company's revenues for the three and six months ended December 31, 1996,
respectively. The cost of billing through LECs is generally greater than
billing customers through independent billing companies; however, the Company
believes that by billing customers through the LECs, savings will also be
recognized by decreased bad debt expense and reduced customer attrition. In
addition, because the majority of customer service is performed by the LECs,
the Company believes it will be able to reduce overhead related to the cost
of servicing these customers directly.
Bad debt expense as a percentage of sales increased for the three and six
months ended December 31, 1996 to 4.5% and 4.8% of sales, respectively, as
compared to 0.9% and 1.0% of sales for the three and six months ended
December 31, 1995, respectively. The increase is primarily the result of
changes in the mix between periods of revenues generated through commissioned
sales, in which the sales agents shared bad debt expense with the Company,
and revenues generated through purchased accounts, in which the Company had
full exposure on uncollectible accounts.
The Company's cost of long-distance (which is a component of cost of sales)
decreased as a percentage of sales to 60.6% and 61.9% from 62.6% and 63.6%
for the three and six months ended December 31, 1996 and 1995, respectively.
The decrease was primarily the result of the Company reducing its cost of
long-distance by negotiating more favorable rates and amending its contract
with AT&T effective in June 1996.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased 17.3% to $3.0 million
for the three months ended December 31, 1996, from $3.7 million for the same
period of the prior year. Selling, general and administrative expenses
increased as a percentage of sales to 25.1% for the three months ended
December 31, 1996 from 19.3% for the same period of the prior year. Selling,
general and administrative expense decreased 8.8% to $6.2 million from $6.8
million for the six months ended December 31, 1996 and 1995, respectively.
These expenses as a percent of sales increased to 24.5% from 15.9% for the
first six months of fiscal 1997 and 1996, respectively. The increase in
selling, general and administrative expenses as a percentage of sales relates
primarily to the substantial decrease in revenues and the corresponding loss
of back office economies of scale and the inability to reduce fixed cost
structures established when revenues of the Company were substantially
larger. Lease expense increased approximately $139,000 in the second quarter
of fiscal 1997 compared to the same period in fiscal 1996 and $330,000 in the
first six months of fiscal 1997 compared to fiscal 1996. The increase was the
result of the addition of two significant leases in January 1996, one of
which related to the phone system and the other to computer equipment.
Professional fees increased approximately $85,000 in the second quarter of
fiscal 1997 compared to the same period in fiscal 1996 and $180,000 for the
six months
11
<PAGE>
ending December 31, 1996 compared to the same period in the previous year.
The increase in professional fees related primarily to legal and consulting
fees incurred with respect to the ongoing negotiations with the Company's
primary lender and with respect to exploring alternatives related to
obtaining additional financing. The increases in lease expense and
professional fees were offset by a decrease in salary and related expenses of
$763,000 for the quarter ended December 31, 1996 as compared to the quarter
ended December 31, 1995 and $893,000 for the six months ended December 31,
1996 versus the same period in 1995. Staffing decreased from 206 employees at
December 31, 1995 to 162 employees at December 31, 1996. In addition, the
Company reduced administrative expenses $95,000 in the second quarter of
fiscal 1997 compared to the same period in fiscal 1996 and $201,000 for the
six months ended December 31, 1996 as compared to the six months ending
December 31, 1995, as part of overall cost reduction efforts.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased 56.6% to $1.8 million for the quarter
ended December 31, 1996 as compared to $1.2 million for the same period in
the previous year and increased 64.8% to $3.7 million for the six months
ended December 31, 1996 as compared to $2.2 million for the six months ended
December 31, 1995. The increases are the result of the significant purchases
of customer accounts during the first and second quarters of fiscal year
1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated $5.4 million in cash flow from operations for the six
months ended December 31, 1996, compared to $2.4 million for the same period
of the prior year. Cash flow from operations was generated primarily through
the increase of the payable to providers and the decrease in net accounts
receivable due to aggressive collection of accounts receivable.
Cash used in investing activities totaled $125,000 for the six months ended
December 31, 1996, compared to $11.4 million for the same period of the
previous year. Cash used in investing activities in the first two quarters of
fiscal 1997 included the acquisition of $76,000 of customer accounts and
$49,000 of asset additions, primarily computer equipment and software
development costs related to the Company's new proprietary billing system.
The new billing system is expected to be tested and placed into service for
select customer groups in the third quarter of fiscal 1997. The significant
decrease in cash expended in investing activities during the first six months
of fiscal 1997 in comparison to the same period in the previous year is the
result of the discontinuation of the Company's purchased customer account
program and the discontinuation of the development of the NetBase Plus
customer management system.
Cash used in financing activities was $5.2 million for the six months ended
December 31, 1996, substantially all of which related to net repayments on
borrowings under the Company's line of credit. The Company's declining
revenue base along with increasingly restrictive borrowing requirements
imposed by the Company's senior lender have resulted
12
<PAGE>
in a significant decrease in funds available under the Company's line of
credit. Cash provided by financing activities totaled $5.6 million for the
six months ended December 31, 1995, substantially all of which related to net
borrowings under the Company's line of credit.
In early 1994, the Company determined that its treatment and disbursement of
sales taxes was not being properly administered and engaged an outside tax
compliance firm to assist in the resolution of the matter with various states
and other regulatory and taxing authorities. The Company has accrued
liabilities for the resolution of this matter totaling $773,000 at December
31, 1996. The improper treatment of sales taxes arose from the Company's
failure to remit the sales tax due to the various taxing authorities on the
incremental component of revenue in excess of the cost of the underlying
service (for which taxes were properly paid). While there can be no
assurance, the Company believes that the amount accrued is adequate for the
satisfaction of this tax liability, including any interest payable, and that
the Company can negotiate payment terms which would not significantly impact
liquidity. The Company anticipates that the tax issues and payment terms will
be resolved during fiscal year 1997. No assurances can be made, however, that
the Company will be able to negotiate favorable terms with the taxing
authorities and a request for immediate payment could have a material adverse
effect on the Company's financial condition.
Effective February 3, 1997, the Company executed an agreement under which it
will issue to The Furst Group $3 million of 10% subordinated notes due
December 31, 1998 and warrants exercisable for 1.5 million shares of Common
Stock at $2.00 per share. The transaction is expected to be completed by
February 24, 1997, and the proceeds will be used for general corporate
purposes, including the payment of certain trade payables. The notes will be
secured by an interest in EqualNet's receivables which is subordinated to the
interest of the Company's senior lender. In connection with this agreement,
the Company began utilizing, effective November 1, 1996, The Furst Group's
contract with Sprint.
The Company also has signed an amendment to its revolving credit facility to
become effective upon receipt by EqualNet of the proceeds of the notes from
the Furst Group. The amendment contains less restrictive covenants than were
previously in place, waives previous financial covenant defaults (including
the events of default at December 31, 1996) and resets the maturity date of
the revised credit facility to July 1, 1997.
Additionally, in February 1996, the Company agreed to amended terms with
AT&T, its primary underlying carrier, to include improved pricing, payment
terms and other concessions and has also successfully negotiated revised
payment terms with its secondary carrier. The Company continues to pursue the
final steps of its financial restructuring: an additional financing of
between $2.0 and $4.0 million in debt or equity and the replacement of its
existing credit agreement, which expires July 1, 1997, with alternate
long-term working capital financing. If the Company is unsuccessful in
achieving one or a combination of these objectives sufficient to meet the
Company's liquidity needs, it will seek an alliance with a strategic partner,
or in the event no such strategic alliance is
14
<PAGE>
accomplished, the Company may be required to seek protection under United
States bankruptcy laws.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time the Company is involved in what it believes to
be routine litigation or other legal proceedings that may be
considered as part of the ordinary course of its business. On
December 9, 1996, the California Public Utilities Commission
approved a settlement agreement with the Company pertaining to
its application to provide intraLATA service and an agreed
disposition of certain pending consumer complaints. Currently the
Company is involved in litigation filed in August 1995 under
Cause No. 95-CH-0142 in the Circuit Court of the Seventh Judicial
Circuit of Sangamon County, Illinois brought by the Illinois
Attorney General under that state's Consumer Fraud and Deceptive
Business Practices Act, seeking injunctive relief, attorneys fees
and civil penalties in the amount of $50,000 for each violation
of that Act. The Company is also involved in litigation filed in
February 1996 under Cause No. IJ96-1153 in the Chancery Court of
Pulansky County, Arkansas, 1st Division, brought by the Arkansas
Attorney General under that state's Deceptive Trade Practices Act
seeking injunctive relief, attorneys fees, restitution to
consumers and civil penalties in the amount of $10,000 for each
violation of the Act. The Company is also involved in litigation
filed in February 1996 in the Fourth Judicial District of the
State of Idaho in and for the County of Ada under Cause No.
CV-DC-9600809D brought by the Idaho Attorney General under that
state's Consumer Protection Act, Telephone Solicitation Act and
Rules of Telephone Solicitations seeking injunctive relief,
restitution to consumers, attorneys fees and civil penalties in
the amount of $5,000 for each violation of either the Consumer
Protection or Telephone Solicitation Acts. The Company has been
advised by the Attorney General for the State of Wisconsin that
he would like to participate in any joint settlement of the above
described litigation. Each of these matters allege that the
Company has received an excessive number of customer complaints
that long-distance service was switched to EqualNet without the
customer's knowledge or informed consent, with remedies being
sought under the deceptive trade practices and consumer
protection statutes of these states. While the Company
acknowledges that some customers may not fully understand the
technical distinction between being a customer of one of the
Company's underlying carriers and being a customer of EqualNet
with all network processes being handled by those same underlying
carriers, the Company vigorously denies that it has engaged in
any program or pattern of wrongfully switching customers'
long-distance service in violation of state or federal laws.
Although it is not possible at this time to predict with any
degree of certainty the ultimate exposure of the Company in these
matters, the Company does not believe that the outcome of any of
these proceedings will
14
<PAGE>
have a material adverse effect on either the Company's results of
operations or financial condition. See Note 5 to the financial
statements in Item 1 hereof.
Item 2. Changes in Securities
On November 12, 1996, the Company issued to Creative
Communications International, Inc. ("Creative") 150,000 shares of
the Company's Common Stock and warrants to purchase an additional
100,000 shares of Common Stock at $7.50 per share in exchange for
substantially all of the assets of Creative. This issuance was
exempt from registration under the Securities Act of 1933
pursuant to Section 4 (2) thereof, as the transaction did not
involve any public offering.
Item 3. Defaults upon Senior Securities
At December 31, 1996, the Company was not in compliance with
certain of the financial covenants of the loan agreement with its
principal lender, including (i) Tangible Debt to Net Worth ratio
of not more than 8.0 to 1.0, (ii) Debt to Net Worth of not more
than 1.5 to 1.0, (iii) Current Ratio of not less than 1.1 to 1.0,
and (iv) Debt to EBITDA ratio of not more than 4.0 to 1.0. To
have been in compliance with all financial covenants at December
31, 1996, a reduction of $10.6 million in the net loss for the
twelve months ended December 31, 1996 and an additional $1.5
million in assets would have been required.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
CAUTIONARY STATEMENTS:
The Company's expectations with respect to operating results and
other matters described in this Quarterly Report on Form 10-Q and
otherwise embodied in oral and written forward looking statements
are subject to the following risks and uncertainties that must be
considered when evaluating the likelihood of the Company's
realization of such expectations:
ATTRITION RATES - In the event that the Company experiences
attrition rates in excess of those anticipated either as a result
of increased provisioning times by its underlying carrier, the
purchase of poor performing traffic, or the inability to properly
manage the existing customer base due to difficulties with the
NetBase system, additional charges that affect earnings may be
incurred.
15
<PAGE>
DEPENDENCE ON INDEPENDENT MARKETING AGENTS - The Company has a
small internal sales force and obtains a significant majority of
its new customers from independent marketing agents ("Agents").
The Company's near-term ability to expand its business depends
upon whether it can continue to maintain favorable relationships
with existing Agents and recruit and establish new relationships
with additional Agents. No assurances can be made as to the
willingness of the existing Agents to continue to provide new
orders to the Company or as to the Company's ability to attract
and establish relationships with new Agents.
INABILITY TO COLLECT ACCOUNTS RECEIVABLE - Although the Company's
bad debt rate has improved somewhat in recent months, if it were
not to continue to improve or revert to the fiscal 1996 rate,
either as a result of the purchase of poorly performing traffic
or the inability of the Company to properly manage existing
customer receivables, additional charges may be incurred that
would affect earnings. In addition, the inability to collect past
due receivables could have a material adverse impact upon the
Company's liquidity and cash flow.
DEPENDENCE ON AT&T AND OTHER FACILITIES-BASED CARRIERS - The
Company does not own transmission facilities and currently
depends primarily upon AT&T and, to a lesser extent, upon Sprint,
through its contract with The Furst Group, to provide the
telecommunications services that it resells to its customers and
the detailed information upon which it bases its customer
billings. The Company's near-term ability to expand its business
depends upon whether it can continue to maintain favorable
relationships with AT&T and Sprint. Although the Company believes
that its relationships with AT&T and Sprint are good and should
remain so with continued contract compliance, the termination of
the Company's current contracts with either AT&T or Sprint or the
loss of the telecommunications services that the Company receives
from AT&T or Sprint could have a material adverse effect on the
Company's results of operations and financial condition.
This dependence on the Company's primary carrier further
manifested itself during the quarter ended March 31, 1996, as
continued delays in provisioning (activating new customers) by
the carrier resulted in a backlog of customers who would
otherwise have been activated on the Company's long-distance
service and billing. Although the carrier has taken certain steps
to decrease the provisioning time which has resulted in an
elimination of the provisioning backlog, there can be no
assurance that similar delays will not occur in the future.
CARRIER COMMITMENTS - The Company has significant commitments
with its primary carrier to resell long-distance services. The
Company's contract with its carrier contains clauses that could
materially and adversely impact the Company should the Company
incur a shortfall in meeting its
16
<PAGE>
commitments. The Company currently is in a shortfall situation
with its primary carrier. Although the Company has from time to
time failed to meet its commitment levels under a particular
contract and in each case has been able to negotiate a settlement
with the carrier which resulted in no penalty being incurred by
the Company, there can be no assurances that the Company will be
able to reach similar favorable settlements with its carriers
currently or in the event that the Company should continue to
fail to meet its commitments.
In recent years, AT&T, MCI Communications Corporation ("MCI") and
Sprint have consistently followed one another in pricing their
long-distance products. If MCI and Sprint were to lower their
rates for long-distance service and AT&T did not adopt a similar
price reduction, adverse customer reaction could affect the
Company's ability to meet its commitments under the AT&T contract
which could have a material adverse affect on the Company's
financial position and results of operations.
DEVELOPMENTAL PROBLEMS WITH NETBASE - NetBase Plus(R), the
Company's second generation customer management system, was not
able to meet the operating requirements of the Company. As a
result, in the third quarter of fiscal 1996 the Company began
reverting to an enhanced version of the original NetBase
operating system. Although the Company successfully completed the
reversion in the fourth quarter of fiscal 1996 and has made
continued improvements to the operating system, to the extent
that the Company experiences significant growth, the existing
NetBase operating system may reach technical limitations and
hinder reporting visibility to management as well as cause a
decline in customer service, thereby negatively impacting
attrition levels and, therefore, results of operations.
RELATIONSHIPS WITH STATE REGULATORY AGENCIES - The Company's
intrastate long-distance telecommunications operations are
subject to various state laws and regulations, including prior
certification, notification or registration requirements. The
Company must generally obtain and maintain certificates of public
convenience and necessity from regulatory authorities in most
states in which it offers service. The Company is presently
responding to consumer protection inquiries from nine states. The
Company believes these inquiries will be resolved satisfactorily,
although settlement offers may be made or accepted in instances
in which it is determined to be cost effective. During the
quarter ended March 31, 1996, the Company recorded an accrual of
$250,000 for such estimated settlements. No assurances can be
made however, that additional states will not begin inquiries or
that the current accrual will be sufficient to provide for
existing or future settlements. Failure to resolve inquiries
satisfactorily or reach a settlement with the regulatory agencies
could, in the extreme, result in the inability of the Company to
provide long-distance service in the jurisdiction requiring
regulatory certification. Any failure to maintain proper
certification in jurisdictions in which the Company provides a
significant amount of intrastate
17
<PAGE>
long-distance service could have a material adverse effect on the
Company's business.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
27.1 Financial Data Schedule
b. Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EQUALNET HOLDING CORP.
Date February 13, 1997 /S/ MICHAEL L. HLINAK
Michael L. Hlinak
Senior Vice President and
Chief Financial Officer
(duly authorized officer and
principal financial officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF EQUALNET HOLDING CORP. AT DECEMBER
31, 1996 AND FOR THE SIX MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-END> DEC-31-1996
<CASH> 496,036
<SECURITIES> 0
<RECEIVABLES> 13,261,215
<ALLOWANCES> 1,792,903
<INVENTORY> 0
<CURRENT-ASSETS> 15,971,862
<PP&E> 5,599,450
<DEPRECIATION> 2,808,574
<TOTAL-ASSETS> 25,837,613
<CURRENT-LIABILITIES> 21,466,054
<BONDS> 0
0
0
<COMMON> 61,738
<OTHER-SE> 4,306,821
<TOTAL-LIABILITY-AND-EQUITY> 25,837,613
<SALES> 25,404,968
<TOTAL-REVENUES> 25,404,968
<CGS> 19,932,937
<TOTAL-COSTS> 19,932,937
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,211,714
<INTEREST-EXPENSE> 478,640
<INCOME-PRETAX> (9,512,288)
<INCOME-TAX> (802,845)
<INCOME-CONTINUING> (8,709,443)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,709,433)
<EPS-PRIMARY> (1.44)
<EPS-DILUTED> (1.44)
</TABLE>
