<PAGE>
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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 SEPTEMBER 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM , 19 TO , 19 .
COMMISSION FILE NUMBER: 0-25482
----------------
EQUALNET COMMUNICATIONS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
TEXAS 76-0457803
(STATE OF OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION 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)
NA
(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 29,269,143 shares of the Registrant's $.01 par value common
stock outstanding as of November 15, 1999
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<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 1999 September 30, 1999
--------------- --------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and equivalents $ 266,000 $ 391,000
Accounts receivable, trade 7,873,000 7,580,000
Other receivables 472,000 631,000
Prepaid expenses and other 401,000 359,000
--------------- --------------------
Total current assets 9,012,000 8,961,000
--------------- --------------------
Property and equipment 20,801,000 20,917,000
Less accumulated depreciation and amortization (8,368,000) (9,215,000)
--------------- --------------------
Net property and equipment 12,433,000 11,702,000
--------------- --------------------
Customer acquisition costs, net 3,862,000 3,379,000
Other assets 407,000 429,000
--------------- --------------------
Total assets $ 25,714,000 $ 24,471,000
=============== ====================
LIABILITIES AND EQUITY
Current Liabilities
Accounts payable $ 3,991,000 $ 5,342,000
Accrued liabilities 5,749,000 5,125,000
Current portion of long term debt - related party 322,000 322,000
Current portion of long term debt 2,726,000 1,138,000
Debt in default 558,000 558,000
Contractual obligations with regard to
receivables sales agreement 3,339,000 2,661,000
--------------- --------------------
Total current liabilities 16,685,000 15,146,000
--------------- --------------------
Long term debt 5,301,000 6,443,000
Commitments and contingencies
Stockholders' Equity:
Preferred stock 16,153,000 16,342,000
Common stock 284,000 288,000
Treasury stock, at cost (232,000) (232,000)
Additional paid-in-capital 46,840,000 47,895,000
Stock warrants 3,019,000 3,019,000
Deferred compensation (20,000) (20,000)
Accumulated deficit (62,316,000) (64,410,000)
--------------- --------------------
Total stockholders' equity 3,728,000 2,882,000
--------------- --------------------
Total liabilities and stockholders' equity $ 25,714,000 $ 24,471,000
=============== ====================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
EQUALNET COMMUNCIATIONS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months Ended September 30,
--------------------------------------------
1998 1999
------------------- --------------------
<S> <C> <C>
Sales $ 8,393,000 $ 8,153,000
Cost of Sales 7,885,000 4,597,000
------------------- --------------------
Gross profit 508,000 3,556,000
Selling, general, and administrative expenses 3,665,000 2,352,000
Depreciation and amortization 2,215,000 1,409,000
------------------- --------------------
Operating loss (5,372,000) (205,000)
------------------- --------------------
Other income (expense):
Interest, net (734,000) (470,000)
Other 17,000 (78,000)
------------------- --------------------
(717,000) (548,000)
------------------- --------------------
Loss before income taxes and
reorganization costs (6,089,000) (753,000)
Benefit for federal income taxes - -
------------------- --------------------
Loss before reorganization costs (6,089,000) (753,000)
Reorganization costs (72,000) -
------------------- --------------------
Net loss $ (6,161,000) $ (753,000)
=================== ====================
Preferred stock dividends and
deemed distributions $ (370,000) $ (463,000)
=================== ====================
Net loss available to common shareholders $ (6,531,000) $ (1,216,000)
=================== ====================
Net loss per share - basic and diluted $ (0.32) $ (0.04)
=================== ====================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
EQUALNET COMMUNICATIONS CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1998 1999
-------------- -------------
<S> <C> <C>
Operating activities:
Net loss from continuing operations $ (6,161,000) $ (753,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,216,000 1,409,000
Interest charge on convertible debt
issued at discount 450,000 -
Provision for bad debt 396,000 178,000
Changes in working capital components: - -
Accounts receivable, trade (2,871,000) 115,000
Prepaid expenses and other current assets (528,000) (40,000)
Accounts payable and accrued liabilities 3,499,000 456,000
Other, net 652,000 -
-------------- -------------
Net cash provided by (used in) operating activities (2,347,000) 1,365,000
-------------- -------------
Investing activities:
Purchases of property and equipment (120,000) (116,000)
Cash paid for acquisition (555,000) -
Proceeds from sale of equipment 75,000 -
-------------- -------------
Net cash used in investing activities (600,000) (116,000)
-------------- -------------
Financing activities:
Proceeds from long-term debt 2,923,000 -
Repayments on long-term debt (4,542,000) (446,000)
Proceeds from convertible debt 2,800,000 -
Proceeds from exchange of common stock for - -
preferred stock 200,000 -
Net proceeds (repayments) on contractual obligations - -
with regard to receivable sales agreements 1,522,000 (678,000)
-------------- -------------
Net cash provided by (used in) financing activities 2,903,000 (1,124,000)
-------------- -------------
Net increase (decrease) in cash (44,000) 125,000
Cash at beginning of period 460,000 266,000
-------------- -------------
Cash at end of period $ 416,000 $ 391,000
============== =============
</TABLE>
See notes to consolidated financial statements.
<PAGE>
EQUALNET COMMUNICATIONS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION
The unaudited consolidated financial statements of Equalnet Communications Corp.
(the "Company") for the three month periods ended September 30, 1999 and 1998
have been prepared in accordance with generally accepted accounting principles
applied on a consistent basis. Significant accounting policies followed by the
Company and its subsidiaries are disclosed in the notes to the consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the year ended June 30, 1999. In the opinion of the Company's management, the
accompanying condensed consolidated financial statements contain the
adjustments, consisting of normal recurring accruals, necessary to present
fairly the consolidated position of the Company and its consolidated
subsidiaries at September 30, 1999, and the consolidated results of their
operations and cash flows for the periods ended September 30, 1999 and 1998.
Operating results for the three months ended September 30, 1999 are not
necessarily indicative of the results which may be expected for the year ended
June 30, 2000.
We have reclassified certain prior period amounts to conform to the current
presentation.
NOTE 2--BANKRUPTCY FILINGS
EqualNet Corporation ("EqualNet"), one of the Company's operating subsidiaries,
and EqualNet Wholesales Services ("Wholesale"), a wholly-owned non-operating
subsidiary of EqualNet filed voluntary petitions for relief under Chapter 11
("Chapter 11") of the United States Bankruptcy Code (the "Bankruptcy Code") on
September 10, 1998 in the United States Bankruptcy Court for the Southern
District of Texas, Houston, Texas. On October 2, 1998, Wholesale filed its
motion to convert its bankruptcy proceedings from a Chapter 11 reorganization to
a Chapter 7 liquidation. Pursuant to the Bankruptcy Code, EqualNet managed its
assets and operated its business as a debtor-in-possession pending confirmation
of its reorganization plan, which plan was confirmed on April 28, 1999 and
consummated on May 28, 1999. The plan of reorganization provided for the
restructuring of amounts and repayment terms for secured and unsecured
creditors. In conjunction with the confirmation and consummation of the
reorganization plan, certain debts were reduced. As voting control of the
Company's common stock remained the same as a result of the confirmation of the
plan of reorganization, fresh start accounting was not used in accordance with
AICPA Statement of Position 90-7.
NOTE 3--DEBT
Netco Acquisition Corp. ("Netco"), a wholly owned subsidiary of the Company, was
in default on its note payable in the principal amount of approximately $4.9
million and $5.2 million as of September 30, 1999 and June 30, 1999,
respectively, and obtained a waiver of this default through October 1, 2000.
USC Telecom defaulted on its note payable of approximately $0.6 million in
February 1999 and, accordingly, the corresponding debt is classified as debt in
default as of September 30, 1999 and June 30, 1999. As further discussed in Note
8, the Company entered into a settlement agreement with the note holder
subsequent to September 30, 1999 whereby the outstanding principal and accrued
interest will be paid by the issuance of a number of shares of the Company''
unregistered common stock.
NOTE 4--INCOME TAXES
The Company recorded a valuation allowance amounting to the entire net deferred
tax asset balance at September 30, 1999, due to operating losses which give rise
to uncertainty as to whether the deferred tax asset is realizable. The Company
has recorded no income tax benefit for the period ended September 30, 1999.
NOTE 5--MANAGEMENT'S PLANS TO RETURN TO PROFITABILITY
For the three month periods ended September 30, 1999 and 1998, the Company
reported pre-tax net operating losses of $0.8 million and $6.1 million,
respectively, has a working capital deficiency, and debt in default. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Pre-tax net operating losses were attributable to several
internal and external factors.
<PAGE>
Continued provisioning challenges through the end of calendar year 1998 led to
delayed billing and increased customer attrition. In addition, the Company
attempted to convert to a new customer management, billing, and rating system in
late fiscal year 1998 which proved to be unsuccessful. Simultaneous with the
Company's attempted conversion and implementation to this customer management,
billing, and rating system the Company acquired a significant customer base;
conversion problems adversely affected the Company's cash collections and, to a
greater extent, led to increased customer attrition.
A significant portion of the Company's capital is provided by receivable sales
agreements with a third-party. Funding under these agreements are based on
specific accounts receivable eligibility requirements with the primary factor
being the collections history per account.
The Company's management is continuing actions to strengthen the financial
position of the Company. New products are being developed to significantly
enhance sales and revenue, including (i) bundled minute long distance products
resembling cellular offerings, (ii) wholesale international rates for retail
customers (iii) pre-paid debit-cards, (iv) advertiser-sponsored long distance
and (v) the pursuit of acquisitions expected to be accretive to earnings. The
Company is also considering entering the wholesale international long distance
market, offering local service as a competitive local exchange carrier, and
offering Internet access. Additionally, the Company is evaluating several
proposals for the resumption of an agent program in order to increase its
customer base, as well as negotiating with several third parties for possible
acquisitions to form strategic alliances in order to maximize the utilization of
the Company's telecommunications switches (the "Switches").
The Company believes the new product offerings noted above are particularly
significant to increasing the Company's revenues and returning to profitability.
Furthermore, management believes the Company must increase its innovation and
not depend on competitive pricing alone in order to become more competitive in
the marketplace. Most of the new product offerings noted above are pricing
packages only and will not require a significant amount of capital. Any new
product offerings requiring technology advancements will most likely come from
strategic alliances or potential mergers. Financing for potential strategic
alliances or mergers is expected to come from the issuance of the Company's
common stock.
In order to provide financing to support operations, the Company must also
continue to increase revenue generated from its existing resources. Specific
actions to maximize revenue generated by the switch network include (i) placing
dedicated customers on the network via connectivity to a local switch, (ii) port
leasing of switch assets and (iii) international product offerings accessed
through the switches. In addition, the Company is continuing to reduce its
primary carrier costs for its existing customer base. The Company continues to
make improvements in its billing and MIS systems to more accurately bill
customers, maximize customer revenue and ensure proper audit of vendor invoices
related to the cost of service. The Company has also implemented a cost
reduction program, and continues to refine these efforts, related to general,
administrative, and overhead expenditures. In addition to utilizing the Switches
to provide transmission of its customer traffic, the Company is focusing on
offering bundled services to its customers, mainly long-distance service,
Internet access, and local service.
Management believes the plans discussed above are critical to returning the
Company to profitability. Additionally, the Company intends to seek possible
strategic alliances and business combinations in order to more rapidly implement
its plans for increasing the service offerings or for reducing costs of the
Company. Management is attempting to balance the cash flows from operations to
meet current needs, and is continuously seeking additionally capital resources
to fund the expansion of service offerings of the Company. Should capital
resource requirements to achieve management's plan to return to profitability
significantly exceed management's ability to meet those needs, the Company's
ability to return to profitability could be significantly delayed or impaired.
NOTE 6--COMMITMENTS AND CONTINGENCIES
On August 7, 1998, Robert H. Turner, the Company's former Chief Executive
Officer filed suit against the Company alleging an unspecified amount of damages
based upon an alleged breach of his employment contract and other claims.
Although the Company denies any wrongdoing or liability in the matter; the
Company has entered into negotiations with Mr. Turner. The Company believes it
has adequate reserves for this matter.
<PAGE>
On September 21, 1998, Cyberserve, Inc., WSHS Enterprises, Inc. and William
Stuart (collectively "Bluegate") filed suit against the Company and Netco
Acquisition LLC alleging damages for breach of contract and other alleged
claims. The matters originated with a letter of intent wherein the Company
proposed the purchase of certain assets of Cyberserve, Inc. and WSHS
Enterprises, Inc. subject to the performance of due diligence by the parties.
Bluegate and certain of its shareholders had threatened to sue the Company in
the event the proposed transaction was not consummated substantially in
conformity with the terms set forth in the Letter of Intent. The damages
Bluegate alleges it incurred were as a result of, among other things, the
claimed modification of its business to its detriment in anticipation of the
integration of its operations with those of EqualNet. It is impossible to
determine with any degree of certainty what, if any, liability Equalnet or any
of its subsidiaries may incur in this matter. The Company denies any wrongdoing
or liability in this matter and intends to vigorously defend itself against all
claims of the plaintiffs. This action is in the initial stage of discovery
proceedings. Accordingly, at this time the Company is unable to determine the
amount of the exposure, if any, under this action.
On September 29, 1998, SA Telecommunications Incorporated asserted claims
pursuant to the Purchase Agreement against USC Telecom and the Company for
operating losses for the period from April 1, 1998 - July 22, 1998, damages for
delayed or unbillable revenue, delivery of shares of the Company's Series C
Senior Preferred Stock, and other items. On December 28, 1998, the court signed
an order approving those claims in the amount of approximately $813,000. The
Company and USC Telecom disputed the monetary claims asserted by SA
Telecommunications in its demand and filed a notice of appeal of the court's
order in the proceedings. On October 9, 1999, SA Telecommunications, Greyrock
Business Credit, and the Company presented an agreement to the SA Telecom
bankruptcy court providing for the settlement of the SA Telecommunications
judgment and amounts owed to Greyrock. The agreement calls for the payment of
the remaining principal balance of the promissory note to Greyrock, plus accrued
but unpaid interest, by the issuance of a number of shares of the Company's
unregistered common stock valued at the lessor of $0.28 per common share (as
adjusted to account for any stock split) or the market price of the unregistered
common stock at the date registration of the shares is effective. In addition,
the agreement calls for satisfaction of the remaining obligation to SA
Telecommunications by the payment of $150,000 cash plus the issuance of an
amount of the Company's unregistered common stock equal to approximately
$660,000 valued at the lesser of $0.28 per common share (as adjusted to account
for any stock split) or the market price of the unregistered common stock at the
date registration of the shares is effective; the Company paid the cash
component of this agreement in October 1999. Dependent upon the timing of the
registration of these shares of the Company's common stock, the amount of the
Company's common stock to be issued will increase, over varying periods of time
from November 1, 1999 to January 30, 2000, from 7.5% to 22.5% of the amount to
be ultimately issued. The Company has reserved the right to repurchase the
shares of the Company's common stock issued in settlement of these obligations
prior to January 31, 2000.
EqualNet's reorganization plan required the Company to issue 3 million shares of
its Common Stock to the Unsecured Creditors' Trust (the Trust) for the benefit
of holders of unsecured claims who were non-insiders or affiliates of the
Company. The Trust may sell up to 375,000 shares of the Company's Common Stock
during each of the first four consecutive six month periods after the effective
date of the reorganization plan. Based upon the price and trading volume, the
Company may authorize the Trust to sell more than 375,000 shares of Common Stock
during any of the four six month periods. If the gross proceeds, prior to
commission, of the Trust's stock sales in any six month period are less than the
average price of $1 per share, then the Company shall pay the trust an amount of
cash to make up the difference between the actual sales price and $1 per share.
At any time during the four six month periods, but not thereafter, the Company
may elect to purchase for $1.50 per share, the entire balance of shares of
Common Stock held by the Trust. Since the effective date of the reorganization
plan, the Trust has sold shares of Common Stock for less than $1. The Company
believes it has adequate reserves for this matter.
EqualNet's reorganization also calls for the Company to issue additional shares
of Common Stock of the Company should the average closing price of the Company's
stock, during the 25 consecutive trading days preceeding the date that is two
years after the effective date of the reorganization be less than $1 per share
as defined Plan of Reorganization.
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. The Company does not believe that the adverse
<PAGE>
determination of any such claims would have a material adverse effect on either
the results of operations or the financial condition of the Company.
NOTE 7--EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
Weighted Average Per Share
Net Loss Common Shares Amount
------------ ---------------- -----------
<S> <C> <C> <C>
Three Months Ended September 30, 1999
- -------------------------------------
Net loss $ (753,000)
Dividends applicable to preferred stock $ (463,000)
------------
Basic and diluted EPS -
Net loss applicable to common stock $(1,216,000) 28,642,458 $(0.04)
============ ================ ===========
Three Months Ended September 30, 1998
- -------------------------------------
Net loss $(6,161,000)
Dividends applicable to preferred stock $ (370,000)
------------
Basic and diluted EPS -
Net loss applicable to common stock $(6,531,000) 20,674,253 $(0.32)
============ ================ ===========
</TABLE>
The analysis above assumes there are no conversions of any securities during the
periods presented because there is a loss in each quarter and, as a result, the
effect of the conversion of any security would be anti-dilutive.
The Company has a potential remaining deemed distribution of approximately $0.9
million for the beneficial conversion feature of Series F Preferred Stock which
was not recognized as of June 30, 1999. The conversion terms of the Series F
Preferred Stock change upon the occurrence of certain events and are subject to
limitations on the convertibility based on the total beneficial ownership of the
Company's common stock held by the Series F Preferred Stock holder. In
accordance with EITF 98-5, "Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios," no deemed distribution
has been recognized in the current quarter due to the contingencies remaining
unresolved.
NOTE 8--SUBSEQUENT EVENTS
On October 9, 1999, SA Telecommunications, Greyrock, and the Company presented
an agreement to the SA Telecom bankruptcy court providing for the settlement of
the SA Telecommunications judgment and amounts owed to Greyrock. The agreement
calls for the payment of the remaining principal balance of the promissory note
to Greyrock, plus accrued but unpaid interest, by the issuance of a number of
shares of the Company's unregistered common stock valued at the lessor of $0.28
per common share (as adjusted to account for any stock split) or the market
price of the unregistered common stock at the date registration of the shares is
effective. In addition, the agreement calls for satisfaction of the remaining
obligation to SA Telecommunications by the payment of $150,000 cash plus the
issuance of an amount of the Company's unregistered common stock equal to
approximately $660,000 valued at the lesser of $0.28 per common share (as
adjusted to account for any stock split) or the market price of the unregistered
common stock at the date registration of the shares is effective; the Company
paid the cash component of the agreement in October 1999. Dependent upon the
timing of the effective date of the registration of these shares of the
Company's common stock, the amount of the Company's common stock to be issued
will increase, over varying periods of time from November 1, 1999 to January 30,
2000, from 7.5% to 22.5% of the amount to be ultimately issued. The Company has
reserved the right to repurchase the shares of the Company's common stock issued
in settlement of these obligations prior to January 31, 2000.
On November 1, 1999, the Company acquired certain assets of the Intelesis Group,
Inc., a development stage company which had been developing an advertiser-
sponsored long distance service. The Company paid total consideration of
$150,000 cash,
<PAGE>
contributed a note receivable of approximately $631,000, and issued
approximately 900,000 shares of the Company's common stock.
In November 1999, the Company entered into an agreement with third-parties to
issue approximately 1.3 million shares of the Company's common stock for
approximately $450,000 cash.
On November 18, 1999, the Company announced its common stock would trade on the
Over the Counter market as a result of the Nasdaq Stock Market's ("Nasdaq")
decision to not continue trading of the Company's common stock as a result of
having not met the Nasdaq's maintenance listing requirement of a $1.00 per share
minimum bid price.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements of Equalnet Communications Corp. (the "Company") and notes
thereto included elsewhere in this report.
Results of Operations
Sales for the three months ended September 30, 1999 decreased 2.9% to $8.2
million compared to sales of $8.4 million for the same period of the prior year.
The decline in revenues is primarily attributable to decreased per minute long
distance charges and normal customer attrition, offset by new business. Gross
margin increased 600% during the current quarter to $3.6 million, compared to
$0.5 million for the same period of the prior year, primarily due to the
decrease in the costs associated with the Company's network of switches which
were not incurred in the current quarter, plus savings associated with renewed
carrier contracts at decreased prices. The net loss applicable to common stock
for the three months ended September 30, 1999, was $1.2 million compared to $6.5
million for the corresponding period in the prior year, an 81.4% improvement.
Included in the net loss for the three months ended September 30, 1998 were $0.3
million of non-cash dividends to preferred shareholders not incurred in the
current period. Excluding these non-cash distributions, net loss improved 73.0%,
compared to the corresponding period in the prior year.
Cost of Sales
The cost of sales for the three months ended September 30, 1999, decreased 41.7%
to $4.6 million compared to $7.9 million for the comparable period of the prior
year. Cost of sales as a percentage of sales decreased to 56.4% for the three
months ended September 30, 1999, from 93.9% for the corresponding period in the
previous year. The primary cause of the decrease was the costs associated with
the Company's network of switches which were not incurred in the current quarter
plus savings associated with renewed carrier contracts at decreased prices.
Bad debt expense as a percentage of sales for the three months ended September
30, 1999 was 2.2% of sales, which was substantially less than the 5% incurred
for the three months ended September 30, 1998, primarily as a result of
increased collections in the current quarter and a decrease in accounts
determined to be uncollectible.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased 35.8% to $2.4 million for
the three months ended September 30, 1999, from $3.7 million for the same period
of the prior year. Selling, general and administrative expenses decreased as a
percentage of sales to 28.8% for the three months ended September 30, 1999, from
the 43.6% for the same period of the prior year. The decrease in selling,
general and administrative expenses as a percentage of sales relates primarily
to the substantial decrease in the size of the Company's infrastructure.
Depreciation and Amortization
Depreciation and amortization decreased 36.4% to $1.4 million for the quarter
ended September 30, 1999, as compared to $2.2 million for the same period in the
previous year. This decrease is primarily attributable to the "declining
balance" method for depreciating customer acquisition costs, which results in
accelerated depreciation amounts in the initial year of amortization as compared
to subsequent periods, as well as write-offs in the prior quarter not incurred
in the current quarter.
<PAGE>
Liquidity and Capital Resources
The Company generated $1.4 million in cash flow from operations for the three
months ended September 30, 1999, compared to the $2.3 million cash flow used in
operations for the same period of the prior year. Cash flow deficits in the
prior quarter were primarily attributable to operating losses incurred by the
Company.
Cash used in investing activities totaled $0.1 million for the three months
ended September 30, 1999, compared to the $0.6 million for the same period of
the previous year. The primary use of cash for investing activities during the
period ended September 30, 1999, was for equipment utilized to increase the
network's efficiencies which, as a result, increased customer call volumes.
Net cash used in financing activities was $1.1 million for the three months
ended September 30, 1999, compared to the cash generated by financing activities
of $2.9 million for the same period of the previous year. The majority of the
prior period amount was generated from the proceeds received from the issuance
of the 2001 Notes.
Management's Plans to Return to Profitability
For the three month periods ended September 30, 1999 and 1998, the Company
reported pre-tax net operating losses of $0.8 million and $6.1 million,
respectively, has a working capital deficiency, and debt in default. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Pre-tax net operating losses were attributable to several
internal and external factors. Continued provisioning challenges through the end
of calendar year 1998 led to delayed billing and increased customer attrition.
In addition, the Company attempted to convert to a new customer management,
billing, and rating system in late fiscal year 1998 which proved to be
unsuccessful. Simultaneous with the Company's attempted conversion and
implementation to this customer management, billing, and rating system the
Company acquired a significant customer base; conversion problems adversely
affected the Company's cash collections and, to a greater extent, led to
increased customer attrition.
A significant portion of the Company's capital is provided by receivable sales
agreements with a third-party. Funding under these agreements are based on
specific accounts receivable eligibility requirements with the primary factor
being the collections history per account.
The Company's management is continuing actions to strengthen the financial
position of the Company. New products are being developed to significantly
enhance sales and revenue, including (i) bundled minute long distance products
resembling cellular offerings, (ii) wholesale international rates for retail
customers (iii) pre-paid debit-cards, (iv) advertiser-sponsored long distance
and (v) the pursuit of acquisitions expected to be accretive to earnings. The
Company is also considering entering the wholesale international long distance
market, offering local service as a competitive local exchange carrier, and
offering Internet access. Additionally, the Company is evaluating several
proposals for the resumption of an agent program in order to increase its
customer base, as well as negotiating with several third parties for possible
acquisitions to form strategic alliances in order to maximize the utilization of
the Company's telecommunications switches (the "Switches").
The Company believes the new product offerings noted above are particularly
significant to increasing the Company's revenues and returning to profitability.
Furthermore, management believes the Company must increase its innovation and
not depend on competitive pricing alone in order to become more competitive in
the marketplace. Most of the new product offerings noted above are pricing
packages only and will not require a significant amount of capital. Any new
product offerings requiring technology advancements will most likely come from
strategic alliances or potential mergers. Financing for potential strategic
alliances or mergers is expected to come from the issuance of the Company's
common stock.
In order to provide financing to support operations, the Company must also
continue to increase revenue generated from its existing resources. Specific
actions to maximize revenue generated by the switch network include (i) placing
dedicated customers on the network via connectivity to a local switch, (ii) port
leasing of switch assets and (iii) international product offerings accessed
through the switches. In addition, the Company is continuing to reduce its
primary carrier costs for its existing customer base. The Company continues to
make improvements in its billing and MIS systems to more accurately bill
customers, maximize customer revenue and ensure proper audit of vendor invoices
related to the cost of service.
<PAGE>
The Company has also implemented a cost reduction program, and continues to
refine these efforts, related to general, administrative, and overhead
expenditures. In addition to utilizing the Switches to provide transmission of
its customer traffic, the Company is focusing on offering bundled services to
its customers, mainly long-distance service, Internet access, and local service.
Management believes the plans discussed above are critical to returning the
Company to profitability. Additionally, the Company intends to seek possible
strategic alliances and business combinations in order to more rapidly implement
its plans for increasing the service offerings or for reducing costs of the
Company. Management is attempting to balance the cash flows from operations to
meet current needs, and is continuously seeking additionally capital resources
to fund the expansion of service offerings of the Company. Should capital
resource requirements to achieve management's plan to return to profitability
significantly exceed management's ability to meet those needs, the Company's
ability to return to profitability could be significantly delayed or impaired.
Year 2000 Issue
The Company recognizes the challenges associated with year 2000 issues ("Y2K")
and has undertaken a comprehensive review and testing of its computer systems to
identify Y2K-related issues associated with any items of software or hardware
used in its business operations. Most of the software systems used by the
Company are licensed from third-parties and have been represented by their
vendors as being Y2K compliant or will be upgraded to Y2K compliant releases
before the end of calendar year 1999. This issue has been addressed by the
Company in multiple phases, including assessment, remediation, testing, and
implementation, and progress is being monitored by the Company's senior
management. All material systems, including non-information technology systems
which may house non-compliant, embedded technology are being or have been
evaluated.
In addition to addressing the Company's own systems, as described above, the
Company must assess the state of readiness of the systems of other entities with
which it does business. Failure by these third-parties to adequately resolve
their Y2K issues could have a material adverse effect on the Company's
operations.
The Company believes its success on being Y2K compliant will not be conclusively
known until the year 2000 is actually reached. Although failure by one or more
of the Company's own systems could result in lost revenues and/or additional
expenses required to carry out manual processing of transactions, the Company
cannot predict the effect external forces could have on its business. Failures
by banking institutions, governmental entities, and others could have far-
reaching effects on the entire economy and the Company.
At September 30, 1999, the major information technology and non-information
technology systems on which the Company's operations depend have been evaluated
and updated, where necessary, and are believed to be Y2K compliant. The Company
continues to evaluate and remediate certain of its less significant information
technology and non-information technology systems. The Company expects to
complete all phases of its Y2K program prior to December 31, 1999.
The Company believes it is not possible to determine with certainty all Y2K
problems affecting the Company have been identified or corrected. The number of
devices which could be affected and the interactions among theses devices are
simply too numerous. In addition, the Company cannot accurately predict how
many failures related to the Y2K problem will occur or the severity, duration,
or financial consequences of such failures. The Company has contingency plans
to define and address the worst-case scenario likely to be faced by the Company.
Expenses incurred by the Company related to assessing, remediating, and testing
its information technology systems, which were not material, have been expensed
as incurred and funded from operations as part. A majority of these costs would
have been incurred as part of normal system and application upgrades. The
Company does not anticipate the cost to become fully Y2K compliant will be
material.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
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: November 19, 1999 /s/ Michael P. Gallagher
--------------------- ---------------------------------
Michael P. Gallagher, Chief
Financial Officer
(duly authorized officer and
principal financial officer)
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