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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
1999
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-27683
Amerivision Communications, Inc.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1378798
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5900 MOSTELLER DRIVE, SUITE 1800 73112
OKLAHOMA CITY, OKLAHOMA (Zip Code)
(Address of principal executive offices)
(405) 600-3800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REQUESTED
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NONE N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.10 par value
(Title of Class)
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 [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At March 30, 2001, there were 842,727 shares of Common Stock of the
Company.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
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TABLE OF CONTENTS
ITEM 1. BUSINESS..................................................................................... 1
ITEM 2. PROPERTIES................................................................................... 13
ITEM 3. LEGAL PROCEEDINGS............................................................................ 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS........................................ 15
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................ 15
ITEM 6. SELECTED FINANCIAL DATA...................................................................... 16
ITEM 7. AMERIVISION COMMUNICATIONS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................................ 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.................................... 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................. 26
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE......... 27
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................... 27
ITEM 11. EXECUTIVE COMPENSATION....................................................................... 28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................... 32
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................... 34
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.............................. 40
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ITEM 1. BUSINESS
GENERAL
AmeriVision Communications, Inc. (the "Company" or "Amerivision") is a
provider of long distance telephone and other telecommunications services
primarily to residential users. The Company acquires customers through
affinity-based marketing. Under this type of marketing program, the Company
obtains membership lists from non-profit organizations that support strong
family values, such as American Family Association, Concerned Women For America,
Christian Broadcasting Network, Christian Coalition, and T.D. Jakes Enterprises
and promotes its services under the LIFELINE(R) service mark to those
organizations' members. The non-profit organizations receive a percentage
(currently approximately 10) % of certain collected revenues generated from
their members ("Giveback"). In some cases the organizations will directly
contact their members to sell the Company's services. In return the
organizations may receive a sign up fee for each new customer obtained by that
organization, in addition to the percentage of revenues. The Company has
experienced substantial success marketing to this family values affinity largely
because its customers, in addition to receiving essential telecommunications
services, are able to indirectly contribute to causes they strongly support. The
Company makes payments to thousands of non-profit organizations and as of
December 31, 1999 had over 400,000 subscribers for its telecommunication
services in all 50 states.
WorldCom, Inc. ("WorldCom") is the primary carrier of the Company's long
distance traffic. Effective February 1, 1999 the Company began operating the
switching assets and personnel of Hebron Communications Corporation ("Hebron"),
which includes telecommunications switches in Oklahoma City and Chicago. The
Company plans to purchase the switches later this year under terms of an asset
purchase agreement with Hebron. The purchase allows the Company to originate and
terminate a portion of its long distance calls. See Item 13 below for a
discussion of Hebron and the terms of the transaction with Hebron.
In addition to long distance and related telecommunication services, (e.g.,
calling cards, prepaid cards and toll free service), the Company also offers its
customers Internet access and paging services under the LifeLine brand. These
programs are discussed below.
AmeriVision offers a nationwide dial-up Internet access service ("ISP")
with an optional filter. The Lifeline ISP includes affinity tools to create a
community for Lifeline's target customers. AmeriVision is expanding its online
capabilities, including on-line interactive Internet customer service, sales and
e-billing.
AmeriVision resells the paging services of Paging Networks, Inc., (now Arch
Wireless) the largest provider of paging service in the United States. The
Company offers alpha and numeric paging on the local, regional and national
level.
The Company was incorporated in 1991 as an Oklahoma corporation and
maintains its principal executive offices at 5900 Mosteller Drive, Suite 1800,
Oklahoma City, Oklahoma 73112. The Company's telephone number is (405) 600-3800.
MAJOR DEVELOPMENTS
Several important developments have occurred with respect to the Company
and its business, which include:
RESOLUTION OF SECURITIES AND EXCHANGE COMMISSION'S INVESTIGATION. In July
1996, at the request of the Company, the Securities and Exchange Commission (the
"Commission") instituted an investigation into whether the Company and its then
directors and principal officers had violated any federal securities laws. In
July 1998 the Commission issued a cease-and-desist order to the Company, Hebron
and Tracy C. Freeny, at that time President of the Company, and Carl Thompson,
at that time Senior Vice President of the Company with respect to the subject
matter of the investigations, which concluded the investigation. See Item 3 -
"Legal Proceedings - Investigation by the Securities and Exchange Commission."
ADDITION OF NEW DIRECTORS. In October 1998, three members of the current
board of directors of the Company were first elected, bringing a wide range of
skills and experiences to the Company. The new directors are Stephen D.
Halliday, a lawyer and accountant with 20 years of professional experience; Jay
A. Sekulow, a lawyer who is in charge of a nationally known public interest law
firm; and John B. Damoose, a former executive with a Fortune 500 corporation.
See Item 10 - Directors and Officers.
ADDITION OF NEW OFFICERS AND KEY EMPLOYEES. In October 1998, Stephen D.
Halliday was elected President and Chief Executive Officer of the Company. Prior
to that, Mr. Halliday had been performing various consulting services for the
Company while serving as a partner at Wiley, Rein & Fielding; a leading
telecommunications law firm. In December 1998, five members of
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PricewaterhouseCoopers LLP telecommunications consulting practice with,
collectively, over 75 years of experience in the telecommunications industry
joined the Company, including Kerry A. Smith, a Vice President of the Company,
and such persons are very active in the Company's business and operations. In
April 1999, David E. Grose joined the Company as Vice President and Chief
Financial Officer and brings with him over 10 years experience as chief
financial officer of publicly-traded concerns. See Item 5 - Directors and
Officers.
TERMINATION OF RELATIONSHIP WITH VISIONQUEST MARKETING SERVICES, INC.
Effective January 1, 1999, the Company and VisionQuest Marketing Services, Inc.
("VisionQuest") mutually terminated their business relationship. Until such time
VisionQuest had performed substantially all of the Company's telemarketing
service requirements, but the Company determined it needed to establish a core
telemarketing business, which it has been able to operate on a more
cost-effective basis than through its prior relationship with VisionQuest. See
Item 13 - Certain Relationships and Related Transactions - Transactions with
VisionQuest.
NEW CREDIT FACILITY WITH COAST BUSINESS CREDIT, INC. In February 1999, the
Company entered into a credit facility with Coast Business Credit, Inc. ("Coast
Loan") providing the Company with up to $12.6 million in financing and in May
1999 the Company was approved to increase the availability under the credit
facility to an aggregate of $30.0 million. The proceeds of the Coast Loan have
been used by the Company to repay more expensive indebtedness and to pay for
necessary capital improvements and restructuring. In connection with the Coast
Loan, certain parties, including Hebron and three directors of the Company, all
agreed to subordinate all amounts owed to them by the Company to the Coast Loan.
NEW SUPPLY AGREEMENT WITH WORLDCOM. In April 1999, the Company entered into
a multi-year supply agreement with WorldCom for long distance services. The
Company lowered its costs as a result of the new agreement and resolved certain
billing disputes and claims between the two parties. See Item 1 - Business -
Suppliers.
TRANSACTIONS WITH HEBRON. Effective February 1999, the Company began
operating certain telecommunications switches of Hebron and, subject to certain
conditions including approval of Hebron's shareholders, will acquire such
switches later this year. The Company will also acquire all of Hebron's assets
related to an Internet product it had been jointly developing with the Company.
The closing of the transaction will allow the Company to have both switched and
switchless long distance under its full control and to operate both the switches
and the Internet assets on a more effective and cost efficient basis than
through its prior relationship with Hebron. See Item 13 - Certain Relationships
and Related Transactions - Transactions with Hebron.
BUSINESS STRATEGY
The Company's overall strategy is to profitably grow its telecommunications
and other services by further developing the family values affinity. Elements of
the Company's strategy include:
o Building the Company's Brand. Although the Company is a significant
affinity-based marketing company, the Company believes that it is
still relatively unknown in the marketplace. The Company has retained
one of the nation's leading non-profit marketing consulting firms, to
assist the Company in improving its image and brand awareness.
o Expanding its Marketing Efforts and Portfolio of
Telecommunications-Related Services. In 1999 substantially all of the
Company's revenues were derived from the provision of long distance
telephone service. The Company believes that it can grow its revenues
by increasing the marketing of its existing services to the membership
of organizations currently endorsing LifeLine services, offering
additional bundled telecommunications services, such as Internet
access, and adding new participating organizations.
o Providing Cost Competitive Services. The Company continually works to
position its services in a manner that is cost-competitive with
similar services provided by major telecommunications services
providers. To achieve competitive margins on its telecommunications
services the Company intends to continually review and refine its
operations to achieve operating and cost effectiveness.
o Building a Business-Oriented Product Offering. Historically, the vast
majority of the Company's customers have been residential. The Company
believes that it can expand its customer profile to include small and
medium size businesses. The Company is planning to increase its
marketing efforts to small and medium size businesses by approaching
organizations currently endorsing LifeLine.
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o Marketing Non-Telecommunications Products and Services. In light of
the Company's success in marketing telecommunications services to the
family-values affinity groups, the Company believes that there is a
substantial opportunity to market non-telecommunication services to
its customer base. For example, the Company currently provides a
credit card product.
INDUSTRY OVERVIEW
LONG DISTANCE
Long distance companies can be categorized in different ways. One
distinction is between facilities-based companies and non-facilities-based
companies, or resellers. Facilities-based companies own transmission facilities,
such as fiber optic cable or digital microwave equipment. Profitability for
facilities-based carriers is dependent not only upon their ability to generate
revenues but also upon their ability to manage complex networking and
transmission costs. Non-facilities-based companies, such as the Company,
contract with facilities-based carriers to provide transmission of their
customers' long distance traffic. Pricing in such contracts is typically either
on a fixed rate lease basis or a call volume basis. Profitability for
non-facilities based carriers is based primarily on their ability to generate
and retain sufficient revenue volume to negotiate attractive pricing with one or
more facilities-based carriers.
A second distinction among long distance companies is that of switch-based
versus switchless carriers. Switched carriers have one or more switches,
computers that direct telecommunications traffic in accordance with programmed
instructions. All of the facilities-based carriers are switched carriers, as are
many non-facilities-based companies. Switchless carriers depend on one or more
facilities-based carriers to provide both transmission capacity and switch
facilities. In addition, switchless resellers enjoy the benefit of offering
their service on a nationwide basis, assuming that their underlying carrier has
a nationwide network. If the Company completes its acquisition of certain assets
of Hebron, the Company will operate and own switches in two markets, Oklahoma
City and Chicago, but will continue to contract with facilities-based carriers
to provide most of its switching services.
Competition in the long distance industry is based primarily upon pricing,
customer service, network quality and value-added services. The success of a
non-facilities-based carrier such as the Company depends almost entirely upon
the amount of traffic that it can commit to the underlying carrier; the larger
the commitment, the lower the cost of service. Subject to contract restrictions
and customer brand loyalty, resellers like the Company may competitively bid
their traffic among other national long distance carriers to gain improvement in
the cost of service. The non-facilities-based carrier devotes its resources
entirely to marketing, operations and customer service, deferring many of the
costs of network maintenance and management to the underlying carrier.
The relationship between resellers and the major underlying carriers is
predicated primarily upon the pricing strategies of the first-tier companies,
which has resulted historically in higher rates for individuals and small
business customers. Individuals and small business customers do not generate
enough volume to receive reduced rates. The higher rates result from the higher
cost of credit, collection, and billing and customer service per revenue dollar
associated with small billing level long distance customers. By committing to
large volumes of traffic, the reseller is guaranteeing traffic to the underlying
carrier. The underlying carrier is also relieved of the administrative burden of
qualifying and servicing large numbers of relatively small accounts. The
successful reseller efficiently markets the long distance product, processes
orders, verifies credit and provides customer service to these large numbers of
small accounts.
INTERNET ACCESS SERVICES
Internet access and related value-added services ("Internet services")
represent a segment of the telecommunications marketplace. Declining prices in
the personal computer market, continuing improvements in Internet connectivity,
advancements in Internet navigation technology, and the proliferation of
services, applications, information and other content on the Internet have
attracted a growing number of users.
PRODUCTS AND SERVICES
Currently, the Company's revenues are substantially all from long distance
sales, however, as discussed below, other products are entering the sales cycle.
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TELECOMMUNICATIONS SERVICES
Long Distance. The Company provides long distance service to over 400,000
subscribers, as of December 31, 1999 most of whom are residential. In addition,
the Company offers calling cards, prepaid phone cards, and toll-free service.
For these services, the Company offers pricing which is competitive (including
discounted rates for higher volume) with the larger long distance companies
Wireless. The Company resells the paging services of Paging Networks, Inc.,
(now Arch Wireless) the largest provider of paging service in the United States.
Local, regional and national paging service is offered on an alpha and numeric
basis. The Company is also exploring offering wireless telephone service by
reselling the services of a national or regional wireless provider.
Internet Access. In July 1999, the Company began offering Internet access
services nationwide on a dial-up basis. The Company's Internet access service
includes an optional filter so that its subscribers will not, subject to certain
limitations inherent to the filtering technology, be able to access "offensive"
materials on the Internet.
NON-TELECOMMUNICATIONS SERVICES
In light of the Company's success in marketing telecommunications services
to family-values affinity groups, the Company believes that there is an
opportunity to market non-telecommunication services to its customer base. The
Company currently issues a branded credit card issued by Guaranty Bank based in
Oklahoma City. The Company believes that the pricing and terms offered to its
participating organizations are competitive with major credit card providers.
MARKETING AND SALES
The Company primarily markets its telecommunications services utilizing the
family values affinity. To obtain new customers, the Company uses sales
executives, telemarketing and various promotional efforts including direct mail,
radio, television, convention advertising and the Internet.
Some of the sales executives expend the majority of their efforts obtaining
new non-profit organizations who will endorse LifeLine services and maintaining
existing relationships. The other sales executives principally seek to expand
the number of members of existing non-profit organizations who endorse LifeLine
services as well as sell additional services to and seek to improve the
retention rate of existing subscribers. Prior to 1999, sales executives were
compensated based on a percentage of sales revenue collected with some
agreements as long as 25 years. On a transition basis these commission
arrangements have been generally terminated and are being replaced by base
salaries and bonuses, if appropriate, based on performance.
Once membership lists of non-profit organizations have been obtained, the
Company generally contacts members and solicits their telecommunications
services through direct mail and telemarketing. The Company works with the
organizations in its direct mail efforts, often placing advertising in
newsletters or inserting brochures about the Company in the organizations'
mailings. The Company also uses its telemarketing resources to contact members
of participating organizations. The Company operates a call center in Tahlequah,
Oklahoma and, as of December 31, 1999, the call center had an aggregate of 350
full and part time employees who operate over 250 call stations. The Company
advertises its services through radio programs, which target viewers and
listeners who support the family-values affinity, including Christian radio and
television networks. The Company participates in conferences and conventions
sponsored by organizations endorsing LifeLine services. Prior to those events,
the Company will either advertise in materials being sent or send materials to
persons attending the event in order to increase awareness of the
telecommunications services the Company offers. At the actual events, the
Company will set up booths or make presentations regarding its
telecommunications services and have personnel on site to explain the services
and assist in enrolling customers.
The Company has also recently begun capitalizing upon the marketing
opportunities created through the Internet. On some websites of participating
organizations, the Company's services are promoted or a link to the Company's
website is provided.
Through improved customer service, increased focus on brand awareness,
competitive rate plans and additional services the Company is striving to
improve its retention rate.
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SUPPLIERS
In April 1999, the Company executed a new 36-month, $72.0 million contract
with WorldCom for provision of the Company's long distance traffic. The Company
is required to pay WorldCom at least $2.0 million per month for services
provided, however, any amount paid by the Company in excess of $2.0 million per
month may be credited against any month in which the Company does not use at
least $2.0 million worth of service. Since April 1999, the Company has paid
WorldCom an average of $2.4 million per month, and has paid less than $2.0
million ($1.97 million) for only one month. The Company also must direct all of
its switchless long distance traffic to WorldCom through the term of the
contract, although the Company may terminate the contract once it has paid
WorldCom $72.0 million (even if that occurs less than 36 months after the
effective date of the contract). WorldCom is not obligated to lower the
Company's rates, although the Company is permitted to request a reduction every
six months and each time the Company has requested a reduction, WorldCom has
granted the request. In addition, with execution of the contract the Company
received a credit and was released of any prior liability and claims to WorldCom
in connection with the settlement of various billing disputes between the
Company and WorldCom. This contract also resulted in a pricing reduction from
the prior WorldCom billing rates charged to the Company and, as discussed above,
additional reductions have been subsequently negotiated.
In connection with the Asset Purchase Agreement with Hebron, as described in
Note B to the financial statements, the Company also assumed responsibility for
the telecommunications contract between Hebron and Broadwing (formerly IXC
Communications, Inc.), the underlying carrier that transports the Company's call
records through the Oklahoma City and Chicago switches. This contract is
effective through September 2003, and requires the Company to maintain minimum
monthly purchase commitments of $550. The Company met the minimum purchase
commitments during 1999
COMPETITION
OVERVIEW. The telecommunications services industry is highly competitive,
rapidly evolving and subject to constant technological change. There are
numerous companies offering the services the Company offers, and the Company
expects competition to increase in the future. The Company believes that
existing competitors are likely to continue to expand their service offerings
and/or lower their prices to appeal to existing or potential customers of the
Company. Many of the Company's existing competitors have financial, personnel
and other resources, including brand name recognition, substantially greater
than that of the Company. Moreover, the Company expects that new competitors are
likely to enter the communications market, and some of these new competitors may
market communications services similar to the Company's services. Some of these
new competitors may have financial, personnel and other resources, including
brand name recognition, substantially greater than those of the Company. In
particular, the regional Bell operating companies ("RBOCs") will be strong
competitors once they are allowed to provide long distance services in their
in-region markets. In addition, AT&T has purchased the cable company
TeleCommunications, Inc. and has received regulatory approval to purchase
another cable company, MediaOne Group Inc. AT&T intends to use these cable
facilities and those of other cable companies with which it has signed
agreements to offer local telephony, long distance, Internet, and other services
to customers in competition with incumbent local exchange carriers and other
competitive local exchange carriers ("CLECs").
In addition, the regulatory environment in which the Company operates is
undergoing significant change. As this regulatory environment evolves, changes
may occur which could create greater or unique competitive advantages for all or
some of the Company's current or potential competitors, or could make it easier
for additional parties to provide services similar to those offered by the
Company.
LONG DISTANCE. The Company provides long distance services by reselling the
facilities of other carriers in the United States. The long distance industry is
intensely competitive and significantly influenced by the marketing and pricing
decisions of the larger industry participants such as AT&T, Sprint and WorldCom.
Moreover, the industry has undergone and will continue to undergo significant
consolidation that has created and will continue to create numerous other
entities with substantial resources to compete for long distance business, such
as Excel Communications, Inc., Frontier and Qwest. In addition, as a result of
the Telecommunications Act of 1996 ("Telecommunications Act"), RBOCs will soon
be able to enter the long distance market. These larger competitors have
significantly greater name recognition and financial, technical, network and
marketing resources. They may also offer a broader portfolio of services and
have longer standing relationships with customers targeted by the Company.
Moreover, there can be no assurance that certain of the Company's competitors
will not be better situated to negotiate contracts with suppliers of
telecommunications services which are more favorable than contracts negotiated
by the Company. Many of the Company's competitors enjoy economies of scale that
can result in a lower cost structure for transmission and related termination
costs, and which could cause significant pricing pressures on the Company.
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The Company competes in the long distance market primarily on the basis of
price, customer service and the ability to provide a variety of communications
products and services. Customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. Prices for long distance calls have declined in recent years and
are likely to continue to decrease. Competition in all of the relevant markets
is expected to increase which could adversely affect net revenue per minute and
gross margins as a percentage of net revenue. There can be no assurance that the
Company will be able to compete effectively in the long distance market.
INTERNET TELEPHONY. Internet Telephony is the transmission of voice long
distance services over Internet protocols rather than traditional long distance
networks ("IP Telephony"). Certain ISPs have recently announced plans to use IP
Telephony to introduce long distance services at rates 30% to 50% below standard
long distance rates. IP Telephony could increase pressure on the Company and
other communications companies to reduce prices and margins from long distance
services. There can be no assurance that the Company will not experience
substantial decreases in call volume, pricing and/or margins due to IP
Telephony. There can also be no assurance that the Company will be able to offer
its telecommunications services to end users at a price which is competitive
with the IP Telephony services offered by these new companies.
INTERNET SERVICE PROVIDER. In July 1999, the Company began providing
Internet access nationwide on a dial up basis. The Internet services market is
highly competitive, as there are no substantial barriers to entry, and the
Company expects that competition will continue to intensify. The Company's
competitors in this market include ISPs, other telecommunications companies,
online service providers and Internet software providers. Many of these
competitors have greater financial, technological and marketing resources than
those available to the Company. Internet services are currently deemed enhanced
services by the FCC and therefore are not subject to federal and state common
carrier regulations, including long distance interstate and intra-state access
fees. There can be no assurance that Internet services will not be subject to
additional regulation in the future.
TECHNOLOGICAL ADVANCES. In the future, the Company may be subject to
intense competition due to the development of new technologies resulting in an
increased supply of transmission capacity. The telecommunications industry is
experiencing a period of rapid and significant technological evolution marked by
the introduction of new product and service offerings and increasing satellite
transmission capacity for services similar to those to be provided by the
Company. The introduction of new products or emergence of new technologies may
cause capacity to greatly exceed the demand, reducing the pricing of certain
services to be provided by the Company. There can be no assurance that the
Company's services will satisfy future customer needs, that the Company's
technologies will not become obsolete in light of future technological
developments, or that the Company will not have to make significant additional
capital investments to upgrade or replace its system and equipment. The effect
on the Company's operations of technological changes cannot be predicted and if
the Company is unable to keep pace with advances, it could have a material
adverse effect on the Company.
REGULATION
The terms and conditions under which the Company provides
telecommunications products and services are subject to government regulation.
Federal laws and Federal Communications Commission ("FCC") regulations apply to
interstate telecommunications, while particular state regulatory authorities
have jurisdiction over telecommunications that originate and terminate within
the same state.
DOMESTIC FEDERAL REGULATION. The Company is classified by the FCC as a
non-dominant carrier, and therefore is subject to significantly reduced federal
regulation. After the reclassification of AT&T as a non-dominant carrier in its
provision of domestic services, among domestic carriers only the LECs are
classified as dominant carriers for the provision of interstate access services.
As a consequence, the FCC regulates many of the rates, charges, and services of
the LECs to a greater degree than the Company's. A separate affiliate of an RBOC
complying with certain statutory separation requirements and, once authorized,
offering in-region interstate inter-exchange services is regulated as a
non-dominant carrier. Similarly, a separate affiliate of an independent LEC
offering in-region interstate inter-exchange services is treated as
non-dominant, but the separation requirements it must comply with are less
strict than those applicable to the RBOCs. This non-dominant treatment may make
it easier for the RBOCs to compete directly with the Company for long distance
subscribers. Because AT&T is no longer classified as a dominant carrier, certain
pricing restrictions that formerly applied to AT&T have been eliminated, which
may make it easier for AT&T to compete with the Company for low volume long
distance subscribers.
The FCC generally does not exercise direct oversight over cost
justification and the level of charges for services of non-dominant carriers,
such as the Company, although it has the statutory power to do so. Non-dominant
carriers are required by statute to offer interstate services under rates,
terms, and conditions that are just, reasonable, and not unduly discriminatory.
The FCC has the
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jurisdiction to act upon complaints filed by third parties or brought on the
FCC's own motion against any common carrier, including non-dominant carriers,
for failure to comply with its statutory obligations. Additionally, the
Telecommunications Act grants explicit authority to the FCC to "forbear" from
regulating any telecommunications services provider in response to a petition
and if the agency determines that the public interest will be served for such
inaction.
The FCC imposes only minimal reporting requirements on non-dominant
carriers, although the Company is subject to certain reporting, accounting, and
record keeping obligations. A number of these requirements are imposed, at least
in part, on all carriers, and others are imposed on carriers such as the Company
whose annual operating revenue exceeds $100 million.
Resale carriers, like all other interstate carriers, are also subject to a
variety of miscellaneous regulations that, for instance, govern the
documentation and verifications necessary to change a subscriber's long distance
carrier, limit the use of "800" numbers for pay-per-call services, require
disclosure of certain information if operator assisted services are provided,
and govern interlocking directors and management. Other types of FCC regulation
may impose costs on the Company, such as regulatory fees, universal service
contribution obligations, North American Numbering Plan Administration fees,
Telecommunications Relay Services obligations, number portability obligations,
Communications Assistance for Law Enforcement Act obligations, the Universal
Service Fund surcharge and the Primary Interexchange Carrier Charge.
The Telecommunications Act authorizes the RBOCs to provide inter-Local
Access and Transport Area ("LATA") services within their regions only, upon
specific FCC approval. To obtain such approval, an RBOC must demonstrate on a
state-by-state basis that is has satisfied a checklist of interconnection and
other requirements. The Telecommunications Act also provides for certain
safeguards against anticompetitive conduct by the RBOCs in the provision of
inter-LATA service including a requirement for a separate subsidiary and certain
joint marketing limitations.
The Telecommunications Act prohibits carriers from changing a subscriber's
carrier of telephone exchange or toll services except in conformance with the
FCC's verification rules. In addition to other penalties imposed by the
Telecommunications Act and the FCC's rules, a carrier that violates the FCC's
verification rules and collects charges from the subscriber is liable to the
carrier previously authorized by the subscriber for the amount collected. The
FCC has adopted rules implementing these provisions. The FCC's order was
appealed and some of its rules have been stayed, pending final review by the
Court of Appeals.
STATE REGULATION. The Company is subject to varying levels of regulation in
virtually all states. The vast majority of the states require the Company to
apply for certification, which entails proof of technical, managerial and
financial ability to provide intrastate telecommunications services, or at least
to register or to be found exempt from regulation, before commencing intrastate
service. A majority of states also require the Company to file and maintain
detailed tariffs listing their rates for intrastate service. Many states also
impose various reporting requirements and/or require prior approval or notice
for various actions including (i) transfers of control of certified carriers;
(ii) corporate reorganizations; (iii) acquisitions of telecommunications
operations; (iv) assignments of carrier assets, including subscriber bases and
(v) carrier securities offerings. Certificates of authority can generally be
conditioned, modified, canceled, terminated, or revoked by state regulatory
authorities for failure to comply with state law and/or the rules, regulations,
and policies of the state regulatory authorities. Fines and other penalties,
including the return of all monies received for intrastate traffic from
residents of a state, may be imposed for such violations. In addition, several
states have verification rules different from the FCC's regarding changing a
subscriber's authorized carrier.
Currently, the Company can provide originating interstate and intrastate
service to customers in all 50 states and the District of Columbia. Of the
states in which the Company provides originating service, some state Public
Utilities Commissions ("PUCs") actively assert regulatory oversight over the
services offered by the Company.
Additionally, the rules for each state vary in regard to the authorization
of long distance versus local service. As a result of the Telecommunications
Act, local competition is now allowed in all states. Generally speaking, as the
rules have been modified, the states have either ordered that all certified long
distance carriers now have the authority to provide local services, or
directives have been given for companies to apply for local authority or revise
existing tariffs to comply with state regulations. In those states, which issued
directives for companies to apply for local authority or revise tariffs, the
Company has complied with such orders.
The Company is also subject to various registration requirements in
connection with the marketing and administration of its credit card business and
with the operation of its call center.
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The Company continuously monitors regulatory developments in all states in
which it does business in order to ensure regulatory compliance. The Company
believes that it is in compliance in all material respects with the requirements
of federal and state regulatory authorities and maintains contact regularly with
the various regulatory authorities in each jurisdiction.
PROPRIETARY RIGHTS
The Company has obtained a federally registered service mark for the name
LIFELINE for long distance telecommunications services. With the exception of
the LIFELINE(R) service mark, the Company does not own or use in its operations
any other material intellectual property.
INFORMATION SYSTEMS
In August 1998, the Company completed a comprehensive independent review of
its information systems ("Information Systems"). Based on the results of such
review, the Company decided that its current Information Systems, which are
based on FoxPro software, were not sufficient, determining that the current
Information Systems need to be modified and supplemented and new Information
Systems need to be implemented in order for the Company to operate more
effectively. To most efficiently accommodate customer growth and new product
offerings, the Company is pursuing a Windows NT environment with underlying
client/server architecture. This platform will also include a data warehouse
with front-end tools to address financial, operational, and sales and marketing
research and reporting. The additional costs of the Information Systems
improvements are anticipated to be in excess of $2.0 million. The Company
currently anticipates funding the Information Systems improvements from the
Coast Loan, but, if proceeds from this loan are not available, it may not have
sufficient other capital resources to implement the improvements. There can be
no assurances that the Company will have the capital resources available that
are necessary to implement the improvements or that, if implemented, the
improvements will function effectively. The failure to implement the
improvements or if the improvements are ineffective Information Systems could
have a material adverse effect on the Company.
EMPLOYEES
As of December 31, 1999, the Company had approximately 350 full time
employees and 100 part time and temporary employees. None of the Company's
employees is party to any collective bargaining agreement and the Company has
never experienced a work stoppage. The Company considers its relations with its
employees to be good.
FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS.
There are many factors that affect the Company's business and the results of
its operations, some of which are beyond the control of the Company. The
following is a description of some of the important factors that may cause the
actual results of the Company's operations in future periods to differ
materially from those currently expected or desired.
THE COMPANY HAS A SIGNIFICANT ACCUMULATED STOCKHOLDERS' DEFICIT AND A HISTORY OF
LOSSES, WHICH ALONG WITH OTHER FACTORS INDICATE THAT THE COMPANY MAY BE UNABLE
TO CONTINUE AS A GOING CONCERN FOR A REASONABLE PERIOD OF TIME. Since the
formation of the Company in 1991, the Company incurred losses in each year
through December 31, 1998. Despite realizing net income in 1999, there can be no
assurances that the Company will attain consistent profitability. In addition,
the accumulated stockholders deficit was $23.8 million at December 31, 1999
primarily because of earlier distributions and redemptions to stockholders and
operating losses. See Note J--Financial Condition and Results of Operations.
THE COMPANY HAS A SUBSTANTIAL AMOUNT OF DEBT AND A HISTORY OF CASH
SHORTAGES AND NEEDS ADDITIONAL CAPITAL TO FINANCE ITS PLANNED ACTIVITIES. THE
COMPANY CANNOT BE CERTAIN THAT IT CAN OBTAIN SUCH FUNDS, WHICH COULD RESULT IN
IT REDUCING ITS SCOPE OF ACTIVITIES. As of December 31, 1999, the Company had
outstanding indebtedness of $54.9 million, which includes current liabilities of
$40.4 million, and total assets of $31.1 million, a working capital deficit of
$22.3 million and a deficit in stockholders' equity of $23.8 million. Since
formation, the Company has experienced significant cash shortages and has had to
raise equity through the sale of securities and borrow money from various
affiliates and others to fund its operations and continue as a going concern.
The Company intends:
o to modify its current Information Systems to improve the flow of
information related to the operations; and
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o to incur other capital expenditures and reorganization expenses.
The aggregate cost of implementation of these activities is not known at
this time, but may exceed $3.0 million. The Company will need to raise
additional capital from public or private equity or debt sources in order to
finance these costs and its working capital needs, debt service obligations and
contemplated capital expenditures. If additional funds were raised through the
issuance of equity securities, the percentage ownership of the Company's then
current shareholders would be reduced. There can be no assurance that the
Company will be able to raise such capital on satisfactory terms or at all. In
the event that the Company is unable to obtain such additional capital or is
unable to obtain such additional capital on acceptable terms, the Company may be
required to reduce the scope of its operations.
THE COMPANY HAS FAILED TO COMPLY WITH CERTAIN PROVISIONS OF SECURITIES
LAWS, WHICH COULD RESULT IN SIGNIFICANT LIABILITIES FOR THE COMPANY. IF SUCH
LIABILITIES WERE TO ARISE, THE COMPANY MAY NOT HAVE THE FUNDS TO PAY SUCH
LIABILITIES AND THE COMPANY'S ABILITY TO CONDUCT ITS OPERATIONS WOULD BE
MATERIALLY AND ADVERSELY IMPACTED. Substantially all of the Company's sales of
Common Stock and certain notes, other than sales to officers and directors of
the Company, failed to comply with registration requirements of federal and
states securities laws, and, possibly, compliance with anti-fraud provisions of
federal and states securities laws. The Company and two of its officers at that
time, after voluntarily presenting these facts to the Securities and Exchange
Commission (the "Commission") in July 1996, consented in July 1998 to the entry
of a cease and desist order from the Commission concerning violations of the
federal securities laws. See Item 8 below for a more detailed description of
these proceedings.
The federal securities laws provide legal causes of action against the
Company by persons buying the securities from the Company including action to
rescind the sales. With respect to the offerings described above, the statutes
of limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. The Company made all of these sales more
than three years ago.
While certain suits under the federal acts may be barred, similar laws in
many of the states provide similar rights. The Company sold stock to persons in
over forty states, and those states typically provide that a purchaser of
securities in a transaction that fails to comply with the state's securities
laws requiring registration of such sales can rescind the purchase, receiving
from the issuing company the purchase price paid plus an interest factor,
frequently 10% per annum from the date of sales of such securities, less any
amounts paid to such security holder. While the statutes of limitations for
these rights appear to have expired for many of these violations, some have not.
Accordingly, the Company has a contingent liability under state securities laws
for those sales of approximately $469,000 at December 31, 1999.
Additionally, the Company may be liable for rescission or other remedies
under states securities laws to the purchasers of the Hebron common stock
requiring registration of such sales because of the relationships of the two
companies, creating an additional contingent liability to the Company. While the
Company may have liability for rescission of the sales of the Hebron securities,
the holders of Hebron securities will not have any damages under the rescission
rights if Hebron successfully completes its currently proposed liquidation. See
Item 13 below for a description of the Hebron transaction including its proposed
liquidation. If the liquidation is completed as currently proposed, and the
Company pays the notes due Hebron in full, the Company anticipates that the
Hebron shareholders would receive assets in the liquidation with a value greater
than the value of their rescission rights. Additionally, statutes of limitations
relating to such rights appear to have expired.
If purchasers of securities of either the Company or Hebron are successful
in asserting any of the above-described claims, it could result in, among other
adverse things, the Company being required to make payments which it may not
have the ability to make without obtaining additional sources of capital and
possibly affect the Company's ability to operate as a going concern.
THE COMPANY'S OPERATIONS AND REVENUES ARE DEPENDENT LARGELY ON ITS ABILITY
TO MAINTAIN FAVORABLE RELATIONSHIPS WITH THE NON-PROFIT ORGANIZATIONS WHOSE
MEMBERS SERVE AS THE COMPANY'S CUSTOMER BASE. THERE ARE NO ASSURANCES THAT THE
RELATIONSHIPS OR THE TERMS OF SUCH RELATIONSHIPS CAN BE MAINTAINED.
Substantially all of the Company's revenues are derived from the members of the
non-profit organizations with which it has relationships. The non-profit
organizations receive a percentage (currently approximately 10%) of certain
collected long distance revenues generated from their members. The Company does
not have long term written agreements with many of these non-profit
organizations. Accordingly, a non-profit organization may have no legal
obligation to maintain its relationship with the Company and there is nothing to
ensure that compensation or the rate of compensation to the non-profit
organizations will remain at current levels. There can be no assurances that the
Company will be able to maintain its relationships with
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the non-profit organizations or establish relationships with new non-profit
organizations. If one or more significant non-profit organizations chooses to
sever its relationship with the Company or the rate of compensation to the
non-profit organizations is increased, it could result in, among other adverse
things, the loss of a significant source of revenue or the incurrence of an
unexpected expense, thus lowering profitability and impairing cash flow.
THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY COMPETITIVE WITH MANY
PARTICIPANTS MUCH LARGER THAN THE COMPANY. THE COMPANY MAY NOT BE ABLE TO
EFFECTIVELY COMPETE WITH ITS COMPETITORS. The telecommunications industry is
highly competitive and is significantly influenced by the marketing and pricing
decisions of the larger industry participants, such as AT&T, WorldCom and
Sprint. Many of the Company's competitors are significantly larger and have
substantially greater financial, technical and marketing resources than the
Company. The industry has relatively insignificant barriers to entry, numerous
entities competing for the same customers and high churn rates (customer
turnover), as customers frequently change long distance providers in response to
the offering of lower rates or promotional incentives by competitors. The
Company competes to a large extent on the basis of price and also on the basis
of customer service and its ability to provide a variety of telecommunications
services. The Company expects competition on the basis of price and service
offerings to increase.
In addition to these competitive factors, recent and pending deregulation
may encourage new entrants. For example, as a result of federal legislation
enacted in 1996, after fulfilling certain statutory requirements, RBOCs will be
allowed to enter the long distance market, AT&T, WorldCom and other long
distance carriers are allowed to enter the local telephone services market, and
any entity (including cable television companies and utilities) is allowed to
enter both the local service and long distance telecommunications markets. In
addition, the FCC has reclassified AT&T as a "non-dominant" carrier, which
substantially reduces the regulatory constraints on AT&T.
THE COMPANY'S OPERATIONS AND REVENUES ARE DEPENDENT ON WORLDCOM, WHICH
PROVIDES TELECOMMUNICATIONS SERVICES TO THE COMPANY'S CUSTOMERS. THE COMPANY
CANNOT ENSURE THE QUALITY OF SUCH SERVICES OR THE CONTINUITY OF THE
RELATIONSHIP. The Company does not own telecommunications transmission lines.
Accordingly, substantially all telephone calls made by the Company's customers
are transmitted over WorldCom's network under an agreement with WorldCom which
is also a competitor of the Company. The Company's ability to maintain and
expand its business is currently dependent upon whether the Company continues to
maintain a favorable relationship with WorldCom and whether WorldCom remains a
viable supplier to the Company. The deterioration or termination of the
Company's relationship with WorldCom or WorldCom's failure to remain a viable
supplier to the Company could result in, among other adverse things, the Company
being temporarily unable to provide the majority of its services or unable to
provide its services at the current cost.
THE COMPANY NEEDS TO ATTRACT AND RETAIN KEY PERSONNEL IN ORDER TO MOST
EFFECTIVELY CONDUCT ITS OPERATIONS. The Company's success depends to a
significant degree upon the continued contributions of its management team,
particularly Stephen D. Halliday, its President and Chief Executive Officer, and
marketing, technical and sales personnel. The Company's employees may
voluntarily terminate their employment with the Company at any time. Competition
for qualified employees and personnel in the telecommunications industry is
intense and, from time to time, there are a limited number of persons with
knowledge of and experience in particular sectors of the telecommunications
industry. The Company's success also will depend on its ability to attract and
retain qualified management, marketing and sales personnel. The process of
locating such personnel with the combination of skills and attributes required
to carry out the Company's strategies is often lengthy. There can be no
assurance that the Company will be successful in attracting and retaining such
personnel. The loss of the services of key personnel, or the inability to
attract additional qualified personnel, could result in, among other adverse
things, a decrease in the Company's financial and operating performance.
THE COMPANY HAS NOT HISTORICALLY MAINTAINED PROPER RECORDS AND HAS HAD TO
RECONSTRUCT SUCH RECORDS. THIS LACK OF RECORDS MAY ADVERSELY AFFECT THE
COMPANY'S OBLIGATIONS AND RIGHTS. The Company over the first several years of
its existence did not maintain complete records as to certain of its corporate
activities. The Company, working with its auditors and legal counsel, has
reconstructed certain records including minutes of meetings of its board of
directors relating to the issuance of Common Stock and notes and approval of
other acts and transactions of the Company. These minutes are based on certain
records of the Company and upon affidavits of persons who served as directors
during such earlier periods. To the extent, if any, that such reconstructed
records fail to reflect shares of Common Stock issued and outstanding, dilution
would occur to known existing shareholders. To the extent, if any, notes or
other indebtedness are outstanding but not reflected in current records, the
Company's net worth would be reduced.
Certain records and documents that were maintained by the Company contain
ambiguities, which require interpretations of their
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meanings and contain provisions inconsistent with actions of the Company. See
for example Note E to Notes to Consolidated Financial Statements concerning the
secured nature of certain notes of the Company. Where records and documents of
the Company are ambiguous, parties to such documents may interpret those records
and documents in a manner contrary to the Company's interpretations, which could
affect the obligations and rights of the Company in an adverse manner.
TELECOMMUNICATION SERVICES ARE SUBJECT TO A LARGE AMOUNT OF GOVERNMENTAL
REGULATION. CHANGES IN THAT REGULATION MAY ADVERSELY RESTRICT OR ALTER THE WAY
THE COMPANY CONDUCTS ITS OPERATIONS. The Telecommunications Act provides
specific guidelines under which the RBOCs can provide long distance services,
which will permit the RBOCs to compete with the Company in the provision of
domestic and international long distance services. The legislation also opens
all local service markets to competition from any entity (including, for
example, long distance carriers, such as AT&T, cable television companies and
utilities). Because the legislation opens the Company's markets to additional
competition, particularly from the RBOCs, the Company's ability to compete may
be adversely affected. Moreover, as a result of and to implement the
legislation, certain federal and other governmental regulations will be adopted,
amended or modified, and any such adoption, amendment or modification could
result in, among other adverse things, more competition or increased operating
expense for the Company.
The FCC and relevant PUCs have the authority to regulate interstate and
intrastate rates, respectively, ownership of transmission facilities, and the
terms and conditions under which the Company's services are provided. Federal
and state regulations and regulatory trends have had, and in the future are
likely to have, both positive and negative effects on the Company and its
ability to compete. In general, neither the FCC nor the relevant state PUCs
currently regulate the Company's long distance rates or profit levels, but
either or both may do so in the future. A move by the FCC toward lessened
regulation has given AT&T, the largest long distance carrier in the U.S.;
virtually complete pricing flexibility that has permitted it to compete more
effectively with smaller long distance carriers, such as the Company. In
addition, the commitments made by the U.S. government in the recently completed
World Trade Organization negotiations will make it easier for certain
foreign-affiliated carriers to provide service in competition with the Company.
There can be no assurance that changes in current or future Federal or state
regulations or future judicial changes would not have a material adverse effect
on the Company.
In order to provide their services, long distance carriers, including the
Company, must generally purchase "access" from LECs to originate calls from and
terminate calls in the local exchange telephone networks. Access charges
presently represent a significant portion of the Company's network costs in all
areas in which it operates. The FCC regulates interstate access charges while
intrastate access charges are regulated by the relevant state PUCs. The FCC is
currently considering how to reform its access charge rules. The access charge
structure ultimately adopted by the FCC could have a material adverse effect on
the Company, particularly if it imposes relatively greater costs on smaller
carriers (such as the Company) compared to larger carriers (such as AT&T and
WorldCom).
The Company currently competes with the RBOCs and other LECs in the
provision of "short haul" toll calls completed within a LATA. Subject to a
number of conditions, the Telecommunications Act eliminated many of the
restrictions, which prohibited the RBOCs from providing long haul, or local toll
service, and thus the Company will face additional competition. To complete long
haul and short-haul toll calls, the Company must purchase "access" from the
LECs. The Company must generally price its toll services at levels equal to or
below the retail rates established by the LECs for their own short-haul or long
haul toll services. To the extent that the LECs are able to reduce the margin
between the access costs to the Company and the retail toll prices charged by
LECs, either by increasing access costs or lowering retail toll rates, or both,
the Company will encounter adverse pricing and cost pressures in competing
against LECs in both the short-haul and long haul toll markets.
THE COMPANY'S INFORMATION SYSTEMS ARE INSUFFICIENT AND MUST BE UPDATED FOR
THE COMPANY TO OPERATE COST-EFFECTIVELY. The Company has determined that its
current Information Systems are not sufficient. It has determined that the
current Information Systems will need to be modified and supplemented and new
Information Systems will need to be implemented in order for the Company to
operate more effectively. The additional costs of the Information Systems
improvements are anticipated to be in excess of $2.0 million. If the proceeds of
the Coast Loan are not available to fund this cost, the Company may not have
sufficient capital resources to implement the improvements. There can be no
assurances that the Company will have or, if necessary, be able to obtain the
capital resources necessary to implement the improvements or that, if
implemented; the improvements will function effectively. The failure to
implement the improvements or the ineffectiveness of the improvements could
result in, among other adverse things, the Company being unable to obtain and
manage important data and information related to its business and operations.
THE COMPANY HAS COMMITTED TO PURCHASE MINIMUM AMOUNTS OF TELECOMMUNICATION
SERVICES AND THE FAILURE TO PURCHASE SUCH AMOUNTS WOULD RESULT IN THE INCURRENCE
OF A SIGNIFICANT
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LIABILITY FOR THE COMPANY. The Company has entered into supply contracts with
WorldCom and IXC for the long distance telecommunication services provided to
its customers. To obtain favorable forward pricing from WorldCom, and IXC the
Company has committed to purchase certain minimum volumes of a variety of long
distance services during the term of the contract. There can be no assurance
that the Company will not incur shortfalls in the future or that it will be able
to successfully renegotiate, or otherwise obtain relief from, its minimum volume
commitments in the future. If future shortfalls occur, the Company may be
required to make substantial payments without associated revenue from customers
or WorldCom or IXC may terminate service and commence formal action against the
Company. Such payments are not presently contemplated in the Company's budgets
and would be difficult to pay and could result in money being used to make this
payment, which would have otherwise been used in other important areas of the
Company.
Because of the Company's commitments to purchase fixed volumes of use from
WorldCom and IXC at predetermined rates, the Company could be adversely affected
if WorldCom or IXC were to lower the rates it makes available to the Company's
target market without a corresponding reduction in the Company's rates.
Similarly, the Company could be adversely affected if WorldCom or IXC fails to
adjust its overall pricing, including prices to the Company, in response to
price reductions of other major carriers. WorldCom and IXC have agreed to review
rates charged to the Company but the WorldCom agreement states that WorldCom is
not legally obligated to lower the rates charged to the Company.
TELECOMMUNICATION SERVICES PROVIDERS, SUCH AS THE COMPANY, CONSISTENTLY
LOSE SIGNIFICANT NUMBERS OF CUSTOMERS. THE LOSS OF A SUBSTANTIAL NUMBER OF
CUSTOMERS WOULD HAVE A MATERIAL ADVERSE EFFECT ON THE OPERATIONS OF THE COMPANY.
Customer attrition is a problem inherent in the long distance industry. The
Company's revenue is adversely affected by customer attrition. The customer
attrition experienced by the Company is attributable to a variety of factors,
including the Company's termination of customers for non-payment and the
marketing and sales initiatives of the Company's competitors such as, among
other things, national advertising campaigns, telemarketing programs and the use
of cash or other incentives. There can be no assurances that this attrition will
not increase from current levels.
SUCCESS IN THE TELECOMMUNICATIONS INDUSTRY IS DEPENDENT ON AN ABILITY TO
OFFER NEW TECHNOLOGY AND SERVICES. THERE ARE NO ASSURANCES THE COMPANY WILL HAVE
THE RESOURCES OR THE CAPABILITIES TO OFFER THE TECHNOLOGY AND SERVICES OFFERED
BY ITS COMPETITORS. The telecommunications industry is characterized by rapidly
evolving technology. The Company believes that its success will increasingly
depend on its ability to offer, on a timely basis, new services based on
evolving technologies and industry standards. There can be no assurance that the
Company will have the ability or resources to develop the new services, that new
technologies required for such services will be available to the Company on
favorable terms or that such services and technologies will enjoy market
acceptance. Further, there can be no assurance that the Company's competitors
will not develop products or services that are technologically superior to those
used by the Company or that achieve greater market acceptance. The development
of any such superior technology by the Company's competitors, or the inability
of the Company to successfully respond to such a development, could render the
Company's existing products or services obsolete.
THE COMPANY DEPENDS ON THE CALL RECORDS GENERATED BY ITS SUPPLIER, WHICH
MAY NOT BE TIMELY OR ACCURATELY DELIVERED. THE FAILURE TO RECEIVE SUCH RECORDS
TIMELY OR THE INACCURACY OF SUCH RECORDS COULD HAVE A MATERIAL ADVERSE EFFECT ON
THE OPERATIONS OF THE COMPANY. The Company depends on the timeliness and
accuracy of call data records provided to it by WorldCom, which supplies the
Company with telecommunications services, and there can be no assurance that
accurate information will consistently be provided on a timely basis. Failure of
the Company to receive prompt and accurate call data records will impair the
Company's ability to bill its customers on a timely basis. Such billing delays
could impair the Company's ability to collect amounts owed by its customers. Due
to the multitude of billing rates and discounts which suppliers must apply to
the calls completed by the Company's customers, and due to routine logistical
issues such as the addition or termination of customers, the Company regularly
has disagreements with WorldCom concerning the amounts invoiced for its
customers' traffic. The Company pays WorldCom according to its own calculation
of the amounts owed as recorded on the computer tapes provided by WorldCom. The
Company's computations of amounts owed are frequently less than the amount shown
on the WorldCom's invoices. Accordingly, WorldCom may consider the Company to be
in arrears in its payments until the amount in dispute is resolved. Although
these disputes have generally been resolved on terms favorable to the Company,
there can be no assurance that this will continue to be the case. Future
disputes, which are not resolved favorably to the Company, could have a material
adverse effect on the Company's financial and operating performance.
THE COMPANY IS PROHIBITED BY ITS LOAN AGREEMENT FROM PAYING DISTRIBUTIONS
WITH RESPECT TO THE COMMON STOCK. A STOCKHOLDER WILL HAVE TO RELY ON THE SALE OF
ITS COMMON STOCK TO RECEIVE ANY RETURN ON ITS INVESTMENT. From July 31, 1994
until December 31, 1997, the Company declared quarterly distributions
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to its shareholders on the shares of Common Stock and accrued distribution
amounts payable to Messrs. Freeny and Thompson for distributions declared from
July 1995 through December 1997. The Company does not anticipate paying any
other cash dividends or distributions in the foreseeable future and anticipates
that future earnings will be retained to repay outstanding indebtedness and to
finance operations. As a result, the only way that a shareholder can get any
return on its investment in Common Stock is by disposing such Common Stock for
which as discussed below, there is currently no established public trading
market. Furthermore, the terms of the Coast Loan limit the payment of any
returns of capital or other dividends or distributions to its shareholders. In
addition, there are state law limitations that restrict the ability of the
Company to pay dividends due to the Company's substantial deficit in
Stockholder's Equity.
THERE IS CURRENTLY NOT AN ESTABLISHED TRADING MARKET FOR THE COMMON STOCK
AND THERE MAY NEVER BE ONE. WITHOUT AN ESTABLISHED TRADING MARKET, IT WILL BE
DIFFICULT IF NOT IMPOSSIBLE TO SELL THE COMMON STOCK. There is no established
public trading market for the shares of Common Stock. As a result, a holder of
shares of Common Stock will not easily or at all be able to dispose of his
shares of Common Stock and must bear the economic risk of their investment for
an indefinite period of time. Further restricting liquidity of the Common Stock
is a right of first refusal provided for in the bylaws of the Company in favor
of the Company and certain stockholders with respect to any sales of Common
Stock by its shareholders. There can be no assurances that an established public
trading market will ever exist for the shares of Common Stock or that a
shareholder will be able to dispose of his shares of Common Stock through any
other methods.
FORWARD-LOOKING STATEMENTS. Certain statements contained in this Form 10-K
are not based on historical facts, but are forward-looking statements that are
based upon numerous assumptions as of the date of this Form 10-K that could
prove to be inaccurate. When used in this Form 10-K, the words "anticipate",
"believe", "estimate", "expect", "will", "could", "may" and similar expressions,
as they relate to management or the Company, are intended to identify
forward-looking statements. Such statements reflect the current views of
management with respect to future events and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should the underlying assumptions prove incorrect,
actual results may vary materially from those described herein.
ITEM 2. PROPERTIES
The Company's executive offices and some of its operations are located in
approximately 60,000 square feet of leased office space in a 195,000 square
foot, 20-story office building owned by Hebron. The Company also operates a call
center in Tahlequah, Oklahoma. The Company believes that these facilities are
adequate for the Company's intended activities for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
INVESTIGATION BY THE SECURITIES AND EXCHANGE COMMISSION
In 1995, the Company determined that it may not have registered its
securities with the Commission when it was obligated to do so under the federal
securities laws and that, consequently, it may have engaged in the sale or
delivery of unregistered securities in violation of the federal securities laws.
In July 1996, the Company voluntarily reported this information to the
Commission, which then instituted an investigation into whether the (a) Company;
(b) Tracy L. Freeny, the Company's Chairman of the Board and, at that time, the
Company's President; and (c) Carl D. Thompson, at that time, the Company's
Senior Vice President had violated any of the federal securities laws. In 1997,
the Commission requested documents relating to Hebron's sale and delivery of
securities. The Company, Freeny, Thompson, and Hebron cooperated with the
Commission during this investigation. Mr. Freeny and Mr. Thompson voluntarily
gave sworn statements to the Commission in 1997. Hebron also voluntarily
provided documents to the Commission when requested to do so.
On September 24, 1997, the Commission's staff attorney who was conducting
the investigation informed the Company that she intended to recommend to the
Commission that it institute cease-and-desist proceedings against the Company
based upon the staff's belief that the Company violated Sections 5(a) and 5(c)
of the Securities Act of 1933, as amended ("Securities Act"), and Section 12(g)
of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and Rule
12g-1 promulgated under the Exchange Act ("Rule 12g-1"). Also on September 24,
1997, the Commission's staff attorney informed Messrs. Freeny and Thompson, and
Hebron that she intended to recommend that the Commission institute
cease-and-desist proceedings against them. On July 15, 1998, the Company and
Messrs. Freeny and Thompson each executed an offer of settlement (the "Offers")
that was contingent upon the Commission accepting the staff attorney's
recommendation. In the Offers, the Company and Messrs. Freeny and Thompson
consented to the entry of a cease-and-desist order which provided that they
would cease and desist from committing or causing any violations or
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future violations of Sections 5(a) and 5(c) of the Securities Act and Section
12(g) of the Exchange Act and Rule 12g-1. Additionally, in the Offers, Hebron
consented to the entry of a cease-and-desist order which provided that it would
cease and desist from committing or causing any violations or future violations
of Sections 5(a) and 5(c) of the Securities Act.
On July 23, 1998, the Commission approved the Commission's staff attorney's
recommendation and accepted the Offers. On July 30, 1998, the Commission issued
a cease-and-desist order which stated that (a) the Company, Messrs. Freeny and
Thompson, and Hebron had violated Sections 5(a) and 5(c) of the Securities Act;
(b) the Company had violated Section 12(g) of the Exchange Act and Rule 12g-1;
and (c) Messrs. Freeny and Thompson had caused the violation of Section 12(g) of
the Exchange Act and Rule 12g-1. The Commission ordered the Company, Messrs.
Freeny and Thompson, and Hebron to cease and desist from committing or causing
any violations and any future violations of Sections 5(a) and 5(c) of the
Securities Act and the Company and Messrs. Freeny and Thompson to cease and
desist from committing or causing any violations or future violations of Section
12(g) of the Exchange Act and Rule 12g-1.
INVESTIGATIONS BY STATE SECURITIES COMMISSIONS
In December 1994, the Washington Department of Financial Institutions -
Securities Division ("WDS") notified the Company that it was aware that the
Company may have offered unregistered securities to residents of the State of
Washington and instructed the Company to cease and desist such offers and to
provide information with respect to any sales of such securities. In April 1997,
the WDS told the Company that it was trying to close its file on the Company and
attempted to serve a subpoena on the Company that sought various documents
relating to the Company's shareholders in the state of Washington. The Company
voluntarily produced documents in response to the improperly served subpoena in
May 1997. The WDS has not corresponded with the Company since May 1997.
In February 1996, the Oklahoma Department of Securities ("ODS") made an
inquiry to the Company with regard to the basis upon which the Company and
Hebron had offered and sold securities and effected issuances of short-term
notes under an advance payment loan program, without registration under the
Oklahoma Securities Act. The Company responded to such inquiry in February 1996
advising the ODS that neither the Company nor its Oklahoma counsel believed that
the short-term notes issued under the advance payment loan program constituted
securities, and claiming that the Common Stock was exempt from registration
under Section 401(b)(9)(B) of the Oklahoma Securities Act. Hebron responded to
the ODS inquiry under separate cover in February 1996. In its response, Hebron
stated that it had not engaged in an advance payment loan program, that it had
authorized a private offering and sale under Section 4(6) of the Securities,
Rule 505 of Regulation D promulgated under the Securities Act and, as
applicable, state Uniform Limited Offering Exemptions. Neither the Company nor
Hebron have had any further contact with the ODS regarding this matter since
their responses.
LIABILITIES FOR BREACH OF SECURITIES LAW
Substantially all of the Company's sales of Common Stock and certain notes,
other than sales to officers and directors of the Company, failed to comply with
Sections 5(a) and (c) of the Securities Act, registration requirements of
certain states' securities laws and, possibly, Section 10 (b) of the Exchange
Act and Rule 10 b-5 promulgated under the Exchange Act and any similar
anti-fraud provisions under state securities laws. The Company and two of its
officers, after voluntarily presenting these facts to the Commission in August
1996, consented in July 1998 to the entry of a cease and desist order from the
Commission concerning violations of the federal securities laws.
The federal securities laws provide legal causes of action against the
Company by persons buying the securities from the Company including action to
rescind the sales. With respect to the offerings described above, the statutes
of limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. The Company made all of these sales more
than three years ago.
While certain suits under the federal acts may be barred, similar laws in
many of the states provide similar rights. The Company sold stock to persons in
over forty states, and those states typically provide that a purchaser of
securities in a transaction that fails to comply with the state's securities
laws can rescind the purchase, receiving from the issuing company the purchase
price paid plus an interest factor, frequently 10% per annum from the date of
sales of such securities, less any amounts paid to such security holder. While
the statutes of limitations for many of these rights appear to have expired,
some have not. Accordingly, the Company has a contingent liability under state
securities laws for those sales of approximately $469,000 at December 31, 1999.
Additionally, the Company may be liable for rescission or other remedies
under states securities laws to the purchasers of the
14
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Hebron common stock because of the relationships of the two companies, creating
an additional contingent liability to the Company. While the Company may have
liability for rescission of the sales of the Hebron securities, the holders of
Hebron securities will not have any damages under the rescission rights if
Hebron successfully completes its currently proposed liquidation. If the
liquidation is completed as currently proposed, and the Company pays the notes
it owes Hebron in full, the Company anticipates that the Hebron shareholders
would receive assets in the liquidation with a value greater than the value of
their rescission rights. The statutes of limitations for these rights under
state securities laws also appear to have expired.
If purchasers of securities of either the Company or Hebron are successful
in asserting any of the above-described claims, it could have a material adverse
effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
No matters were submitted to a vote of holders of Common Stock, through
solicitation of proxies or otherwise, during the year ended December 31, 1999.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICE OF AND DIVIDENDS ON COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the shares of Common
Stock. At December 31, 1999, there were 838,927 outstanding shares of Common
Stock owned by approximately 1,200 holders of record. All of the outstanding
shares of Common Stock can be sold pursuant to Rule 144 of the Securities Act
without limitations except for 251,280 shares of Common Stock held by affiliates
of the Company. All but 22,747 shares of the shares held by affiliates may be
sold subject to the limitations provided for in Rule 144. As of December 31,
1999, the Company had issued (i) options to purchase an aggregate of 90,987
shares of Common Stock to certain of its officers and directors, (ii) warrants
to purchase an aggregate of 3,800 shares of Common Stock to certain creditors of
the Company and (iii) convertible notes in the aggregate principal amount of
$399,000 ("Convertible Notes"). The Convertible Notes generally have no
specified maturity date and are convertible into Common Stock at the option of
the Company. The Convertible Notes contain varying terms with respect to
conversion price. Some of the Convertible Notes contain specific conversion
prices while others do not set forth a conversion price. With respect to the
Convertible Notes, which do not contain specific conversion prices, the Company
has assumed between $135 and $150 per share conversion prices. Based on the
foregoing assumptions, the Company estimates that the outstanding Convertible
Notes are convertible into 2,765 shares of Common Stock. Additionally, if the
Company employs Mr. Halliday on May 24, 2002, the Company is required to issue
him options to purchase shares of Common Stock equal to 2% of the fully diluted
outstanding Common Stock on such date. The Company has not granted any
registration rights to any holder of its Common Stock or any person who has the
right to acquire Common Stock.
During 1996 and 1997, the Company declared distributions on its shares of
Common Stock of $8,137,721 and $6,193,684, respectively; all of which were paid
when declared or have been subsequently paid except for $3,200,000 that was
accrued and is allegedly payable as of December 31, 1999 to Mr. Freeny. The
Company has not declared any distributions or other cash dividends on its shares
of Common Stock since December 31, 1997. The Company does not anticipate paying
any other cash dividends in the foreseeable future and anticipates that future
earnings will be retained to finance operations. Furthermore, the terms of the
Coast Loan limit the payment of any distributions or other dividends to its
shareholders.
RECENT SALES OF UNREGISTERED SECURITIES
In May 1999, the Company issued 9,099 shares of Common Stock to Mr.
Telling, a former director of the Company, pursuant to an employment agreement
between Mr. Telling and the Company effective as of May 24, 1999 (The employment
agreement actually restated an earlier agreement between Mr. Telling and the
Company that was entered into in 1997). Mr. Telling received the shares as
consideration for past services to the Company and the Company did not receive
any cash proceeds in connection with such issuances. Exemption from registration
for all of the sales was claimed under Section 4 (2) of the Securities Act
regarding transactions not involving any public offering. Any person in
connection with these sales was not paid a commission.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA
The historical financial data for the years ended December 31, 1995, 1996,
1997, 1998 and 1999 are derived from the audited consolidated financial
statements of the Company. This information is not necessarily indicative of the
company's future performance. The data presented below should be read in
conjunction with the Company's consolidated financial statements and the notes
thereto included elsewhere herein and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA: 1995 1996 1997 1998 1999
--------- --------- --------- --------- ---------
Net Sales .................................... $ 59,313 $ 100,858 $ 113,351 $ 124,232 $ 114,661
--------- --------- --------- --------- ---------
Operating expenses:
Cost of telecommunication services ......... 35,088 48,748 44,711 48,787 53,050
--------- --------- --------- --------- ---------
Cost of telecommunication services
Provided by related parties ............ -- 4,685 13,529 14,736 1,469
--------- --------- --------- --------- ---------
Selling, general and administrative ........ 21,059 36,194 44,530 49,523 47,645
--------- --------- --------- --------- ---------
Selling, general and administrative
To related parties ..................... 11,222 9,977 5,893 6,805 --
--------- --------- --------- --------- ---------
Depreciation and amortization .............. 375 593 683 2,102 2,899
--------- --------- --------- --------- ---------
Total operating expenses ............... 67,744 100,197 109,346 121,953 105,063
--------- --------- --------- --------- ---------
Operating income (loss) ...................... (8,431) 661 4,005 2,279 9,598
--------- --------- --------- --------- ---------
Other income and (expense):
Interest expense and other financing
charges ................................ (441) (1,536) (3,245) (4,993) (4,873)
--------- --------- --------- --------- ---------
Interest expense and other financing charges
Incurred to related parties ............ (42) (297) (924) (974) (698)
--------- --------- --------- --------- ---------
Loss on loans and other receivables ........ -- (200) -- (552) 182
--------- --------- --------- --------- ---------
Impairment loss on asset held for disposal.. -- -- -- (215) (103)
--------- --------- --------- --------- ---------
Equity in income (losses) of affiliates .... 135 28 (99) 41 --
--------- --------- --------- --------- ---------
Other income ............................... 111 86 14 59 95
--------- --------- --------- --------- ---------
Income (loss) before income tax (benefit)... (8,668) (1,258) (249) (4,355) 4,201
--------- --------- --------- --------- ---------
Income tax expense (benefit) ............... (3,371) (396) 92 (700) 1,977
--------- --------- --------- --------- ---------
Net income (loss) .......................... $ (5,297) $ (862) $ (341) $ (3,655) $ 2,224
--------- --------- --------- --------- ---------
Earnings (loss) per share:
Basic ...................................... $ (9.75) $ (3.79) $ (1.01) $ (4.32) $ 2.83
--------- --------- --------- --------- ---------
Diluted .................................... $ (9.75) $ (3.79) $ (1.01) $ (4.43) $ 2.35
--------- --------- --------- --------- ---------
CASH FLOWS:
Operating activities ....................... $ (5,014) $ 1,489 $ (1,624) $ 7,118 $ (1,664)
--------- --------- --------- --------- ---------
Investing activities ....................... (618) (294) (922) (148) (2,806)
--------- --------- --------- --------- ---------
Financing activities ....................... 2,815 (967) 2,008 (6,350) 4,826
--------- --------- --------- --------- ---------
BALANCE SHEET DATA:
Total assets ............................... $ 18,654 $ 20,961 $ 24,554 $ 25,574 $ 31,094
--------- --------- --------- --------- ---------
Working capital (deficit) .................. (6,592) (18,321) (20,811) (23,635) (22,258)
--------- --------- --------- --------- ---------
Total long-term debt ....................... 15,138 11,601 12,277 11,929 14,428
--------- --------- --------- --------- ---------
Total stockholder's deficit(1) ............. (14,280) (22,934) (25,827) (27,644) (23,758)
--------- --------- --------- --------- ---------
OTHER FINANCIAL DATA:
EBITDA(2) .................................. $ (8,056) $ 1,254 $ 4,688 $ 4,381 $ 12,497
--------- --------- --------- --------- ---------
- ----------
(1) Dividends were declared through December 31, 1997. See "Dividend Policy."
(2) EBITDA (earnings before interest, taxes, depreciation and amortization)
consists of net sales less cost of telecommunication services and selling,
general and administrative expenses. EBITDA is provided because it is a
measure commonly used by investors to analyze and compare companies on the
basis of operating performance. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flows or results of operations in accordance with generally
accepted accounting principles ("GAAP") for the periods indicated. EBITDA
is not a measurement under GAAP and is not necessarily comparable with
similarly titled measures for other companies.
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ITEM 7. AMERIVISION COMMUNICATIONS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company provides domestic long distance and other telecommunications
services, primarily to residential users. Since its formation in 1991, the
Company's annual long distance telephone volume has grown from approximately
$1.0 million in net sales in 1991 to $114.7 million in net sales in 1999.
Substantially all of this growth is attributable to the increase in the
Company's subscriber base. The Company's subscriber base has increased from
approximately 30,000 subscribers at the beginning of 1994 to over 400,000
subscribers at December 31, 1999. The Company does not, however, expect its
revenues or subscriber base to continue to grow at this rate in the future and
has in fact experienced a decline in revenues. See "-Results of Operation- Year
Ended December 31, 1999 Compared to Year Ended December 31, 1998." The net sales
for the year ended December 31, 1999 totaled $114.7 million compared to $124.2
million for the year ended December 31, 1998.
From its inception through December 31, 1998, the Company had incurred
cumulative net operating losses totaling approximately $12.1 million. During the
year ended December 31, 1999, the Company generated net income of $2.2 million,
which was achieved from reductions in operating expenses. The Company's
accumulated stockholders' deficiency increased from approximately $22.6 million
at December 31, 1997 to approximately $27.6 million at December 31, 1998. The
net income of $2.2 million during 1999 contributed to the decrease in
accumulated stockholders' deficiency to approximately $23.8 million at December
31, 1999. In addition to the net operating losses, the accumulated deficit has
been attributed to the Company's declaration of quarterly distributions to its
stockholders during 1994 through 1997 totaling approximately $19.0 million and
by redemptions totaling approximately $4.7 million. Furthermore, the Company's
current liabilities exceeded its current assets by approximately $20.8 million,
$23.6 million and $22.3 million at December 31, 1997, 1998 and 1999,
respectively. These factors among others may indicate that the Company may be
unable to continue as a going concern for a reasonable period of time. See "Note
J to the Consolidated Financial Statements."
The growth in the Company's long distance revenues and customer base is
attributable to the Company's marketing efforts. The Company entered into
agreements or made strategic alliances with various non-profit organizations.
From the first quarter of 1993 through the middle of 1996, the Company relied
substantially on the telemarketing efforts of VisionQuest, a related entity, in
which the Company owned an equity interest, to solicit and acquire new long
distance customers. The non-profit organizations would provide the Company and
VisionQuest with its membership rosters, and VisionQuest would direct its
telemarketing services to those individuals. The Company has decreased the use
of telemarketing for its marketing efforts and began, in the middle of 1996, to
increase its own marketing related efforts through direct mail, radio
advertising, including sponsorship of various radio programs for the
organizations whose members subscribe to the Company's long distance services.
These marketing efforts as well as telemarketing, conferences and internet-based
sales strategies are currently being utilized by the Company to solicit and
acquire new long distance customers.
Sales commissions are paid to both employees and independent contractors.
Salespersons earn commissions based upon a percentage of the commissionable,
billable traffic generated by the non-profit organizations attributable to the
salesperson. The total sales commission for each non-profit organization is
approximately 5.0%. This payment is generally split among several people,
including the outside salesperson that is the primary contact with the
non-profit organization and the inside salesperson that is responsible for
working with the outside salesperson in servicing the accounts. Although the
Company has approximately 100 salespersons and employees who receive
commissions, approximately 55%, 59% and 66% of total commissions were earned by
the top 10 salespersons in 1997, 1998 and 1999, respectively. The highest
compensated salesman is David Dalton who earned $928,960, $757,255 and $667,585
in 1997, 1998 and 1999, respectively.
The Company bills its customers under several different methods. Some
customers receive their long distance bills directly from the Company. The
Company also has billing and collection agreements with several of the RBOCs.
Customers who are billed through the RBOCs receive their long distance phone
bill with their local phone bill from the RBOC. The Company also utilizes two
third party billing and collection services for customer billings through other
LECs or RBOCs with whom the Company does not have a separate billing and
collection agreement.
Effective February 1, 1999, the Company began operating the switching
assets and related personnel of Hebron, which includes telecommunications
switches in Oklahoma City and Chicago. The Company plans to purchase the
switches later this year. This will allow the Company to originate and terminate
certain long distance calls. WorldCom carries the majority of the Company's long
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distance traffic. The Company pays its carriers based on the type of calls, time
of certain calls, duration of calls, the terminating phone numbers, and the
terms of the Company's contract in effect at the time of the calls. In addition
to long distance service, the Company also offers its customers other
telecommunication services such as paging, Internet access services, calling
cards, prepaid phone cards and toll-free service.
The Company pays a royalty of approximately 10.0% of certain of the
customer's collected revenues to a non-profit organization selected by the
customer.
Beginning in the fourth quarter of 1996, the Company began offering a
"Non-Profit Organization Bonus Sign-Up" program in certain instances. During the
years ended December 31, 1997, 1998 and 1999 total bonus sign up expense was
$311,000, $283,000 and $42,000, respectively.
Selling, general and administrative expenses include billing fees charged
by LECs and other third party billing and collection companies, bad debts,
commissions to salespersons, advertising and telemarketing expenses, customer
service and support, and other general overhead expenses.
Interest expense includes the cost of financing the Company's accounts
receivables and asset purchases, including loans from Hebron and Coast Business
Credit ("Coast").
The Company has recognized a net deferred tax for the tax effects of
temporary differences and net operating loss carryforwards, to the extent that
the Company has determined that it is more likely than not that it will realize
those tax benefits.
PICC Fees.
In 1996, the Federal Communications Commission adopted regulations
implementing the Telecommunications Act enacted that year. To support universal
service, carriers are required to contribute certain percentages of their annual
gross receipts to fund the High Cost Fund, the Schools and Libraries Fund, and
the Low Income Fund. The FCC has allowed carriers to offset these charges by
passing them through to their customers. In addition, the FCC adopted a Primary
Interexchange Carrier Charge ("PICC") to allow LECs to recover through
non-usage-sensitive charges certain costs associated with long distance carriers
having access to LEC networks. The FCC has also allowed the long distance
carriers to offset these amounts by passing these charges on to their customers.
RESULTS OF OPERATIONS
STATEMENTS OF OPERATIONS DATA FOR THE YEARS ENDED DECEMBER 31, 1997,
1998 AND 1999:
The following table sets forth for the years indicated the percentage of
net sales represented by certain items in the Company's statements of
operations:
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
----- ----- -----
Net sales ........................................... 100.0% 100.0% 100.0%
------ ------ ------
Operating expenses:
Cost of telecommunication services ............. 51.4% 51.1% 47.5%
Selling, general and administrative expenses ... 44.5% 45.3% 41.6%
Depreciation and amortization expense .......... 0.6% 1.7% 2.5%
------ ------ ------
Total operating expenses .................. 96.5% 98.1% 91.6%
------ ------ ------
Income from operations .............................. 3.5% 1.9% 8.4%
Interest expense .................................... (3.7)% (4.8)% (4.9)%
Other income (expense) .............................. --% (0.6)% 0.1%
------ ------ ------
Income (loss) before income tax (benefit) ........... (0.2)% (3.5)% 3.6%
Income tax expense (benefit) ........................ 0.1% (0.5)% 1.7%
------ ------ ------
Net income (loss) ................................... (0.3)% (3.0)% 1.9%
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YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net Sales: Net sales decreased 7.6% to $114.7 million in 1999 compared to
$124.2 million in 1998. This decrease was the result of a decrease in billable
minutes and the customer base. Total billable minutes were approximately 611
million minutes in 1999 compared to 635 million minutes in 1998, a decrease of
3.8%. PICC and USF fees billed to customers totaled $11.2 million in 1999,
compared to $10.1 million in 1998. The increase was the result of a full year
implementation in 1999 and an increase in the rates in July 1999.
The Company believes it is more cost effective to bill its residential
customers who have smaller than average phone bills through the LECs as opposed
to billing them directly. As a result, a greater percentage of customers who are
billed directly by the Company are the commercial customers or residential
customers who generate larger than average monthly phone bills. Approximately
76.0% of net sales were billed through the LECs or other billing and collection
services in 1999, compared to 77.0% in 1998. Customers receiving their bills
directly from the Company were approximately 24.0% in 1999 compared to 23.0% in
1998.
Cost Of Telecommunication Services: The Company's cost of sales is variable
costs based on amounts paid by the Company to its providers for its customers'
long distance usage. For the year ended December 31, 1999, the Company's overall
cost per minute as compared to 1998 decreased by 13.2%. During the years ended
December 31, 1999 and 1998, the cost of sales and relative percentage of costs
to net sales to each of its providers was as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1998 1999
-------------------------- ------------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
-------- ------------- -------- -------------
WorldCom .............. $ 41,650 33.5% $ 31,178 27.2%
Hebron ................ 14,736 11.9% 1,469 1.2%
PICC/USF Fees ......... 7,137 5.7% 10,070 8.8%
Switched Operations ... -- 11,802 10.3%
-------- -------- -------- --------
Totals ............. $ 63,523 51.1% $ 54,519 47.5%
WorldCom: The Company's overall percentage usage of WorldCom during 1999 as
compared to 1998 declined as a result of the Company entering into a new
agreement with WorldCom for lower rates and receiving a credit in 1999. During
1999, total minutes of usage from WorldCom were approximately 473 million
minutes and during 1998, total minutes of usage from WorldCom were approximately
475 million minutes.
Hebron: The decrease in cost of sales to Hebron is attributable to the
decreased minutes of usage, from approximately 12 million minutes in 1999
compared to 160 million minutes in 1998. The decrease results from the Company
assuming operation of the switches in February 1999.
PICC/USF Fees: These expenses increased for the year ended December 31,
1999 compared to the same period in 1998 because the collection of these fees
was implemented in 1998, and many carriers and LEC's did not bill in the first
month or so of 1998. In addition, the rates were increased in July 1999. See
"General - PICC Fees."
Switched Operations: These expenses reflect the cost of the Company
operating the switches from February 1, 1999 as opposed to previously purchasing
the minutes from Hebron. For the year ended December 31, 1999, total minutes of
usage for the switches were approximately 126 million minutes.
Selling, General and Administrative Expenses: The significant components of
selling, general and administrative expenses include the following:
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YEARS ENDED DECEMBER 31,
-----------------------------------------------
1998 1999
----------------------- ----------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
------- ------------- ------- -------------
Billing fees and charges ............... $12,580 10.1% $ 9,410 8.2%
Advertising expense .................... 5,107 4.1% 3,688 3.3%
Other general and administrative ....... 21,078 16.9% 24,181 21.1%
Related party telemarketing expense .... 6,805 5.5% -- --
Telemarketing expense .................. -- -- 1,529 1.3%
Rebates to non-profit organizations .... 10,758 8.7% 8,837 7.7%
------- ------- ------- -------
Totals .............................. $56,328 45.3% $47,645 41.6%
Billing Fees and Charges: Billing fees and charges include the contractual
billing fees and bad debts charged by LECs and other third party billing
companies. During 1999, the Company decreased its utilization of third party
billing and collection services of Zero Plus Dialing ("ZPDI") and Hold for a
percentage of its billings as compared to 1998. Total billings processed through
ZPDI and Hold decreased to approximately 25.7% of net sales in 1999 compared to
35.0% of net sales in 1998. Applicable billing charges from ZPDI and Hold were
approximately 2.7% and 4.6% of net sales in 1999 and 1998, respectively.
Advertising Expense: Advertising expense decreased in 1999 to $3.7 million,
compared to $5.1 million in 1998, a decrease of 27.8% due to the Company
curtailing certain of its advertising expenses.
Other General and Administrative Expense: Other general and administrative
expenses increased by approximately 14.7% during 1999 compared to 1998 due to
increased fees for professional and other services and due to additional wages
related to an increase in personnel, with some offset in reductions in
commissions.
Telemarketing Expense to Related Party: The Company incurred no related
party telemarketing expense during 1999 compared to $6.8 million during 1998.
This decrease was due to moving telemarketing from utilization of VisionQuest to
being conducted by the Company and due to reduced telemarketing activity. During
1998, reimbursement of 100% of corporate overhead expenses incurred by
VisionQuest was approximately $4.7 million, representing 3.8% of net sales.
Telemarketing Expense: The Company incurred telemarketing costs of $1.5
million in 1999 as it began conducting telemarketing operations internally at
the end of 1999 in conjunction with the opening of a new call center located in
Tahlequah, Oklahoma. The new call center allows the Company to better manage the
costs of telemarketing and control the productivity of the telemarketing
personnel.
Royalties to Non-Profit Organizations: During 1999, royalties to non-profit
organizations decreased by approximately 17.9%, to $8.8 million in 1999 compared
to $10.8 million in 1998. The majority of the decrease is due to an overall
decrease in revenue and a 4% bad debt factor utilized to reduce the
commissionable revenues and a decrease in additional discretionary commission
amounts, set by management to maintain a more constant royalty amount to the
non-profit organizations. At the end of 1999, the Company paid approximately
35,000 organizations through its royalty program, compared to a similar number
of organizations at the end of 1998. For 1999 and 1998, approximately 40.0% and
42.0%, respectively, of total royalties were paid to the top ten organizations.
Depreciation and Amortization: Depreciation and amortization expense
increased 37.9% to $2.9 million in 1999 compared to $2.1 million in 1998. This
increase is attributable to an increase in the carrying value of the Company's
property and equipment primarily due to recording the purchase of switch and
Internet equipment associated with the Hebron transaction and the amortization
of not to compete covenants contained in certain separation agreements.
Interest Expense and Other Finance Charges: Interest expense and other
finance charges decreased to $5.6 million in 1999 compared to $6.0 million in
1998. This decrease is attributable to an increase in borrowings related to the
Company's credit facility offset by a decrease in the average applicable
interest rates for the year ended December 31, 1999 as compared to the year
earlier period.
Other Income (Expense): Interest income and rental income increased to
$95,000 during 1999 compared to $59,000 in 1998, principally as a result of the
Company having more cash to invest in 1999, and partially offset by a decrease
in interest on notes receivable from VisionQuest in 1998. The Company's equity
in the net income of VisionQuest in 1998 was approximately $41,000. In 1998, the
Company relocated substantially all of its corporate offices from a building
that it owned to an adjacent building owned by Hebron. The Company decided to
sell this building, and obtained an appraisal in 1998. As a result of the
appraisal, the Company
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determined that the carrying amount of the building was impaired, and
accordingly, recognized a pre-tax loss of $215,000 in its 1998 financial
statements. Upon the sale of the building in February 1999, the Company recorded
a recovery of this loss of $22,000. During 1997 and 1998, the Company provided
billing and collection services for an unrelated third party. The Company
discontinued providing these services in October 1998. At that time, the Company
had made outstanding advances to this third party totaling approximately
$552,000. The Company determined that it was not likely that it would collect
these advances, and wrote the entire receivable off as of December 31, 1998. In
March 1999, the Company did recover approximately $182,000 of this receivable
from a third party billing and collection agency, but neither the collection
agency nor the Company anticipate further recovery and is not pursuing
collections of the remaining $370,000.
Income Tax Expense (Benefit): In 1999, the Company recorded a deferred
income tax expense of approximately $1.9 million, and in 1998, the Company
recorded a deferred income tax benefit of approximately $700,000. The income tax
benefits recognized in the financial statements consist primarily of the
deferred tax effects of the temporary differences between the financial and tax
bases of assets and liabilities, and net operating loss carryforwards. The
Company believes that it will realize the tax benefits of net operating loss
carryforwards within the period allowed under Federal tax laws (15 years).
Net Income (Loss): During the year ended December 31, 1999, the Company
incurred net income of $2.2 million and in 1998; the Company incurred a net loss
of $3.6 million.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net Sales: Net sales increased 9.6% to $124.2 million in 1998 compared to
$113.4 million in 1997. This increase was the result of PICC and USF revenues in
the amount of $10.1 million, which began in 1998, and an increase in billable
minutes and the customer base. Total billable minutes were approximately 635
million minutes in 1998 compared to 616 million minutes in 1997, an increase of
3.1%.
The Company believes it is more cost effective to bill its residential
customers who have smaller than average phone bills through the LECs as opposed
to billing them directly. As a result, a greater percentage of customers who are
billed directly by the Company are the commercial customers or residential
customers who generate larger than average monthly phone bills. In 1997, the
Company began billing a larger percentage of its customers through the LECs and
other billing and collection services. Approximately 77.0% of net sales were
billed through the LECs or other billing and collection services in 1998,
compared to 73.0% in 1997. Customers receiving their bills directly from the
Company were approximately 23.0% in 1998 compared to 27.0% in 1997.
Cost Of Telecommunication Services: The Company's cost of sales is variable
costs based on amounts paid by the Company to its providers for its customers'
long distance usage. For the year ended December 31, 1998, the Company's overall
cost per minute as compared to 1997 decreased by 8%. During the years ended
December 31, 1998 and 1997, the cost of sales and relative percentage of costs
to net sales to each of its providers was as follows:
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1998
----------------------- ----------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
------- ------------- ------- -------------
WorldCom ......... $44,711 39.5% $41,650 33.5%
Hebron ........... 13,529 11.9% 14,736 11.9%
PICC/USF Fees .... -- -- 7,137 5.7%
------- ------- ------- -------
Totals ........ $58,240 51.4% $63,523 51.1%
WorldCom: The Company's overall percentage usage of WorldCom declined as a
result of the Company directing a larger percentage of its traffic to Hebron in
1998. Total minutes of usage from WorldCom were approximately 475 million
minutes in 1998 compared to 481 million minutes in 1997. In June 1997, the
Company received approximately a $0.01 per minute rate reduction on its regular,
interstate traffic from WorldCom.
Hebron: In March 1997, Hebron began providing the Company with
telecommunications services through its Chicago switch as well as its Oklahoma
City switch. The cost of sales to Hebron remained constant while minutes of
usage increased to 160 million minutes in 1998 compared to 135 million minutes
in 1997, an increase of 18.5%. The cost per minute decreased and was primarily
attributable to a $1.1 million rate reduction provided by Hebron during 1998 to
match rates charged by WorldCom.
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PICC/USF Fees: This program for collection of fees was implemented in 1998.
See "- General - PICC Fees."
Selling, General and Administrative Expenses: The significant components of
selling, general and administrative expenses include the following:
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1998
----------------------- ----------------------
AMOUNT PERCENTAGE OF AMOUNT PERCENTAGE OF
(000'S) NET SALES (000'S) NET SALES
------- ------------- ------- -------------
Billing fees and charges ............... $10,347 9.1% $12,580 10.1%
Advertising expense .................... 4,115 3.6% 5,107 4.1%
Other general and administrative ....... 18,536 16.4% 21,078 16.9%
Related party telemarketing expense .... 5,894 5.2% 6,805 5.5%
Rebates to non-profit organizations .... 11,531 10.2% 10,758 8.7%
------- ------- ------- -------
Totals ................................ $50,423 44.5% $56,328 45.3%
------- ------- ------- -------
Billing Fees and Charges: Billing fees and charges include the contractual
billing fees and bad debts charged by LECs and other third party billing
companies. During 1998, the Company decreased its utilization of third party
billing and collection services for a percentage of its billings as compared to
1997. Total billings processed through ZPDI and Hold decreased to approximately
35.0% of net sales in 1998 compared to 40.0% of net sales in 1997. Applicable
billing charges from ZPDI and Hold were approximately 4.6% and 7.0% of net sales
in 1998 and 1997, respectively.
Advertising Expense: Advertising expense increased significantly in 1998 to
$5.1 million, compared to $4.1 million in 1997, an increase of 24.0% due to
increased marketing efforts, including direct mail, radio and other forms of
advertising.
Other General and Administrative Expense: Other general and administrative
expenses increased by approximately 14.0% during 1998 compared to 1997 due to
increased fees for professional and other services, with some offset in
reductions in commissions.
Telemarketing Expense to Related Party: The Company's telemarketing expense
increased during 1998, as the Company paid VisionQuest its direct cost spent for
telemarketing projects, plus reimbursement of 100% of corporate overhead
incurred by VisionQuest. In 1997, telemarketing expenses included reimbursement
of a portion of the overhead costs incurred by VisionQuest in connection with
its telemarketing activities for the Company. During 1997, total telemarketing
expense was reduced by $670,000, as VisionQuest agreed to reimburse that amount
to the Company, in the form of a note. During 1998 and 1997, corporate overhead
expenses incurred by VisionQuest were approximately $4.7 million and $900,000,
respectively, representing 3.8% and 0.8% of net sales, respectively.
Royalties to Non-Profit Organizations: During 1998, royalties to non-profit
organizations decreased by approximately 7.0%, to $10.8 million in 1998 compared
to $11.5 million in 1997. The majority of the decrease is due to an increase in
the bad debt factor utilized to reduce the commissionable revenues and a
decrease in additional discretionary commission amounts, set by management to
maintain a more constant royalty amount to the non-profit organizations. At the
end of 1998, the Company paid approximately 35,000 organizations through its
royalty program, compared to approximately 31,000 organizations at the end of
1997. For 1998 and 1997, approximately 42.0% and 44.0%, respectively, of total
royalties were paid to the top ten organizations.
Depreciation and Amortization: Depreciation and amortization expense
increased 208% to $2.1 million in 1998 compared to $683,000 in 1997. This
increase is attributable to the amortization of a not to compete covenant
contained in Carl Thompson's separation agreement.
Interest Expense and Other Finance Charges: Interest expense and other
finance charges increased to $6.0 million in 1998 compared to $4.2 million in
1997. The primary reasons for the increase were the Company's increased use of
debt financing and an increase in the Company's use of working capital line of
credit agreements to finance its accounts receivable during 1997.
Other Income (Expense): Interest income and rental income increased to
$59,000 during 1998 compared to $14,000 in 1997, principally as a result of the
Company having more cash to invest and an increase in interest income on certain
notes offset by less space available for rental purposes in a building formerly
owned by the Company. The Company's equity in income and in the net loss
incurred by VisionQuest in 1998 and 1997 was approximately $41,000 and $99,000,
respectively.
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Income Tax Expense (Benefit): In 1998, the Company recorded a deferred
income tax benefit of approximately $700,000, and in 1997, the Company recorded
a deferred income tax expense of approximately $92,000. The income tax benefits
recognized in the financial statements consist primarily of the deferred tax
effects of the temporary differences between the financial and tax bases of
assets and liabilities, and net operating loss carryforwards. The Company
believes that it will realize the tax benefits of net operating loss
carryforwards within the period allowed under Federal tax laws (15 years).
Net Income (Loss): During the years ended December 31, 1998 and 1997, the
Company incurred a net loss of $3.6 million and $341,000, respectively.
FINANCIAL CONDITION AND LIQUIDITY
Net cash used in operations was $1,624,000 in 1997 compared to net cash
provided by operations of $7,118,000 in 1998, and net cash used in operations of
$1,664,000 in 1999. The variations in cash flow from operations are primarily
attributable to the timing of collections on accounts receivable and the timing
of payment of accounts payable. In the opinion of management of the Company, the
increase in cash provided by operations from 1997 to 1998 is not the beginning
of a trend for the following reasons: (a) net cash used in operations of
$1,624,000 in 1997 was primarily due to the increase in accounts receivable as
the Company billed a smaller percentage of its customers directly and switched
more customers to being billed by the LECs; (b) net cash provided by operating
activities of $7,118,000 in 1998 was primarily due to the Company extending
terms on accounts payable with vendors and (c) net cash used by operations of
$1,664,000 in 1999 primarily due to the Company's payment of accounts payable
with vendors.
From its existence through 1995, the Company's primary source of financing
was the sale of equity securities. Approximately $12.0 million in equity
securities were sold to investors during this period. Beginning in December 1995
and continuing through August 1996, the Company also raised approximately $4.9
million through the issuance of short-term promissory notes. Substantially all
of the Company's sales of Common Stock and certain notes, other than sales to
officers and directors of the Company, failed to comply with registration
requirements of the federal and states' securities laws, and, possibly,
anti-fraud provisions of federal and state securities laws. While certain
actions under the federal acts may be barred, similar laws in many of the states
provide similar rights. The Company sold stock to persons in over forty states
and those states typically provide that a purchaser of securities in a
transaction that fails to comply with the state's securities laws can rescind
the purchase, receiving from the issuing company the purchase price paid plus an
interest factor, frequently 10% per annum from the date of sales of such
securities, less any amounts paid to such security holder. Accordingly, the
Company has a contingent liability under state securities laws for those sales
of approximately $469,000 at December 31, 1999.
The Company has also financed its working capital needs through various
accounts receivable credit facilities with Trinity Financial Resources
("Trinity"), Hebron, and other billing and collection companies. In September
1997, the Company entered into a $5,000,000 accounts receivable purchase
agreement with RFC Capital Corporation ("RFC"). Other sources of financing have
included various short and long-term borrowings, primarily from individuals and
related parties, and by extending payables to vendors and tax authorities beyond
payment terms.
The Company's primary uses of cash have historically been for telemarketing
efforts to increase the Company's customer base, and to pay distributions and
redemptions to its stockholders. From the beginning of 1995 through December 31,
1998, total amounts expended for telemarketing activities were approximately
$32.6 million. Substantially all of these expenses were paid to VisionQuest. The
Company now believes it paid higher rates for VisionQuest's services than it
would have paid to an independent service provider. The Company believes that
the amounts it paid to VisionQuest for telemarketing services could have been
$2.0 million to $4.0 million higher than what it could have obtained in an
arms-length transaction from an unaffiliated third party. This estimate is
based upon an estimate of available third party telemarketing rates, but there
can be no assurance that the Company could have obtained such services at such
rates on otherwise acceptable terms. For instance, VisionQuest gave priority to
the Company's requests, and agreed to do business with the Company without long
term or minimum purchase agreements.
In addition, from 1994 through the end of 1997, the Company declared $19.0
million in distributions to its stockholders. As of December 31, 1999, all
distributions had been paid, except for amounts allegedly payable to Mr. Freeny
and Mr. Thompson totaling approximately $3.2 million and $337,500, respectively.
In a letter agreement dated July 14, 1999, the Company and Mr. Freeny agreed to
defer payment of such amounts allegedly owed to Mr. Freeny until such time as
the Company's financial condition further improved and it had funds available,
legally and in good business practice, to pay any such accrued distributions. In
consideration for this deferral and Mr. Freeny's subordination of the accrued
distributions to the Coast Loan, the Company agreed to pay him, in addition to
his salary, $300,000 per year, subject to limitations under the Coast Loan
Agreement, until the payment of the accrued distributions was resumed and, if
resumed, all amounts paid to Mr. Freeny pursuant to the agreement would be
credited against his accrued distributions.
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The Company's financing costs have historically exceeded market rates. Most
of the note payable obligations have borne interest at 18% or 24%, with the
exception of the obligations to Aubrey Price and Hebron for which the Company
paid an effective rate of 51% and 58%, respectively. Interest costs and late
fees on vendor payables and tax obligations also generally have an effective
rate of 18% or higher. The effective interest rates on the Company's accounts
receivable credit facilities have ranged from 12% to as high as the 58% received
by Hebron. Financing costs have increased as the result of fees charged by
Hebron, and finance companies such as Trinity, Hold and RFC in connection with
the line of credit financing and accounts receivable factoring arrangements.
Other LEC billings were financed through the Company's line of credit agreements
with Hebron and Trinity in 1998 and 1997 and from the fourth quarter of 1997
through January 1999, through the Company's credit arrangement with RFC. The
arrangements with Hebron and Trinity provided for a 2.0% billing fee,
respectively as well as 2 cents per call record charge by Hebron, in addition to
the interest charged under the agreements. (See Item 7). During 1998 and 1997,
total-billing fees charged by Hebron, Trinity and RFC were approximately 1.3%
and 1.0% of net sales, respectively.
This combination of high financing costs, distribution payments, and the
short-term nature of most of the Company's indebtedness have contributed to the
Company's lack of profitability and negative working capital, which totaled
$22.3 million at December 31, 1999.
During 1998, the Company was approved for a $30 million credit facility
("Credit Facility") with Coast. In February 1999, the Company closed on the
first phase of the Credit Facility.
The first phase of the Credit Facility was accounts receivable based, and
provided initial funding of approximately $12.6 million. The proceeds from this
Credit Facility were used to replace the existing accounts receivable credit
facilities and purchase agreement, and to enable the Company to become
substantially current on its existing past due vendor payables and tax
obligations. In connection with closing the first phase of the Credit Facility
the Company also obtained $2.5 million in subordinated debt financing from
Patrick Enterprises ("Patrick Note"), an investor. These funds were initially
restricted to maintain reserves as specified in the Credit Facility with Coast.
In April 1999, the Company met the terms and conditions for converting the
Credit Facility from an accounts receivable based facility to a full credit
facility. Accordingly, Coast approved the conversion to the full credit
facility. Under the terms of the Credit Facility, funding availability is based
upon recurring monthly accounts receivable collections or earnings multiples.
The Company's initial availability in April 1999 was approximately $29.0 million
under the Credit Facility, but was increased to the full $30 million later in
the year.
In October 1999, the Company, subject to the condition set forth below,
increased its availability under the Credit Facility to $35.0 million. This
increase is due to an increase in the Company's borrowing multiple for accounts
receivable collections. This increase in availability to the Company was subject
to Coast being able to syndicate the Credit Facility within 90 days following
the Company's request to increase the availability from $30.0 million to $35.0
million. During 1999, the Company either paid off or negotiated with certain of
its non-subordinated creditors to replace their existing indebtedness with some
other form of debt instrument, subordinated to the Credit Facility. This
increased, on a dollar for dollar basis, the Company's availability under the
Credit Facility, as these non-subordinated creditors totaling $6.8 million were
reserved under the Credit Facility. At December 31, 1999, the remaining balance
owed of approximately $154,000 represents lenders who agreed to restructure
their debt as subordinated to Coast Facility.
Of the $35.0 million in availability, currently limited to $30.0 million
due to financial results and loan formula restrictions, approximately $20.9
million was outstanding as of December 31, 1999 under the Credit Facility. The
remaining balance of $9.1 million is available to the Company for working
capital, capital improvements, debt reduction and required reserves. In
addition, the Patrick Note of $2.5 million is due February 1, 2000. This note
was paid down to $2.0 million on February 1, 2000 and the maturity date was
extended to February 1, 2001. In addition, the $2.5 million subordinated Patrick
Note is also available for working capital, capital improvements and debt
reduction. The Credit Facility is secured by a blanket lien on all of the
Company's assets, including accounts receivable and the Company's customer base.
The terms of the Credit Facility are for three years from initial funding, with
an interest rate of prime plus 3.5%. Although the Credit Facility has a
three-year term, it is classified as a current liability in the Company's
financial statements because the agreement contains certain subjective
acceleration clauses and requires that all cash receipts be deposited to a
lockbox, the proceeds of which are used daily to repay the debt.
The Company expects to incur future capital expenditures in the range of
$1.0 to $2.0 million, including upgrades to the Company's management information
systems and various aspects of reorganization.
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In the event the Company's estimates of capital requirements are too low,
and the Company does not have sufficient availability under the Credit Facility
or is unable to obtain alternate sources of financing, the Company may be
required to curtail its capital improvement and telemarketing expansion plans.
Operating Activities
Significant uses of cash in operating activities for the year ended
December 31, 1999 include decreases in accounts payable of $9.4 million.
Accounts receivable increased by $533,000 and prepaid expenses increased by
$709,000. The Company also generated cash from operations by recording net
income of $2.2 million; $2.0 million from recording a deferred income tax
expense; $3.0 million in certain non-cash expenses, principally depreciation and
amortization and $344,000 from recording the issuance of stock warrants, options
and awards.
Significant sources of cash in operating activities in 1998 include
decreases in accounts receivable of $2.7 million. Net non-cash expenses of $2.8
million, principally depreciation, amortization, impairment loss on fixed assets
and losses on other receivables significantly offset the net loss of $3.6
million incurred by the Company in 1998. The Company also generated cash from
operations of approximately $5.8 million by extending or delaying payments to
vendors.
Significant uses of cash in operating activities in 1997 included increases
in accounts receivable of $6.1 million. Net non-cash expenses of $874,000,
principally depreciation and amortization, offset the net loss of $341,000
incurred by the Company in 1997. The Company also generated cash from operations
of approximately $1.6 million by extending or delaying payments to vendors, and
$2.4 million in connection with the sale of certain of its accounts receivable.
Investing Activities
The Company's investing activities for the year ended December 31, 1999
consisted primarily of property and equipment purchases of $3.3 million offset
by proceeds of $522,000 from the sale of an asset held for disposal.
The Company's investing activities in 1998 consisted primarily of property
and equipment purchases of $353,000. Investments totaling $55,000, which had
been pledged as collateral for a loan in 1996, were released in 1998. Sources of
cash included repayments of advances made to related parties totaling $150,000.
The Company's investing activities in 1997 consisted primarily of property
and equipment purchases of $337,000 and a loan made to a related company in the
amount of $670,000. Investments totaling $85,000, which had been pledged as
collateral for a loan in 1996, were released in 1997.
Financing Activities
During the year ended December 31, 1999, financing activities provided $4.8
million in cash. The most significant source of cash was an increase of $12.9
million in borrowings under the Company's Credit Facility. Other financing
activities included borrowings from related parties totaling $262,000 and
repayments to related parties totaling $1.3 million, for net use of cash
totaling $1.0 million, and other borrowings totaling $2.6 million and repayments
totaling $9.2 million, for net use of cash totaling $6.6 million.
During the year ended December 31, 1998, financing activities used $6.4
million in cash. The most significant use of cash was a decrease of $2.9 million
in borrowings under the Company's various line of credit agreements.
Additionally, distributions paid to stockholders and redemption of Common Stock
also comprised the use of cash in financing activities, totaling $1.5 million in
1998. Other financing activities included borrowings from related parties
totaling $1.6 million and repayments to related parties totaling $3.1 million,
for net use of cash totaling $1.5 million, and other borrowings totaling
$400,000 and repayments totaling $748,000, for a net use of cash totaling
$348,000.
During the year ended December 31, 1997, financing activities provided $2.0
million in cash to the Company. The most significant source of cash was an
increase of $6.8 million in borrowings under the Company's various line of
credit agreements. Distributions paid to stockholders and redemptions of Common
Stock comprised the largest use of cash in financing activities, totaling $5.0
million in 1997. Other financing activities included borrowings from related
parties totaling $3.7 million and repayments to related parties totaling $4.4
million, for a net use of cash of $700,000, and other borrowings totaling $1.4
million and repayments totaling $500,000, for net proceeds of cash totaling
$900,000.
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RECENT EVENTS
In July 1999, the Company launched a filtered family friendly Internet
access service nationwide and intends to market this service to both its
existing customers and new customers.
YEAR 2000 COMPUTER ISSUES
The year 2000 issue related to whether the Company's computer systems would
properly recognize date sensitive information due to the change in year 2000, or
"00". Systems that fail to properly recognize such information could generate
erroneous data or cause a system to fail.
To date, the Company has not experienced any significant problems as a
result of the commencement of the year 2000. There remains a possibility that
residual consequences stemming from the change to the year 2000 could occur and,
if these consequences become widespread, they could have a material adverse
effect on the Company's business, financial condition, cash flows and results of
operations. However, the Company considers this possibility remote and does not
anticipate any significant problems due to the year 2000 issue.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 129, "Disclosure of
Information about Capital Structure," which establishes standards for disclosing
information about an entity's capital structure and is effective for financial
statements for periods ending after December 15, 1997. In June 1997, the FASB
issued SFAS No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in the financial statements for fiscal years beginning after December 15, 1997.
The FASB also issued, in June 1997, SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
public companies disclose information about operating segments, products and
services, geographic areas and major customers. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. The Company
has determined that the impact on its financial statements of adopting SFAS Nos.
129, 130 and 131 is not material. In June 1998, the FASB issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for fiscal quarters ending after June 15, 1999. The effective date of
SFAS No. 133 was delayed to fiscal quarters ending after June 15, 2000, by SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133", issued in June 1999.
The Company does not expect the adoption of SFAS No. 133 to have a material
impact on its financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is not exposed to market risk from changes in marketable
securities, as the Company has no such instruments.
The Company is exposed to future earnings or cash flow fluctuations from
changes in interest rates on borrowings under the Credit Facility since amounts
borrowed under the Credit Facility accrue interest at a fluctuating rate equal
to the prime lending rate ("Prime") plus 3.5%. The outstanding balance of the
Company's borrowings under the Credit Facility at December 31, 1999 was $20.9
million. Market risk is estimated as the potential increase in interest rate for
borrowings under the Company's Credit Facility resulting from an increase in
Prime. Based on borrowings under the Credit Facility at December 31, 1999, a
hypothetical increase of 1.00% in Prime increases the Company's cost of
borrowings by approximately $209,000 annually. To date, the Company has not
entered into any derivative financial instruments to manage interest rate risk
and is currently not evaluating the future use of any such financial
instruments.
The Company's operations are all originated within the United States and
therefore conduct all business transactions in U.S. dollars.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are set forth following the
signature page hereof beginning on page F-1.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the executive
officers and directors of the Company:
NAME AGE POSITION
---- --- --------
Stephen D. Halliday........ 51 President, Chief Executive Officer
and Director
Tracy C. Freeny............ 55 Chairman of the Board
John B. Damoose............ 53 Director
Jay A. Sekulow............. 44 Director
David E. Grose............. 47 Vice President and Chief Financial
Officer
Kerry A. Smith............. 38 Vice President
Stephen D. Halliday has been the President, Chief Executive Officer and a
director of the Company since October 1998. From 1980 until 1997, Mr. Halliday
was a partner with Coopers & Lybrand LLP (which is now PricewaterhouseCoopers
LLC) and from 1997 until October 1998 he was a partner in the telecommunications
law firm of Wiley, Rein & Fielding ("WRF") in Washington, D.C. He continues to
serve as of counsel with WRF for matters, which do not involve the Company. Mr.
Halliday graduated from Duke University with bachelor of arts degree in
accounting, William & Mary University with a law degree and Georgetown
University with a masters of law degree in taxation.
Tracy C. Freeny is a founder of the Company and has served as Chairman of
the Board since the formation of the Company in May 1991 and served as President
from such time until October 1998. From 1970 until 1990 Mr. Freeny operated a
life insurance agency affiliated with Phoenix Mutual Life Insurance Company and
is a lifetime member of the life insurance industry Million Dollar Roundtable.
In 1990, Mr. Freeny went to work for AmeriTel Communications, Inc. ("AmeriTel")
a reseller of long distance telephone services and in 1991 was part of the
acquisition of the assets of AmeriTel, which began the Company. Mr. Freeny
graduated from Oklahoma State University with a bachelor of arts degree in
finance. In July 1998, Mr. Freeny agreed to a cease and desist order issued by
the Securities and Exchange Commission regarding the violation of various
federal securities laws. For more information regarding these matters, see Item
3 above.
John B. Damoose has been a director of the Company since October 1998.
Since May 1997, Mr. Damoose has been President of two non-profit organizations,
Religious Heritage of America Foundation and Freedom of Ministries of America.
Prior to that, from May 1996 until May 1997, he served as Co-President of the
Christian Broadcasting Network and from November 1993 until May 1996 he served
as Senior Vice President - Marketing and Communications for International Family
Entertainment. Mr. Damoose also held various management positions with Chrysler
Corporation from November 1982 through November 1993, most recently serving as
Vice President of Worldwide Marketing. Mr. Damoose graduated from the University
of Michigan with a bachelor of science degrees in economics/political science
and Columbia University with a masters degree in business administration.
Jay A. Sekulow has been a director of the Company since October 1998. Mr.
Sekulow is an attorney and has been Chief Counsel of the American Center for Law
and Justice, a non-profit public interest law firm ("ACLJ") since 1992. He has
also been, since 1995, Chief Executive Officer of Regency Productions, Inc.
("Regency"), a radio production company which produces a thirty-minute daily
radio program on legal issues hosted by Mr. Sekulow and, since 1987, President
and a Director of CASE, a non-profit public interest law firm. Mr. Sekulow
graduated cum laude from Mercer University with both a bachelor of arts degree
in history and law degree.
David E. Grose has been a Vice President and the Chief Financial Officer of
the Company since April 1999. From July 1997 through April 1999, Mr. Grose
served as Vice President and Chief Financial Officer of Bayard Drilling
Technologies, Inc., formerly a publicly traded oil and gas drilling company.
Prior to that Mr. Grose was affiliated with Alexander Energy Corporation,
formerly a publicly traded oil and gas exploration and development company, from
its inception in March 1980, serving from 1987 through 1996 as a director and
Vice President, Treasurer and Chief Financial Officer. In August 1996, National
Energy Group acquired Alexander Energy Corporation and he served as Vice
President of Finance and Treasurer through February 1997. Mr. Grose graduated
from
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Oklahoma State University with a bachelor of arts degree in political science
and University of Central Oklahoma with a masters degree in business
administration.
Kerry A. Smith has been a Vice President of the Company since December
1998. Most recently he served as the Telecom/Infocom Practice Director for
PricewaterhouseCoopers LLP in Dallas, Texas, and has extensive product-marketing
experience with WorldCom. Mr. Smith has more than 15 years experience in the
telecommunications industry holding key senior staff and management positions.
His resume includes key positions managing global alliance partners in Canada,
Latin America, Mexico, and Great Britain developing strategic business plans and
launching new products and services. Mr. Smith graduated from Capitol College
with a bachelor of science in telecommunication engineering technology.
BOARD OF DIRECTORS MATTERS
All directors hold offices until the next annual meeting of the
shareholders and until their successors have been duly elected and qualified.
Each officer serves at the discretion of the Board of Directors, subject to the
terms of certain employment agreements described below.
The Board of Directors has established an Audit Committee and a
Compensation/Nominating Committee. The Audit Committee is composed of Messrs.
Sekulow and Damoose, with Mr. Damoose serving as Chairman. The Audit Committee
is responsible for (a) reviewing the scope of, and the fees for, the annual
audit of the Company, (b) reviewing with the independent auditors the Company's
accounting practices and policies, (c) reviewing with the independent auditors
their final report, (d) reviewing with internal and independent auditors overall
accounting and financial controls and (e) being available to the independent
auditors for consultation purposes.
The Compensation/Nominating Committee is composed of Messrs. Sekulow and
Damoose, with Mr. Sekulow serving as Chairman. The Compensation/Nominating
Committee is responsible for reviewing the Company's policies with respect to
the compensation of its officers at the Vice President level or higher,
including the basis of the compensation of its chief executive officer and its
relationship to corporate objectives and identifying and nominating future
nominees as members of the Board of Directors.
The Board of Directors has also adopted a policy statement on conflict of
interest transactions, which requires that all proposed conflict of interest
transactions be approved by a majority of directors who will receive no benefit
from the transaction.
ITEM 11. EXECUTIVE COMPENSATION
The following table summarizes the compensation paid the Company's chief
executive officer and vice president of the Company for services rendered in
1998 and 1999 (collectively, the "Named Executive Officers"). See Item 13 below
for a description of transactions involving Mr. Halliday and the directors of
the Company.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
----------------------------------------- ----------------------
SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS/SARS (#) COMPENSATION($)
--------------------------- ---- ---------- --------- ---------------- ---------------- ---------------
Stephen D. Halliday, President and
Chief Executive Officer............... 1999 $487,500 $100,000 -- 27,296 --
1998 $128,462 -- -- -- $127,500(1)
Kerry A. Smith, Vice President........ 1999 $215,000 $ 50,000 -- -- --
1998 $ 17,917 -- -- -- --
(1) These amounts represent payments made to Mr. Halliday prior to his becoming
the Company's President and Chief Executive Officer.
The following table sets forth the information regarding the options
granted to the Chief Executive Officer of the Company in 1999:
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OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF STOCK PRICE
INDIVIDUAL GRANTS APPRECIATION FOR OPTION TERM
--------------------------------------------------- -----------------------------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS/SARS EXERCISE
UNDERLYING GRANTED TO OR BASE
OPTIONS/SARS EMPLOYEE IN PRICE EXPIRATION
NAME GRANTED (#) FISCAL YEAR ($/SH) DATE 0% 5% 10%
Stephen D. Halliday........ 6,824 25% $28.86 July 1, 2004 n/a $14,174 $69,460
6,824 25% $28.86 July 1, 2005 n/a $24,730 $96,100
6,824 25% $28.86 July 1, 2006 n/a $35,813 $125,404
6,824 25% $28.86 July 1, 2007 n/a $47,451 $157,638
HALLIDAY EMPLOYMENT AGREEMENT
Effective as of May 24, 1999 (the "Commencement Date"), the Company entered
into an amended and restated employment agreement with an initial effective date
of October 1998 (the "Halliday Employment Agreement") with Stephen D. Halliday,
President, Chief Executive Officer and a director of the Company. The initial
term of the Halliday Employment Agreement is for five years, with automatic
one-year extensions. Pursuant to the Halliday Employment Agreement, Mr. Halliday
initially received an annual salary of $450,000 which was increased to $600,000
on October 1, 1999, subject to annual review by the board of directors of the
Company, which shall increase his salary at the annual consumer price index rate
of increase and may further increase but not decrease such salary at the board
of directors discretion. Also, on October 1, 1999, Mr. Halliday received a
one-time bonus of $100,000. Mr. Halliday is also entitled to receive various
medical, dental and group insurance, pension and other retirement benefits,
disability and other benefit plans and vacation as the Company makes available
to its senior executive officers. Mr. Halliday may be terminated in the event of
his disability, for cause (as defined in the Halliday Employment Agreement) or
without cause and Mr. Halliday may terminate his employment for good reason (as
defined in the Halliday Employment Agreement, which includes any termination of
Mr. Halliday's employment by the Company other than for cause and any change of
control of the Company). If Mr. Halliday is terminated for cause or without
cause (subject to the right of Mr. Halliday to terminate his employment for good
reason) because of his death, he or his estate, as the case may be, will receive
his salary and other benefits accrued as of the date of termination or death. If
Mr. Halliday's employment is terminated as a result of his disability, Mr.
Halliday will receive his salary and other benefits accrued as of the date of
disability and 60% of his base salary for the period of disability but not
exceeding the remaining term of the Halliday Employment Agreement. If Mr.
Halliday terminates his employment for good reason, he is entitled to continue
to receive his base salary for the remaining term of the Halliday Employment
Agreement and, in addition, all his Common Stock and options to purchase Common
Stock will continue to vest and he will receive upon each vesting date a cash
bonus which will equal all taxes payable by Mr. Halliday as a result of the
vesting of the Common Stock and the payment of this bonus. If the Company
intends to terminate Mr. Halliday's employment without cause, it must give him
notice and he is entitled to terminate his employment for good reason.
Pursuant to the Halliday Employment Agreement, as of July 1, 2000, the
Company will issue Mr. Halliday shares of Common Stock equal to 0.5% of the
fully diluted outstanding Common Stock on such date, subject to certain vesting
requirements. This issued stock vests as follows: 50% of the shares will vest on
July 1, 2000 and 25% of the shares will vest on each July 1 thereafter. If Mr.
Halliday fails to serve as an officer of the Company, all unvested shares will
be forfeited unless Mr. Halliday terminated his employment for good reason.
Additionally, Mr. Halliday is to receive a cash bonus after any portion of these
shares vests that will equal all taxes payable by him as a result of the vesting
and the payment of this bonus.
The Halliday Employment Agreement also granted Mr. Halliday two options to
purchase shares of Common Stock. The first option effective as of the
Commencement Date granted Mr. Halliday options to purchase 27,296 shares (3% of
fully diluted outstanding Common Stock as of such date) at $28.86 per share (the
fair value of the Common Stock as of February 1, 1998, as was determined by a
third party appraiser) (the "Exercise Price"). These options are subject to the
following vesting schedule: 25% of the options vested on July 1, 1999 and 25% of
the options vest on each July 1 thereafter. The second option, which will be
effective three years after the Commencement Date, will entitle Mr. Halliday to
purchase 2% of the fully diluted outstanding Common Stock as of
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such date at the Exercise Price plus 25%. The second option vests as follows:
50% of the options vest four years after the Commencement Date and 50% of the
options vest five years after the Commencement Date. If Mr. Halliday fails to
serve as an officer of the Company, unless he terminated his employment for good
reason, the vesting will immediately cease; however, Mr. Halliday can exercise
all vested options after such time until the termination of the options. All of
these options will vest upon any sale of the Company. Once an option to purchase
shares has vested it will remain exercisable for five years from such vesting
date.
Tracy Freeny also individually agreed that for as long as Mr. Halliday is
employed by the Company to vote all of his shares of Common Stock for Mr.
Halliday and for a period of five years from the Commencement Date for each of
the other current directors of the Company for election to the board of
directors of the Company. Also, pursuant to an employment agreement, which was
replaced by the Halliday Employment Agreement, Carl Thompson agreed to vote for
Messrs. Halliday, Damoose and Sekulow's election to the board of directors of
the Company. In June 1999, Mr. Thompson executed an agreement pursuant to which
he agreed to honor his agreements contained in such prior employment agreement.
SMITH EMPLOYMENT AGREEMENT
Effective as of December 31, 1998 (the "Effective Date"), the Company
entered into an employment agreement (the "Smith Employment Agreement") with
Kerry A. Smith, a Vice President of the Company. The initial term of the Smith
Employment Agreement is for two years, with automatic one-year extensions
subject to 90 days notification prior to the extension if the Company elects to
not renew his agreement. Pursuant to the Smith Employment Agreement, Mr. Smith
receives an annual base salary of $215,000 and a bonus of $50,000. Both Mr.
Smith's annual base salary and guaranteed bonus are subject to review after the
initial term of the Smith Employment Agreement and may, at the Company's
discretion, be adjusted from time-to-time according to Mr. Smith's
responsibilities, capabilities, performance and other criteria deemed
appropriate by the Company. Mr. Smith is entitled to receive various medical,
dental and group insurance, pension and other retirement benefits, disability
and other benefit plans and vacation as the Company makes available to its
senior executive officers. The Company may also terminate this Agreement at any
time during the initial term and for any reason whatsoever upon ninety (90) day
notice to Mr. Smith. If the Company notifies Mr. Smith of its election to
terminate Mr. Smith before the first anniversary of the Effective Date, Mr.
Smith shall be entitled to receive severance pay equal to six (6) months pay
(and payable in a lump sum or over the course of such period, at the option of
the Company) and health insurance for such period. If the Company notifies Mr.
Smith of its election to terminate Mr. Smith between the first anniversary of
the Effective Date and the second anniversary of the Effective Date, Mr. Smith
shall be entitled to receive severance pay equal to four (4) months pay and
health insurance for such period. Severance pay shall be payable in a lump sum
or over the course of the period covered, at the option of the Company. In
addition to the amounts set forth in the previous two sentences, upon
termination Mr. Smith is entitled to receive a share of the bonus pro rated from
the beginning of the fiscal year in which the termination occurs to the date of
the termination notice. Severance pay after the initial term shall be subject to
negotiation between Mr. Smith and the Company.
FREENY EMPLOYMENT AGREEMENT
Effective as of the Commencement Date (i.e. May 24, 1999), the Company
entered into an employment agreement (the "Freeny Employment Agreement") with
Tracy C. Freeny, Chairman of the Board of the Company, as consideration for the
additional services Mr. Freeny performs for the Company. The initial term of the
Freeny Employment Agreement is for five years, with automatic one-year
extensions. Pursuant to the Freeny Employment Agreement, Mr. Freeny receives an
annual salary of $300,000, subject to annual review by the board of directors of
the Company, which shall increase his salary at the annual consumer price index
rate of increase and may further increase but not decrease such salary at the
board of directors discretion. Mr. Freeny is also entitled to receive various
medical, dental and group insurance, pension and other retirement benefits,
disability and other benefit plans and vacation as the Company makes available
to its senior executive officers. Mr. Freeny may be terminated in the event of
his disability, for cause (as defined in the Freeny Employment Agreement) or
without cause and Mr. Freeny may terminate his employment for good reason (as
defined in the Freeny Employment Agreement, which includes any termination of
Mr. Freeny's employment by the Company other than for cause and any change of
control of the Company). If Mr. Freeny is terminated for cause or without cause
(subject to the right of Mr. Freeny to terminate his employment for good reason)
because of his death, he or his estate, as the case may be, will receive his
salary and other benefits accrued as of the date of termination or death. If Mr.
Freeny's employment is terminated as a result of his disability, Mr. Freeny will
receive his salary and other benefits accrued as of the date of disability and
60% of his base salary for the period of disability but not exceeding the
remaining term of the Freeny Employment Agreement. If Mr. Freeny terminates his
employment for good reason, he is entitled to continue to receive his base
salary for the remaining term of the Freeny Employment Agreement and, in
addition, one year following the date of his termination. If the Company intends
to terminate Mr. Freeny's employment without cause, it must give him notice and
he is entitled to terminate his employment for good reason. Pursuant to a
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33
separate written agreement, Mr. Freeny has agreed to defer certain accrued
distributions allegedly owed to him by the Company. See Item 13 - Certain
Relationships and Related Transactions - Transactions with Messrs. Freeny and
Thompson.
TELLING AGREEMENTS
In 1997 Mr. Freeny (on behalf of the Company) entered into an
employment agreement with John E. Telling, a former director of the Company and
former executive of the Internet department of the Company. Mr. Telling was to
receive an annual salary of $500,000, subject to annual review by the board of
directors of the Company. Mr. Telling was also entitled to receive various
medical, dental and group insurance, pension and other retirement benefits,
disability and other benefit plans and vacation as the Company made available to
its senior executive officers.
Effective as of May 1999, the Company entered into a restated employment
agreement with Mr. Telling (the "Telling Employment Agreement"). The Telling
Employment Agreement restated the 1997 agreement except that Mr. Telling's
annual salary was reduced to $250,000. The initial term of the Telling
Employment Agreement was for five years with automatic one-year extensions.
Pursuant to the 1997 Agreement, the Company issued Mr. Telling 9,099 shares
of Common Stock (1.0% of the fully diluted outstanding Common Stock on such
date) (the "Restricted Shares"), subject to certain vesting requirements. The
1997 Agreement also granted Mr. Telling options to purchase 27,296 shares (3% of
fully diluted outstanding Common Stock as of such date) ("Options") at the
Exercise Price, which were to vest over time. These Options were granted subject
to the following vesting schedule: 25% of the shares vested on July 1, 1999 and
25% of the shares vest on each July 1 thereafter.
Effective as of December 31, 1999, Mr. Telling resigned as a director and
employee of the Company and in connection with such resignation, the Company and
Mr. Telling entered into a letter agreement (the "Resignation Agreement"). The
Resignation Agreement provides for the same terms as the Telling Employment
Agreement and as a result, Mr. Telling will receive, payments totaling $500,000
in 2000 and will receive $250,000 per year from January 1, 2001 until May 1,
2004. Also, the Resignation Agreement provides (a) that the Restricted Shares
immediately vested and the Company paid Mr. Telling a cash bonus equal to all
taxes payable by him as a result of the vesting and the payment of the bonus and
(b) the Options remain in effect and will become exercisable on the terms
provided in the Telling Employment Agreement. The Resignation Agreement also
provided for a mutual release between Mr. Telling and the Company and Mr.
Telling agreed to certain non-competition covenants.
Mr. Telling prior to joining the Company had been a founder and the
president of Hebron. He continued that position while employed by the Company
and holds that position currently.
STOCK AGREEMENTS
Each of Jay A. Sekulow and John B. Damoose, directors of the Company, have
entered into amended and restated stock agreements with the Company (the "Stock
Agreements"). The Stock Agreements are also effective as of the Commencement
Date and provide that the party thereto (the "Party") shall receive certain
compensation for his agreement to serve and continued service as a director of
the Company. On July 1, 2000, the Company shall be obligated to issue each Party
shares of Common Stock equal to 0.5% of fully diluted outstanding Common Stock
on such date, subject to vesting. This issued stock vests as follows: 50% of the
shares will vest on July 1, 2000 and 25% of the shares vest on each July 1
thereafter. If a Party fails for any reason to serve as a director, all unvested
shares will be forfeited. Additionally, each Party is to receive a cash bonus
after any portion of these shares vests that will equal all taxes payable by the
Party as a result of the vesting and the payment of this bonus.
The Stock Agreements also grant each Party options to purchase a certain
number of shares of Common Stock at the Exercise Price. Messrs. Sekulow and
Damoose received options to purchase 27,296 shares (3.0% of fully diluted
outstanding Common Stock as of such date) and 9,099 shares (1.0% of fully
diluted outstanding Common Stock on such date), respectively. These options are
subject to the following vesting schedule: 25% of the options vested on July 1,
1999 and 25% of the options vest on each July 1 thereafter. If a Party ceases to
serve as a director, the vesting will immediately cease; however, the Party can
exercise all vested options after such time until the termination of the
options. All of the options will vest upon any sale of the Company. Once an
option to purchase shares has vested it will remain exercisable for five years
from such vesting date.
Tracy Freeny also individually agreed for a period of five years from the
execution of such agreement to vote all of his shares of Common Stock for the
Party for election to the board of directors of the Company. Also pursuant to a
stock agreement with Mr.
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Sekulow, which was replaced by the Stock Agreement, Carl Thompson agreed to vote
for Messrs. Halliday, Damoose and Sekulow's election to the board of directors
of the Company. In June 1999, Mr. Thompson executed an agreement pursuant to
which he agreed to honor his agreements contained in such prior agreement.
SEPARATION AGREEMENT WITH CARL THOMPSON
In April 1998, Mr. Thompson resigned as Senior Vice President and director
of the Company. In connection with such resignation, the Company, authorized by
Mr. Freeny, and Mr. Thompson entered into an agreement pursuant to which Mr.
Thompson will receive (a) $40,000 a month until all accrued and unpaid
distributions ($995,952 as of the date of the agreement) have been paid, all of
which amounts have been paid as of December 31, 1999, except for $98,000 and (b)
$20,000 a month for the remainder of his life so long as Mr. Thompson does not
take any action significantly detrimental to the Company. The Company paid Mr.
Thompson the last of his accrued and unpaid distributions in March 2000, and has
been paying Mr. Thompson $20,000 per month since April 1998. The agreement also
contains certain non-competition provisions, which Mr. Thompson was required to
comply with until April 1999.
STOCK INCENTIVE PLAN
The Board of Directors has approved a 1999 Stock Incentive Plan (the
"Plan") relating to up to 40,000 shares of Common Stock of the Company
("Shares"). The Plan permits the granting of stock options to employees,
directors and consultants, and includes additional features (such as restricted
shares and stock appreciation rights), described in more detail below, that
enhance the flexibility of the Company in hiring, retaining and motivating key
individuals. The Plan provides that it shall be administered by the compensation
committee of the Board of Directors of the Company (the "Committee"). The Plan
may be amended without shareholder approval, except as specified in the Plan.
Pursuant to the Plan, the Company may from time to time grant to employees,
directors and consultants of the Company and its affiliates, Shares, options to
purchase Shares ("Options"), and stock appreciation rights. Shares issued under
the Plan shall be restricted shares, which are subject to cancellation upon such
terms, and conditions as may be determined by the Company.
Options under the Plan may be either incentive stock options, which receive
special tax treatment, or non-qualified options, which do not receive such
special tax treatment. Incentive stock options will expire not more than ten
years from the date of grant. In addition, it is expected that non-qualified
options will generally expire not more than ten years from the date of grant.
The purchase price per Share to be specified in each Option granted under
the Plan may not be less than the fair market value of a share of Common Stock
of the Company on the date the Option is granted. The Plan permits the
adjustment of outstanding Options to accommodate for mergers, acquisitions and
other events, and to specify a lower purchase price, through amendment of
outstanding options or through cancellation of outstanding options and the grant
of replacement options.
The Plan permits the Company to provide that payment of the purchase price
upon exercise of options may be made in cash, shares owned by the optionee, any
other lawful form of consideration or a combination thereof, in each case
acceptable to the Committee. Any shares received by the Company in payment of
the purchase price will be valued at their fair market value on the date of
exercise.
Stock appreciation rights may be granted in tandem with options or may be
freestanding. The Committee may amend the terms of the stock appreciation rights
from time to time. Payment to participants upon the exercise of stock
appreciation rights will generally be made in cash or in shares (such shares to
be valued at their fair market value on the date of exercise of the stock
appreciation rights). Tandem stock appreciation rights may be granted at the
time a grant is made under the Plan or added to outstanding grants, provided
that in the case of stock appreciation rights granted in tandem with incentive
stock options, such grant may only be made at the time of the grant of the
incentive stock option.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information concerning the
beneficial ownership of Common Stock, $0.10 par value of the Company ("Common
Stock"), as of December 31, 1999, by (a) each person known by the Company to own
beneficially more than 5% of the outstanding Common Stock, (b) each director of
the Company, (c) each Named Executive Officer (as defined in Item 6 below)
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and (d) all executive officers and directors as a group. The Company believes
that each of such stockholders has the sole voting and dispositive power over
the shares held by such stockholder except as otherwise indicated.
EXECUTIVE OFFICERS AND DIRECTORS:
SHARES OWNED
-----------------------
NAME NUMBER PERCENTAGE
---- ------- ----------
Stephen D. Halliday (1) ................. 9,490 1.1
Tracy C. Freeny (2) ..................... 155,183 18.8
John B. Damoose (3) ..................... 2,675 --
Jay A. Sekulow (4) ...................... 42,453 5.1
David E. Grose .......................... -- --
Kerry A. Smith .......................... -- --
All Executive Officers and Directors as
A Group (8 Persons) (1)(2)(3)(4) .... 209,801 25.4
OTHER 5% STOCKHOLDERS:
Sharon Freeny (5) ....................... 155,183 18.8
Harvey Price (6) ........................ 50,000 6.0
Donald Price (7) ........................ 50,000 6.0
- ----------
(1) Includes 6,824 shares subject to options held by Mr. Halliday and 2,666
shares which Mr. Halliday and/or CASE has the option to purchase from Mr.
Thompson. Additionally, the Company is obligated to grant to Mr. Halliday
on July 1, 2000, shares which represent 0.5% of the fully diluted
outstanding Common Stock on such date, in connection with his service on
the Board of Directors of the Company, which shares are not included here
in this total and are subject to forfeiture pursuant to the terms of the
Halliday Employment Agreement (as defined herein).
(2) Includes 152,983 shares held jointly by Mr. Freeny and his wife and 2,200
shares held by Mr. Freeny's minor son. Mr. Freeny disclaims beneficial
ownership of the shares owned by his minor son. Mr. Freeny's address is
6220 N.E. 113th Street, Edmond, Oklahoma 73034.
(3) Includes 2,275 shares subject to options held by Mr. Damoose and 400 shares
subject to warrants to be issued to Mr. Damoose. Additionally, the Company
is obligated to grant to Mr. Damoose on July 1, 2000, shares which
represent 0.5% of the fully diluted outstanding Common Stock on such date,
in connection with his service on the Board of Directors of the Company,
which shares are not included here in this total and are subject to
forfeiture pursuant to the terms of the Stock Agreement (as defined
herein). Mr. Damoose also has the option to acquire shares upon the
conversion of the Damoose Note (as defined herein); however, the number of
shares issuable upon conversion cannot be determined because the conversion
price is not currently ascertainable. The Damoose Note is convertible at
any time into shares of Common Stock, at the option of Damoose, at per
share price equal to the lower of (x) the fair market value of the Common
Stock on January 1, 1998, as determined by an appraisal, or (y) the lowest
publicly traded price of the Common Stock three months following the
establishment of a public trading market for the Common Stock.
(4) Includes 6,824 shares subject to options held by Mr. Sekulow; 2,666 shares
which C.A.S.E., Inc. ("CASE") and/or Mr. Halliday has the option to
purchase from Mr. Thompson; 3,400 shares subject to warrants to be issued
to CASE, an entity of which Mr. Sekulow is President and a director and
29,563 shares held by CASE. Additionally, the Company is obligated to grant
to Mr. Sekulow on July 1, 2000, shares which represent 0.5% of the fully
diluted outstanding Common Stock on such date, in connection with his
service on the Board of Directors of the Company, which shares are not
included here in this total and are subject to forfeiture pursuant to the
terms of the Stock Agreement (as defined herein). CASE also has the right
to acquire shares upon the conversion of the CASE Note (as defined herein);
however, the number of shares issuable upon conversion cannot be determined
because the conversion price is not currently ascertainable. The CASE Note
is convertible at any time into shares of Common Stock, at the option of
CASE, at per share price equal to the lower of (i) the fair market value of
the Common Stock on January 1, 1998, as determined by an appraisal, or (ii)
the lowest publicly traded price of the Common Stock three months following
the establishment of a public trading market for the Common Stock.
(5) Includes 152,983 shares held jointly by Ms. Freeny and her husband and
2,200 shares held by Ms. Freeny's minor son. Ms. Freeny disclaims
beneficial ownership of the shares owned by her minor son. Ms. Freeny's
address is 6620 N.E. 113th Street, Edmond, Oklahoma 73034.
(6) Harvey Price's address is Route 1, Box 49D, Wetomka, Oklahoma 74883.
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(7) Donald Price's address is Route 2, Box 46, Holdenville, Oklahoma 74848.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH MESSRS. FREENY AND THOMPSON
Each of Messrs. Freeny and Thompson is a founder of the Company and
acquired his original shares of Common Stock upon formation of the Company
without payment of cash consideration. These shares represent substantially all
of the shares of Common Stock owned by each of them.
From 1994 until 1997, the Company paid distributions to all shareholders
including distributions of $443,100 to Mr. Freeny and $160,100 to Mr. Thompson.
From July 1, 1995, the Company paid distributions to all shareholders except
Messrs. Freeny and Thompson. As to them, the Company annually accrued
distributions for 1995, 1996 and 1997 of $849,118, $1,659,443 and $1,260,343,
respectively, to Mr. Freeny and annually accrued distributions for 1995, 1996
and 1997 of $301,827, $582,459 and $433,010, respectively, to Mr. Thompson on
their shares of Common Stock. These distributions were accrued on the same per
share basis as paid to all other shareholders of the Company. As of December 31,
1999, the Company's financial statements reflect outstanding non-interest
bearing accrued distributions payable to Messrs. Freeny and Thompson of
$3,200,000 and $98,000, respectively. Pursuant to the Thompson Separation
Agreement (See Item 11), the Company began paying Mr. Thompson monthly
installments of $40,000 towards these accrued but unpaid distributions in
connection and such amounts will continue until paid in full, which will be
completed in March 2000.
In a letter agreement dated July 14, 1999, the Company and Mr. Freeny
agreed to defer payment of such amounts allegedly owed to Mr. Freeny until such
time as the Company's financial condition further improved and it had funds
available, legally and in good business practice, to pay any such accrued
distributions. In consideration for this deferral and Mr. Freeny's subordination
of the accrued distributions to the Coast Loan, the Company agreed to pay him,
in addition to his salary, $300,000 per year until the payment of the accrued
distributions was resumed and, if resumed, all amounts paid to Mr. Freeny
pursuant to the agreement would be credited against his accrued distributions.
During the year ended December 31, 1999, these payments totaled $150,000.
In January 1995, the Company redeemed 2,140 shares of Common Stock for
$214,164 from Mr. Freeny and 250 shares of Common Stock for $25,000 from Mr.
Thompson.
In 1995 and 1996, Tracy Freeny, at that time President and a director of
the Company; Carl Thompson, at that time Senior Vice President and a director of
the Company; and Willeta Thompson, Mr. Thompson's wife, sold 21,204 shares of
Company Common Stock to 100 individuals at an aggregate price of approximately
$2,480,000. The selling price ranged from $40 per share to $150 per share
averaging $117 per share. In connection with each sale, Mr. Freeny caused the
Company to issue a redemption agreement to the purchaser obligating the Company
to buy back the stock at the purchase price plus a guaranteed return. (See Note
H for a description of the redemption agreements.)
The Company believes that these sales were initially made as new issuances
of the Company's stock in consideration for monies received by the Company. The
Company believes that subsequently these sales were characterized as sales of
Mr. Freeny's (and Mr. and Mrs. Thompson's) shares (the "Stock Transactions").
However, the redemption agreements discussed above continued to remain in place
and obligated the Company to redeem shares sold by Mr. Freeny (and Mr. and Mrs.
Thompson).
As discussed above, the monies from the sale of stock characterized as
sales by Mr. Freeny (and Mr. and Mrs. Thompson) in the amount of $2,480,000 had
been received by the Company. These amounts were treated as loans to the Company
(at 8% per annum with a two-year maturity) by Mr. Freeny (and Mr. and Mrs.
Thompson). The Company repaid these loans in 1997 and 1998, and all such notes
were repaid in full by March 31, 1998, as set out in the chart below. The end
result of these loan payments was that Mr. Freeny (and Mr. and Mrs. Thompson)
had completed the sale of $2,480,000 of their stock at an average purchase price
of $117 per share, which utilized Company redemption agreements.
ORIGINAL MATURITY PAYMENT
DATE PAYEE PRINCIPAL DATE STATUS
---- ----- --------- ---- ------
June 1, 1995 Carl Thompson $100,000 May 31, 1997 paid in full at maturity
August 31, 1995 Willeta Thompson 658,813 August 31, 1997 paid in full in March 1998
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37
September 30, 1995 Tracy Freeny 318,134 September 30, 1997 paid in full at maturity
October 31, 1995 Tracy Freeny 962,120 October 31, 1997 paid in full at maturity
November 30, 1995 Tracy Freeny 29,765 November 30, 1997 paid in full at maturity
December 31, 1995 Tracy Freeny 9,399 December 31, 1997 paid in full at maturity
March 31, 1996 Tracy Freeny 343,501 March 31, 1998 paid in full at maturity
October 23, 1996 Tracy Freeny 345,000 demand note paid in full in May 1997
Mr. Freeny never fully disclosed all relevant information to the current
Board regarding the history of the Stock Transactions. Consequently, in January
1999, the Board approved a settlement with a shareholder believing incorrectly
that the shareholder had purchased $750,000 worth of stock from the Company in
October 1995 and received a redemption agreement from the Company. The Board
subsequently discovered that the stock had been purchased from Mr. Freeny, not
the Company, yet the Company had been caused by Mr. Freeny to issue a redemption
agreement. Through December 31, 1999, the Company has redeemed 5,278 shares and
paid a total of $1,060,000 in connection with these redemptions. The amounts
paid consisted of $790,000 for the amounts paid by the stockholders and $270,000
for the specified rate of return, as described in the agreements, for a total
payment of $200.72 per share.
In December 1997, Mr. Thompson borrowed $400,000 from a shareholder of the
Company, Aubrey Price, and subsequently loaned all of the proceeds therefrom to
the Company. Mr. Thompson then directed the Company to make all payments in
respect of his loan to the Company to the shareholder in satisfaction of his
loan to Mr. Thompson. This loan bore interest at an imputed rate of 51% based on
repayment of the loan in 10 monthly payments of $50,000. This loan has been paid
in full.
Additionally, during 1996, 1997 and 1998, Messrs. Freeny and Thompson and
Tom Anderson, Mr. Thompson's son-in-law, periodically made short-term,
non-interest bearing loans to the Company for working capital that remained
outstanding from one day to up to three months. The following table sets forth
the amounts advanced and repaid during such periods:
1996 1997 1998
---- ---- ----
PARTY LOANS REPAYMENTS LOANS REPAYMENTS LOANS REPAYMENTS
- ------------- -------- ---------- -------- ---------- -------- ----------
Tracy Freeny $845,000 $500,000 $601,000 $946,000 $497,824 $400,000
Carl Thompson 155,000 155,000 120,000 120,000 -- --
Tom Anderson 120,000 120,000 -- -- -- --
From 1996 to 1998, Messrs. Freeny and Thompson received sales commissions
from the Company, which were based on the amount of revenue the Company derived
from certain customers. The total amount of commissions was 5% of the revenue
generated from all customers of the Company for which no other sales agent or
representative of the Company was receiving a commission. The total commissions
from such sales were split among Messrs. Freeny, Thompson and a third employee.
In 1996, 1997 and 1998, commissions paid to each of Messrs. Freeny and Thompson
were $228,176 and $228,176; $238,195 and $231,314; and $246,111 and $85,004,
respectively.
Mr. Freeny received payments of $606,000 in 1999, consisting of salary,
bonus and distributions.
TRANSACTIONS WITH VISIONQUEST
The Company, Messrs. Freeny and Thompson and Shawn Rohrer, Mr. Freeny's
son-in-law, formed VisionQuest in March 1993 to contract with the Company to
outsource substantially all of the Company's telemarketing service requirements.
Messrs. Freeny and Thompson served as directors and officers of VisionQuest and
Mr. Rohrer is the President and a director of VisionQuest.
The Company compensated VisionQuest for its service through a variety of
arrangements including commissions, hourly fees and overhead and expense
reimbursements. In 1995, 1996, 1997 and 1998, the Company's total payments to
VisionQuest were $11,103,000, $8,987,000, $5,274,000 and $6,209,000,
respectively, which resulted in the Company paying VisionQuest an effective
hourly rate of $36, $31, $33 and $50, respectively, in those years. The Company
now believes it paid higher rates for VisionQuest's services than it would have
paid to an independent service provider. The Company believes that the amounts
it paid to VisionQuest for telemarketing services could have been $2.0 million
to $4.0 million higher than what it could have obtained in an arms-length
transaction from an unaffiliated third party. This estimate is based upon an
estimate of available third party telemarketing rates, but there can be no
assurance that the Company could have obtained such services at such rates on
otherwise acceptable terms. For instance, VisionQuest gave priority to the
Company's requests, and agreed to do business with the Company without long
term or minimum purchase agreements.
Mr. Freeny received compensation from VisionQuest in 1995, 1996 and 1997
totaling approximately $303,600, $414,000 and $6,500, respectively; Mr. Thompson
received compensation from VisionQuest in 1995, 1996 and 1997 totaling
approximately
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$292,000, $378,000 and $5,800, respectively; and Mr. Rohrer received
compensation from VisionQuest in 1995, 1996 and 1997 totaling approximately
$367,000, $503,000, and $590,000, respectively. The amount of compensation
received by Mr. Rohrer in 1998 is not known. In January 1997 all compensation
paid to Messrs. Freeny and Thompson from VisionQuest was permanently
discontinued.
Periodically during 1997, VisionQuest made short-term working capital loans
to the Company. These loans ranged from $50,000 to $100,000, did not bear
interest and were repaid within three to five business days. All of these loans
have been paid in full. In 1997, the total loans made by VisionQuest were
$400,000 and repayments totaled $300,000 in 1997 with the remaining $100,000
being repaid in 1998.
In connection with its telemarketing services, VisionQuest utilized the
Company's telecommunication services and paid the Company's out-of-pocket
expenses for such services. In 1995, 1996, 1997 and 1998, VisionQuest paid the
Company approximately $930,000, $1,030,000, $788,000 and $1,001,000 for
telecommunication services.
Effective January 1, 1999, pursuant to various written agreements, the
Company and VisionQuest terminated their business relationship. The Company
purchased from VisionQuest the rights to use all of VisionQuest's assets related
to its call center located in Tahlequah, Oklahoma through December 1999
("Tahlequah Assets") for the following consideration (i) 1,099,850 shares of
common stock of VisionQuest, which represented approximately 48% of the
outstanding stock of VisionQuest (397,100 of these shares were owned by the
Company and 702,750 of these shares were owned by Tracy Freeny which he conveyed
to the Company for no consideration immediately prior to the consummation of
this transaction) and (ii) cancellation of all remaining amounts owed by
VisionQuest to the Company pursuant to a promissory note dated December 31, 1997
in the original principal amount of $670,000 ($520,000 was owed as of the
effective date of the transaction). Also, in connection with and as
consideration for the transaction, each of the Company and VisionQuest executed
mutual releases related to all prior dealings between the parties including all
contracts or obligations between the two parties.
TRANSACTIONS WITH HEBRON
Messrs. Telling, Freeny, Thompson and others formed Hebron in December 1995
to provide certain telecommunications services to the Company. By February 1,
1999, Hebron's primary assets consisted of various equipment and leases for
equipment utilized in telecommunications switching network services ("Switching
Assets"), a 20-story, 195,000 square foot office tower in Oklahoma City,
Oklahoma, where the Company's principal executive offices and some of its
operations are located, and certain assets jointly-developed with the Company
and used in connection with the Company's Internet operations ("Internet
Assets").
In 1995, the Company purchased equipment, which was then sold to Hebron in
March 1996 for the Company's cost basis in such equipment. Also in 1995, the
Company entered into a lease agreement with a third party to lease additional
switching network equipment. In March 1996, the Company sublet this equipment to
Hebron on identical terms as the Company's lease terms and ultimately assigned
the lease to Hebron in July 1996, with the Company remaining a guarantor of all
lease obligations. Additionally, the Company assigned a telecommunications
services agreement to Hebron.
During 1996, 1997, 1998 and for the month of January 1999 (the Company
began operating the switches on February 1, 1999), the Company incurred
telecommunications services expense payable to Hebron of approximately
$4,685,000, $13,529,000, $14,736,000 and $1,469,000, respectively and in the
total amount of $34,419,000. In 1997, the Company believes that it could have
obtained the services provided by Hebron on more favorable terms in an arm's
length transaction with an unaffiliated third party. The Company's primary
carrier lowered its rates in 1997. However, in 1998 the Company and Hebron
adjusted the rates being charged so that the Company was paying Hebron generally
what the Company would pay for similar services in an arm's length transaction
with an unaffiliated third party. The Company believes that the amounts it paid
to Hebron for telecommunication services in 1997 were approximately $1.0 million
higher than what it could have obtained from its primary carrier.
In December 1995, the Company advanced Hebron $170,000 to make the cash
payment to purchase the office building owned by Hebron. This advance was
interest free and repaid in March 1996. Beginning in 1996, the Company leased
office space from Hebron. Since January 1998, the Company's principal executive
offices and office space for some of its operations were being leased from
Hebron. During 1997, 1998 and 1999, the Company incurred rent expense payable to
Hebron of approximately $110,000, $380,000 and $530,000, respectively. The
Company believes that the terms of the lease with Hebron were comparable to the
rate available in an arm's length transaction with an unaffiliated third party.
In December 1996, Hebron began providing advance funding to the Company on
billings transmitted by the Company to certain
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39
LECs. Certain shareholders of Hebron, including Judith Telling, Mr. Telling's
wife, and Art Richardson and David Dalton, each directors of Hebron, loaned
Hebron money at 18% per annum so that Hebron could make the loans to the
Company. The Company assigned specific LEC tapes to an independent escrow agent
designated by Hebron, who would forward the tapes to the applicable LEC and,
upon confirmation of receipt of the tape, advance up to 75% of the net tape
amount to the Company. When the escrow agent received payment from the LEC it
would remit payment to the Company of any remaining amounts owed to the Company
after deducting interest of 18% per annum on the advance amount and factoring
fees charged by Hebron of 2% of the tape amount plus $0.02 per call record. In
1996, 1997 and 1998, the Company incurred expenses in connection with these
advances of approximately $57,000, $908,000 and $879,000, respectively. At
December 31, 1998, all amounts had been repaid. Based on the amount of interest
and factoring fees charged on these loans to the Company by Hebron pursuant to
this program, the effective costs of funds on such loans was approximately 58%
per annum. Based upon financing rates subsequently received by the Company from
third party lenders, the Company believes that it could have obtained
unaffiliated third party financing on significantly more favorable terms.
In 1996 and 1997, Hebron paid Mr. Telling and his wife aggregate dividends
of $31,500 and $70,500, respectively, with respect to the stock they owned in
Hebron. Hebron also paid dividends of $23,625 to each of Mr. Freeny and Mr.
Thompson in 1996 and dividends of $52,875 to each of Messrs. Freeny and Thompson
in 1997.
John Telling, a former director and executive of the Company, has been the
President and Chief Executive Officer and a director of Hebron since its
formation in December 1995 and is also a major shareholder of Hebron. In 1997,
1998 and 1999, Hebron paid Mr. Telling $112,308, $187,308 and $125,000,
respectively, as salary and cash bonuses for his services to Hebron and in 1998
Mr. Telling received a bonus of Hebron stock valued at $225,000.
Each of Messrs. Freeny and Thompson served as directors and officers of
Hebron from its formation until November 1996 and are shareholders of Hebron,
and John Damoose, a director of the Company, is a director of Hebron. Messrs.
Telling, Freeny and Thompson received stock in Hebron for serving as directors
of Hebron. As of December 31, 1999, Mr. Telling and his wife, collectively, and
Messrs. Freeny and Thompson owned 8.80%, 5.87%, and 5.87%, respectively, of the
outstanding stock of Hebron. Mr. Damoose does not own any stock in Hebron and
receives no compensation for serving as a director of Hebron. In December 1998,
Messrs. Freeny and Thompson each returned the 2,500 shares of Hebron stock they
received for serving as directors of Hebron.
Effective February 1, 1999, the Company began operating the Switching
Assets and the Internet Assets and anticipates acquiring all of such assets (the
"Hebron Acquisition") no later than April 30, 2000. At the closing of the Hebron
Acquisition, the Company will pay to Hebron the following: (i) as consideration
for the Switching Assets, $567,073 in the form of a promissory note (the "Switch
Note") and (ii) as consideration for the Internet Assets, $584,295 in the form
of a promissory note ("Internet Note"). Also, the Company issued to Hebron a
promissory note ("Payables Note") in the amount of $2,274,416 as consideration
for amounts owed by the Company directly to Hebron for switching services prior
to February 1, 1999. Also, in connection with the Hebron Acquisition, the
Company will assume the following liabilities of Hebron: (a) all liabilities
under contracts related to the Switching Assets and Internet Assets, (b) the
costs of Hebron in excess of its revenues in winding up its business from
February 1, 1999 until May 1, 2001 with such costs not to exceed $1,156,000,
with any such payments to be credited against the outstanding principal balance
of the Switch Note and Internet Note, and (c) all outstanding accounts payable
of Hebron to unaffiliated third parties which result from the use by the Company
of the Switching Assets which totaled $2,338,580. One of the contracts to be
assumed by the Company is a six year contract between Hebron and IXC pursuant to
which Hebron contracts for services guaranteeing IXC a minimum of $550,000
monthly revenue from such contract.
Mr. Freeny will guarantee all of the Company's obligations pursuant to the
Switch Note, Internet Note and Payables Note, with such guaranty being secured
by a pledge of 50,000 shares of Common Stock owned by Mr. Freeny. At the closing
of the Hebron Acquisition, each of Messrs. Freeny and Thompson and another
individual will deliver 20,000 shares of Hebron Stock owned by each of them to
Hebron and in return Hebron will transfer to each 2,000 shares of Amerivision
Common Stock owned by Hebron.
The Switch Note and the Internet Note will have identical terms which will
be as follows: interest accrues at 12.50% per annum for the first nine months
after issuance and 16.25% per annum thereafter, accrued interest is paid monthly
in arrears, principal is payable in six equal installments with the first
payable due 13 months from issuance and continuing each month thereafter until
paid in full 18 months from such issuance and all obligations under these notes
will be subordinated to the Coast Loan. The Payables Note was issued effective
as of February 1, 1999 and its terms are identical to the Switch Note and the
Internet Note except that the outstanding principal amount of the Payables Note
is due and payable in one installment on August 31, 2000.
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Hebron has announced plans to liquidate. Hebron has informed the Company
that it intends to sell the office building in Oklahoma City in which the
Company leases office space and to distribute the proceeds from the sale of
Hebron's assets to Hebron's shareholders.
Mr. Telling became a director of the Company in October 1998 and an officer
in January 1999 and resigned in December 1999. See Item 11 above regarding Mr.
Telling's agreement with the Company.
TRANSACTIONS WITH DIRECTORS
Jay A. Sekulow, a director of the Company, is Chief Executive Officer, a
director and 50% shareholder of Regency Productions, Inc. ("Regency"), and,
through Regency, hosts a daily nationally syndicated radio talk show and Mr.
Sekulow advertises the long distance services of the Company during the show. In
1999, the Company paid Regency as much as $159,000 per month to fund a portion
of the cost that Regency incurs in creating this show In 1997, 1998 and 1999,
these payments were $1,803,000, $1,918,000 and $1,908,000, respectively. The
Company estimates that it has received over 150,000 customer subscriptions as a
result of advertising during Mr. Sekulow's show.
Regency also receives 10% of certain collected revenues from the customers
subscribed as a result of the advertising during the show, the same
consideration paid to all unaffiliated non-profit organizations by the Company
for their endorsement. Mr. Sekulow is also Chief Counsel of ACLJ and President
and a director of CASE, each of which provides its membership list to the
Company in return for receiving 10% of certain collected revenues from members
of such organizations who become customers of the Company, the same arrangement
that all other non-profit organizations have with the Company. For 1997, 1998
and 1999, Regency, ACLJ and CASE collectively received aggregate payments from
the Company as a result of these 10% payments (but not including amounts funded
by the Company in respect of the radio show) of approximately $775,000,
$1,060,000 and $1,107,000, respectively. Additionally, these non-profit
organizations receive an agent commission ranging between 2% and 5% of certain
collected revenues, which for 1997 and 1998 were approximately $168,000, and
$497,000, respectively. Effective January 1, 1999, the Company entered into
Royalty Agreements with each of Regency and CASE, pursuant to which the Company
agreed to pay (a) Regency $110,500 in 1999 and $102,000 in each of 2000 and 2001
and (b) CASE $386,500 in 1999 and $395,000 in each of 2000 and 2001, in each
case as settlement for all past royalties and agency claims by Regency and CASE,
elimination of any agent commissions due after 2001 and certain non-competition
agreements of Regency and CASE, and also in partial settlement of issues arising
from the CASE Loan described below. The terms of the royalty agreements are
substantially the same as arrangements under which the Company phased out the
compensation of certain of its sales agents.
From August 1997 through November 1997, CASE loaned the Company an
aggregate of $1.0 million ("CASE Loan"). To obtain the CASE Loan, the Company
made representations to CASE regarding the use of the CASE Loan proceeds and the
effect of such uses on agent commission payments which would be made to CASE.
The CASE Loan accrued interest at 10% and was due within two years. Although
some principal payments were made, the Company did not have the financial
ability to fully repay the CASE Loan within the two year time period.
Furthermore, the Company had failed to fulfill representations the Company had
made on agent commissions that could be obtained as a result of the CASE Loan.
Nonetheless, CASE consented to Coast's requirement that CASE subordinate the
CASE Loan to the Coast loan. In April 1999, the outstanding principal balance
and all accrued interest thereon of the CASE Loan was converted into a new note
payable to CASE in the principal amount of $850,000, of which $588,183 was the
remaining principal balance and accrued interest on the CASE Loan and $261,817
was a new loan from CASE to the Company (the "CASE Note"). The CASE Note bears
interest at 10% per annum which is payable monthly and the entire outstanding
principal balance is payable in full in April 2004 which can be extended at
CASE's option for an additional five years on the same terms and conditions. The
CASE Note is subordinated to the Coast Loan and is convertible at any time into
shares of Common Stock, at the option of CASE, at a per share price equal to the
lower of (i) the fair market value of the Common Stock on January 1, 1998, as
determined by an appraisal, or (ii) the lowest publicly traded price of the
Common Stock three months following the establishment of a public trading market
for the Common Stock. Prior to the fourth anniversary of the Note, the Company
has the right to prepay the CASE Note at a 10% premium to its then appraised
value (including conversion value) ("Prepayment Right"). In connection with the
issuance of the CASE Note, the Company has issued CASE warrants to purchase
3,400 shares of Common Stock for $0.01 per share. The Company believes that the
terms and conditions of the CASE Loan and CASE Note were at least as favorable
as the Company could have obtained in an arm's length transaction with an
unaffiliated third party.
In June 1998, John Damoose, a director of the Company, loaned the Company
$150,000. The loan accrued interest at 18% and $50,000 of the principal was
repaid in May 1999. In May 1999, the outstanding principal balance and all
accrued interest thereon of the Damoose Loan was converted into a new note
payable to Mr. Damoose in the original principal amount of $100,000 ("Damoose
Note"). The terms of the Damoose Note and the terms of the CASE Note are
identical other than the amounts and the length of the
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extension. The Damoose Note matures in April 2001 and can be extended, at Mr.
Damoose's option, for an additional three years on the same terms and
conditions. In connection with the issuance of the Damoose Note, the Company has
issued Mr. Damoose warrants to purchase 400 shares of Common Stock for $0.01 per
share. The Company believes that the terms and conditions of the Damoose Loan
and Damoose Note were at least as favorable as the Company could have obtained
in an arm's length transaction with an unaffiliated third party.
Additionally, Mr. Damoose is affiliated with a non-profit organization that
receives financial support from the Company in exchange for promotion of the
Company's products and services. During the years ended December 31, 1998 and
1999, the Company paid this organization $-0- and $175,000, respectively.
From 1997 until October 1998, Mr. Halliday, the President, Chief Executive
Officer and a director of the Company, was a partner in the law firm of WRF and
Mr. Halliday continues to serve as Of Counsel with WRF for matters, which do not
involve the Company. In 1997, 1998 and 1999, the Company paid WRF $69,000,
$741,000 and $767,000, respectively, for legal fees and expenses. Mr. Halliday
does not share in or otherwise benefit from the legal fees paid to WRF by the
Company. WRF billed the Company its standard billing rates for work performed
for the Company.
In addition, Messrs. Halliday, Damoose and Sekulow received and are
entitled to receive certain other payments from the Company more particularly
described in Item 11 above.
OTHER MISCELLANEOUS TRANSACTIONS
In 1997, the Company entered into twenty-five year sales representative
agreements with twenty-five of its key sales representatives, including, Tom
Anderson, Mr. Thompson's son-in-law; Diana Riske, Mr. Telling's daughter; and
Jeff Cato, Mr. Freeny's son-in-law. The agreements provide that the sales
representatives will receive a commission of 3% of the net domestic billings of
customers who subscribe to the Company's telecommunication services either
directly or indirectly through any subscriber, business or organization procured
as a result of the sales representatives contact with such subscriber, business
or organization. In addition, the sales representatives will receive a
commission of 1% of the net domestic billings of customers subscribed through
any sales representative of the Company recruited by the sales representative.
The sales representatives will receive substantially all of the payments under
these agreements if they die or are terminated, with or without cause, during
the term of the agreement. Another sales representative who also had a
twenty-five year sales representative agreement, David Dalton, has received
salary and commissions of $936,800, $757,255 and $667,585 for each of 1997, 1998
and 1999 under his agreement. For 1997, 1998 and 1999, Mr. Anderson, Ms. Riske
and Mr. Cato received salary and commissions of approximately $232,000, $206,000
and $150,000; $99,000, $55,000 and $93,000; and $94,000, $134,000 and $133,000,
respectively. In April 1998, Mr. Anderson resigned as an employee of the Company
and, pursuant to the terms of a separation agreement with Mr. Anderson, the
Company will pay him 100% of all amounts under his agreement until the Company
completes an initial public offering, at which point he will receive 75% of such
amounts for as long as the customer continues long distance service with the
Company. In January 1999, all but ten of the sales representatives, who still
had twenty-five year sales representative agreements, including Mr. Dalton and
Ms. Riske, entered into new agreements with terms no longer than six years. In
July 1999, Mr. Cato voluntarily agreed to terminate his contract and continues
to work for the Company as a salaried employee. Of the remaining nine sales
representatives with twenty-five year agreements, the Company settled with five
of them and will make payments that will conclude by September 2002, and
terminated the agreements with the other four. With respect to these four former
sales representatives, the Company is obligated to pay them commissions for
twenty-five years from the date of their termination.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
The Financial Statements listed below are filed as part of this
Form 10-K following the signature page hereof beginning on
page F-1.
Index to Consolidated Financial Statement
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1998 and 1999
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Consolidated Statements of Operations for the Years Ended December 31,
1997, 1998 and 1999
Consolidated Statements of Stockholders' Deficiency for the Years
Ended December 31, 1997, 1998 and 1999
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1998 and 1999
Notes to Consolidated Financial Statements
(b) Exhibits
3.1 - Certificate of Incorporation of the Company
3.2 - Bylaws of the Company
3.3 - Secretary certificate regarding amended and restated bylaws
4.1 - Form of certificate representing shares of the Company's common stock
4.2 - Form of Type A Redemption Agreement
4.3 - Form of Type B Redemption Agreement
4.4 - Form of Type C Redemption Agreement
4.5 - Form of Type D Redemption Agreement
4.6 - Form of Convertible Note
4.7 - Promissory Note dated April 20, 1999, payable by the Company to
C.A.S.E., Inc.
4.8 - Promissory Note dated April 20, 1999, payable by the Company to John
Damoose
10.1 - Agreement, dated as of April 13, 1998, between the Company and Carl
Thompson
10.2 - First Amendment to April 13, 1998 Agreement between Amerivision
Communications, Inc. and Carl Thompson, dated as of December 31,
1998, among the Company, Carl Thompson and Willeta Thompson
10.3 - Amended and Restated Employment Agreement, dated as of May 24, 1999
between the Company and Stephen D. Halliday
10.4 - Amended and Restated Stock Agreement, dated as of May 24, 1999, among
the Company, Jay A. Sekulow and Tracy Freeny
10.5 - Amended and Restated Stock Agreement, dated as of May 24, 1999, among
the Company, John Damoose and Tracy Freeny
10.6 - Employment Agreement, dated as of May 24, 1999, between the Company
and John E. Telling
10.7 - Employment Agreement dated as of May 24, 1999 between the Company and
Tracy Freeny
10.8 - Reaffirmation of Commitments made in Employment Agreement of Stephen
D. Halliday dated as of June 30, 1999
10.9 - Reaffirmation of Commitments made in Stock Agreement of Jay A.
Sekulow dated as of June 30, 1999 10.10 - Agreement effective January
1, 1999, between the Company and VisionQuest
10.11 - Telemarketing Services Agreement, effective as of January 1, 1999
Between the Company and VisionQuest
10.12 - Clarification to Agreement, effective as of June 9, 1999, by and
Between the Company and VisionQuest
10.13 - Asset Purchase Agreement, dated as of April 30, 1999, among Hebron,
the Company, Tracy Freeny, Carl Thompson and S. T. Patrick.
10.14 - Lease/License Agreement, dated as of April 30, 1999 between Hebron
and the Company.
10.15 - Form of Promissory Note payable by the Company to Hebron (form to be
used with respect to Switch Note and Internet Note)
10.16 - Promissory Note dated February 1, 1999, in the original principal
amount of $2,274,416 payable by the Company to Hebron
10.17 - Capital Stock Escrow and Disposition Agreement dated April 30, 1999
among Tracy C. Freeny, Hebron and Bush Ross Gardner Warren & Rudy,
P.A.
10.18 - Loan and Security Agreement dated as of February 4, 1999 between
10.18.1 - Amendment Number One to Loan and Security Agreement dated as of
October 12, 1999 between the Company and Coast Business Credit
10.18.2 - Amendment Number Two to Loan and Security Agreement dated as of May
10, 2000 between the Company and Coast Business Credit
10.19** - Telecommunications Services Agreement dated April 20, 1999 by and
between the Company and WorldCom Network Services, Inc.
10.20** - Program Enrollment Terms dated April 20, 1999 between the Company
and WorldCom Network Services, Inc.
10.21 - Security Agreement dated April 20, 1999 by and between the Company
and WorldCom Network Services, Inc.
10.22 - Letter Agreement dated July 14, 1999 between the Company and Tracy C.
Freeny
10.23 - Employment Agreement dated December 31, 1998, between the Company and
Kerry Smith
10.24 - Letter Agreement dated as of December 31, 1999 between the Company
and John Telling
10.25 - Royalty Agreement dated as of January 1, 1999 between the Company and
Regency Productions, Inc.
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10.26 - Royalty Agreement effective as of January 1, 1999 between the Company
and Christian Advocates Serving Evangelism, Inc.
10.27 - Stock Incentive Plan
21.1 - List of subsidiaries of the Company
27.1* - Financial Data Schedule
* Filed herewith.
** Information from this agreement has been omitted because the Company has
requested confidential treatment. The information has been filed separately
with the Securities and Exchange Commission.
*** Incorporated by reference to the Company's Registration Statement on FORM
10/A and FORM 10, as appropriate.
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SIGNATURES
Pursuant to the requirements of the Section 13 of Securities Exchange Act
of 1934, the Registrant has duly caused this registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
AMERIVISION COMMUNICATIONS, INC.
Date: April 16, 2001 By: /s/ Stephen D. Halliday
------------------------
Stephen D. Halliday
President and Chief Executive Officer
By: /s/ David E. Grose
-------------------
David E. Grose
Vice President and Chief Financial
Officer
(Principal Financial Officer)
By: /s/ Jay Sekulow
---------------
Jay Sekulow
Vice Chairman of the Board
and Director
By: /s/ John Damoose
----------------
John Damoose
Director
By: /s/ Tracy Freeny
----------------
Tracy Freeny
Chairman and Director
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45
Audited Consolidated Financial Statements
AMERIVISION COMMUNICATIONS, INC.
As of December 31, 1998 and 1999, and for the Years Ended December 31, 1997,
1998 and 1999
Independent Auditors' Report.................................................F-1
Consolidated Balance Sheets..................................................F-2
Consolidated Statements of Operations........................................F-4
Consolidated Statements of Stockholders' Deficiency..........................F-5
Consolidated Statements of Cash Flows........................................F-6
Notes to Consolidated Financial Statements...................................F-8
46
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
AmeriVision Communications, Inc.
Oklahoma City, Oklahoma
We have audited the accompanying consolidated balance sheets of AmeriVision
Communications, Inc. as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' deficiency, and cash flows
for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AmeriVision
Communications, Inc. at December 31, 1998 and 1999, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with generally accepted accounting principles.
/s/ Cole & Reed, P.C.
Oklahoma City, Oklahoma
March 31, 2000, except for Note N, for which the effective date is December 6,
2000
F-1
47
CONSOLIDATED BALANCE SHEETS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
December 31
1998 1999
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 635 $ 991
Accounts receivable, net of allowance for uncollectible
accounts of $393 and $500 at December 31, 1998 and 1999, 16,058 16,743
Receivables from related parties 152 --
Investment in and note receivable from affiliate 578 --
Prepaid expenses and other current assets 231 428
------------- -------------
TOTAL CURRENT ASSETS 17,654 18,162
OTHER ASSETS
Property and equipment, net 1,118 5,775
Net deferred income tax benefits 5,577 3,600
Covenants not to compete 546 3,200
Asset held for disposal 500 --
Other assets 179 357
------------- -------------
7,920 12,932
TOTAL ASSETS $ 25,574 $ 31,094
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
48
CONSOLIDATED BALANCE SHEETS (dollars in thousands)--Continued
AMERIVISION COMMUNICATIONS, INC.
December 31
1998 1999
------------ ------------
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES
Revolving line of credit $ -- $ 20,880
Accounts payable and accrued expenses 21,532 14,029
Accounts payable to related parties 3,232 --
Borrowings under accounts receivable based credit facilities 7,964 --
Accrued interest payable 292 5
Short-term notes payable to individuals 5,268 553
Loans and notes payable to related parties, current portion 686 2,657
Current portion of other notes payable and capital lease obligations 2,315 2,300
------------ ------------
TOTAL CURRENT LIABILITIES 41,289 40,424
LONG-TERM DEBT TO RELATED PARTIES, net of current portion 4,218 5,425
ACCRUED DISTRIBUTIONS TO RELATED PARTY 3,225 3,201
LONG-TERM DEBT, net of current portion 1,046 3,694
REDEEMABLE COMMON STOCK, carried at redemption value 1,755 1,639
Shares outstanding at December 31, 1998: 15,737
Shares outstanding at December 31, 1999: 15,537
COMMON STOCK SUBJECT TO RESCISSION 1,685 469
STOCKHOLDERS' DEFICIENCY
Common Stock--par value $0.10 per share, 82 82
authorized 1,000,000 shares
total issued and outstanding:
December 31, 1998: 839,127
December 31, 1999: 838,927
net of redeemable shares and shares subject to rescission:
December 31, 1998: 823,390
December 31, 1999: 823,390
Additional paid-in capital 8,816 10,228
Unearned compensation (465) (317)
Retained earnings (deficit) (36,077) (33,751)
------------ ------------
TOTAL STOCKHOLDERS' DEFICIENCY (27,644) (23,758)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIENCY $ 25,574 $ 31,094
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
49
CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except share and
per share amounts)
AMERIVISION COMMUNICATIONS, INC.
Years Ended December 31
1997 1998 1999
------------- ------------- -------------
NET SALES $ 113,351 $ 124,232 $ 114,661
OPERATING EXPENSES
Cost of telecommunication services 44,711 48,787 53,050
Cost of telecommunication services provided by related parties 13,529 14,736 1,469
Selling, general and administrative expenses 44,530 49,523 47,645
Selling, general and administrative expenses to related parties 5,893 6,805 --
Depreciation and amortization 683 2,102 2,899
------------- ------------- -------------
TOTAL OPERATING EXPENSES 109,346 121,953 105,063
------------- ------------- -------------
INCOME FROM OPERATIONS 4,005 2,279 9,598
OTHER INCOME (EXPENSE)
Interest expense and other finance charges (3,245) (4,993) (4,873)
Interest expense and other finance charges to related parties (924) (974) (698)
(Loss) recovery on loans and other receivables -- (552) 182
Net gain (loss) on long-lived assets -- (215) (103)
Equity in income (losses) of affiliates (99) 41 --
Other income 14 59 95
------------- ------------- -------------
(4,254) (6,634) (5,397)
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE (BENEFIT) (249) (4,355) 4,201
INCOME TAX EXPENSE (BENEFIT) 92 (700) 1,977
------------- ------------- -------------
NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE (341) (3,655) 2,224
------------- ------------- -------------
NET INCOME (LOSS) $ (341) $ (3,655) $ 2,224
============= ============= =============
BASIC EARNINGS (LOSS) PER SHARE $ (1.01) $ (4.32) $ 2.83
============= ============= =============
DILUTED EARNINGS (LOSS) PER SHARE $ (1.01) $ (4.43) $ 2.35
============= ============= =============
Weighted average number of shares outstanding
Basic earnings (loss) per share 799,398 804,045 823,390
============= ============= =============
Diluted earnings (loss) per share 799,398 825,004 947,531
============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
50
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
Nonredeemable Common Stock
-------------------------- Additional Retained
Number of Paid-in Unearned Earnings
Shares Amount Capital Compensation (Deficit) Total
------------ ----------- ---------- ------------ ---------- ----------
BALANCE AT JANUARY 1, 1997 789,926 $ 79 $ 3,121 $ -- $ (26,134) $ (22,934)
Acquisition and cancellation of
nonredeemable common stock (100) -- (5) -- (10) (15)
Expiration of redemption obligations
applicable to redeemable common stock 10,617 1 686 -- -- 687
Expiration of potential rescission claims
on nonredeemable common stock -- -- 2,892 -- -- 2,892
Accretion of redemption value of
redeemable common stock -- -- -- -- (470) (470)
Distributions to nonredeemable stockholders
($7.54 per share) -- -- -- -- (5,646) (5,646)
Net loss -- -- -- -- (341) (341)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1997 800,443 80 6,694 -- (32,601) (25,827)
Expiration of redemption obligations
applicable to redeemable common stock 199 -- 19 -- -- 19
Expiration of potential rescission
claims on nonredeemable common stock 1,530 -- -- 1,530
Decrease in redemption value of redeemable
common stock -- 179 179
Shares reserved for restricted stock awards
to Company officer and directors 22,748 2 545 (547) -- --
Vesting of restricted stock awards and stock options 28 82 -- 110
Net loss -- -- -- -- (3,655) (3,655)
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1998 823,390 82 8,816 (465) (36,077) (27,644)
Decrease in redemption value of
redeemable common stock -- -- -- -- 102 102
Expiration of potential rescission
claims on nonredeemable common stock 1,216 -- -- 1,216
Shares reserved for detachable stock
warrants issued with convertible notes -- -- 158 -- -- 158
Vesting of restricted stock awards and stock options -- -- 38 148 -- 186
Net income -- -- -- -- 2,224 2,224
---------- ---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1999 823,390 $ 82 $ 10,228 $ (317) $ (33,751) $ (23,758)
========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
51
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
Years Ended December 31
1997 1998 1999
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) $ (341) $ (3,655) $ 2,224
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation of property and equipment 611 464 1,890
Amortization of intangible assets 72 1,638 1,009
Equity in undistributed net (income) losses of affiliates 99 (41) --
Losses on other receivables -- 552 --
Impairment loss (recovery) on asset held for disposal -- 215 (22)
Loss on disposal of fixed assets -- -- 125
Deferred income tax expense (benefit) 92 (700) 1,977
Issuance of detachable stock warrants -- -- 158
Stock compensation expense -- 110 186
Changes in assets and liabilities:
Decrease (increase) in operating assets:
Accounts receivable (5,575) 2,187 (685)
Sale of accounts receivable 2,435 -- --
Receivables from related parties (503) 351 152
Other receivables (85) 194 --
Prepaid expenses and other assets 20 (62) 709
Increase (decrease) in operating assets:
Accounts payable and accrued expenses 518 5,412 (7,503)
Accounts payable to related parties 1,221 410 (1,597)
Interest payable (188) 43 (287)
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (1,624) 7,118 (1,664)
INVESTING ACTIVITIES
Purchases of property and equipment (337) (353) (2,983)
Deposits paid on fixed assets -- -- (355)
Proceeds from sale of fixed assets -- -- --
Proceeds from sale of asset held for disposal -- -- 522
Release of investments pledged 85 55 10
Advances and loans to related parties (670) -- --
Repayments from related parties -- 150 --
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (922) (148) (2,806)
FINANCING ACTIVITIES
Proceeds of loans from related parties 3,699 1,554 262
Repayments of loans and other obligations to related parties (4,324) (3,051) (1,297)
Net increase (decrease) in borrowings under line of credit arrangements 6,790 (2,850) 12,916
Loan closing fees paid -- (169) (345)
Proceeds from notes payable and long-term debt 590 250 2,553
Repayment of notes and leases payable (224) (304) (4,510)
Proceeds from short-term notes payable to individuals 773 150 --
Repayment of short-term notes payable to individuals (322) (444) (4,715)
Accrued distributions paid to related party -- (242) (24)
Distributions paid to other stockholders (4,906) (1,090) --
Redemptions of common stock (68) (154) (14)
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,008 (6,350) 4,826
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (538) 620 356
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 553 15 635
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15 $ 635 $ 991
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
52
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)--Continued
AMERIVISION COMMUNICATIONS, INC.
Years Ended December 31
1997 1998 1999
---------- ---------- ----------
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest and other finance charges paid $ 4,357 $ 5,924 $ 5,521
========== ========== ==========
Income taxes paid $ -- $ -- $ 60
========== ========== ==========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Acquisition of assets and increase in liability to related company $ -- $ 192 $ --
========== ========== ==========
Assets acquired by incurring capital lease obligations $ 375 $ 70 $ 351
========== ========== ==========
Assets acquired by incurring capital lease obligations and notes payable
to related parties $ -- $ -- $ 2,983
========== ========== ==========
Conversion of redeemable common stock to subordinated note payable $ -- $ 928 $ --
========== ========== ==========
Issuance of shares for restricted stock awards to Company directors $ -- $ 547 $ --
========== ========== ==========
Exchange of investment in common stock and note receivable for lease
of telemarketing facility and equipment $ -- $ -- $ 578
========== ========== ==========
Conversion of trade payables to related party to notes payable
to related party $ -- $ 1,224 $ 1,635
========== ========== ==========
Termination settlement obligations to former officer and employees $ -- $ 2,184 $ 3,834
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Description of Business: AmeriVision Communications, Inc. (the
"Company") was incorporated in Oklahoma on March 15, 1991. The Company provides
long distance telecommunications services to subscribers throughout the United
States, and completes subscriber calls to all directly dialable locations
worldwide.
The Company is a predominantly switchless long distance reseller, and obtains
the majority of its switching and long haul transmission of its service from
WorldCom, Inc. ("WorldCom"). Beginning in 1996, Hebron Communications
Corporation ("Hebron"), a related party, also began providing the Company with a
portion of its switching and transmission services. Hebron leases switching
facilities in Oklahoma City and Chicago. Both WorldCom and Hebron bill the
Company, at contractual per-minute rates, which vary depending on the time,
distance, and type of call, for the combined usage of the Company's nationwide
base of customers. Effective February 1, 1999, the Company assumed operations of
the switches.
In 1998, the Company began developing an internet access service product, and in
July 1999, began marketing the service, which includes an optional filter.
Principles of Consolidation: The Company owns 100% of the common stock of
AmeriTel Communications, Inc. and AmeriVision Network, Inc. Neither of these
companies has any operations nor any assets or liabilities.
Accounting Estimates: The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
Cash Equivalents: The Company defines cash equivalents as highly liquid,
short-term investments with an original maturity of three months or less.
Investments pledged as collateral for loans are not considered cash equivalents.
Accounts Receivable: The Company bills its customers either directly, through
billing agreements with Local Exchange Carriers ("LEC"), or through two
unrelated billing and collection companies, collectively referred to as the
Billing Agents, which bill the customer through LECs with which the Company does
not have a LEC billing agreement. At December 31, 1998 and 1999, approximately
69% and 75%, respectively, of the Company's total accounts receivable were from
LECs or Billing Agents. In addition, approximately 8% of total accounts
receivable at both December 31, 1998 and 1999, respectively, were attributable
to revenues earned in December of the respective year but not billed to the
customers until the normal billing dates in January of the following year.
Property and Equipment: Property and equipment is stated at cost, net of
accumulated depreciation. Depreciation is provided using straight-line and
accelerated methods over the estimated useful lives of the assets. Estimated
lives range from three to seven years for equipment, and five to seven years for
other fixed assets. Maintenance and repairs are charged to expense as incurred.
F-8
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Asset Held for Disposal: The Company's asset held for disposal at December 31,
1998, is carried at the lower of book value or fair value, less estimated costs
to sell.
Advertising Costs: Advertising and telemarketing costs are expensed as incurred,
and totaled approximately $9,942, $11,912 and $4,640 during the years ended
December 31, 1997, 1998 and 1999, respectively.
Investment in and Note Receivable from Affiliate: At December 31, 1998, the
investment in and note receivable from affiliate included the underlying book
value of the Company's 13.25% ownership in VisionQuest Marketing Services, Inc.
("VisionQuest"), and the balance due related to a note receivable from
VisionQuest. As discussed in Note B, the Company and VisionQuest terminated
their business relationship effective January 1, 1999.
Interest Expense and Other Finance Charges: Interest expense and other finance
charges included interest incurred on short-term and long-term borrowings,
interest and related fees on the Company's line of credit facilities, and
interest, penalties and late charges on amounts payable to vendors and taxing
authorities.
Revenue Recognition: The Company recognizes telecommunications revenues when the
Company's customers make long distance telephone calls from their business or
residential telephones or by using the Company's telephone calling cards. Income
from prepaid telephone calling cards is recognized as the telephone service is
utilized. Income from internet service is recognized in the month that the
service is provided.
Deferred Loan Closing Costs: Costs incurred in connection with the Company's
revolving credit facility with a financial institution have been capitalized and
are being amortized over the term of the credit facility.
Royalty Payments to Non-profit Organizations: The Company pays royalties of
approximately 10% of a customer's commissionable long distance revenues to a
non-profit organization. This royalty payment is included in selling, general
and administrative expenses.
Concentrations of Credit Risk: Financial instruments that potentially subject
the Company to concentrations of credit risk include accounts receivable from
customers and accounts payable to its carrier. The Company's customer base is
distributed throughout the United States, and the Company does not require any
collateral from its customers. Although significant portions of the Company's
revenues are billed through the Billing Agents and LECs, the ultimate
collectibility of these accounts is dependent upon the status of the individual
customer. There are no significant concentrations of revenues or accounts
receivable among individual customers.
F-9
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Concentrations of Credit Risk, continued: The Company enlists the support of
non-profit organizations to promote the Company's services in return for the
Company's royalty payment. The loss of the support of one or more significant
non-profit organizations could have a material, adverse impact on the Company's
results of operations. Approximately 44%, 42%, and 40% of the Company's net
sales during the years ended December 31, 1997, 1998 and 1999, respectively,
were earned from customers that have designated the ten (10) most significant
non-profit organizations as recipients of the Company's royalty payment.
The Company purchases the majority of its long distance switching and network
services from WorldCom.
The Company maintains deposits at financial institutions that at times exceed
federally insured limits. Management does not believe there is any significant
risk of loss associated with this concentration of credit.
Redeemable Common Stock: Redeemable common stock is carried at its redemption
value. Redemption value includes the proceeds received upon issuance of the
common stock, and is increased by accretions resulting from the Company's
agreement to redeem the stock at cost plus annual rates of return, as specified
in the redemption agreements (see Note H). The carrying value is reduced by
quarterly returns of capital payments made to the holders of redeemable common
stock, and by the redemption price paid to each selling stockholder. As the
redemption options expire, as more fully discussed in Note H, the principal
amounts invested by the individual stockholders are reclassified as
nonredeemable common stock.
Nonredeemable Common Stock: Nonredeemable common stock consists of stock issued
to certain officers upon formation of the Company, and to other stockholders
with whom the Company had not executed a redemption agreement. Nonredeemable
common stock also includes the principal amounts invested by stockholders whose
redemption options have expired. As discussed in Notes H and I to the financial
statements, certain of the Company's nonredeemable common stock is characterized
as Common Stock Subject to Rescission in the Company's consolidated balance
sheets.
Income Taxes: Income tax expense is based on pretax financial accounting income.
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. This method also requires the
recognition of future tax benefits such as net operating loss carryforwards, to
the extent that realization of such benefits is more likely than not. The
Company provides a valuation allowance for deferred tax assets for which it does
not consider realization of such assets to be more likely than not.
F-10
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Earnings (Loss) Per Share: The Company presents basic and diluted earnings
(loss) per share. Basic earnings (loss) per share is computed by dividing
earnings (losses) available to nonredeemable common stockholders by the weighted
average number of nonredeemable shares outstanding during the year. Diluted
earnings (loss) per share reflect per share amounts that would have resulted if
dilutive potential nonredeemable common stock had been converted to
nonredeemable common stock. Potential nonredeemable common stock includes
redeemable common stock, stock warrants, stock options and convertible notes
payable. For 1997, conversions of potential nonredeemable common stock were not
included in the computation of earnings (loss) per share, however, since they
would have resulted in an antidilutive effect.
Covenants Not to Compete: Covenants not to compete are discounted to their
present value based upon the terms of the agreement, and are being amortized
over the effective period of the covenant, generally 2 to 4 years.
Fair Values of Financial Instruments: The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
Cash and cash equivalents--The carrying amount of cash and cash
equivalents approximates its fair value, because of the short
maturities of such instruments.
Short and long-term debt--Based upon the Company's current incremental
borrowing rates and the general short-term nature of most debt, the
carrying amount of short and long-term debt approximates its fair
value.
Redeemable Common Stock--The Company believes that the fair value of
its redeemable common stock is not significantly different from its
carrying amount. The redeemable common stock is not traded in the open
market.
Stock-Based Compensation: The Company accounts for stock-based compensation
plans with employees in accordance with Accounting Principles Board Opinion No.
25 ("APB 25"), "Accounting for Stock Issued to Employees", and its various
interpretations. Under APB 25, the Company recognizes compensation expense equal
to the difference between the fair value of the common stock at the date of the
grant and the exercise price of the option. Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation",
prescribes the recognition of compensation expense based on the fair value of
options on the grant date, but allows companies to apply APB 25 if certain pro
forma disclosures are made assuming hypothetical fair value method application.
See Note K for pro forma disclosures required by SFAS No. 123 plus additional
information on the Company's stock-based compensation plans. The Company
accounts for stock option plans with nonemployees in accordance with SFAS No.
123.
Reclassifications: Certain amounts in the prior year financial statements have
been reclassified to conform to the presentation used in the current year.
F-11
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS
Transaction with Company Founders
The two founders of the Company acquired their original shares of Common Stock
upon formation of the Company without payment of cash consideration. These
shares represent substantially all of the shares of Common Stock owned by each
of the two founders.
From 1994 through 1997, the Company declared quarterly distributions to all of
its stockholders, including distributions of $3,910 to one founder and $1,368 to
the other founder. The distributions were accrued on the same per share basis as
paid to all other stockholders of the Company. Through December 31, 1997,
distributions totaling $444 and $160 had been paid to the two founders. In 1998
and 1999, the Company paid accrued distributions of $241 and $24, respectively,
to one founder, leaving a remaining balance accrued at December 31, 1999 of
$3,201. In 1998, the Company paid accrued distributions totaling $273 to the
other founder until his resignation from the Company in April 1998. The Company
then began paying this founder the accrued distributions in connection with his
separation agreement with the Company, as described below. At December 31, 1999,
the remaining balance payable pursuant to the separation agreement was $98.
In a letter agreement dated July 14, 1999, the Company and one of the founders,
currently Chairman of the Board of Directors, agreed to defer payment of such
amounts owed to this founder until such time as the Company's financial
condition further improved and it had funds available, legally and in good
business practice, to pay any such accrued distributions. In consideration for
this deferral and in consideration of subordination of the accrued distributions
to the Company's credit facility (see Note D), the Company agreed to pay this
founder in addition to such founder's salary, $300 per year, until the payment
of the accrued distributions was resumed and, if resumed, all amounts previously
paid pursuant to the agreement would be credited against his accrued
distributions. During 1999, the Company paid the Chairman $150 pursuant to this
agreement.
In April 1998, the Company's other founder resigned. This individual was an
officer and director at the time of his resignation. In connection with his
resignation, the Company and this founder agreed to the following:
o The Company agreed to pay the accrued distributions, totaling
$935 at the time of his resignation, in the amount of $40 per
month. At December 31, 1999, the remaining balance payable was
$98.
o The Company also agreed to pay this founder $20 per month for
the remainder of his life, in exchange for the former
officer's agreement to (1) not compete with the Company for
one year from the date of the agreement, (2) agree to take no
actions significantly detrimental to the Company (other than
competition), and (3) waive any claims against the Company as
of the date of the agreement.
F-12
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Transactions with Company Founders, Continued
The Company recorded a liability of $2,184 as of the date of the agreement,
based upon the present value of the obligation over the expected life of the
former officer at the date of the agreement. The Company also recorded a
covenant not to compete of $2,184 at the date of the agreement, and amortized
this covenant over the one-year term.
In 1995 and 1996, one of the Company's founders, who is currently Chairman of
the Board of Directors, and at that time the President and a director of the
Company; the other founder, now resigned from the Company, at that time Senior
Vice President and a director of the Company; and the latter founder's wife sold
21,204 shares of Company Common Stock to 100 individuals at the aggregate price
of approximately $2,480. The selling price ranged from $40 per share to $150 per
share, averaging $117 per share.
The sales of the stock were originally intended to be issuances of Company
stock. The proceeds of the sales were deposited by the Company, and original
stock certificates were issued by the Company to the stockholders. The Company
also issued redemption agreements to substantially all of the purchasing
stockholders (see Note H for a description of the redemption agreements). These
redemption agreements obligated the Company to buy back the stock at the
original purchase price plus a guaranteed return, as specified in the
agreements. Subsequently, the sales of the stock were characterized as sales of
the founders' shares. The founders and the related family member then classified
the transactions as loans from them to the Company. The loans carried an
interest rate of 8% per annum, and matured two years from the date of issuance.
The Company repaid these notes payable to the founders and related family member
in 1997 and 1998, and all such notes have been repaid in full.
In connection with the above transactions, the Company has redeemed 5,278 shares
and paid a total of $1,060 through December 31, 1999, to the stockholders that
originally purchased the common stock from the Company. The amounts paid
consisted of $790 for the amounts originally paid by the stockholders and $270
for the specified rate of return, as described in the agreements. Of the total
redemptions, approximately $780 was redeemed in 1998, and total payments in 1998
and 1999 pursuant to these redemptions was $42 and $1,006, respectively.
Through 1998, the two founders received sales commissions from the Company,
which were based on the amount of revenues the Company earned from certain
customers. The total amount of commissions was approximately 5% of the revenues
generated from all customers of the Company for which no other sales agent or
representative of the Company was receiving a commission. The total commissions
from such sales were split among the two founders and a third individual. In
1997 and 1998, commissions paid to the two founders totaled $440 and $331,
respectively.
F-13
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Transactions with Other Officers and Directors
A member of the Company's Board of Directors is affiliated with or controls
several organizations that participate in transactions with the Company. In
connection with the Company's 10% royalty program, the Company incurred
approximately $775, $1,060, and $1,107 of royalty expenses in 1997, 1998 and
1999 to organizations affiliated with or controlled by this director. The
Company also incurred advertising expenses of $1,803, $1,918, and $1,908 in
1997, 1998 and 1999, respectively, to organizations affiliated with or
controlled by this director.
These organizations also earned sales commissions in addition to the 10% royalty
payments. During the years ended December 31, 1998 and 1999, sales commissions
earned by these organizations totaled approximately $497 and $102, respectively.
In 1999, the Company terminated the existing sales agreements and entered into
new agreements. The new agreements provide for the Company to pay the
organizations an aggregate of $1,491 over three years, in exchange for the
organizations' release of all prior claims and obligations, and an agreement not
to compete with the Company over the term of the agreements. The Company paid
$497 in 1999, pursuant to these agreements. The Company accrued the present
value of the obligations and is amortizing the noncompete agreements over the
term of the agreements. The liability to these organizations is included in the
financial statement caption Notes Payable and Long-Term Debt to Related Parties,
and is further described in Note F below.
In December 1999, a Company officer and director, who is also the President of
Hebron, resigned from the Company. In connection with his termination agreement,
the Company agreed to pay the former director $1,359 over four (4) years, in
exchange for the director agreeing not to compete with the Company over that
term. The Company accrued the present value of this obligation and is amortizing
the noncompete agreement over the term of the agreement. The liability to the
former director is included in Notes Payable and Long-Term Debt to Related
Parties, and is further described in Note F.
A member of the Company's Board of Directors is affiliated with a non-profit
organization that receives financial support from the Company in exchange for
promotion of the Company's products and services. During the year ended December
31, 1999, the Company paid this organization $175. No such amounts were paid in
1997 or 1998.
During the years ended December 31, 1997, 1998 and 1999, the Company expended
approximately $69, $741 and $767, respectively, to a law firm in which the
Company's current President and CEO is a former partner. The CEO continues to
serve as Of Counsel for the law firm in matters that do not involve the Company.
The CEO does not share in or otherwise benefit from the legal fees paid to the
law firm by the Company. The law firm bills the Company at its standard hourly
rates for services provided to the Company.
F-14
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
VisionQuest
VisionQuest was related to the Company through common ownership, management, and
family relationships. Through June 30, 1998, the Company and its two founders
collectively owned approximately 60% of the outstanding common stock of
VisionQuest. In addition, the Company's two founders served on the Board of
Directors of VisionQuest, and the son-in-law of one of the founders is the
president of VisionQuest, and also a member of the VisionQuest Board of
Directors. As a result of this relationship, the Company was accounting for its
investment in VisionQuest using the equity method of accounting through June 30,
1998. Effective July 1, 1998, VisionQuest acquired all of the VisionQuest common
stock owned by the founder that resigned in April 1998, thus reducing the
Company's effective ownership percentage in VisionQuest to 48% of the
outstanding common stock. Members of VisionQuest management owned the remaining
52%. After this transaction, the Company no longer had the ability to
significantly influence the management or operations of VisionQuest, and
discontinued using the equity method of accounting as of July 1, 1998. The
carrying amount of the Company's investment as of that date was $58. As
discussed below, the Company and VisionQuest terminated all of their business
relationships effective January 1, 1999.
The Company utilized VisionQuest as its provider of telemarketing services from
1993 through December 31, 1998. Total amounts paid to VisionQuest for
telemarketing services during the years ended December 31, 1997 and 1998, were
approximately $5,242 and $6,209, respectively.
Telemarketing expenses incurred in 1998 included the direct costs of
telemarketing services provided by VisionQuest to the Company during 1998, plus
reimbursement of all of VisionQuest's operating expenses and corporate overhead.
From January 1997 to October 1997, the Company paid approximately $1,330 to
VisionQuest related to direct operating expenses incurred by VisionQuest. In
November 1997, the Company and VisionQuest, in anticipation of a merger of the
Company and VisionQuest, agreed that a portion of the operating expenses should
be repaid to the Company. As a result, in April 1998, and effective December 31,
1997, VisionQuest signed a note payable to the Company, totaling $670, to repay
these expenses. In June 1998, VisionQuest repaid $150 of this note to the
Company. The merger did not occur and as a result, the balance of $520 was
canceled effective January 1, 1999. This was as part of an agreement to
terminate all business relationships between the two companies, as discussed
below.
F-15
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
VisionQuest, Continued
As a result of the Company's payment of VisionQuest's corporate payroll and
operating expenses in 1997 and 1998, the Company paid VisionQuest a higher rate
for its telemarketing services than VisionQuest charged independent third
parties. The Company also paid VisionQuest a higher rate for telemarketing
services than the Company could have obtained in an arms-length transaction with
an unaffiliated third party that provides the same telemarketing services. The
Company believes that the amounts it paid to VisionQuest for telemarketing
services were higher than what it could have obtained in an arms-length
transaction from an unaffiliated third party by as much as $1,000 and $3,000 in
1997 and 1998, respectively.
Effective January 1, 1999, the Company and VisionQuest mutually terminated their
business relationship. The Company acquired from VisionQuest the rights to use
all of the assets located in VisionQuest's Tahlequah, Oklahoma telemarketing
center, from January 1, 1999 through September 30, 1999, in exchange for all of
the Company's ownership interests in VisionQuest, all of the Company President's
ownership interests in VisionQuest (which were transferred to the Company for no
consideration immediately prior to the transfer), and cancellation of the note
receivable between the Company and VisionQuest. The agreement also provided for
a release of all claims and obligations between the two companies. Upon transfer
of the stock and cancellation of the note receivable, the Company reclassified
its investment in and note receivable from VisionQuest, totaling $578, to a
prepaid operating lease, and amortized the amount to expense over the term of
the agreement.
Hebron
Hebron was incorporated in November 1995 to provide switching network services
to the Company. Hebron has a relationship with the Company through partially
integrated management. The Company's Chairman and the former Senior Vice
President served on Hebron's Board of Directors from its inception in November
1995 until their resignation in November 1996. In addition, the President of
Hebron served on the Company's Board of Directors from October 1998 through
December 1999 and another Company director is also on Hebron's Board of
Directors.
Cost of sales in 1997, 1998 and 1999 includes approximately $13,529, $14,736 and
$1,469, respectively, of telecommunications services provided by Hebron. In
1997, Hebron charged the Company a higher rate for the switched one-plus
interstate and intrastate services it provided to the Company than the Company
could have obtained from its primary carrier. The higher rates were the result
of the Company's primary carrier lowering its rates in 1997. The Company
believes that the amounts it paid to Hebron for telecommunication services in
1997 were approximately $1,000 higher than what it could have obtained from its
primary carrier. Effective January 1998, Hebron agreed to lower its rates so
that they matched those of the Company's primary carrier.
F-16
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Hebron, Continued
Hebron also charged the Company interest of 18% per annum on the accounts
payable for telecommunication services that are over 55 days from the invoice
date. This interest rate is comparable to the rate charged by the Company's
primary carrier. During 1997, 1998 and 1999, the Company incurred interest
expense of approximately $35, $129 and $22, respectively, related to past due
accounts payable invoices.
The Company's principal operating and administrative offices are located in an
office building owned by Hebron. Total rent expense incurred to Hebron was
approximately $110, $380 and $583 in 1997, 1998 and 1999, respectively.
From December 1996 through October 1998, Hebron provided the Company with an
account receivable line of credit facility (the "Hebron Loan Program"). The
Hebron Loan Program provided for the Company to pay 18% interest on the amounts
advanced under the credit facility, plus fees of 2% of billings processed and 2
cents per call record. As a result of the stated interest rate and the fees, the
effective interest rate of this financing arrangement was approximately 58% in
1996, 1997 and 1998. This effective interest rate was higher than what the
Company could have obtained in an arrangement with independent third parties.
The Company incurred total interest and other related financing costs of
approximately $805 and $885 in 1997 and 1998, respectively, under the Hebron
Loan Program.
At December 31, 1998, all advances under the Hebron Loan Program credit facility
had been repaid. Receivables from related parties of $152 at December 31, 1998,
consists of amounts that had been withheld as a reserve for interest and escrow
fees under the Hebron Loan Program but which were reimbursed to the Company in
January 1999.
In 1997 and through July 1998, the Company transmitted a portion of its accounts
receivables through one of its Billing Agents through an account maintained at
the Billing Agent under Hebron's name. Hebron charged the Company a fee equal to
2% of the net revenues transmitted under this arrangement. The total fees
incurred by the Company in 1997 and 1998 were approximately $135 and $101,
respectively.
In 1997 and 1998, Hebron periodically made loans to the Company for working
capital purposes. The loans generally carried an interest rate of 10%. Total
interest expense incurred on loans made by Hebron to the Company was
approximately $46 and $6, respectively, during the years ended December 31, 1997
and 1998.
At December 31, 1998, the Company owed Hebron $3,892 for telecommunications and
other services incurred through that date. In addition, the Company agreed to
reimburse Hebron for costs and expenses totaling approximately $563 incurred by
Hebron in connection with the development of an internet service product. At
December 31, 1998, $1,224 of this liability has been reclassified as a long-term
obligation, as a result of the transactions described below.
F-17
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE B--RELATED PARTY TRANSACTIONS--Continued
Hebron, Continued
Effective February 1, 1999, the Company and Hebron entered into an asset
purchase agreement (the "Hebron APA"). Under the terms of the Hebron APA, the
Company agreed to:
(1) pay Hebron for all expenses that Hebron incurred prior to
January 31, 1999, related to the switch network, and convert
the balance owed to Hebron for telecommunications services
previously provided, totaling approximately $2,300, to a note
payable,
(2) reimburse Hebron for its costs and expenses incurred on the
Company's behalf in connection with the development of an
internet service product, totaling approximately $584, and
acquire the rights to the assets and assume all of the related
lease obligations incurred by Hebron in connection with the
internet service product, totaling approximately $1,200, and
(3) purchase all of the switch assets at their net book value,
assume all of the related switch lease obligations totaling
approximately $1,300, and issue a note payable to Hebron for
the net amount of $567.
In connection with the Hebron APA, the Company issued a promissory note payable
to Hebron totaling approximately $2,300 for item (1) discussed above. This note
payable has been subordinated to the Company's credit facility described in Note
D. Effective April 1, 2000 the Hebron APA was closed, and, the Company issued
notes payable for the internet and switch assets, which were also subordinated
to the Company's credit facility.
Pursuant to a lease license agreement between the Company and Hebron, the
Company assumed operations of the switch and internet assets effective February
1, 1999. Under the terms of the lease license agreement, the Company and Hebron
agreed that Hebron would transfer to the Company custody and control of the
switch and internet assets, and the Company shall hold and operate such assets
as if the Company owned the assets. The terms of the lease license agreement
also provided that the Company will assume all of the rights and obligations
associated with owning and operating the switch and internet assets. The lease
license agreement also provides that the Company will pay Hebron a monthly fee
equal to the amount of interest that is payable on the switch and internet
assets. Accordingly, the Company has recorded the assets and the related lease
and note payable obligations in its financial statements effective February 1,
1999, and the statement of operations from February 1999 forward reflect the
costs of operating those switches and internet assets.
F-18
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE C--PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31
1998 1999
---------- ----------
Computer and telephone equipment $ 2,477 $ 3,150
Billing system -- 355
Switch equipment -- 1,938
Internet equipment 98 1,169
Leasehold Improvement 30 734
Other fixed assets 119 523
---------- ----------
2,724 7,869
Less accumulated depreciation 1,606 2,094
---------- ----------
$ 1,118 $ 5,775
========== ==========
As discussed in Note B above, the Company recorded the Oklahoma City and Chicago
switches and the internet assets effective February 1, 1999. The total cost of
these assets acquired by assuming the related lease obligations and issuing
notes payable to Hebron for the net book value was approximately $2,926. The
total cost of all assets held under capital lease obligations was $493 and
$3,776 at December 31, 1998 and 1999, respectively. Accumulated depreciation of
leased equipment was approximately $160 and $1,468 at December 31, 1997 and
1998, respectively.
Depreciation expense on property and equipment, including depreciation on assets
held under capital leases, was approximately $611, $464, and $1,890 during the
years ended December 31, 1997, 1998, and 1999, respectively.
In 1998, the Company determined that the carrying amount of the office building
it owned but was no longer utilizing was impaired. The Company reduced the
carrying amount from $715 to $500, which was the estimated fair value of the
building based upon an appraisal, less the estimated costs to sell the building.
The Company recognized a loss of $215 in 1998. In February 1999, the Company
sold the building for $522, and realized a recovery of $22.
NOTE D--LINE OF CREDIT ARRANGEMENTS
The Company has a $30,000 line of credit facility (the "Credit Facility") with a
financial institution. Borrowing availability is based upon collections
multiples and earnings ratios, subject to the maximum line of credit. At
December 31, 1999, the Company could borrow up to the full amount of the $30,000
availability under the Credit Facility. The outstanding balance at December 31,
1999, was $20,880.
F-19
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE D--LINE OF CREDIT ARRANGEMENTS--Continued
The Credit Facility matures on January 30, 2003, and carries an interest rate of
prime plus 3.5%. The stated interest rate at December 31, 1999, was 11.5%. The
weighted average effective interest rate in 1999, which includes amortization of
loan origination costs, was 14.0%. The Credit Facility is secured by
substantially all of the Company's assets, including accounts receivable and the
Company's customer base.
The Credit Facility is classified as a current liability in the Company's
financial statements, because under the terms of the agreement, the Company is
required to maintain a lockbox, and apply collections from customers to the
outstanding amounts under the Credit Facility, and because the terms of the
agreement provide the lender with the discretionary ability to declare the note
due and payable.
The Company incurred $169 and $345 in loan closing fees in 1998 and 1999,
respectively, in connection with the Credit Facility. These fees are included in
other assets and are being amortized over the term of the Credit Facility.
In connection with closing the Credit Facility, several of the Company's
creditors agreed to subordinate the Company's obligations to them in favor of
the financial institution providing the Credit Facility. These creditors include
Patrick Enterprises, Hebron, two members of the Company's Board of Directors,
and a Company founder. Repayment of these obligations is limited as specified in
the loan and security agreement between the Company and the financial
institution. The total outstanding debt owed to subordinated creditors as of
December 31, 1999, was approximately $5,259. In addition, one of the Company's
founders agreed to subordinate accrued distributions, totaling $3,201 at
December 31, 1999, in favor of the Credit Facility.
The Credit Facility contains various financial and other covenants with which
the Company must comply, including a minimum net worth requirement, as defined
in the agreement, of negative ($12,000), restrictions on asset acquisitions,
restrictions on the payment of dividends, and restrictions on principal and
interest payments to subordinated creditors. At December 31, 1999, the Company
was not in compliance with the restrictions on principal payments to certain
subordinated creditors. However, the Company received a letter from the lender
waiving the deficiencies.
In 1997 and 1998, the Company had various line of credit arrangements with
Hebron, as described in Note B, and with various unrelated third parties. The
aggregate outstanding balance on the lines of credit was $7,964 at December 31,
1998. The effective interest rates ranged from 12.5% with one lender to 58% with
Hebron during both 1997 and 1998. The average effective interest rates for all
of the various agreements were approximately 28% and 18% in 1997 and 1998,
respectively. As discussed in Note B, the line of credit arrangement with Hebron
was discontinued in October 1998, and all outstanding advances had been paid in
full as of December 31, 1998. The Company repaid the other credit facilities in
full upon closing of the Credit Facility in February 1999.
F-20
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE E--SHORT-TERM NOTES PAYABLE TO INDIVIDUALS
Short-term notes payable to individuals consist of the following:
December 31
1998 1999
-------------- ---------------
Convertible notes payable $ 421 $ 399
Advance payment loan program notes 4,077 154
Direct bill program notes 770 -
-------------- ---------------
$ 5,268 $ 553
============== ===============
Convertible Notes Payable: In 1995, the Company issued promissory notes payable
to approximately seventy-five (75) individuals, substantially all of which are
convertible to common stock. These notes generally have no specified maturity
date and are convertible to common stock at the option of the Company. Interest
accrues at 10% and is payable quarterly. All of these notes are classified as
current liabilities. The individual notes contain varying terms with regard to
the conversion agreements. Some of the notes do not specify any conversion terms
other than they are convertible at the option of the Company. Other notes
specify that the conversion will be based on a specific price per share.
Notes Payable - Advance Payment Loan Program: In November 1995, the Company
initiated an Advance Payment Loan Program (APLP), under which individuals have
lent the Company money to finance working capital needs. Although the loan
agreements indicated that the loans were to be secured by accounts receivable
from the LECs, no security agreements were perfected and all of the Company's
LEC accounts receivables are pledged under the Company's Credit Facility, as
discussed in Note D. Therefore, these loans are effectively unsecured. Interest
on the APLP notes is 18% per annum, payable quarterly. In June 1999, the Company
repaid in full the outstanding balances of substantially all lenders with a
balance of $10 or less. In October 1999, the Company offered the remaining
lenders to either (a) have their balances paid in full or (b) options to convert
their notes to subordinated debt under various terms. Such conversions would be
subject to the lenders qualifying as accredited investors. Substantially all of
the investors chose to either have their notes repaid or did not respond to the
Company's offer, and the Company repaid these amounts in December 1999.
F-21
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE E--SHORT-TERM NOTES PAYABLE TO INDIVIDUALS--Continued
Notes Payable - Direct Bill Program: In the fourth quarter of 1997, the Company
obtained a series of loans from third parties, for the purpose of financing
working capital operations. The loan agreements indicate that the security for
the loans are the Company's accounts receivable arising from its customers which
are billed directly by the Company, although no security agreements were
perfected. These loans bore interest at rates of 20% to 25% per annum, payable
quarterly. All of these notes were repaid in full in June 1999.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT
Related Parties
Notes payable and long-term debt to related parties consists of the following:
December 31
1998 1999
---------- ----------
Loan payable to a Company founder, made May 1998,
unsecured, no specified interest rate or maturity
date, balance paid in full in 1999 $ 98 $ --
Accrued distributions payable to a Company founder,
unsecured, no stated interest rate, monthly payments
of $40 until paid in full, subordinated to the Credit
Facility in February 1999 575 98
Accrued termination obligation payable to a Company
founder, effective April 1998, payment terms of
$20 per month with an imputed interest rate of
11.25% over his estimated life at the date of
the agreement, unsecured 2,169 2,161
F-22
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Related Parties, Continued
Accrued payable to former Company director and current
President of Hebron, effective December 1999, payment
terms of $42 per month beginning in January 2000, and
$21 per month beginning January 2001 through May 2004,
imputed interest rate of 11.75%, unsecured $ -- $ 1,120
Accrued payable to Christian Advocates Serving Evangelism
(C.A.S.E.), an organization affiliated with a Company
director, effective January 1999, payment terms of
$33 per month beginning in January 2000 through December
2001, imputed interest rate of 11.75%, unsecured -- 708
Accrued payable to Regency Productions, a company affiliated
with a Company director, effective January 1999, payment
terms of $9 per month beginning in January 2000 through
December 2001, imputed interest rate of 11.75%, unsecured -- 183
Note payable to C.A.S.E., dated July 1997, unsecured,
subordinated to the Credit Facility, restructured in April
1999, as described below 688 850
Note payable to Company director, dated June 2, 1998, unsecured,
subordinated to Credit Facility, restructured in April 1999,
as described below 150 100
Note payable to Hebron, dated February 1, 1999, with an original
principal amount of $2,274, interest rate of 12.5% through
November 1999, increased to 16.25% effective December 1999,
subordinated to Credit Facility, monthly interest only payments
plus specified prepayments of principal not to exceed $1,234
through March 2000, balance due August 1, 2000, secured by 50,000
shares of Company common stock owned by a Company founder -- 1,711
Payable to Hebron converted to note payable effective
February 1, 1999, as described above 1,224 --
F-23
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Related Parties, Continued
Note payable to Hebron for switch assets, effective upon
closing of transaction, initial interest rate of 12.5%,
interest only payments for 12 months, matures 18 months
from effective date $ -- $ 567
Note payable to Hebron for internet assets and reimbursement
of related expenses, effective upon closing of transaction,
initial interest rate of 12.5%, interest only payments for
12 months, matures 18 months from effective date -- 584
------------ ------------
4,904 8,082
Amounts due within one year 686 2,657
------------ ------------
$ 4,218 $ 5,425
============ ============
In April 1999, the note payable with C.A.S.E. was restructured. The new note
provided for additional advances of approximately $260, bringing the total
outstanding balance to $850, and monthly interest only payments at 10% for five
years, with the unpaid principal due at maturity in April 2004. The lender has
the option to convert the note to common stock at a per share price equal to the
lower of (1) the fair market value of the common stock on January 1, 1998, as
determined by an appraisal, or (2) the lowest publicly traded price of the
common stock three months following the establishment of a public trading market
for the common stock. The terms of the agreement also provide for the Company to
issue the organization warrants to purchase 3,400 shares of Company common stock
at a strike price of $0.01 per share. In connection with the warrants, the
Company valued the warrants using a minimum value of $41.50 dollars per share.
The value was based upon an appraised value of the Company's common stock as of
June 30, 1999. The Company does not believe that the appraised value of its
common stock as of June 30, 1999 differed significantly from what the results of
an appraisal in April 1999 would have been. Accordingly, the Company recorded
paid-in-capital and a corresponding charge to interest and other financing
charges of $141 for the stock warrants. As a result of the stated interest rate
in the note and the costs associated with the warrants, the effective interest
rate of this agreement is 15.7%.
The note payable to the Company director was also restructured in April 1999.
The balance was paid down to $100, and the new payment terms provide for monthly
interest only payments at 10%, with the unpaid principal due in April 2001. The
note may be extended for an additional three years at the option of the lender.
This note also contains conversion options similar to the ones described above.
The terms of the agreement also provide for the Company to issue the director
warrants to purchase 400 shares of Company common stock at a strike price of
$0.01 per share. In connection with the warrants, the Company valued the
warrants using a minimum value of $41.50 dollars per share, based upon the same
appraisal described above. Accordingly, the Company recorded paid-in-capital and
a corresponding charge to interest and other financing charges of $17 for the
stock warrants. As a result of the stated interest rate in the note and the
costs associated with the warrants, the effective interest rate of this
agreement is 15.9%.
F-24
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Other Notes Payable, Long-Term Debt and Capital Lease Obligations:
Notes payable, long-term debt and capital lease obligations to others consists
of the following:
December 31
1998 1999
---------- ----------
Notes payable to unaffiliated companies and third parties,
dated at various dates in 1996 through 1998, described in
the agreements as being secured by the Company's customer
base or direct bill accounts receivable, but not perfected,
agreements totaling $1,205 contained the personal guaranties
of the Company founders, interest of 18% payable monthly (one
note had a stated interest rate of 25% payable quarterly),
all notes were repaid in full during 1999 $ 1,655 $ --
Loans payable to two individuals, originating in December 1997
and May 1998, maturing in December 2005 and May 2006, monthly
payments of $8 in the aggregate, including interest with an
effective rate of approximately 58% 183 182
Note payable to seller of building, secured by first mortgage
on office building, monthly payments of $10 including interest
at 10%, matures April 1, 2001 (repaid upon sale of building in
February 1999) 245 --
Note payable to individual, interest at 18% payable monthly,
principal due upon maturity in January 2000, subordinated to
the Credit Facility, secured by 50,000 shares of Company common
stock owned by a Company founder, restructured in January 2000
with the Company making a $500 principal reduction, and the balance
of the note allocated among two individuals with a new maturity
date of January 2001, effective interest rates reduced to 15%, no
change in security -- 2,500
Note payable to individual for redemption of 5,000 shares of Type D
redeemable common stock, imputed interest rate of 14%, payable
in monthly installments with the balance paid in full in
August 1999, subordinated to the Credit Facility 928 --
F-25
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE F--NOTES PAYABLE AND LONG-TERM DEBT--Continued
Other Notes Payable, Long-Term Debt and Capital Lease Obligations, Continued:
Accrued obligations payable to former salesmen, effective at various
dates from June 1999 through September 1999, aggregate monthly
payments of $46 per month with imputed interest rate of 10.5%,
maturing at various dates from April 2002 through September 2002,
unsecured $ -- $ 1,213
Capital lease obligation for telephone system, effective February
1997 with subsequent amendments, effective interest rate of 21.5%,
payable in monthly installments of $16 through August 2002 315 352
Capital lease obligation for internet equipment, assumed from
Hebron, monthly payments of $39 through June 2001, effective
interest rate of 12% -- 666
Capital lease obligation for switch equipment, assumed from Hebron,
monthly payments of $26 through December 2000, effective interest
rate of 13.25% -- 368
Capital lease obligation for switch equipment, assumed from Hebron,
monthly payments of $20 through March 2002, effective interest
rate of 12% -- 473
Other notes payable and capital lease obligations 35 240
---------- ----------
3,361 5,994
Amounts due within one year 2,315 2,300
---------- ----------
$ 1,046 $ 3,694
========== ==========
Future maturities of notes payable and long-term debt as of December 31, 1999,
are as follows:
Related
Parties Others Total
--------------- --------------- ---------------
2000 $ 2,657 $ 2,300 $ 4,957
2001 1,910 3,129 5,039
2002 213 401 614
2003 237 41 278
2004 959 49 1,008
Thereafter 2,106 74 2,180
--------------- --------------- ---------------
$ 8,082 $ 5,994 $ 14,076
=============== =============== ===============
F-26
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE G--INCOME TAXES
Income tax expense (benefit) consists of the following:
1997 1998 1999
--------------- --------------- ----------------
Current
Federal and state $ - $ - $ -
Deferred
Federal and state 92 (700) 1,977
--------------- --------------- ----------------
$ 92 $ (700) $ 1,977
=============== =============== ================
At December 31, 1999, the Company has net operating loss carryforwards totaling
approximately $5,100 that may be used to offset future taxable income. These net
operating loss carryforwards expire in the years 2009 through 2014.
Income tax expense (benefit) for the years ended December 31, 1997, 1998 and
1999, differs from the expected rate of 34% for the following reasons:
1997 1998 1999
--------- --------- ---------
Federal income tax (benefit) at statutory rate (34.0) (34.0) 34.0
Expenses and losses not providing a tax benefit 81.9 8.7 2.3
Change in valuation allowance -- 14.9 5.1
State income tax (benefit), net (5.5) (5.7) 5.7
--------- --------- ---------
42.4 (16.1) 47.1
========= ========= =========
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities are as follows:
December 31
1998 1999
---------- ----------
Tax effect of future tax deductible items
Allowance for uncollectible receivables $ 158 $ 200
Deferred telemarketing costs 2,516 858
Accrued termination obligation 650 865
Depreciable assets 75 153
Loss carryforwards 2,228 2,271
Other reserves and settlements 600 118
---------- ----------
Total deferred tax assets 6,227 4,465
Less valuation allowance (650) (865)
---------- ----------
Net deferred tax asset $ 5,577 $ 3,600
========== ==========
F-27
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE G--INCOME TAXES--Continued
The Company believes that the improvements in its operating results, as
discussed in Note J, provides sufficient positive evidence to indicate that it
is more likely than not that it will realize the net deferred tax benefit of
$3,600 recorded in the financial statements. The Company's actual operating
results in 1999 and projections for future taxable income provide for full
utilization of the deferred tax asset, net of the valuation allowance, over the
periods in which the temporary differences are anticipated to reverse.
At December 31, 1998 and 1999, the Company has provided a valuation allowance of
$650 and $865, respectively, for the tax effects of the accrued termination
obligation to the former Company founder , because the Company cannot assess
that it is more likely than not that it will realize these benefits. The change
in the total valuation allowance for the year ended December 31, 1999, is due to
the excess of expenses recorded in the financial statements for the accrued
termination obligation and the deferred stock compensation over the amounts that
were currently deductible for income tax purposes.
The Company's ability to generate the expected amounts of taxable income from
future operations is dependent upon a number of factors, including competitive
pressures on sales and margins in the telecommunications industry, management's
ability to contain expenses, the Company's ability to acquire and retain new
customers, and other factors which are beyond management's ability to control.
There can be no assurance that the Company will meet its expectations for future
taxable income in the carryforward period. However, management has considered
the above factors in reaching the conclusion that it is more likely than not
that future taxable income will be sufficient to realize the net deferred tax
assets at December 31, 1999. The amount of deferred tax assets considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced.
NOTE H--REDEEMABLE AND NONREDEEMABLE COMMON STOCK
From time to time, the Company entered into various agreements with certain of
its shareholders pursuant to which the Company agreed, upon request of one or
more of such shareholders, to redeem the shares of Common Stock owned by such
shareholder. While the Company's Certificate of Incorporation authorizes the
Company to issue a single class of Common Stock, the Company has, for financial
accounting purposes, segregated its Common Stock into two distinct groups,
redeemable and nonredeemable. Of the 838,927 shares of Common Stock outstanding
at December 31, 1999, 15,537 shares are characterized as redeemable common stock
and 823,390 shares are characterized as nonredeemable common stock.
F-28
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE H--REDEEMABLE AND NONREDEEMABLE COMMON STOCK--Continued
The Company has entered into four variations of the redemption agreements, which
it classifies as Type A, Type B, Type C and Type D. Generally, each redemption
agreement provides that the shares of Common Stock shall be repurchased for an
amount that gives the shareholder a specified rate of return based on the length
of time the shareholder owned such shares. Type A agreements were issued
primarily between October 1992 and December 1992 and Type B agreements were
issued primarily between January 1993 and May 1995. Each of the Type A and Type
B agreements expired two years after issuance. All of the Type A and Type B
agreements have now expired pursuant to their terms.
Type C agreements were issued primarily between July 1992 and September 1992 and
have terms identical to the Type A agreements except that Type C agreements have
no expiration. The Company has agreed at its option to redeem the shares of
Common Stock owned for more than two years for the last highest price that the
shares of Common Stock have been sold to an investor. Type D Agreements have no
expiration and were issued from May 1995 until the Company discontinued issuing
redemption agreements altogether in February 1996. Type D agreements provide
that shareholders owning their shares of Common Stock less than one year receive
a 10% annual return; between one year and 18 months receive a 15% annual return;
between 18 months and three years receive an 18% annual return; and over three
years an amount based on a formula specified in the agreement.
During the years ended December 31, 1998 and 1999, substantially all of the
outstanding Type D redeemable common stock had been outstanding for over three
years. Accordingly, the redemption price was based upon the formula specified in
the Type D redemption agreements for stock held over three years. Application of
the formula to the carrying amount of Type D redeemable common stock resulted in
a net reduction of the redemption price of approximately $179 and $102,
respectively, during the years ended December 31, 1998 and 1999.
At December 31, 1998 and 1999, the carrying amount of redeemable common stock is
as follows:
1998 1999
--------------- ----------------
Principal amount invested by stockholders $ 1,506 $ 1,492
Accumulated accretion of agreed upon redemption
price, net of periodic returns of capital paid to
the stockholders 249 147
--------------- ----------------
$ 1,755 $ 1,639
=============== ================
The carrying amounts of redeemable common stock applicable to the various types
of redemption agreements were as follows at December 31, 1998 and 1999:
1998 1999
--------------- ----------------
Type C redemption agreements $ 237 $ 237
Type D redemption agreements 1,518 1,402
--------------- ---------------
$ 1,755 $ 1,639
=============== ================
F-29
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE H--REDEEMABLE AND NONREDEEMABLE COMMON STOCK--Continued
A summary of activity of redeemable common stock during each of the years ended
December 31, 1997, 1998 and 1999 is as follows:
Year Ended December 31
1997 1998 1999
---------- ---------- ----------
Balance at beginning of period $ 3,853 $ 3,035 $ 1,755
Redemptions of redeemable common stock (53) (1,082) (14)
Expiration and cancellation of redemption options (687) (19) --
Change in redemption value of redeemable common stock 470 (179) (102)
Distributions to redeemable stockholders (548) -- --
---------- ---------- ----------
Balance at end of period $ 3,035 $ 1,755 $ 1,639
========== ========== ==========
As discussed in Note I, certain of the Company's nonredeemable common stock may
be subject to rescission by the shareholder because of the Company's failure to
register its securities. Rescission rights for individual stockholders vary,
based upon the states in which the stockholder resides. Common stock that is
subject to rescission is recorded separately from stockholders deficiency in the
Company's balance sheet. As the statute of limitations expire in the respective
states, such amounts are reclassified to stockholders' deficiency. A summary of
the common stock subject to rescission and reclassifications to stockholders'
deficiency is as follows:
Balance at January 1, 1997 $ 6,107
Amount reclassified to stockholders' deficiency (2,892)
----------
Balance at December 31, 1997 3,215
Amount reclassified to stockholders' deficiency (1,530)
----------
Balance at December 31, 1998 1,685
Amount reclassified to stockholders' deficiency (1,216)
----------
Balance at December 31, 1999 $ 469
==========
F-30
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES
Violations of Federal and State Securities Laws
In 1995, the Company determined that it may not have registered its securities
with the Securities and Exchange Commission (the "Commission") when it was
obligated to do so under Federal securities laws and that, consequently, it may
have engaged in the sale or delivery of unregistered securities in violation of
the Federal securities laws. In July 1996, the Company voluntarily reported this
information to the Commission, which then instituted an investigation into
whether the Company and its two principal founders had violated any of the
Federal securities laws. The Company and its two founders cooperated with the
Commission during this investigation.
In September 1997, the Commission's staff attorney who was conducting the
investigation informed the Company that the staff intended to recommend to the
Commission that it institute cease-and-desist proceedings against the Company,
based upon the staff's belief that the Company had violated Sections 5(a) and
5(c) of the Securities Act of 1933, as amended ("Securities Act"), and Section
12(g) of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and
Rule 12g-1 promulgated under the Exchange Act. Also in September 1997, the
Commission's staff attorney informed the two founders and Hebron that the staff
intended to recommend that the Commission institute cease-and-desist proceedings
against them.
On July 15, 1998, the Company, the two founders and Hebron executed an offer of
settlement in which they consented to the entry of a cease-and-desist order
contingent upon the Commission accepting the Commission's staff's
recommendation. The offers provided that the Company and the two founders would
cease and desist from committing or causing any violations or future violations
of Sections 5(a) and 5(c) of the Securities Act and Section 12(g) of the
Exchange Act and Rule 12g-1. Additionally, in the offers, Hebron consented to
the entry of a cease-and-desist order which provided that it would
cease-and-desist from committing or causing any violations or future violations
of Sections 5(a) and 5(c) of the Securities Act.
On July 23, 1998, the Commission approved the Commission's staff attorney's
recommendation and accepted the offers of settlement. On July 30, 1998, the
Commission issued a cease-and-desist order which stated that (a) the Company,
the two founders and Hebron had violated Sections 5(a) and 5(c) of the
Securities Act; (b) the Company had violated Section 12(g) of the Exchange Act
and Rule 12g-1; and (c) the two founders had caused the violation of Section
12(g) of the Exchange Act and Rule 12g-1. The Commission ordered the Company,
the two founders , and Hebron to cease and desist from committing or causing any
violations and any future violations of Sections 5(a) and 5(c) of the Securities
Act and Section 12(g) of the Exchange Act and Rule 12g-1. The Commission did not
order any monetary penalties, fines, sanctions, or disgorgement against the
Company, the two founders , Hebron or anyone else associated with the Company or
any of the other parties.
F-31
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Violations of Federal and State Securities Laws, Continued
The Federal securities laws provide legal causes of action against the Company
by persons buying the securities from the Company, including action to rescind
the sales. With respect to the sales described above, the statutes of
limitations relating to such actions appear to have expired for sales made by
the Company more than three years ago. The Company made substantially all of the
stock sales more than three years ago. However, with respect to such sales,
other causes of actions may exist under federal law, including causes of action
for which the statute of limitations may not have expired.
Each of the states in which the Company has effected sales of common stock has
its own securities laws, which likely have equal applicability to the Company's
activities discussed above. The Company sold stock to persons in over forty
states, and those states typically provide that a purchaser of securities in a
transaction that fails to comply with the state's securities laws can rescind
the purchase, receiving from the issuing company the purchase price paid plus an
interest factor, frequently 10% per annum from the date of sales of such
securities, less any amounts paid to such security holder. The statutes of
limitations for these rights typically do not begin running until a purchaser
discovers the violation of the law, and therefore in most instances, and
depending on individual circumstances, the statute of limitations do not appear
to limit those rights for most purchasers of securities from the Company. Also,
depending on the law of the state and individual circumstances, monetary damages
and other remedies may be granted for breach of state securities laws.
The Company and its attorneys have completed an evaluation of the statutes of
limitations for each of the states in which the Company sold stock to a
stockholder. The Company believes that it may have a liability at December 31,
1999 of $469 to stockholders whose rights of rescission have not expired under
applicable state securities laws. As discussed in Note H, the Company has
recorded this potential liability as Common Stock Subject to Rescission in the
balance sheet.
In addition, the Company may be liable for rescission under state securities
laws to the purchasers of the Hebron common stock because of the relationships
of the two companies. The Company cannot predict how many of the Hebron
stockholders will exercise their right of rescission, and no liability has been
accrued at December 31, 1999.
F-32
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Other Securities Matters
In December 1994, the Washington Department of Financial Institutions -
Securities Division ("WDS") notified the Company that it was aware that the
Company may have offered unregistered securities to residents of the State of
Washington and instructed the Company to cease and desist such offers and to
provide information with respect to any sales of such securities. In April 1997,
the WDS told the Company that it was trying to close its file on the Company and
served a subpoena on the Company that sought various documents relating to the
Company's shareholders in Washington State. The Company voluntarily produced
documents in response to the subpoena in May 1997. The WDS has not corresponded
with the Company since May 1997.
In February 1996, the Oklahoma Department of Securities ("ODS") made an inquiry
to the Company with regard to the basis upon which the Company had offered and
sold securities and effected issuances of short-term notes under the APLP
without registration under the Oklahoma Securities Act. The Company responded to
such inquiry in February 1996 advising the ODS that neither the Company nor its
Oklahoma counsel believed that the short-term notes issued under the APLP
constituted securities, and claiming that the common stock was exempt from
registration under Section 401(b)(9)(B) of the Oklahoma Securities Act. The
Company has not received a response from ODS and consequently has not had any
further contact with the ODS since its response.
Commitments with Providers and Others
In April 1999, the Company entered into a telecommunications contract with
WorldCom, its primary provider of switchless telecommunications services. The
term of the contract is for three years, with early termination provided for
based on meeting specified purchase commitments during the term of the contract.
In connection with the contract, WorldCom agreed to subordinate its interests in
the Company's customer base, as well as its accounts payable and other rights
and obligations, to the financial institution providing the Company's Credit
Facility. WorldCom has a second security lien on all of the assets in which the
financial institution has a first security lien. The agreement provided for
reduced rates and credits for disputed payables. The Company recognized these
credits as a reduction of expenses during the year ended December 31, 1999. The
Company is required to maintain minimum purchase commitments under the terms of
its contract with WorldCom. During the year ended December 31, 1999, the Company
met the minimum purchase commitments, and expects to be able to continue to meet
these requirements. At December 31, 1999, the remaining purchase commitment over
the remainder of the contract was approximately $51,600.
In connection with the Asset Purchase Agreement with Hebron, as described in
Note B, the Company also assumed responsibility for the telecommunications
contract between Hebron and Broadwing (Formerly IXC Communications, Inc.), the
underlying carrier that transports the Company's call records through the
Oklahoma City and Chicago switches. This contract is effective through September
2003, and also requires the Company to maintain minimum monthly purchase
commitments of $550. The Company met the minimum purchase commitments during
1999.
F-33
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
At December 31, 1999, the Company has commitments to purchase equipment and
system software totaling approximately $4,000.
Long-Term Agreements with Salespersons
In 1997, the Company entered into long-term agreements with certain
salespersons. The agreements were effective for twenty-five (25) years, and
provide for a 3% commission of the net domestic phone billings, as defined in
the agreement, to be paid to the salespersons, plus additional commissions
through recruitment efforts, death and termination benefits, and other benefits
as described in the agreements. The termination benefits defined in the original
agreement provide for the salespersons to receive 75% of the commissions earned
under the contract for current subscribers assigned to the salesperson at the
termination date, plus 50% of the commissions earned for all additional
subscribers who enroll under the salespersons' existing non-profit
organizations, for a period of 25 years. In exchange for the extended contract
terms and death and termination benefits, the Company received non-competition
agreements, as defined in the agreements, with each of the salespersons. In
1999, the Company renegotiated or terminated the agreements with these
salespersons, by either (1) replacing the original agreements with full-time or
part-time employment contracts, or independent contractor agreements ranging
from three to five years; (2) entering into covenant agreements with the
salespersons, or (3) continuing to pay the salespersons under the termination
provisions of the original contract.
Deferred Compensation Contracts
In 1997, and as amended in 1998, the Company entered into non-qualified deferred
compensation agreements with certain salespersons. The deferred compensation
plan, which is not funded, allowed these salespersons to defer portions of their
current compensation. The Company agreed to pay the salespersons an amount equal
to their deferred compensation plus an effective rate of return, ranging from
45% to 55%. In 1999, the Company repaid in full all but one of these
obligations. The liability for the deferred compensation contracts is included
in accounts payable and accrued expenses, and totaled approximately $385 and $43
at December 31, 1998 and 1999, respectively.
F-34
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE I--COMMITMENTS AND CONTINGENCIES--Continued
Non-Cancelable Operating Leases
The Company leases office space, copiers and other equipment under agreements
that are accounted for as operating leases. These lease agreements expire in
varying years through 2004. Total lease expense was approximately $229, $472,
and $692 in 1997, 1998 and 1999, respectively. Future commitments under
non-cancelable operating leases are as follows:
Year Ended December 31
2000 $ 614
2001 420
2002 431
2003 111
2004 105
-------------
$ 1,681
=============
Other Matters
From time to time, the Company may be party to litigation, claims and
assessments arising in the normal course of business. In the opinion of
management, the outcomes of such proceedings will not be material to the
Company's financial position, results of operations or cash flows.
NOTE J--FINANCIAL CONDITION AND RESULTS OF OPERATIONS
From its inception through December 31, 1998, the Company had incurred
cumulative net operating losses totaling approximately $12,000. In 1999, the
Company implemented a series of cost reduction measures that enabled the Company
to realize net income of $2,224. Despite the profitability, however, the
Company's total net sales declined by 7.7% from 1998 to 1999, and the net sales
from long distance revenues, exclusive of the pass-through charges that began in
1998, declined from $113,000 and $114,000 in 1997 and 1998, respectively, to
$102,000 in 1999. In addition, the accumulated stockholders' deficiency was
($23,758) at December 31, 1999. These factors, among others, indicate that the
Company will be unable to continue as a going concern for a reasonable period of
time.
F-35
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE J--FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Continued
Beginning in 1998 and continuing into 1999 and 2000, the Company has taken
several steps which management believes will enable the Company to continue to
realize profitability, as well as improve the Company's overall financial
position and liquidity. These steps include:
o Despite recurring net losses, the Company previously had a
policy of declaring returns of capital. From 1994 through
1997, the Company declared cumulative returns of capital to
nonredeemable stockholders totaling approximately $15,700.
Through December 31, 1999, approximately $12,400 had been
paid, and $3,300 was payable at December 31, 1999. The amounts
payable at December 31, 1999 were to the Chairman and the
former Senior Vice President. When declared, the returns of
capital were recorded as a reduction of retained earnings
(deficit). In addition, accretions of the redemption value of
the redeemable common stock, as described in Note H, were also
recorded as a charge to retained earnings (deficit). Through
December 31, 1999, the cumulative charge to retained earnings
(deficit) as a result of accretions to the redeemable common
stock was approximately $3,400. The Company reduced this
liability through payment of the distributions to redeemable
stockholders as well. Cumulative payments of distributions to
redeemable stockholders totaled approximately $3,300. The
deficit in retained earnings larger by approximately $19,100
as a result of the distributions to nonredeemable stockholders
and accretions of the redemption value of redeemable stock to
the redeemable stockholders.
The Company discontinued the policy of declaring distributions
to its stockholders at the end of 1997. Future dividends or
distributions to owners are restricted under the Company's
revolving line of credit agreement, as described in Note D to
the financial statements. The Company believes that retaining
earnings will enable the Company to sustain profitability.
o As discussed in Note D, the Company has obtained funding from
a financial institution for a $30,000 line of credit. The
proceeds of this line of credit have enabled the Company to
become and remain current on its operating liabilities, and to
repay existing loans and notes that carried higher interest
rates. The proceeds have also provided the Company with the
necessary capital to upgrade its core computer systems. The
Company has been notified by the financial institution that it
has been approved for an increase in the line of credit to
$35,000.
o In April 1999, the Company entered into a new
telecommunications contract with WorldCom, as discussed in
Note I to the financial statements. The new agreement provides
the Company with reduced rates on its switchless long distance
services. The Company has passed some of the savings from
reduced rates to its customers, in order to compete with
industry-wide rate reductions, and has retained the benefit of
some of the savings. The agreement provides for further
periodic reviews of the rates, and in December 1999, the
Company received an additional rate reduction from WorldCom.
F-36
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE J--FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Continued
o Effective February 1, 1999, the Company acquired the rights
and responsibilities of the switched services operations that
were previously provided by Hebron, as discussed in Note B to
the financial statements. The Company realized significant
savings in 1999 from operation of the switches as compared to
purchasing the switched services from Hebron, and the Company
expects these savings to continue in the future.
o Beginning in January 1999, the Company began operating its
telemarketing department internally, rather than outsourcing
those services to VisionQuest. Internally operating the
telemarketing department resulted in significant cost savings
in 1999, and the Company expects these savings to continue in
the future. In the fourth quarter of 1999, the Company began
acquiring new telemarketing equipment, and opened a new
telemarketing facility in Tahlequah, Oklahoma in January 2000.
In an effort to increase its revenues and customer base, the
Company plans to increase its telemarketing efforts in 2000.
Management believes that the above factors will enable the Company to continue
to realize profitable operations and reduce its deficits, improve its liquidity
ratios, and continue to meet its obligations on an ongoing basis.
NOTE K--STOCK-BASED COMPENSATION (dollars in thousands, except per share
amounts)
Description of Company Stock Compensation Plans
The Company has entered into various stock option and stock bonus plans with
certain officers and non-employee directors. For stock-based compensation awards
granted to employees, the Company follows the provisions of APB Opinion No. 25,
Accounting for Stock Issued to Employees. For stock-based compensation awards
granted to non-employee directors, the Company follows the provisions of SFAS
No. 123, Accounting for Stock-Based Compensation.
F-37
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION--Continued
Stock Option Plans
Board of Directors Stock Option Plan
Effective October 1, 1998 and January 1, 1999, the Company's Board of Directors
granted two employee directors and two non-employee directors options to
purchase Company stock. Three of the options granted entitle the individuals to
purchase 3% of the fully diluted outstanding common stock as of the grant date.
The other option originally entitled the non-employee director to purchase 0.5%
of the fully diluted common stock; this option was amended in May 1999 to 1% of
the fully diluted common stock. For the employee directors, the fair value of
the common stock, as determined by an independent appraiser, as of the grant
date was less than the exercise price; accordingly, the Company did not
recognize any compensation expense for the employee directors. Stock option
expense recognized under the fair value method prescribed by SFAS No. 123 for
non-employee directors totaled $28, and $38, for 1998 and 1999, respectively.
For the additional options granted to one non-employee director effective July
1, 1999, as discussed above, the Company recognized expense of $8, based upon
the difference between the fair value of the common stock as of the grant date
($41.50 per share) and the exercise price of the stock options ($28.86).
Effective with the May 1999 amendments to the employment agreements with the
employee directors and the stock agreements with the non-employee directors, the
stock options are exercisable at 25% on July 1, 1999, and 25% each July 1
thereafter until fully vested. Each exercise right shall continue in force for a
period of five years following its commencement, irrespective of the
individual's subsequent employment status with the Company.
The following table summarizes the Company's stock option transactions from
January 1, 1998 through December 31, 1999:
Weighted Weighted
Average Shares Average
Shares Exercise Subject to Exercise
Subject to Price Exercisable Price
Options Per Share Options Per Share
------------ ------------ ------------ ------------
Outstanding, December 31, 1997 -- n/a -- n/a
Granted 59,142 $ 28.86 5,914 $ 28.86
Exercised -- -- -- --
Canceled/forfeited -- -- -- --
------------ ------------ ------------ ------------
Outstanding, December 31, 1998 59,142 28.86 5,914 28.86
Granted 31,845 28.86 16,833 28.86
Exercised -- -- -- --
Canceled/forfeited -- -- -- --
------------ ------------ ------------ ------------
Outstanding, December 31, 1999 90,987 28.86 22,747 28.86
F-38
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION--Continued
Following is a recap of the outstanding stock options at December 31, 1999:
Options Outstanding
------------------------------
Options Exercisable
--------------------------
Average Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise Prices Shares Life (Years) Price Shares Price
--------------- ------------- ------------ ----------- ----------- -----------
28.86 90,987 5.0 28.86 45,494 28.86
Pursuant to SFAS No. 123, the Company is required to disclose the pro forma net
earnings and earnings per share effects of the stock options, as if the stock
options had been accounted for under the provisions of SFAS No. 123. SFAS No.
123 prescribes that the compensation cost be recorded equal to the fair value of
the options as of the grant date, and that compensation costs be recognized
ratably over the vesting period of the options. Had compensation costs been
determined in accordance with SFAS No. 123, the Company's net income (loss) and
net income (loss) per share amounts for the years ended December 31, 1998 and
1999 would have been reduced (increased) to the pro forma amounts indicated
below:
1998 1999
------------- -------------
Net income (loss)
As reported $ (3,655) $ 2,224
Pro Forma (3,671) 2,198
Basic earnings (loss) per share
As reported $ (4.32) $ 2.83
Pro forma (4.34) 2.80
Diluted earnings (loss) per share
As reported $ (4.43) $ 2.35
Pro forma (4.45) 2.32
F-39
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE K--STOCK-BASED COMPENSATION--Continued
The Company has obtained an independent appraisal of its common stock for each
date that it granted stock options and bonuses to employees and non-employee
directors. Stock options granted in January 1999 and October 1998 have an
exercise price of $28.86 per share, which exceeds the fair value of the
Company's common stock as of the grant date. The weighted average estimated fair
value of the options granted in January 1999 and October 1998 were $2.83 per
share and $3.94 per share, respectively. The stock options granted in July 1999
have an exercise price of $28.86 per share, which is lower than the fair value
of the Company's common stock as of the grant date. The weighted average
estimated fair value of these options was $20.05 per share.
Because the Company's stock is not publicly traded, the fair value of the
Company stock options was estimated on the date of the grant using the minimum
valuation method, as prescribed by SFAS No. 123. Under the minimum value method,
expected stock price volatility is set at a level that approximates 0%. The
estimated weighted-average fair value of options granted during 1998 and 1999
was calculated using a Black-Scholes option-pricing model with the following
weighted average assumptions:
1998 1999
---------- ----------
Expected stock price volatility 0.0001% 0.0001%
Risk free rate 4.27% 4.55%
Expected dividend yield 0.0% 0.0%
Expected life (years) 8.3 years 7.1 years
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. The Company's stock options have characteristics significantly
different from those of traded options, and changes in the subjective input
assumptions can materially affect the fair value estimate.
Stock Bonuses
The stock bonuses were granted as of October 1, 1998 and January 1, 1999 and
provided for the employee and non-employee directors to collectively receive
2.5% of the fully diluted common stock as of the grant dates. The number of
shares granted in 1998 and 1999 was 13,647 and 9,099, respectively. Compensation
expense is recognized on a straight-line basis over the vesting period. In
addition, the agreements provide for the Company to pay a cash bonus equal to
the amount of income taxes for which the recipients will be liable as a result
of the vesting of the stock bonus, and an additional cash bonus equal to the
amount of income taxes for which the recipient will be liable as a result of the
first cash bonus. During the years ended December 31, 1998 and 1999, the Company
recognized compensation expense of $83 and $147, respectively, pursuant to the
stock bonus. Additional compensation expense of $45 and $80, respectively, was
recognized for the related tax bonus arrangements.
F-40
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE L--EARNINGS (LOSS) PER SHARE (per share amounts not in thousands)
The computation of basic and diluted earnings (loss) per share is as follows:
1997 1998 1999
------------ ------------ ------------
Net income (loss) $ (341) $ (3,655) $ 2,224
Decrease (increase) in redemption value of redeemable common stock (470) 179 102
------------ ------------ ------------
Net income (loss) available to nonredeemable common stockholders $ (811) $ (3,476) $ 2,326
============ ============ ============
Average shares of nonredeemable common stock outstanding 799 804 823
============ ============ ============
Basic Earnings (Loss) Per Share $ (1.01) $ (4.32) $ 2.83
============ ============ ============
Net income (loss) available to nonredeemable common stockholders $ (811) $ (3,476) $ 2,326
Decrease in redemption value of redeemable common stock -- (179) (102)
------------ ------------ ------------
Net income (loss) available to nonredeemable common stockholders
and assumed conversions $ (811) $ (3,655) $ 2,224
============ ============ ============
Average shares of nonredeemable common stock outstanding 799 804 823
Employee stock options -- -- 106
Stock warrants -- -- 3
Conversion of redeemable common stock -- 21 16
------------ ------------ ------------
Average shares of common stock outstanding and assumed conversions 799 825 948
============ ============ ============
Diluted Earnings (Loss) Per Share $ (1.01) $ (4.43) $ 2.35
============ ============ ============
The average shares listed below (in thousands) were not included in the
computation of diluted earnings (loss) per share because to do so would have
been antidilutive for the periods presented:
1997 1998 1999
--------------- --------------- ----------------
Conversion of convertible notes 3 3 3
Conversion of redeemable stock 23 - -
Employee stock options - 18 -
F-41
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE M--QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
------------ ------------ ------------- ------------
(in thousands except per share data restated)
Net sales $ 30,842 $ 31,810 $ 31,494 $ 30,086
Net loss (520) (999) (699) (1,437)
Basic earnings (loss)
per share (0.79) (1.28) (0.58) (1.66)
Diluted earnings (loss)
per share (0.79) (1.28) (0.85) (1.72)
Three Months Ended
----------------------------------------------------------------
March 31, June 30, September 30, December 31,
1999 1999 1999 1999
------------ ------------ ------------- ------------
(in thousands except per share data)
Net sales $ 29,040 $ 28,141 $ 29,371 $ 28,109
Net income (loss) 193 2,339 524 (832)
Basic earnings (loss)
per share 0.23 2.86 0.67 (0.94)
Diluted earnings (loss)
per share 0.21 2.47 0.55 (0.94)
In the second quarter of 1999, the Company received significant credits in
connection with its new telecommunications service agreement with WorldCom. The
Company also recovered $182 of the loss on the advances made to an unrelated
long-distance reseller, as described below.
In the fourth quarter of 1998, the Company provided pre-tax losses of $215 in
connection with the impairment of its former corporate headquarters and $552 for
a loss on a receivable from an unrelated long-distance reseller.
For the first and second quarters of 1998, the fourth quarter of 1999, and the
second quarter of 2000, diluted earnings (loss) per share is the same as basic
earnings (loss) per share, because potentially dilutive securities were
antidilutive.
F-42
88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued (dollars in thousands)
AMERIVISION COMMUNICATIONS, INC.
NOTE N--SUBSEQUENT EVENTS
In May 2000, the Company and the lender entered into an amendment to the Credit
Facility, which increased the maximum availability under the line of credit to
$35,000, subject to the collections and earnings multiples contained in the
original agreement, and as amended.
In December 1999, the Company's Board of Directors approved the 1999 Stock
Incentive Plan (the "Plan"), which authorized 40,000 shares of the Company's
common stock to be reserved for issuance to employees, directors, consultants
and other individuals. The Plan enables the Company to reward participants with
(i) incentive stock options and/or non-qualified stock options to purchase
shares of Company common stock, (ii) stock appreciation rights with respect to
shares of Company common stock, (iii) shares of Company common stock, (iv)
performance share awards which are designated as a specified number of shares of
company common stock and earned based on performance, and (v) performance unit
awards which are designated as having a certain value per unit and earned based
on performance. On July 1, 2000, options to purchase 24,500 shares of Company
common stock granted to certain officers and employees of the Company.
Effective September 1, 2000, the Company adopted the 401k AmeriVision Retirement
Plan (the "401k"). The 401k Plan provides for all employees meeting certain
eligibility requirements to participate in the 401k Plan. The Company may make
discretionary profit-sharing contributions to the 401k Plan.
In November 2000, the Company notified the third-party contractor responsible
for development of the Company's billing system that the Company intended to
terminate the contract between the Company and the contractor. The Company
cannot determine what the ultimate outcome of this matter will be.
F-43
89
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 - Certificate of Incorporation of the Company
3.2 - Bylaws of the Company
3.3 - Secretary certificate regarding amended and restated bylaws
4.1 - Form of certificate representing shares of the Company's
common stock
4.2 - Form of Type A Redemption Agreement
4.3 - Form of Type B Redemption Agreement
4.4 - Form of Type C Redemption Agreement
4.5 - Form of Type D Redemption Agreement
4.6 - Form of Convertible Note
4.7 - Promissory Note dated April 20, 1999, payable by the Company
to C.A.S.E., Inc.
4.8 - Promissory Note dated April 20, 1999, payable by the Company
to John Damoose
10.1 - Agreement, dated as of April 13, 1998, between the Company
and Carl Thompson
10.2 - First Amendment to April 13, 1998 Agreement between
Amerivision Communications, Inc. and Carl Thompson, dated
as of December 31, 1998, among the Company, Carl Thompson
and Willeta Thompson
10.3 - Amended and Restated Employment Agreement, dated as of
May 24, 1999 between the Company and Stephen D. Halliday
10.4 - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the Company, Jay A. Sekulow and Tracy Freeny
10.5 - Amended and Restated Stock Agreement, dated as of May 24, 1999,
among the Company, John Damoose and Tracy Freeny
10.6 - Employment Agreement, dated as of May 24, 1999, between the
Company and John E. Telling
10.7 - Employment Agreement dated as of May 24, 1999 between the
Company and Tracy Freeny
10.8 - Reaffirmation of Commitments made in Employment Agreement of
Stephen D. Halliday dated as of June 30, 1999
10.9 - Reaffirmation of Commitments made in Stock Agreement of Jay A.
Sekulow dated as of June 30, 1999
10.10 - Agreement effective January 1, 1999, between the Company and
VisionQuest
10.11 - Telemarketing Services Agreement, effective as of
January 1, 1999 Between the Company and VisionQuest
10.12 - Clarification to Agreement, effective as of June 9, 1999,
by and Between the Company and VisionQuest
10.13 - Asset Purchase Agreement, dated as of April 30, 1999,
among Hebron, the Company, Tracy Freeny, Carl Thompson and
S. T. Patrick.
10.14 - Lease/License Agreement, dated as of April 30, 1999 between
Hebron and the Company.
10.15 - Form of Promissory Note payable by the Company to Hebron
(form to be used with respect to Switch Note and Internet Note)
10.16 - Promissory Note dated February 1, 1999, in the original principal
amount of $2,274,416 payable by the Company to Hebron
10.17 - Capital Stock Escrow and Disposition Agreement dated April 30,
1999 among Tracy C. Freeny, Hebron and Bush Ross Gardner Warren
& Rudy, P.A.
10.18 - Loan and Security Agreement dated as of February 4, 1999 between
10.18.1 - Amendment Number One to Loan and Security Agreement dated as of
October 12, 1999 between the Company and Coast Business Credit
10.18.2 - Amendment Number Two to Loan and Security Agreement dated as of
May 10, 2000 between the Company and Coast Business Credit
10.19 ** - Telecommunications Services Agreement dated April 20, 1999 by
and between the Company and WorldCom Network Services, Inc.
10.20 ** - Program Enrollment Terms dated April 20, 1999 between the
Company and WorldCom Network Services, Inc.
10.21 - Security Agreement dated April 20, 1999 by and between the
Company and WorldCom Network Services, Inc.
10.22 - Letter Agreement dated July 14, 1999 between the Company and
Tracy C. Freeny
10.23 - Employment Agreement dated December 31, 1998, between the
Company and Kerry Smith
10.24 - Letter Agreement dated as of December 31, 1999 between the
Company and John Telling
10.25 - Royalty Agreement dated as of January 1, 1999 between the
Company and Regency Productions, Inc.
90
10.26 - Royalty Agreement effective as of January 1, 1999 between the
Company and Christian Advocates Serving Evangelism, Inc.
10.27 - Stock Incentive Plan
21.1 - List of subsidiaries of the Company
27.1* - Financial Data Schedule
* Filed herewith.
** Information from this agreement has been omitted because the Company
has requested confidential treatment. The information has been filed
separately with the Securities and Exchange Commission.
*** Incorporated by reference to the Company's Registration Statement on
FORM 10/A and FORM 10, as appropriate.