U.S. SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-K

(Mark One)
[X] ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE ACT OF
    1934.

For Fiscal Year Ended: December 31, 1997

OR

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
    OF 1934.

For the transition period from ____________ to ___________.

Commission file number        0-27580

                           AvTel Communications, Inc.
                           --------------------------
                       (Name of Registrant in Its Charter)

        Delaware                            87-0378021
        --------                            ----------
(State or Other Jurisdiction of           (I.R.S. Employer
Incorporation or Organization)           Identification No.)

501 Bath Street, Santa Barbara, CA             93101
-----------------------------------            -----
(Address of Principal Executive Offices)      (Zip Code)

                           (805) 685-0355
                           --------------
           (Issuer's Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Act:  None.

Securities registered under Section 12(g) of the Act:

Common Stock Par Value $0.01
-----------------------------
(Title of class)

     Indicated by check mark  whether the issuer (1) filed all reports  required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such  shorter  period  that the  registrant  was  required  to file such
reports),  and (2) has been subject to such filing  requirements for the past 90
days. Yes X No
   -----    -----

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of  Regulation  S-K is not  contained in this form  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. [ ]

     The  aggregate  market  value  of the  Registrant's  Common  Stock  held by
non-affiliates of the Registrant was approximately $29,173,500,  computed at the
average bid and asked price of such Common Stock as of March 13, 1998.


APPLICABLE ONLY TO CORPORATE REGISTRANTS

     As of March 15,  1998,  there  were  9,522,247  shares of the  Registrant's
Common Stock, par value $0.01, issued and outstanding, excluding treasury stock.

DOCUMENTS INCORPORATED BY REFERENCE

     The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K
is  incorporated  by reference to the  Registrant's  definitive  Proxy Statement
relating to its annual  meeting of  stockholders  to be held on or about May 28,
1998,  which will be filed with the Commission  within 120 days after the end of
the Registrant's fiscal year.



                                        1




<PAGE>





TABLE OF CONTENTS


Item Number                                                  Page Number

PART I

1.  Business                                                       3

2.  Properties                                                    12

3.  Legal Proceedings                                             12

4.  Submission of Matters to a Vote of Security Holders           12



PART II

5.  Market for Common Equity and Related Stockholder Matters      13

6.  Selected Financial Data                                       14

7.  Management's Discussion and Analysis of Financial
    Condition and Results of Operations                           16

7A. Quantitative and Qualitative Disclosures about
    Market Risk                                                   22

8.  Financial Statements and Supplementary Data                   22

9.  Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure                           22


PART III

10. Directors and Executive Officers of the Registrant            22

11. Executive Compensation                                        22

12. Security Ownership of Certain Beneficial Owners and
    Management                                                    23

13. Certain Relationships and Related Transactions                23

14. Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                           23




                                        2



<PAGE>
                                     PART I

ITEM 1.  BUSINESS


INTRODUCTORY STATEMENT
----------------------

     THIS  ANNUAL  REPORT ON FORM  10-K  CONTAINS  "FORWARD-LOOKING  STATEMENTS"
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES  ACT") AND SECTION 21E OF THE  SECURITIES  EXCHANGE ACT OF 1934,  AS
AMENDED (THE "EXCHANGE  ACT").  FORWARD-LOOKING  STATEMENTS ARE STATEMENTS OTHER
THAN  HISTORICAL  INFORMATION  OR STATEMENTS OF CURRENT  CONDITION AND RELATE TO
FUTURE   EVENTS  OR  THE   FUTURE   FINANCIAL   PERFORMANCE   OF  THE   COMPANY.
FORWARD-LOOKING  STATEMENTS INVOLVE RISKS AND UNCERTAINTIES,  SUCH AS STATEMENTS
OF THE COMPANY'S  STRATEGIES,  PLANS,  OBJECTIVES,  EXPECTATIONS,  ESTIMATES AND
INTENTIONS.  SOME  FORWARD-LOOKING  STATEMENTS  MAY BE IDENTIFIED BY USE OF SUCH
TERMS AS "BELIEVES," "ANTICIPATES," "INTENDS" OR "EXPECTS." THE COMPANY'S ACTUAL
RESULTS   MAY  DIFFER   SIGNIFICANTLY   FROM  THE  RESULTS   DISCUSSED   IN  THE
FORWARD-LOOKING  STATEMENTS.  THE COMPANY  UNDERTAKES  NO OBLIGATION TO PUBLICLY
UPDATE OR REVISE  ANY  FORWARD-LOOKING  STATEMENTS,  WHETHER  AS A RESULT OF NEW
INFORMATION,  FUTURE EVENTS OR OTHERWISE. THE CAUTIONARY STATEMENTS MADE IN THIS
ANNUAL REPORT SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED  FORWARD-LOOKING
STATEMENTS WHEREVER THEY APPEAR IN THIS ANNUAL REPORT.

BACKGROUND
----------

General

     AvTel  Communications,  Inc.  (the  "Company"  or "AvTel") is a provider of
broadband  network  services  integrating  voice,  data and video  solutions for
individuals and corporate customers. The Company sells and markets a broad range
of  telecommunications  and advanced network services through  independent value
added  resellers and internal  direct sales  professionals.  The Company targets
mid-size  corporations,   small-office  home-office   professionals  and  select
residential market segments.

    The  Company was  formerly a Utah  corporation.  On  December  1, 1997,  the
Company  merged  with  and  into  its  wholly-owned  Delaware  subsidiary,  thus
effecting  the  Company's  reincorporation  in  Delaware  (the  "Reincorporation
Merger").  The conversion of the Company's stock in the  Reincorporation  Merger
resulted in an effective  one-for-four  reverse stock split, which was effective
on December 1, 1997 (the "Reverse  Stock  Split").  All share and option numbers
and prices set forth  herein have been  adjusted  to reflect  the Reverse  Stock
Split.

History

     The Company was  incorporated on October 31, 1981, but did not commence its
current business until February, 1995 when it acquired, through a subsidiary, an
80% interest in The Friendly Net, LLC ("TFN") a Utah limited liability  company.
TFN is a  Utah-based  Internet  Service  Provider  ("ISP").  The  remaining  20%
interest in TFN was acquired by the Company in March 1997.

     Prior to October 23, 1996, the Company conducted  operations under the name
"Hi, Tiger International, Inc.". The name change was effected in connection with
the Company's  acquisition  of AvTel  Holdings,  Inc., a California  corporation
("AHI")  on that  date.  As a result  of the  acquisition  of AHI,  the  Company
implemented  a  complete   change  in  its  Board  of  Directors  and  executive
management,  began to pursue several  acquisitions  and strategic  alliances and
started development of a sales and operational  strategy to position the Company
as a  telecommunications  carrier  providing a comprehensive  array of broadband
voice and data network services.

     The  acquisition  of  AHI  was  effected   pursuant  to  the  merger  of  a
wholly-owned subsidiary of the Company with and into AHI (the "AHI Merger") as a
result of which the Company acquired 100% of the issued and outstanding  capital
stock of AHI in  exchange  for  1,063,127  shares of the Company  Common  Stock,
representing  approximately  61% of the issued and  outstanding  Company  Common
Stock  after  giving  effect  to the AHI  Merger,  and  250,000  shares of newly
authorized  shares of the Company's  Series A Convertible  Preferred  Stock. For
accounting  purposes,  the acquisition was treated as a reverse acquisition with
AHI as the acquirer.

                                        3
<PAGE>

     In November, 1996, the Company acquired Silicon Beach Communications,  Inc.
("SBC"),  a  privately  held  California  corporation  that serves as an ISP and
provides software development services. In February,  1997, the Company acquired
all the issued and  outstanding  capital stock of WestNet  Communications,  Inc.
("WNI"), a Ventura,  California ISP.  Following  completion of this acquisition,
the Company began to integrate the customer bases,  network facilities and other
operations of SBC and WNI in order to achieve desired efficiencies and economies
of scale.

     On  December  1,  1997,  the  Company  acquired  Matrix  Telecom,  Inc.,  a
privately-held  Texas  corporation  ("Matrix")  by  means of a share  for  share
exchange (the "Share Exchange"). Matrix is a provider of long distance telephone
services.  See "Background - Acquisition of Matrix" below.  The  Reincorporation
Merger and the Reverse  Stock Split were  conditions to the closing of the Share
Exchange.

Acquisition of Matrix.

     AvTel and Matrix  entered into a Stock Exchange  Agreement  dated April 29,
1997, and subsequently amended (the "Exchange Agreement"), pursuant to which the
persons or entities who owned the issued and outstanding  common stock of Matrix
("Matrix  Stockholders")  would transfer to AvTel all of their Matrix stock and,
in exchange,  AvTel would issue to the Matrix Stockholders shares of the AvTel's
Common Stock (the "Share  Exchange").  The Share Exchange was completed pursuant
to the terms of the Exchange Agreement on December 1, 1997.  Following the Share
Exchange, the former Matrix Stockholders now own approximately 81% of the issued
and  outstanding  Common  Stock of the Company.  For  accounting  purposes,  the
acquisition was treated as a reverse acquisition with Matrix as the acquirer.

      In connection with the completion of the Share Exchange,  the Matrix Stock
Holders and the Company entered into a Registration  Rights and Lockup Agreement
dated  December  1, 1997  (the  "Registration  Rights  and  Lockup  Agreement").
Pursuant to the Registration  Rights and Lockup  Agreement,  certain persons and
entities who hold an aggregate of 67.4% of the  outstanding  Matrix Common Stock
(85.2% of the outstanding Matrix Common Stock,  excluding the shares held by New
Best Connections Inc., a wholly-owned  subsidiary of Matrix; "Best") agreed, for
a two-year period commencing on the closing of the Share Exchange, not to offer,
pledge,  sell, or otherwise  dispose of any shares of the Company issued to them
pursuant to the terms of the Exchange  Agreement.  The Matrix  Stockholders  who
have  agreed to this  two-year  lockup  period are Ronald L.  Jensen,  his adult
children  (James J. Jensen,  Jami J. Jensen,  Janet Jensen  Krieger,  Jeffrey J.
Jensen, and Julie J. Jensen),  and United Group  Association,  Inc. and UA Plus,
Inc. (which are controlled by Mr.
Jensen and his adult children).

     The Registration  Rights and Lockup Agreement requires that the Company use
its best efforts to become  listed on the NASDAQ  SmallCap  Market or the NASDAQ
National  Market and to file a shelf  registration  statement  providing for the
sale by the Matrix  Stockholders of all securities  issued to them in connection
with the Exchange Agreement, subject to the two-year holding restriction imposed
on certain of the Matrix  Stockholders  described above.  Under the Registration
Rights  and Lockup  Agreement,  the  Company  is  obliged to use its  reasonable
efforts to keep the shelf registration statement effective on a continuous basis
for a period described in the Registration  Rights and Lockup Agreement.  If the
Company's  securities are not listed on the NASDAQ SmallCap Market or the NASDAQ
National  Market  within six months  following  the Closing or if the Company is
unable to qualify for use of a shelf registration  statement within such period,
the Matrix Stockholders  (other than those subject to the two-year  restriction)
are entitled to demand that the Company register the AvTel Common Stock received
by them in connection with the Share Exchange on any registration statement then
available to the Company.  The Matrix  Stockholders may also require the Company
to undertake up to two additional demand registrations of their securities.  All
costs  and  expenses  of both  shelf and  demand  registrations  (excluding  any
underwriting  discounts and fees of counsel to the Matrix  Stockholders) will be
borne by the Company.

     Pursuant to the terms of the Exchange Agreement,  Barry A. Peters and Frank
Dziuba resigned as directors of the Company  immediately prior to the completion
of the Share Exchange.  Also pursuant to the terms of the Exchange Agreement, on
December  1, 1997,  John E.  Allen,  Ronald W.  Howard and  Gregory T. Mutz were
appointed to fill vacancies on the Company's Board of Directors.



                                        4
<PAGE>

BUSINESS OF THE COMPANY
------------------------

     As noted  above,  the Company is a provider of broadband  network  services
integrating  voice,  data and video  solutions  for  individuals  and  corporate
customers. The Company sells and markets a broad range of telecommunications and
advanced network services through independent value added resellers and internal
direct  sales   professionals.   The  Company  targets  mid-size   corporations,
small-office  home-office  professionals and select  residential market segments
through  two primary  business  units;  Business  Network  Services  ("BNS") and
Consumer Markets.

Business Network Services

     BNS targets mid-size corporate customers for their broadband data and voice
network needs. Leading this sales strategy, the Company's objective is to become
the underlying  telecommunications  carrier for the transport of data, voice and
video  traffic  over  various wide area  network  configurations  and  protocol.
Through a value-added  sales  process,  BNS designs,  provisions and manages its
customers' networks.  BNS will provide a host of additional value added services
assisting its customers create enhanced intranet and extranet applications.  The
Company  believes its strategy to focus on the corporate  customer for wide-area
network  ("WAN")  and  global-area  network  ("GAN")  needs  offers  significant
opportunity.  BNS  cross-markets  to its customer base a variety of  traditional
telecommunications  products  and  services  such  as  long  distance  telephone
service, executive calling cards and wireless paging.

     Industry.  Information  technology  is fast  becoming the driving  force in
telecommunications. The Company's BNS strategy is driven by corporate end users'
needs for network  connectivity  as a result of new  software  applications  and
technology  advancements  developed in the information technology arena. This is
becoming a critical element in the ability of businesses, professional and other
organizations to improve  productivity and lower costs. This can be accomplished
through the use of a variety of  telecommunications  services,  including branch
office,  remote  office and  telecommuter  networking  ("intranets")  as well as
providing  network  access  to  customers,   vendors,   financial   institutions
("extranets") and the Internet. While management expects that these factors will
result in an increased market demand for these services, there are no assurances
regarding  the size of such  demand  or that the  Company  will be  selected  to
provide its services in response to such demand.

     Strategy.  The  implementation  of this strategy  involves the creation and
marketing of products and services designed for business applications under BNS.
BNS is developing and implementing  sales and marketing  strategies which result
in monthly,  recurring revenues from networking  customers under multi-year term
agreements.  The group's primary sales channel is an agent program through which
BNS  distributes  its  services  through  value  added  resellers   ("VARs")  of
information   technology   products.   BNS  leverages   the  existing   customer
relationships of these channel partners gaining more immediate access to a wider
group of  prospective  customers and greater  credibility  in the sales process.
Additionally,  this  VAR  channel  becomes  the  service  organization  for  BNS
customers  requiring on-site repair and maintenance  visits.  BNS also deploys a
direct sales force, targeting specific niche industries.  However, this strategy
is in its formative stages and the Company is recruiting,  hiring,  training and
developing the personnel  resources  necessary to manage and staff the sales and
marketing  efforts.  Delays or other difficulties in these recruitment and other
activities  could  adversely   affect  the  Company's   ability  to  timely  and
effectively implement these revenue-generating objectives.

     Internetworking.  At an increasing rate,  business,  professional and other
organizations  are seeking to inter-network  their local area networks  ("LANs")
and WANs to share  information and computing  resources for applications such as
e-mail, transaction processing, the sharing of databases, multi-site engineering
and product  development  and  electronic  image  transfer.  The  communications
traffic of many  organizations  has grown  steadily  during the past two decades
leading  to  enterprise-wide  networks  facilitating  rapid and  efficient  data
communications   between  work  groups,   departments   and  branch   locations.
Additionally,  a shift to  enterprise-wide  remote  access has  occurred  due to
increased  business  mobility,  increased  telecommuting,  reduced  cost  of WAN
services and widespread adoption of remote access standards. Internet and remote
access  devices  extend the  organization  network  beyond  the  branch  office,
bringing remote users closer to the enterprise and permitting  connection to the
corporate LAN so users can work  anywhere,  any time.  Users can access  e-mail,
databases and servers as if they were in the corporate office.

                                        5
<PAGE>

     The Company  believes  that, as a result of these shifts,  internetworking,
the method used for interconnecting  networks,  has been undergoing rapid growth
over the past ten years.  This is reflected in the  significant  growth in sales
and distribution of routers, remote access servers,  intranet software and other
various  components  that  enable  internetworking.  As the  computing  paradigm
migrates to client-server  architectures,  enterprise-wide  networks allow those
technologies  to  be  implemented.   The  Company's   strategy   recognizes  the
opportunity  to bridge  the gap  between  telecom  and  computer  providers  and
simplify networking complexities by becoming a single point of contact.

     Connectivity  and  Bandwidth.  The  Company  believes  that  communications
requirements  such as bandwidth  availability  and network  design are replacing
computer  requirements  such as processor speed,  memory or operating systems as
the delimiting factors for business  applications.  Video  conferencing,  remote
patient  diagnostics  with medical  imaging and  telecommuting  are all business
applications  in which the success of the deployment is defined by the available
bandwidth.  The ultimate realization of this trend is the World-Wide Web ("WWW")
and   applications   developed   with   Internet-specific   tools  such  as  SUN
Microsystems'  Java. These Web applications are computer  platform and operating
system  independent  but depend  entirely  upon  connectivity  and bandwidth for
successful deployment and execution.

     As a result,  connectivity is becoming one of the most important factors in
enhancing  business  productivity and customer service.  Large corporations have
historically  created private wide area networks  through leased  dedicated data
lines. However,  dedicated point-to-point  facilities have several deficiencies:
leased lines are very expensive;  remote offices and  telecommuters are omitted;
and leased lines are not suited for unscheduled and asynchronous communications.
Accordingly,  small and medium size  companies  that have sought the benefits of
internetworking  have been  required to use modems and dial-up  telephone  lines
which are generally too slow to handle today's applications.

     Growing demands for high speed capabilities have given way to the emergence
of new carrier-based data communication services to overcome the deficiencies of
both  dedicated  leased and dial-up  lines.  WAN  solutions  vary  substantially
depending on an organization's  size and  communications  needs.  Traditionally,
wideband  digital  transmission  circuits (such as T1 and DS-1) were leased from
public  carriers to provide  voice,  fax and data  communications  links between
larger  offices  and low speed  leased  lines  (such as DS-O) for branch  office
connectivity.  For some  applications,  however,  this has proven  expensive and
inefficient because the entire bandwidth capacity is dedicated 24 hours per day,
whether or not it is used.

     The birth of "packet" based services such as X.25 were developed to address
the  issue of  allocation  and  utilization.  Today,  "fast  packet"  networking
technologies  such as Frame Relay and  Asynchronous  Transfer  Mode ("ATM") have
emerged as an integrated, cost-effective,  flexible WAN solution. These networks
allow for "bandwidth on demand" between any two endpoints on a WAN.

Consumer Markets

     The   Company's   Consumer   Markets  group   targets   home-based   office
professionals  and select  residential  customers  primarily  for  domestic  and
international long distance telephone services, wireless paging, 800 numbers and
calling  cards.  This group sells its portfolio of services  through third party
distributors such as agent  organizations  and affiliate groups.  These products
and services are marketed under the MatrixTM brand name and provided through the
Company's wholly owned subsidiary, Matrix.

     Additionally,  the  Consumer  Markets  group  sells  and  markets  Internet
services to business and residential  customers in select geographic  locations.
Through the Company's  Internet service  subsidiaries,  the Company services the
areas of San Luis Obispo,  Santa Barbara and Ventura  counties in California and
Salt Lake City, Utah. The Company's Internet service subsidiaries cross-market a
variety of products and  services  including  WAN  connectivity,  software,  Web
development and long distance telephone service.

     The Consumer  Markets  group  provides  long  distance  telephone and other
services to customers in 49 states. The Company is fully certified or registered
in all states where  required  and operates  under  Section 214  authority  from
Federal Communications  Commission ("FCC"). The Company,  through a wholly owned
subsidiary has a national-deployed  Carrier Identification Code ("CIC"). The CIC
permits the  Company to market to  subscribers  of other  carriers by having the
customer  dial the CIC  directly,  a process,  which is known in the industry as
"casual calling."

                                        6
<PAGE>

     MatrixTM  services are primarily  marketed  through  direct mail,  outbound
telemarketing and a network of over 6,000 independent  agents.  Sales consist of
both long distance telephone service,  for which the customer must select Matrix
as its long distance carrier,  and casual calling.  Products consist of services
which have fixed  charges for either "peak" and "off peak"  periods,  or a "flat
rate" which is the same 24 hours a day, 7 days a week. Products which follow the
"peak-off peak" structure generally have slightly higher charges during the day,
and lower charges during the nights and weekends, than "flat rate" products, and
are often more  attractive to residential  subscribers who place the majority of
their long distance calls during "off peak" periods.

     The Consumer  Markets group sells through agent  distributors  with a niche
orientation such as ethnic focus and home based professionals. These independent
agent groups are provided with a variety of value-added  support  services which
include: in-house multi-lingual Customer Service department open 24 hours a day,
7 days a  week;  direct  electronic  provisioning  to  local  exchange  carriers
("LECs"); and custom billing and management reports.

Operations and Support

     Customer Service Center.  The Company's  inbound customer service center is
designed to provide the Company's customer base with a high-level of service and
support. Customer Service Representatives ("CSRs") are available 24 hours a day,
7 days a week in order to answer inquiries  generated by the Company's marketing
campaigns, as well as to support existing customers.  CSRs are trained to answer
a broad  range of  inquiries  from  prospective  customers  relating to service,
pricing,  and optional  features.  In addition to  competitive  rates and a wide
variety of products,  the Company is able to offer  business  customers a highly
specialized  direct bill summary package that includes call summaries by account
code,  department,  employee,  project,  client,  area code,  country code,  and
time-of-day.  Customer  call  management  reports are  available in a variety of
media formats.

     The Company's call centers are equipped with state-of-the-art  computer and
telecommunications  technology.  Incoming  calls are managed with the help of an
automatic call distributor and an automated attendant.  Such a system allows for
management  of call queue  time,  the  formation  of  distinct  work  groups for
different projects, and on-line monitoring of customer service calls for quality
assurance purposes. Bilingual CSRs are available during day and evening shifts.

     Billing and  Information  Systems.  The Company has  dedicated  substantial
resources to its  management  information  systems.  The  Company's  information
systems  enable the Company to (i) monitor and respond to the evolving  needs of
its  customers  by  developing  new  and  customized   services;   (ii)  provide
sophisticated  billing information that can be tailored to meet the requirements
of its customer  base;(iii)  provide high quality customer service;  (iv) detect
and  minimize  fraud;  (v) verify  payables  to  suppliers;  and (vi)  integrate
additions to its customer base. In addition, the Company has complete facilities
for rating,  formatting and distributing  direct bills to its larger  commercial
subscribers. Small business customers may receive either a direct or a LEC bill,
depending upon the services provided to the customer.

     Through its  wholly-owned  Matrix  subsidiary,  the Company has invested in
call rating,  billing,  and customer service  infrastructure.  In addition,  the
Company holds billing and collection  agreements with LECs, including all of the
Regional Bell Operating  Companies  ("RBOCs"),  and  Independent  Local Exchange
Companies ("ILECs").  These billing agreements permit the Company to include its
billing  on  the  customer's   local  telephone  bill.  The  Company's   billing
information systems and services also allows it to provide direct bills to
customers.

     Strategic  Alliances  and Carrier  Agreements.  The  Company  has  executed
strategic  alliances with Sprint for its underlying voice carrier services,  LCI
International for data carrier services and GST for Internet backbone  services.
As noted above, the Company holds billing and collection  agreements with all of
the RBOCs and ILEC's. The Company has also executed a development agreement with
Prosoft I-Net Solutions to develop a specialized  training agreement designed to
educate  value-added  resellers of the Company's  services on the integration of
data, voice and video products.

                                        7
<PAGE>

     ACE  Certified  Engineer  Training  Program.  On March 16, 1998 the Company
announced the availability of its ACE Certified  Engineering  training  program.
The ACE program has been designed  specifically for value added resellers in the
telecommunications industry. The ACE program provides a complete curriculum over
a broad  range of  courses.  The  program  includes  four  tracks:  1) a general
overview of the telecommunications industry and technologies; 2) voice equipment
and  network  design;  3) data  communications  and network  design;  and 4) the
integration of voice,  video and data,  traffic design and network  engineering.
Each track is a technical course focusing on how to use,  engineer and integrate
proven and  leading-edge  voice,  video and data  networking  technologies.  The
complete program requires 128 hours of in-depth course work and labs.

Regulation

     The services  which the Company  provides,  either  directly or through its
subsidiaries,  are  subject  to  varying  degrees  of  federal,  state and local
regulation.  The FCC exercises jurisdiction over all facilities of, and services
offered by,  telecommunications  common carriers to the extent that they involve
the provision,  origination or  termination  of  jurisdictionally  interstate or
international  communications.  The state public  service  commissions  ("PSCs")
retain jurisdiction over jurisdictionally intrastate communications. The FCC and
relevant PSCs have the authority to regulate  interstate and  intrastate  rates,
respectively,  ownership of transmission facilities and the terms and conditions
under which Matrix's services are provided.

     In general,  neither the FCC nor the relevant  state PSCs  exercise  direct
oversight over cost  justification  for the Company's  services or the Company's
profit levels, but either or both may do so in the future.  However, the Company
is required by federal and state law and regulations to file tariffs listing the
rates, terms and conditions of services provided.  The Company generally is also
required  to  obtain  certification  from the  relevant  state  PSC prior to the
initiation  of  certain  intrastate  service,  and is  required  to  maintain  a
certificate  issued  by the FCC in  connection  with the  provision  of  certain
international services. Any failure to maintain proper federal and state tariffs
or  certification   or  any   difficulties  or  delays  in  obtaining   required
authorization could have a material adverse effect on the Company.

Competition

     The telecommunications industry is highly competitive and affected by rapid
regulatory and  technological  change.  The Company  believes that the principal
competitive factors in its business include pricing,  customer service,  network
quality,  service  offerings  and the  flexibility  to adapt to changing  market
conditions. The Company's future success will depend in part upon its ability to
compete with AT&T,  MCI,  Sprint and other  carriers  (including  the RBOCs when
approved to enter the long distance  market) and other long distance  providers,
and  America  On-Line  and other  national  and local  ISPs,  many of which have
considerably greater financial and other resources than the Company.

Intellectual Property

     The Company uses several unregistered  trademarks as part of its networking
business,  including  PointStreamTM  and  FrameLinkTM,  which  it  may  seek  to
register.  Matrix has  registered  several  trademarks  for use in its marketing
materials.  The logo used by Matrix to market  its long  distance  service  is a
registered  trademark of Matrix.  While the Company  believes its trademarks are
important to its business, the Company does not believe that failure to register
its trademarks poses any material risk of infringement on its rights to use such
trademarks.

Employees

    As  of  March  15,  1998,  the  Company,  including  its  subsidiaries,  had
approximately 140 full-time employees. Approximately 76% of these employees were
leased from United Group Service  Center,  an entity  affiliated with certain of
the Company's principal  stockholders.  (See Note 6 of the Notes to Consolidated
Financial Statements). None of the employees of the Company are represented by a
union.  The  Company   supplements  its  work  force  from  time  to  time  with
contractors, administrative personnel through employment agencies, and part time
employees. The Company believes that it has good relations with its employees.

                                        8
<PAGE>

RECENT DEVELOPMENTS
-------------------

Board of Directors

      On January 5, 1998,  Ronald W. Howard  tendered his  resignation  from the
Company's  Board of  Directors.  On  January  9, 1998,  the Board  accepted  Mr.
Howard's  resignation  and elected Jeffrey J. Jensen to fill the vacancy created
by Mr. Howard's resignation.

Application for Listing on Nasdaq SmallCap Market

     On March 2, 1998, the Company filed an application to have its Common Stock
listed on the Nasdaq  SmallCap  Market.  The Company is  currently  pursuing its
application  and believes that it will be  successful in such listing.  However,
there can be no assurance that Nasdaq will accept the Common Stock for listing.

RISK FACTORS
------------

IN EVALUATING THE COMPANY, ITS BUSINESS,  OPERATIONS AND FINANCIAL POSITION, THE
FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY,  IN ADDITION TO THE OTHER
INFORMATION  CONTAINED IN THIS FORM 10-K. THE FOLLOWING  FACTORS,  AMONG OTHERS,
COULD AFFECT THE COMPANY'S ACTUAL FUTURE OPERATING  RESULTS AND COULD CAUSE SUCH
RESULTS TO DIFFER FROM THE RESULTS DISCUSSED IN ANY  FORWARD-LOOKING  STATEMENTS
MADE BY OR ON BEHALF OF THE COMPANY.

Operating Results Subject to Significant Fluctuations

     The Company's  quarterly  operating  results are difficult to forecast with
any degree of  accuracy  because a number of factors  subject  these  results to
significant   fluctuations.   As   a   result,   the   Company   believes   that
period-to-period  comparisons  of its  operating  results  are  not  necessarily
meaningful and should not be relied upon as indications of future performance.

Factors Influencing Operating Results, Including Revenues, Costs and Margins.

     The Company's revenues, costs and expenses have fluctuated significantly in
the past and are likely to continue to fluctuate  significantly in the future as
a result of numerous  factors.  The  Company's  revenues in any given period can
vary due to factors  such as call volume  fluctuations;  the addition or loss of
major  customers,   whether  through  competition,   merger,   consolidation  or
otherwise;   the  loss  of  economically  beneficial  routing  options  for  the
termination of the Company's traffic;  pricing pressure resulting from increased
competition;  and  technical  difficulties  with or  failures of portions of the
network used by the Company that impact the Company's ability to provide service
to or bill its customers.  The Company's cost of services and operating expenses
in any  given  period  can vary due to  factors  such as  fluctuations  in rates
charged by carriers to terminate  the Company's  traffic;  increases in bad debt
expense and reserves;  compensation expense resulting from stock options granted
by the  Company;  changes in the  Company's  sales  incentive  plans;  and costs
associated  with  changes  in  staffing  levels of sales,  marketing,  technical
support and  administrative  personnel.  In addition,  the  Company's  operating
results  can vary due to  factors  such as loss of  favorable  routing  options;
actions by regulatory entities; and general economic and political conditions.

Risks Inherent in Acquisition Strategy

     An important component of the Company's past growth has been to develop its
business  through  acquisitions.  This  growth  strategy  is  dependent  on  the
continued  availability  of suitable  acquisition  candidates  and  subjects the
Company to a number of risks.  Acquisitions may place significant demands on the
Company's  financial and management  resources,  as the process for  integrating
acquired operations presents a significant challenge to the Company's management
and may lead to  unanticipated  costs or a diversion of  management's  attention
from day-to-day operations. There can be no assurance that the

                                        9
<PAGE>

Company will be able to  successfully  integrate  any  acquisitions  made by the
Company in the future into  Company  operations.  Additionally,  the Company may
incur  unknown  liabilities  despite  management's  efforts to  investigate  the
operations of the acquired business.

Potential Adverse Effects of Government Regulation

     The  Company's  business  is  subject to various  federal  and state  laws,
regulations,  agency  actions  and court  decisions.  These  laws,  regulations,
actions and decisions may impose prior certification, notification, registration
and/or  tariff   requirements.   Certificates  of  authority  can  generally  be
conditioned,  modified or revoked by state regulatory authorities for failure to
comply with state laws and  regulations.  Fines and other  penalties,  including
revocation of a certificate of authority,  may be imposed.  In addition,  future
changes in any of these  sources  of  regulation  could have a material  adverse
effect on the Company's  business,  operating  results and financial  condition.
Dependence on Key Personnel

     The Company's  success depends to a significant  degree upon the efforts of
senior  management  personnel,  in  particular,  Anthony E. Papa,  the Company's
Chairman  and Chief  Executive  Officer,  and  James P.  Pisani,  the  Company's
President  and Chief  Operating  Officer.  The Company  believes that its future
success  will  depend in large part upon its  continuing  ability to attract and
retain  highly  skilled   personnel.   Competition  for  qualified,   high-level
telecommunications  personnel is intense and there can be no assurance  that the
Company will be successful in attracting and retaining such personnel.  The loss
of the services of one or more of the Company's key individuals,  or the failure
to attract and retain other key personnel, could materially adversely affect the
Company's business, operating results and financial condition.

Significant Competition

     The  telecommunications  industry is intensely  competitive  and subject to
rapid  change.   The  Company's   competitors   include   facilities-based   and
non-facilities-based  providers, many of which have substantially more resources
than the Company.  Providers  compete on the basis of price,  customer  service,
transmission  quality,  breadth of service  offerings and value-added  services.
Additionally,   the  telecommunications   industry  is  in  a  period  of  rapid
technological  evolution,  marked by the introduction of competitive product and
service  offerings,  such as the  utilization of the Internet for  international
voice  and  data  communications.   The  Company  is  unable  to  predict  which
technological  development will challenge its competitive position or the amount
of expenditures will be required to respond to a rapidly changing  technological
environment.  The Company  believes that  competition will continue to increase,
placing  downward  pressure on prices.  Such pressure could adversely affect the
Company's  gross  margins  if the  Company  is not  able  to  reduce  its  costs
commensurate with such price reductions.

Need for Additional Capital to Finance Growth and Capital Requirements

     In the past, the Company's cash flow from operations has been sufficient to
meet its working capital and capital expenditure  requirements.  However,  there
can be no  assurance  that such cash from  operation  will  continue to meet the
Company's  requirements,  particularly  if  the  Company  obtains  one  or  more
attractive  opportunities to purchase the business or assets of another company.
In such event, the Company will need to raise additional  capital from equity or
debt sources.  There can be no assurance  that the Company will be able to raise
such capital on favorable terms or at all.

Volatility of Stock Price

     To date the Common  Stock has been traded on Nasdaq's  Electronic  Bulletin
Board;  its trading  volume has been  variable,  but generally low. As a result,
relatively small trades may significantly  affect the market price of the Common
Stock.  The market price of the shares of Common Stock has been highly  volatile
since the public  announcement of the Share Exchange,  and may be  significantly
affected by factors such as actual or anticipated  fluctuations in the Company's
operating  results,  the announcement of potential  acquisitions by the Company,
changes in regulations, activities of the largest domestic

                                       10
<PAGE>

providers,  industry  consolidation  and mergers,  conditions  and trends in the
telecommunications  market,  adoption of new accounting  standards affecting the
telecommunications   industry,  changes  in  recommendations  and  estimates  by
securities  analysts,  general market conditions and other factors. In addition,
the stock market has from time to time experienced  significant price and volume
fluctuations that have particularly affected the market prices for the shares of
emerging growth companies like the Company.  These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.

Year 2000 Computer Program Failure

     A significant percentage of the software that runs most of the computers in
the United States  relies on two-digit  date codes to perform  computations  and
decision-making  functions.  Commencing  on  January  1,  2000,  these  computer
programs  may  fail  from  an  inability  to  interpret  date  codes   properly,
misinterpreting  "00" as the year 1900 rather  than 2000.  The Company is in the
process of  confirming  its belief that the Company's  billing,  credit and call
tracking  systems  are Year  2000  compliant  and do not use  programs  with the
two-digit  date code flaw.  At the same time,  a number of the  computers of the
Company's  vendors that interface with the Company's systems may run on programs
that have Year 2000 problems and may disrupt the Company's  billing,  credit and
tracking  systems.  Failure  of any of the  computer  programs  integral  to the
Company's  vendors  could  adversely  affect the Company's  business,  operating
results and financial  condition.  See "Management's  Discussion and Analysis of
Financial Condition and Results of Operations."

Forward-looking Statements

     Certain  statements   contained  in  this  Form  10-K,   including  without
limitation,   statements   containing  the  words   "believes,"   "anticipates,"
"intends,"  "expects" and words of similar import,  constitute  "forward-looking
statements"  within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange  Act.  Such  forward-looking  statements  involve  known and
unknown  risks,  uncertainties  and other  factors  that may  cause  the  actual
results,  performance or achievements of the Company to be materially  different
from any future  results,  performance or  achievements  expressed or implied by
such forward-looking  statements.  Such factors include, among others, those set
forth above.  GIVEN THESE  UNCERTAINTIES,  THE  STOCKHOLDERS  OF THE COMPANY ARE
CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS.





                                       11



<PAGE>

ITEM 2. PROPERTIES


     The Company does not own any real  property.  The  Company's  new corporate
headquarters  location is approximately  7,000 square feet and is located at 501
Bath Street Santa Barbara, CA 93101. The Company leases these facilities under a
five-year  lease expiring in March 2003 (subject to certain renewal options held
by the  Company).  The  current  monthly  rent under the lease is  approximately
$12,000, on a "triple-net" basis. Matrix currently leases  approximately  24,050
square  feet of space for its  offices at 8721  Airport  Freeway in Fort  Worth,
Texas, pursuant to a lease agreement expiring on June 30, 2000. The monthly rent
(not including  electricity) is currently  approximately  $19,888.  TFN's office
location is approximately 1,100 square feet and is located at 350 West Broadway,
Suite  111,  Salt  Lake  City,  UT  84101.  TFN's  office  lease is  rented on a
month-to-month  basis at a monthly  rate of $1,400.  SBC's  office  location  is
approximately  3,441  square feet and is located at 104 West  Anapamu,  Suite C,
Santa Barbara 93101. SBC leases this space under a five-year lease,  expiring in
September  2001,  at a monthly rate of $4,645.  The Company  currently  plans to
relocate SBC's  operations and  consolidate  them in the Company's new corporate
headquarters  location in May 1998. The Company believes that it will be able to
terminate  its  obligations  with  respect to SBC's  current  space  without the
payment of  additional  consideration.  The  Company and its  subsidiaries  also
operate  points-of-presence  for the purpose of creating  local access points to
its network backbone.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is not currently a party to any material legal proceedings. The
Company is not aware of  proceeding  against  the  Company  contemplated  by any
governmental authority.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    The Company held a special meeting of its stockholders on November 20, 1997,
for the purposes of approving (i) the Exchange  Agreement and the acquisition of
Matrix by means of the Share Exchange, and (ii) the Agreement and Plan of Merger
that  effectuated  the  Reincorporation  Merger  and  the  Reverse  Stock  Split
(including  approval of the Company's Delaware  Certificate of Incorporation and
Bylaws).  Present at the meeting were  approximately  81.2% of the shares of the
Company's  Common  Stock  and  100% of the  shares  of the  Company's  Series  A
Preferred Stock outstanding as of the record date for the meeting. Both measures
were approved with 1,449,656 shares of the Common Stock  (representing  81.2% of
the Common  Stock  then  outstanding)  and all shares of the Series A  Preferred
Stock voting for, no shares of the Common Stock voting  against,  and 375 shares
of the Common Stock  abstaining.  (The numbers of shares of Common Stock in such
tally have been  adjusted  to reflect the Reverse  Stock  Split).  There were no
broker non-votes.





                                       12




<PAGE>

                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The  Company's  Common  Stock  is  traded  over-the-counter  on the  NASD's
Electronic  Bulletin  Board (the  "Bulletin  Board")  under the  trading  symbol
"AVCO".  There  is no  established  public  trading  market  for  the  Company's
Preferred  Stock.  The following high and low bid  information for the Company's
Common Stock was provided by various  market makers and on-line quote  reporting
services.  The quotations provided reflect inter-dealer  prices,  without retail
mark-up, mark-down or commission and may not represent actual transactions.  All
prices have been adjusted to reflect the Reverse Stock Split.


Year ending December 31, 1996              High Bid           Low Bid
-------------------------------            --------           -------

   First Quarter                           $ 3.50             $ 2.00
   Second Quarter                          $ 5.75             $ 3.00
   Third Quarter                           $ 4.00             $ 4.00
   Fourth Quarter                          $ 5.50             $ 2.00

Year ending December 31, 1997              High Bid           Low Bid
-------------------------------            --------           -------

   First Quarter                           $ 3.50             $ 2.00
   Second Quarter                          $18.00             $ 3.13
   Third Quarter                           $19.00             $ 9.75
   Fourth Quarter                          $19.00             $ 7.00

     The number of  shareholders  of record of the  Company  Common  Stock as of
February  28, 1998,  was 190. At that date there were two record  holders of the
Company's Preferred Stock.

     The Company has applied to The Nasdaq  Stock  Market for  inclusion  of the
Common Stock on The Nasdaq SmallCap Market.  While management  believes that the
Company size,  shareholder  base and other factors will enable it to be included
on The Nasdaq SmallCap Market,  there are no assurances that this will occur, in
which  event the  trading in the  Company's  Common  Stock will  continue  to be
reported on the Bulletin Board.

     The Company has not paid any cash dividends to date and does not anticipate
paying  dividends  in the  foreseeable  future.  It is the present  intention of
management to utilize all available  funds for the  development of the Company's
business.  The  terms of the  Company's  Series A  Convertible  Preferred  Stock
prevent the payment of any dividend on the Company's Common Stock unless (i) all
cumulative dividends on the Series A Convertible Preferred Stock have been fully
paid,  and (ii) the  holders  of at least 50% of the  outstanding  shares of the
Series A Convertible Preferred Stock have approved such dividend.

     On December  1, 1997,  the Company  issued  9,582,493  shares of its Common
Stock,  which were not registered  under the Securities  Act, in connection with
the Share Exchange;  1,999,997 of such shares are currently held by a subsidiary
of the Company as treasury stock. No underwriters  were used in this transaction
and  none of such  shares  were  issued  publicly.  The  Company  relied  on the
exemptions from registration  provided by Section 4(2) of the Securities Act and
Rule 506 of Regulation D promulgated  thereunder.  The person  receiving  shares
were the 23 former  Matrix  shareholders.  The Company  also issued  options for
22,338  shares of Common  Stock to three  former  Matrix  optionholders  with an
exercise  price of $2.24 per share.  These  persons were and are believed by the
Company  to  possess  the  requisite  level  of  financial   sophistication  and
experience in order to qualify for such  exemptions.  The Company made available
to the recipients of such Common Stock all material  information with respect to
the Company and the Share Exchange. Each such person

                                       13
<PAGE>

signed an Exchange Statement containing appropriate  investment  representations
and  covenants.  The specific  details of the  issuances  were  disclosed in the
Company's  definitive  Proxy  Statement  dated October 31, 1997,  and as part of
relevant Form 8-K and Form 10-KSB filings.

     In July 1997, New Best Connections,  Inc. ("Best"), a subsidiary of Matrix,
issued options to purchase  Matrix Common Stock to __ individuals in recognition
of  their  past  services  to  Best,   Matrix  and  related  companies  (and  in
satisfaction  of certain  obligations of Best to  shareholders of Matrix who had
contributed  shares of Matrix stock to Best). As a result of the Share Exchange,
the shares of Matrix  Common Stock  subject to such options have been  converted
into 247,500 shares of the Company's  Common Stock.  The exercise price for such
options is $1.50 per share.  These  options have fully vested in the  respective
optionees;  however,  upon  exercise  the  shares  will be  subject  to  certain
significant restrictions on transfer. None of such options has been exercised as
of March 31, 1998. No underwriters  were or will be used in this connection with
these  options  and none of the shares  issuable  upon  exercise  will be issued
publicly.  The  Company  has  relied  and  will  rely  on  the  exemptions  from
registration  provided  by Section  4(2) of the  Securities  Act and Rule 506 of
Regulation D promulgated thereunder.  The options are believed by the Company to
possess the requisite level of financial  sophistication and experience in order
to qualify  for such  exemptions.  The  Company  made  available,  and will make
available,  to the recipients of such Common Stock all material information with
respect to the Company.

     In June 1997,  Best  awarded  options to purchase  shares of Matrix  Common
Stock to  members  of its  outside  sales  force in  recognition  of their  past
services to Best,  Matrix and related  companies (and in satisfaction of certain
obligations  of Best to  shareholders  of Matrix who had  contributed  shares of
Matrix stock to Best). As a result of the Share  Exchange,  the shares of Matrix
Common Stock subject to such options have been converted  into 1,292,000  shares
of the Company's Common Stock. The exercise price for such options will be $1.50
per share.  The Company  will be required to register  such shares of its Common
Stock before such options can become exercisable.

ITEM 6. SELECTED FINANCIAL DATA

For accounting purposes,  the Share Exchange is treated as a reverse acquisition
of AvTel by Matrix. Accordingly, the Company's results of operations reflect the
operations  of  Matrix  prior to  December  1,  1997 and  reflect  the  combined
operations  of AvTel and Matrix  subsequent  to December 1, 1997.  The following
selected  operations  data of the Company for the years ended December 31, 1997,
1996,  1995 and 1994 and balance sheet data as of December 31, 1997,  1996, 1995
and 1994 have been derived from the Company's (or  Matrix's)  audited  financial
statements.  The  selected  operations  data of the  Company  for the year ended
December 31,  1993,  and balance  sheet data as of December 31, 1993,  have been
derived from unaudited financial  statements of Matrix. These selected financial
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial  statements and
notes thereto included elsewhere herein.


                                       14
<PAGE>
<TABLE>

Statement of Operations Data:
<CAPTION>

                                                        Years ended December 31,

                                        1997         1996         1995         1994         1993
                                ------------   ----------  -----------   ----------  -----------
<S>                             <C>            <C>         <C>           <C>         <C> 

Revenues                        $ 51,389,080   71,558,295   64,289,718   59,551,307   40,568,307

Operating income (loss)          (10,757,960)   4,091,034    2,422,393      604,109     (397,804)

Net income (loss)                (10,191,720)   2,566,734   (2,440,493)     643,200     (474,797)

Proforma net loss per common
       share-basic and diluted         (1.23)         N/A          N/A          N/A          N/A


Cash dividends per common
       share                            --           --           --           --            N/A

</TABLE>

<TABLE>

Balance Sheet Data:
<CAPTION>

                                                           As of December 31,
                                        1997         1996         1995         1994         1993
                                ------------   ----------  -----------   ----------  -----------

<S>                             <C>            <C>         <C>           <C>         <C>  
Working capital (deficit)       $  5,570,657    6,066,620      206,071     (140,741)    (326,746)

Total assets                      18,724,850   20,338,404   17,580,694   14,957,279   11,167,630

Long term debt                          --           --           --           --           --

Stockholders' equity               7,809,048    7,861,883    3,539,522    2,372,333    1,729,133

</TABLE>

N/A - not applicable

Notes to Selected Financial Data of Matrix


(1) Matrix was  originally  formed May 29, 1990 as a Texas general  partnership.
The partners consisted of Matrix Communications, Limited ("MCL") a Texas limited
liability partnership and Onward and Upward, Inc. ("OUI").  Effective January 1,
1994,  the  partnership   was  dissolved.   Prior  to  the   dissolution,   cash
distributions  were made to OUI in  satisfaction  of its  partnership  interest.
Concurrent with the dissolution,  all remaining  tangible and intangible  assets
and liabilities of Matrix then owned by MCL were  transferred to Matrix Telecom,
Inc., a Texas  corporation.  Effective June 30, 1995, MCL was liquidated and its
sole  asset  (Matrix  capital  stock)  was  distributed  to  MCL's  partners  in
proportion to their ownership interests.

(2) Matrix  original  stock issuance  consisted of 100 common shares.  Effective
December  31,  1994, a 10 for 1 stock split was  declared.  Concurrent  with the
dissolution of MCL on June 30, 1995,  Matrix's then outstanding  1,000 shares of
common stock were canceled and 100,000 shares were  distributed to the prior MCL
partners in proportion to the ownership

                                       15
<PAGE>

interest in MCL.  Effective  March 10, 1997, a 18 for 1 stock split was declared
resulting in 3,484,260 shares being then  outstanding.  On December 1, 1997, the
Company effected the Reverse Stock Split as part of the Reincorporation  Merger,
and then  acquired  Matrix  through the issuance of  9,582,493  shares of Common
Stock (including 1,999,997 shares now held as treasury stock). All share amounts
have been restated to reflect the stock splits and share exchanges.

(3) In October 1995,  Matrix issued  2,405,499 shares of its common stock valued
at  $3,607,682  in  exchange  for all of the  outstanding  common  stock  of DNS
Communications,  Inc., a Houston based long distance reseller. Subsequent to the
acquisition,  the operations of DNS generated substantial losses. DNS's customer
churn rate and bad debts as well as projected  cash flows were  evaluated and as
of December 31, 1995 it was determined that the remaining  investment in the DNS
acquired customer base totaling approximately  $4,462,000 should be written off.
See note 2 to the Company's financial statements included elsewhere herein.

(4) Per share  amounts  are not  reflected  for  1996,  1995 and 1994 due to the
recapitalization  of the Company as a result of the reverse acquisition in 1997.
During 1993 the Company operated as a partnership.


ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS


BACKGROUND
----------

     The  following   information   should  be  read  in  connection   with  the
consolidated  financial  statements  of the Company and related  notes  included
elsewhere in this report.

Share Exchange

     As described above under "Business -- Background -- Acquisition of Matrix,"
on  December  1,  1997,  AvTel and  Matrix  completed  the Share  Exchange.  For
accounting purposes,  the Share Exchange was treated as a reverse acquisition of
AvTel by  Matrix.  AvTel  was the  legal  acquirer  and  accordingly,  the Share
Exchange  was effected by the issuance of AvTel Common Stock in exchange for all
of the common stock then outstanding of Matrix.  In addition,  holders of Matrix
outstanding  stock options  received  non-qualified  stock options of AvTel. The
following  discussion of results of operations reflects the operations of Matrix
prior to December 1, 1997 and  reflects  the  combined  operations  of AvTel and
Matrix  subsequent to December 1, 1997.  Accordingly,  references to the Company
refer to  operations  of Matrix  prior to the Share  Exchange  and the  combined
operations of Matrix and AvTel subsequent to the Share Exchange.

     The  reverse  acquisition  of AvTel by Matrix was  accounted  for using the
purchase method of accounting.  In order to value the consideration given in the
Share  Exchange,  the  market  price  of  AvTel's  common  stock  for  a  period
immediately preceding the announcement of the Share Exchange was used. As of the
date of acquisition,  the Company  determined the fair value of the net tangible
and intangible  assets and  liabilities  acquired.  The underlying fair value of
AvTel's net assets was  substantially  less than the  indicated  market value of
AvTel's common and preferred stock.  Accordingly,  the Company recorded a charge
to income of $9.1 million immediately subsequent to the reverse

acquisition.

Acquisition of New Best Connections, Inc.

     Effective July 1, 1997, Matrix acquired New Best Connections, Inc., a Texas
corporation  ("Best"),  an affiliate  of Matrix  through  substantially  similar
common ownership, by means of a share-for-share  exchange. Best's primary assets
were cash of $211,000,  ownership of shares of Matrix common stock (subsequently
exchanged for 1,999,997

                                       16
<PAGE>

shares of AvTel Common Stock in the Share  Exchange),  and Best's  relationships
with the field force of sales agents.  The assets and  liabilities  of Best were
recorded at their  historical  cost,  which  approximated the fair value of such
assets as of July 1, 1997.

Acquisition and Disposition of DNS Communications, Inc.

     In October  1995,  Matrix  issued shares of its common stock valued at $3.6
million  in  exchange   for  all  of  the   outstanding   common  stock  of  DNS
Communications,  Inc.  ("DNS"),  a  Houston-based  long distance  reseller.  The
transaction was accounted for under the purchase  method.  The purchase price in
excess  of the  book  value of DNS net  assets  was  pushed  down to DNS and was
allocated  based upon the  estimated  fair  value of the assets and  liabilities
acquired at the date of acquisition.

     Subsequent to the acquisition,  the operations of DNS generated substantial
losses.  DNS's customer churn rate and bad debts as well as projected cash flows
were evaluated and as of December 31, 1995 it was determined  that the remaining
investment in the DNS acquired customer base totaling approximately $4.4 million
should be written off.

     In June 1996, Matrix sold the customer base acquired in the DNS acquisition
in  addition  to  certain  blocks of  customers  acquired  during  1995 and 1996
together  with  related  assets  to a  former  officer  of  Matrix  and a former
shareholder of DNS for  approximately  $5.2 million.  Matrix  recorded a gain on
this sale of approximately $3.2 million.

     Due to the timing of the  acquisition  and subsequent  decision to sell the
operations of DNS, Matrix has recorded its interest in DNS operations  using the
equity method of accounting.

RESULTS OF OPERATIONS
---------------------

Year Ended December 31, 1997 compared with Year Ended December 31, 1996

Revenue

     Revenue for the year ended  December  31, 1997,  decreased  28.1 % or $20.1
million to $51.4  million  from $71.5  million for the year ended  December  31,
1996.  The decrease in revenue  resulted  primarily from decreases in sales from
three significant sales channels,  all of which were affiliated with the Company
through substantially common ownership.  These sales channels were a distributor
selling via telemarketing,  a distributor  focusing on the casual or dial-around
customer, and a DNS distributor of long distance services. The relationship with
the DNS distributor  was terminated  resulting from the sale of the DNS customer
bases in June of 1996.

     The  Company  in 1997  chose to reduce  its focus on the  promotion  of the
casual or dial-around  customer due to the  significant  costs of direct mailing
and bad debt associated with this product.  Reduced sales from the telemarketing
distributor  resulted  from the erosion of the retail  pricing in the market for
the  residential  consumer.  Pricing  continued  to  decline  during  1997,  and
attrition from a maturing  customer base resulted in losing  customers on higher
gross margin products.  Attrition rates  associated with long distance  products
are a normal industry occurrence;  however, methods of calculation differ within
the industry.

     The Company has sought to reduce its risk from reliance on a small group of
distributors,  and has refocused to obtain multiple  revenue sources external to
the Company. New distributors have significantly contributed to the mix in 1997.
1997 sales from sources other than the Company's  primary 1996 distributors have
increased more than 20%.



                                       17
<PAGE>

     Additionally,  the  combination  of AvTel and Matrix has added  significant
growth  opportunities  for the Company in 1998.  AvTel sells and markets a broad
range of  telecommunications  and advanced network services through  independent
value  added   resellers  and  internal   direct  sales   professionals.   AvTel
capabilities  include the provisioning of broadband network services integrating
voice, data and video solutions. The Company has positioned itself to be a fully
integrated telecom provider focusing on the mid-size corporations in addition to
continuing  to  provide  value  added  services  to small  business  owners  and
residential  consumers  in niche  marketing  areas.  Revenue  from  prior  AvTel
operations  has been  included in the  Company's  financial  results  only since
December 1, 1998.  AvTel  revenues for the eleven months ended November 30, 1997
were approximately $2.6 million.

Gross margin

     Gross margin  decreased $8.7 million in 1997, to $15.1 million for the year
ended December 31, 1997 from $23.8 million for the year ended December 31, 1996.
As a percentage of net sales gross margin  decreased  3.9% to 29.5% for the year
ended  December 31, 1997 from 33.4% for the year ended  December  31, 1996.  Two
primary factors contributed to the decrease in gross margin in 1997.

     First, due to increasing competitive market demands, the Company was forced
to continue  decreasing  its retail rates in 1997 to meet the  competitive  rate
reductions;  however, the underlying carrier costs to the Company did not change
due to contractual commitments.  Accordingly, cost of network as a percentage of
revenue increased reflecting a lower gross margin in 1997 over 1996. The Company
believes  that its  network  costs  will  decrease  in 1998  due to new  carrier
contracts negotiated since the end of 1997.

     Second,  bad debt as a percentage of revenue increased  approximately 2% in
1997,  primarily resulting from increased bad debt associated with the casual or
dial-around  product.  The  majority of the  Company's  revenues  are billed and
collected from the Local Exchange Carriers ("LECs"),  with which the Company has
agreements.  Collection  policies and  aggressiveness  in collection  procedures
differ among the LECs.  The Company  experienced  significant  sales growth in a
geographical location in which the LECs' bad debt percentages were significantly
higher than other LECs. The LECs bad debt  percentages are typically higher than
those experienced by the Company's internal collectors for those customers being
direct billed.  The Company  anticipates its percentage of customers billed on a
direct basis to increase in 1998, as the Company  attempts to decrease its costs
related to bad debts.

Selling, general, and administrative costs

     The Company's selling,  general,  and  administrative  costs decreased $2.6
million in 1997 from 1996. As a percentage of revenue, such costs increased 5.1%
to 31.4% for the year ended  December  31,  1997  compared to 26.3% for the year
ended December 31, 1996. This increase  resulted  primarily from the decrease in
revenues  causing the expense as a percentage  of revenue to  increase.  Certain
changes are more fully described below.

     Certain selling,  general, and administrative costs related to the addition
of AvTel  operations to Matrix  subsequent  to the  effective  date of the Share
Exchange,  December 1, 1997,  amounted  to  approximately  $286,000,  accounting
for.56% of the increase as a percentage  of revenues in 1997 over 1996.  Selling
costs related to direct  mailing to the casual or  dial-around  customer  (which
were absorbed by the sales distributor in 1996) were  approximately  $605,000 in
1997,  accounting  for 1.18% of the increase as a percentage of revenues in 1997
over 1996. Salary expenses increased  approximately  $651,000 between the years,
or 3.76% as a percentage of revenues in 1997 over 1996, resulting primarily from
integration  of AvTel  employees  subsequent  to the Share  Exchange and certain
sales and marketing personnel in 1997.

     Billing  and  collection   fees  and  distributor   commissions   decreased
approximately  $3.9 million,  or 1.82% as a percentage of revenues.  Most of the
new products sold in 1997 were direct billed. As the percentage of direct billed
customers increase,  billing and collection fees have decreased.  Similarly,  as
sales of certain  products having a higher  commission  structure have declined,
commission expense has also declined.

                                       18
<PAGE>

     Certain  regulatory  and  professional  services  increased   approximately
$266,000,  or 1.22% as a percentage of revenues in 1997 over 1996.  Carrier fees
specific to  telecommunication  providers  upon reaching  certain  thresholds of
customers  were met in the last half of the year in 1996;  therefore,  increased
fees in 1997 resulted from being charged the fees for a full year.  Professional
fees  increased  in 1997  over  1996  for two  primary  reasons.  First,  due to
increased market demands for information  systems  programmers,  the Company was
forced  to  secure  external  contractors.  Second,  certain  telemarketing  and
verification costs associated with the sales process increased in 1997 primarily
resulting  from the  sales  distributor  absorbing  these  costs in 1996.  Other
selling,  general and administrative costs decreased  approximately  $213,000 in
1997. As a percentage of revenue,  these costs  increased .81% in 1997 over 1996
due to decreasing revenues.

Acquisition-related writeoff

     The $9.1 million  write off relates to the Share  Exchange and is discussed
under "Background" above.

Depreciation and Amortization

     Depreciation and amortization expense decreased  approximately $314,000 for
the year ended December 31, 1997,  compared to the year ended December 31, 1996,
resulting primarily from older assets becoming fully depreciated.

Interest expense and other income, net

     Interest expense decreased  $219,000 to $12,000 for the year ended December
31, 1997 from  $231,000  for the year ended  December  31,  1996.  The  decrease
resulted  from  reduced  borrowings  in 1997  compared to 1996.  The Company had
sufficient  cash  from  operations  to  meet  operating   expenses  and  capital
expenditures.  Other income net of other  expenses  increased  more than 11% for
1997 over 1996 primarily  resulting from increases in interest  earned from cash
investments.

Income taxes

     The  Company  recognized  a tax  benefit  of  $276,000  for the year  ended
December  31, 1997  compared to a tax expense of $1.7 million for the year ended
December  31,  1996.  The tax  benefit  in 1997  resulted  from  the  loss  from
operations for the year 1997.

Year Ended December 31, 1996 compared with Year Ended December 31, 1995

Revenues

     Revenues  for the year ended  December  31,  1996  increased  11.3% or $7.3
million to $71.6  million  from $64.3  million for the year ended  December  31,
1995.  The increase was due in part to increases in revenues  from a significant
affiliated  distributor  of the casual or dial  around  product.  Prior to 1996,
marketing  for the casual or dial  around  product  was  limited to the state of
California;  however,  in 1996 direct  mailing of this  service was  expanded to
eleven  additional  states  increasing  total revenues in 1996 over 1995 by more
than $2.8  million.  Additional  revenues  were also  driven  from the resale of
certain long distance products. This sales program was implemented at the end of
1995 and increased total sales over 1995 by approximately  $3 million.  Finally,
new distributors  not actively  selling  products in 1995 increased  revenues in
1996 by approximately $1.5 million.

Gross margin

     Gross margin  increased  $2.5  million to $23.8  million for the year ended
December 31, 1996 from $21.3 million for the year ended  December 31, 1995. As a
percentage of net revenues,  gross margin  increased to 33.4% for the year ended
December 31, 1996 from 33.2% for the year ended  December  31, 1995.  The slight
change  in gross  margin  resulted  from a  percentage  increase  in the cost of
network  accounting  which was more than offset by a percentage  decrease in bad
debt expense.

                                       19
<PAGE>

     Network cost for the year ended December 31, 1996 increased $5.5 million to
$46.1  million for the year ended  December 31, 1996 from $40.6  million for the
year ended December 31, 1995. Primarily, the increase resulted from the increase
in revenues.  As a percentage of revenue,  network cost  increased  1.3% in 1996
over 1995.  The primary  reason for the increase  was  increased  revenues  from
distributors  whose  products  are being sold at lower  retail rates than in the
prior  year  in  response  to the  competitive  demand  of the  industry;  thus,
decreasing the Company's product margins.

     Bad debt as a percentage of revenue  decreased  1.5% for the year 1996 over
1995.  The majority of the Company's  revenues are billed and collected from the
LECs, with which the Company has  agreements.  The Company records bad debt as a
percentage of revenue based on the percentage  being reserved by the LEC plus or
minus  any true  ups to  actual  amounts  by the LEC.  Collection  policies  and
aggressiveness  in  collection  procedures  differ  among the  LECs.  Collection
percentages  for  the  LECs  were  significantly   higher  in  1996  over  1995.
Additionally,  travel card fraud was significantly less in 1996 compared to 1995
resulting  primarily  from changing its travel card vendor to one providing real
time fraud monitoring.

Selling, general and administrative expenses

     Selling,  general and administrative expenses increased 5.1% or $910,000 to
$18.8  million for the year ended  December 31, 1996 from $17.9  million for the
year ending  December 31, 1995. As a percentage of revenue,  selling general and
administrative  expenses decreased 1.5% to 26.3% for the year ended December 31,
1996  from  27.8%  for the year  ended  December  1995.  The  decrease  resulted
primarily  from the rise in  revenues  causing the  expense as a  percentage  of
revenue to decrease.

     As a percentage of revenue, commission expense decreased approximately 1.7%
in 1996 over 1995. The change was due to the growth of an internal  revenue base
in  1996  for  which  commissions  are  not  paid;  therefore,  commission  as a
percentage of revenues  declined as this particular  revenue  continued to grow.
Professional   and  legal  expense  as  a  percentage   of  revenues   decreased
approximately  .5% in 1996 over 1995 primarily from 1995 accruals for contingent
liabilities.  Salary expense as a percentage of revenues  increased in 1996 over
1995  approximately  .4% resulting  primarily  from the addition of key employee
positions  and  certain  other  positions  among  operational  groups to provide
carrier services to other companies.

Depreciation and Amortization

     Depreciation and  amortization  expense for 1996 decreased by an immaterial
amount from that for 1995.

Interest expense and other income, net

     Interest  expense  increased to  approximately  $231,000 for the year ended
December 31, 1996 from $6,000 for the year ended  December 31, 1995. The Company
increased its borrowing  for use in operations in 1996;  however this  borrowing
was  extinguished  by the  end of the  second  quarter  in  1996.  Other  income
increased to  approximately  $271,000 for the year ended  December 31, 1996 from
$166,000 for the year ended December 1995. The increase resulted  primarily from
income from cash investments and income from contract services provided to other
companies.

Income taxes

Income taxes increased approximately $605,000 to $1.7 million for the year ended
December 31, 1996 from $1.1 million for the year ended  December 31, 1995 due to
increased  operating income.  The effective tax rate was 40.8% and 41.8% for the
years ended December 31, 1996 and 1995, respectively.



                                       20
<PAGE>

Equity in net income (loss) of DNS

     Equity in DNS  increased  approximately  $4.1  million  for the year  ended
December  31, 1996 from a loss of $3.9  million for the year ended  December 31,
1995.  In June 1996,  the Company  sold the  customer  base  acquired in the DNS
acquisition in addition to certain blocks of customers  acquired during 1995 and
1996 together with related assets for  approximately  $5.2 million.  The Company
recorded a gain on this sale of approximately $3.2 million. This gain offset the
loss from operations of DNS prior to its sale of $3.1 million.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

     The primary  sources of  operating  cash flow for the Company are  revenues
derived from the resale of domestic and international  long distance services to
the public.  Minor  sources of revenues are  received for the  provision of back
office support to affiliated and non-affiliated  companies and for earnings from
investment  income.  The primary uses of cash are payments to underlying network
vendors for provisioning  long distance  facilities,  to sales  distributors for
soliciting long distance sales, and to the major LECs for billing and collecting
directly from the long distance end user. To date,  the Company has financed its
growth, including its capital expenditures,  primarily through funds provided by
operations.  Net cash provided from operations totaled $1.7 million for the year
ended December 31, 1997,  $1.0 million for the year ended December 31, 1996, and
$5.1 million for the year ended December 31, 1995.

     The Company's accounts receivable decreased to $6.9 million at December 31,
1997 from $10.5 million at December 31, 1996.  The decrease was primarily due to
a corresponding decrease in sales described elsewhere in this discussion.

     Current liabilities  decreased to $9.7 million as of December 31, 1997 from
$11.5 million as of December 31, 1996.  The decrease in current  liabilities  is
due to a  corresponding  decrease in sales.  Sales and excise taxes  included in
current liabilities  decreased to $736,000 for the year ended December 31, 1997,
from $1.7 million for the year ended  December 31, 1996,  largely as a result of
the decrease in sales and an adjustment for prior overaccruals.

     Prior  to the  Share  Exchange,  the  Company  loaned  $2.0  million  to an
affiliated  company,  Core  Marketing,  LLC,  during 1997, of which $201,111 was
repaid prior to December 31, 1997. The remainder of the loan is due on or before
September 1, 1998. Additionally,  the Company had loans outstanding from DNS for
$1.6 million at December 31, 1995; all of which were paid in 1996.

     AvTel's operations for the twelve months ended September 30, 1997 (its last
full  fiscal year prior to the  completion  of the Share  Exchange)  resulted in
revenues of  approximately  $2.3  million and a net loss of  approximately  $2.4
million.  These  losses  primarily  resulted  from  costs  associated  with  the
commencement of AvTel's  operations and an impairment loss of approximately $1.4
million  recorded in connection with the AHI Merger.  There is no assurance that
these operations will produce operating income in 1998.

     The Company has been able to finance its capital  expenditures,  which have
consisted  primarily  of  property  and  equipment,  from funds  generated  from
operations.  Cash  received in  acquisitions  totaled  $478,643  during 1997. An
important  component  of the  Company's  past  growth  has been to  develop  its
business through acquisitions, including the Share Exchange. The Company intends
to continue this strategy, and has retained Van Kasper & Company to advise it in
connection with this strategy.

     Although cash provided by operations has provided  sufficient  cash to fund
its growth to date,  the Company  anticipates  that future growth  strategies in
1998 (including possible  acquisitions) will require funding from other sources.
The  Company is  evaluating  its  financing  alternatives.  In  addition to debt
financing,  the Company may utilize  its capital  stock for  acquisitions  under
appropriate circumstances.

                                       21
<PAGE>

INFLATION
---------

     The  Company  does  not  believe  that  the  relatively  moderate  rates of
inflation  over the past three  years have had a  significant  effect on its net
sales or its profitability.

YEAR 2000 COMPLIANCE
--------------------

     The Company has made an effort to insure that the  software  components  of
its information  and billing  systems are Year 2000 compliant.  Management is in
the process of confirming that all of such systems are Year 2000 compliant. Upon
such confirmation,  management believes that, after January 1, 2000, the Company
will be able to continue to accurately  track and bill calls.  At the same time,
it is likely that the  operations of a number of the  Company's  vendors rely on
software that is not Year 2000 compliant.

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

                  Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements of the Company and supplementary data are included
beginning immediately following the signature page to this report.


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     On December 1, 1997, the Company engaged KPMG Peat Marwick LLP to audit its
financial  statements  for fiscal 1997.  This and certain  other  changes in the
Company's accountants were previously reported in Forms 8-K filed on November 7,
1997, and December 9, 1997.

     There are no, and have not been, any disagreements  between the Company and
its accountants on any matter of accounting  principles,  practices or financial
statements disclosure.


                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT


     The  information  required by this Item will be contained in the  Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the
captions  "Election of  Directors"  and  "Compliance  with Section  16(a) of the
Securities Exchange Act of 1934."

ITEM 11. EXECUTIVE COMPENSATION

     The  information  required by this Item will be contained in the  Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the
caption "Executive Compensation."

                                       22
<PAGE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The  information  required by this Item will be contained in the  Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the
captions "Stock Ownership" and "Principal Shareholders."


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The  information  required by this Item will be contained in the  Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the
captions "Certain Relationships and Transactions."


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

     (a) The index to the financial statements and financial statement schedules
filed as part of this report is set forth  immediately  following  the signature
page.

     (b) The  index to the  exhibits  filed as part of this  report is set forth
immediately following the financial statements.

     (c) During the quarter  ended  December  31,  1997,  the Company  filed the
following Current Reports on Form 8-K:

          (i)  Amendment  to Current  Report on Form 8-K/A  filed on October 20,
1997,  amending a Current  Report on Form 8-K filed by Hi, Tiger  International,
Inc. (a predecessor  corporation)  on November 7, 1996.  Amending Item 7 to file
financial  statements and pro forma  financial  information  with respect to the
acquisition of AvTel Holdings, Inc.

          (ii)  Amendment  to Current  Report on Form 8-K/A filed on October 23,
1997,  amending a Current  Report on Form 8-K filed on March 6,  1997.  Amending
Item 7 to file financial  statements and pro forma  financial  information  with
respect to the acquisition of WestNet Communications, Inc.

          (iii)  Current  Report  filed on November 7, 1997.  Item 4 - regarding
dismissal of AvTel's prior independent auditor.

          (iv) Current Report filed on December 9, 1997 (subsequently amended by
Amendment  to Current  Report on Form 8-K/A filed on February 9, 1998.) Items 1,
2, 4 and 7.  Completion of the  Reincorporation  Merger and the Share  Exchange,
engagement of KPMG Peat Marwick LLP as independent auditors and change in fiscal
year.



                                       23

<PAGE>

SIGNATURES

     In accordance  with Section 13 or 15(d) of the Exchange Act, the Registrant
has caused this report to be signed on it behalf by the  undersigned,  thereunto
duly authorized.

                           AVTEL COMMUNICATIONS, INC.


Dated:   April 10, 1998      By /S/ ANTHONY E. PAPA
                             ------------------------
                              Anthony E. Papa,
                              Chairman of the Board and Chief Executive Officer
                              (Principal Executive Officer)


Dated:   April 10, 1998      By /S/ JAMES P. PISANI
                             ------------------------
                              James P. Pisani,
                              President, Chief Operating Officer and
                              Chief Financial Officer
                              (Principal Financial Officer)


Dated:   April 10, 1998      By /S/ VIRGINIA A. BAKER
                             ------------------------
                              Virginia A. Baker
                              Controller and Chief Accounting Officer
                              (Principal Accounting Officer)

                                       24


<PAGE>





     In  accordance  with the Exchange Act, this report has been signed below by
the  following  persons  on  behalf  of the  Registrant  and  in the  capacities
indicated on this 10th day of April, 1998.

                            AVTEL COMMUNICATIONS, INC.


                              By /S/ ANTHONY E. PAPA
                            ------------------------
                              Anthony E. Papa,
                              Chairman of the Board and Chief Executive Officer

                              By  /S/ JAMES P. PISANI
                            ------------------------
                              James P. Pisani,
                              President, Chief Operating Officer and
                              Chief Financial Officer, Director


                              By /S/ VIRGINIA A. BAKER
                            -------------------------
                              Virginia A. Baker
                              Controller and Chief Accounting Officer


                              By /S/ JOHN E. ALLEN
                            -------------------------
                              John E. Allen
                              Director


                              By /S/ JEFFREY J. JENSEN
                            --------------------------
                              Jeffrey J. Jensen
                              Director


                              By /S/ GREGORY T. MUTZ
                            --------------------------
                              Gregory T. Mutz
                              Director



                                       25


<PAGE>




                          INDEPENDENT AUDITORS' REPORT



The Board of Directors
AvTel Communications, Inc.:

We  have  audited  the  accompanying   consolidated   balance  sheets  of  AvTel
Communications,  Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated  statements of operations,  stockholders'  equity, and cash
flows for each of the years in the three-year period ended December 31, 1997. In
connection with our audits of the  consolidated  financial  statements,  we also
have audited the accompanying  financial statement schedule.  These consolidated
financial  statements and financial statement schedule are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
consolidated  financial statements and financial statement schedule 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 that 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  AvTel
Communications,  Inc. and  subsidiaries  at December 31, 1997 and 1996,  and the
results  of their  operations  and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting  principles.  Also in our opinion,  the related  financial  statement
schedule,  when  considered  in  relation  to the basic  consolidated  financial
statements taken as a whole,  presents  fairly,  in all material  respects,  the
information set forth therein.



/s/ KPMG Peat Marwick LLP.
Dallas, Texas
March 24, 1998












                                       F-1



<PAGE>


<TABLE>


                   AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

                           Consolidated Balance Sheets

                           December 31, 1997 and 1996

<CAPTION>


                     Assets                                                 1997          1996
                     ------                                             ------------   -----------
<S>                                                                     <C>            <C>  

Current assets:
   Cash and cash equivalents .........................................  $  4,807,441     4,622,395
   Accounts receivable, net ..........................................     6,961,953    10,507,580
   Due from affiliates ...............................................     2,127,771     1,212,414
   Federal and state income tax receivable ...........................       598,970          --
   Other current assets ..............................................       861,950     2,200,751
                                                                        ------------   -----------
                 Total current assets ................................    15,358,085    18,543,140
Property and equipment, net ..........................................     1,791,682     1,621,355
Other assets, net ....................................................     1,575,083       173,909
                                                                        ------------   -----------
                 Total assets ........................................  $ 18,724,850    20,338,404
                                                                        ============   ===========

    Liabilities and Stockholders' Equity
    ------------------------------------

Current liabilities:
   Accounts payable and other accrued expenses .......................  $  1,546,762     1,888,026
   Accrued network service costs .....................................     4,319,198     4,863,663
   Sales and excise taxes payable ....................................       736,012     1,676,677
   Due to affiliates .................................................     2,719,417     2,597,559
   Other current liabilities .........................................       466,039       554,596
                                                                        ------------   -----------
                 Total current liabilities ...........................     9,787,428    11,580,521
Deferred income taxes ................................................       498,712          --
Other liabilities ....................................................        50,782          --
Common stock subject to put option (note 4) ..........................       578,880       896,000
                                                                        ------------   -----------
                 Total liabilities ...................................    10,915,802    12,476,521
                                                                        ------------   -----------

Stockholders' equity:
   Series A convertible preferred stock, cumulative as to 8%
     dividends.  Authorized 1,000,000 shares, $0.01 par value,
     207,700 shares issued and outstanding.  (Liquidation
     preference of $919,000 including dividends in arrears.) .........         2,077          --
   Common stock, Authorized 20,000,000 shares. At
     December 31, 1997, $0.01 par value; 11,437,056
     shares issued, including 385,920 shares subject to put options ..
     At December 31, 1996, no par value; 8,819,054 shares
     issued, including 482,400 shares subject to put options .........       110,511     7,532,026
   Additional paid in capital ........................................    17,138,739          --
   Retained earnings (accumulated deficit) ...........................    (9,422,729)      769,441
   Treasury stock, 1,999,997 shares in 1997 and 171,548 shares in 1996       (20,000)     (439,584)
                                                                        ------------   -----------
                 Total stockholders' equity ..........................     7,809,048     7,861,883

Commitments and contingencies
                 Total liabilities and stockholders' equity ..........  $ 18,724,850    20,338,404
                                                                        ============   ===========
See accompanying notes to consolidated financial statements.
</TABLE>

                                       F-2
<PAGE>


<TABLE>


                   AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

                      Consolidated Statements of Operations

                  Years ended December 31, 1997, 1996 and 1995

<CAPTION>

                                                                      1997          1996          1995
                                                              ------------   -----------   -----------
<S>                                                           <C>            <C>           <C>  

Revenues (note 6) ..........................................  $ 51,389,080    71,558,295    64,289,718
Cost of revenues (note 6) ..................................    36,227,507    47,674,396    42,980,127
                                                              ------------   -----------   -----------
               Gross margin ................................    15,161,573    23,883,899    21,309,591
                                                              ------------   -----------   -----------

Operating expenses:
         Selling, general and administrative (note 6) ......    16,141,132    18,798,925    17,888,856
         Acquisition related write off .....................     9,098,545          --            --
         Depreciation and amortization .....................       679,856       993,940       998,342
                                                              ------------   -----------   -----------
                                                                25,919,533    19,792,865    18,887,198
                                                              ------------   -----------   -----------
                Operating income (loss) ....................   (10,757,960)    4,091,034     2,422,393

Interest expense (note 6) ..................................       (11,692)     (230,922)       (6,299)
Other income, net ..........................................       301,580       271,171       165,616
                                                              ------------   -----------   -----------
                 Income (loss) before income
                     tax expense and equity in net
                     income (loss) of DNS ..................   (10,468,072)    4,131,283     2,581,710

Income tax expense (benefit) ...............................      (276,352)    1,686,876     1,081,726
                                                              ------------   -----------   -----------
                                                               (10,191,720)    2,444,407     1,499,984

Equity in net income (loss) of DNS .........................          --         122,327    (3,940,477)
                                                              ------------   -----------   -----------
                  Net income (loss) ........................  $(10,191,720)    2,566,734    (2,440,493)
                                                              ============   ===========   ===========

Proforma net loss per common share - basic
   and diluted .............................................  $      (1.23)
                                                              ============

</TABLE>




See accompanying notes to consolidated financial statements 









                                       F-3



<PAGE>


<TABLE>

                   AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

                 Consolidated Statements of Stockholders' Equity

                  Years ended December 31, 1997, 1996 and 1995

<CAPTION>

                                                                                  Retained
                     Preferred Stock           Common Stock          Additional   earnings         Treasury Stock
                     ---------------           ------------           paid in   (accumulated       --------------
                     Shares   Amount       Shares         Amount      capital     deficit)       Shares        Amount         Total
                     -------  ------  -----------   ------------   ----------  -----------   ----------   -----------   -----------
<S>                  <C>      <C>     <C>           <C>            <C>         <C>           <C>          <C>           <C>

Balances at
December 31, 1994 .     --    $ --      4,467,384   $  1,729,133         --        643,200         --     $      --       2,372,333
 Acquisition of DNS
  Communications, Inc.  --      --      2,405,499      3,607,682         --           --           --            --       3,607,682
 Net loss .........     --      --           --             --           --     (2,440,493)        --            --      (2,440,493)
                     -------  ------  -----------   ------------   ----------  -----------   ----------   -----------   -----------
Balances at
December 31, 1995 .     --      --      6,872,883      5,336,815         --     (1,797,293)        --            --       3,539,522
 Purchase of
  common stock ....     --      --           --             --           --           --       (171,548)     (439,584)     (439,584)
 Issuance of
  common stock ....     --      --      1,463,771      2,195,211         --           --           --            --       2,195,211
 Net income .......     --      --           --             --           --      2,566,734         --            --       2,566,734
                     -------  ------  -----------   ------------   ----------  -----------   ----------   -----------   -----------
Balances at
 December 31, 1996      --      --      8,336,654      7,532,026         --        769,441     (171,548)     (439,584)    7,861,883
 Acquisition of Best
  (note 2) ........     --      --        934,987      3,361,208         --           --     (1,999,997)   (3,317,940)       43,268
 Share for share
  exchange between
  AvTel and Matrix
  (note 2): Reverse
  acquisition of
  AvTel ...........  207,700   2,077    1,839,563         18,396    9,129,040         --           --            --       9,149,513
  Reflect new
   capitalization
   of Company .....     --      --       (171,548)   (10,802,234)   7,064,710         --        171,548     3,737,524          --
 Issuance of
  common stock
  for exercise
  of options ......     --      --         15,000            150       52,350         --           --            --          52,500
 Expired put
  options (note 4)      --      --         96,480            965      143,755         --           --            --         144,720
 Stock compensation
  earned (note 7) .     --      --           --             --        748,884         --           --            --         748,884
 Net loss .........     --      --           --             --           --    (10,191,720)        --            --     (10,191,720)
                     -------  ------  -----------   ------------   ----------  -----------   ----------   -----------   -----------
Balances at
December 31, 1997 .  207,700  $2,077   11,051,136   $    110,511   17,138,739   (9,422,729)  (1,999,997)  $   (20,000)    7,809,048
                     =======  ======  ===========   ============   ==========  ===========   ==========   ===========   ===========

</TABLE>

See accompanying notes to consolidated financial statements.



                                       F-4


<PAGE>
<TABLE>



                   AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows
                  Years ended December 31, 1997, 1996 and 1995

<CAPTION>

                                                                    1997         1996         1995
                                                            ------------   ----------   ----------
<S>                                                         <C>            <C>          <C>
Cash flows from operating activities:
   Net income (loss) .....................................  $(10,191,720)   2,566,734   (2,440,493)
   Adjustments to reconcile net income (loss) to
    net cash provided by operating activities:
      Depreciation and amortization ......................       679,856      993,940      998,342
      Amortization of advanced commissions ...............     1,355,492      618,791         --
      Acquisition related write off ......................     9,098,545         --           --
      Provision for bad debts ............................     1,829,770    1,461,471    1,955,842
      Deferred income taxes ..............................       (80,377)    (321,678)     530,885
      Stock compensation earned ..........................       748,884         --           --
      Equity in (income) loss of DNS .....................          --       (122,327)   3,940,477
      Changes in certain operating assets and liabilities:
        Accounts receivable ..............................     1,969,332   (1,971,970)  (2,170,807)
        Due from affiliates ..............................      (915,357)     345,336      630,395
        Federal and state income tax receivable ..........      (598,970)        --        631,183
        Other current assets .............................     1,787,672     (393,781)     (96,791)
        Accounts payable and accrued liabilities .........    (2,877,789)  (1,397,160)     526,850
        Due to affiliates ................................    (1,138,568)    (742,663)     591,889
                                                            ------------   ----------   ----------
              Net cash provided by operating activities ..     1,667,770    1,036,693    5,097,772
                                                            ------------   ----------   ----------

Cash flows from investing activities:
   Cash received in acquisitions .........................       477,643         --           --
   Loans to affiliate ....................................    (2,000,000)        --           --
   Payments received on loans to affiliates ..............       201,111         --           --
   Purchase of property and equipment ....................      (212,421)    (701,718)    (529,805)
   Purchase of customer base .............................          --           --       (103,970)
   Repayments from (to) DNS, net .........................          --      1,577,432   (1,577,432)
   Other .................................................         2,749      (14,482)      52,173
                                                            ------------   ----------   ----------
              Net cash provided by (used in)
                investing activities .....................    (1,530,918)     861,232   (2,159,034)
                                                            ------------   ----------   ----------

Cash flows from financing activities:
   Principal payments on capital leases ..................        (4,306)        --           --
   Cash received for exercise of options .................        52,500         --           --
   Purchase of common stock for treasury .................          --       (439,583)        --
                                                            ------------   ----------   ----------
               Net cash provided by (used in) ............        48,194     (439,583)        --
                                                            ------------   ----------   ----------
                 financing activities

Net increase in cash and cash equivalents ................       185,046    1,458,342    2,938,738
Cash and cash equivalents at beginning of year ...........     4,622,395    3,164,053      225,315
                                                            ------------   ----------   ----------
Cash and cash equivalents at end of year .................  $  4,807,441    4,622,395    3,164,053
                                                            ============   ==========   ==========

                                                                                        (Continued)
</TABLE>



                                       F-5


<PAGE>
<TABLE>



                   AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

                Consolidated Statements of Cash Flows, Continued
<CAPTION>


                                                                    1997         1996         1995
                                                            ------------   ----------   ----------
<S>                                                         <C>            <C>          <C>

Cash paid (received) during the year for:
   Interest ..............................................  $     11,594      212,404        6,300
                                                            ============   ==========   ==========
   Income taxes, net of refunds ..........................  $    925,161    1,482,103     (475,177)
                                                            ============   ==========   ==========
Noncash financing activities:
   Common stock issued for DNS acquisition ...............  $       --           --      3,607,682
                                                            ============   ==========   ==========
   Common stock issued for advanced commissions ..........  $       --      2,195,211
                                                            ============   ==========
   Common stock issued for receivable from
     major shareholder ...................................  $       --        723,600         --
                                                            ============   ==========   ==========
   Common stock issued for Best acquisition ..............  $  3,361,208         --
                                                            ============   ==========
   Treasury stock acquired with Best acquisition .........  $ (3,317,940)        --
                                                            ============   ==========
   Common and preferred stock issued in AvTel reverse
     acquisition .........................................  $  9,149,513         --           --
                                                            ============   ==========   ==========

</TABLE>

See accompanying notes to consolidated financial statements.
















                                       F-6



<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 1997, 1996 and 1995





(1)  Summary of Significant Accounting Policies

     (a)  Business and Background

          On December 1, 1997, AvTel  Communications,  Inc. ("AvTel") and Matrix
          Telecom, Inc. ("Matrix") completed a share for share exchange pursuant
          to a stock  exchange  agreement  dated April 29, 1997 as  subsequently
          amended  ("Share  Exchange").   For  accounting  purposes,  the  Share
          Exchange  was  treated  as a reverse  acquisition  of AvTel by Matrix.
          AvTel was the legal acquiror and  accordingly,  the Share Exchange was
          effected by the issuance by AvTel of 9,582,493  shares of common stock
          in exchange for all of the common stock then outstanding of Matrix. In
          addition,  holders of outstanding Matrix stock options received 22,338
          non-qualified   stock  options  of  AvTel.   The  purchase  method  of
          accounting  was used,  with Matrix  being  treated as the acquiror for
          accounting  purposes.  The  results of  operations  reported  in these
          consolidated  financial  statements  reflect the  operations of Matrix
          prior to December 1, 1997 and reflect the combined operations of AvTel
          and Matrix subsequent to December 1, 1997. References to the "Company"
          refer to  operations  of Matrix  prior to the Share  Exchange  and the
          combined  operations  of  Matrix  and  AvTel  subsequent  to the Share
          Exchange.  As a result of the Share  Exchange,  Matrix became a wholly
          owned subsidiary of AvTel. (See note 2).

          The Share Exchange provided that each Matrix shareholder would receive
          2.4819 AvTel common shares for each common share of Matrix then issued
          including  treasury  shares held by Matrix.  For periods  prior to the
          December 1, 1997 Share Exchange,  all share amounts have been restated
          to reflect  the Share  Exchange  as a 2.4819 for one stock  split.  In
          addition, on March 10, 1997 Matrix declared an 18 for one stock split.
          All share amounts have been restated to also reflect this stock split.

          AvTel was  formed  to be a  provider  of  broadband  network  services
          integrating  voice,  data and  video  solutions  for  individuals  and
          corporate  customers.  The Company  sells and markets a broad range of
          telecommunications  and advanced network services through  independent
          value added  resellers and internal  direct sales  professionals.  The
          Company  targets  mid-size  corporations,   small-office   home-office
          professionals and select  residential  market segments.  To date AvTel
          has generated  revenues  primarily  through the  provisioning  of data
          networking and internet service.




                                       F-7



                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     Matrix provides long distance  telephone  service in forty-nine states over
intercity   facilities   provided  by  fully  certified  dominant  domestic  and
international  carriers.  Matrix  resells  to both  residential  and  commercial
customers;  however, the primary focus is to the small business owner and select
residential  customers.  Matrix is fully certified by the Federal Communications
Commission and certified to operate in all states requiring such  certification.
Matrix holds billing and collection  agreements with all regional bell operating
companies, GTE, and other independent telephone companies.

     (b)  Principles of Consolidation

          The  consolidated  financial  statements  include the  accounts of the
          Company   and   its   wholly-owned   subsidiaries.   All   significant
          intercompany   balances  and  transactions  have  been  eliminated  in
          consolidation.

     (c)  Cash and Cash Equivalents

          For purposes of the statement of cash flows, the Company considers all
          demand deposits,  time deposits,  and other highly liquid  investments
          with a remaining maturity at date of purchase of less than ninety days
          to be cash equivalents.

     (d)  Commissions

          Commissions  to  sales  agents  are  paid  and  expensed  based  on  a
          percentage of billings as incurred.

          Commissions  paid in advance of $221,000 and $1,576,000 as of December
          31, 1997 and 1996, respectively, included in other current assets, are
          being  expensed  over a period of eighteen  months  based on estimated
          billings of the customers for which the commissions were paid.

     (e)  Revenue Recognition

          Long  distance,   frame  relay  and  internet   service  revenues  are
          recognized  as  service  is  provided.  Amounts  paid in  advance  are
          recorded as deferred revenue.

     (f)  Property and Equipment

          Property and equipment are recorded at cost.  Maintenance  and repairs
          are charged  against  income as  incurred,  while  renewals  and major
          replacements  are  capitalized.   The  cost  and  related  accumulated
          depreciation  of assets sold or retired are removed from the accounts,
          and any resulting gain or loss is reflected in operations. The Company
          provides  depreciation on fixed assets using the straight-line  method
          over the estimated useful lives of the respective assets. 

                                      F-8


                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     (g)  Income Taxes

          The Company utilizes the asset and liability method for accounting for
          income taxes.  Under this method,  deferred tax assets and liabilities
          are  recognized  for  the  future  tax  consequences  attributable  to
          differences  between  the  financial  statement  carrying  amounts  of
          existing  assets and  liabilities  and their  respective tax bases and
          operating loss and tax credit  carryforwards.  Deferred tax assets and
          liabilities  are measured using enacted tax rates expected to apply to
          taxable income in the years in which those  temporary  differences are
          expected to be recovered or settled. The effect on deferred tax assets
          and  liabilities  of a change in tax rates is  recognized in income in
          the period that includes the enactment date.

     (h)  Use of Estimates

          Management  of  the  Company  has  made  a  number  of  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 to prepare these consolidated
          financial  statements in conformity with generally accepted accounting
          principles. Actual results could differ from those estimates.

     (i)  Concentrations of Credit Risk

          The Company's  subscribers  are primarily  small  business  owners and
          residential  subscribers  and are  not  concentrated  in any  specific
          geographic  region of the United  States.  The Company has  agreements
          with Local Exchange  Companies,  which provide  billing and collection
          services to the majority of the Company's  subscribers.  A significant
          portion  of  the  Company's  accounts  receivable  is due  from  these
          Companies.

     (j)  Accounts Receivable

          Accounts  receivable are net of allowances  for doubtful  accounts and
          other  provisions of $982,000 and $627,000 as of December 31, 1997 and
          1996, respectively.  The Company establishes an allowance for doubtful
          accounts   based  upon   factors   surrounding   the  credit  risk  of
          subscribers, historical trends and other information.

     (k)  Financial Instruments

          The  Company's  financial   instruments  include  cash,   receivables,
          payables and accrued  expenses.  The carrying amount of such financial
          instruments  approximates  fair value because of the short maturity of
          these instruments.

                                       F-9

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





(l)  Acquired Customer Base

     Acquired  customer  base  of  $1,575,083,   which  is  net  of  accumulated
     amortization of $8,000, at December 31, 1997,  included in other assets, is
     being  amortized  on a  straight-line  basis over five  years.  The Company
     assesses the recoverability of this intangible asset by determining whether
     the acquired  customer base balance can be recovered  through  undiscounted
     future  operating  cash  flows of the  acquired  operations.  The amount of
     impairment,  if any, is measured based on projected  discounted cash flows.
     The assessment of the  recoverability of the acquired customer base will be
     impacted if estimated future operating cash flows are not achieved.

(2)  Acquisitions

     Matrix Telecom, Inc. -- On December 1, 1997, AvTel and Matrix completed the
     Share Exchange. For accounting purposes the Share Exchange was treated as a
     reverse  acquisition of AvTel by Matrix.  AvTel was the legal acquiror and,
     accordingly,  the Share  Exchange  was  effected  by the  issuance of AvTel
     common stock in exchange for all of the common  stock then  outstanding  of
     Matrix. In addition,  holders of outstanding  Matrix stock options received
     non-qualified  stock options of the Company.  After the Share  Exchange the
     former   shareholders  of  Matrix  held   approximately  84%  of  the  then
     outstanding common stock of the Company.

     The  consummation of the Share Exchange was subject to the  satisfaction of
     several  conditions by AvTel.  These included the  reincorporation of AvTel
     (then a Utah corporation; "AvTel Utah") in Delaware by way of a merger (the
     "Reincorporation  Merger")  with and into  AvTel  Communications,  Inc.,  a
     Delaware corporation, a wholly-owned subsidiary formed for the sole purpose
     of this  merger.  As part of the  merger,  AvTel  (the  surviving  Delaware
     corporation)  issued to its  stockholders  one share of new Delaware Common
     Stock  for each  four  shares  of  AvTel-Utah's  Common  Stock  outstanding
     immediately  prior  to  the  Reincorporation   Merger.   AvTel's  Series  A
     Convertible  Preferred  Stock and its  outstanding  options were  similarly
     adjusted.  Accordingly,  the Reincorporation  Merger essentially effected a
     one for four reverse stock split of AvTel's shares.

     In  connection  with  the  reverse  acquisition  of AvTel  by  Matrix,  the
     following  assets  were  acquired,  liabilities  assumed,  and  common  and
     preferred stock issued.

              Current assets other than cash                       $   258,041
              Fixed assets                                             577,836
              Customer base                                          1,583,000
              Goodwill                                               9,098,545
              Current liabilities                                   (1,945,526)
              Long-term liabilities                                   (688,854)
              Common and preferred stock issued                     (9,149,513)
                                                                   -----------
                Cash acquired                                      $   266,471
                                                                   ===========
                                      F-10

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements






     The  reverse  acquisition  of AvTel by Matrix was  accounted  for using the
     purchase method of accounting. In order to value the consideration given in
     the Share  Exchange the market  price of AvTel's  common stock for a period
     immediately  preceding the  announcement of the Share Exchange was used. As
     of the date of  acquisition,  the Company  determined the fair value of the
     net tangible  and  intangible  assets  acquired  and  liabilities  assumed.
     Concurrently,  the Company  determined that the carrying amount of recorded
     goodwill was not recoverable. Accordingly, the Company recorded a charge to
     income of $9,098,545  immediately  subsequent  to the reverse  acquisition.
     Proforma  results of operations of the Company as if the Share Exchange had
     occurred as of the beginning of the periods  presented is as follows except
     that the  acquisition  related loss is reflected as of January 1, 1997, for
     comparative purposes:

                                                       Year ended
                                                      December 31,
                                                      ------------
                                                  1997             1996
                                            --------------       ----------

     Revenue                                $   54,094,095       73,512,954
     Net income (loss)                         (12,634,346)       2,289,495
     Proforma net loss per share            $        (1.11)             --


     Best Connections,  Inc. ("Best") -- Effective July 1, 1997, shareholders of
     Best,  an  affiliate  of Matrix  through  substantially  common  ownership,
     contributed  their  ownership  of Best to Matrix in  exchange  for  934,987
     shares of Matrix common stock.  Best's primary assets were 1,999,997 shares
     of Matrix common stock and cash of $211,000.  The assets and liabilities of
     Best were recorded at their  historical  cost which  approximated  the fair
     value of such  assets as of July 1, 1997.  As a result of the  combination,
     Matrix  assumed the  obligation  to grant up to 1,999,997  stock options to
     agents of Best,  certain employees of affiliated  companies and potentially
     others.  Such option grants relate to services,  including  sales promotion
     activities,  to be  performed by the  recipients  on behalf of the Company.
     Accordingly,  the fair value of such  options will be charged to expense by
     the Company as the related services are provided.

     In connection with the Matrix and Best  combination,  the following  assets
     were acquired, liabilities assumed and common stock issued:

          Fixed assets                                             $    15,137
          Current liabilities                                         (183,014)
          Common stock issued                                        3,361,208
          Treasury stock acquired                                   (3,317,940)
                                                                   -----------
          Cash acquired                                            $   211,172
                                                                   ===========

                                      F-11

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements






     Results of operations  for 1997 and 1996 would not have been  significantly
     different had the Best and Matrix combination  occurred as of the beginning
     of the respective years.

     DNS  Communications,  Inc.  ("DNS")  --  In  October  1995,  Matrix  issued
     2,405,499  shares of its common stock valued at  $3,607,682 in exchange for
     all of the  outstanding  common stock of DNS, a Houston based long distance
     reseller.  The transaction was accounted for under the purchase method. The
     purchase  price in excess of the book value of DNS net assets was allocated
     based upon the estimated fair value of the assets  acquired and liabilities
     assumed at the date of acquisition and included the following:


          Current assets                                   $ 1,978,262
          Acquired customer base                             6,351,131
          Other noncurrent assets                              114,384
          Accounts payable and accrued expenses             (2,346,102)
          Deferred tax liability                            (2,489,993)
                                                           -----------
                    Value assigned to common stock issued  $ 3,607,682
                                                           ===========

     Summarized results of operations of DNS is as follows:

                                                      Period from
                                   Year Ended       October 1, 1995 to
                                December 31, 1996   December 31, 1995
                                -----------------   -----------------

          Revenue                  $   11,027,000        $  4,277,000
          Net income (loss)               122,000          (3,940,000)

     Subsequent to the acquisition,  the operations of DNS generated substantial
     losses.  DNS's  customer churn rate and bad debts as well as projected cash
     flows were evaluated and as of December 31, 1995 it was determined that the
     remaining   investment   in  the  DNS  acquired   customer   base  totaling
     approximately  $4,462,000 should be written off. Such amount net of related
     deferred taxes is included in the loss of DNS reflected above for 1995.

     In June 1996, Matrix sold the customer base acquired in the DNS acquisition
     in addition to certain  blocks of customers  acquired  during 1995 and 1996
     together  with  related  assets to a former  officer of Matrix and a former
     shareholder of DNS for approximately $5,270,000.  Matrix recorded a gain on
     this sale of approximately  $3,221,000.  This gain is included in equity in
     net income (loss) of DNS in the 1996 statement of operations.

                                      F-12

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     Due to the timing of the  acquisition  and subsequent  decision to sell the
     operations of DNS, Matrix has recorded its interest in DNS operations using
     the equity method of accounting.

(3)  Property and Equipment

     Property and equipment consisted of the following:

                                            Estimated          December 31
                                                               -----------
                                            useful life      1997       1996
                                            -----------   ----------  ---------
        Communications system                 2-5 years   $1,318,326  1,328,679
        Office furniture and equipment        1-7 years    2,945,795  2,815,451
        Leasehold improvements               lease term      416,220    416,220
                                                          ---------- ----------
                                                           4,680,341  4,560,350
                                                          (2,888,659)(2,938,995)
                                                          ----------  ---------
                                                          $1,791,682  1,621,355
                                                          ==========  =========

     Depreciation expense was $632,000, $877,000 and $882,000 for 1997, 1996 and
     1995, respectively.

(4)  Stockholders' Equity

     The  preferred  shareholders  are  entitled  to receive  cumulative  annual
     dividends at a rate of 8% and are entitled to a preference  in  liquidation
     in the amount of $4 per share plus  unpaid  dividends.  There were  $88,000
     cumulative  preferred  stock dividends in arrears at December 31, 1997. The
     preferred  stock is  convertible,  on a one-for-one  basis,  into shares of
     Company  common  stock.   The  Company  has  1,000,000   preferred   shares
     authorized.

     In October 1995,  the Company issued  2,405,499  shares of its no par value
     common stock valued at $3,607,682 for 100% of the outstanding shares of DNS
     Communications, Inc. ("DNS"), a Houston based long distance reseller.

     In December 1996, the Company issued  1,463,771  shares of its no par value
     common stock for future  commissions  due to  affiliates  as of October 31,
     1996.  A value of $1.50  per share was used in  determining  the  number of
     shares to issue in settlement of the $2,195,211 obligation. Of this amount,
     $1,355,000  and  $619,000 was  expensed as  commission  expense in 1997 and
     1996, respectively.

     During 1996, the Company sold to certain employees 482,400 shares of common
     stock at $1.50 per share. As of December 31, 1996, the Company had recorded
     a $723,600  receivable for such shares,  which was subsequently  collected.
     Proceeds used to repay the $723,600 receivable were loaned to

                                      F-13

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements






     the  employees by a major  shareholder  of the Company.  As of December 31,
     1997 and 1996,  the shares  subject to this  agreement  could be put to the
     Company at the option of the employee at approximately  $1.50 and $1.86 per
     share  ($578,880  and  $896,000),  respectively.  Such  amounts  have  been
     included in other liabilities. Activity in common stock outstanding related
     to shares subject to put follows:

                                                             Shares     Amount
                                                            --------  ---------

          Sale of common shares subject to put               482,400  $ 723,600
          Increase in share value subject to put charged
             to expense                                         --      172,400
                                                            --------   --------
                      Balance, December 31, 1996             482,400    896,000

          Decrease in share value subject to put recorded
              as a reduction to expense                         --     (172,400)
          Vested shares no longer subject to put             (96,480)  (144,720)

                       Balance, December 31, 1997            385,920  $ 578,880
                                                            ========   ========

     Under certain  circumstances (e.g., employee termination) the Company has a
     call at amounts discussed above.

     During May 1996, the Company  purchased 171,548 shares of its no par common
     stock as treasury  stock for  $439,584.  As further  discussed in note 8 in
     connection  with the Best and Matrix  combination  effective  July 1, 1997,
     Matrix  acquired  an  additional  1,999,997  shares of its common  stock as
     treasury stock. As a part of the  recapitalization  done in connection with
     the AvTel reverse  acquisition,  Matrix  retired the 171,548  shares of its
     common  stock  discussed  above  and the  Company  recorded  the  remaining
     treasury stock at par value.

(5)  Federal and State Income Taxes

     The provision for income taxes consisted of the following:

                                                      1997        1996     1995
                                                      ----        ----     ----

     Current tax expense (benefit):
         Federal                              $   (234,899)  1,751,047  480,736
         State and local                           (41,453)    257,507   70,105
                                                  --------   ---------  -------
                                                  (276,352)  2,008,554  550,841
                                                  --------   ---------  -------
                                      F-14

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements







     Deferred tax expense (benefit):
                Federal                           --       (254,350)    424,708
                State and local                   --        (67,328)    106,177
                                              --------   ----------   ---------
                                                  --       (321,678)    530,885
                                              --------   ----------   ---------
                                            $ (276,352)   1,686,876   1,081,726
                                              ========   ==========   =========

     Income tax expense  differs from the amounts  computed by applying the U.S.
     federal  income tax rate of 34 percent to pretax  income as a result of the
     following:

                                                     1997        1996       1995
                                              -----------   ---------  ---------

Computed "expected" tax expense (benefit)     $(3,559,144)  1,404,637    870,502
State and local taxes, net of federal income
    tax effect                                    (27,359)    125,518    116,346
Nondeductible acquisition related write off     3,093,522        --         --
Losses not providing tax benefit                  330,190        --         --
Other                                            (113,561)    156,721     94,878
                                              -----------   ---------  ---------
                                              $  (276,352)  1,686,876  1,081,726
                                              ===========   =========  =========

     Deferred  income  taxes as of December 31, 1997 and 1996 reflect the impact
     of temporary  differences  between financial statement carrying amounts and
     tax  bases  of  assets  and  liabilities.  The  tax  effects  of  temporary
     differences that give rise to significant  portions of the net deferred tax
     assets at December 31, 1997 and 1996 are presented below:


                                                                 December 31

                                                               1997       1996
                                                          -----------    -------


Deferred tax assets:
       Net operating loss carryover                       $   814,425       --
       Compensation related items                             299,554       --
       Contingent liabilities and other items                 204,978    134,288
                                                          -----------    -------
       Gross deferred tax asset                             1,318,957    134,288
       Less valuation allowance                            (1,184,669)      --
                                                          -----------    -------
               Net deferred tax asset                         134,288    134,288

Deferred tax liabilities:
       Customer base intangible                              (633,000)      --
                                                          -----------    -------
               Net deferred tax asset (liability)         $  (498,712)   134,288
                                                          ===========    =======



                                      F-15

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements







     The valuation allowance for deferred tax assets increased $1,184,669 during
     1997,  $854,479 of which relates to temporary  differences  of AvTel as the
     date of the acquisition.

     In assessing the realizability of deferred tax assets, management considers
     whether it is more likely than not that some portion or all of the deferred
     tax assets will not be realized.  The ultimate  realization of deferred tax
     assets is dependent upon the generation of future taxable income during the
     periods in which those temporary differences become deductible.  Management
     considers the  scheduled  reversal of deferred tax  liabilities,  projected
     future taxable income and prior taxes paid in making this assessment. Based
     upon its evaluation of these factors,  management  believes that it is more
     likely  than  not that the  Company  will  realize  the  benefits  of these
     deductible  differences,  net of the valuation  allowance,  at December 31,
     1997.  At  December  31,  1997,   the  Company  has  net   operating   loss
     carryforwards  for federal tax purposes of  approximately  $2,400,000 which
     had been  generated  by AvTel  prior to the reverse  acquisition  which are
     available on a limited basis to offset future federal  taxable  income,  if
     any,  through  2012.  When  realized such benefit will first be utilized to
     reduce long term intangible  assets recorded in the reverse  acquisition of
     AvTel by Matrix.

(6)  Related Party Transactions

     The  Company has had  transactions  in the normal  course of business  with
     various  companies which are affiliated  with  shareholders of the Company.
     Pacific Gateway Exchange, Inc. ("PGE"), an affiliated company, provides the
     Company with significant domestic and international  transmission services.
     Common  shareholders  hold  an  interest  in  both  PGE  and  the  Company.
     Affiliates  of the  Company  also  act as  agents  for the  Company  in the
     solicitation  of new  customers.  A  significant  number  of the  Company's
     employees are leased from United Group Service  Center,  an affiliate,  who
     provides  such services to a number of  affiliated  companies.  The Company
     provides  long  distance  service  to a  number  of  affiliated  companies.
     Balances  with  affiliates  related to  operating  activities  are  settled
     monthly.  In  addition,  the  Company  has made both  interest  bearing and
     noninterest bearing advances to affiliated companies.





                                      F-16


                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     Due from affiliates consists of the following:

                                                               December 31
                                                            1997       1996
                                                        ----------  ---------

Core Marketing - note receivable due September 1, 1998  $1,798,889       --
United Membership Marketing Group (long distance
       services)                                            44,888       --
Specialized Card Services (long distance services)          20,564       --
UICI Administrators (long distance services)                28,965       --
Excell Agent Services (long distance services)                --      193,285
Interactive Media Works (IMW) (long distance services)      25,263        525
Core Marketing (long distance services)                    111,280    134,652
Other receivables from various affiliates                   97,922    160,352
Receivable from major shareholder for stock issued            --      723,600
                                                        ----------  ---------

                                                        $2,127,771  1,212,414
                                                        ==========  =========

     Due to affiliates consists of the following:

                                                             1997        1996
                                                       ----------   ---------

PGE (network transmission services)                    $2,335,787   2,244,411
Group Association (UGA) and
       Core Marketing (commissions)                       134,618     144,612
Other payables to various affiliates                      249,012     208,536
                                                       ----------   ---------
                                                       $2,719,417   2,597,559
                                                       ==========   =========

     Significant  services  and  transactions  incurred in the normal  course of
     operations with affiliated companies are summarized as follows:

                                                      1997       1996       1995
                                                ----------  ---------  ---------

Revenues include the following:
 U.S. Teleco-billing and collection services,
     customer service and accounting services   $  200,370       --         --
 Long distance revenues from affiliates:  UGA,
     UICI, IMW, and Core Marketing               3,351,375  5,445,903  3,180,302
                                                ----------  ---------  ---------
                                                $3,551,745  5,445,903  3,180,302
                                                ==========  =========  =========


                                      F-17

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements


<TABLE>
<CAPTION>


<S>                                                          <C>          <C>         <C>
Cost of revenues includes the following:
  Network transmission services - PGE                        $15,917,688  20,527,236  17,195,182
                                                             ===========  ==========  ==========

Selling, general and administrative includes the following:
  Expenses paid on behalf of PGE for access
      services, for which the Company was reimbursed         $ 3,534,154   5,040,051   3,142,222
  Expenses incurred for leasing employees from
      United Group Service Center                              4,395,820   4,542,007   3,655,712
  Sales commissions to affiliates:  TravelCom 800,
      Core Marketing, UICI, UGA and
      Best Connections                                           990,533   5,335,233   6,314,878
  Overhead expenses reimbursed to/from
      UGA Divisions                                              110,761      77,231     105,007
  Core Marketing - casual mailings                               603,742        --          --
                                                             -----------  ----------  ----------
                                                             $ 9,635,010  14,994,522  13,217,819
                                                             ===========  ==========  ==========

Interest expense includes the following:
  Interest paid to shareholder                               $      --       173,380       6,299
                                                             ===========  ==========  ==========
</TABLE>


     During 1996, the Company  obtained  loans of $4,900,000  from a significant
     shareholder for working capital and other purposes.  Such amount was repaid
     during 1996.

(7)  Stock Compensation

     AvTel options -- Prior to the Share Exchange AvTel adopted a 1997 Incentive
     Stock Option Plan (the "AvTel 1997 Plan") for option grants to officers and
     key employees. The AvTel 1997 Plan authorizes grants of options to purchase
     up to 250,000  shares of authorized  but unissued  common stock and 125,000
     shares of restricted common stock.  Stock options are to be granted with an
     exercise  price  greater  than or equal to the stock's fair market value at
     the date of grant.  Options  generally vest 25% after one year and 25% each
     year thereafter until fully vested. Such options typically expire after ten
     years. In addition, AvTel had other options which had been granted prior to
     the  adoption  of the  AvTel  1997  Plan.  After  the  Share  Exchange  all
     outstanding options became obligations of the Company.

     Matrix options -- Periodically,  the Board of Matrix approved stock options
     for certain  officers and employees.  Stock option  transactions  of Matrix
     prior to the Share  Exchange are reflected in the table below.  At the time
     of the Share  Exchange,  Matrix had 22,338 options  outstanding to purchase
     its common  stock.  In  connection  with the Share  Exchange,  the  Company
     reissued  these stock options and they vested  immediately.  These reissued
     options expire in December 2002.

                                      F-18

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements






     The per share weighted  average fair value of stock options  granted during
     1995 was $1.67 on the date of the grant  using the Black  Scholes  option -
     pricing model with the following  weighted-average  assumptions:  risk-free
     interest rate of 7.0%, and an expected life of 20 years.

     The Company  applies APB  Opinion No. 25 in  accounting  for the AvTel 1997
     Plan  and  the  Matrix  options  discussed  above;  and,  accordingly,   no
     compensation  cost has been  recognized  for its  stock  options  issued to
     employees  in the  financial  statements.  For  stock  options  granted  to
     nonemployees,  the Company accounts for such options in accordance with the
     requirements of SFAS No. 123. Had the Company determined  compensation cost
     based on the fair  value at the  grant  date for  stock  options  issued to
     employees under SFAS No. 123, the Company's net loss in 1997 and 1995 would
     have been  increased by  approximately  $5,000 and net income in 1996 would
     have been decreased by approximately $5,000.

     Best Connections, Inc. options -- As discussed in note 2 as a result of the
     Matrix  combination with Best, Matrix assumed the obligation to issue stock
     options to Best's agents under Best's 1997 Option Plan. Effective as of the
     date of  combination,  July 1, 1997,  1,292,000  options to purchase Matrix
     common  shares  were  granted to Best  agents at $1.50 per share which will
     result in aggregate  commission expense of approximately  $764,000 over the
     vesting period.  The option price per share was $1.50.  The agents' options
     become  exercisable  no later than  December  31, 1999 and may be exercised
     earlier based on qualified billings of long distance customers generated by
     the agents during six month measurement  periods.  After the Share Exchange
     such options became  obligations  of the Company.  As of December 31, 1997,
     421,343  options have been earned  under the Plan and the Company  recorded
     expense  totaling  approximately  $249,000 related to such options based on
     qualified  billings  for 1997.  In January  1998,  311,985 of such  options
     became  exercisable.  Options generally expire two years from the date they
     become exercisable or sixty days subsequent to termination of employment.

     The per share weighted  average fair value of stock options granted on July
     1, 1997 was $.59 on the date of the grant using the Black Scholes  option -
     pricing model with the  following  weighted-average  assumptions:  expected
     volatility of 30%, risk-free interest rate of 6.0%, and an expected life of
     3.5 years.

     Best  Connections,  Inc.  options and  restricted  stock  agreements  -- As
     discussed in note 2 as a result of the Matrix combination with Best, Matrix
     assumed the obligation to issue stock options,  consisting of Matrix common
     shares owned by Best, to employees of affiliated companies.  Effective July
     15, 1997, the Company issued 247,500 options to purchase an equal number of
     shares of its common stock, at $1.50 per share subject to the provisions of
     a Restricted Stock Agreement. The stock options expire if unexercised after
     December 15, 2002. The Restricted Stock Agreement includes a call provision
     by the Company that lapses ten percent each six months  beginning  December
     15, 1997 through June 15, 2002

                                      F-19

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     or fully lapses in the event of death or permanent disability of the option
     holder. The call price is equal to the initial purchase price of $1.50 plus
     the  aggregate  amount of net  income  or loss per  share  for each  fiscal
     quarter  beginning after December 15, 1997. In no event will the call price
     be less than the initial purchase price. The Company is recognizing expense
     over the life of the options in accordance  with the provisions of SFAS No.
     123 and, during 1997, the Company recorded expense of $499,000. At December
     31,  1997,  no options  had been  exercised  and  therefore  no shares were
     subject to the terms of the Restricted Stock Agreement.

     The per share  weighted  average  fair  value of stock  options  granted on
     December  15,  1997 was  $6.88 on the date of the  grant  using  the  Black
     Scholes  option  -  pricing  model  with  the  following   weighted-average
     assumptions:  expected  volatility of 30%, risk-free interest rate of 6.0%,
     and an expected life of five years.

     Stock option activity is as follows:

                                                                Weighted average
                                                                     Exercise
                                                       Options         Price
                                                    ----------      ---------
Outstanding at December 31, 1994                          --        $     --
       Granted                                          53,607           2.24
                                                                    ---------
Outstanding at December 31, 1995                        53,607           2.24
       Canceled                                        (31,269)          2.24
                                                                    ---------
Outstanding at December 31, 1996                        22,338           2.24
       AvTel options outstanding at time of
           Share Exchange                              255,109           4.52
       Granted                                       1,539,500           1.50
       Exercised                                       (15,000)          3.50
                                                                    ---------
Outstanding at December 31, 1997                     1,801,947           1.78
                                                    ==========      =========

Exercisable at December 31, 1995                          --        $     --
Exercisable at December 31, 1996                         3,574           2.24
Exercisable at December 31, 1997                       349,972           2.21

     Total expense recorded for stock based awards during 1997 was $748,884.

     The following  table  summarizes  certain  information  about the Company's
     stock options at December 31, 1997.

                                      F-20


                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements




<TABLE>
<CAPTION>

                               Options Outstanding                              Options Exercisable
                               -------------------                              -------------------
                                       Weighted
                                        average         Weighted
        Range of        Number of      remaining         average               Number of        Weighted average
     exercise prices     options    contractual life  exercise price       options exercisable   exercise price
     ---------------   ---------   ----------------   --------------       -------------------   --------------
<S>  <C>               <C>         <C>                <C>                  <C>                   <C>               <C>      
     $   1.00 - 3.00   1,756,674      3.8 years          $  1.64                  310,949           $    1.56
         4.00 - 6.00      28,097      6.4                   4.89                   21,847                4.86
            8.00           5,429      9.1                   8.00                    5,429                8.00
           12.00          11,747      8.8                  12.00                   11,747               12.00

</TABLE>

(8)  Proforma Net Loss per Common Share 

          In February 1997, the Financial Accounting Standards Board issued SFAS
          128,  Earnings per Share.  SFAS 128  supersedes the earnings per share
          calculation  methods  of APB 15,  effective  for  annual  and  interim
          periods  ending  after  December  15, 1997.  In  accordance  with this
          standard,  the net loss per share amount  presented  on the  Company's
          Consolidated  Statement of  Operations  for 1997 have been  calculated
          using the measurement provisions of SFAS 128.

          The  following  data show amounts used in computing net loss per share
          under the provisions of SFAS 128.

                                                                        1997
                                                                   ------------

Net loss                                                           $(10,191,720)
Less preferred dividends                                                  5,540
                                                                   ------------
  Loss applicable to common shareholders                           $(10,197,260)
                                                                   ============

Proforma weighted average number of common shares
  used in basic and diluted net loss per common share                 8,267,296

Net loss per common share -
  Basic and diluted                                                $      (1.23)
                                                                   ============

          Per  share  amounts  are not  reflected  for  1996 and 1995 due to the
          recapitalization of the Company as a result of the reverse acquisition
          in 1997.



                                      F-21

                                                                     (Continued)


<PAGE>





AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements





     For the  period  prior to the  reverse  acquisition,  the  number of shares
     outstanding  of  Matrix  multiplied  by the  exchange  ratio  was  used  to
     calculate the weighted  average number of shares  outstanding for pro forma
     purposes. Basic and diluted proforma net loss per common share are equal as
     assuming   conversion  of   potentially   dilutive   securities   would  be
     antidilutive.  At December  31, 1997,  the Company has 509,947  outstanding
     options at a  weighted-average  exercise  price per share of $2.49 (note 7)
     and 207,700 shares of preferred stock which are  convertible  into an equal
     number of shares of common stock (note 4). The potentially  dilutive effect
     of these  securities has not been  considered in the computation of diluted
     net loss per common share since their effect would be antidilutive.

(9)  Leasing Activities and Other Commitments

     The Company  leases  office  space and various  equipment  under  operating
     leases  expiring in various  years  through  2001.  In the normal course of
     business,  operating  leases are  generally  renewed or  replaced  by other
     leases.  Total rental expenses were $245,000 in 1997,  $325,000 in 1996 and
     $239,000  in  1995.  Future  minimum  lease  payments  under  noncancelable
     operating  leases (with  initial or remaining  lease terms in excess of one
     year) and future  minimum  capital  lease  payments as of December 31, 1997
     are: 1998 - $353,000; 1999 - $353,000; 2000 - $329,000 and 2001 - 68,000.

     Substantially  all of the Company's  switching and transmission  facilities
     have  been  provided  by  two  suppliers   under   negotiated   contractual
     agreements.  The  Company  purchases  long  distance  services  at  certain
     per-minute  rates,  which vary  depending on the time and type of call.  At
     December 31, 1997, there are outstanding  contractual agreements committing
     the Company to $6,773,000 minimum usage for 1998.

(10) Contingencies

     The  Company  presently  has  contingent  liabilities  relating  to various
     lawsuits and other matters  related to the conduct of its business.  On the
     basis of information  furnished by counsel and others,  management believes
     these   contingencies  upon  resolution  will  not  materially  affect  the
     financial condition or results of operations of the Company.



                                      F-22




<PAGE>
AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES

Schedule II - Valuation and Qualifying Accounts

Years ended December 31, 1997, 1996, and 1995

                            Balance at                                Balance at
                             beginning                                  end of
   Description               of period  Additions (a)  Deductions (b)   period

Allowance for doubtful
   accounts - year ended
   December 31, 1997        $  627,000  1,829,770       1,474,770      982,000
                            ==========  =========       =========      =======

Allowance for doubtful
   accounts - year ended
   December 31, 1996        $  730,000  1,461,471       1,564,471      627,000
                            ==========  =========       =========      =======

Allowance for doubtful
   accounts - year ended
   December 31, 1995        $  789,000  1,955,842       2,014,842      730,000
                            ==========  =========       =========      =======




(a)         Charged to costs and expense
(b)         Accounts written off









                                      F-23






<PAGE>




                         EXHIBIT INDEX

Exhibit
Number           Title of Document                             Page Number
----  ---------------------------------------------------      -----------

2.1  Acquisition Agreement, dated as of August 30, 1996, by
     and among Hi-Tiger International, Inc., a Utah
     corporation, AvTel  Communications, Inc., a Utah
     corporation, and AvTel Holdings, Inc., a California
     corporation. (Incorporated by reference to Exhibit A to
     Registrant's Information Statement on Schedule 14C dated
     October 2, 1996).

2.2  Amendment No.1 to Acquisition Agreement, dated October
     22, 1996, among Hi-Tiger International, Inc., AvTel
     Communications, Inc. and AvTel Holdings, Inc.
     (Incorporated  by reference to Exhibit 2.2 to Registrant's
     Current Report on Form 8-K dated October 23, 1996).

2.3  Agreement and Plan of Reorganization, dated November 20,
     1996 between the Registrant and Silicon Beach
     Communications, Inc. (Incorporated by reference to
     Exhibit 10.04 to Registrant's Annual Report on Form 10-KSB
     for the year ended September 30, 1996).

2.4  Stock Purchase Agreement, dated as of February 1, 1997,
     by and among the Registrant, Hi, Tiger, Inc., WestNet
     Communications, Inc., Theodore E. Padova, Howard M.
     Tamaroff and Christiana G. Bryson, Hallas Color Photo
     Lab, Inc., dba Image Source, Inc., Joseph P. and Lisa
     Gerardin, James D. Hennigan, Kathleen Sweeney Jonsson
     and Alan J. Noelle.  (Incorporated by reference to
     Exhibit 2.1 to Registrant's Current Report on Form 8-K
     dated February 21, 1997).

2.5  Stock Exchange Agreement, dated as of April 29, 1997, by
     and between the Registrant and Matrix Telecom, Inc.
     (Incorporated by reference to Exhibit 2 to Registrant's
     Current Report on Form 8-K dated April 30, 1997).

2.6  Amendment to Stock Exchange Agreement, dated as of August
     25, 1997, by and between AvTel Communications, Inc. and
     Matrix Telecom, Inc. (Incorporated by reference to
     Exhibit 2 to Registrant's Current Report on Form 8-K dated
     August 25, 1997).

2.7  Agreement and Plan of Merger, dated as of October 3,
     1997, between AvTel Communications, Inc., a Delaware
     corporation and AvTel Communications, Inc., a Utah
     corporation.  (Incorporated  by  reference to
     Exhibit 2.7 to Registrant's Annual Report on Form 10-KSB
     for the year ended September 30, 1997).








<PAGE>





3.1  Certificate of Incorporation of the Registrant.  (Incorporated by reference
     to Exhibit 3.1 to  Registrant's  Annual  Report on Form 10-KSB for the year
     ended September 30, 1997).

3.2  Bylaws of the Registrant. (Incorporated
     by reference to Exhibit 3.2 to  Registrant's  Annual  Report on Form 10-KSB
     for the year ended September 30, 1997).

10.1 Rights  Agreements  dated  October 23,  1996,  between the  Registrant  and
     holders  of  the  Registrant's   Series  A  Convertible   Preferred  Stock.
     (Incorporated by reference to Exhibit 4.2 to Registrant's Current Report on
     Form 8-K dated October 23, 1996).

10.2 Employment  Agreement,  dated as of August 1, 1996,  between the Registrant
     and  Anthony E.  Papa.  (Incorporated  by  reference  to  Exhibit  10.01 to
     Registrant's  Annual Report on Form 10-KSB for the year ended September 30,
     1996).

10.3 Employment  Agreement,  dated as of August 1, 1996,  between the Registrant
     and  James P.  Pisani.  (Incorporated  by  reference  to  Exhibit  10.01 to
     Registrant's  Annual Report on Form 10-KSB for the year ended September 30,
     1996).

10.4 Employment Agreement, dated as of November 20, 1996, between the Registrant
     and  Frank   Dziuba.   (Incorporated   by  reference  to  Exhibit  10.4  to
     Registrant's  Annual Report on Form 10-KSB for the year ended September 30,
     1997).

10.5 Employment Agreement,  dated as of January 27, 1997, between the Registrant
     and D. Stephen DeWindt,  as amended.  (Incorporated by reference to Exhibit
     10.5 to  Registrant's  Annual  Report  on Form  10-KSB  for the year  ended
     September 30, 1997).

10.6 1997 Stock Incentive Plan.  (Incorporated  by reference to Exhibit A to the
     Registrant's  definitive  Proxy  Statement on Schedule 14A dated January 8,
     1997.)

10.7 Registration  Rights and Lockup  Agreement dated December 1, 1997,  between
     the Registrant and Matrix Telecom,  Inc., on behalf of the  stockholders of
     Matrix,  (Incorporated  by reference to Exhibit 4 to  Registrant's  Current
     Report on Form 8-K dated December 1, 1997).

10.8 Triple Net Real Property Lease (Multi-Tenant Building) dated as of February
     16,  1998,  by and  between  Bath Street  Partners,  a  California  limited
     partnership and the Company.

10.9 Commercial Lease Agreement dated February 28, 1995,
     Matrix Telecom, Inc. and Ameritas Life Insurance Corp.,
     as amended by Lease Modification Agreement dated March 2,
     1995.







<PAGE>






10.10 Resale Solutions Switched Services Agreement dated March 12,
      1998, between Matrix Telecom, Inc. and Sprint Communications
      Company L.P.

10.11 IXplus  License  Agreement  dated as of April  23,  1991,  between  Matrix
      Telecom and Electronic Data Systems  Corporation,  as amended by Amendment
      Number One dated as of October 1, 1992.

21   List of Subsidiaries.

23 Consent of KPMG Peat Marwick LLP.

27   Financial Data Schedule.




<PAGE>