** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 

| **(Mark One)** |   |                                                                                                                                                          |
|----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ý         |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                  |
|           |   |                                                                                                                                                          |
|           |   | **For the quarterly period ended June 30,  2003**                                                                                                             |
|           |   |                                                                                                                                                          |
| **Or**         |
|           |   |                                                                                                                                                          |
| **o**          |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                           |
|           |   |                                                                                                                                                          |
|           |   | **For the transition period  from          to          ** |

 

**Commission file no. 0-27683**

 

**AmeriVisionCommunications, Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Oklahoma**                                                          |   | **73-1378798**                        |
|-----------------------------------------------------------------------|--------|---------------------------------------|
| (State or  other jurisdiction of incorporation or organization)       |   | (IRS  Employer Identification Number) |
|                                                                  |   |                                  |
| **5900 Mosteller Drive, Suite 1800****Oklahoma  City, Oklahoma** |   | **73112**                             |
| (Address of  principal executive offices)                             |   | (Zip Code)                            |
|                                                                  |   |                                  |
| **(405) 600-3500**                                               |
| (Registrant’s  telephone number, including area code)            |

 

Securities registered pursuantto Section 12(b) of the Act:

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act) Yes o  No ý

 

At June 30, 2003, there were 860,906 shares of our common stockoutstanding.

 

 

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AMERIVISION COMMUNICATIONS, INC. INDEX

 
| **Part I.**  | **Financial Information**                                                                                                                                     |
|-------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.           | Financial Statements                                                                                                                                          |
|              | Condensed  Consolidated Balance Sheets-December 31, 2002 and June 30, 2003  (unaudited)                                                                  |
|              | Condensed Consolidated Statements of Operations (unaudited)— Three  and six months ended June 30, 2002 and 2003                                          |
|              | Condensed  Consolidated Statements of Stockholders’ Deficiency for the year ended  December 31, 2002 and six months ended June 30, 2003 (unaudited) |
|              | Condensed Consolidated Statements of Cash  Flows (unaudited)—Three and six months ended June 30, 2002 and 2003                                           |
|              | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                                              |
| Item 2.           | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                   |
| Item 3.           | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                   |
| Item 4.           | Controls and Procedures                                                                                                                                       |
| **Part II.** | **Other Information**                                                                                                                                         |
| Item 1.           | Legal  Proceedings                                                                                                                                            |
| Item 2.           | Changes in Securities and Use of Proceeds                                                                                                                     |
| Item 3.           | Default Upon Senior Securities                                                                                                                                |
| Item 4.           | Submission  of Matters to a Vote of Security Holders                                                                                                          |
| Item 5.           | Other Information                                                                                                                                             |
| Item 6.           | Exhibits and reports on Form 8-K                                                                                                                         |
| Signatures        |                                                                                                                                                          |

 

2

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**PART I****. FINANCIALINFORMATION**

 

**Item 1****. FinancialStatements**

 

AMERIVISIONCOMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCESHEETS

(In thousands)

(Information at June 30, 2003is unaudited)

 
|                                                                                                                                                                                                     |   | **December  31,  2002** |       | **June 30,  2003** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|--------------------|------------|
|                                                                                                                                                                                                     |   |                    |       |               |       |
| **ASSETS**                                                                                                                                                                                               |   |                    | ** ** |               | ** ** |
| Current  Assets:                                                                                                                                                                                         |   |                    |       |               |       |
| Cash                                                                                                                                                                                                     |   | $                       | 799        |               | $          | 1,439 |   |
| Accounts  receivable, net of allowance for uncollectible accounts of $1,542 and $936 at  December 31, 2002 and June 30, 2003, respectively                                                               |   | 8,538                   |       | 5,968              |       |
| Prepaid  expenses and other current assets                                                                                                                                                               |   | 1,047                   |       | 1,046              |       |
| Total  current assets                                                                                                                                                                                    |   | 10,384                  |       | 8,453              |       |
| Property and  equipment, net                                                                                                                                                                             |   | 2,400                   |       | 1,531              |       |
| Net deferred  income tax benefits                                                                                                                                                                        |   | 1,465                   |       | 1,529              |       |
| Covenants  not to compete, net                                                                                                                                                                           |   | 2,319                   |       | 1,842              |       |
| Other assets                                                                                                                                                                                             |   | 623                     |       | 572                |       |
| Total assets                                                                                                                                                                                             |   | $                       | 17,191     |               | $          | 13,927 |   |
|                                                                                                                                                                                                     |   |                    | ** ** |               | ** ** |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIENCY**                                                                                                                                                       |   |                    | ** ** |               | ** ** |
| Current  Liabilities:                                                                                                                                                                                    |   |                    |       |               |       |
| Revolving  line of credit                                                                                                                                                                                |   | $                       | 13,719     |               | $          | 12,166 |   |
| Accounts  payable and accrued expenses                                                                                                                                                                   |   | 8,802                   |       | 7,464              |       |
| Current  portion of other notes payable and capital lease obligations                                                                                                                                    |   | 1,140                   |       | 1,299              |       |
| Loans and  notes payable to related parties, current portion                                                                                                                                             |   | 4,829                   |       | 5,060              |       |
| Short-term  notes payable to individuals                                                                                                                                                                 |   | 279                     |       | 279                |       |
| Total  current liabilities                                                                                                                                                                               |   | 28,769                  |       | 26,268             |       |
| Long-term  debt to related parties, net of current portion                                                                                                                                               |   | 859                     |       | 307                |       |
| Long-term  debt, net of current portion                                                                                                                                                                  |   | 259                     |       | 55                 |       |
| Redeemable  common stock, carried at redemption value                                                                                                                                                    |   | 1,200                   |       | 1,200              |       |
|                                                                                                                                                                                                     |   |                    |       |               |       |
| Commitments  and Contingencies                                                                                                                                                                           |   |                    |       |               |       |
| Stockholders’  deficiency:                                                                                                                                                                          |   |                    |       |               |       |
| Common  stock, $0.10 par value, 1,000,000 shares authorized; shares issued and  outstanding at December 31, 2002 and June 30, 2003 of 832,869 and 845,369  respectively, net of 15,537 redeemable shares |   | 82                      |       | 84                 |       |
| Additional  paid-in capital                                                                                                                                                                              |   | 11,000                  |       | 11,088             |       |
| Retained  earnings (accumulated deficit)                                                                                                                                                                 |   | (24,978                 | )          | (25,075            | )          |
| Total  stockholders’ deficiency                                                                                                                                                                     |   | (13,896                 | )          | (13,903            | )          |
| Total  liabilities and stockholders’ deficiency                                                                                                                                                     |   | $                       | 17,191     |               | $          | 13,927 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

3

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AMERIVISIONCOMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per shareamounts)

(Unaudited)

 
|                                               |   | **Three months  ended  June 30,** |   | **Six months  ended  June 30,** |   |
|----------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                               |   | **2002**                          |   | **2003**                        |   | **2002** |   | **2003** |   |
| Revenues:                                          |   |                              |   |                            |   |   |   |   |   |
| Net sales                                          |   | $                                 | 17,470 |                            | $      | 10,770 |   | $ | 33,845 |   | $ | 23,110 |   |
| Operating  expenses:                               |   |                              |   |                            |   |   |   |   |   |
| Cost of  telecommunication services                |   | 8,523                             |   | 4,330                           |   | 15,063 |   | 8,982 |   |
| Selling,  general and administrative expenses      |   | 7,125                             |   | 5,286                           |   | 14,461 |   | 11,622 |   |
| Depreciation  and amortization                     |   | 538                               |   | 792                             |   | 1,075 |   | 1,359 |   |
| Total  operating expenses                          |   | 16,186                            |   | 10,408                          |   | 30,599 |   | 21,963 |   |
| Income from  operations                            |   | 1,284                             |   | 362                             |   | 3,246 |   | 1,147 |   |
| Other income  (expense):                           |   |                              |   |                            |   |   |   |   |   |
|                                               |   |                              |   |                            |   |   |   |   |   |
| Interest  expense                                  |   | (517                              | )      | (512                            | )      | (1,093 | ) | (984 | ) |
| Interest  expense to related parties               |   | (118                              | )      | (181                            | )      | (244 | ) | (361 | ) |
| Other income                                       |   | 33                                |   | 34                              |   | 41 |   | 37 |   |
| Total other  income (expense)                      |   | (602                              | )      | (659                            | )      | (1,296 | ) | (1,308 | ) |
| Income (loss)  before income tax expense (benefit) |   | 682                               |   | (297                            | )      | 1,950 |   | (161 | ) |
| Income tax  expense (benefit)                      |   | 267                               |   | (117                            | )      | 751 |   | (64 | ) |
| Net income  (loss)                                 |   | $                                 | 415    |                            | $      | (180 | ) | $ | 1,199 |   | $ | (97 | ) |
|                                               |   |                              |   |                            |   |   |   |   |   |
| Earnings  (loss) per share:                        |   |                              |   |                            |   |   |   |   |   |
| Basic  earnings (loss) per share                   |   | $                                 | .49    |                            | $      | (.21 | ) | $ | 1.45 |   | $ | (.12 | ) |
| Diluted  earnings (loss) per share                 |   | $                                 | .43    |                            | $      | (.21 | ) | $ | 1.26 |   | $ | (.12 | ) |
| Weighted  average common shares outstanding:       |   |                              |   |                            |   |   |   |   |   |
| Basic                                              |   | 832,438                           |   | 839,369                         |   | 829,627 |   | 836,286 |   |
| Diluted                                            |   | 955,190                           |   | 839,369                         |   | 953,379 |   | 836,286 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

4

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AMERIVISIONCOMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’DEFICIENCY

(In thousands)

 
|                                                                     |   | **Stockholders’  deficiency** |     |
|--------------------------------------------------------------------------|--------|------------------------------------|----------|
|                                                                     |   | **Common  Stock**                  |     | **Additional  Paid-in  Capital** |   | **Unearned  Compensation** |   | **Retained  Earnings  Accumulated  (Deficit)** |   | **Total** |   |
|                                                                     |   |                               |     |   |   |   |   |   |   |   |   |
| Balance at December 31, 2001                                             |   | $                                  |  82 |   | $ |  9,275 |   | $ |  (14 | ) | $ |  (26,323 | ) | $ | (16,980 | ) |
| Expiration of potential rescission claims  on nonredeemable common stock |   | -0                                 | -        | 1,222 |   | -0 | - | -0 | - | 1,222 |   |
| Stock issued to board of directors for  services                         |   | -0                                 | -        | 84 |   | -0 | - | -0 | - | 84 |   |
| Vesting of restricted stock awards and  stock options                    |   | -0                                 | -        | 2 |   | 14 |   | -0 | - | 16 |   |
| Forfeiture of stock awards                                               |   | -0                                 | -        | 397 |   | -0 | - | -0 | - | 397 |   |
| Issuance of common stock for payment of  note payable                    |   | -0                                 | -        | 20 |   | -0 | - | -0 | - | 20 |   |
| Net income                                                               |   | -0                                 | -        | -0 | -  | -0 | - | 1,345 |   | 1,345 |   |
| Balance at December 31, 2002                                             |   | $                                  |  82 |   | $ |  11,000 |   | $ |  -0 | - | $ |  (24,978 | ) | $ |  (13,896 | ) |
| Issuance of common stock (unaudited)                                     |   | 2                                  |     | 88 |   |   |   |   |   | 90 |   |
| Net income (loss) (unaudited)                                            |   | -0                                 | -        | -0 | - | -0 | - | (97 | ) | (97 | ) |
| Balance at June 30, 2003 (unaudited)                                     |   | $                                  |  84 |   | $ |  11,088 |   | $ |  -0 | - | $ |  (25,075 | ) | $ |  (13,903 | ) |

 

The accompanying notes are anintegral part of these financial statements.

 

5

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AMERIVISIONCOMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 
|                                                                                                |   | **Six months  ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                                |   | **2002**                        |   | **2003** |   |
|                                                                                                |   |                            |   |   |   |
| Cash flows  from operating activities:                                                              |   |                            |   |   |   |
| Net income                                                                                          |   | $                               | 1,199  |   | $ | (97 | ) |
| Adjustments  to reconcile net income to net cash provided by operating activities:                  |   |                            |   |   |   |
| Depreciation  of property and equipment                                                             |   | 822                             |   | 881 |   |
| Amortization  of covenants not to compete                                                           |   | 252                             |   | 477 |   |
| Amortization  of unearned compensation related to stock option,awards and issuance of  common stock |   | 139                             |   | 90 |   |
| Deferred  income tax benefit                                                                        |   | 751                             |   | (64 | ) |
| Change in  assets and liabilities:                                                                  |   |                            |   |   |   |
| Decrease  (increase) in operating assets:                                                           |   |                            |   |   |   |
| Accounts  receivable                                                                                |   | 81                              |   | 2,570 |   |
| Prepaid  expenses and other assets                                                                  |   | (246                            | )      | 52 |   |
| Increase  (decrease) in operating liabilities, accounts payable and accrued expenses                |   | 1,303                           |   | (1,338 | ) |
| Net cash  provided by operating activities                                                          |   | 4,301                           |   | 2,571 |   |
| Cash flows  from investing activities:                                                              |   |                            |   |   |   |
| Purchase of  property and equipment                                                                 |   | (914                            | )      | (12 | ) |
| Cash flows  from financing activities:                                                              |   |                            |   |   |   |
| Repayments  of loans and other obligations to related parties                                       |   | (238                            | )      | (320 | ) |
| Net decrease  in borrowings under line of credit arrangements                                       |   | (3,408                          | )      | (1,553 | ) |
| Repayment of  notes payable and capital lease obligations                                           |   | (595                            | )      | (46 | ) |
| Net cash  used in financing activities                                                              |   | (4,241                          | )      | (1,919 | ) |
| Net change  in cash and cash equivalents                                                            |   | (854                            | )      | 640 |   |
| Cash and  cash equivalents at beginning of period                                                   |   | 1,743                           |   | 799 |   |
| Cash and  cash equivalents at end of period                                                         |   | $                               | 889    |   | $ | 1,439 |   |
|                                                                                                |   |                            |   |   |   |
| Cash paid  during the period for interest                                                           |   | $                               | 1,309  |   | $ | 973 |   |
|                                                                                                |   |                            |   |   |   |
| Cash paid  during the period for income taxes                                                       |   | $                               | -0     | - | $ | -0 | - |
|                                                                                                |   |                            |   |   |   |
| Non cash  transaction:                                                                              |   |                            |   |   |   |
| Recognition  of non compete agreement and related notes payable                                     |   | $                               | 2,011  |   | $ | -0 | - |

 

The accompanying notes are anintegral part of these financial statements.

 

6

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AMERIVISIONCOMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

**NOTEA—BASIS OF PRESENTATION**

 

The accompanying unaudited consolidatedcondensed financial statements for AmeriVision Communications, Inc. havebeen prepared in accordance with generally accepted accounting principles forinterim financial information. Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been omitted. In the opinion of our management,the condensed consolidated financial statements reflect all adjustments, of anormal and recurring nature, that are necessary to present fairly our financialposition as of June 30, 2003 and the results of our operations  for the three and six months ended, June 30,2002 and 2003, and cash flows for the six months ended June 30, 2002 and 2003.

 

The balance sheet at December 31, 2002has been derived from the audited financial statements at that date but doesnot include all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements. It is recommended thatthese condensed consolidated financial statements be read in conjunction withthe consolidated financial statements and notes as of and for the year endedDecember 31, 2002 included in the Company's 2002 annual report 10K. Theinterim results are not necessarily indicative of the results for a full year.

 

**NOTEB—EARNINGS (LOSS) PER SHARE (share and dollars in thousands, per share amountsnot in thousands)**

 

The computation of basic and diluted earnings(loss) per share for the three and six months ended June 30, 2002 and 2003, isas follows:

 

|                                                                                      |   | **Three months  ended  June 30,** |   | **Six months  ended  June 30,** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                      |   | **2002**                          |   | **2003**                        |   | **2002** |   | **2003** |   |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **Basic Earnings (Loss) Per Share**                                                       |   |                              |   |                            |   |   |   |   |   |
| Net income  (loss) available to nonredeemable common stockholders                         |   | $                                 | 415    |                            | $      | (180 | ) | $ | 1,199 |   | $ | (97 | ) |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Average  shares of nonredeemable common stock outstanding                                 |   | 823                               |   | 839                             |   | 830 |   | 836 |   |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Basic  earnings (loss) per share                                                          |   | $                                 | .49    |                            | $      | (.21 | ) | $ | 1.45 |   | $ | (.12 | ) |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| **Diluted Earnings (Loss) Per Share**                                                     |   |                              |   |                            |   |   |   |   |   |
| Net income  (loss) available to nonredeemable common stockholders and assumed conversions |   | $                                 | 415    |                            | $      | (180 | ) | $ | 1,199 |   | $ | (97 | ) |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Average  shares of nonredeemable common stock outstanding                                 |   | 832                               |   | 839                             |   | 830 |   | 836 |   |
| Stock  options and awards                                                                 |   | 107                               |   | -0                              | -      | 107 |   | -0 | - |
| Conversion  of redeemable common stock                                                    |   | 16                                |   | -0                              | -      | 16 |   | -0 | - |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Average  shares of common stock outstanding and assumed conversions                       |   | 955                               |   | 839                             |   | 953 |   | 836 |   |
|                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Diluted  earnings (loss) per share                                                        |   | $                                 | .43    |                            | $      | (.21 | ) | $ | 1.26 |   | $ | (.12 | ) |

 

The conversion of redeemable common stock andthe issuance of stock options were not assumed in the calculation of dilutedearnings (loss) per share for the three and six months ended June 30, 2003because to do so would be antidilutive for the periods.

 

7

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**NOTEC — LEGAL MATTERS**

 

InAugust 2002, the Florida Department of Revenue issued to AmeriVisionCommunications, Inc. proposed assessments totaling approximately $1.8 million,which includes penalties and interest of approximately $1 million forunderpayment of Florida sales and use taxes and gross receipts taxes, duringthe period September 1993 through August 1998. The Company disagrees with theproposed assessments and filed a protest with the Department. On April 28, 2003the Department issued a Notice of Decision, reducing portions of the proposedassessments and sustaining the remainder. The balance shown on the Notice ofDecision after application of interest through April 14, 2003 is $1.7 million.The Company has filed a petition for reconsideration of the Notice of Decision,and has engaged Florida counsel to advise and assist it in this matter.  The company believes, based upon priorexperience, it is not liable for this assessment and has not recorded it as aliability as of June 30, 2003 in the financial statements.

 

**NOTED — LINE OF CREDIT ARRANGEMENTS**

 

On February 4,1999, the Company obtained a line of credit (the “Credit Facility”) from CoastBusiness Credit (“Coast”), a division of Southern Pacific Bank, a Californiacorporation. On August 6, 2002, the Company was notified by Coast of its intentionnot to renew the Credit Facility following the occurrence of its maturity date,January 30, 2003. During September 2002, the Company was also notified of anevent of default under the Credit Facility. The event of default resulted froma greater decrease in the appraised value of the Company’s subscriber base thanallowed by the Credit Facility. As of December 31, 2002, the Company was alsoin default of its debt service coverage ratio. Subsequent to year end, theCompany did receive a waiver of this default from Coast. On February 7,2003, the California Division of Financial Institutions closed Southern PacificBank, the parent company of Coast, and the Federal Deposit InsuranceCorporation (“FDIC”) was named receiver. The Company executed two amendments tothe existing Credit Facility, whereby the FDIC as receiver of Coast agreed toforbear from taking any further actions against the Company through May 31,2003. The terms of the amendments included requirements that the Company would:reduce the maximum borrowing under the Credit Facility to $14.1 million by May31, 2003, pay certain fees, not make any payments to subordinated note holders,and follow a determined plan for expenditures.

 

On May 14, 2003, the Credit Facility was soldto LINC Credit L.L.C. (“LINC Credit”) The Company entered into a forbearanceagreement (“Forbearance Agreement”) with LINC Credit effective July 14,2003.  The Forbearance Agreementprovides for the Credit Facility to remain in place and for LINC Credit toforego its remedies under the Credit Facility until September 30, 2003 atwhich time the Forbearance Agreement may be extended for two additional monthsunder certain conditions.  Upontermination of the Forbearance Agreement, LINC Credit will have the right, butnot the obligation, to accelerate the repayment of the entire amountoutstanding under the Credit Facility.

 

The Credit Facility carries an interest rateof prime plus 3.5%, adjustable monthly, with a contractual floor of 9.0%. Thestated interest rate at June 30, 2003 was 9.0%.  The Credit Facility is secured by substantially all of theCompany’s assets, including accounts receivable and the Company’s customerbase. Outstanding balances at December 31, 2002 and June 30, 2003 were$13.7 million and $12.1 million respectively.

 

OnJuly 7, 2003, the amount outstanding under the Credit Facility wasapproximately $12.1 million. Advances were made to the Company pursuant to theForbearance Agreement equal to the net amount of funds collected by LINCCredit, primarily from the Company’s lockbox, for the period June 19, 2003through July 14, 2003, less the sum of $300,000.  Advances from cash collected by LINC Credit during theforbearance period will be reduced by $35,000 per week for the period July 15,2003 through August 29, 2003, and by $40,000 per week for the period September1, 2003 to September 30, 2003.  Duringthe extension period the advances will be reduced by $40,000 per week throughto October 31, 2003 and then by $45,000 per week until the termination of the ForbearanceAgreement.

 

Several of the Company’s creditors (the“Subordinated Creditors”) have agreed to accept a subordinated position infavor of the issuer of the Credit Facility. Repayment of these obligations islimited as specified in the various subordination agreements executed by theSubordinated Creditors. The total outstanding debt owed to the SubordinatedCreditors as of June 30, 2003, was approximately $4.7 million.

 

The Credit Facility contains variousfinancial and other covenants with which the Company must comply, includingrestrictions on asset acquisitions, restrictions on the payment of dividends,and restrictions on principal and interest payments to the SubordinatedCreditors.

 

8

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The Company is actively pursuing otheravailable financing options that may be available. As discussed further inNote E to the financial statements, if the Company is not successful inobtaining alternative financing, there could be a material adverse effect on theCompany’s ability to continue as a going concern and to meet its obligations asthey come due.

 

 

**NOTEE — FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

At June 30, 2003, the Company had anaccumulated stockholders’ deficiency of $13.9 million and negative workingcapital of $17.8 million. Declining billable minutes, lower rates, andelimination of certain other fees, have reduced the Company’s net sales from$33.8 million for the period ended June 30, 2002, to $23.1 million for the sameperiod in 2003. In addition, as discussed in Note D, the Credit Facilityhas matured and is subject to the terms of the Forbearance Agreement.   The Company is also in default to certainsubordinated and non-subordinated debt holders with an aggregate outstandingbalance of approximately $5.5 million, some of which may be subject to legalchallenge.  These debt holders may havethe right to demand payment of the outstanding balances, plus penalties andaccrued interest, subject to the terms of their agreements.  The Company has retained a finance andrestructuring consultant who is actively pursuing new financing alternatives toreplace both its Credit Facility and a portion of its debt holders.

 

Management plans to maintain the cost-cuttingmeasures enacted in previous years and continue to search for new ways tocontrol expenses, including negotiations of new carrier contracts and improvedcollection procedures. The Company is implementing a series of initiatives andprograms designed to help increase the customer base resulting in increasedrevenues. The Company has begun a new agent program known as the “LifeLineGiving Network.” In May 2003, the Company  finalized an agreementto resell a bundled telephone package which includes local and long distanceservice.

 

The Company believes that the combination ofcontinued cost-cutting measures, revenue enhancement programs, and successfulnegotiation of a new credit facility must occur to enable the Company tocontinue in existence as a going concern. Should the Board of Directors’ andmanagement’s plans be unsuccessful, however, the Company may be unable to meetits obligations as they come due or continue in existence as a going concern.The financial statements do not contain any adjustments that might be necessaryshould the Company be unable to continue in existence as a going concern.

 

**NOTEF — STOCK BASED COMPENSATION (share and dollars in thousands, per share amountsnot in thousands)**

 

At June 30, 2003, the Company had severalstock-based compensation plans. The Company accounts for those plans under therecognition and measurement provisions of Accounting Principles Board OpinionNo. 25 (“APB 25”), “Accounting for Stock Issued to Employees”, and itsvarious interpretations. No stock-based employee compensation cost is reflectedin the calculation of net income (loss), as all options granted under thoseplans had an exercise price equal to or greater than the market value of theunderlying common stock on the date of the grant. The following tableillustrates the effect on net income loss and earnings loss per share if theCompany had applied the fair value recognition provisions of FASB StatementNo. 123, “Accounting for Stock-Based Compensation”, to stock-basedemployee compensation.

 
|                               |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                               |   | **2002**                        |   | **2003**                      |   | **2002** |   | **2003** |   |
|                               |   |                            |   |                          |   |   |   |   |   |
| Net income  (loss)                 |   |                            |   |                          |   |   |   |   |   |
| As reported                        |   | $                               | 415    |                          | $      | (180 | ) | $ | 1,199 |   | $ | (97 | ) |
| Pro Forma                          |   | 404                             |   | (190                          | )      | 1,188 |   | (107 | ) |
| Basic  earnings (loss) per share   |   |                            |   |                          |   |   |   |   |   |
| As reported                        |   | $                               | .49    |                          | $      | (.21 | ) | $ | 1.45 |   | $ | (.12 | ) |
| Pro forma                          |   | .48                             |   | (.22                          | )      | 1.43 |   | (.13 | ) |
| Diluted  earnings (loss) per share |   |                            |   |                          |   |   |   |   |   |
| As reported                        |   | $                               | .43    |                          | $      | (.21 | ) | $ | 1.26 |   | $ | (.12 | ) |
| Pro forma                          |   | .42                             |   | (.22                          | )      | 1.25 |   | (.13 | ) |

 

9

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**Item 2****.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**FINANCIALCONDITION**

 

The data presented below should be read inconjunction with our condensed consolidated financial statements and the notesthereto included elsewhere herein.

 

|                                 |   | **December  31,** |    | **June 30,**     |   |
|--------------------------------------|--------|-------------------|---------|------------------|--------|
|                                 |   | **2002**          |    | **2003**         |   |
|                                 |   | **(000’s)**  |    | **(000’s)** |   |
| BALANCE  SHEET DATA:                 |   |              |    |             |   |
| Working  capital (deficit)           |   | $                 | (18,385 | )                | $      | (17,815 | ) |
| Total  long-term debt                |   | $                 | 2,318   |             | $      | 1,562 |   |
| Total  stockholders’ deficiency |   | $                 | (13,896 | )                | $      | (13,903 | ) |
|                                      |        |                   |         |                  |        |  |  |  |

 

###### **GENERAL**

 

Since 1998, we have experienced a decline inannual net sales from $124.2 million in 1998 to $64.1 million in2002. The net sales for the six months ended June 30, 2002 and 2003, were $33.8million and $23.1 million.  FromJune 2002 to June 2003, subscribers with traffic have decreased by11%. To counteract the decline in revenue and subscribers we have implementedseveral significant cost cutting strategies, as well as strategies to increaseour subscriber base and net revenues. The Company has finalized agreements toprovide local service through a bundled package and continues to exploreopportunities for additional services to be marketed to its client base.

 

Currently, the Company has a Credit Facilitywith LINC Credit, LLC, which is subject to a Forbearance Agreement, dated July14, 2003 (See, Note D to Financial Statements — Line of Credit Arrangements).We continue to hold discussions with our lenders concerning refinancing thedebts and to explore other alternatives for financing our operations. To thatend, we hired a Finance and Restructuring consultant in July to assist us inthis process.  We can provide noassurance that we will be successful in refinancing our debt, consummatingreorganization, or otherwise becoming able to meet our obligations as theybecome due. Therefore, at June 30, 2003, substantially all of our long-termdebt is classified as current. Unless these matters can be resolved, thereexists substantial doubt about our ability to continue as a going concern, asexpressed in our independent auditors’ report included in our 2002 AnnualReport on Form 10-K.

 

From our inception through December 31,2002 we have incurred cumulative net operating losses totaling$12.1 million. During the years ended December 31, 2001 and 2002, wegenerated net income of $3.4 million, and $1.3 million. Theimprovements of net income from operating activities were primarily achieved asa result of reductions in operating expenses. For the six month period endedJune 30, 2003 our net loss was $97,000 compared to a net income of  $1.2 million for the same period in 2002. Wehave reduced our accumulated stockholders’ deficiency from $25.8 millionat December 31, 1997 to $13.9 million at June 30, 2003. In additionto the net operating losses, the accumulated deficit was partially due to ourdeclaration and payment of quarterly capital distributions to our stockholdersduring the period between 1994 and 1997, totaling $16.0 million, and ourredemption of common stock totaling $4.7 million.

 

Our current liabilities exceeded our currentassets by $18.4 million at December 31, 2002 and $18.8 million atJune 30, 2003, mainly as a result of the long-term debt being classified ascurrent.

 

We bill our customers under several differentmethods. Some customers receive their long distance bills directly from us. Wealso have billing and collection agreements with several of the regional belloperating companies, or RBOCs. Customers who are billed through the RBOCsreceive their long distance phone bills with their local phone bills from theRBOC.

 

10

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Selling, general and administrative expensesinclude billing fees charged by Local Exchange Carriers (“LECs”) and otherthird party billing and collection companies, bad debts, commissions tosalespersons, advertising and telemarketing expenses, customer service andsupport, and other general overhead expenses.

 

Interest expense includes the cost offinancing our accounts receivable and asset purchases, including loans from ourprimary financial institution under our Credit Facility.

 

We have recognized a net deferred tax asset,primarily due to net operating loss carry-forwards and allowance for doubtfulaccounts.

 

In 1996, the FCC adopted regulationsimplementing the Telecommunications Act of 1996. To support universal service,carriers are required to contribute certain percentages of their annual grossreceipts to fund the High Cost Fund, the Schools and Libraries Fund, and theLow Income Fund, collectively known as the Universal Service Fund, or USF. TheFCC has allowed carriers to offset these charges by passing them through totheir customers at a percentage rate greater than what is charged to thecarrier. Effective April 2003, the FCC has passed additional legislationthat will no longer allow for additional markup to customers of the passthrough liability. As a result, we have reduced our USF charges according tothe quarterly rates set by the FCC. For the three and six month period endedJune 30, 2003, our net sales included USF fees of  $593,000 and $1.4 million before taking into account the cost ofsuch telecommunication service of $504,000 and $885,000.

 

 

**RESULTSOF OPERATIONS**

 

THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE AND SIXMONTHS ENDED JUNE 30, 2003

 

The following table for the three and sixmonth periods indicated the percentage of net sales represented by certainitems in our statements of operations:

 
|                                           |   | **Three Months Ended June 30** |   | **Six Months Ended June 30,** |   |
|------------------------------------------------|--------|--------------------------------|--------|-------------------------------|--------|
|                                           |   | **2002**                       |   | **2003**                      |   | **2002** |   | **2003** |   |
|                                           |   |                           |   |                          |   |   |   |   |   |
| Net sales                                      |   | 100.0                          | %      | 100.0                         | %      | 100.0 | % | 100.0 | % |
| Operating  expenses:                           |   |                           |   |                          |   |   |   |   |   |
| Cost of  telecommunications service            |   | 48.8                           | %      | 40.2                          | %      | 44.5 | % | 38.9 | % |
| Selling,  general & administrative expense |   | 40.8                           | %      | 49.1                          | %      | 42.7 | % | 50.3 | % |
| Depreciation  and amortization expense         |   | 3.1                            | %      | 7.3                           | %      | 3.2 | % | 5.8 | % |
| Total  operating expenses                      |   | 92.7                           | %      | 96.6                          | %      | 90.4 | % | 95.0 | % |
| Income from  operations                        |   | 7.3                            | %      | 3.4                           | %      | 9.5 | % | 5.0 | % |
| Interest  expense and other                    |   | (3.0                           | )%     | (4.7                          | )%     | (3.2 | )% | (4.3 | )% |
| Income  (loss) before income tax               |   | 3.9                            | %      | (2.7                          | )%     | 5.7 | % | (0.7 | )% |
| Income tax  expense (benefit)                  |   | 1.5                            | %      | (1.0                          | )%     | 2.2 | % | (0.2 | )% |
| Net income  (loss)                             |   | 2.4                            | %      | (1.7                          | )%     | 3.5 | % | (0.5 | )% |

 

***NetSales*:** Net sales decreased 38% to$10.8 million for the current quarter from $.5 million for the samequarter the year earlier.  Net salesdecreased 32% from $33.8 million for the six months ended June 30, 2002compared to $23.1 million for the six months ended June 30, 2003. This decreasewas the result of fewer billable minutes being used by a smaller customer baseas well as a reduction in per minute charges to our customers and thetermination of one wholesale customer that accounted for $2.4 million and$2.7million of net sales for the three and six months ended June 30, 2002compared to $0 in the same periods in the current year. Total billable minutes,excluding wholesale minutes, decreased 23% for the current quarter and sixmonths ended June 30, 2003 compared to the same  periods last year.  FromJune 2002 to June 2003, subscribers with traffic have decreased by 11%.

 

11

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Our new rateplans are geared towards direct bill as we continue to build our customerretention and brand awareness.   As ofJune 30, 2002, 40% of our customers received a bill directly from us  compared to 55% as of June 2003.

 

***Costof Telecommunication Services*:** Our cost of salesare variable costs based on amounts paid to our providers for our customers’long distance usage, as well as the amounts paid to providers for customerservice and support. For the three and six months ended June 30, 2002, theoverall cost of telecommunication services were 48.8% and 44.5% of net salescompared to 40.2% and 38.9% of net sales for the same period in 2003, a 17.6%and 12.6% decrease in these costs as a percentage of net sales.

 

During the three and six month periods endedJune 30, 2002 and June 30, 2003, the cost of sales and relative percentage ofcosts to net sales was as follows:

 
|                                     |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                     |   | **2002**                             |   | **2003**                           |   | **2002** |   | **2003** |   |
|                                     |   | **Amount**                           |   | **Percentage  of  Net Sales**      |   | **Amount** |   | **Percentage  of  Net Sales** |   | **Amount** |   | **Percentage   of  Net Sales** |   | **Amount** |   | **Percentage  of  Net Sales** |   |
|                                     |   | **(000’s)**                     |   |                               |   | **(000’s)** |   |   |   | **(000’s)** |   |   |   | **(000’s)** |   |   |   |
| Switchless  and switched operation costs |   | $                                    | 7,268  |                               | 41.6   | % | $ | 3,505 |   | 32.5 | % | $ | 12,660 |   | 37.4 | % | $ | 7,397 |   | 32.0 | % |
| PICC/USF  fees                           |   | 806                                  |   | 4.6                                | %      | 544 |   | 5.1 | % | 1,632 |   | 4.8 | % | 983 |   | 4.3 | % |
| Other  related costs                     |   | 449                                  |   | 2.6                                | %      | 281 |   | 2.6 | % | 771 |   | 2.3 | % | 602 |   | 2.6 | % |
| Totals                                   |   | $                                    | 8,523  |                               | 48.8   | % | $ | 4,330 |   | 40.2 | % | $ | 15,063 |   | 44.5 | % | $ | 8,982 |   | 38.9 | % |

 

Overall switchless and switched operationcosts decreased $3.8 million and $5.3 million in the three and six monthperiods ended June 30, 2003 compared to the same period in 2002, due to reducedcarrier costs per minute, a reduction in total consumer minutes and thetermination of the wholesale customer relationship described previously.

 

***Selling,General and Administrative Expenses*:** Selling,general and administrative expenses decreased by  $1.8 million and $2.9 million from the three and six months endedJune 30, 2002 to the same period in 2003, while the relative percent of netsales increased by  21% and 18%.  This was primarily due to fixed  costs and the cost of manpower being dividedover a reduced net sales amount. The significant components of selling, generaland administrative expenses include the following:

 
|                                  |   | **Three Months Ended June 30,** |   | **Six Months Ended June 30,** |   |
|---------------------------------------|--------|--------------------------------------|--------|-------------------------------|--------|
|                                  |   | **2002**                             |   | **2003**                      |   | **2002** |   | **2003** |   |
|                                  |   | **Amount**                           |   | **Percentage  of  Net Sales** |   | **Amount** |   | **Percentage  of  Net Sales** |   | **Amount** |   | **Percentage   of  Net Sales** |   | **Amount** |   | **Percentage  of  Net Sales** |   |
|                                  |   | **(000’s)**                     |   |                          |   | **(000’s)** |   |   |   | **(000’s)** |   |   |   | **(000’s)** |   |   |   |
| Billing and  Collection Expenses      |   | $                                    | 1,618  |                          | 9.3    | % | $ | 1,069 |   | 9.9 | % | $ | 3,485 |   | 10.3 | % | $ | 2,935 |   | 12.7 | % |
| Advertising  and Marketing Expense    |   | 204                                  |   | 1.1                           | %      | 80 |   | 0.7 | % | 418 |   | 1.2 | % | 211 |   | 0.9 | % |
| Payments to  non-profit Organizations |   | 1,133                                |   | 6.4                           | %      | 770 |   | 7.1 | % | 2,345 |   | 7.0 | % | 1,623 |   | 7.0 | % |
| Salaries  & Wages                 |   | 1,818                                |   | 10.4                          | %      | 1,735 |   | 16.2 | % | 3,799 |   | 11.2 | % | 3,470 |   | 15.0 | % |
| Other                                 |   | 2,352                                |   | 13.5                          | %      | 1,632 |   | 15.2 | % | 4,414 |   | 13.0 | % | 3,383 |   | 14.7 | % |
| Total                                 |   | $                                    | 7,125  |                          | 40.7   | % | $ | 5,286 |   | 49.1 | % | $ | 14,461 |   | 42.7 | % | $ | 11,622 |   | 50.3 | % |

 

***Billingand Collection Expenses*:** Billing and collectionexpenses include the contractual billing fees and bad debts charged by LECs andother third party billing companies. It also includes bad debt charge-offs fromour direct bill customers. The efforts to collect the direct bill customeraccounts are completed by internal personnel.

 

12

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***Advertisingand Marketing Expense*:** Advertising expense decreasedfor the three and six months ended June 30, 2003 to

$80,000and $211,000, compared to $204,000 and $418,000 for the same period in 2002.The decrease was primarily due to more focused efforts on specific marketing.

 

***Affinity PartnerRelationships:*** Sharing with Affinity Partnersdecreased by ** **$356,000 and $707,000 from the three and six monthsended June 30, 2002 compared to the same periods in 2003, due primarily to anoverall decrease in net sales. During the six months ended June 30, 2003, wemade 3,500 monthly sharing distributions to Affinity Partners. During the sixmonths ended June 30, 2003, two groups representing four Affinity Partners,which accounted for 18% of our gross revenue for the period, notified us thatthey would no longer endorse our products or services.  We expect that the loss of theseendorsements will result in a loss of revenues from these organizations in thefuture. However, in the second quarter of 2003, we signed an agreement with asignificant new Affinity Partner, and we are actively pursuing newrelationships with other new partners.

 

***Salariesand Wages*:** Salaries and Wages expenses decreasedby $83,000 and $329,000 for the three and six months ended June 30, 2003compared to the same period in 2002, due primarily to reorganization efforts.

 

***OtherGeneral and Administrative Expense*:** Other generaland administrative expenses decreased by $720,000 and $1 million during thethree and six months ended June 30, 2003 compared to the same period in 2002.The primary reason for these decreases was due to increased controls onexpenses.

 

***Depreciationand Amortization*:** Depreciation and amortizationexpense totaled **$**538,000 and $1.4million  for the three and six monthsended June 30, 2003 compared to $538,000 and $1.1 million in the same period in2002.

 

***InterestExpense and Other Finance Charges*:** Interestexpense and other finance charges increased by 9% and 1% to $693,000 and $1.3million for the three and six months ended June 30, 2003 compared to $635,000and  $1.3 million in the same periods in2002. This increase is attributable to an increase in the interest rate on therevolving Credit Facility as the debt came due which was offset in part by areduction in our Credit Facility balance due to repayments from operating cashflow.

 

***IncomeTax Expense (*Benefit):** During the three and sixmonths ended June 30, 2003 and 2002 we recorded deferred income tax benefits of$117,000 and $64,000 compared to deferred tax expense of $267,000 and $751,000for the same period in 2002.  The incometax benefits recognized in the financial statements consist primarily of thedeferred tax effects of the temporary differences between the financial and taxbasis of assets and liabilities, and net operating loss carry-forwards.

 

***NetIncome*:** During the three and six months ended June30, 2003 we reported net losses of $180,000 and $97,000 compared to net incomeof $682,000 and $1.9 million for the three and six months ended June 30, 2002.

 

**FINANCIALCONDITION AND LIQUIDITY**

 

Our working capital has improved by $430,000from December 31, 2002 to June 30, 2003 while our cash increased by $640,000.During the same period, we reduced our Credit Facility by $1.6 million.

 

***CreditFacility and Loans:***  On February 4, 1999, the Company obtained a line of credit (the “CreditFacility”) from Coast Business Credit (“Coast”), a division of Southern PacificBank, a California corporation. On August 6, 2002, the Company was notified byCoast of its intention not to renew the Credit Facility following theoccurrence of its maturity date, January 30, 2003. During September 2002, theCompany was also notified of an event of default under the Credit Facility. Theevent of default resulted from a greater decrease in the appraised value of theCompany’s subscriber base than allowed by the Credit Facility. As of December31, 2002, the Company was also in default of its debt service coverage ratio.Subsequent to year end, the Company did receive a waiver of this default fromCoast. On February 7, 2003, the California Division of FinancialInstitutions closed Southern Pacific Bank, the parent company of Coast, and theFederal Deposit Insurance Corporation (“FDIC”) was named receiver. The Companyexecuted two amendments to the existing Credit Facility, whereby the FDIC asreceiver of Coast agreed to forbear from taking any further actions against theCompany through May 31, 2003. The terms of the amendments included requirementsthat the Company would: reduce the maximum borrowing under the Credit Facilityto $14.1 million by May 31, 2003, pay certain fees, not make any payments tosubordinated note holders, and follow a determined plan for expenditures.

 

13

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On May 14, 2003, the Credit Facility was soldto LINC Credit L.L.C. (“LINC Credit”) The Company entered into a forbearanceagreement (“Forbearance Agreement”) with LINC Credit effective July 14,2003.  The Forbearance Agreementprovides for the Credit Facility to remain in place and for LINC Credit toforego its remedies under the Credit Facility until September 30, 2003 atwhich time the Forbearance Agreement may be extended for two additional monthsunder certain conditions.  Upontermination of the Forbearance Agreement, LINC Credit will have the right, butnot the obligation, to accelerate the repayment of the entire amountoutstanding under the Credit Facility.

 

The Credit Facility carries an interest rateof prime plus 3.5%, adjustable monthly, with a contractual floor of 9.0%. Thestated interest rate at June 30, 2003 was 9.0%.  The Credit Facility is secured by substantially all of theCompany’s assets, including accounts receivable and the Company’s customerbase. Outstanding balances at December 31, 2002 and June 30, 2003 were$13.7 million and $12.1 million respectively.

 

OnJuly 7, 2003, the amount outstanding under the Credit Facility wasapproximately $12.1 million. Advances were made to the Company pursuant to theForbearance Agreement equal to the net amount of funds collected by LINCCredit, primarily from the Company’s lockbox, for the period June 19, 2003through July 14, 2003, less the sum of $300,000.  Advances from cash collected by LINC Credit during theforbearance period will be reduced by $35,000 per week for the period July 15,2003 through August 29, 2003, and by $40,000 per week for the period September1, 2003 to September 30, 2003.  Duringthe extension period the advances will be reduced by $40,000 per week throughto October 31, 2003 and then by $45,000 per week until the termination of theForbearance Agreement.

 

Several of the Company’s creditors (the“Subordinated Creditors”) have agreed to accept a subordinated position infavor of the issuer of the Credit Facility. Repayment of these obligations islimited as specified in the various subordination agreements executed by theSubordinated Creditors. The total outstanding debt owed to the SubordinatedCreditors as of June 30, 2003, was approximately $4,700,000.

 

The Credit Facility contains variousfinancial and other covenants with which the Company must comply, includingrestrictions on asset acquisitions, restrictions on the payment of dividends,and restrictions on principal and interest payments to the SubordinatedCreditors.

 

The Company is actively pursuing otheravailable financing options that may be available. As discussed further inNote E to the financial statements, if the Company is not successful inobtaining alternative financing, there could be a material adverse effect onthe Company’s ability to continue as a going concern and to meet its obligationsas they come due.

 

As a result of the Company’s default underthe Credit Facility, Coast required the Company to stop payment to theSubordinated Creditors, and consequently the Company is in default of$5.5 million principal amount of our subordinated and certainnon-subordinated notes, which may be subject to legal challenge.  A non-subordinated lender presently may havethe right, but not the obligation, to accelerate the repayment of the entire$1.6 million principal balance and related penalties and interestoutstanding under these notes, which may be subject to legal challenge. Thesubordinated lenders also may have the right to demand repayment of the entire$3.9 million principal balance and related penalties and interestoutstanding under these notes, subject to notification to and prior rights ofthe secured creditor.  Certain of oursubordinated note holders have expressed a desire to accelerate the repaymentof their notes.

 

14

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### **CASH FLOWS**

### ** **

## ***Operating Activities***

 

Significant uses of cash in operatingactivities during the six months ended June 30, 2003 include a decrease inaccounts payable and accrued expenses of $1.3 million.  Significant sources of cash in operatingactivities for 2003 were a decrease in accounts receivable of $2.6 million. Wealso generated cash from operations by recording certain non-cash expenses,principally depreciation and amortization of $1.4 million.

 

Significant uses of cash for operatingactivities during six months ended June 30, 2002 included an increase inprepaid expenses and other assets of $246,000. A significant source of cash foroperating activities during the six months ended June 30, 2002 includes anincrease in accounts payable and accrued expenses of $1.3 million. We alsogenerated cash from operations by recording net income of $1.2 million,deferred income tax expense of $751,000, and certain non-cash expenses,principally depreciation and amortization of $1.1 million.

 

###### ***Investing Activities***

 

Our investing activities during the sixmonths ended June 30, 2002 and 2003 consisted of property and equipmentpurchases of $914,000 and $12,000.

 

***Financing Activities***

 

During the six months ended June 30, 2002 and2003, financing activities used $4.2 million and $1.9 million in cash. The mostsignificant use of cash was the repayments of notes, leases payable, andreduction of our Credit Facility. The repayment of loans to related partiestotaled $238,000 and $320,000 for the six months ended June 30, 2002 and 2003.

 

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**OTHER MATTERS**

 

***Intangible Assets***

 

We amortize intangible assets representingcovenants not to compete on a straight-line basis over their contractualperiods ranging up to five years. At each balance sheet date, we assess whetherthere has been any permanent impairment in the value of these intangible assetssuch as an occurrence of the breach of the agreement. The factors considered byus include if any breach in the agreements has occurred. We believe there hasbeen no impairment in the carrying value of intangible assets at June 30, 2003.However, the contractual period of a covenant not to compete with a former CEOcan be accelerated upon termination of the consulting agreement with the formerCEO. If the consulting agreement is terminated by the former CEO or by us, itwould cause the remaining book value of the non-competition agreement,$1.6 million, to be amortized as an expense over the succeeding sixmonths.

 

#### ***Inflation andChanging Prices***

 

Telecommunications revenues do notnecessarily track the changes in general inflation. Rather, they tend torespond to the level of activity on the part of the telecommunications industryin combination with the number of competing companies. Capital and operatingcosts are influenced to a larger extent by specific price changes in thetelecommunications industry and to a lesser extent by changes in generalinflation.

 

#### ***Forward-LookingInformation***

 

This report contains forward-lookingstatements and information that are based on the beliefs of our management aswell as assumptions made by and information currently available to management.All statements other than statements of historical fact included in this Reportconstitute forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995, including but not limited tostatements identified by the words “anticipate,” “believe,” “intend,”“estimate” and “expect” and similar expressions. Such statements reflect ourcurrent views with respect to future events, based on what we believe arereasonable assumptions; however, such statements are subject to certain risks,uncertainties and assumptions. Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual results may vary materially from those in the forward-lookingstatements. We disclaim any intention or obligation to update or review anyforward-looking statements or information, whether as a result of new information,future events or otherwise.

 

**Item 3****.Quantitative and Qualitative Disclosure about Market Risk**

 

We are not exposed to market risk from thechanges in marketable securities, as we have no such instruments.

 

Inflation generally affects us by increasingour cost of labor, equipment and new materials. We do not believe thatinflation has had any material effect on our results of operations during thethree and six month periods ending June 30, 2002 and 2003.

 

We are exposed to future earnings or cashflow fluctuations from changes in interest rates on borrowings under our CreditFacility since amounts borrowed under the Credit Facility accrue interest at afluctuating rate equal to the prime lending rate plus 3.5%. Our stated interestrate at June 30, 2003 was 9.0%, which represents the floor rate of our CreditFacility. At June 30, 2003 we had $12.2 million of outstanding debtbearing interest at floating rates. Market risk is estimated as the potentialincrease in interest rate for borrowing under our Credit Facility resultingfrom an increase in prime. Based on borrowings under our Credit Facility atJune 30, 2003, a hypothetical increase of one percentage point in prime wouldincrease our interest expense on an annual basis by $122,000.

 

Our operationsare all originated within the United States and we therefore conduct allbusiness transactions in U.S. dollars.

 

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**Item 4****. Controlsand Procedures**

 

Within the 90-day period prior to the filingof this report, an evaluation was performed under the supervision and with theparticipation of our management, including the Chief Executive Officer (CEO)and the Chief Financial Officer (CFO), of the effectiveness of the design andoperation of our disclosure controls and procedures (as defined inRule 13a-14(c) under the Securities and Exchange Act of 1934). Basedon that evaluation, our management, including the CEO and CFO, concluded thatour disclosure controls and procedures were effective.

 

Except for the resignation of the our ChiefFinancial Officer in April 2003, there have been no significant changes in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation.

 

Randall Muth joined the company in May of2003 and was promoted to Chief Financial Officer in July 2003.

 

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**PART II****. OTHERINFORMATION**

 

**Item1. Legal Proceedings**

 

InAugust 2002, the Florida Department of Revenue issued to AmeriVisionCommunications, Inc. proposed assessments totaling approximately $1.8 million,which includes penalties and interest of approximately $1 million forunderpayment of Florida sales and use taxes and gross receipts taxes, duringthe period September 1993 through August 1998. The Company disagrees with theproposed assessments and filed a protest with the Department. On April 28, 2003the Department issued a Notice of Decision, reducing portions of the proposedassessments and sustaining the remainder. The balance shown on the Notice ofDecision after application of interest through April 14, 2003 is $1.7 million.The Company has filed a petition for reconsideration of the Notice of Decision,and has engaged Florida counsel to advise and assist it in this matter.  The company believes, based upon priorexperience, it is not liable for this assessment and has not recorded it as aliability as of June 30, 2003 in the financial statements.

 

 

**Item2. Changes in Securities and Use of Proceeds**

 

In June 2003, we issued 12,000 shares ofcommon stock to the Board of Directors for their service to the Company.

 

 

### **Item 3. Default uponSenior Securities**

 

We are currently in a “Permitted Event ofDefault” of our Credit Facility, as that term is defined in our Forbearance Agreement.  Our existing “Permitted Event of Default” ofour Credit Facility has been waived pursuant to the terms of the ForbearanceAgreement with our primary lender.

 

 

###### **Item 4. Submission of Matters to a Vote ofSecurity Holders**

 

On July 31, 2003, the company held its annualmeeting of shareholders.  At thatmeeting, nine directors were nominated as set forth in management’s proxymaterial, along with one nomination from the floor.  Nine directors were elected by plurality vote.  They were:

 

Tom Choquette

David Clark

Sharon Freeny

Wilbur Fullbright

Belarmino Gonzalez

Kenneth Guthrie

Curtis Nestegard

Art Richardson

Wallace Walcher

 

Appointment ofthe independent auditors was ratified.

 

**Item 5****. OtherInformation**

 

***Agreements withCarriers.*** In 2003, we lowered our transmission service costs and resolved certainbilling disputes and claims between our vendors and us. We are continuingnegotiations with existing and prospective carriers that could further reduceour cost of telecommunications service for 2003.

 

***CFO***.  Randall Muth joined our management team inMay of 2003 and was promoted to Chief Financial Officer in July 2003.  Mr. Muth has spent the last 18 years of hiscareer in senior management positions in both finance and operations withpublic and private companies operating in the communications andtelecommunications sectors.  Prior tothat, Mr. Muth spent a number of years in public practice with national publicaccounting firms, providing financial accounting and tax services toclients.  Mr. Muth earned his Bachelorof Commerce degree from the University of Alberta.

 

18

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**Item 6****. Exhibitsand reports on Form 8-K**

 

**(a)**                                  **Exhibits**

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                                                       |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                                                                                  |
| 3.1                 |   | Certificate of Incorporation of the  Registrant (which is incorporated herein by reference to Exhibit 3.1 to  Registrant’s Form 10 registration statement, filed October15, 1999)                                                                                                                                                                |
| 3.2                 |   | Amended and Restated Bylaws of the  Registrant (which is incorporated herein by reference to Exhibit 3.2(ii) to  Registrant’s Second Quarter Form 10-Q, filed August 19, 2002)                                                                                                                                                                   |
| 4.1                 |   | Form of certificate representing shares of  the Registrant’s common stock (which is incorporated herein by reference to  Exhibit 4.1 to Registrant’s Form 10 registration statement, filed October 15,  1999)                                                                                                                               |
| 4.2                 |   | Form of Type C Redemption Agreement (which  is incorporated herein by reference to Exhibit 4.4 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                                                                                                                                          |
| 4.3                 |   | Form of Type D Redemption Agreement (which  is incorporated herein by reference to Exhibit 4.5 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                                                                                                                                          |
| 4.4                 |   | Form of Convertible Note (which is  incorporated herein by reference to Exhibit 4.6 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                                                                                                                                                     |
| 4.5                 |   | Promissory Note dated April 20, 1999,  payable by the Registrant to John Damoose (which is incorporated herein by  reference to Exhibit 4.8 to Registrant’s Form 10 registration statement,  filed October 15, 1999)                                                                                                                             |
| 4.7                 |   | Promissory Note dated April 20, 1999,  payable by the Registrant to C.A.S.E. (which is incorporated herein by  reference to Exhibit 4. to Registrant’s Form 10 registration statement, filed  October 15, 1999)                                                                                                                                  |
| 4.8                 |   | Form of Subordinated Note dated February 1,  2001. (which is incorporated herein by reference to Exhibit 4.8 to  Registrant’s 2002 Form 10-K, filed April 15, 2003)                                                                                                                                                                              |
| 4.8.1               |   | List of Subordinated Notes dated February  1, 2001. (which is incorporated herein by reference to Exhibit 4.8.1 to  Registrant’s 2002 Form 10-K, filed April 15, 2003)                                                                                                                                                                           |
| 4.9                 |   | Promissory Note dated November 15, 2001,  payable by the Registrant to Larry J. Geringer (which is incorporated herein  by reference to Exhibit 4.9 to Registrant’s 2002 Form 10-K, filed April 15,  2003)                                                                                                                                       |
| 4.10                |   | Promissory Note dated November 15, 2001, payable  by the Registrant to Tineke C. Geringer. (which is incorporated herein by  reference to Exhibit 4.10 to Registrant’s 2002 Form 10-K, filed April 15,  2003)                                                                                                                                    |
| 4.11                |   | Form of Subordinated Tranche ‘B’ and ‘C’  Note Payable dated February 15, 2000. (which is incorporated herein by  reference to Exhibit 4.11 to Registrant’s 2002 Form 10-K, filed April 15,  2003)                                                                                                                      |
| 4.11.1              |   | List of Subordinated Tranche ‘B’ and ‘C’  Note Payables dated February 15, 2000. (which is incorporated herein by  reference to Exhibit 4.11.1 to Registrant’s 2002 Form 10-K, filed April 15,  2003)                                                                                                                   |
| 9.1                 |   | Freeny Voting Trust Agreement, dated  September 1, 2001, by and among the Registrant, Tracy C. Freeny and Sharon  Freeny, as beneficiaries, and David Clark, Russell Beaty, and David Thompson,  as trustees (which is incorporated herein by reference to Exhibit 10.30 to  Registrant’s 2001 Third Quarter Form 10-Q, filed December 28, 2001) |
| 10.1                |   | Loan and Security Agreement dated as of  February 4, 1999 between the Registrant and Coast Business Credit (which is  incorporated herein by reference to Exhibit 10.18 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                                                                 |
| 10.1.1              |   | Amendment Number One to Loan and Security  Agreement dated as of October 12, 1999 between the Registrant and Coast  Business Credit (which is incorporated herein by reference to Exhibit 10.18.1  to Registrant’s Form 10 registration statement, filed October 15, 1999)                                                                       |
| 10.1.2              |   | Amendment Number Two to Loan and Security  Agreement dated as of May 10, 2000 between the Registrant and Coast Business  Credit (which is incorporated herein by reference to Exhibit 10.18.2 to  Registrant’s Form 10 registration statement, filed July 10, 2000)                                                                              |

 

19

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| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                       |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                                  |
| 10.1.3              |   | Amendment Number Three to Loan and Security  Agreement dated as of December 19, 2001 between the Registrant and Coast  Business Credit (which is incorporated herein by reference to Exhibit 10.1.3  to Registrant’s 2001 Form 10-K, filed, April 16, 2002)                                      |
| 10.1.4              |   | Amendment Number Four to Loan and Security  Agreement dated as of March 22, 2002 between the Registrant and Coast  Business Credit. (which is incorporated herein by reference to Exhibit 10.1.4  to Registrant’s 2002 Form 10-K, filed April 15, 2003)                                          |
| 10.1.5              |   | Amendment Number Five to Loan and Security  Agreement dated as of November 26, 2002 between the Registrant and Coast  Business Credit. (which is incorporated herein by reference to Exhibit 10.1.5  to Registrant’s 2002 Form 10-K, filed April 15, 2003)                                       |
| 10.1.6              |   | Amendment Number Six to Loan and Security  Agreement dated as of January 31, 2003 between the Registrant and Coast  Business Credit. (which is incorporated herein by reference to Exhibit 10.1.6  to Registrant’s 2002 Form 10-K, filed April 15, 2003)                                         |
| 10.1.7              |   | Waiver of Event of Default on Loan and  Security Agreement dated as of February 27, 2003 between the Registrant and  Coast Business Credit. (which is incorporated herein by reference to Exhibit  10.1.7 to Registrant’s 2002 Form 10-K, filed April 15, 2003)                                  |
| 10.2                |   | Settlement Agreement, dated as of August  31, 2001, by and between the Registrant and Tracy C. Freeny (which is  incorporated herein by reference to Exhibit 10.28 to Registrant’s 2001 Third  Quarter Form 10-Q, filed December 28, 2001)                                                       |
| 10.3**              |   | Consulting Agreement, dated as of September  1, 2001, by and between the Registrant and Tracy C. Freeny (which is  incorporated herein by reference to Exhibit 10.29 to Registrant’s 2001 Third  Quarter Form 10-Q, filed December 28, 2001)                                                     |
| 10.4                |   | Confidentiality Agreement, effective as of  August 31, 2001, by and between the Registrant and Tracy C. Freeny (which is  incorporated herein by reference to Exhibit 10.31 to Registrant’s 2001 Third  Quarter Form 10-Q, filed December 28, 2001)                                              |
| 10.5                |   | Promissory Note dated September 1, 2001, payable  by the Registrant to Tracy C. Freeny (which is incorporated herein by  reference to Exhibit 10.32 to Registrant’s 2001 Third Quarter Form 10-Q,  filed December 28, 2001)                                                                      |
| 10.6**              |   | Amended and Restated Employment Agreement,  dated as of May 24, 2000 between the Registrant and Stephen D. Halliday  (which is incorporated herein by reference to Exhibit 10.3 to Registrant’s  Form 10 registration statement, filed July 10, 2000), which may be subject to  legal challenge. |
| 10.8                |   | Asset Purchase Agreement, dated as of April  30, 1999, among Hebron, AmeriVision, Tracy Freeny, Carl Thompson and S. T.  Patrick (which is incorporated herein by reference to Exhibit 10.13 to  Registrant’s Form 10 registration statement, filed October 15, 1999)                            |
| 10.9                |   | Lease/License Agreement, dated as of April  30, 1999 between Hebron and AmeriVision (which is incorporated herein by  reference to Exhibit 10.14 to Registrant’s Form 10 registration statement,  filed October 15, 1999)                                                                        |
| 10.10               |   | Form of Promissory Note payable by  AmeriVision to Hebron (form to be used with respect to Switch Note and  Internet Note) (which is incorporated herein by reference to Exhibit 10.15 to  Registrant’s Form 10 registration statement filed October 15 1999)                                    |
| 10.11               |   | Promissory Note dated February 1, 1999, in  the original principal amount of $2,274,416 payable by AmeriVision to Hebron  (which is incorporated herein by reference to Exhibit 10.16 to Registrant’s  Form 10 registration statement, filed October 15, 1999)                                   |
| 10.12               |   | Capital Stock Escrow and Disposition  Agreement dated April 30, 1999 among Tracy C. Freeny, Hebron and Bush Ross  Gardner Warren & Rudy, P.A. (which is incorporated herein by reference to  Exhibit 10.17 to Registrant’s Form 10 registration statement, filed October  15, 1999)          |
| 10.13**             |   | Letter Agreement dated as of December 31,  1999 between the Company and John Telling (which is incorporated herein by  reference to Exhibit 10.24 to Registrant’s Form 10 registration statement,  filed July 10, 2000)                                                                          |

 

20

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| **Exhibit  Number** |   | **Description**                                                                                                                                                                                                                                                                                                             |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                                                                                                        |
| 10.14**             |   | Stock Incentive Plan (which is incorporated  herein by reference to Exhibit 10.27 to Registrant’s Form 10 registration  statement, filed July 10, 2000)                                                                                                                                                                |
| 10.15               |   | Acknowledgement and Agreement, dated as  January 1, 2002 between the Registrant and Stephen D. Halliday (which is  incorporated herein by reference to Exhibit 10.1 to Registrant’s 2002 Form  10-Q, filed August 19, 2002), which may be subject to legal challenge.                                                  |
| 10.16               |   | Consulting and Settlement Agreement, dated  as January 1, 2002 between the Registrant and Stephen D. Halliday (which is  incorporated herein by reference to Exhibit 10.1 to Registrant’s 2002 Form  10-Q, filed August 19, 2002), which may be subject to legal challenge.                                            |
| 10.17               |   | Promissory Note, dated as July 10, 2002 between  the Registrant and Stephen D. Halliday (which is incorporated herein by  reference to Exhibit 10.1 to Registrant’s 2002 Form 10-Q, filed August 19,  2002), which may be subject to legal challenge.                                                                  |
| 10.18               |   | Confidentiality and Non-Competition  Agreement, dated as June 26, 2002 between the Registrant and Stephen D.  Halliday (which is incorporated herein by reference to Exhibit 10.1 to  Registrant’s 2002 Form 10-Q, filed August 19, 2002), which may be subject to  legal challenge.                                   |
| 10.21**             |   | Consulting Agreement dated October 1, 2002  between the Registrant and Task Force 3, LLC (which is incorporated herein by  reference to Exhibit 10.21 to Registrant’s 2002 Form 10-K, filed April 20,  2003)                                                                                                           |
| 10.22**             |   | Employment Agreement dated January 31, 2002  between the Registrant and Al Jones (which is incorporated herein by  reference to Exhibit 10.22 to Registrant’s 2002 Form 10-K, filed April 20,  2003)                                                                                                                   |
| 10.23**             |   | Employment Agreement dated November 11,  2002 between the Registrant and Robert Cook (which is incorporated herein by reference  to Exhibit 10.23 to Registrant’s 2002 Form 10-K, filed April 20, 2003)                                                                                                                |
| 10.24               |   | Telecommunications Services Agreement dated April 20, 1999 by and  between the Registrant and WorldCom Network Services, Inc. (which is  incorporated herein by reference to Exhibit 10.19 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                    |
| 10.24.1(+)          |   | Telecommunications Services Agreement  Amendment 14 dated January 16, 2003 by and between the Registrant and  WorldCom Network Services, Inc. (which is incorporated herein by reference to  Exhibit 10.24.1 to Registrant’s 2003 Form 10Q, filed July 31, 2003.                                                       |
| 10.24.2(+)          |   | Telecommunications Services Agreement  Amendment 15 dated November 26, 2002 by and between the Registrant and  WorldCom Network Services, Inc. (which is incorporated herein by reference to  Exhibit 10.24.2 to Registrant’s 2003 Form 10Q, filed July 31, 2003.                                                      |
| 10.24.3(+)          |   | Telecommunications Services Agreement  Amendment 16 dated January17, 2003 by and between the Registrant and WorldCom  Network Services, Inc. (which is incorporated herein by reference to Exhibit  10.24.3 to Registrant’s 2003 Form 10Q, filed July 31, 2003.                                                        |
| 10.25               |   | Program Enrollment Terms dated April 20, 1999 by and between the  Registrant and WorldCom Network Services, Inc. (which is incorporated herein  by reference to Exhibit 10.20 to Registrant’s Form 10 registration statement,  filed October 15, 1999)                                                                 |
| 10.25.1(+)          |   | Amended and Restated Program Enrollment  Terms dated November 11, 2001 by and between the Registrant and WorldCom  Network Services, Inc. (which is incorporated herein by reference to Exhibit  10.25.1 to Registrant’s 2002 Form 10-K, filed April 20, 2003)                                                         |
| 10.26               |   | Security Agreement dated April 20,1999 by  and between the Registrant and WorldCom Network Services, Inc. (which is  incorporated herein by reference to Exhibit 10.20 to Registrant’s Form 10  registration statement, filed October 15, 1999)                                                                        |
| 10.27(+)            |   | Master Service Agreement dated October 18,  2002 by and between the Registrant and Broadwing Communications Services,  Inc. (which is incorporated herein by reference to Exhibit 10.27 to  Registrant’s 2002 Form 10-K, filed April 20, 2003)                                                                         |
| 10.28               |   | Lease agreement dated January 1, 2000, by  and between the Registrant and Hebron Communications Corporation.  (which is incorporated herein by reference  to Exhibit 10.28 to Registrant’s 2003 Form 10Q, filed July 31, 2003.                                                                                    |
| 10.29               |   | Lease agreement dated November 18, 2002, by  and between the Registrant and Hebron Communications Corporation. (which is  incorporated herein by reference to Exhibit 10.29 to Registrant’s 2003 Form  10Q, filed July 31, 2003.                                                                                       |
| 10.30*              |   | Forbearance Agreement dated July 14, 2003,  by and between the Registrant and Continental Business Credit, Textron  Financial Corporation, Republic Financial Corporation, and LINC Credit,  L.L.C. (which is incorporated herein by reference to Exhibit 10.30 to  Registrant’s 2003 Form 10Q, filed August 14, 2003. |
| 10.31(+)*           |   | Special Rate Amendment No. 17 dated June  11, 2003 by and between the Registrant and MCI WorldCom Network. (which is  incorporated herein by reference to Exhibit 10.31 to Registrant’s 2003 Form  10Q, filed August 14, 2003.                                                                                         |
| 31.1*               |   | Certification of President and Chief  Executive Officer of Amerivision Communication, Inc.                                                                                                                                                                                                                                  |
| 31.2*               |   | Certification of Vice President and Chief  Financial Officer of Amerivision Communication, Inc.                                                                                                                                                                                                                             |
| 32.1*               |   | Certification of the President and Chief  Executive Officer pursuant to 18 U.S.C. § 1350                                                                                                                                                                                                                               |
| 32.2*               |   | Certification of the Vice President and  Chief Financial Officer pursuant to 18 U.S.C. § 1350                                                                                                                                                                                                                          |

 

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*                                         Filedherewith

**                                  Compensatorycontract

(+)                                 Confidentialtreatment requested

 

21

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**(b)**           **Reports on Form 8-K**

 

On March 11, 2003, we filed an 8-K announcingthe FDIC being appointed receiver of our lender and our negotiations of amerger with PowerNet Global Communications, Inc.

 

 

**SIGNATURES**

 

Pursuant to the requirements of theSecurities and Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
|                  | **AMERIVISION COMMUNICATIONS, INC.** |
|-----------------------|-------------------------------------------|
|                  |                                      |
|                  |                                      |
|                  |                                      | /s/ Robert D. Cook |   |
| DATE: AUGUST 14, 2003 | By:                                       | Robert D. Cook, President and Chief  Executive Officer |   |
|                  |                                      |   |
|                  |                                      | /s/ Randall W. Muth |   |
|                  | By:                                       | Randall W. Muth, Chief Financial Officer |   |

 

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